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Table of Contents

 

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

(Mark One)

 

x      Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended September 27, 2015

 

OR

 

o         Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

Commission File Number: 0-21660

 

PAPA JOHN’S INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

61-1203323

(State or other jurisdiction of
 incorporation or organization)

 

(I.R.S. Employer Identification
number)

 

2002 Papa Johns Boulevard

Louisville, Kentucky  40299-2367

(Address of principal executive offices)

 

(502) 261-7272

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

Non-accelerated filer o

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

At October 27, 2015, there were outstanding 39,014,067 shares of the registrant’s common stock, par value $0.01 per share.

 

 

 



Table of Contents

 

INDEX

 

 

 

Page No.

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Balance Sheets — September 27, 2015 and December 28, 2014

2

 

 

 

 

Condensed Consolidated Statements of Income — Three and Nine Months Ended September 27, 2015 and September 28, 2014

3

 

 

 

 

Consolidated Statements of Comprehensive Income — Three and Nine Months Ended September 27, 2015 and September 28, 2014

4

 

 

 

 

Consolidated Statements of Cash Flows — Nine Months Ended September 27, 2015 and September 28, 2014

5

 

 

 

 

Notes to Condensed Consolidated Financial Statements

6

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

15

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

26

 

 

 

Item 4.

Controls and Procedures

28

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

28

 

 

 

Item 1A.

Risk Factors

28

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

28

 

 

 

Item. 5

Other Information

29

 

 

 

Item 6.

Exhibits

30

 

1



Table of Contents

 

PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

 

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

 

(In thousands, except per share amounts)

 

September 27,
2015

 

December 28,
2014

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

24,441

 

$

20,122

 

Accounts receivable, net

 

56,445

 

56,047

 

Notes receivable, net

 

7,738

 

6,106

 

Income taxes receivable

 

796

 

9,527

 

Inventories

 

24,335

 

27,394

 

Deferred income taxes

 

9,990

 

8,248

 

Prepaid expenses

 

15,914

 

18,736

 

Other current assets

 

9,462

 

9,828

 

Assets held for sale

 

9,555

 

 

Total current assets

 

158,676

 

156,008

 

Property and equipment, net

 

209,137

 

219,457

 

Notes receivable, less current portion, net

 

10,444

 

12,801

 

Goodwill

 

79,913

 

82,007

 

Deferred income taxes

 

3,021

 

3,914

 

Other assets

 

33,426

 

38,616

 

Total assets

 

$

494,617

 

$

512,803

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

35,546

 

$

38,832

 

Income and other taxes payable

 

10,012

 

9,637

 

Accrued expenses and other current liabilities

 

78,562

 

58,293

 

Total current liabilities

 

124,120

 

106,762

 

Deferred revenue

 

3,627

 

4,257

 

Long-term debt

 

239,000

 

230,451

 

Deferred income taxes

 

14,251

 

22,188

 

Other long-term liabilities

 

44,034

 

41,875

 

Total liabilities

 

425,032

 

405,533

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

8,274

 

8,555

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock ($0.01 par value per share; no shares issued)

 

 

 

Common stock ($0.01 par value per share; issued 43,708 at September 27, 2015 and 43,331 at December 28, 2014)

 

437

 

433

 

Additional paid-in capital

 

155,170

 

147,912

 

Accumulated other comprehensive income (loss)

 

(1,305

)

671

 

Retained earnings

 

126,045

 

92,876

 

Treasury stock (4,673 shares at September 27, 2015 and 3,549 shares at December 28, 2014, at cost)

 

(232,032

)

(155,659

)

Total stockholders’ equity, net of noncontrolling interests

 

48,315

 

86,233

 

Noncontrolling interests in subsidiaries

 

12,996

 

12,482

 

Total stockholders’ equity

 

61,311

 

98,715

 

Total liabilities, redeemable noncontrolling interests and stockholders’ equity

 

$

494,617

 

$

512,803

 

 

See accompanying notes.

 

2



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(Unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

(In thousands, except per share amounts)

 

Sept. 27, 2015

 

Sept. 28, 2014

 

Sept. 27, 2015

 

Sept. 28, 2014

 

 

 

 

 

 

 

 

 

 

 

North America revenues:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurant sales

 

$

180,059

 

$

169,076

 

$

563,308

 

$

517,269

 

Franchise royalties

 

22,079

 

22,131

 

70,519

 

65,728

 

Franchise and development fees

 

206

 

217

 

666

 

493

 

Domestic commissary sales

 

145,863

 

149,224

 

457,203

 

463,852

 

Other sales

 

14,076

 

23,359

 

50,110

 

49,704

 

International revenues:

 

 

 

 

 

 

 

 

 

Royalties and franchise and development fees

 

6,755

 

6,673

 

19,894

 

18,769

 

Restaurant and commissary sales

 

20,246

 

19,719

 

58,859

 

56,825

 

Total revenues

 

389,284

 

390,399

 

1,220,559

 

1,172,640

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurant expenses:

 

 

 

 

 

 

 

 

 

Cost of sales

 

42,150

 

42,460

 

132,943

 

129,646

 

Salaries and benefits

 

50,229

 

45,835

 

155,389

 

139,223

 

Advertising and related costs

 

16,293

 

15,369

 

49,555

 

46,979

 

Occupancy costs and other restaurant operating expenses

 

39,864

 

35,687

 

113,037

 

104,951

 

Total domestic Company-owned restaurant expenses

 

148,536

 

139,351

 

450,924

 

420,799

 

Domestic commissary expenses:

 

 

 

 

 

 

 

 

 

Cost of sales

 

111,205

 

116,908

 

350,108

 

364,302

 

Salaries and benefits and other commissary operating expenses

 

24,029

 

22,221

 

72,420

 

68,162

 

Total domestic commissary expenses

 

135,234

 

139,129

 

422,528

 

432,464

 

Other operating expenses

 

13,475

 

22,794

 

47,726

 

47,446

 

International restaurant and commissary expenses

 

16,481

 

16,605

 

48,209

 

47,366

 

General and administrative expenses

 

36,053

 

33,671

 

120,029

 

104,199

 

Other general expenses

 

1,607

 

3,143

 

4,427

 

6,640

 

Depreciation and amortization

 

10,461

 

10,520

 

30,638

 

29,539

 

Total costs and expenses

 

361,847

 

365,213

 

1,124,481

 

1,088,453

 

Operating income

 

27,437

 

25,186

 

96,078

 

84,187

 

Legal settlement expense

 

 

 

(12,278

)

 

Net interest expense

 

(1,180

)

(968

)

(3,576

)

(2,323

)

Income before income taxes

 

26,257

 

24,218

 

80,224

 

81,864

 

Income tax expense

 

7,281

 

7,256

 

24,541

 

26,522

 

Net income before attribution to noncontrolling interests

 

18,976

 

16,962

 

55,683

 

55,342

 

Income attributable to noncontrolling interests

 

(1,005

)

(887

)

(4,696

)

(3,208

)

Net income attributable to the Company

 

$

17,971

 

$

16,075

 

$

50,987

 

$

52,134

 

 

 

 

 

 

 

 

 

 

 

Calculation of income for earnings per share:

 

 

 

 

 

 

 

 

 

Net income attributable to the Company

 

$

17,971

 

$

16,075

 

$

50,987

 

$

52,134

 

Decrease (increase) in noncontrolling interest redemption value

 

49

 

(42

)

192

 

(81

)

Net income attributable to participating securities

 

(73

)

(77

)

(223

)

(295

)

Net income attributable to common shareholders

 

$

17,947

 

$

15,956

 

$

50,956

 

$

51,758

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.46

 

$

0.39

 

$

1.29

 

$

1.25

 

Diluted earnings per common share

 

$

0.45

 

$

0.39

 

$

1.27

 

$

1.23

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

39,394

 

40,739

 

39,640

 

41,248

 

Diluted weighted average common shares outstanding

 

39,895

 

41,386

 

40,210

 

42,021

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.175

 

$

0.14

 

$

0.455

 

$

0.39

 

 

See accompanying notes.

 

3



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

(In thousands)

 

Sept. 27, 2015

 

Sept. 28, 2014

 

Sept. 27, 2015

 

Sept. 28, 2014

 

 

 

 

 

 

 

 

 

 

 

Net income before attribution to noncontrolling interests

 

$

18,976

 

$

16,962

 

$

55,683

 

$

55,342

 

Other comprehensive income (loss), before tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

(1,700

)

(1,634

)

(1,125

)

(708

)

Interest rate swaps (1)

 

(1,386

)

694

 

(2,011

)

247

 

Other comprehensive income (loss), before tax

 

(3,086

)

(940

)

(3,136

)

(461

)

Income tax effect:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

629

 

605

 

416

 

262

 

Interest rate swaps (2)

 

513

 

(256

)

744

 

(91

)

Income tax effect

 

1,142

 

349

 

1,160

 

171

 

Other comprehensive income (loss), net of tax

 

(1,944

)

(591

)

(1,976

)

(290

)

Comprehensive income before attribution to noncontrolling interests

 

17,032

 

16,371

 

53,707

 

55,052

 

Comprehensive loss, redeemable noncontrolling interests

 

(587

)

(724

)

(2,915

)

(3,066

)

Comprehensive (loss) income, nonredeemable noncontrolling interests

 

(418

)

(163

)

(1,781

)

(142

)

Comprehensive income attributable to the Company

 

$

16,027

 

$

15,484

 

$

49,011

 

$

51,844

 

 


(1)         Amounts reclassified out of accumulated other comprehensive income (“AOCI”) into net interest (expense) income included $390 and $1,177 for the three and nine months ended September 27, 2015, respectively, and $250 and $749 for the three and nine months ended September 28, 2014, respectively.

 

(2)         The income tax effects of amounts reclassified out of AOCI into net interest (expense) income were $145 and $436 for the three and nine months ended September 27, 2015, respectively, and $92 and $277 for the three and nine months ended September 28, 2014, respectively.

 

See accompanying notes.

 

4



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

Nine Months Ended

 

(In thousands)

 

Sept. 27, 2015

 

Sept. 28, 2014

 

 

 

 

 

 

 

Operating activities

 

 

 

 

 

Net income before attribution to noncontrolling interests

 

$

55,683

 

$

55,342

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Provision for uncollectible accounts and notes receivable

 

813

 

1,714

 

Depreciation and amortization

 

30,638

 

29,539

 

Deferred income taxes

 

2,259

 

7,687

 

Stock-based compensation expense

 

7,124

 

5,958

 

Excess tax benefit on equity awards

 

(9,884

)

(8,493

)

Other

 

3,268

 

3,916

 

Changes in operating assets and liabilities, net of acquisitions:

 

 

 

 

 

Accounts receivable

 

(1,994

)

(6,861

)

Income taxes receivable

 

8,731

 

 

Inventories

 

2,178

 

(9,792

)

Prepaid expenses

 

2,033

 

2,461

 

Other current assets

 

367

 

(313

)

Other assets and liabilities

 

819

 

3,887

 

Accounts payable

 

(3,380

)

(1,380

)

Income and other taxes payable

 

375

 

6,434

 

Accrued expenses and other current liabilities

 

20,508

 

(5,163

)

Deferred revenue

 

200

 

(110

)

Net cash provided by operating activities

 

119,738

 

84,826

 

 

 

 

 

 

 

Investing activities

 

 

 

 

 

Purchases of property and equipment

 

(26,508

)

(37,700

)

Loans issued

 

(2,497

)

(5,221

)

Repayments of loans issued

 

3,961

 

3,371

 

Acquisitions, net of cash acquired

 

(491

)

(4,264

)

Other

 

406

 

25

 

Net cash used in investing activities

 

(25,129

)

(43,789

)

 

 

 

 

 

 

Financing activities

 

 

 

 

 

Net proceeds on line of credit facility

 

8,549

 

66,784

 

Cash dividends paid

 

(17,950

)

(16,119

)

Excess tax benefit on equity awards

 

9,884

 

8,493

 

Tax payments for equity award issuances

 

(10,947

)

(7,540

)

Proceeds from exercise of stock options

 

4,569

 

4,752

 

Acquisition of Company common stock

 

(80,166

)

(94,152

)

Contributions from noncontrolling interest holders

 

683

 

1,086

 

Distributions to noncontrolling interest holders

 

(4,950

)

(1,200

)

Other

 

377

 

423

 

Net cash used in financing activities

 

(89,951

)

(37,473

)

Effect of exchange rate changes on cash and cash equivalents

 

(339

)

(86

)

Change in cash and cash equivalents

 

4,319

 

3,478

 

Cash and cash equivalents at beginning of period

 

20,122

 

13,670

 

Cash and cash equivalents at end of period

 

$

24,441

 

$

17,148

 

 

See accompanying notes.

 

5



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

September 27, 2015

 

1.              Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for annual financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the nine months ended September 27, 2015 are not necessarily indicative of the results that may be expected for the fiscal year ended December 27, 2015. For further information, refer to the consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K for Papa John’s International, Inc. (referred to as the “Company,” “Papa John’s” or in the first person notations of “we,” “us” and “our”) for the year ended December 28, 2014.

 

2.              Significant Accounting Policies

 

Noncontrolling Interests

 

Papa John’s has joint ventures in which there are noncontrolling interests, including the following as of September 27, 2015 and September 28, 2014:

 

 

 

Number of
Restaurants

 

Restaurant Locations

 

Papa John’s
Ownership

 

Noncontrolling
Interest
Ownership

 

September 27, 2015

 

 

 

 

 

 

 

 

 

Star Papa, LP

 

85

 

Texas

 

51

%

49

%

Colonel’s Limited, LLC

 

61

 

Maryland and Virginia

 

70

%

30

%

PJ Minnesota, LLC

 

35

 

Minnesota

 

70

%

30

%

PJ Denver, LLC

 

27

 

Colorado

 

60

%

40

%

 

 

 

 

 

 

 

 

 

 

September 28, 2014

 

 

 

 

 

 

 

 

 

Star Papa, LP

 

82

 

Texas

 

51

%

49

%

Colonel’s Limited, LLC

 

56

 

Maryland and Virginia

 

70

%

30

%

PJ Minnesota, LLC

 

34

 

Minnesota

 

70

%

30

%

PJ Denver, LLC

 

25

 

Colorado

 

60

%

40

%

 

We are required to report consolidated net income at amounts attributable to the Company and the noncontrolling interests. Additionally, disclosures are required to clearly identify and distinguish between the interests of the Company and the interests of the noncontrolling owners, including a disclosure on the face of the condensed consolidated statements of income attributable to the noncontrolling interest holder.

 

6



Table of Contents

 

The income before income taxes attributable to these joint ventures for the three and nine months ended September 27, 2015 and September 28, 2014 was as follows (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 27,

 

Sept. 28,

 

Sept. 27,

 

Sept. 28,

 

 

 

2015

 

2014

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

Papa John’s International, Inc.

 

$

1,570

 

$

1,387

 

$

7,240

 

$

4,979

 

Noncontrolling interests

 

1,005

 

887

 

4,696

 

3,208

 

Total income before income taxes

 

$

2,575

 

$

2,274

 

$

11,936

 

$

8,187

 

 

The following summarizes the redemption feature, location within the condensed consolidated balance sheets and the value at which the noncontrolling interests are recorded for each joint venture as of September 27, 2015:

 

Joint Venture

 

Redemption Feature

 

Location within the
Condensed Consolidated
Balance Sheets

 

Recorded Value

 

 

 

 

 

 

 

Star Papa, LP

 

Redeemable

 

Temporary equity

 

Carrying value

PJ Denver, LLC

 

Redeemable

 

Temporary equity

 

Redemption value

Colonel’s Limited, LLC

 

No redemption feature

 

Permanent equity

 

Carrying value

PJ Minnesota, LLC

 

No redemption feature

 

Permanent equity

 

Carrying value

 

The noncontrolling interest holders of two joint ventures have the option to require the Company to purchase their interests. Since redemption of the noncontrolling interests is outside of the Company’s control, the noncontrolling interests are presented in the caption “Redeemable noncontrolling interests” in the condensed consolidated balance sheets and include the following joint ventures:

 

·                  The Star Papa, LP agreement contains a redemption feature that is not currently redeemable, but it is probable to become redeemable in the future. Due to specific valuation provisions contained in the agreement, this noncontrolling interest has been recorded at its carrying value.

 

·                  The PJ Denver, LLC agreement contains a redemption feature that is currently redeemable and, therefore, this noncontrolling interest has been recorded at its current redemption value. The change in redemption value is recorded as an adjustment to “Redeemable noncontrolling interests” and “Retained earnings” in the condensed consolidated balance sheets.

 

The following summarizes changes in these redeemable noncontrolling interests (in thousands):

 

Balance at December 28, 2014

 

$

8,555

 

Net income

 

2,915

 

Distributions

 

(3,004

)

Change in redemption value

 

(192

)

Balance at September 27, 2015

 

$

8,274

 

 

The noncontrolling interests of our Colonel’s Limited, LLC and PJ Minnesota, LLC joint ventures are recorded at carrying value in “Stockholders’ equity” in the condensed consolidated balance sheets at both September 27, 2015 and December 28, 2014, as the noncontrolling interest holders’ agreements had no redemption features.

 

Deferred Income Tax Accounts and Tax Reserves

 

We are subject to income taxes in the United States and several foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and the related assets and liabilities. The provision for

 

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income taxes includes income taxes paid, currently payable or receivable and those deferred. We use an estimated annual effective rate based on expected annual income to determine our quarterly provision for income taxes. Discrete items are recorded in the quarter in which they occur.

 

Deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Deferred tax assets are also recognized for the estimated future effects of tax loss carryforwards. The effect on deferred taxes of changes in tax rates is recognized in the period in which the new tax rate is enacted. As a result, our effective tax rate may fluctuate. Valuation allowances are established when necessary on a jurisdictional basis to reduce deferred tax assets to the amounts we expect to realize. As of September 27, 2015, we had a net deferred tax liability of approximately $1.2 million.

 

Tax authorities periodically audit the Company. We record reserves and related interest and penalties for identified exposures as income tax expense. We evaluate these issues on a quarterly basis to adjust for events, such as statute of limitations expirations, court rulings or audit settlements, which may impact our ultimate payment for such exposures.

 

Fair Value Measurements and Disclosures

 

The Company is required to determine the fair value of financial assets and liabilities based on the price that would be received to sell the asset or paid to transfer the liability to a market participant. Fair value is a market-based measurement, not an entity specific measurement. The fair value of certain assets and liabilities approximates carrying value because of the short-term nature of the accounts, including cash, accounts receivable and accounts payable. The fair value of our notes receivable, net of allowances, also approximates carrying value. The fair value of the amount outstanding under our revolving credit facility approximates its carrying value due to its variable market-based interest rate. These assets and liabilities are categorized as Level 1 as defined below.

 

Certain assets and liabilities are measured at fair value on a recurring basis and are required to be classified and disclosed in one of the following categories:

 

·                  Level 1: Quoted market prices in active markets for identical assets or liabilities.

·                  Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

·                  Level 3: Unobservable inputs that are not corroborated by market data.

 

Our financial assets and liabilities that were measured at fair value on a recurring basis as of September 27, 2015 and December 28, 2014 are as follows (in thousands):

 

 

 

Carrying

 

Fair Value Measurements

 

 

 

Value

 

Level 1

 

Level 2

 

Level 3

 

 

 

 

 

 

 

 

 

 

 

September 27, 2015

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

Cash surrender value of life insurance policies (a)

 

$

17,412

 

$

17,412

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

Interest rate swaps (b)

 

2,417

 

 

2,417

 

 

 

 

 

 

 

 

 

 

 

 

December 28, 2014

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

Cash surrender value of life insurance policies (a)

 

$

18,238

 

$

18,238

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

Interest rate swaps (b)

 

376

 

 

376

 

 

 

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(a)         Represents life insurance policies held in our non-qualified deferred compensation plan.

 

(b)         The fair values of our interest rate swaps are based on the sum of all future net present value cash flows. The future cash flows are derived based on the terms of our interest rate swaps, as well as considering published discount factors, and projected London Interbank Offered Rates (“LIBOR”).

 

There were no transfers among levels within the fair value hierarchy during the nine months ended September 27, 2015.

 

Variable Interest Entities

 

Papa John’s domestic restaurants, both Company-owned and franchised, participate in Papa John’s Marketing Fund, Inc. (“PJMF”), a nonstock corporation designed to operate at break-even for the purpose of designing and administering advertising and promotional programs for all participating domestic restaurants. PJMF is a variable interest entity as it does not have sufficient equity to fund its operations without ongoing financial support and contributions from its members. Based on the ownership and governance structure and operating procedures of PJMF, we have determined that we do not have the power to direct the most significant activities of PJMF and therefore are not the primary beneficiary. Accordingly, consolidation of PJMF is not appropriate.

 

Revenue from Contracts with Customers

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued “Revenue from Contracts with Customers” (Accounting Standards Update 2014-09), a comprehensive new revenue recognition standard that will supersede nearly all existing revenue recognition guidance under GAAP. This update requires companies to recognize revenue at amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods or services at the time of transfer. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance. Such estimates may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. Companies can either apply a full retrospective adoption or a modified retrospective adoption.

 

We are required to adopt the new requirements in the first quarter of 2018 based on the FASB’s decision to defer the effective date by one year. We are evaluating the method of adoption and its impact of the new requirements on our consolidated financial statements. We currently do not believe the impact will be significant.

 

3.              Calculation of Earnings Per Share

 

We compute earnings per share using the two-class method. The two-class method requires an earnings allocation formula that determines earnings per share for common shareholders and participating security holders according to dividends declared and participating rights in undistributed earnings. We consider time-based restricted stock awards to be participating securities because holders of such shares have non-forfeitable dividend rights. Under the two-class method, undistributed earnings allocated to participating securities are subtracted from net income attributable to the Company in determining net income attributable to common shareholders.

 

Additionally, in accordance with Accounting Standards Codification (“ASC”) 480, Distinguishing Liabilities from Equity, the change in the redemption value for the noncontrolling interest of PJ Denver, LLC increases or decreases income attributable to common shareholders.

 

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The calculations of basic and diluted earnings per common share are as follows (in thousands, except per-share data):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 27,

 

Sept. 28,

 

Sept. 27,

 

Sept. 28,

 

 

 

2015

 

2014

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

Net income attributable to the Company

 

$

17,971

 

$

16,075

 

$

50,987

 

$

52,134

 

Decrease (increase) in noncontrolling interest redemption value

 

49

 

(42

)

192

 

(81

)

Net income attributable to participating securities

 

(73

)

(77

)

(223

)

(295

)

Net income attributable to common shareholders

 

$

17,947

 

$

15,956

 

$

50,956

 

$

51,758

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

39,394

 

40,739

 

39,640

 

41,248

 

Basic earnings per common share

 

$

0.46

 

$

0.39

 

$

1.29

 

$

1.25

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share:

 

 

 

 

 

 

 

 

 

Net income attributable to common shareholders

 

$

17,947

 

$

15,956

 

$

50,956

 

$

51,758

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

39,394

 

40,739

 

39,640

 

41,248

 

Dilutive effect of outstanding equity awards (a)

 

501

 

647

 

570

 

773

 

Diluted weighted average common shares outstanding

 

39,895

 

41,386

 

40,210

 

42,021

 

Diluted earnings per common share

 

$

0.45

 

$

0.39

 

$

1.27

 

$

1.23

 

 


(a)         Excludes 219 and 234 awards for the three and nine months ended September 27, 2015 and 270 and 208 awards for the three and nine months ended September 28, 2014, because their inclusion would have had an antidilutive effect.

 

4.              Debt

 

Our debt is comprised entirely of borrowings under our unsecured revolving line of credit (“Credit Facility”). The outstanding balance was $239.0 million as of September 27, 2015 and $230.5 million as of December 28, 2014. On October 31, 2014, we amended our Credit Facility to increase the amount available to $400 million from the previous $300 million availability and to extend the maturity date from April 30, 2018 to October 31, 2019. Additionally, we have the option to increase the Credit Facility an additional $100 million. The interest rate charged on outstanding balances is LIBOR plus 75 to 175 basis points. The commitment fee on the unused balance ranges from 15 to 25 basis points. The remaining availability under the Credit Facility, reduced for outstanding letters of credit, was approximately $138.5 million as of September 27, 2015.

 

The Credit Facility contains customary affirmative and negative covenants, including financial covenants requiring the maintenance of specified fixed charges and leverage ratios. At September 27, 2015, we were in compliance with these covenants.

 

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We use interest rate swaps to hedge against the effects of potential interest rate increases on borrowings under our Credit Facility. During the quarter ended September 27, 2015, we executed three additional forward starting swaps for $125.0 million that become effective in 2018 upon expiration of the two existing swaps for $125.0 million. As of September 27, 2015, we have the following interest rate swap agreements:

 

Effective Dates

 

Debt Amount

 

Fixed Rates

 

 

 

 

 

 

 

July 30, 2013 through April 30, 2018

 

$75 million

 

1.42

%

 

 

 

 

 

 

December 30, 2014 through April 30, 2018

 

$50 million

 

1.36

%

 

 

 

 

 

 

April 30, 2018 through April 30, 2023

 

$55 million

 

2.33

%

 

 

 

 

 

 

April 30, 2018 through April 30, 2023

 

$35 million

 

2.36

%

 

 

 

 

 

 

April 30, 2018 through April 30, 2023

 

$35 million

 

2.34

%

 

Our swaps are derivative instruments that are designated as cash flow hedges because the swaps provide a hedge against the effects of rising interest rates on borrowings. The newly executed forward starting swaps are also deemed cash flow hedges based upon our intent to replace the existing facility that matures in 2019 with new variable rate debt. As of September 27, 2015, the swaps were highly effective cash flow hedges with no ineffectiveness for the three and nine month periods ended September 27, 2015. The newly executed forward starting swaps are deemed effective given the probability of future forecasted interest payments.

 

The effective portion of the gain or loss on the swaps is reported as a component of accumulated other comprehensive income and reclassified into earnings in the same period or periods during which the swaps affect earnings. Gains or losses on the swaps representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. Amounts payable or receivable under the swaps are accounted for as adjustments to interest expense.

 

The weighted average interest rate for the Credit Facility, including the impact of the previously mentioned swaps, were 2.0% and 1.8% for the three months ended September 27, 2015 and September 28, 2014, respectively, and 2.0% and 1.7% for the nine months ended September 27, 2015 and September 28, 2014, respectively. Interest paid, including payments made or received under the swaps, was $1.3 million and $1.0 million for the three months ended September 27, 2015 and September 28, 2014, respectively, and $3.9 million and $2.6 million for the nine months ended September 27, 2015 and September 28, 2014, respectively. As of September 27, 2015, the portion of the $2.4 million interest rate swap liability that would be reclassified into earnings during the next twelve months as interest expense approximates $715,000.

 

5.                    Litigation

 

Litigation

 

The Company is involved in a number of lawsuits, claims, investigations and proceedings, including the matter identified below, consisting of intellectual property, employment, consumer, commercial and other matters arising in the ordinary course of business. In accordance with ASC 450, Contingencies, the Company has made accruals with respect to these matters, where appropriate, which are reflected in the Company’s financial statements. We review these provisions at least quarterly and adjust these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case.

 

Perrin v. Papa John’s International, Inc. and Papa John’s USA, Inc. is a conditionally certified collective and class action filed in August 2009 in the United States District Court, Eastern District of Missouri (“the Court”), alleging that delivery drivers were not properly reimbursed for mileage and expenses in accordance with the Fair Labor Standards Act (“FLSA”). Approximately 3,900 drivers out of a potential class size of 28,800 opted into the action. In late December 2013, the Court granted a motion for class certification in five additional states, which added approximately 15,000 plaintiffs to the case. The trial, originally scheduled for August 2015, was stayed in June 2015, pending U.S. Supreme Court review of another relevant case regarding certification. After the stay

 

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was granted, the parties reached a settlement in principle, which has been preliminarily approved by the Court in September 2015. The Court has scheduled a final approval hearing in January 2016. The Company continues to deny any liability or wrongdoing in this matter. In accordance with this preliminary settlement agreement, the Company recorded a pre-tax expense of $12.3 million in June 2015 under the provisions of ASC 450, Contingencies.  There was no impact for the quarter ended September 27, 2015. This amount is separately reported as Legal settlement expense in the condensed consolidated statements of income.

 

6.              Segment Information

 

We have five reportable segments: domestic Company-owned restaurants, domestic commissaries, North America franchising, international operations, and “all other” units. The domestic Company-owned restaurant segment consists of the operations of all domestic (“domestic” is defined as contiguous United States) Company-owned restaurants and derives its revenues principally from retail sales of pizza and side items, such as breadsticks, cheesesticks, chicken poppers and wings, dessert items and canned or bottled beverages. The domestic commissary segment consists of the operations of our regional dough production and product distribution centers and derives its revenues principally from the sale and distribution of food and paper products to domestic Company-owned and franchised restaurants. The North America franchising segment consists of our franchise sales and support activities and derives its revenues from sales of franchise and development rights and collection of royalties from our franchisees located in the United States and Canada. The international operations segment principally consists of Company-owned restaurants in China and distribution sales to franchised Papa John’s restaurants located in the United Kingdom, Mexico and China and our franchise sales and support activities, which derive revenues from sales of franchise and development rights and the collection of royalties from our international franchisees. International franchisees are defined as all franchise operations outside of the United States and Canada. All other business units that do not meet the quantitative thresholds for determining reportable segments, which are not operating segments, we refer to as our “all other” segment, which consists of operations that derive revenues from the sale, principally to Company-owned and franchised restaurants, of printing and promotional items, risk management services, and information systems and related services used in restaurant operations, including our point-of-sale system, online and other technology-based ordering platforms.

 

Generally, we evaluate performance and allocate resources based on profit or loss from operations before income taxes and intercompany eliminations. Certain administrative and capital costs are allocated to segments based upon predetermined rates or actual estimated resource usage. We account for intercompany sales and transfers as if the sales or transfers were to third parties and eliminate the activity in consolidation.

 

Our reportable segments are business units that provide different products or services. Separate management of each segment is required because each business unit is subject to different operational issues and strategies. No single external customer accounted for 10% or more of our consolidated revenues.

 

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Our segment information is as follows (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 27, 2015

 

Sept. 28, 2014

 

Sept. 27, 2015

 

Sept. 28, 2014

 

 

 

 

 

 

 

 

 

 

 

Revenues from external customers:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

180,059

 

$

169,076

 

$

563,308

 

$

517,269

 

Domestic commissaries

 

145,863

 

149,224

 

457,203

 

463,852

 

North America franchising

 

22,285

 

22,348

 

71,185

 

66,221

 

International

 

27,001

 

26,392

 

78,753

 

75,594

 

All others

 

14,076

 

23,359

 

50,110

 

49,704

 

Total revenues from external customers

 

$

389,284

 

$

390,399

 

$

1,220,559

 

$

1,172,640

 

 

 

 

 

 

 

 

 

 

 

Intersegment revenues:

 

 

 

 

 

 

 

 

 

Domestic commissaries

 

$

53,398

 

$

53,830

 

$

165,744

 

$

160,143

 

North America franchising

 

643

 

574

 

1,985

 

1,761

 

International

 

73

 

78

 

223

 

236

 

All others

 

3,833

 

6,421

 

11,459

 

18,238

 

Total intersegment revenues

 

$

57,947

 

$

60,903

 

$

179,411

 

$

180,378

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

8,088

 

$

8,133

 

$

41,185

 

$

32,069

 

Domestic commissaries

 

10,192

 

8,897

 

32,694

 

26,174

 

North America franchising

 

19,172

 

19,023

 

61,545

 

56,389

 

International

 

3,184

 

1,436

 

6,807

 

4,071

 

All others

 

(556

)

(298

)

(230

)

(150

)

Unallocated corporate expenses (1)

 

(13,482

)

(12,242

)

(60,636

)

(35,405

)

Elimination of intersegment losses (profits)

 

(341

)

(731

)

(1,141

)

(1,284

)

Total income before income taxes

 

$

26,257

 

$

24,218

 

$

80,224

 

$

81,864

 

 

 

 

 

 

 

 

 

 

 

Property and equipment:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

215,945

 

 

 

 

 

 

 

Domestic commissaries

 

109,532

 

 

 

 

 

 

 

International

 

21,266

 

 

 

 

 

 

 

All others

 

49,541

 

 

 

 

 

 

 

Unallocated corporate assets

 

176,089

 

 

 

 

 

 

 

Accumulated depreciation and amortization

 

(363,236

)

 

 

 

 

 

 

Net property and equipment

 

$

209,137

 

 

 

 

 

 

 

 


(1)         Includes a $12.3 million legal settlement expense in the nine-month period of 2015. See “Note 5” for additional information.

 

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7.              Assets Held for Sale

 

The Company has decided to refranchise the China market and is planning a sale of its existing China operations, consisting of the Company-owned restaurants and a commissary.  We expect to sell the business within the next 12 months; upon completion of the sale, the Company will not have any Company-owned international restaurants. We have classified the assets as held for sale within the condensed consolidated balance sheet. Upon the transfer of these assets to held for sale, no loss was recognized as their fair value exceeded their carrying value. The following summarizes the associated assets that are classified as held for sale (in thousands):

 

 

 

September 27, 2015

 

Inventories

 

$

808

 

Prepaid expenses

 

790

 

Net property and equipment

 

5,406

 

Goodwill

 

1,719

 

Other assets

 

832

 

Total assets held for sale

 

$

9,555

 

 

The Company-owned China operations have incurred losses before income taxes of $0.4 million and $1.4 million for the three months ended September 27, 2015 and September 28, 2014, respectively, and losses before income taxes of $0.9 million and $2.3 million for the nine months ended September 27, 2015 and September 28, 2014, respectively. The losses for the three and nine months ended September 28, 2014, include an impairment charge of $0.7 million for eight Company-owned restaurants in China. These results are reported in our International segment.

 

8.              Subsequent Event - Acquisition

 

In October 2015, the Company signed a letter of intent to purchase 19 domestic franchised Papa John’s restaurants in the Southeast for approximately $11.0 million. The transaction is expected to be completed in the first quarter of 2016.

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

Papa John’s International, Inc. (referred to as the “Company,” “Papa John’s” or in the first person notations of “we,” “us” and “our”) began operations in 1984. At September 27, 2015, there were 4,786 Papa John’s restaurants (744 Company-owned and 4,042 franchised) operating in all 50 states and in 38 international countries and territories. Our revenues are principally derived from retail sales of pizza and other food and beverage products to the general public by Company-owned restaurants, franchise royalties, sales of franchise and development rights, sales to franchisees of food and paper products, printing and promotional items, risk management services, and information systems and related services used in their operations.

 

The results of operations are based on the preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”). The preparation of consolidated financial statements requires management to select accounting policies for critical accounting areas and make estimates and assumptions that affect the amounts reported in the consolidated financial statements. Significant changes in assumptions and/or conditions in our critical accounting policies could materially impact the operating results. See “Notes 1 and 2” of “Notes to Condensed Consolidated Financial Statements” for a discussion of the basis of presentation and the significant accounting policies.

 

Restaurant Progression

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 27, 2015

 

Sept. 28, 2014

 

Sept. 27, 2015

 

Sept. 28, 2014

 

 

 

 

 

 

 

 

 

 

 

North America Company-owned:

 

 

 

 

 

 

 

 

 

Beginning of period

 

693

 

672

 

686

 

665

 

Opened

 

4

 

5

 

8

 

9

 

Closed

 

 

(1

)

 

(3

)

Acquired from franchisees

 

 

7

 

3

 

12

 

End of period

 

697

 

683

 

697

 

683

 

International Company-owned:

 

 

 

 

 

 

 

 

 

Beginning of period

 

48

 

59

 

49

 

58

 

Opened

 

 

 

 

1

 

Closed

 

(1

)

(1

)

(2

)

(1

)

End of period

 

47

 

58

 

47

 

58

 

North America franchised:

 

 

 

 

 

 

 

 

 

Beginning of period

 

2,653

 

2,614

 

2,654

 

2,621

 

Opened

 

31

 

37

 

68

 

86

 

Closed

 

(20

)

(14

)

(55

)

(65

)

Sold to Company

 

 

(7

)

(3

)

(12

)

End of period

 

2,664

 

2,630

 

2,664

 

2,630

 

International franchised:

 

 

 

 

 

 

 

 

 

Beginning of period

 

1,340

 

1,142

 

1,274

 

1,084

 

Opened

 

50

 

54

 

142

 

123

 

Closed

 

(12

)

(30

)

(38

)

(41

)

End of period

 

1,378

 

1,166

 

1,378

 

1,166

 

Total restaurants - end of period

 

4,786

 

4,537

 

4,786

 

4,537

 

 

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Item Impacting Comparability; Non-GAAP Measure

 

The following table reconciles our GAAP financial results to the adjusted (non-GAAP) financial results, excluding the legal settlement expense for Perrin v. Papa John’s International, Inc. and Papa John’s USA, Inc., a conditionally certified collective and class action, for the three and nine months ended September 27, 2015. We present these non-GAAP measures because we believe the legal settlement impacts the comparability of our results of operations. For additional information about the legal settlement, see “Note 5” of “Notes to Condensed Consolidated Financial Statements.”

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 27,

 

Sept. 28,

 

Sept. 27,

 

Sept. 28,

 

(In thousands, except per share amounts)

 

2015

 

2014

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes, as reported

 

$

26,257

 

$

24,218

 

$

80,224

 

$

81,864

 

Legal settlement expense

 

 

 

12,278

 

 

Income before income taxes, as adjusted

 

$

26,257

 

$

24,218

 

$

92,502

 

$

81,864

 

 

 

 

 

 

 

 

 

 

 

Net income, as reported

 

$

17,971

 

$

16,075

 

$

50,987

 

$

52,134

 

Legal settlement expense

 

 

 

7,986

 

 

Net income, as adjusted

 

$

17,971

 

$

16,075

 

$

58,973

 

$

52,134

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share, as reported

 

$

0.45

 

$

0.39

 

$

1.27

 

$

1.23

 

Legal settlement expense

 

 

 

0.20

 

 

Diluted earnings per share, as adjusted

 

$

0.45

 

$

0.39

 

$

1.47

 

$

1.23

 

 

The non-GAAP results shown above and within this document, which exclude the legal settlement, should not be construed as a substitute for or a better indicator of the Company’s performance than the Company’s GAAP results. Management believes presenting certain financial information without the legal settlement is important for purposes of comparison to prior year results. In addition, management uses this metric to evaluate the Company’s underlying operating performance and to analyze trends.

 

FOCUS System

 

As of September 27, 2015, we have implemented our new, proprietary point-of-sale system (“FOCUS”) in our domestic restaurants. FOCUS had the following impact on our condensed consolidated statements of income for the three and nine months ended September 27, 2015 and September 28, 2014 (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept 27,

 

Sept. 28,

 

Sept 27,

 

Sept. 28,

 

 

 

2015

 

2014

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

Franchise royalties (a)

 

$

(673

)

$

(63

)

$

(1,980

)

$

(68

)

Other sales (b)

 

38

 

9,708

 

9,846

 

9,848

 

Other operating expenses (c)

 

(56

)

(9,773

)

(9,959

)

(10,424

)

Depreciation and amortization (d) 

 

(1,261

)

(1,064

)

(3,737

)

(1,643

)

Net decrease in income before income taxes

 

$

(1,952

)

$

(1,192

)

$

(5,830

)

$

(2,287

)

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

(0.04

)

$

(0.02

)

$

(0.10

)

$

(0.04

)

 


(a)         Royalty incentive program tied to franchise rollout of FOCUS.

 

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(b)         Represents revenues for equipment installed at domestic franchised restaurants.

(c)          Includes cost of sales associated with equipment installed at franchised restaurants and other costs to support the rollout of the program.

(d)         Includes depreciation expense for both the capitalized software and for equipment installed at Company-owned restaurants, which are being depreciated over five to seven years, respectively.

 

Results of Operations

 

Summary of Operating Results - Segment Review

 

Discussion of Revenues

 

Consolidated revenues were $389.3 million for the three months ended September 27, 2015, a decrease of $1.1 million, or 0.3%, over the corresponding 2014 period. The decrease for the three month period was primarily due to lower FOCUS equipment sales and lower PJ Food Service (“PJFS”) sales as a result of lower commodity costs. For the nine months ended September 27, 2015, total revenues were $1.22 billion, an increase of $47.9 million, or 4.1%, over the corresponding 2014 period. The changes in revenues for the three and nine months ended September 27, 2015, compared to the corresponding periods in 2014, were primarily due to the following:

 

·                  Domestic Company-owned restaurant sales increased $11.0 million, or 6.5%, and $46.0 million, or 8.9%, for the three and nine months ended September 27, 2015, respectively, primarily due to increases of 4.7% and 6.8% in comparable sales and increases of 2.8% and 2.9% in equivalent units during the three and nine months ended September 27, 2015, respectively. “Comparable sales” represents the change in year-over-year sales for the same base of restaurants for the same fiscal periods. “Equivalent units” represents the number of restaurants open at the beginning of a given period, adjusted for restaurants opened, closed, acquired or sold during the period on a weighted average basis.

·                  North America franchise royalty revenue decreased approximately $50,000, or 0.2%, for the three months ended September 27, 2015 as the increase in revenue from a 2.4% increase in franchise comparable sales was offset by higher royalty incentives. Revenues increased $4.8 million, or 7.3%, for the nine months ended September 27, 2015 primarily due to an increase of 4.4% in franchise comparable sales and due to lower royalty incentives.

·                  International royalties and franchise and development fees increased approximately $80,000, or 1.2%, and $1.1 million, or 6.0%, for the three and nine months ended September 27, 2015, respectively, primarily due to increases in the number of franchised restaurants and increases in comparable sales of 8.5% and 7.8%, calculated on a constant dollar basis. The negative impact of foreign currency exchange rates reduced our revenues by approximately $800,000 and $2.1 million for the three- and nine-month periods.

·                  International restaurant and commissary sales increased approximately $500,000, or 2.7%, and $2.0 million, or 3.6%, for the three and nine months ended September 27, 2015, respectively, primarily due to an increase in United Kingdom commissary revenues from increases in units and higher comparable sales. This increase was partially offset by lower sales at China Company-owned restaurants due to the disposition of eleven restaurants in 2014 and negative comparable sales. Additionally, sales were negatively impacted $1.3 million and $3.8 million for the three- and nine month periods, respectively, by foreign currency exchange rates.

·                  Other sales decreased approximately $9.3 million, or 39.7%, and increased $400,000, or 0.8%, for the three and nine months ended September 27, 2015, respectively. The decrease for the three-month period was primarily due to higher FOCUS equipment sales to franchisees in 2014. FOCUS equipment sales had no significant impact on operating income results. See the “FOCUS System” section above for additional information.

·                  Domestic commissary sales decreased $3.4 million, or 2.3%, and $6.6 million, or 1.4%, for the three and nine months ended September 27, 2015, respectively, as lower revenues associated with lower cheese prices were somewhat offset by increases in restaurant sales volumes.

 

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Discussion of Operating Results

 

Third quarter 2015 income before income taxes was $26.3 million compared to $24.2 million in the prior year comparable period, or an increase of 8.4%. Income before income taxes was $80.2 million for the nine months ended September 27, 2015, compared to $81.9 million for the prior year comparable period.  Excluding the previously discussed legal settlement, income before income taxes was $92.5 million for the nine months ended September 28, 2015, or an increase of 13.0%. Income before income taxes is summarized in the following table on a reporting segment basis. Alongside the GAAP income before income taxes data, we have included “adjusted” income before income taxes for the nine-month period of 2015 to exclude the legal settlement expense. We believe this non-GAAP measure is important for purposes of comparing to prior year results.

 

 

 

Three Months Ended

 

 

 

Sept. 27,

 

Sept. 28,

 

Increase

 

(In thousands)

 

2015

 

2014

 

(Decrease)

 

 

 

 

 

 

 

 

 

Domestic company-owned restaurants

 

$

8,088

 

$

8,133

 

$

(45

)

Domestic commissaries

 

10,192

 

8,897

 

1,295

 

North America franchising

 

19,172

 

19,023

 

149

 

International

 

3,184

 

1,436

 

1,748

 

All others

 

(556

)

(298

)

(258

)

Unallocated corporate expenses

 

(13,482

)

(12,242

)

(1,240

)

Elimination of intersegment profits

 

(341

)

(731

)

390

 

Total income before income taxes (a)

 

$

26,257

 

$

24,218

 

$

2,039

 

 

 

 

Nine Months Ended

 

 

 

As Reported

 

Legal

 

Adjusted

 

 

 

Adjusted

 

 

 

Sept. 27,

 

Settlement

 

Sept. 27,

 

Sept. 28,

 

Increase

 

(In thousands)

 

2015

 

Expense

 

2015

 

2014

 

(Decrease)

 

 

 

 

 

 

 

 

 

 

 

 

 

Domestic company-owned restaurants

 

$

41,185

 

$

 

$

41,185

 

$

32,069

 

$

9,116

 

Domestic commissaries

 

32,694

 

 

32,694

 

26,174

 

6,520

 

North America franchising

 

61,545

 

 

61,545

 

56,389

 

5,156

 

International

 

6,807

 

 

6,807

 

4,071

 

2,736

 

All others

 

(230

)

 

(230

)

(150

)

(80

)

Unallocated corporate expenses

 

(60,636

)

12,278

 

(48,358

)

(35,405

)

(12,953

)

Elimination of intersegment losses

 

(1,141

)

 

(1,141

)

(1,284

)

143

 

Total income before income taxes (a)

 

$

80,224

 

$

12,278

 

$

92,502

 

$

81,864

 

$

10,638

 

 


(a)         Includes FOCUS system costs of approximately $2.0 million and $1.2 million for the three months ended September 27, 2015 and September 28, 2014, respectively, and approximately $5.8 million and $2.3 million for the nine months ended September 27, 2015 and September 28, 2014, respectively. See the “Focus System” section above for additional information.

 

The increases of $2.0 million, or 8.4%, and $10.6 million, or 13.0%, excluding the legal settlement, for the three- and nine-month periods in 2015, respectively, were primarily due to the following:

 

·                  Domestic Company-owned Restaurant Segment. Domestic Company-owned restaurants’ income before income taxes were relatively flat for the third quarter of 2015, compared to the same quarter of the prior year, as higher profits from the 4.7% increase in comparable sales and lower commodity costs were offset by incremental insurance expense of approximately $2.9 million primarily from higher non-owned automobile claims costs. Income before income taxes increased approximately $9.1 million for the nine-month period, compared to the corresponding prior year period, as higher profits from the 6.8% increase in comparable sales and lower commodity costs were partially offset by incremental insurance costs of $3.9 million and higher depreciation expense of $1.1 million associated with FOCUS

 

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equipment. The market price for cheese averaged $1.68 and $1.62 per pound for the three- and nine-month periods in 2015, compared to $2.14 and $2.16 per pound in the prior year comparable periods.

 

·                  Domestic Commissary Segment. Domestic commissaries’ income before income taxes increased approximately $1.3 million and $6.5 million for the three and nine months ended September 27, 2015, respectively, compared to the corresponding prior year periods primarily due to higher margins and incremental profits from higher restaurant volumes. These increases were partially offset by incremental insurance expense of approximately $1.6 million and $2.2 million for the three and nine-month periods, respectively, primarily from higher automobile claims costs.

 

·                  North America Franchising Segment. North America Franchising income before income taxes was $149,000 higher for the third quarter of 2015, compared to the same quarter of the prior year, as higher royalties from the 2.4% comparable sales increase were substantially offset by higher royalty incentives. Income before income taxes increased $5.2 million for the nine months ended September 27, 2015, compared to the corresponding prior year period, due to higher royalties from the 4.4% comparable sales increase and lower royalty incentives.

 

·                  International Segment. Income before income taxes increased approximately $1.7 million and $2.7 million for the three and nine months ended September 27, 2015, respectively, compared to the corresponding prior year periods. The increases were primarily due to increases in units and comparable sales increases of 8.0% and 7.5%, which resulted in both higher royalties and increases of approximately $1.4 million and $1.9 million in United Kingdom results for the three- and nine-month periods, respectively. These increases were somewhat offset by the impact of negative foreign currency exchange rates of approximately $900,000 and $2.2 million for the three- and nine-month periods, respectively. Additionally, the 2014 periods include an impairment charge of approximately $700,000 for eight Company-owned restaurants in China.

 

·                  All Others Segment. The “All Others” reporting segment income before income taxes, which primarily includes our online and mobile ordering business and our wholly-owned print and promotions subsidiary, Preferred Marketing Solutions, decreased approximately $250,000 and $80,000 for the three and nine months ended September 27, 2015, respectively, compared to the corresponding prior year periods. The decrease of approximately $250,000 for the three-month period was primarily due to higher infrastructure costs to support our online and mobile ordering business, partially offset by higher online volumes. The decrease of approximately $80,000 for the nine-month period was primarily due to reduced operating results at Preferred Marketing Solutions, primarily associated with an increased number of discounted direct mail campaigns, partially offset by improvements in our online and mobile ordering business due to higher online volumes.

 

·                  Unallocated Corporate Expenses. Unallocated corporate expenses increased approximately $1.2 million and $13.0 million for the three and nine months ended September 27, 2015, respectively, compared to the corresponding 2014 periods. The increase of $1.2 million for the third quarter was primarily due to higher health insurance claims costs. The increase of $13.0 million for the nine-month period was primarily due to higher salaries and benefits, including an increase in health insurance claims costs, and increased legal and interest costs. In addition, management incentive compensation costs have increased in 2015 due to higher annual operating results.

 

Diluted earnings per share were $0.45 for the three months ended September 27, 2015, compared to $0.39 in the corresponding prior year period. Diluted earnings per share were $1.27 ($1.47, excluding the $0.20 legal settlement), for the nine months ended September 27, 2015, compared to $1.23 in the corresponding prior year period. Diluted earnings per share increased $0.02 and $0.07 for the three- and nine-month periods, respectively, due to reductions in shares outstanding (a 3.6% reduction for the three-month period and a 4.3% reduction for the nine-month period). Additionally, FOCUS system costs reduced diluted earnings per share by $0.04 and $0.02 for the three months ended September 27, 2015 and September 28, 2014, respectively, and $0.10 and $0.04 for the nine months ended September 27, 2015 and September 28, 2014, respectively.

 

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Table of Contents

 

Review of Consolidated Operating Results

 

Revenues. Domestic Company-owned restaurant sales were $180.1 million for the three months ended September 27, 2015, compared to $169.1 million for the same period in 2014, and $563.3 million for the nine months ended September 27, 2015, compared to $517.3 million for the same period in 2014. The increases of $11.0 million and $46.0 million were primarily due to the previously mentioned increases of 4.7% and 6.8% in comparable sales and increases of 2.8% and 2.9% in equivalent units during the three and nine months ended September 27, 2015, respectively.

 

North America franchise royalties were $22.1 million and $70.5 million for the three and nine months ended September 27, 2015, respectively, representing a decrease of approximately $50,000, or 0.2%, and an increase of $4.8 million, or 7.3%, from the comparable periods in the prior year. The decrease for the three-month period was primarily due to increased levels of royalty incentives which more than offset the higher royalties from an increase in North America franchise sales. The increase for the nine-month period was primarily due to higher royalties from the increase in North America franchise sales and reduced levels of royalty incentives. North America franchise sales increased 3.1% to $499.2 million for the three months ended September 27, 2015, compared to $484.3 million for the same period in 2014, and increased 4.9% to $1.585 billion for the nine months ended September 27, 2015, compared to $1.511 billion for the same period in 2014. The increases were primarily due to the 2.4% and 4.4% increases in comparable sales for the three- and nine-month periods, respectively. Franchise restaurant sales are not included in Company revenues; however, our domestic royalty revenue is derived from these sales.

 

Average weekly sales for comparable units include restaurants that were open throughout the periods presented below. The comparable sales base for domestic Company-owned and North America franchised restaurants, respectively, includes restaurants acquired by the Company or divested to franchisees during the previous twelve months. Average weekly sales for non-comparable units include restaurants that were not open throughout the periods presented below and include non-traditional sites. Average weekly sales for non-traditional units not subject to continuous operations are calculated based upon actual days open.

 

The comparable sales base and average weekly sales for 2015 and 2014 for domestic Company-owned and North America franchised restaurants consisted of the following:

 

 

 

Three Months Ended

 

 

 

September 27, 2015

 

September 28, 2014

 

 

 

Company

 

Franchised

 

Company

 

Franchised

 

 

 

 

 

 

 

 

 

 

 

Total domestic units (end of period)

 

697

 

2,664

 

683

 

2,630

 

Equivalent units

 

685

 

2,521

 

667

 

2,496

 

Comparable sales base units

 

668

 

2,355

 

649

 

2,311

 

Comparable sales base percentage

 

97.5

%

93.4

%

97.3

%

92.6

%

Average weekly sales - comparable units

 

$

20,382

 

$

15,596

 

$

19,628

 

$

15,306

 

Average weekly sales - total non-comparable units (a)

 

$

13,525

 

$

10,073

 

$

15,081

 

$

10,179

 

Average weekly sales - all units

 

$

20,208

 

$

15,234

 

$

19,504

 

$

14,926

 

 


(a) Includes 124 traditional and 214 non-traditional units as of September 27, 2015 and 150 traditional and 204 non-traditional units as of September 28, 2014.

 

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Table of Contents

 

 

 

Nine Months Ended

 

 

 

September 27, 2015

 

September 28, 2014

 

 

 

Company

 

Franchised

 

Company

 

Franchised

 

 

 

 

 

 

 

 

 

 

 

Total domestic units (end of period)

 

697

 

2,664

 

683

 

2,630

 

Equivalent units

 

682

 

2,536

 

662

 

2,513

 

Comparable sales base units

 

665

 

2,348

 

644

 

2,302

 

Comparable sales base percentage

 

97.5

%

92.6

%

97.3

%

91.6

%

Average weekly sales - comparable units

 

$

21,369

 

$

16,482

 

$

20,209

 

$

15,879

 

Average weekly sales - total non-comparable units (a)

 

$

13,686

 

$

10,324

 

$

13,759

 

$

10,356

 

Average weekly sales - all units

 

$

21,184

 

$

16,204

 

$

20,026

 

$

15,415

 

 


(a)   Includes 124 traditional and 214 non-traditional units as of September 27, 2015 and 150 traditional and 204 non-traditional units as of September 28, 2014.

 

Domestic commissary sales decreased 2.3% to $145.9 million for the three months ended September 27, 2015, from $149.2 million in the comparable 2014 period and decreased 1.4% to $457.2 million for the nine months ended September 27, 2015, from $463.9 million in the comparable 2014 period. The decreases were primarily due to decreases in cheese prices, which were somewhat offset by increases in sales volumes. PJFS pricing for cheese is based on a fixed dollar markup; when cheese prices decrease, revenues will decrease with no overall impact on the related dollar margin.

 

Other sales decreased approximately $9.3 million, or 39.7%, and increased approximately $400,000, or 0.8%, for the three and nine months ended September 27, 2015, from the prior comparable periods. The decrease for the three-month period was primarily due to lower FOCUS equipment sales to franchisees. See the “FOCUS System” section above for additional information.

 

International royalties and franchise and development fees increased approximately $80,000, or 1.2%, for the three months ended September 27, 2015, and increased $1.1 million, or 6.0%, for the nine months ended September 27, 2015, from the prior comparable periods. The increases were due to increases in units and comparable sales of 8.5% and 7.8%, calculated on a constant dollar basis, for the three- and nine-month periods, respectively. The negative impact of foreign currency exchange rates reduced our revenues by approximately $800,000 and $2.1 million for the three- and nine-month periods. International franchise sales were $146.1 million for the three months ended September 27, 2015, compared to $139.4 million for the same period in 2014, representing an increase of 4.8%. International franchise sales for the nine months ended September 27, 2015 increased 7.0% to $438.9 million compared to $410.3 million for the same period in 2014. International franchise sales are not included in Company revenues; however, our international royalty revenue is derived from these sales.

 

International restaurant and commissary sales increased approximately $500,000, or 2.7%, for the three months ended September 27, 2015, and increased $2.0 million, or 3.6%, for the nine months ended September 27, 2015, from the prior comparable periods. The increases were primarily due to higher commissary revenues from increases in units and comparable sales. The increases were partially offset by lower sales at China Company-owned restaurants due to the disposition of eleven restaurants in 2014 and negative comparable sales. Additionally, sales were negatively impacted $1.3 million and $3.8 million for the three- and nine month periods, respectively, by foreign currency exchange rates.

 

Costs and expenses.  The restaurant operating margin for domestic Company-owned units was 17.5% for the three months ended September 27, 2015, compared to 17.6% for the same period in 2014, and was 20.0% for the nine months ended September 27, 2015, compared to 18.6% for the same period in 2014. The margins were comprised of the following changes for the three and nine months ended September 27, 2015, as compared to the same periods in 2014:

 

·                  Cost of sales were 1.7% and 1.5% lower for the three and nine months ended September 27, 2015, as compared to the same periods in 2014, primarily due to lower commodity costs, primarily cheese.

 

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·                  Salaries and benefits were 0.8% and 0.7% higher for the three and nine months ended September 27, 2015, primarily due to higher bonuses paid to general managers and minimum wage increases.

·                  Advertising and related costs were 0.3% lower for the nine months ended September 27, 2015 (no change for the third quarter) primarily due to lower discretionary spending and the benefit of higher sales.

·                  Occupancy costs and other restaurant operating costs were 1.0% higher and 0.2% lower for the three and nine months ended September 27, 2015. The higher operating expenses for the three months ended were due to the previously mentioned increase in non-owned automobile insurance claims costs, partially offset by lower mileage reimbursement due to lower gas prices.

 

Domestic commissary margin was 7.3% for the three months ended September 27, 2015, compared to 6.8% for the corresponding period in 2014, and 7.6% for the nine months ended September 27, 2015, compared to 6.8% for the corresponding period in 2014 and consisted of the following differences:

 

·                  Cost of sales were 2.1% and 2.0% lower for the three and nine months ended September 27, 2015 primarily due to lower cheese costs which have a fixed-dollar markup. As cheese prices are lower, food cost as a percentage of sales is lower.

·                  Salaries and benefits and other commissary operating expenses were 1.6% and 1.1% higher as a percentage of sales. This is primarily due to the previously discussed incremental automobile insurance claims costs of $1.6 million and $2.2 million for the three- and nine-month periods of 2015, respectively. Additionally, PJFS revenues are lower due to lower cheese prices, which increases overall salaries and benefits and other commissary operating expenses as a percentage of sales.

 

Other operating expenses as a percentage of other sales were 95.7% for the three months ended September 27, 2015 compared to 97.6% for the corresponding period in 2014 and 95.2% for the nine months ended September 27, 2015 compared to 95.5% in the prior comparable periods. The lower operating expenses for the quarter were primarily due to the decreasing number of franchise FOCUS systems sales, and related operating expenses, as we finished the rollout. Overall, FOCUS systems sales have a low margin. The nine month results reflect the impact of an increased number of direct mail campaigns offered to our domestic restaurants by Preferred Marketing Solutions.

 

International restaurant and commissary expenses as a percentage of sales were 81.4% for the third quarter of 2015 and 84.2% in the third quarter of 2014. For the nine months ended September 27, 2015, expenses were 81.9% as compared to 83.4% for the corresponding 2014 period. The decreases as a percentage of sales for the three- and nine-month periods were primarily due to the benefit of higher commissary sales volumes and higher commissary margins.

 

General and administrative (G&A) costs were $36.1 million, or 9.3%, of revenues for the three months ended September 27, 2015, compared to $33.7 million, or 8.6%, of revenues for the same period in 2014. G&A costs were $120.0 million, or 9.8%, of revenues for the nine months ended September 27, 2015, compared to $104.2 million, or 8.9%, of revenues for the same period in 2014. The increase of $2.4 million for the three-month period was primarily due to higher insurance claims costs, primarily health insurance, and international support costs. The increase of $15.8 million for the nine-month period was primarily due to the following:

 

·                  Corporate G&A costs increased primarily due to higher salaries and benefits, including an increase in health insurance claims costs, increased legal costs, and higher management incentive compensation due to higher annual operating results.

·                  Domestic Company-owned restaurant supervisor bonuses increased due to higher sales and higher operating profits.

·                  International G&A costs increased primarily due to incremental advertising spending and other international support costs.

 

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Other general expenses decreased approximately $1.5 million and $2.2 million for the three and nine months ended September 27, 2015, respectively, primarily due to lower provisions for uncollectible accounts and notes receivable and the $700,000 impairment charge in the prior year for eight Company-owned restaurants in China.

 

Depreciation and amortization was $10.5 million (2.7% of revenues) for the three months ended September 27, 2015, compared to $10.5 million (2.7% of revenues) for the same 2014 period, and $30.6 million (2.5% of revenues) for the nine months ended September 27, 2015, compared to $29.5 million (2.5% of revenues) for the 2014 period. The nine-month period of 2015 includes higher depreciation from both FOCUS capitalized software costs and Company-owned restaurants equipment costs.

 

Legal settlement expense. This line item consists of $12.3 million of settlement costs in the nine month period of 2015 for a conditionally certified collective and class action alleging our delivery drivers were not properly reimbursed for mileage and expenses in accordance with the Fair Labor Standards Act (“FLSA”). For additional information, see “Note 5” of “Notes to Condensed Consolidated Financial Statements.”

 

Net interest expense. Net interest expense increased approximately $200,000 and $1.3 million for the three and nine months ended September 27, 2015, respectively, primarily due to a higher average outstanding debt balance and higher effective interest rates.

 

Income tax expense. Our effective income tax rates were 27.7% and 30.6% for the three and nine months ended September 27, 2015, respectively, representing decreases from the prior year comparable periods of 2.2% and 1.8% for the three- and nine-month periods, respectively. The rates for 2015 include higher benefits from various tax deductions and credits, including the U.S. federal manufacturing deduction.

 

Planned Sale of China Company-owned Operations

 

The Company has decided to refranchise the China market and is planning a sale of its existing China operations, consisting of the Company-owned restaurants and a commissary. We expect to sell the business within the next 12 months; upon completion of the sale, the Company will not have any Company-owned  international restaurants.

 

The Company-owned China operations have incurred losses before income taxes of $0.4 million and $1.4 million for the three months ended September 27, 2015 and September 28, 2014, respectively, and losses before income taxes of $0.9 million and $2.3 million for the nine months ended September 27, 2015 and September 28, 2014, respectively, which are recorded in our International segment. The losses for the three and nine months ended September 28, 2014, include an impairment charge of $0.7 million for eight Company-owned restaurants in China. We do not expect the sale of our China operations to have a significant impact on our financial results.

 

See “Note 7” of “Notes to Condensed Consolidated Financial Statements” for additional information.

 

Liquidity and Capital Resources

 

Our debt is comprised entirely of borrowings under our unsecured revolving credit facility (“Credit Facility”) with a maturity date of October 31, 2019. Outstanding balances under this $400 million Credit Facility were $239.0 million as of September 27, 2015 and $230.5 million as of December 28, 2014.

 

The interest rate charged on outstanding balances is LIBOR plus 75 to 175 basis points. The commitment fee on the unused balance ranges from 15 to 25 basis points. The increment over LIBOR and the commitment fee are determined quarterly based upon the ratio of total indebtedness to earnings before interest, taxes, depreciation and amortization (“EBITDA”), as defined by the Credit Facility. The remaining availability under the Credit Facility, reduced for outstanding letters of credit, was approximately $138.5 million as of September 27, 2015.

 

We use interest rate swaps to hedge against the effects of potential interest rate increases on borrowings under our Credit Facility. During the quarter ended September 27, 2015, we executed three additional forward starting

 

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swaps for $125.0 million that become effective in 2018 upon expiration of the two existing swaps for $125.0 million. As of September 27, 2015, we have the following interest rate swap agreements:

 

Effective Dates

 

Debt Amount