PAPA JOHNS INTERNATIONAL INC - Quarter Report: 2015 March (Form 10-Q)

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 March 29, 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)

 

 

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.

 

 

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 April 28, 2015, there were outstanding 39,783,131 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 — March 29, 2015 and December 28, 2014	2
	Condensed Consolidated Statements of Income — Three Months Ended March 29, 2015 and March 30, 2014	3
	Consolidated Statements of Comprehensive Income — Three Months Ended March 29, 2015 and March 30, 2014	4
	Consolidated Statements of Cash Flows — Three Months Ended March 29, 2015 and March 30, 2014	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23
Item 4.	Controls and Procedures	24
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	24
Item 1A.	Risk Factors	25
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25
Item 6.	Exhibits	26

 

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Item 1. Financial Statements

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

 

(In thousands, except per share amounts)		March 29, 2015			December 28, 2014
		(Unaudited)
Assets
Current assets:
Cash and cash equivalents		$	23,524		$	20,122
Accounts receivable, net		56,187			56,047
Notes receivable, net		6,103			6,106
Income taxes receivable		3,628			9,527
Inventories		26,354			27,394
Deferred income taxes		7,576			8,248
Prepaid expenses		15,982			18,736
Other current assets		10,132			9,828
Total current assets		149,486			156,008
Property and equipment, net		216,080			219,457
Notes receivable, less current portion, net		12,482			12,801
Goodwill		81,421			82,007
Deferred income taxes		3,914			3,914
Other assets		38,594			38,616
Total assets		$	501,977		$	512,803
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	35,009		$	38,832
Income and other taxes payable		9,804			9,637
Accrued expenses and other current liabilities		55,521			58,293
Total current liabilities		100,334			106,762
Deferred revenue		3,906			4,257
Long-term debt		231,000			230,451
Deferred income taxes		20,508			22,188
Other long-term liabilities		44,130			41,875
Total liabilities		399,878			405,533
Redeemable noncontrolling interests		8,798			8,555
Stockholders’ equity:
Preferred stock ($0.01 par value per share; no shares issued)		—			—
Common stock ($0.01 par value per share; issued 43,523 at March 29, 2015 and 43,331 at December 28, 2014)		435			433
Additional paid-in capital		148,981			147,912
Accumulated other comprehensive (loss) income		(982		)	671
Retained earnings		109,616			92,876
Treasury stock (3,879 shares at March 29, 2015 and 3,549 shares at December 28, 2014, at cost)		(177,216		)	(155,659		)
Total stockholders’ equity, net of noncontrolling interests		80,834			86,233
Noncontrolling interests in subsidiaries		12,467			12,482
Total stockholders’ equity		93,301			98,715
Total liabilities, redeemable noncontrolling interests and stockholders’ equity		$	501,977		$	512,803

 

See accompanying notes.

 

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Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(Unaudited)

 

		Three Months Ended
(In thousands, except per share amounts)		March 29, 2015			March 30, 2014
North America revenues:
Domestic Company-owned restaurant sales		$	197,287		$	178,193
Franchise royalties		25,359			22,614
Franchise and development fees		265			144
Domestic commissary sales		162,333			164,047
Other sales		21,614			12,750
International revenues:
Royalties and franchise and development fees		6,498			5,779
Restaurant and commissary sales		18,928			17,850
Total revenues		432,284			401,377
Costs and expenses:
Domestic Company-owned restaurant expenses:
Cost of sales		47,504			45,156
Salaries and benefits		53,658			47,583
Advertising and related costs		16,770			16,256
Occupancy costs and other restaurant operating expenses		37,100			34,598
Total domestic Company-owned restaurant expenses		155,032			143,593
Domestic commissary expenses:
Cost of sales		125,126			128,924
Salaries and benefits and other commissary operating expenses		24,610			22,879
Total domestic commissary expenses		149,736			151,803
Other operating expenses		20,603			11,431
International restaurant and commissary expenses		15,478			14,885
General and administrative expenses		41,933			36,966
Other general expenses		1,816			1,533
Depreciation and amortization		10,041			9,164
Total costs and expenses		394,639			369,375
Operating income		37,645			32,002
Net interest (expense) income		(1,209		)	(592		)
Income before income taxes		36,436			31,410
Income tax expense		12,197			10,869
Net income before attribution to noncontrolling interests		24,239			20,541
Income attributable to noncontrolling interests		(2,003		)	(1,230		)
Net income attributable to the Company		$	22,236		$	19,311
Calculation of income for earnings per share:
Net income attributable to the Company		$	22,236		$	19,311
Decrease (increase) in noncontrolling interest redemption value		70			(8		)
Net income attributable to participating securities		(100		)	(137		)
Net income attributable to common shareholders		$	22,206		$	19,166
Basic earnings per common share		$	0.56		$	0.46
Diluted earnings per common share		$	0.55		$	0.45
Basic weighted average common shares outstanding		39,827			41,778
Diluted weighted average common shares outstanding		40,510			42,696
Dividends declared per common share		$	0.14		$	0.125

 

See accompanying notes.

 

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Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

 

		Three Months Ended
(In thousands)		March 29, 2015			March 30, 2014
Net income before attribution to noncontrolling interests		$	24,239		$	20,541
Other comprehensive income (loss), before tax:
Foreign currency translation adjustments		(1,541		)	(33		)
Interest rate swaps (1)		(1,084		)	(43		)
Other comprehensive income (loss), before tax		(2,625		)	(76		)
Income tax effect:
Foreign currency translation adjustments		570			12
Interest rate swaps (2)		401			16
Income tax effect		971			28
Other comprehensive income (loss), net of tax		(1,654		)	(48		)
Comprehensive income before attribution to noncontrolling interests		22,585			20,493
Comprehensive (income) loss, redeemable noncontrolling interests		(1,313		)	(1,255		)
Comprehensive (income) loss, nonredeemable noncontrolling interests		(690		)	25
Comprehensive income attributable to the Company		$	20,582		$	19,263

 

(1) Amounts reclassified out of accumulated other comprehensive income (“AOCI”) into net interest (expense) income included $394 and $249 for the three months ended March 29, 2015 and March 30, 2014, respectively.

 

(2) The income tax effects of amounts reclassified out of AOCI into net interest (expense) income were $146 and $92 for the three months ended March 29, 2015 and March 30, 2014, respectively.

 

See accompanying notes.

 

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Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

 

		Three Months Ended
(In thousands)		March 29, 2015			March 30, 2014
Operating activities
Net income before attribution to noncontrolling interests		$	24,239		$	20,541
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for uncollectible accounts and notes receivable		659			145
Depreciation and amortization		10,041			9,164
Deferred income taxes		5,055			6,170
Stock-based compensation expense		2,264			2,190
Excess tax benefit on equity awards		(5,091		)	(4,900		)
Other		1,180			1,110
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable		(1,312		)	(854		)
Income taxes receivable		5,899			—
Inventories		1,043			(3,210		)
Prepaid expenses		2,755			1,919
Other current assets		(303		)	(204		)
Other assets and liabilities		(154		)	(795		)
Accounts payable		(3,828		)	(1,311		)
Income and other taxes payable		167			3,268
Accrued expenses and other current liabilities		(2,291		)	(6,958		)
Deferred revenue		(74		)	403
Net cash provided by operating activities		40,249			26,678
Investing activities
Purchases of property and equipment		(7,558		)	(11,137		)
Loans issued		(506		)	(1,758		)
Repayments of loans issued		1,083			1,164
Acquisitions, net of cash acquired		(341		)	—
Other		20			7
Net cash used in investing activities		(7,302		)	(11,724		)
Financing activities
Net proceeds on line of credit facility		549			19,267
Cash dividends paid		(5,545		)	(5,240		)
Excess tax benefit on equity awards		5,091			4,900
Tax payments for equity award issuances		(5,557		)	(3,233		)
Proceeds from exercise of stock options		2,210			2,989
Acquisition of Company common stock		(24,765		)	(32,800		)
Distributions to noncontrolling interest holders		(1,705		)	(300		)
Other		253			223
Net cash used in financing activities		(29,469		)	(14,194		)
Effect of exchange rate changes on cash and cash equivalents		(76		)	(42		)
Change in cash and cash equivalents		3,402			718
Cash and cash equivalents at beginning of period		20,122			13,670
Cash and cash equivalents at end of period		$	23,524		$	14,388

 

See accompanying notes.

 

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Papa John’s International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

March 29, 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 complete 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 three months ended March 29, 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 March 29, 2015 and March 30, 2014:

 

		Number of Restaurants		Restaurant Locations		Papa John’s Ownership		Noncontrolling Interest Ownership
March 29, 2015
Star Papa, LP		84		Texas		51	%	49	%
Colonel’s Limited, LLC		56		Maryland and Virginia		70	%	30	%
PJ Minnesota, LLC		35		Minnesota		70	%	30	%
PJ Denver, LLC		25		Colorado		60	%	40	%
March 30, 2014
Star Papa, LP		80		Texas		51	%	49	%
Colonel’s Limited, LLC		52		Maryland and Virginia		70	%	30	%
PJ Minnesota, LLC		34		Minnesota		80	%	20	%
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.

 

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The income before income taxes attributable to these joint ventures for the three months ended March 29, 2015 and March 30, 2014 was as follows (in thousands):

 

		March 29,			March 30,
		2015			2014
Papa John’s International, Inc.		$	3,010		$	1,848
Noncontrolling interests		2,003			1,230
Total income before income taxes		$	5,013		$	3,078

 

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 March 29, 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		1,313
Distributions		(1,000		)
Change in redemption value		(70		)
Balance at March 29, 2015		$	8,798

 

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 March 29, 2015 and December 28, 2014, as the noncontrolling interest holders’ agreements had no redemption features.

 

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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 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 March 29, 2015, we had a net deferred tax liability of approximately $9.0 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.

 

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Our financial assets and liabilities that were measured at fair value on a recurring basis as of March 29, 2015 and December 28, 2014 are as follows (in thousands):

 

		Carrying			Fair Value Measurements
		Value			Level 1			Level 2			Level 3
March 29, 2015
Financial assets:
Cash surrender value of life insurance policies (a)		$	18,806		$	18,806		$	—		$	—
Financial liabilities:
Interest rate swaps (b)		1,470			—			1,470			—
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			—

 

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

(b)         The fair value 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 three months ended March 29, 2015.

 

Variable Interest Entity

 

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, we determined that consolidation of PJMF is not appropriate.

 

Revenue from Contract with Customers

 

In May 2014, the Financial Accounting Standards Board issued “Revenue from Contracts with Customers” (Accounting Standards Update (“ASU”) 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.

 

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We are required to adopt the new requirements in the first quarter of 2017; however, the Financial Accounting Standards Board recently issued a proposal to deter the effective date and thus the Company’s adoption to the first quarter of 2018. 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.

 

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

 

		Three Months Ended
		March 29,			March 30,
		2015			2014
Basic earnings per common share:
Net income attributable to the Company		$	22,236		$	19,311
Decrease (increase) in noncontrolling interest redemption value		70			(8		)
Net income attributable to participating securities		(100		)	(137		)
Net income attributable to common shareholders		$	22,206		$	19,166
Weighted average common shares outstanding		39,827			41,778
Basic earnings per common share		$	0.56		$	0.46
Diluted earnings per common share:
Net income attributable to common shareholders		$	22,206		$	19,166
Weighted average common shares outstanding		39,827			41,778
Dilutive effect of outstanding equity awards (a)		683			918
Diluted weighted average common shares outstanding		40,510			42,696
Diluted earnings per common share		$	0.55		$	0.45

 

(a)         Excludes 112 awards at March 29, 2015 and 102 awards at March 30, 2014, as the effect of including such awards would have been antidilutive.

 

4.              Debt

 

Our debt is comprised entirely of an unsecured revolving line of credit (“Credit Facility”). The outstanding balance was $231.0 million as of March 29, 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

 

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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 $147.7 million as of March 29, 2015.

 

The Credit Facility contains customary affirmative and negative covenants, including financial covenants requiring the maintenance of specified fixed charges and leverage ratios. At March 29, 2015, we were in compliance with these covenants.

 

We use interest rate swaps to hedge against the effects of potential interest rate increases on borrowings under our Credit Facility. We currently have the following interest rate swaps:

 

Effective Dates		Floating Rate Debt		Fixed Rates
July 30, 2013 through April 30, 2018		$75 million		1.42	%
December 30, 2014 through April 30, 2018		$50 million		1.36	%

 

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 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. As of March 29, 2015, the swaps are highly effective cash flow hedges with no ineffectiveness for the three month period ended March 29, 2015.

 

The weighted average interest rate for the Credit Facility, including the impact of the previously mentioned swaps, was 2.1% and 1.5% for the three months ended March 29, 2015 and March 30, 2014, respectively. Interest paid, including payments made or received under the swaps, was $1.3 million and $717,000 for the three months ended March 29, 2015 and March 30, 2014, respectively. As of March 29, 2015, the portion of the $1.5 million interest rate swap liability that would be reclassified into earnings during the next twelve months as interest expense approximates $477,000.

 

5.             Litigation

 

The Company is involved in a number of lawsuits, claims, investigations and proceedings, including those specifically 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 action filed in August 2009 in the United States District Court, Eastern District of Missouri, alleging that delivery drivers were not reimbursed for mileage and expenses in accordance with the Fair Labor Standards Act. Approximately 3,900 drivers out of a potential class size of 28,800 have opted into the action. In late December 2013, the District Court granted a motion for class certification in five additional states, which added approximately 15,000 plaintiffs to the case. The trial is scheduled for August 2015.

 

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We intend to vigorously defend against all claims in this lawsuit. However, given the inherent uncertainties of this litigation, the outcome of this case cannot be predicted and the amount of any potential loss cannot be reasonably estimated. A negative outcome in this case could have a material adverse effect on the Company.

 

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
		March 29, 2015			March 30, 2014
Revenues from external customers:
Domestic Company-owned restaurants		$	197,287		$	178,193
Domestic commissaries		162,333			164,047
North America franchising		25,624			22,758
International		25,426			23,629
All others		21,614			12,750
Total revenues from external customers		$	432,284		$	401,377
Intersegment revenues:
Domestic commissaries		$	57,887		$	54,721
North America franchising		671			604
International		75			68
All others		3,932			3,730
Total intersegment revenues		$	62,565		$	59,123
Income (loss) before income taxes:
Domestic Company-owned restaurants		$	18,480		$	13,285
Domestic commissaries		11,800			10,431
North America franchising		22,319			19,484
International		1,344			732
All others		443			590
Unallocated corporate expenses		(17,205		)	(12,461		)
Elimination of intersegment profit		(745		)	(651		)
Total income before income taxes		$	36,436		$	31,410
Property and equipment:
Domestic Company-owned restaurants		$	210,463
Domestic commissaries		109,062
International		25,454
All others		47,079
Unallocated corporate assets		170,893
Accumulated depreciation and amortization		(346,871		)
Net property and equipment		$	216,080

 

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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 March 29, 2015, there were 4,699 Papa John’s restaurants (739 Company-owned and 3,960 franchised) operating in all 50 states and 37 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 our 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
		March 29, 2015		March 30, 2014
Papa John’s Restaurant Progression:
North America Company-owned:
Beginning of period		686		665
Opened		3		2
Closed		—		(1	)
Acquired		2		—
End of period		691		666
International Company-owned:
Beginning of period		49		58
Closed		(1	)	—
End of period		48		58
North America franchised:
Beginning of period		2,654		2,621
Opened		18		21
Closed		(20	)	(27	)
Divested		(2	)	—
End of period		2,650		2,615
International franchised:
Beginning of period		1,274		1,084
Opened		50		23
Closed		(14	)	(6	)
End of period		1,310		1,101
Total restaurants - end of period		4,699		4,440

 

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FOCUS System

 

As of March 29, 2015, the Company had implemented its new, proprietary point-of-sale system (“FOCUS”) in substantially all domestic restaurants. FOCUS had the following impact on our condensed consolidated statements of income for the three months ended March 29, 2015 and March 30, 2014 (in thousands):

 

		Three Months Ended
		Mar. 29,			Mar. 30,
		2015			2014
Franchise royalties (a)		$	(570	)	$	—
Other sales (b)		8,540			12
Other operating expenses (c)		(8,529		)	(189		)
Depreciation and amortization (d)		(1,237		)	(50		)
Net decrease in income before income taxes		$	(1,796	)	$	(227	)
Diluted earnings per common share		$	(0.03	)	$	(0.01	)

 

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

(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 $432.3 million for the first quarter of 2015, an increase of $30.9 million, or 7.7% over the corresponding 2014 period. The increase in revenues for the first quarter of 2015 was primarily due to the following:

 

·                  Domestic Company-owned restaurant sales increased $19.1 million, or 10.7%, primarily due to an increase of 8.1% in comparable sales during the first quarter of 2015 and a 3.2% increase in equivalent units. “Comparable sales” represents the change in year-over-year sales for the same base of restaurants for the same fiscal periods.

·                  North America franchise royalty revenue increased approximately $2.7 million, or 12.1%, primarily due to an increase of 6.0% in comparable sales and due to reduced levels of royalty incentives in the first quarter of 2015.

·                  Domestic commissary sales decreased $1.7 million, or 1.0%, as lower revenues associated with lower cheese prices were somewhat offset by increases in sales volumes.

·                  Other sales increased $8.9 million, or 69.5%, primarily due to FOCUS equipment sales to franchisees.

 

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·                  International royalties and franchise and development fees increased approximately $700,000, or 12.4%, primarily due to an increase in units and comparable sales of 8.0%, calculated on a constant dollar basis. The increase was somewhat offset by the negative impact of foreign currency exchange rates.

·                  International restaurant and commissary sales increased $1.1 million, or 6.0%, primarily due to an increase in 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. Additionally, sales were negatively impacted by foreign currency exchange rates.

 

Discussion of Operating Results

 

First quarter 2015  income before income taxes was $36.4 million, compared to $31.4 million in the prior year comparable period, or a 16.0% increase as summarized in the following table on a reporting segment basis (in thousands):

 

		Three Months Ended
		March 29,			March 30,			Increase
		2015			2014			(Decrease)
Domestic Company-owned restaurants		$	18,480		$	13,285		$	5,195
Domestic commissaries		11,800			10,431			1,369
North America franchising		22,319			19,484			2,835
International		1,344			732			612
All others		443			590			(147		)
Unallocated corporate expenses		(17,205		)	(12,461		)	(4,744		)
Elimination of intersegment profits		(745		)	(651		)	(94		)
Total income before income taxes (a)		$	36,436		$	31,410		$	5,026

 

(a)         Includes FOCUS system rollout costs of approximately $1.8 million and $200,000 for the three months ended March 29, 2015 and March 30, 2014, respectively. See the Focus System section above for additional information.

 

The increase of $5.0 million, or 16.0%, in income before income taxes was primarily due to the following:

 

·                  Domestic Company-owned Restaurant Segment. Domestic Company-owned restaurants’ income before income taxes increased $5.2 million in the first quarter of 2015. The increase was primarily due to the 8.1% increase in comparable sales and higher profits from lower commodity costs. The market price for cheese averaged $1.54 per pound for the first quarter of 2015, compared to $2.21 per pound in the prior year. This was slightly offset by higher depreciation expense associated with FOCUS equipment of approximately $500,000.

 

·                  Domestic Commissary Segment. Domestic commissaries’ income before income taxes increased approximately $1.4 million primarily due to incremental profits from higher restaurant volumes.

 

·                  North America Franchising Segment. North America Franchising income before income taxes increased approximately $2.8 million primarily due to higher royalties attributable to the 6.0% comparable sales increase and reduced levels of royalty incentives.

 

·                  International Segment. Income before income taxes increased approximately $600,000 primarily due to the previously mentioned increase in units and comparable sales of 7.7%, which resulted in both higher

 

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