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 June 29, 2014

 

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

 

(I.R.S. Employer Identification

incorporation or organization)

 

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 July 29, 2014, there were outstanding 40,926,449 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 – June 29, 2014 and December 29, 2013

 

2

 

 

 

 

 

Condensed Consolidated Statements of Income – Three and Six Months Ended June 29, 2014 and June 30, 2013

 

3

 

 

 

 

 

Consolidated Statements of Comprehensive Income – Three and Six Months Ended June 29, 2014 and June 30, 2013

 

4

 

 

 

 

 

Consolidated Statements of Cash Flows – Six Months Ended June 29, 2014 and June 30, 2013

 

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

 

25

 

 

 

 

Item 4.

Controls and Procedures

 

26

 

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

26

 

 

 

 

Item 1A.

Risk Factors

 

27

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

27

 

 

 

 

Item 6.

Exhibits

 

28

 

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)

 

June 29,
2014

 

December 29,
2013

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

19,971

 

$

13,670

 

Accounts receivable, net

 

48,377

 

53,203

 

Notes receivable, net

 

5,862

 

3,566

 

Inventories

 

31,895

 

23,035

 

Deferred income taxes

 

7,673

 

8,004

 

Prepaid expenses

 

14,156

 

14,336

 

Other current assets

 

9,646

 

9,226

 

Total current assets

 

137,580

 

125,040

 

Property and equipment, net

 

218,448

 

212,097

 

Notes receivable, less current portion, net

 

11,534

 

13,239

 

Goodwill

 

82,106

 

79,391

 

Other assets

 

35,532

 

34,524

 

Total assets

 

$

485,200

 

$

464,291

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

33,719

 

$

35,653

 

Income and other taxes payable

 

5,824

 

4,401

 

Accrued expenses and other current liabilities

 

54,468

 

57,807

 

Total current liabilities

 

94,011

 

97,861

 

Deferred revenue

 

5,579

 

5,827

 

Long-term debt

 

210,000

 

157,900

 

Deferred income taxes

 

12,928

 

14,660

 

Other long-term liabilities

 

45,644

 

42,835

 

Total liabilities

 

368,162

 

319,083

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

8,433

 

7,024

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

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

 

 

 

Common stock ($0.01 par value per share; issued 43,152 at June 29, 2014 and 42,796 at December 29, 2013)

 

432

 

428

 

Additional paid-in capital

 

139,705

 

137,552

 

Accumulated other comprehensive income

 

2,765

 

2,463

 

Retained earnings

 

66,944

 

41,297

 

Treasury stock (2,297 shares at June 29, 2014 and 1,129 shares at December 29, 2013, at cost)

 

(101,830

)

(44,066

)

Total stockholders’ equity, net of noncontrolling interests

 

108,016

 

137,674

 

Noncontrolling interests in subsidiaries

 

589

 

510

 

Total stockholders’ equity

 

108,605

 

138,184

 

Total liabilities, redeemable noncontrolling interests and stockholders’ equity

 

$

485,200

 

$

464,291

 

 

See accompanying notes.

 

2



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

(In thousands, except per share amounts)

 

June 29, 2014

 

June 30, 2013

 

June 29, 2014

 

June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

North America revenues:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurant sales

 

$

170,000

 

$

155,153

 

$

348,193

 

$

313,051

 

Franchise royalties

 

20,983

 

20,230

 

43,597

 

40,963

 

Franchise and development fees

 

132

 

219

 

276

 

765

 

Domestic commissary sales

 

150,581

 

140,003

 

314,628

 

283,897

 

Other sales

 

13,595

 

12,444

 

26,345

 

25,051

 

International revenues:

 

 

 

 

 

 

 

 

 

Royalties and franchise and development fees

 

6,317

 

5,391

 

12,096

 

10,458

 

Restaurant and commissary sales

 

19,256

 

15,746

 

37,106

 

30,605

 

Total revenues

 

380,864

 

349,186

 

782,241

 

704,790

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurant expenses:

 

 

 

 

 

 

 

 

 

Cost of sales

 

42,030

 

37,825

 

87,186

 

74,898

 

Salaries and benefits

 

45,805

 

42,053

 

93,388

 

85,325

 

Advertising and related costs

 

15,354

 

14,677

 

31,610

 

29,470

 

Occupancy costs

 

9,446

 

8,939

 

18,757

 

17,650

 

Other restaurant operating expenses

 

25,220

 

22,431

 

50,507

 

45,176

 

Total domestic Company-owned restaurant expenses

 

137,855

 

125,925

 

281,448

 

252,519

 

Domestic commissary expenses:

 

 

 

 

 

 

 

 

 

Cost of sales

 

118,470

 

107,676

 

247,394

 

218,599

 

Salaries and benefits

 

6,847

 

6,084

 

13,871

 

12,100

 

Other commissary operating expenses

 

16,215

 

15,185

 

32,070

 

30,646

 

Total domestic commissary expenses

 

141,532

 

128,945

 

293,335

 

261,345

 

Other operating expenses

 

13,221

 

11,132

 

24,652

 

22,584

 

International restaurant and commissary expenses

 

15,876

 

12,983

 

30,761

 

25,636

 

General and administrative expenses

 

33,562

 

33,126

 

70,528

 

66,284

 

Other general expenses

 

1,964

 

1,597

 

3,497

 

2,782

 

Depreciation and amortization

 

9,855

 

8,530

 

19,019

 

17,067

 

Total costs and expenses

 

353,865

 

322,238

 

723,240

 

648,217

 

Operating income

 

26,999

 

26,948

 

59,001

 

56,573

 

Net interest (expense) income

 

(763

)

(340

)

(1,355

)

332

 

Income before income taxes

 

26,236

 

26,608

 

57,646

 

56,905

 

Income tax expense

 

8,397

 

8,563

 

19,266

 

18,541

 

Net income before attribution to noncontrolling interests

 

17,839

 

18,045

 

38,380

 

38,364

 

Income attributable to noncontrolling interests

 

(1,091

)

(895

)

(2,321

)

(1,908

)

Net income attributable to the Company

 

$

16,748

 

$

17,150

 

$

36,059

 

$

36,456

 

 

 

 

 

 

 

 

 

 

 

Calculation of income for earnings per share:

 

 

 

 

 

 

 

 

 

Net income attributable to the Company

 

$

16,748

 

$

17,150

 

$

36,059

 

$

36,456

 

Increase in noncontrolling interest redemption value

 

(31

)

 

(39

)

 

Net income attributable to participating securities

 

(81

)

 

(218

)

 

Net income attributable to common shareholders

 

$

16,636

 

$

17,150

 

$

35,802

 

$

36,456

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.40

 

$

0.39

 

$

0.86

 

$

0.83

 

Diluted earnings per common share

 

$

0.40

 

$

0.39

 

$

0.85

 

$

0.81

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

41,225

 

43,484

 

41,501

 

43,996

 

Diluted weighted average common shares outstanding

 

41,970

 

44,500

 

42,332

 

45,086

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.125

 

$

 

$

0.250

 

$

 

 

See accompanying notes.

 

3



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

(In thousands)

 

June 29, 2014

 

June 30, 2013

 

June 29, 2014

 

June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

Net income before attribution to noncontrolling interests

 

$

17,839

 

$

18,045

 

$

38,380

 

$

38,364

 

Other comprehensive income (loss), before tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

959

 

(586

)

926

 

(1,721

)

Interest rate swaps (1)

 

(404

)

190

 

(447

)

73

 

Other comprehensive income (loss), before tax

 

555

 

(396

)

479

 

(1,648

)

Income tax effect:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

(355

)

217

 

(343

)

637

 

Interest rate swaps (2)

 

149

 

(71

)

165

 

(27

)

Income tax effect

 

(206

)

146

 

(178

)

610

 

Other comprehensive income (loss), net of tax

 

349

 

(250

)

301

 

(1,038

)

Comprehensive income before attribution to noncontrolling interests

 

18,188

 

17,795

 

38,681

 

37,326

 

Comprehensive income, redeemable noncontrolling interests

 

(1,086

)

(895

)

(2,341

)

(1,908

)

Comprehensive (loss) income, nonredeemable noncontrolling interests

 

(5

)

 

20

 

 

Comprehensive income attributable to the Company

 

$

17,097

 

$

16,900

 

$

36,360

 

$

35,418

 

 


(1) Amounts reclassified out of accumulated other comprehensive income (“AOCI”) into net interest (expense) income included $250 and $499 for the three and six months ended June 29, 2014, respectively and $44 and $88 for the three and six months ended June 30, 2013, respectively.

 

(2) The income tax effects of amounts reclassified out of AOCI into net interest (expense) income were $93 and $185 for the three and six months ended June 29, 2014, respectively and $16 and $32 for the three and six months ended June 30, 2013, respectively.

 

See accompanying notes.

 

4



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

Six Months Ended

 

(In thousands)

 

June 29, 2014

 

June 30, 2013

 

 

 

 

 

 

 

Operating activities

 

 

 

 

 

Net income before attribution to noncontrolling interests

 

$

38,380

 

$

38,364

 

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

 

 

 

 

 

Provision for uncollectible accounts and notes receivable

 

936

 

780

 

Depreciation and amortization

 

19,019

 

17,067

 

Deferred income taxes

 

6,298

 

8,256

 

Stock-based compensation expense

 

3,612

 

3,784

 

Excess tax benefit on equity awards

 

(7,890

)

(3,803

)

Other

 

2,270

 

694

 

Changes in operating assets and liabilities, net of acquisitions:

 

 

 

 

 

Accounts receivable

 

3,400

 

496

 

Inventories

 

(7,295

)

456

 

Prepaid expenses

 

180

 

2,000

 

Other current assets

 

(152

)

(37

)

Other assets and liabilities

 

(17

)

(1,954

)

Accounts payable

 

(1,934

)

(3,896

)

Income and other taxes payable

 

1,423

 

(9,022

)

Accrued expenses and other current liabilities

 

(3,970

)

(5,870

)

Deferred revenue

 

305

 

(83

)

Net cash provided by operating activities

 

54,565

 

47,232

 

 

 

 

 

 

 

Investing activities

 

 

 

 

 

Purchases of property and equipment

 

(26,239

)

(25,493

)

Loans issued

 

(2,642

)

(3,103

)

Repayments of loans issued

 

1,880

 

2,908

 

Acquisitions, net of cash acquired

 

(3,179

)

 

Other

 

3

 

319

 

Net cash used in investing activities

 

(30,177

)

(25,369

)

 

 

 

 

 

 

Financing activities

 

 

 

 

 

Net proceeds on line of credit facility

 

52,100

 

44,983

 

Cash dividends paid

 

(10,404

)

 

Excess tax benefit on equity awards

 

7,890

 

3,803

 

Tax payments for equity award issuances

 

(7,498

)

(1,841

)

Proceeds from exercise of stock options

 

3,361

 

3,696

 

Acquisition of Company common stock

 

(63,304

)

(58,806

)

Contributions from noncontrolling interest holders

 

100

 

450

 

Distributions to noncontrolling interest holders

 

(600

)

(1,750

)

Other

 

293

 

(468

)

Net cash used in financing activities

 

(18,062

)

(9,933

)

Effect of exchange rate changes on cash and cash equivalents

 

(25

)

(90

)

Change in cash and cash equivalents

 

6,301

 

11,840

 

Cash and cash equivalents at beginning of period

 

13,670

 

16,396

 

Cash and cash equivalents at end of period

 

$

19,971

 

$

28,236

 

 

See accompanying notes.

 

5



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

June 29, 2014

 

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 six months ended June 29, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ended December 28, 2014. 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 29, 2013.

 

2.              Significant Accounting Policies

 

Reclassifications

 

Certain prior year amounts in the condensed consolidated statements of income have been reclassified to conform to the current year presentation, which had no effect on current or previously reported net income.

 

Noncontrolling Interests

 

Papa John’s has joint ventures in which there are noncontrolling interests, including the following as of June 29, 2014 and June 30, 2013:

 

 

 

Number of
Restaurants

 

Restaurant Locations

 

Papa John’s
Ownership

 

Noncontrolling
Interest
Ownership

 

June 29, 2014

 

 

 

 

 

 

 

 

 

Star Papa, LP

 

81

 

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

%

 

 

 

 

 

 

 

 

 

 

June 30, 2013

 

 

 

 

 

 

 

 

 

Star Papa, LP

 

78

 

Texas

 

51

%

49

%

Colonel’s Limited, LLC

 

52

 

Maryland and Virginia

 

70

%

30

%

PJ Minnesota, LLC

 

31

 

Minnesota

 

80

%

20

%

PJ Denver, LLC

 

24

 

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 the joint ventures for the three and six months ended June 29, 2014 and June 30, 2013 was as follows (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 29,

 

June 30,

 

June 29,

 

June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

Papa John’s International, Inc.

 

$

1,744

 

$

1,284

 

$

3,592

 

$

2,792

 

Noncontrolling interests

 

1,091

 

895

 

2,321

 

1,908

 

Total income before income taxes

 

$

2,835

 

$

2,179

 

$

5,913

 

$

4,700

 

 

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 June 29, 2014:

 

Joint Venture

 

Redemption Feature

 

Location within the
Condensed Consolidated
Balance Sheets

 

Recorded Value

 

 

 

 

 

 

 

Colonel’s Limited, LLC

 

Mandatorily redeemable

 

Other long-term liabilities

 

Redemption value

Star Papa, LP

 

Redeemable

 

Temporary equity

 

Carrying value

PJ Denver, LLC

 

Redeemable

 

Temporary equity

 

Redemption value

PJ Minnesota, LLC

 

No redemption feature

 

Permanent equity

 

Carrying value

 

The Colonel’s Limited, LLC agreement contains a mandatory redemption clause and, accordingly, the Company has recorded this noncontrolling interest as a liability at its redemption value in other long-term liabilities. The redemption value is adjusted at each reporting date and any change is recorded in interest expense. We recorded interest income of $48,000 and interest expense of $36,000 in the second quarter of 2014 and 2013, respectively, and interest income of $21,000 and $773,000 in the first six months of 2014 and 2013 respectively. The redemption value was $11.1 million as of June 29, 2014 and $10.8 million as of December 29, 2013.

 

The noncontrolling interest holders of two other 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 29, 2013

 

$

7,024

 

Net income

 

1,370

 

Change in redemption value

 

39

 

Balance at June 29, 2014

 

$

8,433

 

 

We have a fourth joint venture, PJ Minnesota, LLC, that had a redemption feature until a contract amendment removed the redemption feature in the fourth quarter of 2013. The noncontrolling interest was reclassified from

 

7



Table of Contents

 

temporary equity to “Stockholders’ equity” in the condensed consolidated balance sheet at December 29, 2013, at carrying value.

 

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 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 June 29, 2014, we had a net deferred tax liability of approximately $5.3 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 June 29, 2014 and December 29, 2013 are as follows (in thousands):

 

 

 

Carrying

 

Fair Value Measurements

 

 

 

Value

 

Level 1

 

Level 2

 

Level 3

 

 

 

 

 

 

 

 

 

 

 

June 29, 2014

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

Cash surrender value of life insurance policies (a)

 

$

17,613

 

$

17,613

 

$

 

$

 

Interest rate swap (b)

 

41

 

 

41

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

Interest rate swap (b)

 

584

 

 

584

 

 

 

 

 

 

 

 

 

 

 

 

December 29, 2013

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

Cash surrender value of life insurance policies (a)

 

$

16,798

 

$

16,798

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

Interest rate swap (b)

 

76

 

 

76

 

 

 


(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 six months ended June 29, 2014.

 

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, we determined that consolidation is not appropriate.

 

Recent Accounting Pronouncement

 

In May 2014, the Financial Accounting Standards Board 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 2017. We are currently evaluating the impact of the new requirements on our consolidated financial statements. We currently do not believe the impact will be significant.

 

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3.              Stockholders’ Equity

 

In the fourth quarter of 2013, we completed a two-for-one stock split of our outstanding shares in the form of a stock dividend. The stock dividend was distributed on December 27, 2013 with approximately 21.0 million shares of stock distributed.  In conjunction with the stock split, we also retired shares held in treasury. The per-share and share amounts for 2013 in the accompanying condensed consolidated financial statements and notes to the financial statements have been adjusted to reflect the stock split.

 

4.              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 increase in the redemption value for the noncontrolling interest of PJ Denver, LLC reduces 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

 

Six Months Ended

 

 

 

June 29,

 

June 30,

 

June 29,

 

June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

Net income attributable to the Company

 

$

16,748

 

$

17,150

 

$

36,059

 

$

36,456

 

Increase in noncontrolling interest redemption value

 

(31

)

 

(39

)

 

Net income attributable to participating securities

 

(81

)

 

(218

)

 

Net income attributable to common shareholders

 

$

16,636

 

$

17,150

 

$

35,802

 

$

36,456

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

41,225

 

43,484

 

41,501

 

43,996

 

Basic earnings per common share

 

$

0.40

 

$

0.39

 

$

0.86

 

$

0.83

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share:

 

 

 

 

 

 

 

 

 

Net income attributable to common shareholders

 

$

16,636

 

$

17,150

 

$

35,802

 

$

36,456

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

41,225

 

43,484

 

41,501

 

43,996

 

Dilutive effect of outstanding equity awards (a)

 

745

 

1,016

 

831

 

1,090

 

Diluted weighted average common shares outstanding

 

41,970

 

44,500

 

42,332

 

45,086

 

Diluted earnings per common share

 

$

0.40

 

$

0.39

 

$

0.85

 

$

0.81

 

 


(a)         Excludes 284 and 176 awards for the three and six months ended June 29, 2014 and 218 and 151 awards for the three and six months ended June 30, 2013, as the effect of including such awards would have been antidilutive.

 

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5.              Debt

 

Our debt is comprised entirely of a revolving line of credit. The outstanding balance was $210.0 million as of June 29, 2014 and $157.9 million as of December 29, 2013.

 

In September 2010, we entered into a five-year, $175 million unsecured revolving credit facility, which was amended in November 2011 to extend the maturity date to November 30, 2016. On April 30, 2013, we amended and restated our revolving credit facility to increase the amount available for borrowing thereunder to $300 million and extend the maturity date to April 30, 2018. 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 revolving credit facility, reduced for outstanding letters of credit, was approximately $67.5 million as of June 29, 2014.

 

The revolving credit facility contains customary affirmative and negative covenants, including financial covenants requiring the maintenance of specified fixed charges and leverage ratios. At June 29, 2014, we were in compliance with these covenants.

 

In August 2011, we entered into an interest rate swap agreement that resulted in a fixed rate of 0.53%, instead of the variable rate of LIBOR, with a notional amount of $50 million and a maturity date of August 2013. On December 31, 2012, we amended our interest rate swap agreement to extend the maturity date to December 30, 2015. The amendment resulted in a change to the fixed rate (to 0.56% from 0.53%) but did not impact the notional amount of the interest rate swap agreement. On July 30, 2013, we terminated the $50 million swap and entered into a new $75 million swap. The new swap has an interest rate of 1.42% and a maturity date of April 30, 2018, which coincides with the maturity date of our revolving credit facility. The termination of the previous swap did not have a material impact on our 2013 results. In May 2014, we entered into a $50 million forward interest rate swap with an interest rate of 1.36%, an effective date of December 30, 2014 and a maturity date of April 30, 2018.

 

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 June 29, 2014, the swaps are highly effective cash flow hedges with no ineffectiveness for the three- and six-month periods ended June 29, 2014.

 

The weighted average interest rates for our revolving credit facility, including the impact of the previously mentioned swap agreement, were 1.7% and 1.6% for the three and six months ended June 29, 2014, respectively. Interest paid, including payments made or received under the swap, was $853,000 and $424,000 for the three months ended June 29, 2014 and June 30, 2013, respectively, and $1.6 million and $802,000 for the six months ended June 29, 2014 and June 30, 2013, respectively. As of June 29, 2014, the portion of the $543,000 net interest rate swap liability that would be reclassified into earnings during the next twelve months as interest expense approximates $142,000.

 

6.                    Litigation

 

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

 

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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. Additionally, in late December 2013, the District Court granted a motion for class certification in five additional states, which will add approximately 15,000 plaintiffs to the case.

 

We intend to vigorously defend against all claims in this lawsuit. However, given the inherent uncertainties of 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.

 

7.              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, chicken wings, cookie and dessert pizza and soft drinks to the general public. 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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Table of Contents

 

Our segment information is as follows (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

June 29, 2014

 

June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

Revenues from external customers:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

170,000

 

$

155,153

 

$

348,193

 

$

313,051

 

Domestic commissaries

 

150,581

 

140,003

 

314,628

 

283,897

 

North America franchising

 

21,115

 

20,449

 

43,873

 

41,728

 

International

 

25,573

 

21,137

 

49,202

 

41,063

 

All others

 

13,595

 

12,444

 

26,345

 

25,051

 

Total revenues from external customers

 

$

380,864

 

$

349,186

 

$

782,241

 

$

704,790

 

 

 

 

 

 

 

 

 

 

 

Intersegment revenues:

 

 

 

 

 

 

 

 

 

Domestic commissaries

 

$

51,592

 

$

46,115

 

$

106,313

 

$

92,912

 

North America franchising

 

583

 

552

 

1,187

 

1,105

 

International

 

90

 

73

 

158

 

140

 

All others

 

8,087

 

3,318

 

11,817

 

6,486

 

Total intersegment revenues

 

$

60,352

 

$

50,058

 

$

119,475

 

$

100,643

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

10,651

 

$

8,175

 

$

23,936

 

$

19,131

 

Domestic commissaries

 

6,846

 

9,642

 

17,277

 

19,805

 

North America franchising

 

17,882

 

17,396

 

37,366

 

35,618

 

International

 

1,903

 

866

 

2,635

 

1,207

 

All others

 

(442

)

1,153

 

148

 

1,812

 

Unallocated corporate expenses

 

(10,702

)

(10,413

)

(23,163

)

(19,931

)

Elimination of intersegment losses (profits)

 

98

 

(211

)

(553

)

(737

)

Total income before income taxes

 

$

26,236

 

$

26,608

 

$

57,646

 

$

56,905

 

 

 

 

 

 

 

 

 

 

 

Property and equipment:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

203,632

 

 

 

 

 

 

 

Domestic commissaries

 

105,711

 

 

 

 

 

 

 

International

 

27,711

 

 

 

 

 

 

 

All others

 

43,113

 

 

 

 

 

 

 

Unallocated corporate assets

 

161,786

 

 

 

 

 

 

 

Accumulated depreciation and amortization

 

(323,505

)

 

 

 

 

 

 

Net property and equipment

 

$

218,448

 

 

 

 

 

 

 

 

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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 June 29, 2014, there were 4,487 Papa John’s restaurants (731 Company-owned and 3,756 franchised) operating in all 50 states and in 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 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

 

Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

June 29, 2014

 

June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

North America Company-owned:

 

 

 

 

 

 

 

 

 

Beginning of period

 

666

 

649

 

665

 

648

 

Opened

 

2

 

5

 

4

 

6

 

Closed

 

(1

)

 

(2

)

 

Acquired from franchisees

 

5

 

 

5

 

 

End of period

 

672

 

654

 

672

 

654

 

International Company-owned:

 

 

 

 

 

 

 

 

 

Beginning of period

 

58

 

50

 

58

 

48

 

Opened

 

1

 

1

 

1

 

3

 

End of period

 

59

 

51

 

59

 

51

 

North America franchised:

 

 

 

 

 

 

 

 

 

Beginning of period

 

2,615

 

2,572

 

2,621

 

2,556

 

Opened

 

28

 

32

 

49

 

63

 

Closed

 

(24

)

(16

)

(51

)

(31

)

Sold to Company

 

(5

)

 

(5

)

 

End of period

 

2,614

 

2,588

 

2,614

 

2,588

 

International franchised:

 

 

 

 

 

 

 

 

 

Beginning of period

 

1,101

 

926

 

1,084

 

911

 

Opened

 

46

 

43

 

69

 

69

 

Closed

 

(5

)

(10

)

(11

)

(21

)

End of period

 

1,142

 

959

 

1,142

 

959

 

Total restaurants - end of period

 

4,487

 

4,252

 

4,487

 

4,252

 

 

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Table of Contents

 

FOCUS System

 

The Company is implementing a new, proprietary point-of-sale system (“FOCUS”) in substantially all domestic system-wide restaurants. As of June 29, 2014, we had installed FOCUS in 383 restaurants (369 Company-owned and 14 franchised), with the majority of the installations expected to occur by the end of 2014.

 

The costs related to implementing FOCUS are projected to decrease income before income taxes by approximately $5.0 million in 2014, or an $0.08 negative impact on diluted earnings per share, as compared to 2013.  FOCUS had the following impact on our condensed consolidated statements of income for the three and six months ended June 29, 2014 (in thousands):

 

 

 

Three Months

 

Six Months

 

 

 

June 29,

 

June 29,

 

 

 

2014

 

2014

 

 

 

 

 

 

 

Other sales (a)

 

$

123

 

$

135

 

Other operating expenses (b)

 

(462

)

(651

)

Depreciation and amortization (c)

 

(529

)

(579

)

Net decrease in income before income taxes

 

$

(868

)

$

(1,095

)

 

 

 

 

 

 

Diluted earnings per common share

 

$

(0.01

)

$

(0.02

)

 


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

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

(c)          Includes depreciation expense for both the capitalized software and for equipment installed at Company-owned restaurants.

 

Total income before income taxes and other measures excluding FOCUS system rollout costs included within this filing are not measures defined by GAAP. These non-GAAP measures should not be construed as substitutes for or better indicators of the company’s performance than the company’s GAAP results. Management believes presenting income before income taxes and other measures excluding the FOCUS system rollout costs is important for purposes of comparison to prior year results and analyzing each segment’s operating results. In addition, management uses these non-GAAP measures to allocate resources and analyze trends and underlying operating performance of the Company.

 

As part of the rollout, we have partnered with a third party to offer a financing option for this system to our franchisees.  The arrangement with the third party requires us to offer a guarantee for the loans.  The term of these loans will be five years or less and will require us to perform under the guarantee when a franchisee has a late payment in excess of 60 days. The guarantee is limited to the greater of 10% of all loans or 100% of all loans that have higher risk profiles.  Higher risk loan profiles are determined based on pre-established criteria including length of time in business, credit rating, and other factors.  As part of this program, we have the ability to decline funding on higher risk loans.

 

We will record a liability for the estimated fair value of the guarantee.  As of June 29, 2014, we have no recorded liability as the FOCUS franchise rollout has just started.

 

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Results of Operations

 

Summary of Operating Results - Segment Review

 

Discussion of Revenues

 

Consolidated revenues were $380.9 million for the three months ended June 29, 2014, an increase of $31.7 million, or 9.1%, over the corresponding 2013 period. For the six months ended June 29, 2014, total revenues were $782.2 million, an increase of $77.5 million, or 11.0%, over the corresponding 2013 period. The increases in revenues for the three and six months ended June 29, 2014, were primarily due to the following:

 

·                  Domestic Company-owned restaurant sales increased $14.8 million, or 9.6%, and $35.1 million, or 11.2% for the three and six months ended June 29, 2014, respectively, primarily due to increases of 7.5% and 9.5% in comparable sales. “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 $750,000, or 3.7%, and $2.6 million or 6.4%, for the three and six months ended June 29, 2014, respectively, primarily due to increases of 5.4% and 7.2% in comparable sales, partially offset by increases in royalty incentives to franchisees for meeting certain development and performance targets.

·                  Domestic commissary sales increased $10.6 million, or 7.6%, and $30.7 million, or 10.8%, for the three and six months ended June 29, 2014, respectively, due to increases in the prices of certain commodities, primarily cheese, and increases in sales volumes for the six-month period.

·                  International royalties and franchise and development fees increased approximately $900,000, or 17.2%, and $1.6 million, or 15.7%, for the three and six months ended June 29, 2014, respectively, primarily due to increases in the number of restaurants and increases in comparable sales of 8.6% and 7.6%, calculated on a constant dollar basis.

·                  International restaurant and commissary sales increased $3.5 million, or 22.3%, and $6.5 million, or 21.2%, respectively, primarily due to increases in China Company-owned restaurant sales, due to increases in units, and increases in our United Kingdom commissary revenues, due to increases in units and higher comparable sales.

 

Discussion of Operating Results

 

Second quarter 2014 income before income taxes was $26.2 million compared to $26.6 million in the prior year comparable period, or a decrease of $372,000, or 1.4%. Excluding FOCUS rollout costs of $868,000, income before income taxes increased $496,000, or 1.9%. Income before income taxes was $57.6 million for the six months ended June 29, 2014, compared to $56.9 million for the prior year comparable period, or an increase of $741,000, or 1.3%. Excluding FOCUS rollout costs of $1.1 million, income before income taxes increased $1.8 million, or 3.2%. See the FOCUS System section for additional information.

 

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Table of Contents

 

Income before income taxes is summarized in the following table on a reporting segment basis (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 29,

 

June 30,

 

Increase

 

June 29,

 

June 30,

 

Increase

 

 

 

2014

 

2013

 

(Decrease)

 

2014

 

2013

 

(Decrease)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

10,651

 

$

8,175

 

$

2,476

 

$

23,936

 

$

19,131

 

$

4,805

 

Domestic commissaries

 

6,846

 

9,642

 

(2,796

)

17,277

 

19,805

 

(2,528

)

North America franchising

 

17,882

 

17,396

 

486

 

37,366

 

35,618

 

1,748

 

International

 

1,903

 

866

 

1,037

 

2,635

 

1,207

 

1,428

 

All others

 

(442

)

1,153

 

(1,595

)

148

 

1,812

 

(1,664

)

Unallocated corporate expenses

 

(10,702

)

(10,413

)

(289

)

(23,163

)

(19,931

)

(3,232

)

Elimination of intersegment losses (profits)

 

98

 

(211

)

309

 

(553

)

(737

)

184

 

Total income before income taxes

 

$

26,236

 

$

26,608

 

$

(372

)

$

57,646

 

$

56,905

 

$

741

 

FOCUS system rollout costs (a)

 

868

 

 

868

 

1,095

 

 

1,095

 

Total income before income taxes, excluding FOCUS system rollout costs (b)

 

$

27,104

 

$

26,608

 

$

496

 

$

58,741

 

$

56,905

 

$

1,836

 

 


(a)         See the FOCUS System section for additional information.

(b)         Represents a measure that is not defined by accounting principles generally accepted in the United States (“GAAP”) . See the FOCUS System section for additional information.

 

The decrease of $372,000, or 1.4%, and increase of $741,000, or 1.3%, including FOCUS rollout costs, for the three- and six-month periods, respectively, were primarily due to the following:

 

·                  Domestic Company-owned Restaurant Segment. Domestic Company-owned restaurants’ income before income taxes increased approximately $2.5 million and $4.8 million for the three and six months ended June 29, 2014, respectively, compared to the corresponding prior year periods. The increases were primarily due to the 7.5% and 9.5% increases in comparable sales, partially offset by the impact of higher commodity costs. The market price for cheese averaged $2.13 and $2.17 per pound for the three- and six-month periods in 2014, compared to $1.78 and $1.72 per pound in the prior year comparable periods.

 

·                  Domestic Commissary Segment. Domestic commissaries’ income before income taxes decreased approximately $2.8 million and $2.5 million for the three and six months ended June 29, 2014, respectively, compared to the corresponding prior year periods. The decrease for the three-month period was primarily due to a lower margin of approximately $800,000, higher insurance claims costs of approximately $1.1 million and higher costs associated with various ongoing commissary initiatives. The decrease for the six-month period was due to the previously mentioned higher costs, partially offset by incremental profits from higher sales. We manage commissary results on a full year basis and anticipate the 2014 full year profit margin will approximate 2013.

 

·                  North America Franchising Segment. North America Franchising income before income taxes increased $486,000 and $1.7 million for the three and six months ended June 29, 2014, respectively, compared to the corresponding prior year periods. The increases were primarily due to higher royalties from the 5.4% and 7.2% comparable sales, partially offset by the previously mentioned increases in royalty incentives.

 

·                  International Segment. Income before income taxes increased approximately $1.0 million and $1.4 million for the three and six months ended June 29, 2014, respectively, compared to the corresponding prior year periods. The increases were primarily due to increases in units and comparable sales increases of 8.6% and 7.6%, which resulted in both higher royalties and increases in United Kingdom profits. These increases were partially offset by unfavorable results at our China Company-owned restaurant operations.

 

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Table of Contents

 

·                  All Others Segment. The “All Others” reporting segment, which primarily includes our online and mobile ordering business and our wholly-owned print and promotions subsidiary, Preferred Marketing Solutions, decreased approximately $1.6 million and $1.7 million for the three and six months ended June 29, 2014, respectively, compared to the corresponding prior year periods. The decreases were primarily due to higher infrastructure costs to support our digital ordering business and a lower margin at our print and promotions business from a discounted direct mail campaign provided to domestic franchised restaurants.

 

·                  Unallocated Corporate Expenses. Unallocated corporate expenses increased approximately $300,000 and $3.2 million for the three and six months ended June 29, 2014, respectively, compared to the corresponding 2013 periods. The components of unallocated corporate expenses were as follows (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 29,

 

June 30,

 

Increase

 

June 29,

 

June 30,

 

Increase

 

 

 

2014

 

2013

 

(Decrease)

 

2014

 

2013

 

(Decrease)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

General and administrative (a)

 

$

8,146

 

$

8,358

 

$

(212

)

$

18,475

 

$

17,045

 

$

1,430

 

Net interest expense (income) (b)

 

781

 

376

 

405

 

1,386

 

(283

)

1,669

 

Depreciation

 

1,839

 

1,638

 

201

 

3,614

 

3,391

 

223

 

Other (income) expense

 

(502

)

41

 

(543

)

(895

)

(222

)

(673

)

FOCUS system rollout costs (c)

 

438

 

 

438

 

583

 

 

583

 

Total unallocated corporate expenses

 

$

10,702

 

$

10,413

 

$

289

 

$

23,163

 

$

19,931

 

$

3,232

 

 


(a)         The increase in unallocated general and administrative costs for the six-month period was primarily due to higher salaries and benefits and equity compensation costs.

(b)         The increase in net interest expense (income) was primarily due to a higher average outstanding debt balance with a higher effective interest rate. Additionally, the 2013 six-month period included an approximate $773,000 benefit from a decrease in the redemption value of a mandatorily redeemable noncontrolling interest in a joint venture.

(c)          Includes depreciation expense for capitalized FOCUS software costs and other costs to support the rollout of the program.

 

Diluted earnings per share were as follows for the three and six months ended June 29, 2014 and June 30, 2013:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 29,
2014

 

June 30,
2013

 

Increase

 

June 29,
2014

 

June 30,
2013

 

Increase

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share as reported (a)

 

$

0.40

 

$

0.39

 

$

0.01

 

$

0.85

 

$

0.81

 

$

0.04

 

FOCUS system rollout costs

 

0.01

 

 

0.01

 

0.02

 

 

0.02

 

Diluted earnings per share, excluding Focus system rollout costs (b)

 

$

0.41

 

$

0.39

 

$

0.02

 

$

0.87

 

$

0.81

 

$

0.06

 

 


(a)         Diluted earnings per share increased $0.02 and $0.05 for the three- and six-month periods, respectively, due to reductions in shares outstanding (a 5.7% reduction for the three-month period and a 6.1% reduction for the six-month period).

(b)         Represents a measure that is not defined by GAAP. See the FOCUS System section for additional information.

 

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Table of Contents

 

Review of Consolidated Operating Results

 

Revenues. Domestic Company-owned restaurant sales were $170.0 million for the three months ended June 29, 2014, compared to $155.2 million for the same period in 2013, and $348.2 million for the six months ended June 29, 2014, compared to $313.1 million for the same period in 2013.  The increases of $14.8 million and $35.1 million were primarily due to the previously mentioned increases of 7.5% and 9.5% in comparable sales and increases of 2.5% and 2.3% in equivalent units during the three and six months ended June 29, 2014, respectively. “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 royalties were $21.0 million and $43.6 million for the three and six months ended June 29, 2014, respectively, representing increases of approximately $750,000, or 3.7%, and $2.6 million, or 6.4%, from the comparable periods in the prior year. The increases in royalties were primarily due the previously mentioned increases of 5.4% and 7.2% in comparable sales and increases of 1.1% and 1.5% in equivalent units during the three and six months ended June 29, 2014, partially offset by increases in royalty incentives for meeting certain development and performance targets.  North America franchise sales increased 6.6% to $496.7 million for the three months ended June 29, 2014, compared to $466.2 million for the same period in 2013, and increased 8.5% to $1.03 billion for the six months ended June 29, 2014, compared to $946.3 million for the same period in 2013. 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.

 

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Table of Contents

 

The comparable sales base and average weekly sales for 2014 and 2013 for domestic Company-owned and North America franchised restaurants consisted of the following:

 

 

 

Three Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

 

 

Company

 

Franchised

 

Company

 

Franchised

 

 

 

 

 

 

 

 

 

 

 

Total domestic units (end of period)

 

672

 

2,614

 

654

 

2,588

 

Equivalent units

 

664

 

2,518

 

648

 

2,493

 

Comparable sales base units

 

643

 

2,295

 

633

 

2,266

 

Comparable sales base percentage

 

96.9

%

91.1

%

97.7

%

90.9

%

Average weekly sales - comparable units

 

$

19,923

 

$

15,654

 

$

18,604

 

$

14,885

 

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

 

$

13,084

 

$

10,226

 

$

10,880

 

$

9,381

 

Average weekly sales - all units

 

$

19,710

 

$

15,173

 

$

18,430

 

$

14,383

 

 

 

 

Six Months Ended

 

 

 

June 29, 2014

 

June 30, 2013

 

 

 

Company

 

Franchised

 

Company

 

Franchised

 

 

 

 

 

 

 

 

 

 

 

Total domestic units (end of period)

 

672

 

2,614

 

654

 

2,588

 

Equivalent units

 

660

 

2,522

 

646

 

2,486

 

Comparable sales base units

 

641

 

2,298

 

633

 

2,253

 

Comparable sales base percentage

 

97.1

%

91.1

%

98.0

%

90.6

%

Average weekly sales - comparable units

 

$

20,503

 

$

16,166

 

$

18,794

 

$

15,136

 

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

 

$

13,133

 

$

10,426

 

$

11,495

 

$

9,870

 

Average weekly sales - all units

 

$

20,289

 

$

15,656

 

$

18,652

 

$

14,643

 

 


(a)         Includes 157 traditional and 191 non-traditional units as of June 29, 2014 and 175 traditional and 169 non-traditional units as of June 30, 2013.

 

Domestic commissary sales increased 7.6% to $150.6 million for the three months ended June 29, 2014, from $140.0 million in the comparable 2013 period and increased 10.8% to $314.6 million for the six months ended June 29, 2014, from $283.9 million in the comparable 2013 period. The increases were primarily due to increases in the prices of certain commodities, primarily cheese, and increases in restaurant sales volumes for the six-month period.

 

Other sales increased approximately $1.2 million, or 9.2%, and $1.3 million, or 5.2%, for the three and six months ended June 29, 2014, respectively, primarily due to increases in equipment sales to franchisees.

 

International royalties and franchise and development fees increased approximately $900,000, or 17.2%, for the three months ended June 29, 2014, and increased $1.6 million, or 15.7%, for the six months ended June 29, 2014, from the prior comparable periods. The increases were due to increases in units and comparable sales of 8.6% and 7.6%, calculated on a constant dollar basis, for the three- and six-month periods, respectively. International franchise sales were $140.1 million for the three months ended June 29, 2014, compared to $110.8 million for the same period in 2013, and $270.9 million for the six months ended June 29, 2014, compared to $218.4 million for the same period in 2013.  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 $3.5 million, or 22.3%, for the three months ended June 29, 2014, and increased $6.5 million, or 21.2%, for the six months ended June 29, 2014, from the prior comparable periods. The increases are due to increases in China Company-owned restaurant sales, due to increases in units, and increases in our United Kingdom commissary revenues, due to both increases in units and higher comparable sales at our franchised United Kingdom restaurants.

 

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Table of Contents

 

Costs and expenses.  The restaurant operating margins for domestic Company-owned units were relatively consistent at 18.9% for the three months ended June 29, 2014, compared to 18.8% for the same period in 2013, and 19.2% for the six months ended June 29, 2014, compared to 19.3% for the same period in 2013. The margins were comprised of the following changes for the three and six months ended June 29, 2014:

 

·                  Cost of sales was 0.3% and 1.1% higher for the three and six months ended June 29, 2014, as compared to the same periods in 2013, primarily due to higher commodity costs, primarily cheese and meats, somewhat offset by a higher ticket average.

·                  Salaries and benefits were 0.2% and 0.4% lower as a percentage of sales for the three and six months ended June 29, 2014, as compared to the same periods in 2013. The decreases were primarily due to the benefit of higher sales.

·                  Advertising and related costs as a percentage of sales were 0.4% and 0.3% lower for the three and six months ended June 29, 2014, as compared to the same periods in 2013, primarily due to the benefit of higher sales.

·                  Occupancy costs and other operating costs, on a combined basis, were relatively consistent (20.4% and 20.3% for the three months ended June 29, 2014 and June 30, 2013, respectively, and 19.9% and 20.0% for the six months ended June 29, 2014 and June 30, 2013, respectively).

 

Domestic commissary margin was 6.0% for the three months ended June 29, 2014, compared to 7.9% for the corresponding period in 2013, and 6.8% for the six months ended June 29, 2014, compared to 7.9% for the corresponding period in 2013 and consisted of the following differences:

 

·                  Cost of sales was 1.8% and 1.6% higher as a percentage of sales for the three and six months ended June 29, 2014 primarily due to higher cheese costs, which have a fixed-dollar markup. As cheese prices are higher, food cost as a percentage of sales is higher. In addition, commissary margins were lower for the three-month period.

·                  Salaries and benefits were 4.5% and 4.3% for the three-month periods of 2014 and 2013, respectively, and 4.4% and 4.3% for the six-month periods of 2014 and 2013, respectively. The higher costs were attributable to ongoing commissary initiatives, including in-house distribution.

·                  Other commissary operating expenses were 0.1% and 0.6% lower as a percentage of sales. The lower operating expenses as a percentage of sales were due to higher sales from higher commodities, including cheese prices. Total operating expenses increased in dollars primarily due to higher insurance claims costs of $1.1 million.

 

International restaurant and commissary expenses were 82.4% of international restaurant and commissary sales in the second quarter of 2014 as compared to 82.5% in the second quarter of 2013 and were 82.9% for the six months ended June 29, 2014 as compared to 83.8% for the corresponding 2013 period. The decreases as a percentage of sales were primarily due to lower operating expenses in the United Kingdom primarily due to the benefit of higher sales.

 

General and administrative (“G&A”) costs of $33.6 million, or 8.8%, of revenues for the three months ended June 29, 2014, were relatively consistent with G&A costs of $33.1 million, or 9.5%, of revenues for the same period in 2013. G&A costs were $70.5 million, or 9.0%, of revenues for the six months ended June 29, 2014, compared to $66.3 million, or 9.4%, of revenues for the same period in 2013. The increase of $4.2 million for the six-month period was primarily due to the following:

 

·                  Unallocated corporate general and administrative expenses increased due to higher salaries and benefits and equity compensation costs.

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

·                  International general and administrative costs increased due to infrastructure and promotional activity costs.

·                  Domestic commissaries general and administrative costs increased due to higher salaries, benefits and travel costs to support in-house distribution and other on-going commissary initiatives.

 

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Table of Contents

 

Other general expenses reflected net expense of $2.0 million for the three months ended June 29, 2014, compared to $1.6 million for the comparable period in 2013, and $3.5 million for the six months ended June 29, 2014, compared to $2.8 million for the comparable period in 2013, as detailed below (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 29,

 

June 30,

 

Increase

 

June 29,

 

June 30,

 

Increase

 

 

 

2014

 

2013

 

(Decrease)

 

2014

 

2013

 

(Decrease)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Franchise and development incentives (a)

 

$

1,229

 

$

1,050

 

$

179

 

$

2,532

 

$

2,111

 

$

421

 

Supplier marketing income

 

(250

)

(250

)

 

(500

)

(500

)

 

Other

 

985

 

797

 

188

 

1,465

 

1,171

 

294

 

Total other general expenses

 

$

1,964

 

$

1,597

 

$

367

 

$

3,497

 

$

2,782

 

$

715

 

 


(a)         Represents incentives provided to domestic franchisees for opening new restaurants.

 

Depreciation and amortization was $9.9 million (2.6% of revenues) for the three months ended June 29, 2014, compared to $8.5 million (2.4% of revenues) for the same 2013 period, and $19.0 million (2.4% of revenues) for the six months ended June 29, 2014, compared to $17.1 million (2.4% of revenues) for the 2013 period. The increases in depreciation expense were due to incremental depreciation related to both our New Jersey dough production capital expenditures and our FOCUS capitalized software costs and equipment costs at Company-owned restaurants.

 

Net interest (expense) income. Net interest (expense) income consisted of the following for the three and six months ended June 29, 2014 and June 30, 2013 (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 29,

 

June 30,

 

(Increase)

 

June 29,

 

June 30,

 

(Increase)

 

 

 

2014

 

2013

 

Decrease

 

2014

 

2013

 

Decrease

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense - line of credit (a)

 

$

(975

)

$

(457

)

$

(518

)

$

(1,711

)

$

(779

)

$

(932

)

Investment income

 

164

 

153

 

11

 

335

 

338

 

(3

)

Change in redemption value of mandatorily redeemable noncontrolling interest in a joint venture (b)

 

48

 

(36

)

84

 

21

 

773

 

(752

)

Net interest (expense) income

 

$

(763

)

$

(340

)

$

(423

)

$

(1,355

)

$

332

 

$

(1,687

)

 


(a)         The increase in interest expense for the three and six months ended June 29, 2014 was due to a higher average outstanding debt balance and a higher effective interest rate.

(b)   &