Papa John‘s International, Inc.
PAPA JOHNS INTERNATIONAL INC (Form: 10-Q, Received: 05/08/2018 16:37:35)

Table of Contents

 

C:/USERS/JENNIFER_MCALLISTER/DESKTOP/PJ_SECONDARY_LOGO_CMYK.JPG

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

(Mark One)

 

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

 

For the quarterly period ended April 1, 2018

 

OR

 

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 John’s 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 ☒  No ☐

 

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 ☒  No ☐

 

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

Large accelerated filer ☒

    

Accelerated filer ☐

Non-accelerated filer ☐

 

Smaller reporting company ☐

 

 

Emerging growth company ☐

If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 ☐  No ☒

 

At May 1, 2018, there were outstanding 32,193,319 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 — April 1, 2018 and December 31, 2017

3

 

 

 

 

Condensed Consolidated Statements of Income — Three months ended April 1, 2018 and March 26, 2017

4

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income — Three months ended April 1, 2018 and March 26, 2017

5

 

 

 

 

Condensed Consolidated Statements of Cash Flows — Three months ended April 1, 2018 and March 26, 2017

6

 

 

 

 

Notes to Condensed Consolidated Financial Statements

7

 

 

 

Item 2.  

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

24

 

 

 

Item 3.  

Quantitative and Qualitative Disclosures About Market Risk

31

 

 

 

Item 4.  

Controls and Procedures

33

 

 

 

PART II.  

OTHER INFORMATION

 

 

 

 

Item 1.  

Legal Proceedings

33

 

 

 

Item 1A.  

Risk Factors

33

 

 

 

Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

34

 

 

 

Item 6.  

Exhibits

35

 

 

2

 


 

Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

 

 

 

 

 

 

 

 

 

    

April 1,

    

December 31,

(In thousands, except per share amounts)

 

2018

 

2017

 

 

(Unaudited)

 

 

Assets

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

31,935

 

$

22,345

Accounts receivable, net

 

 

62,949

 

 

64,644

Notes receivable, net

 

 

4,662

 

 

4,333

Income tax receivable

 

 

 —

 

 

3,903

Inventories

 

 

28,285

 

 

30,620

Prepaid expenses

 

 

27,990

 

 

28,522

Other current assets

 

 

17,529

 

 

9,494

Assets held for sale

 

 

5,900

 

 

6,133

Total current assets

 

 

179,250

 

 

169,994

Property and equipment, net

 

 

229,576

 

 

234,331

Notes receivable, less current portion, net

 

 

16,084

 

 

15,568

Goodwill

 

 

86,746

 

 

86,892

Deferred income taxes, net

 

 

614

 

 

585

Other assets

 

 

67,547

 

 

48,183

Total assets

 

$

579,817

 

$

555,553

 

 

 

 

 

 

 

Liabilities and stockholders’ equity (deficit)

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

 

$

31,072

 

$

32,006

Income and other taxes payable

 

 

10,094

 

 

10,561

Accrued expenses and other current liabilities

 

 

92,890

 

 

70,293

Deferred revenue current

 

 

2,400

 

 

 —

     Current portion of long-term debt

 

 

20,000

 

 

20,000

Total current liabilities

 

 

156,456

 

 

132,860

Deferred revenue

 

 

13,671

 

 

2,652

Long-term debt, less current portion, net

 

 

568,770

 

 

446,565

Deferred income taxes, net

 

 

6,125

 

 

12,546

Other long-term liabilities

 

 

76,993

 

 

60,146

Total liabilities

 

 

822,015

 

 

654,769

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

 

7,037

 

 

6,738

 

 

 

 

 

 

 

Stockholders’ equity (deficit):

 

 

 

 

 

 

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

 

 

 —

 

 

 —

Common stock ($0.01 par value per share; issued 44,268 at April 1, 2018 and 44,221

 

 

 

 

 

 

    at December 31, 2017)

 

 

443

 

 

442

Additional paid-in capital

 

 

163,198

 

 

184,785

Accumulated other comprehensive income (loss)

 

 

4,110

 

 

(2,117)

Retained earnings

 

 

280,853

 

 

292,251

Treasury stock (12,245 shares at April 1, 2018 and 10,290 shares at

 

 

 

 

 

 

    December 31, 2017, at cost)

 

 

(714,097)

 

 

(597,072)

Total stockholders’ equity (deficit), net of noncontrolling interests

 

 

(265,493)

 

 

(121,711)

Noncontrolling interests in subsidiaries

 

 

16,258

 

 

15,757

Total stockholders’ equity (deficit) 

 

 

(249,235)

 

 

(105,954)

Total liabilities, redeemable noncontrolling interests and stockholders’ equity (deficit)

 

$

579,817

 

$

555,553

 

 

See accompanying notes.

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Table of Contents

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(Unaudited)

 

 

 

 

 

 

 

 

 

    

Three Months Ended

 

 

April 1,

 

March 26,

(In thousands, except per share amounts)

    

2018

    

2017

Revenues:

 

 

 

 

 

 

Domestic Company-owned restaurant sales

 

$

190,242

 

$

206,896

North America franchise royalties and fees

 

 

24,806

 

 

27,607

North America commissary

 

 

161,713

 

 

171,340

International

 

 

30,114

 

 

25,622

Other revenues

 

 

20,494

 

 

17,801

Total revenues

 

 

427,369

 

 

449,266

Costs and expenses:

 

 

 

 

 

 

Operating costs (excluding depreciation and amortization shown separately below):

 

 

 

 

 

 

Domestic Company-owned restaurant expenses

 

 

157,319

 

 

165,419

North America commissary

 

 

151,681

 

 

159,957

International expenses

 

 

19,030

 

 

15,791

Other expenses

 

 

20,958

 

 

17,547

General and administrative expenses

 

 

39,729

 

 

36,414

Depreciation and amortization

 

 

11,539

 

 

10,457

Total costs and expenses

 

 

400,256

 

 

405,585

Refranchising gain, net

 

 

204

 

 

 —

Operating income

 

 

27,317

 

 

43,681

Net Interest expense

 

 

(4,955)

 

 

(1,810)

Income before income taxes

 

 

22,362

 

 

41,871

Income tax expense

 

 

4,982

 

 

11,972

Net income before attribution to noncontrolling interests

 

 

17,380

 

 

29,899

Income attributable to noncontrolling interests

 

 

(643)

 

 

(1,471)

Net income attributable to the Company

 

$

16,737

 

$

28,428

 

 

 

 

 

 

 

Calculation of income for earnings per share:

 

 

 

 

 

 

Net income attributable to the Company

 

$

16,737

 

$

28,428

Change in noncontrolling interest redemption value

 

 

 —

 

 

520

Net income attributable to participating securities

 

 

(75)

 

 

(117)

Net income attributable to common shareholders

 

$

16,662

 

$

28,831

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.50

 

$

0.78

Diluted earnings per common share

 

$

0.50

 

$

0.77

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

 

33,279

 

 

36,810

Diluted weighted average common shares outstanding

 

 

33,552

 

 

37,350

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.225

 

$

0.200

 

See accompanying notes.

 

 

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Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

April 1,

 

March 26,

(In thousands)

    

2018

    

2017

 

 

 

 

 

 

 

Net income before attribution to noncontrolling interests

 

$

17,380

 

$

29,899

Other comprehensive income (loss), before tax:

 

 

 

 

 

 

Foreign currency translation adjustments

 

 

1,983

 

 

613

Interest rate swaps (1)

 

 

6,718

 

 

(468)

Other comprehensive income (loss), before tax

 

 

8,701

 

 

145

Income tax effect:

 

 

 

 

 

 

Foreign currency translation adjustments

 

 

(473)

 

 

(227)

Interest rate swaps (2)

 

 

(1,545)

 

 

173

Income tax effect (3)

 

 

(2,018)

 

 

(54)

Other comprehensive income (loss), net of tax

 

 

6,683

 

 

91

Comprehensive income before attribution to noncontrolling interests

 

 

24,063

 

 

29,990

Less: comprehensive income, redeemable noncontrolling interests

 

 

344

 

 

(794)

Less: comprehensive income, nonredeemable noncontrolling interests

 

 

299

 

 

(677)

Comprehensive income attributable to the Company

 

$

24,706

 

$

28,519

 


(1)

Amounts reclassified out of accumulated other comprehensive income (loss) into net interest expense included $108 and $198 for the three months ended April 1, 2018 and March 26, 2017, respectively.

 

(2)

The income tax effects of amounts reclassified out of accumulated other comprehensive income (loss) into net interest expense were $25 and $73 for the three months ended April 1, 2018 and March 26, 2017, respectively.

 

(3)

As of January 1, 2018, we adopted ASU 2018-02, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,” and reclassified stranded tax effects of approximately $450 to retained earnings.  See “Note 2” of “Notes to Condensed Consolidated Financial Statements” for additional information. 

 

See accompanying notes.

 

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Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

April 1,

 

March 26,

(In thousands)

    

2018

    

2017

Operating activities

 

 

 

 

 

 

Net income before attribution to noncontrolling interests

 

$

17,380

 

$

29,899

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

 

 

 

 

 

 

Provision for uncollectible accounts and notes receivable

 

 

1,539

 

 

(417)

Depreciation and amortization

 

 

11,539

 

 

10,457

Deferred income taxes

 

 

(2,004)

 

 

1,015

Stock-based compensation expense

 

 

2,475

 

 

2,736

Gain on refranchising

 

 

(204)

 

 

 —

Other

 

 

1,903

 

 

769

Changes in operating assets and liabilities, net of acquisitions:

 

 

 

 

 

 

Accounts receivable

 

 

86

 

 

(1,048)

Income tax receivable

 

 

3,903

 

 

2,372

Inventories

 

 

2,193

 

 

2,425

Prepaid expenses

 

 

(217)

 

 

3,574

Other current assets

 

 

5,097

 

 

(134)

Other assets and liabilities

 

 

(514)

 

 

(1,577)

Accounts payable

 

 

1,209

 

 

(5,239)

Income and other taxes payable

 

 

(466)

 

 

7,817

Accrued expenses and other current liabilities

 

 

(3,103)

 

 

(5,164)

Deferred revenue

 

 

220

 

 

(156)

Net cash provided by operating activities

 

 

41,036

 

 

47,329

Investing activities

 

 

 

 

 

 

Purchases of property and equipment

 

 

(9,320)

 

 

(15,064)

Loans issued

 

 

(563)

 

 

(715)

Repayments of loans issued

 

 

1,636

 

 

863

Acquisitions, net of cash acquired

 

 

 —

 

 

(21)

Proceeds from divestitures of restaurants

 

 

3,690

 

 

 —

Other

 

 

114

 

 

 7

Net cash used in investing activities

 

 

(4,443)

 

 

(14,930)

Financing activities

 

 

 

 

 

 

Repayments of term loan

 

 

(5,000)

 

 

 —

Net proceeds (repayments) of revolving credit facility

 

 

127,000

 

 

(5,575)

Cash dividends paid

 

 

(7,565)

 

 

(7,354)

Tax payments for equity award issuances

 

 

(1,342)

 

 

(2,259)

Proceeds from exercise of stock options

 

 

1,770

 

 

3,248

Acquisition of Company common stock

 

 

(141,736)

 

 

(13,075)

Distributions to noncontrolling interest holders

 

 

(432)

 

 

(702)

Other

 

 

183

 

 

396

Net cash used in financing activities

 

 

(27,122)

 

 

(25,321)

Effect of exchange rate changes on cash and cash equivalents

 

 

119

 

 

74

Change in cash and cash equivalents

 

 

9,590

 

 

7,152

Cash and cash equivalents at beginning of period

 

 

22,345

 

 

15,563

Cash and cash equivalents at end of period

 

$

31,935

 

$

22,715

See accompanying notes.

 

 

 

 

 

 

 

 

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Papa John’s International, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

April 1, 2018

 

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 annual financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the three months ended April 1, 2018 are not necessarily indicative of the results that may be expected for the fiscal year ending December 30, 2018. 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 31, 2017.

 

2. Significant Accounting Policies

 

Noncontrolling Interests

 

Papa John’s has four joint venture arrangements in which there are noncontrolling interests held by third parties after the divestiture of one joint venture in the first quarter of 2018.  See Note 7 for more information on this divestiture.  These joint ventures include 216 restaurants at April 1, 2018.  We are required to report the 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 holders.

 

The income before income taxes attributable to these joint ventures for the three months ended April 1, 2018 and March 26, 2017 was as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

April 1,

 

March 26,

 

    

2018

    

2017

 

 

 

 

 

 

 

Papa John’s International, Inc.

 

$

1,295

 

$

2,362

Noncontrolling interests

 

 

643

 

 

1,471

Total income before income taxes

 

$

1,938

 

$

3,833

 

The following summarizes the redemption feature, location and related accounting within the condensed consolidated balance sheets for these joint venture arrangements:

 

 

 

 

 

 

 

    

 

    

 

Type of Joint Venture Arrangement

    

Location within the Balance Sheets

    

Recorded Value

 

 

 

 

 

Joint venture with no redemption feature

 

Permanent equity

 

Carrying value

Option to require the Company to purchase the noncontrolling interest - not currently redeemable

 

Temporary equity

 

Carrying value

 

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Revenue Recognition

 

Revenue is measured based on consideration specified in contracts with customers and excludes incentives and amounts collected on behalf of third parties, primarily sales tax.  The Company recognizes revenue when it satisfies a performance obligation by transferring control over a product or service to a customer.  Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by the Company from a customer, are excluded from revenue.  Delivery costs, including freight associated with our domestic commissary and other sales are accounted for as fulfillment costs and are included in operating costs.

 

As further described in Accounting Standards Adopted and Note 3, Adoption of ASU 2014-09, “Revenue from Contracts with Customers,” revenue recognition in 2018 follows ASU 2016-08, “Revenue from Contracts with Customers (Topic 606):  Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” and ASU 2016-10, “Revenue from Contracts with Customers (Topic 606):  Identifying Performance Obligations and Licensing.”  Prior year revenue recognition follows ASU Topic 605, Revenue Recognition.

 

The following describes principal activities, separated by major product or service, from which the Company generates its revenues:

 

Company-owned Restaurant Sales  

 

The domestic and international company-owned restaurants principally generate revenue from retail sales of high-quality pizza, side items including breadsticks, cheesesticks, chicken poppers and wings, dessert items and canned or bottled beverages. Revenues from Company-owned restaurants are recognized when the products are delivered to or carried out by customers.

 

Our domestic customer loyalty program, Papa Rewards, is a spend-based program that rewards customers with points for each online purchase.  Papa Rewards points are accumulated and redeemed online for free products. The accrued liability in the Condensed Consolidated Balance Sheets, and corresponding reduction of company-owned restaurant sales in the Condensed Consolidated Statements of Income is for the estimated reward redemptions at domestic company-owned restaurants based upon historical redemption patterns. The liability is calculated using the estimated selling price of the products for which rewards are expected to be redeemed. Revenue is recognized when the customer redeems points for products.  Prior to the adoption of Topic 606, the liability related to Papa Rewards was estimated using the incremental cost accrual model which was based on the expected cost to satisfy the award.  The corresponding expense was recorded in general and administrative expenses in the Condensed Consolidated Statements of Income.

 

Commissary Sales  

 

Commissary sales are comprised of food and supplies sold to franchised restaurants and are recognized as revenue upon shipment or delivery of the related products to the franchisees and payments are generally due within 30 days.

 

Franchise Royalties and Fees

 

Franchise royalties which are based on a percentage of franchise restaurant sales are recognized as sales occur.  Royalty reductions, offered as part of a new store development incentive or as incentive for other behaviors including acceleration of restaurant remodels or equipment upgrades, are recognized at the same time as the related royalty as they are not separately distinguishable from the full royalty rate. Franchise royalties are billed on a monthly basis.

 

The majority of initial franchise license fees and area development fees are from international locations.  The franchise license fees are billed at the store opening date.  Area development exclusivity fees are billed upon execution of the development agreements which grant the right to develop franchised restaurants in future periods in specific geographic areas.  Area development exclusivity fees are included in deferred revenue in the Condensed Consolidated Balance Sheets and allocated on a pro rata basis to all stores opened under that specific development agreement.  Franchise license renewal fees for both domestic and international locations, which generally occur every 10 years, are billed before the renewal date.   The pre-opening services provided to franchisees do not contain separate and distinct performance obligations from the franchise right; thus, the fees collected will be amortized on a straight-line basis

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beginning at the store opening date through the term of the franchise agreement, which is typically 10 years. Fees received for future renewal periods are amortized over the life of the renewal period.  For periods prior to adoption of Topic 606, revenue was recognized when we performed our obligations related to such fees, primarily the store opening date for initial franchise fees and area development fees, or the date the renewal option was effective for renewal fees.

 

The Company offers various incentive programs for franchisees including royalty incentives, new restaurant opening (i.e. development incentives) and other various support initiatives. Royalties, franchise fees and commissary sales are reduced to reflect any incentives earned or granted under these programs that are in the form of discounts. Other development incentives for opening restaurants are offered in the form of Company equipment through a lease agreement at substantially no cost. This equipment is amortized over the term of the lease agreement, which is generally three to five years, and is recognized in general and administrative expenses in our Condensed Consolidated Statements of Income.  The equipment lease agreement has separate and distinguishable obligations from the franchise right and is accounted for under ASC Topic 840, Leases. 

 

Other Revenues

 

Fees for information services, including software maintenance fees, help desk fees and online ordering fees are recognized as revenue as such services are provided and are included in other revenue.

 

Revenues for printing, promotional items, and direct mail marketing services are recognized upon shipment of the related products to franchisees and other customers. Direct mail advertising discounts are also periodically offered by our Preferred Marketing Solutions subsidiary. Other revenues are reduced to reflect these advertising discounts.

 

Rental income, primarily derived from properties leased by the Company and subleased to franchisees in the United Kingdom, is recognized on a straight-line basis over the respective operating lease terms, in accordance with ASC Topic 840, Leases. 

 

Franchise Marketing Fund revenues represent contributions collected by various international and domestic marketing funds where we have determined that we have control over the activities of the fund.  Contributions are based on a percentage of monthly restaurant sales.  The adoption of Topic 606 revises the determination of whether these arrangements are considered principal versus agent.  When we are determined to be the principal in these arrangements, advertising fund contributions and expenditures are reported on a gross basis in the Condensed Consolidated Statements of Income.  We expect such advertising fund contributions and expenditures will be largely offsetting and therefore do not expect a significant impact on our reported income before income taxes.  Our obligation related to these funds is to develop and conduct advertising activities in a specific country, region, or market, including the placement of electronic and print materials.  Marketing fund contributions are billed monthly.

 

For periods prior to the adoption of Topic 606, the revenues and expenses of certain international advertising funds and the Co-op Funds in which we possess majority voting rights, were included in our Condensed Consolidated Statements of Income on a net basis as we previously concluded we were the agent in regard to the funds based upon principal/agent determinations in industry-specific guidance in GAAP that was in effect during those time periods.

 

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 Papa John’s 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 attribute carryforwards (e.g., net operating losses, capital losses, and foreign tax credits). The effect on deferred taxes of changes in tax rates is recognized

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in the period in which the new tax rate is enacted. Valuation allowances are established when necessary on a jurisdictional basis to reduce deferred tax assets to the amounts we expect to realize.

 

On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was enacted, significantly decreasing the U.S. federal income tax rate for corporations effective January 1, 2018.  As a result, we remeasured our deferred tax assets, liabilities and related valuation allowances.  This remeasurement yielded a one-time benefit of approximately $7.0 million due to the lower income tax rate in 2017.  Given the substantial changes associated with the Tax Act, the estimated financial impacts for 2017 are provisional and subject to further interpretation and clarification of the Tax Act during 2018.    As of April 1, 2018, we had a net deferred income tax liability of approximately $5.5 million. 

 

In February 2018, the FASB issued ASU 2018-02, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” (“ASU 2018-02”), that allows for an entity to reclassify disproportionate income tax effects in accumulated other comprehensive income (loss) (“AOCI”) caused by the Tax Act to retained earnings. See “Accounting Standards Adopted” section below for additional details. 

 

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 or state 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 carrying value of our notes receivable, net of allowances, also approximates fair value. The fair value of the amount outstanding under our revolving credit facility approximates its carrying value due to its variable market-based interest rate. These assets and liabilities are categorized as Level 1 as defined below.

 

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

 

·

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

·

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

·

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

 

Our financial assets that were measured at fair value on a recurring basis as of April 1, 2018 and December 31, 2017 are as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Carrying

 

Fair Value Measurements

 

 

    

Value

    

Level 1

    

Level 2

    

Level 3

 

April 1, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash surrender value of life insurance policies (a)

 

$

28,469

 

$

28,469

 

$

 —

 

$

 —

 

Interest rate swaps (b)

 

 

7,369

 

 

 —

 

 

7,369

 

 

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash surrender value of life insurance policies (a)

 

$

28,645

 

$

28,645

 

$

 —

 

$

 —

 

Interest rate swaps (b)

 

 

651

 

 

 —

 

 

651

 

 

 —

 


(a)

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

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(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”).

 

Our assets and liabilities that were measured at fair value on a non-recurring basis as of April 1, 2018 and December 31, 2017 include assets and liabilities held for sale.  The fair value was determined using a market-based approach with unobservable inputs (Level 3) less any estimated selling costs. 

 

There were no transfers among levels within the fair value hierarchy during the three months ended April 1, 2018.

 

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, consolidation of PJMF is not appropriate.

 

Accounting Standards Adopted

 

Revenue from Contracts with Customers

 

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”), which supersedes nearly all existing revenue recognition guidance under GAAP, including industry-specific requirements, and provides companies with a single revenue recognition framework for recognizing revenue from contracts with customers. In March and April 2016, the FASB issued Topic 606.   This update and subsequently issued amendments require companies to recognize revenue at amounts that reflect the consideration to which the companies expect to be entitled in exchange for those goods or services at the time of transfer. Topic 606 requires that we assess contracts to determine each separate and distinct performance obligation.  If a contract has multiple performance obligations, we allocate the transaction price using our best estimate of the standalone selling price to each distinct good or service in the contract.

 

The Company adopted Topic 606 as of January 1, 2018. See Note 3 for additional information.

 

Certain Tax effects from Accumulated Other Comprehensive Income

 

In February 2018, the FASB issued ASU 2018-02, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” (“ASU 2018-02”), guidance that allows for an entity to reclassify disproportionate income tax effects in accumulated other comprehensive income (“AOCI”) caused by the Tax Act to retained earnings.  The guidance is effective for fiscal years beginning after December 15, 2018 with early adoption permitted, including interim periods within those years.  The Company adopted ASU 2018-02 in the first quarter of 2018 by electing to reclassify the income tax effects from AOCI to retained earnings.  The impact of the adoption was not material to our condensed consolidated financial statements.

 

Accounting Standards to be Adopted in Future Periods

 

Leases

 

In February 2016, the FASB issued ASU 2016-02, “Leases,” (“ASU 2016-02”), which amends leasing guidance by requiring companies to recognize a right-of-use asset and a lease liability for all operating and capital leases (financing) with lease terms greater than twelve months.  The lease liability will be equal to the present value of lease payments. The lease asset will be based on the lease liability, subject to adjustment, such as for initial direct costs.  For income statement purposes, leases will continue to be classified as operating or capital (financing) with lease expense in both

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cases calculated substantially the same as under the prior leasing guidance. ASU 2016-02 is effective for interim and annual periods beginning after December 15, 2018 (fiscal 2019 for the Company), and early adoption is permitted.  The Company has not yet determined the full impact of the adoption on its consolidated financial statements but expects the adoption will result in a significant increase in the non-current assets and liabilities reported on our Consolidated Balance Sheet. 

 

Reclassification

 

Certain prior year amounts have been reclassified in the Condensed Consolidated Statement of Income.  See Note 10 for additional information.

 

3.  Adoption of ASU 2014-09, “Revenue from Contracts with Customers”

 

The Company adopted ASU 2014-09 and Topic 606 using the modified retrospective transition method effective January 1, 2018.  Results for reporting periods beginning after January 1, 2018 are presented in accordance with Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historical accounting under Topic 605, Revenue Recognition. 

 

The cumulative effect adjustment of $21.5 million was recorded as a reduction to retained earnings as of January 1, 2018 to reflect the impact of adopting Topic 606.   The impact of applying Topic 606 for the quarter ended April 1, 2018, was an increase in revenues of $2.4 million and a decrease of $0.5 million in pre-tax income.

 

The adoption of Topic 606 did not impact the recognition and reporting of our three largest sources of revenue: sales from Company-owned restaurants, commissary sales, or continuing royalties or other revenues from franchisees that are based on a percentage of the franchise sales.  The items impacted by the adoption include the presentation and amount of our loyalty program costs, the timing of franchise and development fees revenue recognition, and the presentation of various Domestic co-operative and International advertising funds as further described below.

 

Cumulative adjustment from adoption

 

As noted above, an after-tax reduction of $21.5 million was recorded to retained earnings to reflect the cumulative impact of adopting Topic 606. This is comprised of $10.8 million related to franchise fees, $8.0 million related to the customer loyalty program and $2.7 million related to marketing funds.

 

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The following chart presents the specific line items impacted by the cumulative adjustment.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Adjusted

 

 

As Reported

 

 

 

 

 

Balance Sheet

 

    

December 31,

    

 

Total

 

 

at January 1,

(In thousands, except per share amounts)

 

2017

 

 

Adjustments

 

 

2018

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

22,345

 

$

4,279

 

$

26,624

Accounts receivable, net

 

 

64,644

 

 

493

 

 

65,137

Notes receivable, net

 

 

4,333

 

 

 —

 

 

4,333

Income tax receivable

 

 

3,903

 

 

 —

 

 

3,903

Inventories

 

 

30,620

 

 

 —

 

 

30,620

Prepaid expenses

 

 

28,522

 

 

(4,959)

 

 

23,563

Other current assets

 

 

9,494

 

 

 —

 

 

9,494

Assets held for sale

 

 

6,133

 

 

 —

 

 

6,133

Total current assets

 

 

169,994

 

 

(187)

 

 

169,807

Property and equipment, net

 

 

234,331

 

 

 —

 

 

234,331

Notes receivable, less current portion, net

 

 

15,568

 

 

 —

 

 

15,568

Goodwill

 

 

86,892

 

 

 —

 

 

86,892

Deferred income taxes, net

 

 

585

 

 

 —

 

 

585

Other assets

 

 

48,183

 

 

(907)

 

 

47,276

Total assets

 

$

555,553

 

$

(1,094)

 

$

554,459

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity (deficit)

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

32,006

 

$

(2,161)

 

$

29,845

Income and other taxes payable

 

 

10,561

 

 

 —

 

 

10,561

Accrued expenses and other current liabilities

 

 

70,293

 

 

15,860

 

 

86,153

Deferred revenue current

 

 

 —

 

 

2,400

 

 

2,400

     Current portion of long-term debt

 

 

20,000

 

 

 —

 

 

20,000

Total current liabilities

 

 

132,860

 

 

16,099

 

 

148,959

Deferred revenue

 

 

2,652

 

 

10,798

 

 

13,450

Long-term debt, less current portion, net

 

 

446,565

 

 

 —

 

 

446,565

Deferred income taxes, net

 

 

12,546

 

 

(6,464)

 

 

6,082

Other long-term liabilities

 

 

60,146

 

 

 —

 

 

60,146

Total liabilities

 

 

654,769

 

 

20,433

 

 

675,202

 

 

 

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

 

6,738

 

 

 —

 

 

6,738

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity (deficit):

 

 

 

 

 

 

 

 

 

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

 

 

 —

 

 

 —

 

 

 —

Common stock ($0.01 par value per share; issued 44,221 at December 31, 2017

 

 

442

 

 

 —

 

 

442

Additional paid-in capital

 

 

184,785

 

 

 —

 

 

184,785

Accumulated other comprehensive loss

 

 

(2,117)

 

 

 —

 

 

(2,117)

Retained earnings

 

 

292,251

 

 

(21,527)

 

 

270,724

Treasury stock (10,290 shares at December 31, 2017, at cost)

 

 

(597,072)

 

 

 —

 

 

(597,072)

Total stockholders’ equity (deficit), net of noncontrolling interests

 

 

(121,711)

 

 

(21,527)

 

 

(143,238)

Noncontrolling interests in subsidiaries

 

 

15,757

 

 

 —

 

 

15,757

Total stockholders’ equity (deficit) 

 

 

(105,954)

 

 

(21,527)

 

 

(127,481)

Total liabilities, redeemable noncontrolling interests and stockholders’ equity (deficit)

 

$

555,553

 

$

(1,094)

 

$

554,459

 

 

 

 

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The impact of adoption for the first quarter of 2018 is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As Reported

 

 

 

 

 

Balance Sheet

 

    

April 1,

    

 

Total

 

 

Without Adoption

(In thousands, except per share amounts)

 

2018

 

 

Adjustments

 

 

of Topic 606

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

31,935

 

$

(3,422)

 

$

28,513

Accounts receivable, net

 

 

62,949

 

 

(376)

 

 

62,573

Notes receivable, net

 

 

4,662

 

 

 —

 

 

4,662

Income tax receivable

 

 

 —

 

 

 —

 

 

 —

Inventories

 

 

28,285

 

 

 —

 

 

28,285

Prepaid expenses

 

 

27,990

 

 

4,398

 

 

32,388

Other current assets

 

 

17,529

 

 

 —

 

 

17,529

Assets held for sale

 

 

5,900

 

 

 —

 

 

5,900

Total current assets

 

 

179,250

 

 

600

 

 

179,850

Property and equipment, net

 

 

229,576

 

 

 —

 

 

229,576

Notes receivable, less current portion, net

 

 

16,084

 

 

 —

 

 

16,084

Goodwill

 

 

86,746

 

 

 —

 

 

86,746

Deferred income taxes, net

 

 

614

 

 

 —

 

 

614

Other assets

 

 

67,547

 

 

907

 

 

68,454

Total assets

 

$

579,817

 

$

1,507

 

$

581,324

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity (deficit)

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

31,072

 

$

1,237

 

$

32,309

Income and other taxes payable

 

 

10,094

 

 

 —

 

 

10,094

Accrued expenses and other current liabilities

 

 

92,890

 

 

(14,854)

 

 

78,036

Deferred revenue current

 

 

2,400

 

 

(2,400)

 

 

 —

     Current portion of long-term debt

 

 

20,000

 

 

 —

 

 

20,000

Total current liabilities

 

 

156,456

 

 

(16,017)

 

 

140,439

Deferred revenue

 

 

13,671

 

 

(11,027)

 

 

2,644

Long-term debt, less current portion, net

 

 

568,770

 

 

 —

 

 

568,770

Deferred income taxes, net

 

 

6,125

 

 

6,593

 

 

12,718

Other long-term liabilities

 

 

76,993

 

 

 —

 

 

76,993

Total liabilities

 

 

822,015

 

 

(20,451)

 

 

801,564

 

 

 

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

 

7,037

 

 

 —

 

 

7,037

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity (deficit):

 

 

 

 

 

 

 

 

 

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

 

 

 —

 

 

 —

 

 

 —

Common stock ($0.01 par value per share; issued 44,268 at April 1, 2018)

 

 

443

 

 

 —

 

 

443

Additional paid-in capital

 

 

163,198

 

 

 —

 

 

163,198

Accumulated other comprehensive income (loss)

 

 

4,110

 

 

 —

 

 

4,110

Retained earnings

 

 

280,853

 

 

21,958

 

 

302,811

Treasury stock (12,245 shares at April 1, 2018, at cost)

 

 

(714,097)

 

 

 —

 

 

(714,097)

Total stockholders’ equity (deficit), net of noncontrolling interests

 

 

(265,493)

 

 

21,958

 

 

(243,535)

Noncontrolling interests in subsidiaries

 

 

16,258

 

 

 —

 

 

16,258

Total stockholders’ equity (deficit) 

 

 

(249,235)

 

 

21,958

 

 

(227,277)

Total liabilities, redeemable noncontrolling interests and stockholders’ equity (deficit)

 

$

579,817

 

$

1,507

 

$

581,324

 

 

 

 

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As Reported

 

 

 

 

 

 

 

Three Months Ended

 

 

 

 

Income Statement

 

 

April 1,

 

Total

 

Without Adoption of

(In thousands, except per share amounts)

    

2018

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