Papa John‘s International, Inc.
PAPA JOHNS INTERNATIONAL INC (Form: 10-Q, Received: 08/06/2013 17:17:05)

GRAPHIC

 
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 30, 2013

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
incorporation or organization)
(I.R.S. Employer Identification
number)
 

2002 Papa Johns Boulevard
Louisville, Kentucky  40299-2367
(Address of principal executive offices)
(502) 261-7272
(Registrant's telephone number, including area code)

         Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:
  Yes [X]            No [   ]
 
         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 [   ]
 
         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  [   ]  
Non-accelerated filer  [   ]
Smaller reporting company  [   ]
 
              Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
  Yes  [   ]          No  [X]
 
         At July 30, 2013, there were outstanding 21,732,784 shares of the registrant’s common stock, par value $0.01 per share.
 
 
 
 

 
 
INDEX


Page No.
     
     
 
     
  2
     
 
3
     
 
4
     
 
5
 
 
 
 
6
     
 
7
     
15
     
25
     
26
     
 
     
26
     
26
     
27
     
28
 
 
1

 
 
PART 1. FINANCIAL INFORMATION

           
Papa John’s International, Inc. and Subsidiaries
 
 
             
(In thousands)
 
June 30, 2013
   
December 30, 2012
 
   
(Unaudited)
       
Assets
           
Current assets:
           
 Cash and cash equivalents
  $ 28,236     $ 16,396  
 Accounts receivable, net
    43,235       44,647  
 Notes receivable
    3,440       4,577  
 Inventories
    21,722       22,178  
 Deferred income taxes
    7,715       10,279  
 Prepaid expenses
    10,782       12,782  
 Other current assets
    7,804       7,767  
Total current assets
    122,934       118,626  
Property and equipment, net
    201,942       196,661  
Notes receivable, less current portion, net
    13,839       12,536  
Goodwill
    78,088       78,958  
Other assets
    32,675       31,627  
Total assets
  $ 449,478     $ 438,408  
                 
Liabilities and stockholders’ equity
               
Current liabilities:
               
 Accounts payable
  $ 28,728     $ 32,624  
 Income and other taxes payable
    1,407       10,429  
 Accrued expenses and other current liabilities
    51,950       60,528  
Total current liabilities
    82,085       103,581  
Deferred revenue
    6,736       7,329  
Long-term debt
    133,241       88,258  
Deferred income taxes
    11,955       10,672  
Other long-term liabilities
    40,858       40,674  
Total liabilities
    274,875       250,514  
                 
Redeemable noncontrolling interests
    6,846       6,380  
                 
Stockholders’ equity:
               
 Preferred stock
    -       -  
 Common stock
    373       371  
 Additional paid-in capital
    288,214       280,905  
 Accumulated other comprehensive income
    786       1,824  
 Retained earnings
    392,917       356,461  
 Treasury stock
    (514,533 )     (458,047 )
Total stockholders’ equity
    167,757       181,514  
Total liabilities, redeemable noncontrolling interests and stockholders’ equity
  $ 449,478     $ 438,408  
 
See accompanying notes.
 
 
2

 
 
Papa John's International, Inc. and Subsidiaries
 Consolidated Statements of Income
 (Unaudited)
                         
   
Three Months Ended
   
Six Months Ended
 
(In thousands, except per share amounts)
 
June 30, 2013
   
June 24, 2012
   
June 30, 2013
   
June 24, 2012
 
                         
   North America revenues:
                       
 Domestic Company-owned restaurant sales
  $ 155,153     $ 143,527     $ 313,051     $ 287,342  
 Franchise royalties
    20,230       19,101       40,963       39,619  
 Franchise and development fees
    219       206       765       428  
 Domestic commissary sales
    140,003       126,593       283,897       264,203  
 Other sales
    12,444       11,771       25,051       24,029  
   International revenues:
                               
 Royalties and franchise and development fees
    5,391       4,701       10,458       9,187  
 Restaurant and commissary sales
    15,746       12,680       30,605       25,047  
Total revenues
    349,186       318,579       704,790       649,855  
Costs and expenses:
                               
Domestic Company-owned restaurant expenses:
                               
 Cost of sales
    37,825       32,881       74,898       65,337  
 Salaries and benefits
    42,053       39,839       85,325       78,652  
 Advertising and related costs
    14,677       13,278       29,470       25,977  
 Occupancy costs
    8,939       8,619       17,650       16,517  
 Other operating expenses
    22,431       20,830       45,176       41,248  
Total domestic Company-owned restaurant expenses
    125,925       115,447       252,519       227,731  
Domestic commissary and other expenses:
                               
 Cost of sales
    114,045       104,412       231,823       217,250  
 Salaries and benefits
    10,264       9,218       20,331       18,221  
 Other operating expenses
    15,768       13,498       31,775       27,804  
Total domestic commissary and other expenses
    140,077       127,128       283,929       263,275  
International operating expenses
    12,983       10,975       25,636       21,367  
General and administrative expenses
    33,126       31,463       66,284       63,059  
Other general expenses
    1,597       1,135       2,782       6,809  
Depreciation and amortization
    8,530       8,104       17,067       16,031  
Total costs and expenses
    322,238       294,252       648,217       598,272  
Operating income
    26,948       24,327       56,573       51,583  
Net interest (expense) income
    (340 )     (861 )     332       (597 )
Income before income taxes
    26,608       23,466       56,905       50,986  
Income tax expense
    8,563       8,005       18,541       17,218  
Net income, including redeemable noncontrolling interests
    18,045       15,461       38,364       33,768  
Income attributable to redeemable noncontrolling interests
    (895 )     (1,172 )     (1,908 )     (2,498 )
Net income, net of redeemable noncontrolling interests
  $ 17,150     $ 14,289     $ 36,456     $ 31,270  
                                 
Basic earnings per common share
  $ 0.79     $ 0.60     $ 1.66     $ 1.31  
Earnings per common share - assuming dilution
  $ 0.77     $ 0.59     $ 1.62     $ 1.29  
                                 
Basic weighted average shares outstanding
    21,742       23,733       21,998       23,893  
Diluted weighted average shares outstanding
    22,250       24,112       22,543       24,270  
                                 
See accompanying notes.
                               

 
 
3

 

 
Papa John's International, Inc. and Subsidiaries
 
 
(Unaudited)
 
                         
                         
   
Three Months Ended
   
Six Months Ended
 
(In thousands)
 
June 30, 2013
   
June 24, 2012
   
June 30, 2013
   
June 24, 2012
 
                         
Net income, including redeemable noncontrolling interests
  $ 18,045     $ 15,461     $ 38,364     $ 33,768  
Other comprehensive income (loss), before tax:
                               
   Foreign currency translation adjustments
    (586 )     (445 )     (1,721 )     (154 )
   Interest rate swap
    190       (9 )     73       (137 )
Other comprehensive income (loss), before tax
    (396 )     (454 )     (1,648 )     (291 )
Income tax effect:
                               
   Foreign currency translation adjustments
    217       -       637       -  
   Interest rate swap
    (71 )     3       (27 )     51  
Income tax effect
    146       3       610       51  
Other comprehensive income (loss), net of tax
    (250 )     (451 )     (1,038 )     (240 )
Comprehensive income, including redeemable
                               
   noncontrolling interests
    17,795       15,010       37,326       33,528  
Comprehensive income, redeemable noncontrolling interests
    (895 )     (1,172 )     (1,908 )     (2,498 )
Comprehensive income, net of redeemable
                               
   noncontrolling interests
  $ 16,900     $ 13,838     $ 35,418     $ 31,030  
                                 
See accompanying notes.
                               
 
 
4

 
 
Papa John's International, Inc. and Subsidiaries
(Unaudited)


   
Common
               
Accumulated
                   
   
Stock
         
Additional
   
Other
               
Total
 
   
Shares
   
Common
   
Paid-In
   
Comprehensive
   
Retained
   
Treasury
   
Stockholders'
 
(In thousands)
 
Outstanding
   
Stock
   
Capital
   
Income (Loss)
   
Earnings
   
Stock
   
Equity
 
                                           
                                           
Balance at December 25, 2011
    24,019     $ 367     $ 262,456     $ 1,849     $ 294,801     $ (353,826 )   $ 205,647  
Comprehensive income:
                                                       
  Net income, net of redeemable
                                                       
    noncontrolling interests (1)
    -       -       -       -       31,270       -       31,270  
  Other comprehensive loss
    -       -       -       (240 )     -       -       (240 )
Comprehensive income
                                                    31,030  
Exercise of stock options
    361       4       10,396       -       -       -       10,400  
Tax effect of equity awards
    -       -       468       -       -       -       468  
Acquisition of Company
                                                       
  common stock
    (957 )     -       -       -       -       (38,728 )     (38,728 )
Stock-based compensation expense
    -       -       3,218       -       -       -       3,218  
Issuance of restricted stock
    34       -       (1,541 )     -       -       1,541       -  
Other
    -       -       (134 )     -       -       259       125  
Balance at June 24, 2012
    23,457     $ 371     $ 274,863     $ 1,609     $ 326,071     $ (390,754 )   $ 212,160  
                                                         
Balance at December 30, 2012
    22,241     $ 371     $ 280,905     $ 1,824     $ 356,461     $ (458,047 )   $ 181,514  
Comprehensive income:
                                                       
  Net income, net of redeemable
                                                       
    noncontrolling interests (1)
    -       -       -       -       36,456       -       36,456  
  Other comprehensive loss
    -       -       -       (1,038 )     -       -       (1,038 )
Comprehensive income
                                                    35,418  
Exercise of stock options
    223       2       3,694       -       -       -       3,696  
Tax effect of equity awards
    -       -       1,963       -       -       -       1,963  
Acquisition of Company
                                                       
  common stock
    (978 )     -       -       -       -       (58,806 )     (58,806 )
Stock-based compensation expense
    -       -       3,784       -       -       -       3,784  
Issuance of restricted stock
    68       -       (2,148 )     -       -       2,148       -  
Other
    -       -       16       -       -       172       188  
Balance at June 30, 2013
    21,554     $ 373     $ 288,214     $ 786     $ 392,917     $ (514,533 )   $ 167,757  
 
(1)
Net income at June 30, 2013 and June 24, 2012 is net of $1,908 and $2,498, respectively, allocable to the redeemable noncontrolling interests for our joint venture arrangements.
 
At June 24, 2012, the accumulated other comprehensive income of $1,609 was comprised of unrealized foreign currency translation gains of $1,718, offset by a net
unrealized loss on the interest rate swap agreement of $80 and a $29 pension plan liability.
 
At June 30, 2013, the accumulated other comprehensive income of $786 was comprised of unrealized foreign currency translation gains of $806, offset by a net
unrealized loss on the interest rate swap agreement of $20.
 
 
See accompanying notes.
 
 
5

 

Papa John's International, Inc. and Subsidiaries
(Unaudited)

   
Six Months Ended
 
(In thousands)
 
June 30, 2013
   
June 24, 2012
 
             
Operating activities
           
Net income, including redeemable noncontrolling interests
  $ 38,364     $ 33,768  
Adjustments to reconcile net income to net cash provided by operating activities:
         
    Provision for uncollectible accounts and notes receivable
    780       719  
    Depreciation and amortization
    17,067       16,031  
    Deferred income taxes
    8,256       1,797  
    Stock-based compensation expense
    3,784       3,218  
    Excess tax benefit on equity awards
    (3,803 )     (1,471 )
    Other
    694       2,872  
    Changes in operating assets and liabilities, net of acquisitions:
               
         Accounts receivable
    496       (75 )
         Inventories
    456       533  
         Prepaid expenses
    2,000       (338 )
         Other current assets
    (37 )     755  
         Other assets and liabilities
    (1,954 )     756  
         Accounts payable
    (3,896 )     (587 )
         Income and other taxes payable
    (9,022 )     75  
         Accrued expenses and other current liabilities
    (5,870 )     3,297  
         Deferred revenue
    (83 )     3,812  
Net cash provided by operating activities
    47,232       65,162  
                 
Investing activities
               
Purchases of property and equipment
    (25,493 )     (15,046 )
Loans issued
    (3,103 )     (1,206 )
Repayments of loans issued
    2,908       1,730  
Acquisitions, net of cash acquired
    -       (5,908 )
Proceeds from divestitures of restaurants
    -       948  
Other
    319       (4 )
Net cash used in investing activities
    (25,369 )     (19,486 )
                 
Financing activities
               
Net proceeds (repayments) on line of credit facility
    44,983       (1,489 )
Excess tax benefit on equity awards
    3,803       1,471  
Tax payments for restricted stock issuances
    (1,841 )     (822 )
Proceeds from exercise of stock options
    3,696       10,400  
Acquisition of Company common stock
    (58,806 )     (38,728 )
Contributions from redeemable noncontrolling interest holders
    450       -  
Distributions to redeemable noncontrolling interest holders
    (1,750 )     (1,930 )
Other
    (468 )     125  
Net cash used in financing activities
    (9,933 )     (30,973 )
Effect of exchange rate changes on cash and cash equivalents
    (90 )     (20 )
Change in cash and cash equivalents
    11,840       14,683  
Cash and cash equivalents at beginning of period
    16,396       18,942  
Cash and cash equivalents at end of period
  $ 28,236     $ 33,625  
                 
See accompanying notes.
               

 
6

 
 
Papa John's International, Inc. and Subsidiaries
(Unaudited)

June 30, 2013

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 30, 2013 are not necessarily indicative of the results that may be expected for the fiscal year ended December 29, 2013. 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 30, 2012.

2.
Significant Accounting Policies

Accumulated Other Comprehensive Income
 
Effective December 31, 2012, we adopted Accounting Standards Update 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income,” on a prospective basis. The updated standard requires the reporting of reclassifications out of accumulated other comprehensive income (“AOCI”). We are required to disclose the effect of significant items reclassified out of AOCI into our consolidated statements of income either parenthetically in the consolidated statements of income for each caption impacted or in a note to the condensed consolidated financial statements. For the three and six months ended June 30, 2013 and June 24, 2012, we did not have any significant amounts reclassified out of AOCI.

Noncontrolling Interests

The Consolidation topic of the Accounting Standards Codification (“ASC”) requires all entities to report noncontrolling interests in subsidiaries separate from the equity of the parent company. The Consolidation topic further requires that consolidated net income be reported at amounts attributable to the parent and the noncontrolling interest, rather than expensing the income attributable to the noncontrolling interest holder. Additionally, disclosures are required to clearly identify and distinguish between the interests of the parent company and the interests of the noncontrolling owners, including a disclosure on the face of the consolidated statements for income attributable to the noncontrolling interest holder.
 
 
7

 
 
Papa John’s has joint ventures in which there are redeemable noncontrolling interests, including the following as of June 30, 2013 and June 24, 2012:


   
Number of
Restaurants
 
Restaurant Locations
 
Papa John's
Ownership
   
Reedeemable
Noncontrolling
Interest
Ownership
 
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 %
                           
June 24, 2012
                         
Star Papa, LP
    76  
Texas
    51 %     49 %
Colonel's Limited, LLC
    52  
Maryland and Virginia
    70 %     30 %

The income before income taxes attributable to the joint ventures for the three and six months ended June 30, 2013 and June 24, 2012 was as follows (in thousands):


   
Three Months
   
Six Months
 
   
June 30,
   
June 24,
   
June 30,
   
June 24,
 
   
2013
   
2012
   
2013
   
2012
 
                         
Papa John's International, Inc.
  $ 1,284     $ 1,854     $ 2,792     $ 3,897  
Noncontrolling interests
    895       1,172       1,908       2,498  
Total income before income taxes
  $ 2,179     $ 3,026     $ 4,700     $ 6,395  


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 net interest expense. The redemption value was $11.2 million as of June 30, 2013 and $11.8 million as of December 30, 2012.

As part of the other joint venture agreements, the noncontrolling interest holders 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 Minnesota, LLC and PJ Denver, LLC agreements contain redemption features that are currently redeemable and, therefore, these noncontrolling interests have been recorded at their current redemption values, which approximate their carrying values.

 
8

 

A reconciliation of the beginning and ending recorded values of the redeemable noncontrolling interests for the six months ended June 30, 2013 is as follows (in thousands):


Balance at December 30, 2012
  $ 6,380  
Net income
    1,016  
Contributions from redeemable noncontrolling interest holders
    450  
Distributions to redeemable noncontrolling interest holders
    (1,000 )
Balance at June 30, 2013
  $ 6,846  

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 30, 2013, we had a net deferred tax liability of approximately $4.2 million.

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

Fair Value Measurements and Disclosures

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

 
9

 

Our financial assets and liabilities that were measured at fair value on a recurring basis as of June 30, 2013 and December 30, 2012 are as follows (in thousands):


 
Balance Sheet
 
Carrying
   
Fair Value Measurements
 
 
Location
 
Value
   
Level 1
   
Level 2
   
Level 3
 
                           
June 30, 2013
                         
Financial assets:
                         
   Cash surrender value of
                         
      life insurance policies *
Other assets
  $ 15,155     $ 15,155     $ -     $ -  
                                   
Financial liabilities:
                                 
   Interest rate swap
Other long-term liabilities
    31       -       31       -  
                                   
December 30, 2012
                                 
Financial assets:
                                 
   Cash surrender value of
                                 
      life insurance policies *
Other assets
  $ 13,551     $ 13,551     $ -     $ -  
                                   
Financial liabilities:
                                 
   Interest rate swap
Other long-term liabilities
    104       -       104       -  
                                   
* Represents life insurance policies held in our non-qualified deferred compensation plan.
                 


There were no transfers among levels within the fair value hierarchy during the six months ended June 30, 2013.

The fair value of our interest rate swap is 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 swap, as well as considering published discount factors, and projected London Interbank Offered Rates (“LIBOR”).

Subsequent Events

Dividend

On August 2, 2013, our Board of Directors approved the initiation of quarterly cash dividends to its shareholders. A quarterly dividend of $0.25 per common share will be paid on September 20, 2013 to shareholders of record as of the close of business on September 6, 2013. Future dividends will be subject to Board declaration.

Interest Rate Swap

On July 30, 2013, we terminated our existing $50 million interest rate swap and entered into a new $75 million interest rate swap through April 30, 2018. See Note 3 for additional information.

There were no other subsequent events that required recognition or disclosure.

3.
Debt

Our debt is comprised entirely of a revolving credit facility. The outstanding balance under this facility was $133.2 million as of June 30, 2013 and $88.3 million as of December 30, 2012.

 
10

 
 
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. Outstanding balances are charged a percentage margin of 75 basis points to 175 basis points over LIBOR or other bank rates at our option. The remaining availability under the revolving credit facility, reduced for outstanding letters of credit, was approximately $147.2 million as of June 30, 2013.

The revolving credit facility has affirmative and negative covenants, including financial covenants requiring the maintenance of specified fixed charges and leverage ratios. At June 30, 2013, we were in compliance with these covenants.

In August 2011, we entered into an interest rate swap agreement that provided for a fixed rate of 0.53%, as compared to LIBOR, with a notional amount of $50.0 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 of interest (to 0.56% from 0.53%) but did not impact the notional amount of the interest rate swap agreement. The amendment and restatement of our revolving credit facility on April 30, 2013 did not impact our interest rate swap.

Our swap is a derivative instrument that is designated as a cash flow hedge because the swap provides a hedge against the effects of rising interest rates on borrowings. The effective portion of the gain or loss on the swap is reported as a component of AOCI and reclassified into earnings in the same period or periods during which the swap affects earnings. Gains or losses on the swap representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. Amounts payable or receivable under the swap are accounted for as adjustments to interest expense. As of June 30, 2013, the swap is a highly effective cash flow hedge with no ineffectiveness for the three- and six-month periods ended June 30, 2013.

The weighted average interest rates for our revolving credit facility, including the impact of the swap agreement, were 1.1% for the three and six months ended June 30, 2013  and 1.3% for the three and six months ended June 24, 2012. Interest paid, including payments made or received under the swap, was $424,000 and $232,000 for the three months ended June 30, 2013 and June 24, 2012, respectively, and $802,000 and $482,000 for the six months ended June 30, 2013 and June 24, 2012, respectively.

On July 30, 2013, we terminated our existing $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 existing swap will not have a material impact on our third quarter and full year results.

 
11

 

4.
Calculation of Earnings Per Share

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


   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 24,
   
June 30,
   
June 24,
 
   
2013
   
2012
   
2013
   
2012
 
                         
Basic earnings per common share:
                       
Net income, net of redeemable noncontrolling interests
  $ 17,150     $ 14,289     $ 36,456     $ 31,270  
Weighted average shares outstanding
    21,742       23,733       21,998       23,893  
Basic earnings per common share
  $ 0.79     $ 0.60     $ 1.66     $ 1.31  
                                 
Earnings per common share - assuming dilution:
                               
Net income, net of redeemable noncontrolling interests
  $ 17,150     $ 14,289     $ 36,456     $ 31,270  
                                 
Weighted average shares outstanding
    21,742       23,733       21,998       23,893  
Dilutive effect of outstanding equity awards
    508       379       545       377  
Diluted weighted average shares outstanding
    22,250       24,112       22,543       24,270  
Earnings per common share - assuming dilution
  $ 0.77     $ 0.59     $ 1.62     $ 1.29  
 
Shares subject to options to purchase common stock with an exercise price greater than the average market price for the quarter are not included in the computation of earnings per common share – assuming dilution because the effect would be antidilutive. The weighted average number of shares subject to antidilutive options was 218,000 and 151,000 for the three and six months ended June 30, 2013, respectively (none for the three and six months ended June 24, 2012).

5.
Litigation

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

Agne  v. Papa John’s International, Inc. et al . is a class action filed on May 28, 2010 in the United States District Court for the Western District of Washington seeking damages for violations of the Telephone Consumer Protection Act and Washington State telemarketing laws alleging, among other things that several Papa John’s franchisees retained a vendor to send unsolicited commercial text message offers primarily in Washington and Oregon. The court granted plaintiff’s motion for class certification in November 2012; we filed a petition for permission to appeal the court’s ruling on class certification to the United States Court of Appeals for the Ninth Circuit.

On February 13, 2013, the parties tentatively agreed to the financial terms of a settlement of the litigation. The court preliminarily approved the terms in June 2013 but final court approval is not expected until later in the year. A reasonable estimate of the total cost of the settlement was provided for at December 30, 2012. Actual costs will be impacted by the claimant participation rate, but we do not expect actual costs to be materially different from our estimates. We expect the majority of the settlement payments to be made in 2013.

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 reimbursed for mileage and expenses in violation of the Fair Labor Standards Act. Approximately 3,900 drivers out of a potential class size of 28,800 have opted into the action. A motion to certify five additional state classes is pending and could result in another 14,000 plaintiffs if granted.

 
12

 
 
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.

6.
Segment Information

We have defined 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, 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 our Company-owned restaurants 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 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.

 
13

 

Our segment information is as follows (in thousands):
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30, 2013
   
June 24, 2012
   
June 30, 2013
   
June 24, 2012
 
                         
Revenues from external customers:
                       
  Domestic Company-owned restaurants
  $ 155,153     $ 143,527     $ 313,051     $ 287,342  
  Domestic commissaries
    140,003       126,593       283,897       264,203  
  North America franchising
    20,449       19,307       41,728       40,047  
  International
    21,137       17,381       41,063       34,234  
  All others
    12,444       11,771       25,051       24,029  
Total revenues from external customers
  $ 349,186     $ 318,579     $ 704,790     $ 649,855  
                                 
Intersegment revenues:
                               
  Domestic commissaries
  $ 46,115     $ 39,953     $ 92,912     $ 81,490  
  North America franchising
    552       561       1,105       1,110  
  International
    73       56       140       110  
  All others
    3,318       2,664       6,486       5,685  
Total intersegment revenues
  $ 50,058     $ 43,234     $ 100,643     $ 88,395  
                                 
Income (loss) before income taxes:
                               
  Domestic Company-owned restaurants
  $ 8,175     $ 9,358     $ 19,131     $ 21,679  
  Domestic commissaries
    9,642       7,978       19,805       19,144  
  North America franchising
    17,396       16,619       35,618       34,759  
  International
    866       320       1,207       592  
  All others
    1,153       471       1,812       866  
  Unallocated corporate expenses
    (10,413 )     (10,799 )     (19,931 )     (25,583 )
  Elimination of intersegment profits
    (211 )     (481 )     (737 )     (471 )
Total income before income taxes
  $ 26,608     $ 23,466     $ 56,905     $ 50,986  
                                 
Property and equipment:
                               
  Domestic Company-owned restaurants
  $ 188,119                          
  Domestic commissaries
    102,498                          
  International
    24,546                          
  All others
    39,187                          
  Unallocated corporate assets
    150,018                          
  Accumulated depreciation and amortization
    (302,426 )                        
Net property and equipment
  $ 201,942                          
                                 
 
 
14

 
 
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 1985. At June 30, 2013, there were 4,252 Papa John’s restaurants (705 Company-owned and 3,547 franchised) operating in all 50 states and 34 countries. 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.

Non-GAAP Measures

In connection with a 2012 multi-year supplier agreement, the Company received a $5.0 million supplier marketing payment in the first quarter of 2012, which the Company then contributed to the Papa John’s Marketing Fund (“PJMF”), an unconsolidated, non-profit corporation, for the benefit of domestic restaurants. The Company’s contribution to PJMF was fully expensed in the first quarter of 2012. The Company is recognizing the supplier marketing payment evenly as income over the five-year term of the agreement ($250,000 per quarter).

PJMF elected to distribute the $5.0 million supplier marketing payment to the domestic system as advertising credits in the first quarter of 2012. Our domestic Company-owned restaurants’ portion of the 2012 advertising credits resulted in an increase in income before income taxes of approximately $1.0 million.

The overall impact of the two transactions described above, which are collectively defined as the “Incentive Contribution,” increased income before income taxes for the three and six months ended June 30, 2013, by $250,000 and $500,000, respectively, increased income before income taxes by $250,000 for the three months ended June 24, 2012, and reduced income before income taxes by $3.5 million for the six months ended June 24, 2012.

 
15

 

The following table reconciles our GAAP financial results to the adjusted financial results, excluding the impact of the Incentive Contribution, for the three and six months ended June 30, 2013 and June 24, 2012:

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 24,
   
Increase
   
June 30,
   
June 24,
   
Increase
 
(In thousands, except per share amounts)
 
2013
   
2012
   
(Decrease)
   
2013
   
2012
   
(Decrease)
 
                                     
Income before income taxes, as reported
  $ 26,608     $ 23,466     $ 3,142     $ 56,905     $ 50,986     $ 5,919  
Incentive Contribution
    (250 )     (250 )     -       (500 )     3,471       (3,971 )
Income before income taxes, excluding Incentive Contribution
  $ 26,358     $ 23,216     $ 3,142     $ 56,405     $ 54,457     $ 1,948  
                                                 
Net income, as reported
  $ 17,150     $ 14,289     $ 2,861     $ 36,456     $ 31,270     $ 5,186  
Incentive Contribution
    (164 )     (164 )     -       (329 )     2,275       (2,604 )
Net income, excluding Incentive
                                               
Contribution
  $ 16,986     $ 14,125     $ 2,861     $ 36,127     $ 33,545     $ 2,582  
                                                 
Earnings per diluted share, as reported
  $ 0.77     $ 0.59     $ 0.18     $ 1.62     $ 1.29     $ 0.33  
Incentive Contribution
    (0.01 )     -       (0.01 )     (0.02 )     0.09       (0.11 )
Earnings per diluted share, excluding Incentive Contribution
  $ 0.76     $ 0.59     $ 0.17     $ 1.60     $ 1.38     $ 0.22  

The financial measures we present in this report, which exclude the Incentive Contribution, are non-GAAP measures and should not be construed as a substitute for or a better indicator of the Company’s performance than the Company’s GAAP measures. Management believes presenting the financial information excluding the impact of the Incentive Contribution is important for purposes of comparison to prior year results. In addition, management uses these non-GAAP measures to allocate resources, and analyze trends and underlying operating performance. Annual cash bonuses, and certain long-term incentive programs for various levels of management, were based on financial measures that excluded the Incentive Contribution. The presentation of the non-GAAP measures in this report is made alongside the most directly comparable GAAP measures. See “Discussion of Operating Results” below for further analysis regarding the impact of the Incentive Contribution.

In addition, we present free cash flow in this report, which is a non-GAAP measure. We define free cash flow as net cash provided by operating activities (from the consolidated statements of cash flows) less the purchases of property and equipment. We view free cash flow as an important measure because it is one factor that management uses in determining the amount of cash available for discretionary investment. Free cash flow is not a term defined by GAAP and as a result our measure of free cash flow might not be comparable to similarly titled measures used by other companies. Free cash flow should not be construed as a substitute for or a better indicator of our performance than the Company’s GAAP measures. See “Liquidity and Capital Resources” for a reconciliation of free cash flow to the most directly comparable GAAP measure.
 
 
16

 
 
Restaurant Progression


   
Three Months Ended
   
Six Months Ended
 
   
June 30, 2013
   
June 24, 2012
   
June 30, 2013
   
June 24, 2012
 
                         
North America Company-owned:
                       
 Beginning of period
    649       597       648       598  
 Opened
    5       -       6       -  
 Closed
    -       (2 )     -       (3 )
 Acquired from franchisees
    -       56       -       56  
 Sold to franchisees
    -       (8 )     -       (8 )
 End of period
    654       643       654       643  
International Company-owned:
                               
 Beginning of period
    50       29       48       30  
 Opened
    1       4       3       4  
 Closed
    -       -       -       (1 )
 End of period
    51       33       51       33  
North America franchised:
                               
 Beginning of period
    2,572       2,498       2,556       2,463  
 Opened
    32       35       63       82  
 Closed
    (16 )     (10 )     (31 )     (22 )
 Acquired from Company
    -       8       -       8  
 Sold to Company
    -       (56 )     -       (56 )
 End of period
    2,588       2,475       2,588       2,475  
International franchised:
                               
 Beginning of period
    926       809       911       792  
 Opened
    43       28       69       51  
 Closed
    (10 )     (15 )     (21 )     (21 )
 End of period
    959       822       959       822  
Total restaurants - end of period
    4,252       3,973       4,252       3,973  
 
Results of Operations

Summary of Operating Results - Segment Review