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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended March 30, 2014

 

OR

 

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

 

Commission File Number:  0-21660

 

PAPA JOHN’S INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

 

2002 Papa Johns Boulevard

Louisville, Kentucky 40299-2367

(Address of principal executive offices)

 

(502) 261-7272

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

 

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

 

At April 29, 2014, there were outstanding 41,264,884 shares of the registrant’s common stock, par value $0.01 per share.

 

 

 

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INDEX

 

			Page No.
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets – March 30, 2014 and December 29, 2013		2
	Condensed Consolidated Statements of Income – Three Months Ended March 30, 2014 and March 31, 2013		3
	Consolidated Statements of Comprehensive Income – Three Months Ended March 30, 2014 and March 31, 2013		4
	Consolidated Statements of Cash Flows – Three Months Ended March 30, 2014 and March 31, 2013		5
	Notes to Condensed Consolidated Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		22
Item 4.	Controls and Procedures		23
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings		23
Item 1A.	Risk Factors		24
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		24
Item 6.	Exhibits		25

 

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PART 1. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

 

(In thousands, except per share amounts)		March 30, 2014			December 29, 2013
		(Unaudited)
Assets
Current assets:
Cash and cash equivalents		$	14,388		$	13,670
Accounts receivable, net		53,682			53,203
Notes receivable, net		5,825			3,566
Inventories		27,767			23,035
Deferred income taxes		5,830			8,004
Prepaid expenses		12,417			14,336
Other current assets		9,430			9,226
Total current assets		129,339			125,040
Property and equipment, net		213,427			212,097
Notes receivable, less current portion, net		11,852			13,239
Goodwill		79,430			79,391
Other assets		34,551			34,524
Total assets		$	468,599		$	464,291
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	34,342		$	35,653
Income and other taxes payable		7,669			4,401
Accrued expenses and other current liabilities		51,876			57,807
Total current liabilities		93,887			97,861
Deferred revenue		5,953			5,827
Long-term debt		177,167			157,900
Deferred income taxes		13,729			14,660
Other long-term liabilities		43,589			42,835
Total liabilities		334,325			319,083
Redeemable noncontrolling interests		7,789			7,024
Stockholders’ equity:
Preferred stock ($0.01 par value per share; no shares issued)		—			—
Common stock ($0.01 par value per share; issued 43,026 at March 30, 2014 and 42,796 at December 29, 2013)		430			428
Additional paid-in capital		139,292			137,552
Accumulated other comprehensive income		2,415			2,463
Retained earnings		55,384			41,297
Treasury stock (1,648 shares at March 30, 2014 and 1,129 shares at December 29, 2013, at cost)		(71,521		)	(44,066		)
Total stockholders’ equity, net of noncontrolling interests		126,000			137,674
Noncontrolling interests in subsidiaries		485			510
Total stockholders’ equity		126,485			138,184
Total liabilities, redeemable noncontrolling interests and stockholders’ equity		$	468,599		$	464,291

 

See accompanying notes.

 

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Papa John’s International, Inc. and Subsidiaries

 Condensed Consolidated Statements of Income

(Unaudited)

 

		Three Months Ended
(In thousands, except per share amounts)		March 30, 2014			March 31, 2013
North America revenues:
Domestic Company-owned restaurant sales		$	178,193		$	157,898
Franchise royalties		22,614			20,733
Franchise and development fees		144			546
Domestic commissary sales		164,047			143,894
Other sales		12,750			12,607
International revenues:
Royalties and franchise and development fees		5,779			5,067
Restaurant and commissary sales		17,850			14,859
Total revenues		401,377			355,604
Costs and expenses:
Domestic Company-owned restaurant expenses:
Cost of sales		45,156			37,073
Salaries and benefits		47,583			43,272
Advertising and related costs		16,256			14,793
Occupancy costs		9,311			8,711
Other restaurant operating expenses		25,287			22,745
Total domestic Company-owned restaurant expenses		143,593			126,594
Domestic commissary expenses:
Cost of sales		128,924			110,923
Salaries and benefits		7,024			6,016
Other commissary operating expenses		15,855			15,461
Total domestic commissary expenses		151,803			132,400
Other operating expenses		11,431			11,452
International restaurant and commissary expenses		14,885			12,653
General and administrative expenses		36,966			33,158
Other general expenses		1,533			1,185
Depreciation and amortization		9,164			8,537
Total costs and expenses		369,375			325,979
Operating income		32,002			29,625
Net interest (expense) income		(592		)	672
Income before income taxes		31,410			30,297
Income tax expense		10,869			9,978
Net income before attribution to noncontrolling interests		20,541			20,319
Income attributable to noncontrolling interests		(1,230		)	(1,013		)
Net income attributable to the Company		$	19,311		$	19,306
Calculation of income for earnings per share:
Net income attributable to the Company		$	19,311		$	19,306
Increase in noncontrolling interest redemption value		(8		)	—
Net income attributable to participating securities		(137		)	—
Net income attributable to common shareholders		$	19,166		$	19,306
Basic earnings per common share		$	0.46		$	0.43
Diluted earnings per common share		$	0.45		$	0.42
Basic weighted average common shares outstanding		41,778			44,512
Diluted weighted average common shares outstanding		42,696			45,612
Dividends declared per common share		$	0.125		$	—

 

See accompanying notes.

 

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Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(Unaudited)

 

		Three Months Ended
(In thousands)		March 30, 2014			March 31, 2013
Net income before attribution to noncontrolling interests		$	20,541		$	20,319
Other comprehensive income (loss), before tax:
Foreign currency translation adjustments		(33		)	(1,135		)
Interest rate swap (1)		(43		)	(117		)
Other comprehensive income (loss), before tax		(76		)	(1,252		)
Income tax effect:
Foreign currency translation adjustments		12			420
Interest rate swap (2)		16			44
Income tax effect		28			464
Other comprehensive income (loss), net of tax		(48		)	(788		)
Comprehensive income before attribution to noncontrolling interests		20,493			19,531
Comprehensive income, redeemable noncontrolling interests		(1,255		)	(1,013		)
Comprehensive loss, nonredeemable noncontrolling interests		25			—
Comprehensive income attributable to the Company		$	19,263		$	18,518

 

(1)	Amounts reclassified out of accumulated other comprehensive income (“AOCI”) into net interest (expense) income included $249 and $44 for the three months ended March 30, 2014 and March 31, 2013, respectively.
(2)	The income tax effects of amounts reclassified out of AOCI into net interest (expense) income were $92 and $16 for the three months ended March 30, 2014 and March 31, 2013, respectively.

 

See accompanying notes.

 

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Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

 

		Three Months Ended
(In thousands)		March 30, 2014			March 31, 2013
Operating activities
Net income before attribution to noncontrolling interests		$	20,541		$	20,319
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for uncollectible accounts and notes receivable		145			314
Depreciation and amortization		9,164			8,537
Deferred income taxes		6,170			3,325
Stock-based compensation expense		2,190			1,681
Excess tax benefit on equity awards		(4,900		)	(1,142		)
Other		1,110			(180		)
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable		(854		)	(627		)
Inventories		(3,210		)	(1,744		)
Prepaid expenses		1,919			3,238
Other current assets		(204		)	142
Other assets and liabilities		(795		)	38
Accounts payable		(1,311		)	(406		)
Income and other taxes payable		3,268			1,243
Accrued expenses and other current liabilities		(6,958		)	(4,641		)
Deferred revenue		403			(183		)
Net cash provided by operating activities		26,678			29,914
Investing activities
Purchases of property and equipment		(11,137		)	(13,248		)
Loans issued		(1,758		)	(1,748		)
Repayments of loans issued		1,164			1,916
Other		7			319
Net cash used in investing activities		(11,724		)	(12,761		)
Financing activities
Net proceeds on line of credit facility		19,267			20,652
Cash dividends paid		(5,240		)	—
Excess tax benefit on equity awards		4,900			1,142
Tax payments for equity award issuances		(3,233		)	(843		)
Proceeds from exercise of stock options		2,989			2,704
Acquisition of Company common stock		(32,800		)	(32,122		)
Contributions from noncontrolling interest holders		—			350
Distributions to noncontrolling interest holders		(300		)	(1,000		)
Other		223			112
Net cash used in financing activities		(14,194		)	(9,005		)
Effect of exchange rate changes on cash and cash equivalents		(42		)	7
Change in cash and cash equivalents		718			8,155
Cash and cash equivalents at beginning of period		13,670			16,396
Cash and cash equivalents at end of period		$	14,388		$	24,551

 

See accompanying notes.

 

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Papa John’s International, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

March 30, 2014

 

1.              Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the three months ended March 30, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ended December 28, 2014. For further information, refer to the consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K for Papa John’s International, Inc. (referred to as the “Company”, “Papa John’s” or in the first person notations of “we”, “us” and “our”) for the year ended December 29, 2013.

 

2.              Significant Accounting Policies

 

Reclassifications

 

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

 

Noncontrolling Interests

 

Papa John’s has joint ventures in which there are noncontrolling interests, including the following as of March 30, 2014 and March 31, 2013:

 

		Number of Restaurants		Restaurant Locations		Papa John’s Ownership		Noncontrolling Interest Ownership
March 30, 2014
Star Papa, LP		80		Texas		51	%	49	%
Colonel’s Limited, LLC		52		Maryland and Virginia		70	%	30	%
PJ Minnesota, LLC		34		Minnesota		80	%	20	%
PJ Denver, LLC		25		Colorado		60	%	40	%
March 31, 2013
Star Papa, LP		78		Texas		51	%	49	%
Colonel’s Limited, LLC		52		Maryland and Virginia		70	%	30	%
PJ Minnesota, LLC		30		Minnesota		80	%	20	%
PJ Denver, LLC		23		Colorado		60	%	40	%

 

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

 

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The income before income taxes attributable to these joint ventures for the three months ended March 30, 2014 and March 30, 2013 was as follows (in thousands):

 

		March 30,			March 31,
		2014			2013
Papa John’s International, Inc.		$	1,848		$	1,508
Noncontrolling interests		1,230			1,013
Total income before income taxes		$	3,078		$	2,521

 

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

 

Joint Venture		Redemption Feature		Location within the Condensed Consolidated Balance Sheets		Recorded Value
Colonel’s Limited, LLC		Mandatorily redeemable		Other long-term liabilities		Redemption value
Star Papa, LP		Redeemable		Temporary equity		Carrying value
PJ Denver, LLC		Redeemable		Temporary equity		Redemption value
PJ Minnesota, LLC		No redemption feature		Permanent equity		Carrying value

 

The Colonel’s Limited, LLC agreement contains a mandatory redemption clause and, accordingly, the Company has recorded this noncontrolling interest as a liability at its redemption value in other long-term liabilities. The redemption value is adjusted at each reporting date and any change is recorded in interest expense. We recorded interest expense of $27,000 in the first quarter of 2014 and interest income of $800,000 in the first quarter of 2013. The redemption value was $11.0 million as of March 30, 2014 and $10.8 million as of December 29, 2013.

 

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

 

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

 

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

 

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

 

Balance at December 29, 2013		$	7,024
Net income		757
Change in redemption value		8
Balance at March 30, 2014		$	7,789

 

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

 

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

 

Deferred Income Tax Accounts and Tax Reserves

 

We are subject to income taxes in the United States and several foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and the related assets and liabilities. The provision for income taxes includes income taxes paid, currently payable or receivable and those deferred. We use an estimated annual effective rate based on expected annual income to determine our quarterly provision for income taxes. Discrete items are recorded in the quarter in which they occur.

 

Deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Deferred tax assets are also recognized for the estimated future effects of tax loss carryforwards. The effect on deferred taxes of changes in tax rates is recognized in the period in which the new tax is enacted. As a result, our effective tax rate may fluctuate. Valuation allowances are established when necessary on a jurisdictional basis to reduce deferred tax assets to the amounts we expect to realize. As of March 30, 2014, we had a net deferred tax liability of approximately $7.9 million.

 

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

 

Fair Value Measurements and Disclosures

 

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

 

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

 

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

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

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

 

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Our financial assets and liabilities that were measured at fair value on a recurring basis as of March 30, 2014 and December 29, 2013 are as follows (in thousands):

 

		Carrying			Fair Value Measurements
		Value			Level 1			Level 2			Level 3
March 30, 2014
Financial assets:
Cash surrender value of life insurance policies (a)		$	17,141		$	17,141		$	—		$	—
Financial liabilities:
Interest rate swap (b)		129			—			129			—
December 29, 2013
Financial assets:
Cash surrender value of life insurance policies (a)		$	16,798		$	16,798		$	—		$	—
Financial liabilities:
Interest rate swap (b)		76			—			76			—

 

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

(b)         The fair 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”).

 

There were no transfers among levels within the fair value hierarchy during the three months ended March 30, 2014.

 

Variable Interest Entities

 

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

 

3.             Stockholders’ Equity

 

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

 

Subsequent to the end of the first quarter, on April 29, 2014, our stockholders approved an amendment to our Certificate of Incorporation to increase the total number of authorized common shares from 50.0 million to 100.0 million.

 

4.              Calculation of Earnings Per Share

 

We compute earnings per share using the two-class method. The two-class method requires an earnings allocation formula that determines earnings per share for common shareholders and participating security holders

 

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according to dividends declared and participating rights in undistributed earnings. We consider time-based restricted stock awards to be participating securities because holders of such shares have non-forfeitable dividend rights. Under the two-class method, undistributed earnings allocated to participating securities are subtracted from net income attributable to the Company in determining net income attributable to common shareholders.

 

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

 

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

 

		Three Months Ended
		March 30,			March 31,
		2014			2013
Basic earnings per common share:
Net income attributable to the Company		$	19,311		$	19,306
Increase in noncontrolling interest redemption value		(8		)	—
Net income attributable to participating securities		(137		)	—
Net income attributable to common shareholders		$	19,166		$	19,306
Weighted average common shares outstanding		41,778			44,512
Basic earnings per common share		$	0.46		$	0.43
Diluted earnings per common share:
Net income attributable to common shareholders		$	19,166		$	19,306
Weighted average common shares outstanding		41,778			44,512
Dilutive effect of outstanding equity awards (a)		918			1,100
Diluted weighted average common shares outstanding		42,696			45,612
Diluted earnings per common share		$	0.45		$	0.42

 

(a)         Excludes 102 awards at March 30, 2014, as the effect of including such awards would have been antidilutive (none at March 31, 2013).

 

5.              Debt

 

Our debt is comprised entirely of a revolving line of credit. The balance was $177.2 million as of March 30, 2014 and $157.9 million as of December 29, 2013.

 

In September 2010, we entered into a five-year, $175 million unsecured revolving credit facility, which was amended in November 2011 to extend the maturity date to November 30, 2016. On April 30, 2013, we amended and restated our revolving credit facility to increase the amount available for borrowing thereunder to $300 million and extend the maturity date to April 30, 2018. The interest rate charged on outstanding balances is LIBOR plus 75 to 175 basis points. The commitment fee on the unused balance ranges from 15 to 25 basis points. The remaining availability under the revolving credit facility, reduced for outstanding letters of credit, was approximately $102.1 million as of March 30, 2014.

 

The revolving credit facility contains customary affirmative and negative covenants, including financial covenants requiring the maintenance of specified fixed charges and leverage ratios. At March 30, 2014, we were in compliance with these covenants.

 

In August 2011, we entered into an interest rate swap agreement that resulted in a fixed rate of 0.53%, instead of the variable rate of LIBOR, with a notional amount of $50 million and a maturity date of August 2013. On

 

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

 

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 accumulated other comprehensive income 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 March 30, 2014, the swap is a highly effective cash flow hedge with no ineffectiveness for the three month period ended March 30, 2014.

 

The weighted average interest rates for the credit facilities, including the impact of the previously mentioned swap agreements, were 1.5% and 1.2% for the three months ended March 30, 2014 and March 31, 2013, respectively. Interest paid, including payments made or received under the swaps, was $717,000 and $378,000 for the three months ended March 30, 2014 and March 31, 2013, respectively. As of March 30, 2014, the portion of the $129,000 interest rate swap liability that would be reclassified into earnings during the next twelve months as interest expense approximates $32,000.

 

6.              Litigation

 

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

 

Perrin v. Papa John’s International, Inc. and Papa John’s USA, Inc. is a conditionally certified collective action filed in August 2009 in the United States District Court, Eastern District of Missouri, alleging that delivery drivers were not reimbursed for mileage and expenses in accordance with the Fair Labor Standards Act. Approximately 3,900 drivers out of a potential class size of 28,800 have opted into the action. Additionally, in late December 2013, the District Court granted a motion for class certification in five additional states, which will add approximately 15,000 plaintiffs to the case.

 

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

 

7.              Segment Information

 

We have five reportable segments: domestic Company-owned restaurants, domestic commissaries, North America franchising, international operations, and “all other” units.

 

The domestic Company-owned restaurant segment consists of the operations of all domestic (“domestic” is defined as contiguous United States) Company-owned restaurants and derives its revenues principally from retail sales of pizza and side items, such as breadsticks, cheesesticks, chicken poppers, chicken wings, 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

 

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America franchising segment consists of our franchise sales and support activities and derives its revenues from sales of franchise and development rights and collection of royalties from our franchisees located in the United States and Canada. The international operations segment principally consists of Company-owned restaurants in China and distribution sales to franchised Papa John’s restaurants located in the United Kingdom, Mexico and China and our franchise sales and support activities, which derive revenues from sales of franchise and development rights and the collection of royalties from our international franchisees. International franchisees are defined as all franchise operations outside of the United States and Canada. All other business units that do not meet the quantitative thresholds for determining reportable segments, which are not operating segments, we refer to as our “all other” segment, which consists of operations that derive revenues from the sale, principally to Company-owned and franchised restaurants, of printing and promotional items, risk management services, and information systems and related services used in restaurant operations, including our online and other technology-based ordering platforms.

 

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

 

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

 

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Our segment information is as follows (in thousands):

 

		Three Months Ended
		March 30, 2014			March 31, 2013
Revenues from external customers:
Domestic Company-owned restaurants		$	178,193		$	157,898
Domestic commissaries		164,047			143,894
North America franchising		22,758			21,279
International		23,629			19,926
All others		12,750			12,607
Total revenues from external customers		$	401,377		$	355,604
Intersegment revenues:
Domestic commissaries		$	54,721		$	46,797
North America franchising		604			553
International		68			67
All others		3,730			3,168
Total intersegment revenues		$	59,123		$	50,585
Income (loss) before income taxes:
Domestic Company-owned restaurants		$	13,285		$	10,956
Domestic commissaries		10,431			10,163
North America franchising		19,484			18,222
International		732			341
All others		590			659
Unallocated corporate expenses		(12,461		)	(9,518		)
Elimination of intersegment profit		(651		)	(526		)
Total income before income taxes		$	31,410		$	30,297
Property and equipment:
Domestic Company-owned restaurants		$	199,613
Domestic commissaries		104,465
International		27,034
All others		41,929
Unallocated corporate assets		161,545
Accumulated depreciation and amortization		(321,159		)
Net property and equipment		$	213,427

 

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

 

Overview

 

Papa John’s International, Inc. (referred to as the “Company,” “Papa John’s” or in the first person notations of “we,” “us” and “our”) began operations in 1985. At March 30, 2014, there were 4,440 Papa John’s restaurants (724 Company-owned and 3,716 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 our operating results. See “Notes 1 and 2” of “Notes to Condensed Consolidated Financial Statements” for a discussion of the basis of presentation and the significant accounting policies.

 

Restaurant Progression

 

		Three Months Ended
		March 30, 2014		March 31, 2013
Papa John’s Restaurant Progression:
North America Company-owned:
Beginning of period		665		648
Opened		2		1
Closed		(1	)	—
End of period		666		649
International Company-owned:
Beginning of period		58		48
Opened		—		2
End of period		58		50
North America franchised:
Beginning of period		2,621		2,556
Opened		21		31
Closed		(27	)	(15	)
End of period		2,615		2,572
International franchised:
Beginning of period		1,084		911
Opened		23		26
Closed		(6	)	(11	)
End of period		1,101		926
Total restaurants - end of period		4,440		4,197

 

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Results of Operations

 

Summary of Operating Results - Segment Review

 

Discussion of Revenues

 

Consolidated revenues were $401.4 million for the first quarter of 2014, an increase of $45.8 million, or 12.9% over the corresponding 2013 period. The increase in revenues for the first quarter of 2014 was primarily due to the following:

 

·                  Domestic Company-owned restaurant sales increased $20.3 million, or 12.9%, primarily due to an increase of 11.4% in comparable sales during the first quarter of 2014. “Comparable sales” represents the change in year-over-year sales for the same base of restaurants for the same fiscal periods.

·                  North America franchise royalty revenue increased approximately $1.9 million, or 9.1%, primarily due to an increase of 8.9% in comparable sales during the first quarter of 2014.

·                  Domestic commissary sales increased $20.2 million, or 14.0%, due to increases in the prices of certain commodities, primarily cheese, and an increase in sales volumes.

·                  International royalties and franchise and development fees increased approximately $700,000, or 14.1%, primarily due to an increase in units and comparable sales of 6.4%, calculated on a constant dollar basis.

·                  International restaurant and commissary sales increased $3.0 million, or 20.1%, primarily due to an increase in China Company-owned restaurant sales due to an increase in units and an increase in our United Kingdom commissary revenues, due to both an increase in units and higher comparable sales.

 

Discussion of Operating Results

 

First quarter 2014 income before income taxes was $31.4 million, compared to $30.3 million in the prior year, or a 3.7% increase as summarized in the following table on a reporting segment basis (in thousands):

 

		Three Months Ended
		March 30,			March 31,			Increase
		2014			2013			(Decrease)
Domestic Company-owned restaurants		$	13,285		$	10,956		$	2,329
Domestic commissaries		10,431			10,163			268
North America franchising		19,484			18,222			1,262
International		732			341			391
All others		590			659			(69		)
Unallocated corporate expenses		(12,461		)	(9,518		)	(2,943		)
Elimination of intersegment profits		(651		)	(526		)	(125		)
Total income before income taxes		$	31,410		$	30,297		$	1,113

 

The increase of $1.1 million, or 3.7%, in income before income taxes was primarily due to the following:

 

·                  Domestic Company-owned Restaurant Segment. Domestic Company-owned restaurants’ income before income taxes increased $2.3 million in the first quarter of 2014. The increase was primarily due to the 11.4% increase in comparable sales, partially offset by lower profits from higher commodity costs. The market price for cheese averaged $2.21 per pound for the first quarter of 2014, compared to $1.66 per pound in the prior year.

 

·                  Domestic Commissary Segment. Domestic commissaries’ income before income taxes increased approximately $300,000 as the incremental profits from higher sales were partially offset by higher transition costs related to bringing distribution in house at certain of our commissaries from a third party. We manage commissary results on a full year basis and anticipate the 2014 full year profit margin will approximate 2013.

 

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·                  North America Franchising Segment. North America Franchising income before income taxes increased approximately $1.3 million primarily due to higher royalties from the 8.9% comparable sales, partially offset by an increase in royalty incentives.

 

·                  International Segment. Income before income taxes increased approximately $400,000 primarily due to the increase in units and comparable sales of 6.4%, which resulted in both higher royalties and an increase in United Kingdom profits.

 

·                  All Others Segment. The “All Others” reporting segment income before income taxes, which primarily includes our online and mobile ordering business and our wholly-owned print and promotions subsidiary, Preferred Marketing Solutions, was relatively consistent at $590,000 in the first quarter of 2014, compared to $659,000 in the prior year.

 

·                  Unallocated Corporate Segment. Unallocated corporate expenses increased approximately $2.9 million for the first quarter of 2014, as compared to the corresponding quarter in 2013. The components of unallocated corporate expenses were as follows (in thousands):

 

 

		Three Months Ended
		March 30,			March 31,			Increase
		2014			2013			(Decrease)
General and administrative (a)		$	10,329		$	8,688		$	1,641
Net interest expense (income) (b)		604			(659		)	1,263
Depreciation		1,775			1,753			22
Other income		(247		)	(264		)	17
Total unallocated corporate expenses		$	12,461		$	9,518		$	2,943

 

(a)         The increase in unallocated general and administrative costs was primarily due to higher salaries, benefits and long-term performance-based incentive compensation costs.

(b)         The increase in net interest expense (income) was primarily due to a higher average outstanding debt balance with a higher effective interest rate and the prior year inclusion of an approximate $800,000 benefit from a decrease in the redemption value of a mandatorily redeemable noncontrolling interest in a joint venture.

 

Diluted earnings per share were $0.45 in the first quarter of 2014, compared to $0.42 in the first quarter of 2013. Diluted earnings per share increased $0.03 due to the reduction in weighted average shares outstanding (6.4% reduction).

 

Review of Consolidated Operating Results

 

Revenues. Domestic Company-owned restaurant sales were $178.2 million for the first quarter of 2014, an increase of $20.3 million, or 12.9%, compared to the first quarter of 2013, primarily due to the previously mentioned increase of 11.4% in comparable sales and a 2.0% increase in equivalent units. “Equivalent units” represents the number of restaurants open at the beginning of a given period, adjusted for restaurants opened, closed, acquired or sold during the period on a weighted average basis.

 

North America franchise royalties were $22.6 million for the first quarter of 2014, an increase of $1.9 million, or 9.1%, compared to the first quarter of 2013. The increase was primarily due to an increase in North America franchise sales. North America franchise sales increased 10.3% to $529.7 million in the first quarter of 2014, from $480.1 million in the same quarter of 2013, primarily due to an 8.9% increase in comparable sales and a

 

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