pzza_Current folio_10Q

Table of Contents

 

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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 July 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 July 31, 2018, there were outstanding 31,619,630 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 — July 1, 2018 and December 31, 2017

3

 

 

 

 

Condensed Consolidated Statements of Income — Three and Six months ended July 1, 2018 and June 25, 2017

4

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income — Three and Six months ended July 1, 2018 and June 25, 2017

5

 

 

 

 

Condensed Consolidated Statements of Cash Flows — Six months ended July 1, 2018 and June 25, 2017

6

 

 

 

 

Notes to Condensed Consolidated Financial Statements

7

 

 

 

Item 2. 

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

28

 

 

 

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

38

 

 

 

Item 4. 

Controls and Procedures

40

 

 

 

PART II. 

OTHER INFORMATION

 

 

 

 

Item 1. 

Legal Proceedings

40

 

 

 

Item 1A. 

Risk Factors

41

 

 

 

Item 2. 

Unregistered Sales of Equity Securities and Use of Proceeds

42

 

 

 

Item 6. 

Exhibits

44

 

 

2

 


 

Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

 

 

 

 

 

 

 

 

 

    

July 1,

    

December 31,

(In thousands, except per share amounts)

 

2018

 

2017

 

 

(Unaudited)

 

 

Assets

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

25,719

 

$

22,345

Accounts receivable, net

 

 

62,973

 

 

64,644

Notes receivable, net

 

 

5,180

 

 

4,333

Income tax receivable

 

 

 —

 

 

3,903

Inventories

 

 

27,109

 

 

30,620

Prepaid expenses

 

 

26,729

 

 

28,522

Other current assets

 

 

7,223

 

 

9,494

Assets held for sale

 

 

2,786

 

 

6,133

Total current assets

 

 

157,719

 

 

169,994

Property and equipment, net

 

 

227,722

 

 

234,331

Notes receivable, less current portion, net

 

 

15,648

 

 

15,568

Goodwill

 

 

85,064

 

 

86,892

Deferred income taxes, net

 

 

709

 

 

585

Other assets

 

 

71,309

 

 

48,183

Total assets

 

$

558,171

 

$

555,553

 

 

 

 

 

 

 

Liabilities and stockholders’ (deficit)

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

 

$

33,307

 

$

32,006

Income and other taxes payable

 

 

8,904

 

 

10,561

Accrued expenses and other current liabilities

 

 

81,197

 

 

70,293

Deferred revenue current

 

 

2,426

 

 

 —

     Current portion of long-term debt

 

 

20,000

 

 

20,000

Total current liabilities

 

 

145,834

 

 

132,860

Deferred revenue

 

 

15,329

 

 

2,652

Long-term debt, less current portion, net

 

 

556,387

 

 

446,565

Deferred income taxes, net

 

 

5,140

 

 

12,546

Other long-term liabilities

 

 

78,515

 

 

60,146

Total liabilities

 

 

801,205

 

 

654,769

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

 

7,356

 

 

6,738

 

 

 

 

 

 

 

Stockholders’ (deficit):

 

 

 

 

 

 

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

 

 

 —

 

 

 —

Common stock ($0.01 par value per share; issued 44,280 at July 1, 2018 and 44,221

 

 

 

 

 

 

    at December 31, 2017)

 

 

443

 

 

442

Additional paid-in capital

 

 

188,026

 

 

184,785

Accumulated other comprehensive income (loss)

 

 

2,240

 

 

(2,117)

Retained earnings

 

 

285,460

 

 

292,251

Treasury stock (12,733 shares at July 1, 2018 and 10,290 shares at

 

 

 

 

 

 

    December 31, 2017, at cost)

 

 

(742,695)

 

 

(597,072)

Total stockholders’ (deficit), net of noncontrolling interests

 

 

(266,526)

 

 

(121,711)

Noncontrolling interests in subsidiaries

 

 

16,136

 

 

15,757

Total stockholders’ (deficit) 

 

 

(250,390)

 

 

(105,954)

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

 

$

558,171

 

$

555,553

 

See accompanying notes.

3

 


 

Table of Contents

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Three Months Ended

 

Six Months Ended

 

 

July 1,

 

June 25,

 

July 1,

 

June 25,

(In thousands, except per share amounts)

    

2018

    

2017

    

2018

    

2017

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurant sales

 

$

181,379

 

$

202,756

 

$

371,621

 

$

409,652

North America franchise royalties and fees

 

 

23,912

 

 

26,588

 

 

48,718

 

 

54,195

North America commissary

 

 

153,455

 

 

160,059

 

 

315,168

 

 

331,399

International

 

 

29,069

 

 

27,245

 

 

59,183

 

 

52,867

Other revenues

 

 

20,144

 

 

18,130

 

 

40,638

 

 

35,931

Total revenues

 

 

407,959

 

 

434,778

 

 

835,328

 

 

884,044

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurant expenses

 

 

147,781

 

 

162,433

 

 

305,100

 

 

327,852

North America commissary

 

 

143,300

 

 

149,472

 

 

294,981

 

 

309,429

International expenses

 

 

18,248

 

 

17,272

 

 

37,278

 

 

33,063

Other expenses

 

 

20,698

 

 

17,482

 

 

41,656

 

 

35,029

General and administrative expenses

 

 

38,712

 

 

40,248

 

 

78,441

 

 

76,662

Depreciation and amortization

 

 

11,731

 

 

10,654

 

 

23,270

 

 

21,111

Total costs and expenses

 

 

380,470

 

 

397,561

 

 

780,726

 

 

803,146

Refranchising loss, net

 

 

(2,122)

 

 

 —

 

 

(1,918)

 

 

 —

Operating income

 

 

25,367

 

 

37,217

 

 

52,684

 

 

80,898

Net Interest expense

 

 

(5,662)

 

 

(1,759)

 

 

(10,617)

 

 

(3,569)

Income before income taxes

 

 

19,705

 

 

35,458

 

 

42,067

 

 

77,329

Income tax expense

 

 

7,040

 

 

10,476

 

 

12,022

 

 

22,448

Net income before attribution to noncontrolling interests

 

 

12,665

 

 

24,982

 

 

30,045

 

 

54,881

Income attributable to noncontrolling interests

 

 

(874)

 

 

(1,444)

 

 

(1,517)

 

 

(2,915)

Net income attributable to the Company

 

$

11,791

 

$

23,538

 

$

28,528

 

$

51,966

 

 

 

 

 

 

 

 

 

 

 

 

 

Calculation of income for earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to the Company

 

$

11,791

 

$

23,538

 

$

28,528

 

$

51,966

Change in noncontrolling interest redemption value

 

 

 —

 

 

662

 

 

 —

 

 

1,182

Net income attributable to participating securities

 

 

(72)

 

 

(99)

 

 

(147)

 

 

(216)

Net income attributable to common shareholders

 

$

11,719

 

$

24,101

 

$

28,381

 

$

52,932

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.37

 

$

0.66

 

$

0.87

 

$

1.44

Diluted earnings per common share

 

$

0.36

 

$

0.65

 

$

0.86

 

$

1.42

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

 

31,941

 

 

36,732

 

 

32,610

 

 

36,771

Diluted weighted average common shares outstanding

 

 

32,175

 

 

37,217

 

 

32,860

 

 

37,283

 

 

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.225

 

$

0.200

 

$

0.450

 

$

0.400

 

See accompanying notes.

 

 

4

 


 

Table of Contents

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

July 1,

 

June 25,

 

July 1,

 

June 25,

(In thousands)

    

2018

    

2017

    

2018

    

2017

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income before attribution to noncontrolling interests

 

$

12,665

 

$

24,982

 

$

30,045

 

$

54,881

Other comprehensive (loss) income, before tax:

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments (1)

 

 

(5,295)

 

 

808

 

 

(3,312)

 

 

1,421

Interest rate swaps (2)

 

 

2,834

 

 

(1,857)

 

 

9,552

 

 

(2,325)

Other comprehensive (loss) income, before tax

 

 

(2,461)

 

 

(1,049)

 

 

6,240

 

 

(904)

Income tax effect:

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments (1)

 

 

1,218

 

 

(299)

 

 

745

 

 

(526)

Interest rate swaps (3)

 

 

(627)

 

 

687

 

 

(2,172)

 

 

860

Income tax effect (4)

 

 

591

 

 

388

 

 

(1,427)

 

 

334

Other comprehensive (loss) income, net of tax

 

 

(1,870)

 

 

(661)

 

 

4,813

 

 

(570)

Comprehensive income before attribution to noncontrolling interests

 

 

10,795

 

 

24,321

 

 

34,858

 

 

54,311

Less: comprehensive income, redeemable noncontrolling interests

 

 

(319)

 

 

(745)

 

 

(404)

 

 

(1,539)

Less: comprehensive income, nonredeemable noncontrolling interests

 

 

(555)

 

 

(699)

 

 

(1,113)

 

 

(1,376)

Comprehensive income attributable to the Company

 

$

9,921

 

$

22,877

 

$

33,341

 

$

51,396

 


 

(1)

On June 15, 2018, the Company refranchised 34 Company-owned restaurants and a quality control center located in China.  In conjunction with the transaction, approximately $1,300 of accumulated other comprehensive income and $300 associated deferred tax related to foreign currency translation were reversed.  See “Note 7” of “Notes to Condensed Consolidated Financial Statements” for additional information.

 

(2)

Amounts reclassified out of accumulated other comprehensive income (loss) into net interest expense included $89 and $197 for the three and six months ended July 1, 2018, respectively, and $126 and $324 for the three and six months ended June 25, 2017, respectively.

 

(3)

The income tax effects of amounts reclassified out of accumulated other comprehensive income (loss) were $20 and $45 for the three and six months ended July 1, 2018, respectively, and $47 and $120 for the three and six months ended June 25, 2017, respectively.

 

(4)

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 in the first quarter of 2018.  See “Note 2” of “Notes to Condensed Consolidated Financial Statements” for additional information. 

 

 

See accompanying notes.

 

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Table of Contents

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

July 1,

 

June 25,

(In thousands)

    

2018

    

2017

Operating activities

 

 

 

 

 

 

Net income before attribution to noncontrolling interests

 

$

30,045

 

$

54,881

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

 

 

 

 

 

 

Provision for uncollectible accounts and notes receivable

 

 

3,591

 

 

(1,091)

Depreciation and amortization

 

 

23,270

 

 

21,111

Deferred income taxes

 

 

(2,511)

 

 

158

Stock-based compensation expense

 

 

4,929

 

 

5,571

Loss on refranchising

 

 

1,918

 

 

 —

Other

 

 

3,032

 

 

1,978

Changes in operating assets and liabilities, net of acquisitions:

 

 

 

 

 

 

Accounts receivable

 

 

(148)

 

 

(355)

Income tax receivable

 

 

3,678

 

 

(45)

Inventories

 

 

3,188

 

 

550

Prepaid expenses

 

 

1,159

 

 

2,966

Other current assets

 

 

5,524

 

 

(372)

Other assets and liabilities

 

 

(2,202)

 

 

(1,559)

Accounts payable

 

 

2,511

 

 

(3,950)

Income and other taxes payable

 

 

(1,656)

 

 

1,275

Accrued expenses and other current liabilities

 

 

(2,506)

 

 

(3,002)

Deferred revenue

 

 

379

 

 

(253)

Net cash provided by operating activities

 

 

74,201

 

 

77,863

Investing activities

 

 

 

 

 

 

Purchases of property and equipment

 

 

(21,562)

 

 

(30,457)

Loans issued

 

 

(1,904)

 

 

(1,476)

Repayments of loans issued

 

 

2,720

 

 

2,125

Acquisitions, net of cash acquired

 

 

 —

 

 

(21)

Proceeds from divestitures of restaurants

 

 

3,690

 

 

 —

Other

 

 

146

 

 

25

Net cash used in investing activities

 

 

(16,910)

 

 

(29,804)

Financing activities

 

 

 

 

 

 

Repayments of term loan

 

 

(10,000)

 

 

 —

Net proceeds of revolving credit facility

 

 

119,400

 

 

5,156

Cash dividends paid

 

 

(14,762)

 

 

(14,703)

Tax payments for equity award issuances

 

 

(1,353)

 

 

(2,282)

Proceeds from exercise of stock options

 

 

2,179

 

 

5,218

Acquisition of Company common stock

 

 

(148,440)

 

 

(33,968)

Distributions to noncontrolling interest holders

 

 

(1,110)

 

 

(1,389)

Other

 

 

231

 

 

494

Net cash used in financing activities

 

 

(53,855)

 

 

(41,474)

Effect of exchange rate changes on cash and cash equivalents

 

 

(62)

 

 

99

Change in cash and cash equivalents

 

 

3,374

 

 

6,684

Cash and cash equivalents at beginning of period

 

 

22,345

 

 

15,563

Cash and cash equivalents at end of period

 

$

25,719

 

$

22,247

See accompanying notes.

 

 

 

 

 

 

 

 

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Table of Contents

Papa John’s International, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

July 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 and six months ended July 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

 

Use of Estimates

 

The preparation of Condensed Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Significant items that are subject to such estimates and assumptions include allowance for doubtful accounts and notes receivable, intangible assets, online customer loyalty program obligation, insurance reserves and tax reserves. Although management bases its estimates on historical experience and assumptions that are believed to be reasonable under the circumstances, actual results could significantly differ from these estimates. 

 

Noncontrolling Interests

 

At the beginning of 2018, Papa John’s had five joint venture arrangements in which there were noncontrolling interests held by third parties.  In the first quarter of 2018, one joint venture was divested and an additional joint venture was divested subsequent to the end of the second quarter.  That joint venture was classified as held for sale as of July 1, 2018.

 

As of July 1, 2018, there were 215 restaurants that comprise these joint ventures, including our held for sale joint venture as compared to 223 restaurants at June 25, 2017.  As of the beginning of the third quarter of 2018, there were 184 restaurants under these joint venture arrangements.  See Note 7 for more information on these related divestitures.

 

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

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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 and six months ended July 1, 2018 and June 25, 2017 was as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

 

 

 

 

    

Three Months Ended

 

Six Months Ended

 

 

July 1,

 

June 25,

 

July 1,

 

June 25,

 

    

2018

    

2017

    

2018

    

2017

 

 

 

 

 

 

 

 

 

 

 

 

 

Papa John’s International, Inc.

 

$

1,577

 

$

2,341

 

$

2,872

 

$

4,703

Noncontrolling interests

 

 

874

 

 

1,444

 

 

1,517

 

 

2,915

Total income before income taxes

 

$

2,451

 

$

3,785

 

$

4,389

 

$

7,618

 

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

 

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, the Company adopted ASC Topic 606, “Revenue from Contracts with Customers” (“Topic 606”), in the first quarter of 2018. Prior year revenue recognition follows ASC 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. Currently, the liability related to Papa Rewards 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 and the

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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. 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 exclusivity fees are from international locations. Initial 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 beginning at the store opening date through the term of the franchise agreement, which is typically 10 years. Fees received for future license 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 license renewal fees.

 

The Company offers various incentive programs for franchisees including royalty incentives, new restaurant opening incentives (i.e. development incentives) and other 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 to the franchisee. This equipment is amortized by us 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 (“Co-op” or “Co-operative”) 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 revised the principal versus agent determination of these arrangements. When we are determined to be the principal in these arrangements,

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advertising fund contributions and expenditures are reported on a gross basis in the Condensed Consolidated Statements of Income.  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 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 in 2017.  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 July 1, 2018, the Company has not made any material adjustments to the December 30, 2017 estimates.  Our net deferred income tax liability was approximately $4.4 million at July 1, 2018. 

 

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 and cash equivalents, 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 term debt and revolving credit facility approximates its carrying value due to its variable market-based interest rate (Level 2).

 

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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 July 1, 2018 and December 31, 2017 are as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Carrying

 

Fair Value Measurements

 

 

    

Value

    

Level 1

    

Level 2

    

Level 3

 

July 1, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash surrender value of life insurance policies (a)

 

$

29,771

 

$

29,771

 

$

 —

 

$

 —

 

Interest rate swaps (b)

 

 

10,203

 

 

 —

 

 

10,203

 

 

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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.

(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  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 six months ended July 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

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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, which allows for an entity to reclassify disproportionate income tax in 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 (Topic 842),” (“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 cases calculated substantially the same as under the prior leasing guidance. In July 2018, the FASB issued the following amendments to clarify the implementation guidance: ASU 2018-10, “Codification Improvements to Topic 842, Leases,” and ASU 2018-11, “Leases (Topic 842): Targeted Improvements.”  The amendment allows for a modified retrospective adoption approach and new required lease disclosures for all leases existing or entered into after either the beginning of the year of adoption or the earliest comparative period in the consolidated financial statements.  ASU 2016-02 is effective for interim and annual periods beginning after December 15, 2018, 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. 

 

Goodwill

 

In January 2017, the FASB issued ASU 2017-04, “Intangibles – Goodwill and Other,” (“ASU 2017-04”), which simplifies the accounting for goodwill.  ASU 2017-04 eliminates the second step of the goodwill impairment test, which requires a hypothetical purchase price allocation.  The goodwill impairment is the difference between the carrying value and fair value, not to exceed the carrying amount.  ASU 2017-04 is effective for annual and interim periods in fiscal years beginning after December 15, 2019.  The Company is currently evaluating this standard and its potential impact on our consolidated financial statements.

 

Reclassification

 

Certain prior year amounts have been reclassified in the Condensed Consolidated Statements of Income.  See Note 11 for additional information.

 

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

 

The Company adopted 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 three and six months ended July

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1, 2018, was an increase in revenues of $1.8 million and $4.3 million respectively and a decrease in pre-tax income of $1.4 million and $1.9 million, respectively.

 

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 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 in the first quarter of 2018 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’ (deficit), net of noncontrolling interests

 

 

(121,711)

 

 

(21,527)

 

 

(143,238)

Noncontrolling interests in subsidiaries

 

 

15,757

 

 

 —

 

 

15,757

Total stockholders’ (deficit) 

 

 

(105,954)

 

 

(21,527)

 

 

(127,481)

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

 

$

555,553

 

$

(1,094)

 

$

554,459

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As Reported

 

 

 

 

 

Balance Sheet

 

    

July 1,

    

 

Total

 

 

Without Adoption

(In thousands, except per share amounts)

 

2018

 

 

Adjustments

 

 

of Topic 606

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

25,719

 

$