Papa John’s Announces First Quarter 2018 Results and Reaffirms 2018 Outlook

Papa John’s International, Inc. (NASDAQ: PZZA) yesterday announced financial results for the first quarter ended April 1, 2018.

Highlights

• First quarter earnings per diluted share of $0.50 in 2018 compared to $0.77 in the first quarter of 2017
• North America comparable sales decrease of 5.3%
• International comparable sales increases of 0.3%; international franchise sales increase of 21.1%, excluding the impact of foreign currency
• 13 net unit openings in first quarter of 2018 driven by International operations
• Free cash flow of $31.7 million in the first quarter as compared to $32.3 million in the first quarter of 2017
• 2018 outlook reaffirmed

“Although first quarter results were lower than the prior year, they were consistent with our expectations. We remain focused on enhancing our value perception and driving our strategic initiatives,” said Steve Ritchie, President and CEO of Papa John’s.

All operating highlights are compared to the same period of the prior year, unless otherwise noted.

Consolidated revenues decreased $21.9 million, or 4.9%, for the first quarter of 2018 primarily due to lower comparable sales for North America restaurants and lower North America commissary sales due to lower volumes. These decreases were partially offset by higher International revenues due to an increase in equivalent units and the favorable impact of foreign exchange rates of approximately $2.8 million. Additionally, the first quarter of 2018 included an increase in Other revenues of approximately $2.7 million primarily due to the required reporting of franchise marketing fund contributions as revenues (previously netted with expenses) under the newly adopted revenue recognition standard, Revenue from Contracts with Customers (“Topic 606”); see the “Revenue Recognition and Income Statement Presentation” section below for more details.

Consolidated income before income taxes of $22.4 million for the first quarter of 2018 decreased $19.5 million, or 46.6%, compared to the first quarter of 2017. Income before income taxes, as a percentage of consolidated revenues, was 5.2% for the first quarter of 2018, as compared to 9.3% for the first quarter of 2017. Significant changes in the components of income before income taxes are as follows:

• Domestic Company-owned restaurants operating margin decreased $8.6 million, or 2.7% as a percentage of related revenues, primarily due to lower comparable sales, increased labor costs including higher minimum wages and increased non-owned automobile costs.
• North America franchise royalties and fees decreased $2.8 million, or 10% as compared to the first quarter of 2017, primarily due to lower comparable sales, and an increase in royalty waivers to franchisees.
• North America commissary operating margin decreased $1.4 million, or 0.4% as a percentage of related revenues, primarily due to lower sales volumes.
• International operating margin increased $1.3 million primarily due to higher royalties from increased equivalent units and the favorable impact of foreign exchange rates.
• Other operating margin decreased $718,000, or 3.7%, primarily due to higher advertising spend in the United Kingdom. The “Revenue Recognition and Income Statement Presentation” section below provides more information on our newly reported “Other revenues” and “Other expenses” income statement line items.
• General and administrative (“G&A”) costs increased $3.3 million, or 9.1%, primarily due to an increase in bad debt expense, higher legal fees and an increase in various technology initiative costs.
• Net interest expense increased $3.1 million for the first quarter due to an increase in average outstanding debt, which is primarily due to share repurchases, as well as higher interest rates.

The first quarter 2018 effective income tax rate was 22.3%, representing a decrease of 6.3% from the prior year comparable period rate of 28.6%. This decrease was primarily due to the reduction of the U.S. corporate tax rate effective January 1, 2018 as part of the Tax Cuts and Jobs Act. This decrease was offset by an approximate 3.8% increase in the income tax rate for share based compensation tax deductions, which were unfavorable in 2018 due to the lower stock price of the company as restrictions lapsed on equity awards.

Diluted earnings per share decreased 35.1% to $0.50 for the first quarter of 2018. This decrease was primarily due to a decrease in net income as previously discussed.

We believe North America, international and global restaurant and comparable sales growth information, as defined in the table above, is useful in analyzing our results since our franchisees pay royalties that are based on a percentage of franchise sales. Franchise sales also generate commissary revenue in the United States and in certain international markets. Franchise restaurant and comparable sales growth information is also useful for comparison to industry trends and evaluating the strength of our brand. Management believes the presentation of franchise restaurant sales growth, excluding the impact of foreign currency, provides investors with useful information regarding underlying sales trends and the impact of new unit growth without being impacted by swings in the external factor of foreign currency. Franchise restaurant sales are not included in company revenues.

Free Cash Flow

The company’s free cash flow, a non-GAAP financial measure, for the first quarter of 2018 and 2017 was as follows (in thousands):

We define free cash flow as net cash provided by operating activities (from the consolidated statements of cash flows) less the amounts spent on the purchase of property and equipment. We view free cash flow as an important measure because it is a 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 the company’s liquidity or performance than the company’s GAAP measures.

See the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission (SEC) for additional information concerning our operating results and cash flow for the three months ended April 1, 2018.

Global Restaurant Unit Data

At April 1, 2018, there were 5,212 Papa John’s restaurants operating in all 50 states and in 45 international countries and territories, as follows:

The company has added 130 net worldwide units over the trailing four quarters ended April 1, 2018. Our development pipeline as of April 1, 2018 included approximately 1,110 restaurants (160 units in North America and 950 units internationally), the majority of which are scheduled to open over the next six years.

Share Repurchase Activity

The following table reflects our repurchases for the first quarter of 2018 and subsequent repurchases through May 1, 2018 (in thousands):

There were 33.6 million diluted weighted average shares outstanding for the first quarter of 2018, representing a decrease of 10.2% over the prior year comparable period. Approximately 32.0 million actual shares of the company’s common stock were outstanding as of April 1, 2018.

As previously disclosed, on March 1, 2018 we announced a $100 million accelerated share repurchase agreement (“ASR Agreement”) with Bank of America, N.A. (“BofAML”). Pursuant to the terms of the ASR Agreement, we paid BofAML $100 million in cash. Then on March 6, 2018, we received an initial delivery of approximately 1.3 million shares of common stock for $78.0 million or 78% of the total ASR agreement. Additional shares may be received prior to and/or at final settlement for the remaining $22.0 million, based generally on the average of the daily volume-weighted average prices of the company’s common stock during the term of the ASR Agreement, less a discount. Subsequent to the end of the quarter through May 1, 2018, the Company acquired an additional 28,739 shares at an aggregate cost of $1.7 million through the ASR Agreement.

Cash Dividend

We paid a cash dividend of approximately $7.6 million ($0.225 per common share) during the first quarter of 2018. Subsequent to the first quarter, on May 2, 2018, our Board of Directors declared a second quarter dividend of $0.225 per common share (approximately $7.3 million based on the number of shares outstanding as of May 1, 2018). The dividend will be paid on May 25, 2018 to shareholders of record as of the close of business on May 14, 2018. The declaration and payment of any future dividends will be at the discretion of our Board of Directors, subject to the company’s financial results, cash requirements, and other factors deemed relevant by our Board of Directors.

Revenue Recognition and Income Statement Presentation

On January 1, 2018, we adopted the new revenue recognition standard using the modified retrospective method. Under the modified retrospective method, prior period results were not restated to reflect the impact of Topic 606, resulting in reduced comparability between 2018 and 2017 operating results. The impact of adoption includes the following:

• $21.5 million reduction in retained earnings for the opening balance sheet cumulative adjustment.
• $2.4 million increase in total revenues primarily due to the requirement to present revenues and expenses related to marketing funds we control on a “gross” basis. This gross up is reported in the new financial statement line items, Other revenues and Other expenses, as discussed further below; this change in reporting had no significant impact on consolidated pre-tax income results.
• $485,000 decrease in pre-tax income for the first quarter primarily due to the revised method of accounting for franchise fees.
• EPS decrease of approximately $0.01 in the first quarter.

Additional detail on the adoption and 2018 impact of the new revenue recognition standard can be found in our Form 10-Q for the three months ended April 1, 2018 filed with the SEC.

While not required as part of the adoption of Topic 606, our income statement includes newly created Other revenues and Other expenses line items. Other revenues and Other expenses include the Topic 606 “gross up” of revenues and expenses derived from certain domestic and international marketing fund co-ops we control, as previously discussed. Additionally, Other revenues and Other expenses include various reclassifications from North America commissary and other, International expenses and General and administrative expenses to better reflect and aggregate various domestic and international services provided by the company for the benefit of franchisees. Related Quarter 1 of 2017 amounts have also been reclassified to conform to the new 2018 presentation, as detailed in the “Summary of Income Statement Presentation Reclassifications” included with this press release. These reclassifications had no impact on reported total revenues or total costs and expenses. Refer to the ‘Investor Relations’ section on our company website for details of income statement presentation reclassifications for each quarter of 2017.

2018 Outlook

The company is reaffirming its previously issued 2018 outlook, as we expect our initiatives will result in improved sales and operating results in the last half of the year.