Papa John’s: Announces Q1-2019 Results, Reaffirms Outlook

Louisville / KY. (pj) Papa John’s International Inc., one of the world’s largest pizza delivery companies, announced financial results for the first quarter ended March 31, 2019. Highlights:

  • First quarter 2019 loss per diluted share of (USD 0.12)
  • Excluding Special charges, adjusted earnings per diluted share of USD 0.31 compared to USD 0.52 for first quarter of 2018
  • System-wide North America comparable sales decrease of 6.9%
  • International comparable sales decrease of 0.1 percent; international franchise sales increase of 10.5 percent, excluding the impact of foreign currency
  • 33 net unit openings in the first quarter of 2019 driven by International operations
  • The company issued USD 252.5 million of Series B Preferred Stock to certain funds affiliated with, or managed by, Starboard Value LP (collectively «Starboard») and certain franchisees during the quarter

Steve Ritchie, President and CEO of Papa John’s, said, «The first quarter was a time of promise for Papa John’s. We made further progress in transforming the culture, thinking and momentum within the company. We have significantly strengthened and refreshed the company’s leadership, adding talented members to the senior management team and highly-qualified directors to the board this year. At the same time, we continued reevaluating all aspects of our go-to-market strategy, identifying multiple opportunities to improve the customer experience, customer value proposition and franchisee unit economics. Last quarter, we made several improvements in the key drivers of our business. Substantial, positive change takes time and effort, but with the passion and dedication of our team members and franchise partners, I am very excited about the future of Papa John’s.»

Operating Highlights

As more fully described within this press release, beginning this quarter, the company consolidated the financial results of the Papa John’s Marketing Fund Inc. («PJMF). The financial statements for the first quarter of 2018 have been restated to reflect the consolidation of PJMF. The consolidation of PJMF is not expected to have a material impact on the company’s annual consolidated financial results, including the income (loss) before income taxes, as PJMF operates at or near break-even results annually. The consolidation of PJMF also did not have a material impact on the company’s 2018 financial statements. Operating highlights, including restated data for the first quarter of 2018, are as follow:

(In thousands, except per share amounts) 2019-03-31 (a) 2018-04-01 (b) Decrease %
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Total revenue USD 398,405 USD 450,122 (11.5 percent)
(Loss) income before income taxes (767 ) 23,064 (103.3 percent)
Net (loss) income (1,731 ) 17,443 (109.9 percent)
Diluted (loss) earnings per share (0.12 ) 0.52 (123.1 percent)
Adjusted diluted earnings per share (c) 0.31 0.52 (40.4 percent)
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(a) The consolidation of PJMF resulted in revenues of USD 23.5 million, income before income taxes and net income of approximately USD 600,000 and diluted earnings per share of USD 0.02.
(b) The consolidation of PJMF resulted in revenues of USD 22.8 million, income before income taxes and net income of approximately USD 700,000 and diluted earnings per share of USD 0.02.
(c) Adjusted to exclude special charges in 2019, which impact comparability. The reconciliation of GAAP to non-GAAP financial results is included in the table below.

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Adjusted financial results excluding Special charges, which impact comparability, are summarized in the following reconciliation. The table reconciles our GAAP financial results to our adjusted financial results, which are non-GAAP measures. All highlights are compared to the same period of the prior year, unless otherwise noted.

(In thousands, except per share amounts) 2019-03-31 2018-04-01 (1)
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GAAP (loss) income before income taxes USD (767 ) USD 23,064
Special charges (2) 15,854
Adjusted income before income taxes USD 15,087 USD 23,064
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GAAP net (loss) income attributable to common shareholders USD (3,801 ) USD 17,368
Special charges (2) 13,548
Adjusted net income attributable to common shareholders USD 9,747 USD 17,368
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GAAP diluted (loss) earnings per share USD (0.12 ) USD 0.52
Special charges (2) 0.43
Adjusted diluted earnings per share USD 0.31 USD 0.52
(1) The first quarter of 2018 has been restated to include PJMF.
(2) The company incurred USD 15.9 million of costs (defined as «Special charges») in the first quarter of 2019, including the following (in thousands):

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Loss Before After Tax Diluted Loss
Income taxes Net Loss (d) per Share
Royalty relief (a) USD 4,873 USD 3,742 USD 0.12
Legal and advisory fees (b) 5,067 3,892 0.12
Mark-to-market adjustment on option valuation (c) 5,914 5,914 0.19
Total Special charges USD 15,854 USD 13,548 USD 0.43
(a) Represents financial assistance provided to the entire North America system in the form of short-term royalty reductions.
(b) Represents costs associated with the activities of the Special Committee of the Board of Directors, including legal costs associated with legal proceedings initiated by John H. Schnatter and advisory costs associated with the review of a wide range of strategic opportunities that culminated in Starboard’s strategic investment in the company by affiliates of Starboard.
(c) The company recorded a one-time mark-to-market adjustment of USD 5.9 million (USD 5.6 million in general and administrative expenses and USD 300,000 as a reduction in royalties) related to the increase in the Starboard and franchisee options to purchase Series B preferred stock that culminated in the purchase of USD 52.5 million of preferred stock in late March.
(d) The tax effect was calculated using the company’s marginal rate of 23.2 percent, excluding the mark-to-market adjustment on the Series B Preferred stock option valuation, which was not tax deductible.

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The non-GAAP adjusted results shown above and within this document, which exclude Special charges, should not be construed as a substitute for or a better indicator of the company’s performance than the company’s GAAP results. Management believes presenting certain financial information excluding the Special charges is important for purposes of comparison to prior year results. In addition, management uses these metrics to evaluate the company’s underlying operating performance and analyze trends.

Consolidated revenues decreased USD 51.7 million, or 11.5 percent, for the first quarter of 2019. Excluding the impact of refranchising 62 company-owned restaurants in North America and the company-owned restaurants and a quality control center in China during 2018, consolidated revenues decreased USD 36.4 million, or 8.1 percent, for the first quarter of 2019, primarily due to the following:

  • Negative 9.0 percent comparable sales for domestic company-owned restaurants and negative 6.1 percent for North America franchised restaurants, which resulted in lower company-owned restaurant revenues, royalties and North American commissary sales.
  • Short-term royalty reductions of approximately USD 4.9 million which are part of our franchise assistance program and are included in the previously mentioned Special charges.
  • International revenues, excluding refranchising, were approximately USD 0.5 million lower as unfavorable foreign exchange rates of approximately USD 1.7 million were substantially offset by higher royalties from increased equivalent units.

The company reported a consolidated loss before income taxes of USD 0.8 million for the first quarter of 2019, compared to consolidated income before income taxes of USD 23.1 million for the first quarter of 2018, a decrease of USD 23.9 million. Excluding the impact of the previously mentioned Special charges, consolidated income before income taxes was USD 15.1 million, or a decrease of USD 8.0 million from the first quarter of 2018. Significant changes in income before income taxes are as follows:

  • Domestic Company-owned restaurants operating margin decreased USD 3.9 million, or a decrease of 0.6 percent as a percentage of related revenues, primarily due to lower comparable sales, partially offset by favorable commodities costs and favorable workers’ compensation and non-owned automobile insurance costs.
  • North America franchise royalties and fees decreased USD 7.3 million, or 29.3 percent, compared to the first quarter of 2018, primarily due to the USD 4.9 million of short-term royalty reductions granted to the entire North America system as part of the franchise assistance program, which is included in the Special charges. Excluding the short-term royalty relief, royalties were USD 2.4 million lower than the corresponding quarter in 2018 due to negative comparable sales of 6.1 percent and an increase in royalty waivers provided to certain franchisees.
  • North America commissary operating margin increased USD 0.3 million, or 0.7 percent as a percentage of related revenues, as the lower North America sales volumes were offset by favorable commodities costs and reductions in certain operating costs, including labor.
  • International operating margin increased USD 0.3 million primarily due to higher royalties from increased equivalent units, partially offset by the unfavorable impact of foreign exchange rates.
  • General and administrative («G+A») costs increased USD 11.1 million, or 27.9 percent, primarily due to costs associated with the Special charges of approximately USD 10.7 million, including USD 5.1 million of legal and advisory fees and the one-time mark- to-market adjustment for the Series B Preferred stock option valuation of USD 5.6 million, as previously noted.
  • Net interest expense increased USD 1.2 million primarily due to an increase in interest rates as compared to the first quarter of 2018 on lower outstanding debt. Total debt outstanding was USD 380.0 million as of March 31, 2019, which was a reduction of USD 245.0 million from December 30, 2018. The decrease in outstanding debt was funded primarily from the proceeds of the issuance of Series B Preferred Stock to Starboard.

Operating margin (loss) is not a measure defined by GAAP and should not be considered in isolation, or as an alternative to evaluation of the company’s financial performance. In addition to an evaluation of GAAP consolidated (loss) income before income taxes, we believe the presentation of operating margin (loss) is beneficial as it represents an additional measure used by the company to further evaluate operating efficiency and performance of the various business units. Additionally, operating margin (loss) discussion may be helpful for comparison within the industry. The operating margin (loss) results detailed herein can be calculated by business unit based on the specific revenue and operating expense line items on the face of the Consolidated Statements of Operations. Consolidated (loss) income before income taxes reported includes G+A expenses, depreciation and amortization, refranchising and impairment gains/(losses), net, and net interest expense that have been excluded from this operating margin (loss) calculation.

We expect our annual tax rate to be in the range of 21 percent to 24 percent. As previously noted, there is not a tax deduction for the USD 5.9 million expense associated with the one-time mark-to-market valuation of the Series B Preferred stock option.

Diluted loss per share was USD 0.12 for the first quarter of 2019, compared to diluted earnings per share of USD 0.52 for the prior year period. Adjusted diluted earnings per share was USD 0.31 for the first quarter of 2019, as compared to USD 0.52 for the first quarter of 2018.

Global Restaurant and Comparable Sales Information

First quarter 2019-03-31 2018-04-01
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Global restaurant sales (decline) / growth (a) (5.5 percent) (1.3 percent)
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Global restaurant sales (decline) /growth, excluding the impact of foreign currency (a) (3.7 percent) (1.0 percent)
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Comparable sales (decline) / growth (b)
Domestic company-owned restaurants (9.0 percent) (6.1 percent)
North America franchised restaurants (6.1 percent) (5.0 percent)
System-wide North America restaurants (6.9 percent) (5.3 percent)
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System-wide international restaurants (0.1 percent) 0.3 %
(a) Includes both company-owned and franchised restaurant sales.
(b) Represents the change in year-over-year sales for the same base of restaurants for the same fiscal periods. Comparable sales results for restaurants operating outside of the United States are reported on a constant Dollar basis, which excludes the impact of foreign currency translation.

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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.

Global Restaurant Unit Data

At March 31, 2019, there were 5,336 Papa John’s restaurants operating in all 50 states and in 47 international countries and territories, as follows:

Domestic Company- owned Franchised North America Total North America International System-wide
First Quarter
Beginning – December 30, 2018 645 2,692 3,337 1,966 5,303
Opened 1 26 27 49 76
Closed (28 ) (28 ) (15 ) (43 )
Acquired 1 1 1
Sold (1 ) (1 ) (1 )
Ending – March 31, 2019 645 2,691 3,336 2,000 5,336
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Unit growth (decline) (1 ) (1 ) 34 33
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percent increase (decrease) (0.0 percent) (0.0 percent) 1.7 % 0.6 %

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The company has added 124 net worldwide units over the trailing four quarters ended March 31, 2019. Our development pipeline as of March 31, 2019 included approximately 1,015 restaurants (115 units in North America and 900 units internationally), the majority of which are scheduled to open over the next six years.

Consolidation of the Papa John’s Marketing Fund Inc.

Papa John’s domestic restaurants, both Company-owned and franchised, participate in PJMF, a nonstock corporation that is designed to break even as it spends all annual contributions received from the system. PJMF collects a percentage of revenues from Company-owned and franchised restaurants in the United States for the purpose of designing and administering advertising and promotional programs. PJMF is a variable interest entity («VIE») that funds its operations with ongoing financial support and contributions from the domestic restaurants, of which approximately 80 percent are franchised.

During the first quarter of 2019, we reassessed the governance structure and the operating procedures of PJMF and determined that the company has the power to control certain significant activities of PJMF, based on the applicable accounting guidance. Prior to 2019, the Company did not consolidate PJMF. The company has concluded the previous accounting policy to not consolidate PJMF was an immaterial error and has determined that PJMF should be consolidated. The company has corrected this immaterial error by restating the comparative 2018 condensed consolidated financial statements. The revenues and expenses of PJMF are included in Other revenues and Other expenses, where other consolidated marketing funds are reported, in the Condensed Consolidated Statements of Operations.

The consolidation of PJMF is not expected to have a material impact on the company’s annual consolidated financial statements, including the income (loss) before income taxes as PJMF operates at or near break-even results annually. The consolidation of PJMF also did not have a material impact on the company’s 2018 financial statements.

Additional detail on the consolidation of PJMF can be found in our Form 10-Q for the three months ended March 31, 2019 filed with the SEC.

Adoption of ASC 842: Leases

On December 31, 2018, we adopted Accounting Standards Update («ASU») 2016-02, Topic 842, which requires companies to recognize a right-of-use asset and a lease liability on the balance sheet for contracts that meet the definition of a lease. The guidance also requires additional disclosures regarding the amount, timing, and uncertainty of cash flows arising from leases. We adopted Topic 842 prospectively using the optional transition method with no cumulative effect adjustment recorded as of December 31, 2018. The adoption resulted in a USD 157.0 million operating lease liability and a USD 154.1 million right-of-use asset as of March 31, 2019. There was no significant impact on our operating results, diluted earnings per share or debt compliance and covenant calculations from the adoption of this new accounting standard.

Additional detail of the adoption and 2019 impact of the new leasing standard can be found in our Form 10-Q for the three months ended March 31, 2019 filed with the SEC.

Other Business Matters

On February 3, 2019, the company entered into a Securities Purchase Agreement (the «Securities Purchase Agreement») with Starboard pursuant to which Starboard made a USD 200 million strategic investment in the company’s newly designated Series B convertible preferred stock, USD 1,000 stated value per share (the «Series B Preferred Stock»). In addition, on March 29, 2019, Starboard made an additional USD 50 million investment in the Series B Preferred Stock pursuant to an option that was included in the Securities Purchase Agreement. The company also issued USD 2.5 million of Series B Preferred stock on the same terms as Starboard to certain Papa John’s franchisees who satisfied accredited investor requirements under the federal securities laws. The initial preferred dividend rate is 3.6 percent per annum of the stated value, payable quarterly in arrears. The Series B Preferred Stock also participates on an as-converted basis in any regular or special dividends paid to common shareholders. If at any time, the company reduces the regular dividend paid to common shareholders, the Series B Preferred Stock dividend will remain the same as if the common stock dividend had not been reduced.

The company recorded a one-time mark-to-market adjustment of USD 5.9 million for the time between the grant dates and the purchase dates for both the USD 50 million option exercised by Starboard and the shares purchased by franchisees. As previously noted, the mark-to-market adjustment was recorded in G+A expenses for USD 5.6 million (Starboard) and as a reduction to North America franchise royalties and fees of USD 0.3 million (franchisees) within the Condensed Consolidated Statements of Operations with no associated tax benefit.

2019 Outlook

The company is reaffirming its previously issued 2019 outlook, as we expect the initiatives we are implementing will result in improved sales and operating results in the last half of the year.

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