Papa John’s: Announces Third Quarter 2018 Results

Louisville / KY. (pj) Papa John’s International Inc. announced financial results for the three and nine months ended September 30, 2018. Highlights:

• Loss per diluted share of (USD 0.41) and adjusted earnings per diluted share of USD 0.20 in the third quarter of 2018, excluding the impact of Special items; adjusted earnings per diluted share down 66.7 percent from the third quarter 2017 of USD 0.60
• System-wide North America comparable sales decrease of 9.8 percent
• International comparable sales decrease of 3.3 percent; total international sales increase of 10.0 percent, driven by unit growth
• Company completed the refranchising of 31 company-owned restaurants in Minnesota during the third quarter
• Cash flow from operations of USD 98.8 million; free cash flow of USD 68.2 million for the first nine months of 2018
• 2018 EPS outlook narrowed to a range of USD 1.30 to USD 1.60

Steve Ritchie, President and CEO of Papa John’s said, «During the quarter, we took important actions resulting in improved consumer sentiment and North America comp sales that were slightly ahead of expectations. While the operating environment remains challenging, these early indicators combined with our strong cash flow give us confidence in the consumer initiatives underway across the Company.»

Operating Highlights

(In thousands, except per share amounts)		Q3/2018				Q3/2017			Change			9M-2018			9M-2017			Change
Total revenue		USD	364,007			USD	431,709		(15.7	%)		USD	1,199,335		USD	1,315,753		(8.8	%)
(Loss)/ Income before income taxes			(19,953	)			30,949		(164.5	%)			22,114			108,278		(79.6	%)
Net (loss)/ income			(13,033	)			21,817		(159.7	%)			15,495			73,783		(79.0	%)
Diluted (loss)/ earnings per share		USD	(0.41	)		USD	0.60		(168.3	%)		USD	0.47		USD	2.02		(76.7	%)
Adjusted diluted earnings per share		USD	0.20			USD	0.60		(66.7	%)		USD	1.18		USD	2.02		(41.6	%)

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

Adjusted financial results excluding Special items, 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)

Q3/2018

Q3/2017

9M-2018

9M-2017

GAAP (Loss)/Income before income taxes

USD

(19,953

)

USD

30,949

USD

22,114

USD

108,278

Special items:

Special charges (1)

24,833

–

24,833

–

Refranchising losses, net (2)

–

–

1,918

–

Adjusted income before income taxes

USD

4,880

USD

30,949

USD

48,865

USD

108,278

GAAP (Loss)/Net income

USD

(13,033

)

USD

21,817

USD

15,495

USD

73,783

Special items:

Special charges (3)

19,270

–

19,270

–

Refranchising losses, net (3)

–

–

1,488

–

Tax impact of China refranchising

–

–

2,435

–

Adjusted net income

USD

6,237

USD

21,817

USD

38,688

USD

73,783

GAAP Diluted (Loss)/ Earnings per share

USD

(0.41

)

USD

0.60

USD

0.47

USD

2.02

Special items:

Special charges

0.61

–

0.59

–

Refranchising losses, net

–

–

0.05

–

Tax impact of China refranchising

–

–

0.07

–

Adjusted diluted earnings per share

USD

0.20

USD

0.60

USD

1.18

USD

2.02

(1) ‘Special charges’ is defined as the costs and expenses in response to recent events including: (i) re-imaging costs at nearly all domestic restaurants and costs to replace or write-off certain branded assets of approximately USD 3.6 million, (ii) financial assistance to domestic franchisees, such as short-term royalty reductions, in an effort to mitigate closings of approximately USD 9.9 million, and (iii) costs associated with a third-party audit of the culture at Papa John’s commissioned by the Special Committee of the Board of Directors as well as costs associated with implementing new policies and procedures to address any findings as a result of the audit, and additional legal and advisory costs, including costs associated with the activities of the Special Committee totaling approximately USD 11.3 million.

(2) The refranchising losses of USD 1.9 million before tax and USD 1.5 million net of tax for the nine months ended September 30, 2018 are primarily due to the China refranchise of the 34 company-owned restaurants and the quality control center in China that occurred during the second quarter of 2018. We also had USD 2.4 million of additional tax expense associated with the China refranchise. This additional tax expense is primarily attributable to the required recapture of operating losses previously taken by Papa John’s International.

(3) Tax effect was calculated using the company’s marginal rate of 22.4 percent.

The non-GAAP adjusted results shown above 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 the financial information excluding these Special items 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 67.7 million, or 15.7 percent, for the third quarter of 2018 and decreased USD 116.4 million, or 8.8 percent, for the nine months ended September 30, 2018. These decreases were primarily due to the following:

• lower comparable sales for North America restaurants that resulted in lower company-owned restaurant revenues, lower royalties and decreased North America commissary sales,
• the refranchising of 62 company-owned restaurants in North America which reduced total revenues on a quarter and year-to-date basis approximately USD 15.0 million and USD 27.2 million, respectively, compared to the prior year comparable periods,
• the short-term royalty reductions that are part of our franchise assistance program of approximately USD 9.9 million, which are included in the previously mentioned special charges, and
• decreases in International revenues due to the refranchising of the company-owned restaurants and quality control center in China of approximately USD 4.1 million, partially offset by higher International royalties due to an increase in equivalent units;
• these decreases were offset by increases in revenues of approximately USD 1.5 million and USD 5.7 million, respectively, 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.

The consolidated loss before income taxes was USD 20.0 million for the third quarter of 2018 in comparison to consolidated income before income taxes of USD 30.9 million in the third quarter of 2017, representing a decrease in income of USD 50.9 million. The consolidated loss before income taxes, as a percentage of consolidated revenues, was 5.5 percent for the third quarter of 2018. The decline in income was primarily attributable to the previously mentioned USD 24.8 million of Special charges and the impact of lower North America and International revenues. Additionally, the decrease is attributable to higher restaurant operating costs and higher interest expense. Significant changes in the operating results by business unit are detailed as follows:

• Domestic Company-owned restaurants operating margin decreased USD 12.0 million, or 3.3 percent as a percentage of related revenues, primarily due to lower comparable sales of 13.2 percent and higher non-owned automobile costs. Additionally, the adoption of Topic 606 reduced the restaurant operating margin due to the revised method of accounting for the customer loyalty program.
• North America franchise royalties and fees decreased USD 12.8 million, or 49.9 percent, as compared to the third quarter of 2017, primarily due to the 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. Royalties were further reduced due to the negative 8.6 percent comparable sales and an increase in other franchise royalty waivers not associated with the Special charges.
• North America commissary operating margin remained relatively flat but increased 0.5 percent as a percentage of related revenues primarily due to lower operating costs.
• International operating margin decreased USD 400,000 primarily due to lower income from the United Kingdom quality control center on lower sales margins, partially offset by higher royalties from increased equivalent units. As a percentage of international revenues, the operating margin increased 3.1 percent primarily due to the divestiture of our China operations in the second quarter of 2018.
• Other operating margin decreased USD 2.1 million primarily due to higher costs related to various technology initiatives and increased advertising spend in the United Kingdom.
• General and administrative (G+A) costs increased USD 19.7 million, or 55.1 percent, primarily due to costs associated with the special charges of approximately USD 14.9 million as previously detailed. The remainder of the increase is due to higher technology initiative costs and increases in professional and legal fees for matters not associated with the special charges. The increase for the quarter also includes the cost for our annual operators’ conference due to the shift in the timing from the second quarter in 2017 to the third quarter in 2018.
• Net interest expense increased USD 3.4 million for the third quarter due to an increase in average outstanding debt, including the impact of share repurchases, as well as higher interest rates.
• For the nine months ended September 30, 2018 consolidated income before income taxes was USD 22.1 million, a decrease of USD 86.2 million compared to the nine months ended September 24, 2017. Income before income taxes, as a percentage of consolidated revenues, was 1.8 percent for the nine months ended September 30, 2018 compared to 8.2 percent for the nine months ended September 24, 2017. These decreases were primarily due to the same reasons noted above for the three-month period. Additionally, for the nine months ended September 30, 2018, the North America commissary operating margin decreased USD 1.9 million compared to the corresponding period in 2017 primarily due to lower sales volumes and the company’s commitment to maintain a lower overall profit margin as additional support to franchisees.

Operating margin is not a measurement 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 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 discussion may be helpful for comparison within the industry. The operating margin results detailed herein can be calculated by business unit based on the specific revenue and operating expense line items on the face of the Condensed Consolidated Statements of Operations. Consolidated (loss) income before income taxes reported includes G+A expenses, depreciation and amortization, refranchising losses and net interest expense that have been excluded from this operating margin calculation.

The effective income tax (benefit) and expense for the three and nine-month comparable periods are as follows:

			Q3/2018				Q3/2017				9M-2018			9M-2017
Income/(loss) before income taxes			USD	(19,953	)		USD	30,949			USD	22,114		USD	108,278
Income tax (benefit)/expense				(7,359	)			8,280				4,663			30,728
Effective tax (benefit)/expense rate				(36.9%	)			26.8%				21.1%			28.4%

.
The decrease for the both the three and nine months ended September 30, 2018 is primarily due to the decrease in income as well as the decrease in the federal statutory rate from 35 percent to 21 percent in the first quarter of 2018. The third quarter also includes an additional benefit of USD 2.4 million related to the remeasurement of net deferred tax liabilities as a part of the Company’s 2017 filed federal income tax return. The decrease for the nine-month period is partially offset by the USD 2.4 million of income tax expense from the China refranchising, as previously discussed.

Diluted loss per share was USD 0.41 for the three months ended September 30, 2018 as compared to diluted earnings per share of USD 0.60 for the third quarter of 2017. For the nine months ended September 30, 2018, diluted earnings per share was USD 0.47 in comparison to USD 2.02 for the nine months ended September 24, 2017. Adjusted diluted earnings per share of USD 0.20 and USD 1.18 for the three and nine months ended September 30, 2018 decreased 66.7 percent and 41.6 percent, respectively, in comparison to the prior year.

Global Restaurant and Comparable Sales Information

		Q3/2018			Q3/2017			9M-2018			9M-2017
Global restaurant sales (decline) / growth (a)		(6.6	%)		4.4	%		(3.3	%)		4.5	%
Global restaurant sales (decline) / growth, excluding the impact of foreign currency (a)		(5.9	%)		5.0	%		(3.2	%)		5.2	%
Comparable sales (decline) / growth (b)
Domestic company-owned restaurants		(13.2	%)		1.7	%		(8.7	%)		2.3	%
North America franchised restaurants		(8.6	%)		0.7	%		(6.4	%)		1.2	%
System-wide North America restaurants		(9.8	%)		1.0	%		(7.0	%)		1.5	%
System-wide international restaurants		(3.3	%)		5.3	%		(1.3	%)		5.0	%

(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.

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 September 30, 2018, there were 5,247 Papa John’s restaurants operating in all 50 states and in 46 international countries and territories, as follows:

		Domestic Company-owned			Franchised North America			Total North America			International			System-wide
Third Quarter
Beginning – July 1, 2018		678			2,729			3,407			1,840			5,247
Opened		1			16			17			79			96
Closed		(1	)		(67	)		(68	)		(28	)		(96	)
Acquired		–			31			31			–			31
Sold		(31	)		–			(31	)		–			(31	)
Ending – September 30, 2018		647			2,709			3,356			1,891			5,247
Year-to-date
Beginning – December 31, 2017		708			2,733			3,441			1,758			5,199
Opened		6			60			66			193			259
Closed		(5	)		(146	)		(151	)		(60	)		(211	)
Acquired		–			62			62			34			96
Sold		(62	)		–			(62	)		(34	)		(96	)
Ending – September 30, 2018		647			2,709			3,356			1,891			5,247
Unit growth (decline)		(61	)		(24	)		(85	)		133			48
percent increase (decrease)		(8.6	%)		(0.9	%)		(2.5	%)		7.6	%		0.9	%

.
The company has added 146 net worldwide units over the trailing four quarters ended September 30, 2018. Our development pipeline as of September 30, 2018 included approximately 1,160 restaurants (140 units in North America and 1,020 units internationally), the majority of which are scheduled to open over the next six years.

Non-traditional restaurant closings in our North America operations, included in the table above, were 37 for the third quarter of 2018 and 54 on a year-to-date basis. These non-traditional restaurant closings include restaurants located within stadium and university venues.

Update of Previously Issued Financial Guidance

The negative publicity surrounding the company’s brand that began in July 2018 has continued to impact the North America system-wide sales and the company cannot predict how long and the extent to which negative publicity will continue. As previously noted, the company incurred USD 24.8 million of Special charges during the third quarter. The company expects to continue to incur significant Special charges for the remainder of 2018, which could continue into 2019, as a result of the above-mentioned events. The Special charges are now expected to approximate USD 50 million to USD 60 million for the full-year 2018, including a recently announced contribution to the national marketing fund in the fourth quarter. The Special charges for the fourth quarter are expected to approximate USD 25 million to USD 35 million, including the following:

• financial assistance to domestic franchisees, such as short-term royalty reductions,
• contributions to the national marketing fund in the fourth quarter to increase marketing and promotional activities,
• costs associated with the continuation of the third-party audit of the culture at Papa John’s commissioned by the Special Committee as well as costs associated with implementing new policies and procedures to address any findings of the audit, and
• additional legal and advisory costs, including costs associated with the implementation of plans and activities of the Special Committee.

We are narrowing our previously issued financial outlook for certain metrics and reaffirming our other outlook metrics, as follows:

		Updated Outlook		Previous Outlook
North America Comparable Sales		(6.5 percent) to (8.5 percent)		(7.0 percent) to (10.0 percent)
International Comparable Sales		(2 percent) to 1 percent		(2 percent) to 1 percent
Adjusted Diluted EPS (1)		USD 1.30 – USD 1.60		USD 1.30 – USD 1.80
Net global unit growth		0.0 percent – 3.0 percent		0.0 percent – 3.0 percent
Debt / Adjusted Ebitda ratio		Above 4.0x		Above 4.0x
Income tax rate (2)		20 percent – 24 percent		20 percent – 24 percent
Capital Expenditures		USD 45 – USD 50 million		USD 45 – USD 50 million
Block Cheese Prices per lb.		High USD 1.50s		Low USD 1.60s

(1) This adjusted diluted EPS guidance excludes the impact of the restaurant divestitures and the Special charges mentioned above, which have an estimated EPS impact of USD 1.32 to USD 1.56 for 2018. We believe excluding these items from adjusted EPS is meaningful to our financial statement users as it presents our core results excluding unusual, non-recurring items.

(2) The tax rate excludes any tax impact from the divestiture of our China company-owned operations and the Special charges mentioned above.