Papa John’s: Announces Second Quarter 2018 Results

Louisville / KY. (pj) Papa John’s International Inc., the world’s third largest pizza company, announced financial results for the three and six months ended July 01, 2018. Highlights:

• Earnings per diluted share of USD 0.36 and adjusted earnings per diluted share of USD 0.49 in the second quarter of 2018, excluding the impact of China refranchising; adjusted earnings per diluted share down 24.6 percent from the second quarter 2017 of USD 0.65
• System-wide North America comparable sales decrease of 6.1 percent
• International comparable sales decrease of 0.8 percent; total international sales increase of 12.2 percent, driven by unit growth
• 35 net unit openings in second quarter of 2018 driven by international operations
• Company completed the refranchising of 34 company-owned restaurants in China during Q2
• Cash flow from operations of USD 74.2 million; free cash flow of USD 52.6 million for the first six months of 2018
• 2018 outlook revised downward including lowered adjusted EPS range of USD 1.30 to USD 1.80 as a result of negative sales trends

«Earlier this year, we began implementing key changes in how we operate and market our products to refocus on quality and better connect with customers,» said Steve Ritchie, President and CEO of Papa John’s. «While results have been challenged by recent events, we are committed to these strategic priorities and continue to believe that they will lead to enhanced performance. We have also begun an external audit of Papa John’s culture and will address any improvements that are recommended at its conclusion. Our entire leadership team understands the importance of getting our culture and business improvements right. We have important work ahead of us, and I feel certain that with the collective efforts of our 120,000 corporate and franchise team members that the best days for Papa John’s are ahead.»

Operating Highlights

(In thousands, except per share amounts)		Q2-2018			Q2-2017			Change			H1-2018			H1-2017			Change
Total revenue		USD	407,959		USD	434,778		(6.2	%)		USD	835,328		USD	884,044		(5.5	%)
Income before income taxes			19,705			35,458		(44.4	%)			42,067			77,329		(45.6	%)
Net income			11,791			23,538		(49.9	%)			28,528			51,966		(45.1	%)
Diluted EPS		USD	0.36		USD	0.65		(44.6	%)		USD	0.86		USD	1.42		(39.4	%)
Diluted EPS, adjusted		USD	0.49		USD	0.65		(24.6	%)		USD	0.98		USD	1.42		(31.0	%)

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)

Q2-2018

Q2-2017

H1-2018

H1-2017

GAAP Income before income taxes

USD

19,705

USD

35,458

USD

42,067

USD

77,329

Special items:

Refranchising losses, net

2,122

–

1,918

–

Adjusted income before income taxes

USD

21,827

USD

35,458

USD

43,985

USD

77,329

GAAP Net income

USD

11,791

USD

23,538

USD

28,528

USD

51,966

Special items:

Refranchising losses, net (1)

1,647

–

1,488

–

Tax impact of China refranchising

2,435

–

2,435

–

Adjusted net income

USD

15,873

USD

23,538

USD

32,451

USD

51,966

GAAP Diluted earnings per share

USD

0.36

USD

0.65

USD

0.86

USD

1.42

Special items:

Refranchising losses, net

0.05

–

0.05

–

Tax impact of China refranchising

0.08

–

0.07

–

Adjusted diluted earnings per share

USD

0.49

USD

0.65

USD

0.98

USD

1.42

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

On June 15, 2018, we refranchised our China operations including our 34 company-owned restaurants and the quality control center. The refranchising losses, net of tax, of USD 1.6 million for the second quarter of 2018 and USD 1.5 million for the six months ended July 1, 2018 are primarily driven by this China refranchise. 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.

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, to analyze trends, and to determine compensation.

Consolidated revenues decreased USD 26.8 million, or 6.2 percent, for the second quarter of 2018 and decreased USD 48.7 million, or 5.5 percent, for the six months ended July 1, 2018. These decreases were primarily due to lower comparable sales for North America restaurants that resulted in lower company-owned restaurant revenues, lower royalties and decreased North America commissary sales. These decreases were somewhat offset by higher International revenues due to an increase in equivalent units and the favorable impact of foreign exchange rates and the impact of higher commodity prices on North America commissary revenues. Additionally, 2018 included an increase in revenues of approximately USD 1.8 million and USD 4.3 million for the quarter and six months ended July 1, 2018, 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 (Topic 606); see the «Revenue Recognition and Income Statement Presentation» section below for more details.

Consolidated income before income taxes of USD 19.7 million for the second quarter of 2018 decreased USD 15.8 million, or 44.4 percent, compared to the second quarter of 2017. Income before income taxes, as a percentage of consolidated revenues, was 4.8 percent for the second quarter of 2018, as compared to 8.2 percent for the second quarter of 2017. The USD 15.8 million decrease was primarily driven by lower North America revenues as explained above, higher restaurant operating costs, higher interest expense and a loss on the sale of our China operations. Significant changes in the components of income before income taxes are as follows:

• Domestic Company-owned restaurants operating margin decreased USD 6.7 million, or 1.4 percent as a percentage of related revenues, primarily due to lower comparable sales of 7.2 percent and increased operating costs including higher commodities and minimum wages as well as increased 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 2.7 million, or 10.1 percent as compared to the second quarter of 2017, primarily due to lower comparable sales of 5.7 percent and an increase in franchise royalty waivers.
• North America commissary operating margin decreased USD 400,000, and remained flat as a percentage of related revenues, primarily due to lower sales volumes.
• International operating margin increased USD 800,000, or 0.6 percent as a percentage of related revenues, primarily due to higher royalties from increased equivalent units and higher income from the United Kingdom Quality Control Center.
• Other operating margin decreased USD 1.2 million, or 6.3 percent, primarily due to higher costs related to various technology initiatives and increased advertising spend in the United Kingdom. The «Revenue Recognition and Income Statement Presentation» section below provides more information on our «Other revenues» and «Other expenses» income statement line items.
• General and administrative (G+A) costs decreased USD 1.5 million, or 3.8 percent, primarily due to lower management incentive and benefit costs as well as a shift in the timing of the annual operators’ conference to the third quarter of 2018. These cost decreases were partially offset by an increase in various technology initiative costs and higher bad debt expenses.
• Refranchising losses of USD 2.1 million were incurred in the second quarter of 2018 primarily related to the refranchising of China, as previously discussed.
• Net interest expense increased USD 3.9 million for the second quarter due to an increase in average outstanding debt, which is primarily due to share repurchases, as well as higher interest rates.

For the six months ended July 1, 2018 consolidated income before income taxes was USD 42.1 million, a decrease of USD 35.3 million, or 45.6 percent, compared to the six months ended June 25, 2017. Income before income taxes, as a percentage of consolidated revenues, was 5.0 percent for the six months ended July 1, 2018 compared to 8.7 percent for the six months ended June 25, 2017. These decreases were primarily due to the same reasons noted above for the three-month period. In addition, for the six months ended July 1, 2018, G+A expenses increased USD 1.8 million, or 2.3 percent, primarily due to an increase in various technology initiative costs and higher bad debt expenses and legal fees.

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 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 Income Statement. Consolidated 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 rates were 35.7 percent and 28.6 percent for the three and six months ended July 1, 2018, respectively, representing an increase of 6.2 percent and a decrease of 0.5 percent, respectively, from the prior year comparable periods. The increase for the three months ended July 1, 2018 was due the impact of the China refranchising, as previously discussed. Excluding the China refranchising impact of 12.4 percent and 5.8 percent, the effective income tax rates were 23.4 percent and 22.8 percent for the three and six months ended July 1, 2018, respectively.

Diluted earnings per share decreased 44.6 percent to USD 0.36 for the second quarter of 2018 and decreased 39.4 percent to USD 0.86 for the six months ended July 1, 2018. Adjusted diluted earnings per share decreased 24.6 percent to USD 0.49 for the second quarter of 2018 and 31.0 percent to USD 0.98 for the six months ended.

Global Restaurant and Comparable Sales Information

		Q2-2018		Q2-2017		H1-2018		H1-2017
Global restaurant sales (decline) / growth (a)		(2.3%)		4.1%		(1.8%)		4.5%
Global restaurant sales growth, excluding the impact of foreign currency (a)		2.3%		5.1%		0.6%		5.3%
Comparable sales (decline) / growth (b)
Domestic company-owned restaurants		(7.2%)		2.3%		(6.7%)		2.7%
North America franchised restaurants		(5.7%)		1.1%		(5.3%)		1.4%
System-wide North America restaurants		(6.1%)		1.4%		(5.7%)		1.7%
System-wide international restaurants		(0.8%)		3.9%		(0.3%)		4.9%

(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.

Free Cash Flow

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

		H1-2018				H1-2017
Net cash provided by operating activities (a)		USD	74,201			USD	77,863
Purchases of property and equipment (b)			(21,562	)			(30,457	)
Free cash flow		USD	52,639			USD	47,406

(a) The decrease of USD 3.7 million was primarily due to lower net income somewhat offset by favorable changes in working capital items.

(b) The decrease of USD 8.9 million was primarily due to higher capital expenditures in 2017 related to the construction of the company’s new domestic commissary in Georgia, which opened in the third quarter of 2017.

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 liquidity measure because it is one factor that management uses in determining the amount of cash available for investment. However, it does not represent residual cash flows available for discretionary expenditures. 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 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 for the three and six months ended July 1, 2018 and cash flow for the six months ended July 1, 2018.

Global Restaurant Unit Data

At July 1, 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
Second Quarter
Beginning – April 1, 2018		679			2,745			3,424			1,788			5,212
Opened		1			26			27			61			88
Closed		(2	)		(42	)		(44	)		(9	)		(53	)
Acquired		–			–			–			34			34
Sold		–			–			–			(34	)		(34	)
Ending – July 1, 2018		678			2,729			3,407			1,840			5,247
Year-to-date
Beginning – December 31, 2017		708			2,733			3,441			1,758			5,199
Opened		5			44			49			114			163
Closed		(4	)		(79	)		(83	)		(32	)		(115	)
Acquired		–			31			31			34			65
Sold		(31	)		–			(31	)		(34	)		(65	)
Ending – July 1, 2018		678			2,729			3,407			1,840			5,247
Unit growth (decline)		(30	)		(4	)		(34	)		82			48
% increase (decrease)		(4.2	%)		(0.1	%)		(1.0	%)		4.7	%		0.9	%

.
The company has added 159 net worldwide units over the trailing four quarters ended July 1, 2018. Our development pipeline as of July 1, 2018 included approximately 1,210 restaurants (140 units in North America and 1,070 units internationally), the majority of which are scheduled to open over the next six years.