PAPA JOHNS INTERNATIONAL INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview Papa John’s International, Inc. (referred to as the “Company,” “Papa John’s,” “Papa Johns” or in the first-person notations of “we,” “us” and “our”) operates and franchises pizza delivery and carryout restaurants and, in certain international markets, dine-in and delivery restaurants under the trademark “Papa John’s.” Papa John’s began operations in 1984. As of June 25, 2023, there were 5,780 Papa John’s restaurants in operation, consisting of 612 Company-owned and 5,168 franchised restaurants operating in 48 countries and territories. Our revenues are derived from retail sales of pizza and other food and beverage products to the general public by Company-owned restaurants, franchise royalties, and sales of franchise and development rights. Additionally, we derive revenues from sales to franchisees of various items including food and paper products from our Domestic Quality Control Centers (“QC Centers”), operation of our International QC Center in the (United Kingdom (“UK”), contributions received by Papa John’s Marketing Fund (“PJMF”) which is our national marketing fund, printing and promotional items and information systems equipment, and software and related services. We believe that in addition to supporting both Company and franchised profitability and growth, these activities contribute to product quality and consistency throughout the Papa John’s system. In discussions of our business, “Domestic” is defined as within the contiguous United States, “North America” includes Canada, and “International” includes the rest of the world other than North America. Recent Developments and Trends The Company has focused on executing strategic priorities and building a foundation for long-term success, while navigating a challenging macroeconomic environment. Our progress and significant transactions during the second quarter of 2023 are described below. Growth Strategy . The Company delivered its sixteenth consecutive quarter of Global system-wide restaurant sales growth and continues to expand both domestically and internationally. This growth will be fueled by continued product innovation and our development strategy. Our expanding development pipeline is a key long-term growth driver as we believe there is significant opportunity to offer our differentiated, premium position to more customers globally and domestically. In the second quarter of 2023, we opened 47 net new restaurants, for global unit growth of 0.8%. We expect this growth to accelerate in 2023 with global development to be between 270 to 310 net new units . In April 2023, we announced our future expansion into India through a development agreement to open 650 new restaurants in India by 2033. Going forward we expect annual net new unit growth to be between 5% and 7%. This would imply net new unit growth of 1,150 to 1,400 units between 2022 and 2025, compared with our previous expectation of 1,400 to 1,800 net new units during this same time. This slightly lower rate of growth takes into consideration continued global economic pressures. Operational Initiatives. We launched the “Back to BETTER” initiative in late 2022, which focuses on improving operational execution at the store level in order to drive better financial performance. We have aligned the organization on improving out-the-door times, overall customer satisfaction, increasing orders and optimization. Running BETTER operations is intended to increase customer and employee satisfaction, as well as drive customer loyalty. We are seeing improvement in our restaurant level operating margins, and we experienced a 2.8% increase in comparable sales for Domestic Company-owned restaurants for the first six months of 2023. We expect this initiative to continue throughout 2023. UK Market Conditions. Macroeconomic conditions in the UK, the largest region in our International segment, continue to present challenges in light of ongoing inflation and rising interest rates. Against this backdrop, the Company and franchisees have experienced declines in sales and profitability in the UK market. While uncertain how long these conditions will last, the Company is committed to its presence in the UK and is invested in the Company’s long-term success in this region. As we navigate this challenging economic environment, we recently established a Company-owned restaurant portfolio in the UK, allowing us to build a similar model to the one we have created in the US. This model enables us to scale our capabilities with franchisees in the UK, and worldwide, including revenue management capabilities, product and technological innovation and operational efficiencies to improve sales and restaurant-level profitability over the longer term. 23 Global Restaurant Sales and Unit Information “Comparable sales” represents sales for the same base of restaurants for the same fiscal periods. “Comparable sales growth (decline)” represents the change in year-over-year comparable sales. “Global system-wide restaurant sales” represents total restaurant sales for all Company-owned and franchised restaurants open during the comparable periods, and “Global system-wide restaurant sales growth (decline)” represents the change in global system-wide restaurant sales year-over-year. Comparable sales, Comparable sales growth (decline), Global system-wide restaurant sales and Global system-wide sales growth (decline) exclude franchisees for which we suspended corporate support. “Equivalent units” represents the number of restaurants open at the beginning of a given period, adjusted for restaurants opened, closed, acquired or sold during the period on a weighted average basis. We believe Domestic Company-owned, North America franchised, and International Comparable sales growth (decline) and Global system-wide restaurant sales information is useful in analyzing our results since our franchisees pay royalties and marketing fund contributions that are based on a percentage of franchise sales. Comparable sales and Global system-wide restaurant 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. Franchise sales also generate commissary revenue in the United States and in certain international markets. Comparable sales growth (decline) and Global system-wide restaurant sales information is also useful for comparison to industry trends and evaluating the strength of our brand. Management believes the presentation of Global system-wide 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 the Company’s revenues. Three Months Ended Six Months Ended Amounts below exclude the impact of foreign currency June 25, 2023 June 26, 2022 June 25, 2023 June 26, 2022 Comparable sales growth (decline): Domestic Company-owned restaurants 2.2% (1.5)% 2.8% (1.3)% North America franchised restaurants (2.3)% 1.4% (1.6)% 2.1% North America restaurants (1.4)% 0.9% (0.7)% 1.4% International restaurants (0.7)% (8.0)% (3.3)% (3.6)% Total comparable sales growth (decline) (1.3)% (1.4)% (1.3)% 0.1% System-wide restaurant sales growth (decline): Domestic Company-owned restaurants 2.5% 1.2% 3.7% 8.9% North America franchised restaurants (0.6)% 2.7% 0.1% 1.4% North America restaurants —% 2.4% 0.8% 2.8% International restaurants (a) 8.6% 3.4% 5.8% 8.3% Total global system-wide restaurant sales growth (decline) 2.0% 2.6% 2.0% 4.2% _______________________________ (a) The six months ended June 25, 2023 and June 26, 2022 exclude the impact of franchisee suspended restaurants. 24 Restaurant Progression Three Months Ended Six Months Ended June 25, 2023 June 26, 2022 June 25, 2023 June 26, 2022 North America Company-owned: Beginning of period 520 608 522 600 Opened — 1 — 8 Closed — — (2) — Sold — — — — Acquired 1 — 1 1 Refranchised — (90) — (90) End of period 521 519 521 519 North America franchised: Beginning of period 2,864 2,746 2,854 2,739 Opened 13 17 29 32 Closed (8) (16) (14) (23) Sold (1) — (1) (1) Refranchised — 90 — 90 End of period 2,868 2,837 2,868 2,837 International Company-owned Beginning of period — — — — Acquired 91 — 91 — End of period 91 91 — 91 — International franchised: Beginning of period 2,349 2,170 2,330 2,311 Opened 55 72 98 127 Closed (13) (27) (37) (35) Sold (91) — (91) — Suspended (a) — — — (188) End of period 2,300 2,215 2,300 2,215 Total restaurants – end of period 5,780 5,571 5,780 5,571 Trailing four quarters net store growth (b) 209 236 ___________________________________ (a) As previously disclosed, the Company has suspended corporate support for all franchised restaurants located in Russia. These suspended restaurants are excluded from net unit growth calculations. (b) Excludes suspended restaurants. 25 Results of Operations Revenues The following table sets forth the various components of Revenues from the Condensed Consolidated Statements of Operations. Three Months Ended Six Months Ended Increase (Decrease) (Dollars in thousands) June 25, 2023 June 26, 2022 June 25, 2023 June 26, 2022 QTD YTD Revenues: Domestic Company-owned restaurant sales $ 175,780 $ 171,411 $ 355,646 $ 370,176 2.5 % (3.9) % North America franchise royalties and fees 34,711 34,917 70,783 69,185 (0.6) % 2.3 % North America commissary revenues 206,980 219,383 419,546 429,062 (5.7) % (2.2) % International revenues 34,608 31,958 66,071 66,575 8.3 % (0.8) % Other revenues 62,451 64,996 129,533 130,359 (3.9) % (0.6) % Total revenues $ 514,530 $ 522,665 $ 1,041,579 $ 1,065,357 (1.6) % (2.2) % For the three and six months ended June 25, 2023, the discussion of changes in revenues below for International, Other revenues, Domestic Company-owned restaurants and North America franchised restaurants include explanations of the impact to the comparable results for the acquisition of 91 stores in the UK in 2023 (the “2023 acquisition”) and for the refranchising of 90 restaurants during the second quarter of 2022 (the “2022 refranchising”). See “Note 12. Acquisitions” and “Note 10. Divestitures” of the “Notes to Condensed Consolidated Financial Statements” for additional information. Total revenues decreased $8.1 million or 1.6% to $514.5 million for the three months ended June 25, 2023 and decreased $23.8 million or 2.2% to $1.0 billion for the six months ended June 25, 2023, as compared to each prior year comparable period. Excluding the impacts of the 2023 acquisition and the 2022 refranchising, total revenues decreased $9.8 million or 1.9% and decreased $7.6 million, or 0.7%, for the three and six months ended June 25, 2023, respectively. Domestic Company-owned restaurant sales increased $4.4 million, or 2.5% for the three months ended June 25, 2023 and decreased $14.5 million, or 3.9% for the six months ended June 25, 2023, as compared to the prior year comparable periods. Excluding the impact of refranchising in the second quarter of 2022, Domestic Company-owned restaurant sales increased $12.8 million, or 3.7%, for the six months ended June 25, 2023. The increases for the three and six month periods were primarily due to comparable sales growth of 2.2% and 2.8% for the three and six months ended June 25, 2023, respectively. North America franchise royalties and fees decreased $0.2 million, or 0.6% for the three months ended June 25, 2023 and increased $1.6 million, or 2.3% for the six months ended June 25, 2023, as compared to each prior year comparable period. Excluding the impact of the 2022 refranchising, North America franchise royalties increased $0.2 million or 0.3%, for the six months ended June 25, 2023. Comparable sales for the three and six months ended June 25, 2023 were negative 2.3% and negative 1.6%, respectively. Equivalent units were negative 1.5% for the second quarter and negative 0.1% for the six months ended June 25, 2023, excluding the impact of the 2023 acquisition. North America franchise restaurant sales decreased 0.8% to $747.7 million for the three months ended June 25, 2023 compared to the prior year comparable period. Excluding the impact of 2022 refranchising, North America franchise restaurant sales decreased 0.1% to $1.5 billion for the six months ended June 25, 2023 compared to the prior year comparable period. North America franchise restaurant sales are not included in Company revenues; however, our North America franchise royalties are derived from these sales. North America commissary revenues decreased $12.4 million, or 5.7% for the three months ended June 25, 2023 and decreased $9.5 million, or 2.2% for the six months ended June 25, 2023, compared to the prior year comparable periods. Excluding the impact of the 2022 refranchising, North America commissary revenues decreased $17.6 million, or 4.0% for the six months ended June 25, 2023. The declines in North America commissary revenues were primarily a result of lower volumes in the 2023 periods and declining commodity prices during the second quarter of 2023. 26 International revenues increased $2.7 million, or 8.3% for the three months ended June 25, 2023 and decreased $0.5 million, or 0.8% for the six months ended June 25, 2023, compared to the prior year comparable periods, respectively. Excluding the impact of the 2023 acquisition, revenues increased $0.7 million, or 2.0%, and decreased $2.5 million, or 3.8%, for the three and six months ended June 25, 2023, respectively. Our International revenues were pressured by lower comparable sales of 0.7% and 3.3% for the three and six months ended June 25, 2023 related to inflationary pressures in the UK market. These decreases were offset by positive foreign currency fluctuations. International franchise restaurant sales increased $19.2 million to $300.5 million and increased $8.0 million to $594.0 million for the three and six months ended June 25, 2023, respectively. Excluding the impact of the 2023 acquisition and the previously disclosed suspended restaurants and foreign currency fluctuations, International franchise restaurant sales increased 8.6% and 5.8% for the three and six months ended June 25, 2023, respectively. International franchise restaurant sales are not included in Company revenues; however, our international royalty revenue is derived from these sales. Other revenues, which primarily includes our national marketing funds, online and mobile ordering business and our wholly-owned print and promotions subsidiary, decreased $2.5 million, or 3.9%, and decreased $0.8 million, or 0.6%, for the three and six months ended June 25, 2023, respectively, compared to the prior year comparable periods. The decreases were primarily due to decreases in franchise sales resulting in lower marketing fund revenues and technology fees. 27 Costs and Expenses The following table sets forth the various components of Costs and expenses from the Condensed Consolidated Statements of Operations, expressed as a percentage of the associated revenue component. (Dollars in thousands) Three Months Ended June 25, 2023 % of Related Revenues June 26, 2022 % of Related Revenues Increase (Decrease) in % of Revenues Costs and expenses: Operating costs (excluding depreciation and amortization shown separately below): Domestic Company-owned restaurant expenses $ 143,705 81.8 % $ 142,026 82.9 % (1.1) % North America commissary expenses 190,468 92.0 % 204,470 93.2 % (1.2) % International expenses 20,435 59.0 % 19,236 60.2 % (1.2) % Other expenses 58,996 94.5 % 60,648 93.3 % 1.2 % General and administrative expenses 50,324 9.8 % 44,646 8.5 % 1.3 % Depreciation and amortization 15,690 3.0 % 12,735 2.4 % 0.6 % Total costs and expenses 479,618 93.2 % 483,761 92.6 % 0.6 % Operating income $ 34,912 6.8 % $ 38,904 7.4 % (0.6) % (Dollars in thousands) Six Months Ended June 25, 2023 % of Related Revenues June 26, 2022 % of Related Revenues Increase (Decrease) in % of Revenues Costs and expenses: Operating costs (excluding depreciation and amortization shown separately below): Domestic Company-owned restaurant expenses $ 291,489 82.0 % $ 303,687 82.0 % — % North America commissary expenses 386,883 92.2 % 401,560 93.6 % (1.4) % International expenses 37,746 57.1 % 39,150 58.8 % (1.7) % Other expenses 120,074 92.7 % 121,203 93.0 % (0.3) % General and administrative expenses 102,268 9.8 % 110,584 10.4 % (0.6) % Depreciation and amortization 30,411 2.9 % 24,674 2.3 % 0.6 % Total costs and expenses 968,871 93.0 % 1,000,858 93.9 % (0.9) % Refranchising and impairment loss — — % (11,160) (1.0) % 1.0 % Operating income $ 72,708 7.0 % $ 53,339 5.0 % 2.0 % Total costs and expenses were $479.6 million or 93.2% of total revenues for the three months ended June 25, 2023, as compared to $483.8 million or 92.6% of total revenues for the prior year comparable period. For the six months ended June 25, 2023, total costs and expenses were $968.9 million or 93.0% of total revenues, as compared to $1.0 billion, or 93.9% of total revenues for the prior year comparable period. The changes in total costs and expenses, as percentages of revenues, were primarily due to the following: Domestic Company-owned restaurant expenses were $143.7 million or 81.8% of related revenues for the three months ended June 25, 2023, compared to expenses of $142.0 million or 82.9% of related revenues for the prior year period resulting from decreases in certain commodity expenses. For the six months ended June 25, 2023 Domestic Company-owned restaurant expenses were $291.5 million or 82.0% of related revenues compared to $303.7 million or 82.0% of related revenues for the prior year comparable period. 28 North America commissary expenses were $190.5 million or 92.0% of related revenues for the three months ended June 25, 2023 compared to expenses of $204.5 million or 93.2% of related revenues for the prior year comparable period. For the six months ended June 25, 2023 North America commissary expenses were $386.9 million, or 92.2% of related revenues compared to $401.6 million or 93.6% of related revenues for the prior year period. The expenses, as a percentage of related revenues, decreased 1.2% and 1.4% for the three and six months ended June 25, 2023, respectively, primarily due to lower volumes and lower pricing in the second quarter of 2023 driven by commodity price declines. International expenses were $20.4 million or 59.0% of related revenues for the three months ended June 25, 2023 as compared to $19.2 million, or 60.2% of related revenues for the prior year comparable period. For the six months ended June 25, 2023, International expenses were $37.7 million, or 57.1% of related revenues, as compared to $39.2 million, or 58.8% of related revenues for the prior year comparable period. The expenses, as a percentage of related revenues, decreased 1.3% and 1.7%, respectively, primarily due to lower volumes in our international commissary. Other expenses were $59.0 million or 94.5% of related revenues for the three months ended June 25, 2023 as compared to $60.6 million or 93.3% of related revenues for the prior year comparable period. For the six months ended June 25, 2023, Other expenses were $120.1 million, or 92.7% of related revenues, compared to $121.2 million, or 93.0% of related revenues for the prior year comparable period. Other expenses, as a percentage of related revenues, decreased 1.2% and 0.3%, respectively, primarily due to timing of expenditures on technology platform initiatives to further enhance our digital capabilities and the customer experience. General and Administrative Expenses General and administrative (“G&A”) expenses were $50.3 million, or 9.8% of revenues for the three months ended June 25, 2023, compared to $44.6 million, or 8.5% of revenues for the prior year period. For the six months ended June 25, 2023, G&A expenses were $102.3 million or 9.8% of revenues, compared to $110.6 million or 10.4% of revenues for the prior year comparable period. G&A expenses consisted of the following: (Dollars in thousands) Three Months Ended Six Months Ended June 25, 2023 June 26, 2022 June 25, 2023 June 26, 2022 Administrative expenses (a) $ 48,401 $ 42,889 $ 98,237 $ 88,979 UK repositioning and acquisition-related costs (b) 1,308 — 1,308 Legal settlement accruals (c) — — — 5,000 Specific accounts receivable and notes receivable provisions (d) — — — 14,636 Other costs (e) 661 1,507 2,017 1,507 Other general expenses, net (46) 250 706 462 General and administrative expenses $ 50,324 $ 44,646 $ 102,268 $ 110,584 ___________________________________ (a) For the three and six months ended June 25, 2023, administrative expenses increased $5.5 million and $9.3 million primarily due to higher costs from our franchise operating conference in the second quarter of 2023 and higher incentive compensation costs, partially offset by lower travel. The six month period also included higher labor costs. (b) Represents costs associated with repositioning the UK portfolio as well as transaction costs related to acquisition of stores from franchisees. (c) Represents an accrual of a certain legal settlement, recorded in General and administrative expenses. See “Note 9. Litigation, Commitments and Contingencies” for further information. (d) Represents a one-time, non-cash provision of $14.6 million on accounts receivable and notes receivable in connection with the conflict in Ukraine and related government actions in the first quarter of 2022. (e) Represents severance and related costs associated with the transition of certain executives incurred during the three and six months ended June 25, 2023 and June 26, 2022. Depreciation and Amortization. Depreciation and amortization expense was $15.7 million or 3.0% of revenues for the three months ended June 25, 2023, compared to $12.7 million or 2.4% of revenues for the prior year comparable period. For the six months ended June 25, 2023, Depreciation and amortization expense was $30.4 million, or 2.9% of revenues compared to $24.7 million, or 2.3% of revenues, for the prior year comparable period. The increases were primarily due to higher depreciation expense related to our investments in technology support initiatives. 29 Refranchising and Impairment Loss There was no Refranchising and impairment loss during the six months ended June 25, 2023. Refranchising and impairment loss was $11.2 million for the six months ended June 26, 2022, consisting of an $8.4 million loss on the 2022 refranchising and an impairment loss of $2.8 million for reacquired franchise rights due to the financial and operational impact of the conflict in Ukraine and government actions taken in response to that conflict. See “Note 10. Divestitures” of “Notes to Condensed Consolidated Financial Statements” for additional information on these items. 30 Operating Income by Segment Operating income is summarized in the following table on a reporting segment basis. Adjusted operating income, a non-GAAP measure, is also presented below. See “Non-GAAP Measures” for a reconciliation to the most comparable U.S. GAAP measure. We believe this non-GAAP measure is important for comparability purposes. Three Months Ended June 25, 2023 Three Months Ended June 26, 2022 (In thousands) Reported Adjustments (a) Adjusted Reported Adjustments (a) Adjusted Reported Increase (Decrease) Adjusted Increase (Decrease) Domestic Company-owned restaurants $ 6,641 $ — $ 6,641 $ 5,924 $ — $ 5,924 $ 717 $ 717 North America franchising 32,111 — 32,111 32,624 — 32,624 (513) (513) North America commissaries 10,397 — 10,397 10,957 — 10,957 (560) (560) International 3,763 1,308 5,071 7,306 — 7,306 (3,543) (2,235) All others 1,343 — 1,343 2,187 — 2,187 (844) (844) Unallocated corporate expenses (19,701) 661 (19,040) (19,344) 1,507 (17,837) (357) (1,203) Elimination of intersegment (profits) 358 — 358 (750) — (750) 1,108 1,108 Total $ 34,912 $ 1,969 $ 36,881 $ 38,904 $ 1,507 $ 40,411 $ (3,992) $ (3,530) Six Months Ended June 25, 2023 Six Months Ended June 26, 2022 (In thousands) Reported Adjustments (a) Adjusted Reported Adjustments (a) Adjusted Reported Increase (Decrease) Adjusted Increase (Decrease) Domestic Company-owned restaurants $ 13,291 $ — $ 13,291 $ 7,912 $ 8,412 $ 16,324 $ 5,379 $ (3,033) North America franchising 65,511 — 65,511 64,761 — 64,761 750 750 North America commissaries 21,127 — 21,127 20,292 — 20,292 835 835 International 10,995 1,308 12,303 11,761 3,515 15,276 (766) (2,973) All others 4,500 — 4,500 5,906 — 5,906 (1,406) (1,406) Unallocated corporate expenses (43,067) 2,017 (41,050) (56,454) 20,376 (36,078) 13,387 (4,972) Elimination of intersegment (profits) 351 — 351 (839) — (839) 1,190 1,190 Total $ 72,708 $ 3,325 $ 76,033 $ 53,339 $ 32,303 $ 85,642 $ 19,369 $ (9,609) ___________________________________ (a) See “Non-GAAP Measures” below for a detail of the adjustments in each period and for a reconciliation to the most comparable U.S. GAAP measure. Operating income was $34.9 million and $72.7 million for the three and six months ended June 25, 2023, respectively, compared to $38.9 million and $53.3 million for the prior year comparable periods, a decrease of $4.0 million and increase of $19.4 million, respectively. Adjusted operating income was $36.9 million and $76.0 million for the three and six months ended June 25, 2023, respectively, compared to $40.4 million and $85.6 million for the prior year comparable periods, 31 decreases of $3.5 million and $9.6 million, respectively. The decreases in adjusted operating income in 2023 compared to 2022 were primarily due to the following: • Domestic Company-owned restaurants increased $0.7 million and decreased $3.0 million for the three and six months ended June 25, 2023, respectively. The three month period increase of $0.7 million was primarily due to higher revenues from comparable sales growth of 2.2% and margin improvement from labor efficiencies. Excluding the impact of the 2022 refranchising, the six month period decreased $0.8 million as higher compensation, insurance and utility costs in 2023 were partially offset by comparable sales growth of 2.8%. • North America franchising decreased $0.5 million and increased $0.8 million for the three and six months ended June 25, 2023, respectively. Excluding the impact of the 2022 refranchising, North America franchising decreased $0.6 million. The decreases were primarily due to 2.3% and 1.6% decreases in comparable sales, respectively and equivalent units decreases of 1.5% and 0.1%, respectively. • North America commissaries decreased $0.6 million and increased $0.8 million for the three and six months ended June 25, 2023, respectively. The three month period decrease of $0.6 million was primarily due to lower volumes. Excluding the impact of the 2022 refranchising for the six month period, North America commissaries increased $0.5 million primarily due to declining commodity prices during the second quarter of 2023, lower delivery costs, partially offset by lower volumes. • International decreased $2.2 million and $3.0 million for the three and six months ended June 25, 2023, respectively. Excluding the impact of the 2023 acquisition, International decreased $2.1 million and $2.8 million, primarily due to lower UK restaurant and commissary revenues and royalties attributed to lower comparable sales, which declined 0.7% and 3.3%, for the three and six months ended June 25, 2023, respectively. • All Others, which primarily includes our online and mobile ordering business and our marketing funds, decreased $0.8 million and $1.4 million for the three and six months ended June 25, 2023, respectively, compared to the prior year comparable periods, primarily due to higher depreciation expense related to our investments in technology support initiatives. • Unallocated corporate expenses increased $1.2 million and $5.0 million for the three and six months ended June 25, 2023, respectively. The increases are primarily due to higher costs for our franchise operating conference in the second quarter of 2023, higher labor and incentive compensation costs, insurance costs and higher depreciation expense related to our investments in technology support initiatives. 32 Items Below Operating Income The following table sets forth the various items below Operating income from the Condensed Consolidated Statements of Operations: Three Months Ended Six Months Ended Increase (Decrease) (In thousands, except per share amounts) June 25, 2023 June 26, 2022 June 25, 2023 June 26, 2022 QTD YTD Operating income $ 34,912 $ 38,904 $ 72,708 $ 53,339 $ (3,992) $ 19,369 Net interest expense (11,275) (6,081) (20,296) (10,344) (5,194) (9,952) Income before income taxes 23,637 32,823 52,412 42,995 (9,186) 9,417 Income tax expense 5,778 7,093 12,007 5,838 (1,315) 6,169 Net income before attribution to noncontrolling interests 17,859 25,730 40,405 37,157 (7,871) 3,248 Net income attributable to noncontrolling interests (91) (297) (261) (1,230) 206 969 Net income attributable to the Company $ 17,768 $ 25,433 $ 40,144 $ 35,927 $ (7,665) $ 4,217 Calculation of net income for earnings per share: Net income attributable to the Company $ 17,768 $ 25,433 $ 40,144 $ 35,927 $ (7,665) $ 4,217 Dividends paid to participating securities — (82) — (141) 82 141 Net income attributable to participating securities — (111) — (93) 111 93 Net income attributable to common shareholders $ 17,768 $ 25,240 $ 40,144 $ 35,693 $ (7,472) $ 4,451 Basic earnings per common share $ 0.55 $ 0.71 $ 1.20 $ 1.00 $ (0.16) $ 0.20 Diluted earnings per common share $ 0.54 $ 0.70 $ 1.20 $ 0.99 $ (0.16) $ 0.21 Net Interest Expense Net interest expense increased $5.2 million and $10.0 million, or 85.4% and 96.2% for the three and six months ended June 25, 2023, respectively, due primarily to higher average outstanding debt as well as an increase in the LIBOR rate. The higher outstanding debt on our senior secured revolving credit facility (“the PJI Revolving Facility”) was primarily utilized to finance share repurchases in the first quarter of 2023. Total debt outstanding was $791.5 million and $605.0 million as of June 25, 2023 and December 25, 2022, respectively. Income Tax Expense (Benefit) Our effective income tax rates were 24.4% and 22.9% for three and six months ended June 25, 2023, compared to income tax rates of 21.6% and 13.6% for the prior year comparable periods. The lower effective tax rate for the six months ended June 26, 2022 was caused by higher excess tax benefits generated by stock option exercises and vesting of restricted shares in 2022 along with a lower pre-tax income. Quarter Ended Six Months Ended (Dollars in thousands) June 25, 2023 June 26, 2022 June 25, 2023 June 26, 2022 Income before income taxes $ 23,637 $ 32,823 $ 52,412 $ 42,995 Income tax expense (benefit) $ 5,778 $ 7,093 $ 12,007 $ 5,838 Effective tax rate 24.4 % 21.6 % 22.9 % 13.6 % 33 Net Income Attributable to Noncontrolling Interests Net income attributable to noncontrolling interests was $0.1 million and $0.3 million for the three and six months ended June 25, 2023, compared with $0.3 million and $1.2 million for the prior year comparable period. The decrease was due to the refranchising of our 51% ownership interest in a 90-restaurant consolidated joint venture in Texas on March 28, 2022. Diluted Earnings Per Common Share Diluted earnings per common share was $0.54 and $1.20 for the three and six months ended June 25, 2023, respectively, compared to $0.70 and $0.99 for the prior year comparable period, representing a decrease of $0.16 and an increase of $0.21 for the three and six months ended June 25, 2023, respectively. Adjusted diluted earnings per common share, a non-GAAP measure, was $0.59 and $1.28 for the three and six months ended June 25, 2023, compared to adjusted diluted earnings per common share of $0.74 and $1.69 for the prior year comparable periods, representing decreases of $0.15 and $0.41, respectively. See “Non-GAAP Measures” for additional information. Non-GAAP Measures In addition to the results provided in accordance with U.S. GAAP, we provide certain non-GAAP measures, which present results on an adjusted basis. These are supplemental measures of performance that are not required by or presented in accordance with U.S. GAAP and include the following: adjusted operating income, adjusted net income attributable to common shareholders and adjusted diluted earnings per common share. We believe that our non-GAAP financial measures enable investors to assess the operating performance of our business relative to our performance based on U.S. GAAP results and relative to other companies. We believe that the disclosure of these non-GAAP measures is useful to investors as they reflect metrics that our management team and Board utilize to evaluate our operating performance, allocate resources and administer employee incentive plans. The most directly comparable U.S. GAAP measures to adjusted operating income, adjusted net income attributable to common shareholders and adjusted diluted earnings per common share are operating income, net income attributable to common shareholders and diluted earnings per common share, respectively. These non-GAAP measures should not be construed as a substitute for or a better indicator of the Company’s 34 performance than the Company’s U.S. GAAP results. The table below reconciles our GAAP financial results to our non-GAAP financial measures. Three Months Ended Six Months Ended (In thousands, except per share amounts) June 25, 2023 June 26, 2022 June 25, 2023 June 26, 2022 Operating income $ 34,912 $ 38,904 $ 72,708 $ 53,339 UK repositioning and acquisition-related costs (a) 1,308 — 1,308 — Refranchising and impairment losses (b) — — — 25,796 Legal settlement (c) — — — 5,000 Other costs (d) 661 1,507 2,017 1,507 Adjusted operating income $ 36,881 $ 40,411 $ 76,033 $ 85,642 Net income attributable to common shareholders $ 17,768 $ 25,240 $ 40,144 $ 35,693 UK repositioning and acquisition-related costs (a) 1,308 — 1,308 — Refranchising and impairment losses (b) — — — 25,796 Legal settlement (c) — — — 5,000 Other costs (d) 661 1,507 2,017 1,507 Tax effect of adjustments (e) (449) (339) (758) (7,269) Adjusted net income attributable to common shareholders (f) $ 19,288 $ 26,408 $ 42,711 $ 60,727 Diluted earnings per common share $ 0.54 $ 0.70 $ 1.20 $ 0.99 UK repositioning and acquisition-related costs (a) 0.04 — 0.04 — Refranchising and impairment losses (b) — — — 0.72 Legal settlement (c) — — — 0.14 Other costs (d) 0.02 0.05 0.06 0.04 Tax effect of adjustments (e) (0.01) (0.01) (0.02) (0.20) Adjusted diluted earnings per common share (f) $ 0.59 $ 0.74 $ 1.28 $ 1.69 ___________________________________ (a) Represents costs associated with repositioning the UK portfolio as well as transaction costs related to the acquisition of stores from franchisees. (b) Refranchising and impairment losses consisted of the following pre-tax adjustments: Six Months Ended (In thousands) June 26, 2022 Refranchising impairment loss (1) $ 8,412 Ukraine-related charge (2) 17,384 Total adjustment $ 25,796 (1) Represents a one-time, non-cash charge of $8.4 million ($0.23 loss per diluted share) recorded in the first quarter of 2022 associated with the refranchising of the Company’s controlling interest in the 90-restaurant joint venture, recorded as Refranchising and impairment loss. (2) Represents a one-time non-cash charge of $17.4 million ($0.48 loss per diluted share) on accounts receivable, notes receivable, and impairment of reacquired franchised rights in connection with the conflict in Ukraine and related government actions in the first quarter of 2022, which were recorded as Refranchising and impairment loss of $2.8 million and General and administrative expenses of $14.6 million. (c) Represents an accrual of a certain legal settlement, recorded in General and administrative expenses. See “Note 9. Litigation, Commitments and Contingencies” for further information. (d) Represents severance and related costs associated with the transition of certain executives incurred during the three and six months ended June 25, 2023 and June 26, 2022, which were recorded in General and administrative expenses. 35 (e) The tax effect on non-GAAP adjustments was calculated by applying the marginal tax rates of 22.8% and 22.5% for the three and six-month periods ended June 25, 2023 and June 26, 2022, respectively. (f) Amounts shown exclude the impact of allocation of undistributed earnings to participating securities. In addition, we present free cash flow in this report, which is a non-GAAP measure. Please see “Liquidity and Capital Resources – Free Cash Flow” for a discussion of why we believe free cash flow provides useful information regarding our financial condition and results of operations, and a reconciliation of free cash flow to the most directly comparable U.S. GAAP measure. Liquidity and Capital Resources Our primary sources of liquidity and capital resources are cash flows from operations and borrowings under our credit facility. Our principal uses of cash are operating expenses, capital expenditures, and returning value to our shareholders in the form of cash dividends and share repurchases. Our capital priorities are: • investing for growth • maintaining a strong balance sheet, and • returning capital to shareholders The Company believes that its balances of cash and cash equivalents and borrowing capacity, along with cash generated by operations, will be sufficient to satisfy its cash requirements, cash dividends, interest payments and share repurchases over the next twelve months and beyond. Cash Flows The table below summarizes our cash flows for the six months ended June 25, 2023 and June 26, 2022 (in thousands): Six Months Ended June 25, 2023 June 26, 2022 Total cash provided by (used in): Operating activities $ 93,735 $ 45,585 Investing activities (35,727) (12,523) Financing activities (61,620) (50,677) Change in cash and cash equivalents, excluding the effect of exchange rate changes on cash and cash equivalents $ (3,612) $ (17,615) Operating Activities Total cash provided by operating activities was $93.7 million for the six months ended June 25, 2023 compared to $45.6 million for the corresponding period of 2022. The increase of $48.2 million primarily reflects favorable working capital changes, principally related to higher incentive compensation payments during the six months ended June 26, 2022 and other current liabilities, as well as lower inventory and accounts receivable balances primarily due to lower volumes. Investing Activities Total cash used in investing activities was $35.7 million for the six months ended June 25, 2023 compared to $12.5 million for the same period in 2022, or an increase of $23.2 million. The increase in cash used in investing activities was primarily due to an increase in capital expenditures as well as cash proceeds of $14.0 million, net of transaction costs, received from the 2022 refranchising during the six months ended June 26, 2022. Our capital expenditures consisted primarily of capital investments for existing stores, new store locations and capital expenditures for strategic initiatives. We estimate that our capital expenditures during 2023 will be approximately $80 million to $90 million. This estimate includes the acquisition of sites and construction costs for new Company-owned stores that have opened or that we expect to open during 2023. We intend to fund our capital expenditures with cash generated by operations and borrowings under our PJI Revolving Facility, as necessary. 36 Financing Activities Total cash used in financing activities was $61.6 million for the six months ended June 25, 2023 compared to $50.7 million for the same period of 2022, an increase of $10.9 million. In 2023, cash used for financing activities includes outflows of $210.3 million in share repurchases and $28.5 million of common stock dividends paid, partially offset by net borrowings of $171.0 million from the PJI Revolving Facility and $15.5 million from the PJMF revolving line of credit (the “PJMF Revolving Facility”). In 2022, cash used for financing activities includes outflows of $75.5 million in share repurchases and $25.1 million of common dividends paid, partially offset by net borrowings of $55.0 million from the PJI Revolving Facility. Debt Our outstanding debt as of June 25, 2023 was $791.5 million, which was comprised of $400.0 million of our 3.875% senior notes (the “Notes”) and $391.5 million outstanding under the PJI Revolving Facility and the PJMF Revolving Facility. Remaining availability under the PJI Revolving Facility was approximately $224.0 million as of June 25, 2023. Our Credit Agreement, dated September 14, 2021, contains affirmative and negative covenants that, among other things, require customary reporting obligations and restrict, subject to certain exceptions, the incurrence of additional indebtedness and liens, the consummation of certain mergers, consolidations, sales of assets and similar transactions, the making of investments, equity distributions and other restricted payments, and transactions with affiliates. The Company is also subject to certain financial covenants, as shown in the following table, that could restrict or impose constraints on the liquidity of our business: Permitted Ratio Actual Ratio as of June 25, 2023 Leverage ratio Not to exceed 5.25 to 1.0 3.4 to 1.0 Interest coverage ratio Not less than 2.00 to 1.0 3.5 to 1.0 Our leverage ratio is defined as outstanding debt divided by Consolidated EBITDA (as defined in the Credit Agreement) for the most recent four fiscal quarters. Our interest coverage ratio is defined as the sum of Consolidated EBITDA and consolidated rental expense for the most recent four fiscal quarters divided by the sum of consolidated interest expense and consolidated rental expense for the most recent four fiscal quarters. We were in compliance with all financial covenants as of June 25, 2023. In addition, the Indenture governing the Notes contains customary covenants that, among other things and subject to certain exceptions, limit our ability and the ability of certain of our subsidiaries to: incur additional indebtedness and guarantee indebtedness; pay dividends or make other distributions or repurchase or redeem our capital stock; prepay, redeem or repurchase certain debt; issue certain preferred stock or similar equity securities; make loans and investments; sell assets; incur liens; enter into transactions with affiliates; enter into agreements restricting our subsidiaries’ ability to pay dividends; and consolidate, merge or sell all or substantially all of our assets. The PJMF Revolving Facility consists of a $20.0 million revolving line of credit pursuant to a Revolving Loan Agreement, dated September 30, 2015 with U.S. Bank National Association, as lender. Debt outstanding under the PJMF Revolving Facility was approximately $15.5 million as of June 25, 2023. The PJMF operating results and the related debt outstanding do not impact the financial covenants under the Credit Agreement. Refer to Note 12 of the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 25, 2022 for additional information. Share Repurchases As part of our long-term growth and capital allocation strategy, we are committed to investing in share repurchases to provide ongoing value and enhanced returns to our shareholders. On October 28, 2021, our Board of Directors approved a share repurchase program with an indefinite duration for up to $425.0 million of the Company’s common stock. 37 The following table summarizes our repurchase activity under these programs for the three and six months ended June 25, 2023 and June 26, 2022: (In thousands, except average price per share) Total Number of Shares Purchased Average Price Paid per Share Aggregate Cost of Shares Purchased Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs Three Months Ended June 25, 2023 — $ — $ — $ 90,160 June 26, 2022 452 $ 94.56 $ 42,762 $ 349,329 (In thousands, except average price per share) Total Number of Shares Purchased Average Price Paid per Share Aggregate Cost of Shares Purchased (a) Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs Six Months Ended June 25, 2023 2,523 $ 83.10 $ 209,640 $ 90,160 June 26, 2022 753 $ 100.23 $ 75,471 $ 349,329 (a) The shares repurchased during the six months ended June 25, 2023 included 2,176,928 shares repurchased on March 1, 2023 from certain funds affiliated with, or managed by, Starboard Value LP at a price of $82.52 per share for aggregate consideration of $179.6 million. The Company utilizes a written trading plan under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, from time to time to facilitate the repurchase of shares of our common stock under this share repurchase program. There can be no assurance that we will repurchase shares of our common stock either through a Rule 10b5-1 trading plan or otherwise. Dividends The Company paid aggregate dividends to common stockholders of $28.5 million ($0.84 per share) and $25.1 million ($0.70 per share) for the six months ended June 25, 2023 and June 26, 2022, respectively. O n July 31, 2023, our Board of Directors declared a third quarter dividend of $0.46 per common share (approximately $15.1 million in the aggregate), which will be paid on August 25, 2023 to stockholders of record as of the close of business on August 14, 2023. The declaration and payment of any future dividends will be at the discretion of our Board of Directors. Free Cash Flow Free cash flow, a non-GAAP measure, is defined as net cash provided by operating activities (from the Condensed Consolidated Statements of Cash Flows) less the purchases of property and equipment. We view free cash flow as an important financial measure because it is one 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 performance than the Company’s GAAP measures. The Company’s free cash flow was as follows for the six month periods of 2023 and 2022 (in thousands): Six Months Ended June 25, 2023 June 26, 2022 Net cash provided by operating activities $ 93,735 $ 45,585 Purchases of property and equipment (34,759) (30,744) Free cash flow $ 58,976 $ 14,841 Cash Requirements There have been no material changes in our cash requirements other than in the ordinary course of business since the end of 2022. Refer to “Contractual Obligations” presented within “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 25, 2022 for additional information regarding our cash requirements. 38 Forward-Looking Statements Certain matters discussed in this Quarterly Report on Form 10-Q and other Company communications that are not statements of historical fact constitute forward-looking statements within the meaning of the federal securities laws. Generally, the use of words such as “expect,” “intend,” “estimate,” “believe,” “anticipate,” “will,” “forecast,” “outlook”, “plan,” “project,” or similar words identify forward-looking statements that we intend to be included within the safe harbor protections provided by the federal securities laws. Such forward-looking statements include or may relate to projections or guidance concerning business performance, revenue, earnings, cash flow, earnings per share, share repurchases, the current economic environment, commodity and labor costs, currency fluctuations, profit margins, net unit growth, unit level performance, capital expenditures, restaurant and franchise development, labor shortages, labor cost increases, inflation, royalty relief, franchisee support, the effectiveness of our menu innovations and other business initiatives, investments in product and digital innovation, marketing efforts and investments, liquidity, compliance with debt covenants, impairments, strategic decisions and actions, dividends, effective tax rates, regulatory changes and impacts, investments in the UK market, adoption of new accounting standards, and other financial and operational measures. Such statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict and many of which are beyond our control. Therefore, actual outcomes and results may differ materially from those matters expressed or implied in such forward-looking statements. The risks, uncertainties and assumptions that are involved in our forward-looking statements include, but are not limited to: • the ability of the Company to manage challenging macroeconomic conditions in the United States and internationally, including the United Kingdom; • the ability of the Company to manage staffing and labor shortages at Company and/or franchised restaurants and our quality control centers; • increases in labor costs, food costs or sustained higher other operating costs, including as a result of supply chain disruption, inflation or climate change; • the potential for delayed new store openings, both domestically and internationally; • the increased risk of phishing, ransomware and other cyber-attacks; • risks to the global economy and our business related to the conflict in Ukraine and other international conflicts; • increased costs for branding initiatives and launching new advertising and marketing campaigns and promotions to boost consumer sentiment and sales trends, and the risk that such initiatives will not be effective; • risks related to a possible economic recession or downturn that could, among other things, reduce consumer spending or demand and result in changing consumer practices; • risks related to social media, including publicity adversely and rapidly impacting our brand and reputation; • aggressive changes in pricing or other marketing or promotional strategies by competitors, which may adversely affect sales and profitability; and new product and concept developments by food industry competitors; • changes in consumer preferences or consumer buying habits, including the growing popularity of delivery aggregators, as well as changes in general economic conditions or other factors that may affect consumer confidence and discretionary spending, including higher unemployment; • the adverse impact on the Company or our results caused by global health concerns, product recalls, food quality or safety issues, incidences of foodborne illness, food contamination and other general public health concerns about our Company-owned or franchised restaurants or others in the restaurant industry; • the effectiveness of our technology investments and changes in unit-level operations; • the ability of the Company and its franchisees to meet planned growth targets and operate new and existing restaurants profitably, including difficulties finding qualified franchisees, store level employees or suitable sites; • increases in insurance claims and related costs for programs funded by the Company up to certain retention limits, including medical, owned and non-owned vehicles, workers’ compensation, general liability and property; • disruption of our supply chain or commissary operations which could be caused by our sole source of supply of mozzarella cheese, desserts, garlic cups or limited source of suppliers for other key ingredients or more generally due to weather, natural disasters including drought, disease, or geopolitical or other disruptions beyond our control, including the coronavirus pandemic; • increased risks associated with our International operations, including economic and political conditions and risks associated with the withdrawal of the UK from the European Union, instability or uncertainty in our international markets, especially emerging markets, fluctuations in currency exchange rates, difficulty in meeting planned sales targets and new store growth; • the impact of current or future claims and litigation and our ability to comply with current, proposed or future legislation that could impact our business including compliance with the European Union General Data Protection Regulation; • risks related to our indebtedness, including increased interest rates, and the current state of the credit markets; 39 • the Company’s ability to continue to pay dividends to stockholders based upon profitability, cash flows and capital adequacy if restaurant sales and operating results decline; • disruption of critical business or information technology systems, or those of our suppliers, and risks associated with systems failures and data privacy and security breaches, including theft of confidential Company, employee and customer information, including payment cards; and • changes in Federal or state income, general and other tax laws, rules and regulations and changes in generally accepted accounting principles. These and other risk factors are discussed in detail in “Part I. Item 1A. – Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 25, 2022, as updated by “Part II. Item 1A. - Risk Factors” in this Quarterly Report on Form 10-Q and they may be updated from time to time in our future reports filed with the Securities and Exchange Commission. We undertake no obligation to update publicly any forward-looking statements, whether as a result of future events, new information or otherwise, except as required by law.