By George Wilson
In this series of posts we are focusing on non-GAAP measure problems and related SEC comments. As the first and second posts in this series did, this post gives you an opportunity to see if you can spot the issue, and then provides the background and SEC guidance behind the issue.
As a brief reminder, the SEC’s guidance about the use of non-GAAP measures is primarily in three places:
Regulation G for non-GAAP measures used anywhere,
S-K Item 10(e), for non-GAAP measures in filed documents, and
The related Compliance and Disclosure Interpretations.
Just like the first and second posts in this series, you can read the excerpt of the release behind the comment and try to spot the issue. If you prefer, you can read straight through to the comment and explanation that follow.
These excerpts are from Papa John’s International, Inc’s Form 10-K for the fiscal year ended December 29, 2019. Can you spot the non-GAAP issue? As you review this information, focus your thoughts on the “special charges” and in particular the “Marketing fund investments.”
To begin, here is one of the non-GAAP measures presented by Papa John’s:
Papa John’s also provided this detail about the special charges:
As you review the list of non-GAAP adjustments, letter (b) regarding marketing support to franchisees seems like it is a cash expense.
This is the comment the SEC issued about this non-GAAP adjustment:
Form 10-K for the Fiscal Year Ended December 29, 2019
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Items Impacting
Comparability; Non-GAAP Measures, page 40
- Please tell us the consideration you gave to Question 100.01 of the Non-GAAP Financial Measures Compliance and Disclosure Interpretations in adjusting your non-GAAP measures to remove marketing fund investments made by you.
The C&DI referenced, Question 100.01 makes a very important point:
Question: Can certain adjustments, although not explicitly prohibited, result in a non-GAAP measure that is misleading?
Answer: Yes. Certain adjustments may violate Rule 100(b) of Regulation G because they cause the presentation of the non-GAAP measure to be misleading. For example, presenting a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business could be misleading. [May 17, 2016]
This is Papa John’s first of two responses to this comment:
We did consider the guidance in Question 100.01 of the Non-GAAP Financial Measures Compliance and Disclosure Interpretations in our presentation of our adjusted (non-GAAP) financial results excluding marketing fund investments identified as “Special charges.” The marketing fund investments included in “Special charges” of $27.5 million and $10.0 million for the years ended December 29, 2019 and December 30, 2018, respectively, represent discretionary, non-contractual marketing fund investments to support national media initiatives. Domestic Company-owned and franchised Papa John’s restaurants are required to contribute a certain minimum percentage of their sales (currently 5.0% of sales) to the Papa John’s Marketing Fund, our national marketing fund, which are not included as part of the “Special charges.” The national marketing fund is responsible for developing and conducting marketing and advertising for the domestic Papa John’s system. Beginning in the fourth quarter of 2018, the Company began making significant discretionary, non-contractual marketing fund investments to supplement the contractual Company-owned and franchised restaurant-level system contributions. These discretionary, non-contractual marketing fund investments were part of the Company’s previously announced program of increased support and financial assistance to the North America franchise system in response to the severe decline in North America sales. The decline in North America sales followed extensive negative publicity and consumer sentiment as a result of statements by the Company’s founder and former spokesman in late 2017 and July 2018. The discretionary, non-contractual marketing fund investments were made as a response to these extraordinary adverse events to defend and repair the brand’s reputation and were not made in the ordinary course of business.
Question 100.01 notes that a non-GAAP financial measure may be misleading if it excludes “normal, recurring, cash operating expenses necessary to operate a registrant’s business.” The Company does not consider the incremental marketing fund investments to be normal, recurring, cash operating expenses necessary to operate the Company’s business. Furthermore, as stated in the Company’s Form 10-K for the fiscal year ended December 29, 2019, such investments are of a limited duration and are only “expected to continue through the third quarter of 2020”, which further supports the conclusion that the charges are not of a recurring nature. As a result, we do not consider these investments to be representative of our underlying operating performance and thus believe the exclusion in our non-GAAP financial results provides investors with important additional information regarding our underlying operating results and is important for purposes of comparisons to prior year results. In addition, management uses the non-GAAP financial results to evaluate the Company’s underlying operating performance and to analyze trends. Accordingly, we respectfully advise the staff that we considered the guidance in Question 100.01 and believe that the exclusion of the discretionary marketing fund investments from our non-GAAP financial results and the related presentation and disclosure does not cause those results to be misleading.
To help further clarify the nature of these charges, beginning in our Form 10-Q for the quarter ended March 29, 2020, we will revise the footnoted description of these marketing fund investments in our “Special charges” table as follows: “Represents incremental discretionary marketing fund investments in excess of contractual Company-owned restaurant-level contributions, which were made as part of our previously announced temporary support package to our franchisees.”
After this first response the SEC and Papa John’s had further phone discussions about this issue. Interestingly, the SEC did not issue a second comment letter. While we cannot know the content of these discussions, they were clearly substantive. They resulted in this final answer by Papa John’s:
Response: As discussed during the phone conversation between the Staff and the Company on April 24, 2020, beginning with the Company’s earnings release for the first quarter of fiscal 2020, the Company will no longer present adjusted (non-GAAP) financial results excluding the marketing fund investments made by the Company.
As always, your thoughts and comments are welcome!