Papa John‘s International, Inc.
PAPA JOHNS INTERNATIONAL INC (Form: 10-K, Received: 02/28/2006 17:35:42)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

ý

 

Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

 

 

For the fiscal year ended December 25, 2005

 

 

 

or

 

 

 

o

 

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

 

 

For the transition period from                           to

 

Commission File Number:  0-21660

 

PAPA JOHN’S INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

61-1203323

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

2002 Papa Johns Boulevard

Louisville, Kentucky  40299-2334

(Address of principal executive offices)

 

(502) 261-7272

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

(Title of Each Class)

 

(Name of each exchange on which registered)

 

None

 

None

 

 

 

 

 

Securities registered pursuant to Section 12(g) of the Act:

 

 

 

Common Stock, $.01 par value                 The NASDAQ Stock Market

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

 

 

 

Yes o No ý

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

 

Yes o   No ý

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes ý No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

 

 

 

 

o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer ý

 

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12-b-2 of the Exchange Act).

 

 

Yes o No ý

 

The aggregate market value of the common stock held by non-affiliates of the Registrant, computed by reference to the closing price as of the last business day of the Registrant’s most recently completed second fiscal quarter, June 26, 2005, was approximately $441,541,124.

 

As of February 21, 2006 there were 33,182,720 shares of the Registrant’s Common Stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of Part III are incorporated by reference to the Registrant’s Proxy Statement for the Annual Meeting of Stockholders to be held April 19, 2006.

 

 



 

TABLE OF CONTENTS

 

PART I

 

 

 

Item 1.

 

Business

 

Item 1A.

 

Risk Factors

 

Item 1B.

 

Unresolved Staff Comments

 

Item 2.

 

Properties

 

Item 3.

 

Legal Proceedings

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

 

 

 

 

PART II

 

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Item 6.

 

Selected Financial Data

 

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

Item 8.

 

Financial Statements and Supplementary Data

 

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

Item 9A.

 

Controls and Procedures

 

Item 9B.

 

Other Information

 

 

 

 

 

PART III

 

 

 

Item 10.

 

Directors and Executive Officers of the Registrant

 

Item 11.

 

Executive Compensation

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

Item 13.

 

Certain Relationships and Related Transactions

 

Item 14.

 

Principal Accounting Fees and Services

 

 

 

 

 

PART IV

 

 

 

Item 15.

 

Exhibits, Financial Statement Schedules

 

 

1



 

PART I

 

Item 1. Business

 

General

 

Papa John’s International, Inc . (referred to as the “Company”, “Papa John’s” or in the first person notations of “we”, “us” and “our”) operates and franchises pizza delivery and carryout restaurants under the trademark “Papa John’s”. At December 25, 2005, the Company and its franchisees operated domestically in 49 states, the District of Columbia, the U.S. Virgin Islands and Puerto Rico and in 22 countries, and under the trademark “Perfect Pizza” in the United Kingdom. The first Company-owned Papa John’s restaurant opened in 1985 and the first franchised restaurant opened in 1986. We acquired Perfect Pizza Holdings Limited (referred to as “Perfect Pizza” and “Papa John’s UK”) in 1999 as part of our plan to develop restaurants internationally (see Development). At December 25, 2005, there were 2,926 Papa John’s restaurants in operation, consisting of 504 Company-owned and 2,422 franchised restaurants. Additionally, there were 112 franchised Perfect Pizza restaurants in operation.

 

As more fully described in Management's Discussion and Analysis of Financial Condition and Results of Operations, the Company recently developed a plan to sell its Perfect Pizza operations, consisting of the franchised units and related distribution operations. The Company believes the sale of the Perfect Pizza operations will be completed within the next 12 months.

 

All of our periodic report filings with the Securities and Exchange Commission (“SEC”) pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended, are available, free of charge, through our web site located at www.papajohns.com, including our annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, and any amendments to those reports. These reports are available through our website as soon as reasonably practicable after we electronically file such reports or amendments with the SEC. Printed copies of such documents are also available free of charge upon written request to Investor Relations, Papa John’s International, Inc., P.O. Box 99900, Louisville, KY 40269-0900.

 

Strategy

 

Our goal is to build the strongest brand loyalty of all pizzerias internationally. The key elements of our strategy include:

 

Menu. Domestic Papa John’s restaurants offer a menu of high-quality pizza along with side items, including breadsticks, cheesesticks, chicken strips and wings, dessert pizza and canned or bottled soft drinks. Papa John’s traditional crust pizza is prepared using fresh dough (never frozen). Papa John’s pizzas are made from a proprietary blend of wheat flour, cheese made from 100% real mozzarella, fresh-packed pizza sauce made from vine-ripened tomatoes (not from concentrate) and a proprietary mix of savory spices, and a choice of high-quality meat (100% beef, pork and chicken with no fillers) and vegetable toppings. Domestically, all ingredients and toppings can be purchased from our Quality Control Center (“QC Centers”) system, which delivers to individual restaurants twice weekly. Each traditional crust pizza offers a container of our special garlic sauce and a pepperoncini pepper, and each thin crust pizza is served with a packet of special seasonings. In international markets, the menu mix (toppings and side items) is adapted to local tastes.

 

We have offered a thin crust pizza since 1999. During 2005, we introduced Papa’s Perfect Pan, which features a square, thick buttery-tasting crust made with olive oil, and a new zesty robusto pizza sauce

 

2



 

with chunks of tomato and flavored with garlic, Italian herbs and spices. Both the thin and pan crusts are par-baked products produced by third-party vendors.

 

Efficient Operating System. We believe our operating and distribution systems, restaurant layout and designated delivery areas result in lower restaurant operating costs and improved food quality, and promote superior customer service. Our domestic QC Center system takes advantage of volume purchasing of food and supplies, and provides consistency and efficiencies of scale in fresh dough production. This eliminates the need for each restaurant to order food from multiple vendors and commit substantial labor and other resources to dough preparation.

 

Commitment to Team Member Training and Development. We are committed to the development and motivation of our team members through training programs, incentive compensation and opportunities for advancement. Team member training programs are conducted for corporate team members, and offered to our franchisees at training locations across the United States. We offer performance-based financial incentives to restaurant team members at various levels. Our management compensation program is designed to attract and retain highly motivated people.

 

Marketing. Our restaurant-level marketing programs target the delivery area of each restaurant, making extensive use of targeted print materials in direct mail and store-to-door couponing. Local marketing efforts also include a variety of community-oriented activities with schools, sports teams and other organizations. Local marketing efforts are supplemented with radio and television advertising, produced locally and on a national basis. Seven national television campaigns aired in 2005. We also advertise nationally via the internet.

 

Franchise System. We are committed to maintaining and developing a strong franchise system by attracting experienced operators, partnering with them to expand and grow their business and monitoring their compliance with our high standards. We seek to attract franchisees with experience in restaurant or retail operations and with the financial resources and management capability to open single or multiple locations. To ensure consistent food quality, each domestic franchisee is required to purchase dough and seasoned sauce from our QC Centers and purchase all other supplies from our QC Centers or approved suppliers. QC Centers outside the U.S. or in remote areas may be operated by franchisees pursuant to license agreements or by other third parties. We devote significant resources to provide Papa John’s franchisees with assistance in restaurant operations, management training, team member training, marketing, site selection and restaurant design. We also provide significant assistance to licensed international QC Centers in sourcing high-quality suppliers located in-country or regional suppliers to the extent possible.

 

Unit Economics

 

In 2005, the 472 domestic Company-owned restaurants included in the most recent quarter’s comparable restaurant base generated average annual sales, based on a 52-week year, of $818,000, average cash flow (restaurant operating income plus depreciation) of $172,000 and average restaurant operating income of $148,000. This average operating income represents 18.0% of average sales and 54.7% of the $270,000 average cash investment for these Company-owned restaurants.

 

The average cash investment for the seven domestic Company-owned restaurants opened during the 2005 fiscal year, exclusive of land, was approximately $241,000. We expect the average cash investment for the 20 Company-owned restaurants expected to open in 2006 to be approximately $250,000. Substantially all domestic restaurants do not offer dine-in areas, which reduces our restaurant capital investment.

 

3



 

Development

 

A total of 198 Papa John’s restaurants were opened during 2005, consisting of eight Company-owned and 190 franchised restaurants (101 domestic and 89 international), while 102 Papa John’s restaurants closed during 2005, consisting of one Company-owned and 101 franchised (73 domestic and 28 international). During 2005, six franchised Perfect Pizza restaurants were opened, 11 franchised restaurants were closed and one restaurant was converted to a Papa John’s restaurant.

 

During 2006, we plan to open approximately 20 Company-owned restaurants domestically and expect franchisees to open approximately 190 to 220 restaurants (90 to 105 domestically and 100 to 115 internationally). We also expect approximately 70 to 100 Papa John’s restaurants to close during 2006, the majority of which are expected to be domestic franchise units. Domestic and international franchise unit expansion is expected to spread throughout markets across North and South America, Asia, Europe, and the Middle East. Our expansion in Asia will include a significant focus in China, Korea and India.

 

Our Company-owned expansion strategy is to continue to open domestic restaurants in existing markets, thereby increasing consumer awareness and enabling us to take advantage of operational and advertising efficiencies. Our experience in developing markets indicates that market penetration through the opening of multiple restaurants within a particular market results in increased average restaurant sales in that market over time. We have co-developed markets with some franchisees or divided markets among franchisees, and will continue to utilize market co-development in the future. We continually evaluate the number and market areas of our Company-owned restaurants, and may purchase or sell restaurants from time to time. We also have two domestic joint ventures and may consider entering into more of these arrangements in the future.

 

We recently began implementing a “buy and build” strategy in one large metropolitan market. Under this strategy, the Company will purchase franchise restaurants in an under-penetrated or emerging domestic market with the intention of building additional Company-owned restaurants to increase market awareness. We plan to explore implementing this strategy in other markets, including the possible use of joint venture partners.

 

Restaurant Design and Site Selection

 

Backlit awnings, neon window designs and other visible signage characterize the exterior of most Papa John’s restaurants. A typical domestic Papa John’s restaurant averages 1,100 to 1,500 square feet. Papa John’s restaurants are designed to facilitate a smooth flow of food orders through the restaurant. The layout includes specific areas for order taking, pizza preparation and routing, resulting in simplified operations, lower training and labor costs, increased efficiency and improved consistency and quality of food products. The typical interior of a Papa John’s restaurant has a vibrant color scheme, and includes a bright menu board, custom counters and a carryout customer area. The counters are designed to allow customers to watch the team members slap out the dough and put sauce and toppings on pizzas. Most of our international Papa John’s restaurants are between 900 and 1400 square feet, however, several have been opened in larger spaces to include dine-in service and average 35 to 100 seats. We will utilize dine-in service as part of our international growth strategy based on a country-by-country evaluation of consumer preferences and trends.

 

We consider the location of a restaurant to be important and therefore devote significant resources to the investigation and evaluation of potential sites. The site selection process includes a review of trade area demographics, target population density, household income levels and competitive factors. A member of

 

4



 

our development team inspects each potential domestic Company-owned restaurant location and substantially all franchised restaurant locations and the surrounding market before a site is approved. Our restaurants are typically located in strip shopping centers or freestanding buildings that provide visibility, curb appeal and accessibility. Our restaurant design can be configured to fit a wide variety of building shapes and sizes, which increases the number of suitable locations for our restaurants.

 

A number of freestanding restaurants have been opened in the Papa John’s system. We seek either existing buildings suitable for conversion, or locations suitable for the construction of our prototype restaurant. At December 25, 2005, freestanding units represented approximately 24% of domestic Company-owned restaurants, and a relatively small percentage of domestic franchised restaurants. We do not expect to add a significant number of domestic freestanding restaurants in the future.

 

We provide layout and design services and recommendations for subcontractors, signage installers and telephone systems to Papa John’s franchisees. Our franchisees can purchase complete new store equipment packages through an approved third party supplier under a commission arrangement with the Company. We sell replacement packages, smallwares and related items to our franchisees through our support services subsidiary, Papa John’s Support Services, Inc.

 

We have designed a re-image package for the interior of our domestic restaurants at a cost of approximately $5,000 per unit. We expect to re-image all Company-owned restaurants in 2006 at a total cost of approximately $2.0 million and will offer the re-image package to franchisees on an elective basis.

 

Quality Control Centers (“QC”); Strategic Supply Chain Management

 

Our domestic QC Centers, comprised of ten regional production and distribution centers in 2005, supply pizza dough, food products, paper products, smallwares and cleaning supplies twice weekly to each restaurant. This system enables us to monitor and control product quality and consistency, while lowering food costs. Our full-service QC Centers are located in Louisville, Kentucky; Dallas, Texas; Pittsburgh, Pennsylvania; Orlando, Florida; Raleigh, North Carolina; Denver, Colorado; Rotterdam, New York; Portland, Oregon; Des Moines, Iowa; and Phoenix, Arizona. The QC Center system capacity is continually evaluated in relation to planned restaurant growth, and facilities are developed or upgraded as operational or economic conditions warrant. We consider the current QC center system capacity sufficient to accommodate domestic restaurant unit development for the next several years.

 

Our subsidiary, Papa John's UK, leases a distribution center in the United Kingdom. The primary difference between a full-service QC Center and a distribution center is that full-service QC Centers produce fresh pizza dough in addition to providing other food and paper products used in our restaurants. International full-service QC Centers, licensed to franchisees and non-franchisee third parties, are generally located in the markets where our franchisees have restaurants. We expect future international QC Centers to be licensed to franchisees or non-franchisee third parties; however, we may open Company-owned QC Centers at our discretion. We also have the right to acquire licensed QC Centers from our international licensees in certain circumstances.

 

We set quality standards for all products used in our restaurants and designate approved outside suppliers of food and paper products that meet our quality standards. In order to ensure product quality and consistency, all Papa John’s restaurants are required to purchase seasoned sauce and dough from our QC Centers. Franchisees may purchase other goods directly from our QC Centers or approved suppliers. National purchasing agreements with most of our suppliers generally result in volume discounts to us, allowing us to sell products to our restaurants at prices that we believe are below those generally available in the marketplace. Within our domestic QC Center system, products are distributed to restaurants by refrigerated trucks leased and operated by us or transported by a dedicated logistics company.

 

5



 

PJ Food Service, Inc. (“PJFS”), our wholly owned subsidiary that operates our domestic Company-owned QC Centers, has a purchasing arrangement with BIBP Commodities, Inc. (“BIBP”), a third-party entity formed by franchisees for the sole purpose of reducing cheese price volatility to domestic system-wide restaurants. Under this arrangement, PJFS purchases cheese at a fixed quarterly price based in part on historical average cheese prices. Gains and losses incurred by the selling entity are passed to the QC Centers via adjustments to the selling price over time. Ultimately, PJFS purchases cheese at a price approximating the actual average market price, but with more predictability and less price volatility. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Consolidation of BIBP Commodities, Inc. (“BIBP”) as a Variable Interest Entity, and “Note 5” of “Notes to Consolidated Financial Statements” for additional information concerning BIBP and the purchasing arrangement, and the related financial statement treatment thereof.

 

Marketing Programs

 

All Company-owned and franchised Papa John’s restaurants within a co-developed market are required to join an area advertising cooperative (“Co-op”). Each member restaurant contributes a percentage of sales to the Co-op for market-wide programs, such as radio, television and print advertising. The rate of contribution and uses of the monies collected are determined by a majority vote of the Co-op’s members. The restaurant-level and Co-op marketing efforts are supported by print and electronic advertising materials that are produced by the Papa John’s Marketing Fund, Inc., a non-profit corporation (the “Marketing Fund”). The Marketing Fund produces and buys air time for Papa John’s national television commercials, in addition to other brand-building activities, such as consumer research and public relations activities. All domestic Company-owned and franchised Papa John’s restaurants are required to contribute a certain percentage of sales to the Marketing Fund. The contribution rate to the Marketing Fund can be increased above the required contribution rate if a majority of the domestic restaurants agree to such increase. The contribution percentage was 2.25% during 2005, 3.25% for the period June through December 2004, and 2.0% from January through May 2004 and throughout 2003. Effective at the beginning of fiscal 2006, the contribution percentage to the Marketing Fund increased to 2.6% and is expected to remain at that level throughout 2006.

 

Restaurant-level marketing programs target the delivery area of each restaurant, making extensive use of targeted print materials in direct mail and store-to-door couponing. The local marketing efforts also include a variety of community-oriented activities with schools, sports teams and other organizations. In markets in which Papa John’s has a significant presence, local marketing efforts are supplemented with radio and television advertising.

 

We provide both Company-owned and franchised restaurants with pre-approved print marketing materials and with catalogs for the purchase of uniforms and promotional items. We also provide direct marketing services to Company-owned and franchised restaurants using customer information gathered by our proprietary point-of-sale technology (see Company Operations – Point of Sale Technology).

 

We have developed a system by which all domestic Papa John’s restaurant customers are able to place orders online via the internet, including a new “plan ahead ordering” advance ordering feature. We receive a percentage fee based on online sales from domestic franchisees, in addition to royalties, for this service.

 

We offer our customers the opportunity to purchase a reloadable gift card, (“Papa Card”) that can be purchased in any denomination from $10 to $100. We also offer Papa Cards for sale to consumers in limited third party outlets and continue to explore additional Papa Card distribution opportunities. The Papa Card may be redeemed for delivery, carryout and online orders and is accepted at substantially all Papa John’s traditional U.S. restaurants.

 

6



 

Company Operations

 

Restaurant Personnel. A typical Papa John’s restaurant employs a restaurant manager, one or two assistant managers and approximately 20 to 25 hourly team members, most of whom work part-time. The manager is responsible for the day-to-day operation of the restaurant and maintaining Company-established operating standards. The operating standards and other resources are contained in a comprehensive operations manual supplied to each restaurant. We seek to hire experienced restaurant managers and staff, provide comprehensive training on operations and managerial skills, and motivate and retain them by providing opportunities for advancement and performance-based financial incentives.

 

We also employ directors of operations who are responsible for overseeing an average of seven Company-owned restaurants. The directors of operations report to operations vice presidents who are individually responsible for the management of approximately 100 Company-owned restaurants in specific geographic regions. These team members are eligible to earn performance-based financial incentives.

 

Training and Education. We have a department dedicated to training and developing team members, as well as assisting with new restaurant openings. With regional training locations across the country, we are capable of training multiple operators during new program or product introductions. Domestically, we provide an on-site training team three days before and three days after the opening of any Company-owned or franchised restaurant requesting assistance. Operations personnel, both corporate and franchise, complete our management training program and on-going development programs in which instruction is given on all aspects of our systems and operations. The programs include hands-on training and some classroom instruction at an operating Papa John’s restaurant by a Company certified general training manager. Our training includes new team member orientation, in-store and delivery training, core management skills training, new product or program implementation and ongoing developmental programs.

 

Point of Sale Technology . Point of sale technology (our proprietary PROFIT System TM ) is in place in all domestic traditional Papa John’s restaurants and in a majority of Papa John’s international restaurants. We believe this technology facilitates faster and more accurate order-taking and pricing, reduces paperwork and allows the restaurant manager to better monitor and control food and labor costs. We believe the PROFIT System enhances restaurant-level marketing capabilities through the development of a database containing information on customers and their buying habits with respect to our products. Polling capabilities allow us to obtain restaurant operating information, thereby improving the speed, accuracy and efficiency of restaurant-level reporting. During 2004, we introduced a new generation of the PROFIT System to the domestic and international Papa John’s system. This updated version was designed to improve operational efficiencies at the restaurant level and improve our data collection process. The updated PROFIT System was installed in all domestic Company-owned and franchised restaurants during 2005. The PROFIT System is also closely integrated with our online ordering system in all domestic traditional Papa John’s restaurants. This enables Papa John’s to offer nationwide online ordering to our customers.

 

Reporting. Management at Company-owned restaurants evaluates daily reports of sales, cash deposits and operating costs. Physical inventories of all food and beverage items are taken nightly.

 

Joint Venture. We operate 114 Company-owned restaurants under two joint venture arrangements. Under the first arrangement, we own 70% of 36 Papa John’s restaurants located in Virginia and Maryland. Under the second arrangement, we own 51% of 78 Papa John’s restaurants located in Texas. We will continue to evaluate further joint venture arrangements on an individual basis as opportunities arise.

 

7



 

Hours of Operations. Our domestic restaurants are open seven days a week, typically from 11:00 a.m. to 12:30 a.m. Monday through Thursday, 11:00 a.m. to 1:30 a.m. on Friday and Saturday and 12:00 noon to 11:30 p.m. on Sunday.

 

Franchise Program

 

General. We continue to attract franchisees with significant restaurant and retail experience. We consider our franchisees to be a vital part of our system’s continued growth and believe our relationship with our franchisees is good. As of December 25, 2005, there were 2,422 franchised Papa John’s restaurants operating in 49 states, the District of Columbia, the U.S. Virgin Islands, Puerto Rico and 22 countries, and 112 franchised Perfect Pizza restaurants operating in the United Kingdom. As of December 25, 2005, we have development agreements with our franchisees for approximately 271 additional domestic franchised restaurants committed to open through 2012 and agreements for 848 additional international franchised restaurants to open through 2016. There can be no assurance that all of these restaurants will be opened or that the development schedule set forth in the development agreements will be achieved. During 2005, 190 (101 domestic and 89 international) franchised Papa John’s restaurants were opened, and six Perfect Pizza franchised restaurants were opened. Our franchisees have converted 62 Perfect Pizza restaurants to Papa John’s restaurants since 2000.

 

Approval. Franchisees are approved on the basis of the applicant’s business background, restaurant operating experience and financial resources. We seek franchisees to enter into development agreements for single or multiple restaurants. We require the franchisee to either complete our training program or to hire a full-time operator who completes the training and has either an equity interest or the right to acquire an equity interest in the franchise operation.

 

Development and Franchise Agreements. We enter into development agreements with our domestic franchisees for the opening of a specified number of restaurants within a defined period of time and specified geographic area. Under our current standard development agreement, the franchisee is required to pay, at the time of signing the agreement, a non-refundable fee of $25,000 for the first restaurant and $5,000 for any additional restaurants. The non-refundable fee is credited against the standard $25,000 franchise fee payable to us upon signing the franchise agreement for a specific location. Generally, a franchise agreement is executed when a franchisee secures a location.

 

Our standard domestic franchise agreement provides for a term of ten years (with one ten-year renewal option) and payment to us of a royalty fee of 4% of sales. Substantially all existing franchise agreements permit us to increase the royalty fee up to 5% of sales. The royalty fee cannot be increased to an amount greater than the percentage royalty fee then in effect for new franchisees.

 

We have the right to terminate a franchise agreement for a variety of reasons, including a franchisee’s failure to make payments when due or failure to adhere to our policies and standards. Many state franchise laws limit the ability of a franchisor to terminate or refuse to renew a franchise.

 

We opened our first franchised restaurant outside the United States in 1998. We define “international” to be all markets outside the contiguous United States in which we have either a development agreement or a master franchise agreement with a franchisee for the opening of a specified number of restaurants within a defined period of time and specified geographic area. Under a master franchise agreement, the

 

8



 

franchisee has the right to subfranchise a portion of the development to one or more subfranchisees approved by us. Under our current standard international development agreement (except for Hawaii and Alaska, in which the initial fees are the same as domestic restaurants), the franchisee is required to pay total fees of $25,000 per restaurant, $5,000 at the time of signing the agreement, and $20,000 when the restaurant opens or the agreed-upon development date, whichever comes first. Under our current standard master franchise agreement, the master franchisee is required to pay total fees of $25,000 per restaurant owned and operated by the master franchisee, under the same terms as the development agreement, and $15,000 for each subfranchised restaurant, $5,000 at the time of signing the agreement and $10,000 when the restaurant opens or the agreed-upon development date, whichever comes first.

 

Our current standard international master franchise and development agreements provide for payment to us of a royalty fee of 5% of sales (3% of sales by subfranchised restaurants), with no provision for increase. The remaining terms applicable to the operation of individual restaurants are substantially equivalent to the terms of our standard domestic franchise agreement. From time to time, development agreements will be negotiated at other than standard terms for fees and royalties.

 

We have entered into a limited number of development and franchise agreements for non-traditional restaurant units and continue to analyze opportunities to expand these types of units. These agreements generally cover venues or areas not originally targeted for development and have terms differing from the standard agreement. These agreements have not had a significant impact on our revenues or earnings.

 

Franchise Restaurant Development. We provide assistance to Papa John’s franchisees in selecting sites, developing restaurants and evaluating the physical specifications for typical restaurants. Each franchisee is responsible for selecting the location for its restaurants but must obtain our approval of restaurant design and location based on accessibility and visibility of the site and targeted demographic factors, including population, density, income, age and traffic. Our domestic franchisees may purchase complete new store equipment packages through an approved third party supplier under a commission arrangement with the Company. Internationally, our franchisees buy their equipment from approved third-party suppliers.

 

Franchisee Loans. Selected franchisees have borrowed funds from our subsidiary, Capital Delivery, Ltd., principally for use in the construction and development of their restaurants. We have also entered into loan agreements with certain franchisees that purchased restaurants from us or other franchisees. Loans made to franchisees typically bear interest at fixed or floating rates (with a stated average interest rate of 5.8% at December 25, 2005) and in most cases are secured by the fixtures, equipment and signage (and where applicable, the land) of the restaurant and the ownership interests in the franchisee. At December 25, 2005, franchisee loans outstanding totaled $7.7 million ($1.5 million of net loans were eliminated upon consolidating franchisee variable interest entities or “VIEs”), net of a $1.5 million reserve for uncollectible amounts. See “Note 11” of “Notes to Consolidated Financial Statements” for additional information.

 

We have a commitment to lend up to $17.6 million to BIBP, a franchisee-owned corporation. We have an outstanding loan of $13.1 million to BIBP at December 25, 2005, which is eliminated in consolidation. See “Note 11” of “Notes to Consolidated Financial Statements” for additional information.

 

Franchise Insurance Program. Our franchisees have the opportunity to purchase various insurance policies, such as non-owned automobile and workers’ compensation, through our insurance agency, Risk Services Corp. (“Risk Services”). In October 2000, we established a captive insurance company (“Captive”) located in Bermuda, RSC Insurance Services, Ltd., to accommodate this business. Beginning in October 2004, a third-party commercial insurance company began providing fully-insured coverage to franchisees participating in the franchise insurance program. Accordingly, this new agreement eliminates

 

9



 

our risk of loss for franchise insurance coverage written after September 2004. As of December 25, 2005, approximately 50% of domestic franchise restaurants had obtained insurance coverage through Risk Services. See “Note 12” of “Notes to Consolidated Financial Statements” for additional information.

 

Franchise Training and Support. During late 2005, the field support structure for domestic franchisees was reorganized and merged into the Company-owned restaurant management structure. The new field support structure consists of Franchise Business Directors (“FBDs”), each of whom is responsible for serving an average of approximately 100 franchise units. Every franchisee is required to have a principal operator approved by us who satisfactorily completes our required training program and who devotes his or her full business time and efforts to the operation of the franchisee’s restaurants. Each franchise restaurant manager is also required to complete our Company-certified management training program. Domestically, we provide an on-site training crew three days before and three days after the opening of a franchisee’s first two restaurants. Internationally, we provide an on-site training crew five days before and five days after the opening of a franchisee’s first two stores. Ongoing supervision of training is monitored by the franchise training team. Multi-unit franchisees are encouraged to appoint training store general managers or hire a full-time training coordinator certified to deliver Company-approved programs in order to train new team members and management candidates for their restaurants. Our FBD’s maintain open communication with the franchise community, relaying operating and marketing information and new ideas between franchisees and us. Internationally, training is monitored by our international director of training as well as regional directors and international business managers assigned to specific franchisee territories. We also maintain communications with our franchisees through periodic system-wide meetings and newsletters.

 

Franchise Operations. All franchisees are required to operate their Papa John’s restaurants in compliance with our policies, standards and specifications, including matters such as menu items, ingredients, materials, supplies, services, fixtures, furnishings, decor and signs. Each franchisee has full discretion to determine the prices to be charged to its customers.

 

Franchise Advisory Council. We have a Franchise Advisory Council that consists of Company and franchisee representatives of domestically owned restaurants. The Advisory Council and subcommittees hold regular meetings to discuss new marketing ideas, operations, growth and other relevant issues. In addition, the Company is aware that certain franchisees have formed an operators’ exchange group for the purpose of communicating and addressing issues, needs and opportunities among its members and the Company.

 

We currently communicate with, and receive input from, our franchisees in several forms, including through the Company’s Franchise Advisory Council, annual operations conferences and various regional meetings conducted with franchisees throughout the year and participation in an operators’ exchange best practices forum in which numerous franchisees also participate. We are committed to communicating with, and receiving input from, our franchisees.

 

Reporting and Business Processes. We collect sales and other operating information from domestic Papa John’s franchisees daily. We have agreements with substantially all Papa John’s domestic franchisees permitting us to debit electronically the franchisees’ bank accounts for substantially all payments to us including the payment of royalties, Marketing Fund contributions, risk management services, and purchases from our Print and Promotions operations and QC Centers. This system significantly reduces the resources needed to process receivables, improves cash flow and mitigates the amount of past-due accounts related to these items. Domestic franchisees generally are required to purchase and install the Papa John’s PROFIT System in their restaurants (see Company Operations — Point of Sale Technology).

 

10



 

Industry and Competition

 

The restaurant industry is intensely competitive with respect to price, service, location, food quality and variety. There are many well-established competitors with substantially greater financial and other resources than Papa John’s. Competitors include a large number of international, national and regional restaurant chains, as well as local pizza operators. Some of our competitors have been in existence for a substantially longer period than us and may have higher restaurant penetration and stronger, more developed brand awareness in the markets where our restaurants are, or may be located. Based on independent third-party research, the United States Quick Service Restaurant (“QSR”) Pizza category, which includes dine-in, carry-out and delivery, had sales of approximately $33.5 billion in 2005, of which Papa John’s share was reported as 5.2%. Within the pizza segment of the restaurant industry, we believe our primary competitors are the national pizza chains, including Pizza Hut, Domino’s and Little Caesars, and several regional chains, including chains executing a “take and bake” concept. A change in the pricing or other marketing strategies of one or more of our competitors could have an adverse impact on our sales and earnings. Additionally, a continued increased emphasis on drive thru, carryout and curbside pickup availability by casual dining restaurants, such as Applebee’s and Outback, as well as improved quality of fresh and frozen supermarket offerings, could also have an adverse impact on our sales and earnings.

 

With respect to the sale of franchises, we compete with many franchisors of restaurants and other business concepts. In general, there is also active competition for management personnel and attractive commercial real estate sites suitable for our restaurants.

 

Government Regulation

 

We, along with our franchisees, are subject to various federal, state and local laws affecting the operation of our respective businesses. Each Papa John’s restaurant is subject to licensing and regulation by a number of governmental authorities, which include health, safety, sanitation, building and fire agencies in the state or municipality in which the restaurant is located. Difficulties in obtaining, or the failure to obtain, required licenses or approvals could delay or prevent the opening of a new restaurant in a particular area. Our full-service QC Centers are licensed and subject to regulation by state and local health and fire codes, and the operation of our trucks is subject to Department of Transportation regulations. We are also subject to federal and state environmental regulations.

 

We are subject to Federal Trade Commission (“FTC”) regulation and various state laws regulating the offer and sale of franchises. Several state laws also regulate substantive aspects of the franchisor-franchisee relationship. The FTC requires us to furnish to prospective franchisees a franchise offering circular containing prescribed information. Substantive state laws that regulate the franchisor-franchisee relationship presently exist in a substantial number of states, and bills have been introduced in Congress from time to time, which would provide for federal regulation of the franchisor-franchisee relationship in certain respects. The state laws often limit, among other things, the duration and scope of non-competition provisions and the ability of a franchisor to terminate or refuse to renew a franchise. Some foreign countries also have disclosure requirements and other laws regulating franchising and the franchisor-franchisee relationship. Further government initiatives, such as “living wage” or other proposed increases in minimum wage rates, could adversely affect Papa John’s as well as the restaurant industry. As we expand internationally, we will be subject to applicable laws in each jurisdiction where franchised units are established.

 

11



 

Trademarks

 

Our rights in our principal trademarks and service marks are a significant part of our business. We are the owner of the federal registration of the trademark “Papa John’s.” We have also registered “Pizza Papa John’s and design” (our logo), “Better Ingredients. Better Pizza.” and “Pizza Papa John’s Better Ingredients. Better Pizza. and design” as trademarks and service marks. We also own federal registrations for several ancillary marks, principally advertising slogans. We have also applied to register our primary trademark, “Pizza Papa John’s and design,” in more than 90 foreign countries and the European Community. We are aware of the use by other persons in certain geographical areas of names and marks which are the same as or similar to our marks. It is our policy to pursue registration of our marks whenever possible and to oppose vigorously any infringement of our marks.

 

Employees

 

As of December 25, 2005, we employed 13,194 persons, of whom approximately 11,417 were restaurant team members, 556 were restaurant management and supervisory personnel, 529 were corporate personnel and 692 were QC Center and support services personnel. Most restaurant team members work part-time and are paid on an hourly basis. None of our team members is covered by a collective bargaining agreement. We consider our team member relations to be excellent.

 

Item 1A. Risk Factors

 

This Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”), including information within Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following cautionary statements are being made pursuant to the provisions of the Act and with the intention of obtaining the benefits of the “safe harbor” provisions of the Act. Although we believe that our expectations are based on reasonable assumptions, actual results may differ materially from those in the forward-looking statements as a result of various factors, including but not limited to, the following:

 

1.                The ability of the Papa John’s system to continue to open new restaurants is affected by a number of factors, many of which are beyond our control. These factors include, among other things, litigation, selection and availability of suitable restaurant locations, increases in or sustained high levels of food, paper, utilities, fuel, employee compensation and benefits, insurance and similar costs, negotiation of suitable lease or financing terms, constraints on permitting and construction of restaurants, higher than anticipated construction costs, and the hiring, training and retention of management and other personnel. Accordingly, there can be no assurance that system-wide, Papa John’s will be able to meet planned growth targets, open restaurants in markets now targeted for expansion, or continue to operate in existing markets profitably.

 

2.                The restaurant industry is intensely competitive with respect to price, service, location and food quality, and there are many well-established competitors with substantially greater financial and other resources than the Papa John’s system. Some of these competitors have been in existence for a substantially longer period than Papa John’s and may be better established in the markets where restaurants operated by us or our franchisees are, or may be, located. Experience has shown that a change in the pricing or other marketing or promotional strategies, including new product and concept developments, of one or more of our major competitors can have an adverse impact on sales and earnings of Papa John’s and our system-wide restaurant operations.

 

3.                An increase in the cost of cheese or other commodities could adversely affect the profitability of our system-wide restaurant operations. Cheese costs, historically representing 35% to 40% of our food

 

12



 

cost, and other commodities are subject to seasonal fluctuations, weather, availability, demand and other factors that are beyond our control. Additionally, sustained increases in fuel and utility costs could adversely affect the profitability of our restaurant and QC Center businesses.

 

4.                Changes in consumer taste (for example, changes in dietary preferences that could cause consumers to avoid pizza in favor of foods that are perceived as more healthful), demographic trends, traffic patterns and the type, number and location of competing restaurants could adversely affect our restaurant business.

 

5.                Health- or disease-related disruptions or consumer concerns about the commodity supply or the Company’s food products could negatively impact the availability and/or cost of commodities and adversely impact restaurant operations and our financial results.

 

6.                System-wide restaurant operations are subject to federal and state laws governing such matters as wages, working conditions, citizenship requirements and overtime. A significant number of hourly personnel employed by our franchisees and us are paid at rates related to the federal minimum wage. Accordingly, further increases in the federal minimum wage or the enactment of additional state or local minimum wage increases above federal wage rates will increase labor costs for our system-wide operations. Additionally, labor shortages in various markets could result in higher required wage rates.

 

7.                Any or all of the factors listed in 1. through 6. potentially adversely impacting restaurant sales or costs could be especially harmful to the financial viability of franchisees in under-penetrated or emerging markets. A decline in or failure to improve financial performance for this group of franchisees could lead to unit closings at greater than anticipated levels and therefore impact contributions to marketing funds, our royalty stream, PJFS and support services efficiencies and other system-wide results.

 

8.                Domestically, we are dependent on sole suppliers for our cheese, flour, and thin and pan crust dough products. Alternative sources for these ingredients may not be available on a timely basis to supply these key ingredients or be available on terms as favorable to us as under our current arrangements. Domestic restaurants purchase substantially all food and related products from our QC Centers. Accordingly, both our corporate and franchised restaurants could be harmed by any prolonged disruption in the supply of products from our QC Centers.

 

9.                Domestic franchisees are only required to purchase seasoned sauce and dough from our QC Centers and changes in purchasing practices by domestic franchisees could adversely affect the financial results of our QC Centers.

 

10.          Beginning in October of 2004, a third-party commercial insurance company began providing fully-insured coverage to franchisees participating in our franchise insurance program, thus eliminating our risk of loss for franchise insurance coverage written after September 2004. The Captive’s relatively immature claims history limits the predictive value of estimating the costs of incurred and future claims, thus our operating income is subject to potential significant adjustments for changes in estimated insurance reserves for policies written from the Captive’s inception in October 2000 through September 2004.

 

11.          Our domestic and international operations could be negatively impacted by significant changes in international economic, political and health conditions. In addition, our international operations are subject to additional factors, including compliance with foreign laws, currency regulations and fluctuations, differing business and social cultures and consumer preferences, diverse government

 

13



 

regulations and structures, availability and cost of land and construction, ability to source high-quality ingredients and other commodities in a cost-effective manner, and differing interpretation of the obligations established in franchise agreements with international franchisees. Accordingly, there can be no assurance that our operations will achieve or maintain profitability or meet planned growth rates.

 

Item 1B. Unresolved Staff Comments

 

None.

 

Item 2. Properties

 

As of December 25, 2005, there were 2,926 Papa John’s restaurants and 112 franchised Perfect Pizza restaurants system-wide.

 

Company-owned Papa John’s Restaurants

 

 

 

Number of

 

 

 

Restaurants

 

 

 

 

 

Florida

 

32

 

Georgia

 

68

 

Illinois

 

3

 

Indiana

 

40

 

Kentucky

 

41

 

Maryland

 

50

 

Missouri

 

19

 

New Jersey

 

15

 

New Mexico

 

10

 

North Carolina

 

63

 

Ohio

 

16

 

Pennsylvania

 

12

 

South Carolina

 

4

 

Tennessee

 

27

 

Texas

 

78

 

Virginia

 

24

 

Total Domestic Company-owned Papa John’s Restaurants

 

502

 

United Kingdom

 

2

 

Total Company-owned Papa John’s Restaurants

 

504

 

 

Note: Company-owned Papa John’s restaurants include restaurants owned by majority-owned joint ventures. There were 114 such restaurants at December 25, 2005 (78 in Texas, 24 in Virginia and 12 in Maryland).

 

14



 

Domestic Franchised Papa John’s Restaurants

 

 

 

Number of

 

 

 

Restaurants

 

 

 

 

 

Alabama

 

62

 

Arizona

 

66

 

Arkansas

 

13

 

California

 

173

 

Colorado

 

50

 

Connecticut

 

3

 

Delaware

 

12

 

Florida

 

207

 

Georgia

 

64

 

Idaho

 

8

 

Illinois

 

56

 

Indiana

 

75

 

Iowa

 

22

 

Kansas

 

31

 

Kentucky

 

52

 

Louisiana

 

40

 

Maine

 

6

 

Maryland

 

37

 

Massachusetts

 

16

 

Michigan

 

48

 

Minnesota

 

49

 

Mississippi

 

20

 

Missouri

 

44

 

Montana

 

9

 

Nebraska

 

16

 

Nevada

 

19

 

New Hampshire

 

2

 

New Jersey

 

24

 

New Mexico

 

7

 

New York

 

58

 

North Carolina

 

63

 

North Dakota

 

6

 

Ohio

 

134

 

Oklahoma

 

26

 

Oregon

 

19

 

Pennsylvania

 

79

 

Rhode Island

 

5

 

South Carolina

 

42

 

South Dakota

 

7

 

Tennessee

 

61

 

Texas

 

129

 

Utah

 

25

 

Virginia

 

89

 

Washington

 

55

 

West Virginia

 

21

 

Wisconsin

 

37

 

Wyoming

 

5

 

Washington, D.C.

 

5

 

 

 

 

 

Total Domestic Franchised Papa John’s Restaurants

 

2,097

 

 

15



 

International Franchised Papa John’s Restaurants

 

 

 

Number of

 

 

 

Restaurants

 

 

 

 

 

Alaska

 

4

 

Bahamas

 

5

 

Bahrain

 

6

 

Canada

 

14

 

Cayman Islands

 

1

 

China

 

26

 

Costa Rica

 

11

 

Ecuador

 

3

 

Hawaii

 

15

 

Ireland

 

2

 

Kuwait

 

4

 

Mexico

 

39

(a)

Nicaragua

 

1

 

Oman

 

4

 

Pakistan

 

1

 

Peru

 

4

 

Portugal

 

2

 

Puerto Rico

 

13

 

Russia

 

6

 

Saudi Arabia

 

17

 

South Korea

 

39

 

Trinidad

 

2

 

U.S. Virgin Islands

 

2

 

United Arab Emirates

 

1

 

United Kingdom

 

87

 

Venezuela

 

16

 

 

 

 

 

Total International Franchised Papa John’s Restaurants

 

325

 

 


(a) In the fourth quarter, we terminated the master franchise agreement in Mexico. In January and February, 17 franchised and subfranchised restaurants in Mexico closed. We expect that a substantial majority of the 22 remaining franchised and subfranchised restaurants in Mexico will close by the end of the first quarter. The royalty income earned from the restaurants closed or expected to close was not material to our 2005 operating results. We are committed to the development of Mexico as an important international market and are currently evaluating our alternatives, including potential direct investment via a joint venture or other methods.

 

We define “domestic” operations as units located in the contiguous United States.

 

Most Papa John’s restaurants are located in leased space. The initial term of most restaurant leases is generally five years with most leases providing for one or more options to renew for at least one additional term. Virtually all of our leases specify a fixed annual rent. Generally, the leases are triple net leases, which require us to pay all or a portion of the cost of insurance, taxes and utilities. Certain leases further provide that the lease payments may be increased annually, with a small number of escalations based on changes in the Consumer Price Index.

 

16



 

Approximately 45 Company-owned restaurants are located in buildings we own on land either owned or leased by us. These restaurants range from 1,100 to 3,000 square feet. Three of these restaurants are located in multi-bay facilities. These multi-bay facilities contain from 2,800 to 5,000 square feet, and the space not utilized by the Papa John’s restaurant in each facility is leased or held for lease to third party tenants.

 

At December 25, 2005, we had 201 restaurants located in the United Kingdom (87 franchised and 2 Company-owned Papa John’s restaurants and 112 franchised Perfect Pizza restaurants). In addition to leasing the 2 Company-owned restaurant sites, we lease and sublease to franchisees 162 of the 199 franchised restaurant sites. The initial lease terms on the Company and franchised sites are generally 10 to 15 years. The initial lease terms of the franchisee subleases are generally five to ten years. As more fully described in Management’s Discussion and Analysis of Financial Condition and Results of Operations, we have developed a plan to sell our Perfect Pizza operations located in the United Kingdom during the next 12 months.

 

 

Information with respect to our leased QC Centers and other facilities as of December 25, 2005 is set forth below.

 

Facility

 

Square Footage

 

Raleigh, NC

 

61,000

 

Denver, CO

 

32,000

 

Phoenix, AZ

 

57,000

 

Des Moines, IA

 

43,000

 

Rotterdam, NY

 

45,000

 

Portland, OR

 

37,000

 

Pittsburgh, PA

 

52,000

 

 

We own approximately five acres in Orlando, Florida on which our 63,000 square foot full-service commissary is located. We also own eight acres and a 175,000 square foot facility in Dallas, Texas, of which 77,500 square feet is used by our full-service commissary and the remaining space is available for future production or for leasing. In addition, we own approximately 72 acres in Louisville, Kentucky with a 42,000 square foot building housing our printing operations and a 247,000 square foot building, approximately 30% to 40% of which accommodates the Louisville QC Center operation and promotional division. The remainder of the building houses our corporate offices.

 

The Papa John’s UK management team is located in 6,000 square feet of leased office space in London with a remaining lease term of 10 years. In addition, Papa John’s UK leased a distribution center located in a 30,000 square foot facility in Staffordshire, England.

 

Item 3. Legal Proceedings

 

We are subject to claims and legal actions in the ordinary course of our business. We believe that all such claims and actions currently pending against us are either adequately covered by insurance or would not have a material adverse effect on us if decided in a manner unfavorable to us.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

Not applicable.

 

17



 

EXECUTIVE OFFICERS OF THE REGISTRANT

 

Set forth below are the executive officers of Papa John’s, together with their ages as of January 1, 2006, their positions and the years in which they first became an officer:

 

 

Name

 

Age

 

Position

 

First Elected
Executive Officer

 

 

 

 

 

 

 

John H. Schnatter

 

44

 

Founder and Executive Chairman

 

1985

 

 

 

 

 

 

 

Nigel Travis

 

56

 

President and Chief Executive Officer

 

2005

 

 

 

 

 

 

 

William M. Van Epps

 

57

 

Senior Vice President and Chief Operations Officer

 

2002

 

 

 

 

 

 

 

Julie L. Larner

 

45

 

Senior Vice President and President – PJ Food Service, Inc.

 

2001

 

 

 

 

 

 

 

Charles W. Schnatter

 

43

 

Senior Vice President and Chief Development Officer

 

1991

 

 

 

 

 

 

 

J. David Flanery

 

48

 

Senior Vice President, Chief Financial Officer and Treasurer

 

1994

 

 

 

 

 

 

 

Michael R. Cortino

 

49

 

Senior Vice President, Corporate Operations

 

2000

 

 

 

 

 

 

 

Timothy C. O’Hern

 

42

 

Senior Vice President, Development

 

2005

 

 

 

 

 

 

 

Richard J. Emmett

 

50

 

Senior Vice President, General Counsel and Secretary

 

1992

 

 

 

 

 

 

 

Christopher J. Sternberg

 

40

 

Senior Vice President, Corporate Communications

 

2006

 

John H. Schnatter created the Papa John’s concept and founded Papa John’s in 1985. He has served as Executive Chairman since April 2005. From 1990 to April 2005, he served as Chairman of the Board and Chief Executive Officer and as President from 1985 to 1990 and from January 2001 to April 2005. He has been a franchisee since 1986.

 

Nigel Travis has served as President and Chief Executive Officer since April 1, 2005 after joining Papa John’s in January 2005 as Executive Vice President. He also serves as a member of our Board of Directors. Prior to joining Papa John’s, Mr. Travis held various leadership positions at Blockbuster, Inc., from 1994 to 2004, most recently as President and Chief Operating Officer. From 1985 to 1994, Mr. Travis served in various capacities for Grand Metropolitan PLC (London, England), including leadership positions at Burger King Corporation for five years. Mr. Travis is the lead director of the Bombay Company, Inc.

 

William M. Van Epps has served as Senior Vice President and Chief Operations Officer since 2004, responsible for domestic corporate and franchised restaurant operations and international operations. Mr. Van Epps served as our Managing Director, International from September 2001 to 2004. Prior to joining

 

18



 

Papa John’s, Mr. Van Epps served for two years as President, International Division of Yorkshire Global Restaurants, responsible for the international development of Long John Silver’s and A&W restaurants. From 1993 to 1999, he served in several positions with AFC Enterprises, including President of its International Division. From 1988 to 1993, he was Vice President, Marketing and International for Western Sizzlin, Inc.

 

Julie L. Larner has served as Senior Vice President and President - PJ Food Service, Inc. since 2004. Ms. Larner served as Senior Vice President, Chief Administrative Officer and Treasurer from 2001 to 2004. Ms. Larner has been with Papa John’s since 1992, serving as controller for PJ Food Service, Inc. from 1992 to 1997 and its Vice President of Finance and Administration from 1998 to 2001.

 

Charles W. Schnatter has served as Senior Vice President and Chief Development Officer since 2001 and served as Secretary from 1991 until October 2005; he has been a Senior Vice President since 1993. Mr. Schnatter also held the position of General Counsel from 1991 to March 2002. From 1988 to 1991, he was an attorney with Greenebaum Doll & McDonald PLLC, Louisville, Kentucky, a law firm, which provides legal services to us. Mr. Schnatter has been a franchisee since 1989.

 

J. David Flanery has served as Senior Vice President, Chief Financial Officer and Treasurer since 2004. He previously served as Senior Vice President of Finance since August 2002. He served as Vice President of Finance from 1995 through August 2002, after having joined Papa John’s in 1994 as Corporate Controller. From 1979 to 1994, Mr. Flanery was with Ernst & Young LLP in a variety of positions, most recently as Audit Senior Manager. Mr. Flanery is a licensed Certified Public Accountant.

 

Michael R. Cortino has served as Senior Vice President, Domestic Operations since August 2005; he previously served as Senior Vice President, Corporate Operations after serving as Vice President of Operations Support since 1999. Prior to joining Papa John’s, Mr. Cortino served five years as Vice President of Corporate Operations for AFC Enterprises – Church’s Chicken Brand and ten years as a market manager and in other positions with Taco Bell.

 

Timothy C. O’Hern rejoined Papa John’s in early 2005 as Senior Vice President, Development, after spending two years managing the operations of a Papa John’s franchisee in which he has an ownership interest. Prior to his departure from Papa John’s in 2002, Mr. O’Hern held various positions, including Vice President of Global Development from February 2001 to 2002, Vice President of U.S. Development from March 1997 to February 2001, Director of Franchise Development from December 1996 to March 1997 and Construction Manager from November 1995 to December 1996. He has been a franchisee since 1993.

 

Richard J. Emmett has served as Senior Vice President and General Counsel since March 2002, after serving as Senior Vice President and Senior Counsel since March 1997, and has served as Secretary since October 2005. Mr. Emmett is responsible for our legal, risk management and people departments. Mr. Emmett also served as Senior Vice President of Development from August 1996 to March 1997. From 1992 to 1996, Mr. Emmett held the position of Vice President and Senior Counsel. From 1983 to 1992, Mr. Emmett was an attorney with the law firm of Greenebaum Doll & McDonald PLLC, having become a partner of the firm in 1989. Mr. Emmett has been a franchisee since 1992.

 

Christopher J. Sternberg has served as Senior Vice President, Corporate Communications since April 2005, after serving as Vice President and Assistant to the Executive Chairman since 2000. Mr. Sternberg served as Vice President, Corporate Communications from 1997 to 2000. Mr. Sternberg joined the Company in 1994 as Assistant Counsel in our Legal Department. From 1990 to 1994, he was an attorney with Greenebaum Doll & McDonald PLLC, Louisville, Kentucky.

 

19



 

John and Charles Schnatter are brothers. There are no other family relationships among the executive officers and other key personnel.

 

PART II

 

Item 5.            Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Our common stock trades on the NASDAQ National Market tier of The NASDAQ Stock Market under the symbol PZZA. As of February 21, 2006, there were approximately 811 record holders of common stock. The following table sets forth for the quarters indicated the high and low closing sales prices of our common stock, as reported by The NASDAQ Stock Market. All sales prices have been adjusted to reflect a two-for-one split of the Company’s outstanding shares of common stock. The stock split was effected in the form of a stock dividend and entitled each shareholder of record at the close of business on December 23, 2005 to receive one additional share for every outstanding share of common stock held on the record date. The stock dividend of approximately 16.5 million shares of common stock was distributed on January 13, 2006.

 

2005

 

High

 

Low

 

First Quarter

 

$

18.28

 

$

15.81

 

Second Quarter

 

20.36

 

16.99

 

Third Quarter

 

24.64

 

19.71

 

Fourth Quarter

 

29.98

 

24.74

 

 

2004

 

High

 

Low

 

First Quarter

 

$

18.49

 

$

15.90

 

Second Quarter

 

17.56

 

14.08

 

Third Quarter

 

15.63

 

14.01

 

Fourth Quarter

 

17.79

 

14.63

 

 

Since our initial public offering of common stock in 1993, we have not paid cash dividends on our common stock, and have no current plans to do so.

 

The Papa John’s Board of Directors has authorized the repurchase of up to $525.0 million of common stock under a share repurchase program that began December 9, 1999, and runs through December 31, 2006. Through December 25, 2005, as adjusted for the two-for-one common stock split, a total of 34.7 million shares with an aggregate cost of $495.9 million and an average price of $14.29 per share have been repurchased under this program. Subsequent to year-end (through February 21, 2006), we acquired an additional 121,000 shares at an aggregate cost of $3.8 million. As of February 21, 2006, approximately $25.3 million remains available for repurchase of common stock under this authorization.

 

20



 

The following table summarizes our repurchase activity, as adjusted for the two-for-one stock split, by fiscal period during 2005 (in thousands, except per share amounts):

 

Fiscal Period

 

Total
Number
of Shares
Purchased

 

Average
Price
Paid per
Share

 

Total Number
of Shares Purchased
as Part of Publicly
Announced Plans
or Programs

 

Maximum Dollar
Value of Shares
that May Yet Be
Purchased Under the
Plans or Programs

 

 

 

 

 

 

 

 

 

 

 

12/27/2004 - 01/23/2005

 

263

 

$

17.19

 

31,697

 

$

99,940

 

01/24/2005 - 02/20/2005

 

218

 

$

17.26

 

31,915

 

$

96,178

 

02/21/2005 - 03/27/2005

 

325

 

$

17.37

 

32,240

 

$

90,528

 

03/28/2005 - 04/24/2005

 

*

 

32,240

 

$

90,528

 

04/25/2005 - 05/22/2005

 

*

 

32,240

 

$

90,528

 

05/23/2005 - 06/26/2005

 

*

 

32,240

 

$

90,528

 

06/27/2005 - 07/24/2005

 

*

 

32,240

 

$

90,528

 

07/25/2005 - 08/21/2005

 

*

 

32,240

 

$

90,528

 

08/22/2005 - 09/25/2005

 

961

 

$

23.81

 

33,201

 

$

67,636

 

09/26/2005 - 10/23/2005

 

706

 

$

25.23

 

33,907

 

$

49,839

 

10/24/2005 - 11/20/2005

 

567

 

$

25.65

 

34,474

 

$

35,299

 

11/21/2005 - 12/25/2005

 

226

 

$

27.29

 

34,700

 

$

29,135

 

 


*There were no share repurchases during these periods.

 

Our share repurchase authorization increased from $450.0 million to $500.0 million on August 11, 2005, and increased to $525.0 million on December 6, 2005. For presentation purposes, the maximum dollar value of shares that may be purchased was adjusted retroactively to December 27, 2004.

 

The Company retired all common stock shares held in treasury as of December 23, 2005 in connection with the stock dividend.

 

21



 

Item 6. Selected Financial Data

 

The selected financial data presented for each of the years in the five-year period ended December 25, 2005 was derived from our audited consolidated financial statements. The selected financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and Notes thereto included in Item 7 and Item 8, respectively, of this Form 10-K.

 

 

 

Year Ended (1)

 

(In thousands, except per share data)

 

Dec. 25,
2005

 

Dec. 26,
2004

 

Dec. 28,
2003

 

Dec. 29,
2002

 

Dec. 30,
2001

 

Income Statement Data

 

 

 

 

 

 

 

 

 

 

 

Domestic revenues:

 

 

 

 

 

 

 

 

 

 

 

Company-owned restaurant sales

 

$

434,525

 

$

412,676

 

$

416,049

 

$

429,813

 

$

445,849

 

Variable interest entities restaurant sales (2)

 

11,713

 

14,387

 

 

 

 

Franchise royalties (3)

 

52,289

 

50,292

 

49,851

 

51,386

 

50,768

 

Franchise and development fees

 

3,026

 

2,475

 

1,475

 

1,734

 

2,927

 

Commissary sales

 

398,372

 

376,642

 

369,825

 

381,217

 

390,889

 

Other sales

 

50,474

 

53,117

 

48,541

 

50,055

 

52,730

 

International revenues:

 

 

 

 

 

 

 

 

 

 

 

Royalties and franchise and development fees (4)

 

6,529

 

5,010

 

3,810

 

3,032

 

2,810

 

Restaurant and commissary sales (5)

 

11,860

 

10,747

 

10,572

 

9,521

 

6,346

 

Total revenues

 

968,788

 

925,346

 

900,123

 

926,758

 

952,319

 

Operating income (6)

 

72,700

 

36,682

 

55,353

 

74,914

 

75,717

 

Investment income

 

1,248

 

689

 

672

 

1,126

 

1,958

 

Interest expense

 

(4,316

)

(5,313

)

(6,851

)

(7,677

)

(8,857

)

Income from continuing operations before income taxes  and cumulative effect of a change in accounting principle

 

69,632

 

32,058

 

49,174

 

68,363

 

68,818

 

Income tax expense

 

25,364

 

12,021

 

18,440

 

25,637

 

25,975

 

Income from continuing operations before cumulative  effect of a change in accounting principle

 

44,268

 

20,037

 

30,734

 

42,726

 

42,843

 

Income from discontinued operations, net of tax (7)

 

1,788

 

3,184

 

3,242

 

4,071

 

4,402

 

Cumulative effect of accounting change, net of tax (8)

 

 

 

(413

)

 

 

Net income

 

$

46,056

 

$

23,221

 

$

33,563

 

$

46,797

 

$

47,245

 

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations before cumulative  effect of a change in accounting principle (9)

 

$

1.32

 

$

0.58

 

$

0.86

 

$

1.07

 

$

0.95

 

Income from discontinued operations, net of tax (7) (9)

 

0.05

 

0.09

 

0.09

 

0.10

 

0.10

 

Cumulative effect of accounting change, net of tax (8) (9)

 

 

 

(0.01

)

 

 

Basic earnings per common share (9)

 

$

1.37

 

$

0.67

 

$

0.94

 

$

1.17

 

$

1.05

 

Earnings per common share - assuming dilution:

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations before cumulative effect of a change in accounting principle (9)

 

$

1.29

 

$

0.58

 

$

0.85

 

$

1.05

 

$

0.94

 

Income from discontinued operations, net of tax (7) (9)

 

0.05

 

0.09

 

0.09

 

0.10

 

0.10

 

Cumulative effect of accounting change, net of tax (8) (9)

 

 

 

(0.01

)

 

 

Earnings per common share - assuming dilution (9)

 

$

1.34

 

$

0.67

 

$

0.93

 

$

1.15

 

$

1.04

 

Basic weighted average shares outstanding (9)

 

33,594

 

34,414

 

35,876

 

40,136

 

45,200

 

Diluted weighted average shares outstanding (9)

 

34,316

 

34,810

 

36,074

 

40,600

 

45,506

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance Sheet Data

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

350,562

 

$

374,487

 

$

347,214

 

$

366,832

 

$

387,439

 

Total debt

 

55,116

 

94,230

 

61,250

 

140,085

 

105,310

 

Total stockholders’ equity

 

161,279

 

139,223

 

159,272

 

121,947

 

195,632

 

 

22



 


(1)           We operate on a 52-53 week fiscal year ending on the last Sunday of December of each year. All fiscal years presented consisted of 52 weeks.

(2)           We began consolidating variable interest entities (VIEs) restaurants in 2004. See “Note 5” of “Notes to Consolidated Financial Statements.”

(3)           Domestic Franchise royalties were derived from franchise restaurant sales of $1.38 billion in 2005, $1.30 billion in 2004, $1.29 billion in 2003, $1.32 billion in 2002 and $1.30 billion in 2001.

(4)           International Royalties were derived from franchise restaurant sales of $104.2 million in 2005, $67.6 million in 2004, $65.0 million in 2003, $52.2 million in 2002 and $42.1 million in 2001.

(5)           Restaurant sales for Company-owned United Kingdom restaurants were $642,000 in 2005, $629,000 in 2004, $2.4 million in 2003, $4.0 million in 2002 and $4.5 million in 2001.

(6)           The operating results include the consolidation of BIBP beginning in 2004, which increased operating income approximately $5.8 million in 2005 and reduced operating income approximately $22.9 million in 2004. Operating income includes restaurant closure, impairment and disposition losses (gains) of ($2.0 million) in 2005, ($203,000) in 2004, $5.5 million in 2003, $1.1 million in 2002 and ($1.2 million) in 2001. See “Notes 5 and 8” of “Notes to Consolidated Financial Statements.”

(7)           The Perfect Pizza operations are classified as “discontinued operations” and the related assets as “held for sale”. See “Note 4” of “Notes to Consolidated Financial Statements.”

(8)           Reflects the cumulative effect on income and earnings per share of a change in accounting principle, net of tax, as required by Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.

(9)           Adjusted to reflect a two-for-one common stock split effected in the form of a 100% stock dividend to stockholders of record on December 23, 2005.

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Introduction

 

Papa John’s International, Inc. (referred to as the “Company,” “Papa John’s” or in the first person notations of “we,” “us” and “our”) began operations in 1985 with the opening of the first Papa John’s restaurant in Jeffersonville, Indiana. At December 25, 2005, there were 2,926 Papa John’s restaurants in operation, consisting of 504 Company-owned and 2,422 franchised, and 112 franchised Perfect Pizza restaurants in the United Kingdom. Our revenues are principally derived from retail sales of pizza and other food and beverage products to the general public by Company-owned restaurants, franchise royalties, sales of franchise and development rights, sales to franchisees of food and paper products, printing and promotional items, risk management services, and information systems and related services used in their operations.

 

New unit openings in 2005 were 204 as compared to 175 in 2004 and 105 in 2003 and unit closings in 2005 were 113 as compared to 153 in 2004 and 116 in 2003. The improvement in net unit growth during 2005 reflects improved operating margins for domestic unit restaurants and our continued international expansion. We expect net unit growth of approximately 140 to 170 units during 2006.

 

We have continued to produce strong average sales from our domestic Company-owned restaurants even with a very competitive market environment. Our expansion strategy is to cluster restaurants in targeted markets, thereby increasing consumer awareness and enabling us to take advantage of operational, distribution and advertising efficiencies. Average annual Company-owned sales for our most recent quarter’s comparable base restaurants were $818,000 for 2005, compared to $737,000 for 2004 and $733,000 for 2003. Average sales volumes in new markets are generally lower than in those markets in which we have established a significant market position. The comparable annual sales for Company-owned restaurants increased 7.4% in 2005, increased 0.5% in 2004 and decreased 3.0% in 2003.

 

23



 

We continually strive to obtain high-quality sites with good access and visibility, and to enhance the appearance and quality of our restaurants. We believe that these factors improve our image and brand awareness. The average cash investment for the restaurants in our most recent comparable sales base is $270,000. The average cash investment for the seven domestic Company-owned restaurants opened during 2005, exclusive of land, increased to approximately $241,000 from $232,000 for the six units opened in 2004. We expect the average cash investment for the anticipated 20 Company-owned restaurants opening in 2006 to be approximately $250,000.

 

Approximately 46% of our revenues for 2005, compared to 47% of our revenues for both 2004 and 2003, were derived from the sale to franchisees of food and paper products, printing and promotional items, risk management services and information systems equipment and software and related services by us, our commissary subsidiary, PJ Food Service, Inc. (“PJFS”), our support services subsidiary, Papa John’s Support Services, Inc., our insurance subsidiaries, RSC Insurance Services, Ltd. and Risk Services Corp. and our United Kingdom subsidiary, Papa John’s UK (“PJUK”). We believe that, in addition to supporting both Company and franchised growth, these subsidiaries contribute to product quality and consistency and restaurant profitability throughout the Papa John’s system.

 

Our fiscal year ends on the last Sunday in December of each year. All fiscal years presented consist of 52 weeks.

 

Results of Operations and Critical Accounting Policies and Estimates

 

The results of operations are based on the preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States. The preparation of consolidated financial statements requires management to select accounting policies for critical accounting areas as well as estimates and assumptions that affect the amounts reported in the consolidated financial statements. The Company’s accounting policies are more fully described in Note 2 of Notes to Consolidated Financial Statements. Significant changes in assumptions and/or conditions in our critical accounting policies could materially impact the operating results. We have identified the following accounting policies and related judgments as critical to understanding the results of our operations.

 

Allowance for Doubtful Accounts and Notes Receivable

 

We establish reserves for uncollectible accounts and notes receivable based on overall receivable aging levels and a specific evaluation of accounts and notes for franchisees with known financial difficulties. These reserves and corresponding write-offs could significantly increase if the identified franchisees continue to experience deteriorating financial results.

 

Long-lived and Intangible Assets

 

The recoverability of long-lived assets is evaluated if impairment indicators exist. Indicators of impairment include historical financial performance, operating trends and our future operating plans. If impairment indicators exist, we evaluate the recoverability of long-lived assets on an operating unit basis (e.g., an individual restaurant) based on undiscounted expected future cash flows before interest for the expected remaining useful life of the operating unit. Recorded values for long-lived assets that are not expected to be recovered through undiscounted future cash flows are written down to current fair value, which is generally determined from estimated discounted future net cash flows for assets held for use or net realizable value for assets held for sale.

 

The recoverability of intangible assets (i.e., goodwill) is evaluated annually, or more frequently if impairment indicators exist, on a reporting unit basis by comparing the fair value derived from

 

24



 

discounted expected cash flows of the reporting unit to its carrying value. We recorded a goodwill impairment charge of $1.1 million associated with PJUK during the fourth quarter of 2005, reflecting our updated estimated fair value of PJUK.

 

We have developed strategic plans for PJUK to improve future operating results. These plans include selling the Perfect Pizza operations, consisting of the franchised units and related distribution operations, initiatives to increase brand awareness and increase net Papa John’s brand franchise unit openings over the next several years. If such initiatives, including the sale of the Perfect Pizza operations, are not successful, additional impairment charges may occur.

 

Insurance Reserves

 

Our insurance programs for workers’ compensation, general liability, owned and non-owned automobiles and health insurance coverage provided to our employees are self-insured up to certain individual and aggregate reinsurance levels. Losses are accrued based upon estimates of the aggregate retained liability for claims incurred using certain third-party actuarial projections and our claims loss experience. The estimated insurance claims losses could be significantly affected should the frequency or ultimate cost of claims significantly differ from historical trends used to estimate the insurance reserves recorded by the Company.

 

From October 2000 through September 2004, our franchisee insurance program, which provides insurance to our franchisees, was self-insured. Beginning in October 2004, a third-party commercial insurance company began providing fully-insured coverage to franchisees participating in the franchise insurance program. Accordingly, this new agreement eliminates our risk of loss for franchise insurance coverage written after September 2004. Our operating income will still be subject to potential adjustments for changes in estimated insurance reserves for policies written from the inception of the Captive insurance company in October 2000 to September 2004. Such adjustments, if any, will be determined in part based upon periodic actuarial valuations.

 

Deferred Income Tax Assets and Tax Reserves

 

As of December 25, 2005, we had a net deferred income tax asset balance of $9.0 million, of which approximately $7.2 million relates to BIBP’s net operating loss carryforward. We have not provided a valuation allowance for the deferred income tax assets related to BIBP’s net operating losses, since we believe it is more likely than not that BIBP’s future earnings will be sufficient to ensure the realization of the net deferred income tax assets for federal and state purposes.

 

Certain tax authorities periodically audit the Company. We provide reserves for potential exposures when we consider it probable that a taxing authority may take a sustainable position on a matter contrary to our filed position. We evaluate these issues on a quarterly basis to adjust for events, such as court rulings or audit settlements that may impact our ultimate payment for such exposures.

 

Consolidation of BIBP Commodities Inc. (“BIBP”) as a Variable Interest Entity

 

BIBP is a franchisee-owned corporation that conducts a cheese-purchasing program on behalf of domestic Company-owned and franchised restaurants. As required by the Financial Accounting Standards Board’s (“FASB”) Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (FIN 46), we began consolidating the financial results of BIBP in the fourth quarter of 2003. We recognized pre-tax income of approximately $4.5 million during 2005 and pre-tax losses of approximately $23.5 million during 2004 from the consolidation of BIBP. We expect the consolidation of BIBP to continue to have a significant impact on Papa John’s operating income in future periods due to the volatility of cheese prices. Papa John’s will recognize the operating losses generated by BIBP if the shareholders’ equity of BIBP is in a net deficit

 

25



 

position. Further, Papa John’s will recognize subsequent operating income generated by BIBP up to the amount of BIBP losses previously recognized by Papa John’s.

 

Accounting Changes

 

Interpretation No. 46 of Accounting Research Bulletin No. 51 (FIN 46)

 

As previously discussed, FIN 46 addresses the potential consolidation of variable interest entities (VIEs). The provisions of FIN 46 significantly alter the method for evaluating whether certain VIEs, as defined, should be consolidated in a company’s financial statements. As noted above, we began consolidating BIBP at December 28, 2003. A cumulative effect adjustment was not required with the adoption of FIN 46 as BIBP had a surplus in stockholders’ equity at December 28, 2003. Papa John’s is also the primary beneficiary, as defined by FIN 46, of certain franchise entities that qualify as VIEs, even though we have no ownership interest in them. As of December 25, 2005, we are the primary beneficiary of three franchise entities (representing 14 restaurants) with annual revenues approximating $9.0 million. The consolidation of franchise entities deemed VIEs had no significant impact on our operating results during 2005 or 2004. We do not expect our future operating earnings to be significantly impacted by consolidating such entities.

 

26



 

Percentage Relationships and Restaurant Data and Unit Progression

 

The following tables set forth the percentage relationship to total revenues, unless otherwise indicated, of certain income statement data, and certain restaurant data for the years indicated.

 

 

 

Year Ended

 

 

 

Dec. 25,
2005

 

Dec. 26,
2004

 

Dec. 28,
2003

 

Income Statement Data:

 

 

 

 

 

 

 

Domestic revenues:

 

 

 

 

 

 

 

Company-owned restaurant sales

 

44.9

%

44.6

%

46.2

%

Variable interest entities restaurant sales

 

1.2

 

1.6

 

 

Franchise royalties

 

5.4

 

5.4

 

5.5

 

Franchise and development fees

 

0.3

 

0.3

 

0.2

 

Commissary sales

 

41.1

 

40.7

 

41.1

 

Other sales

 

5.2

 

5.7

 

5.4

 

International revenues:

 

 

 

 

 

 

 

Royalties and franchise and development fees

 

0.7

 

0.5

 

0.4

 

Restaurant and commissary sales

 

1.2

 

1.2

 

1.2

 

Total revenues

 

100.0

 

100.0

 

100.0

 

Costs and expenses:

 

 

 

 

 

 

 

Domestic Company-owned restaurant cost of sales (1)

 

21.5

 

24.2

 

22.2

 

Domestic Company-owned restaurant operating expenses (1)

 

58.2

 

60.3

 

60.9

 

Variable interest entities restaurant expenses (2)

 

87.0

 

88.0

 

 

Domestic commissary and other expenses (3)

 

90.9

 

92.0

 

90.9

 

Loss (income) from the franchise cheese purchasing program, net of minority interest (4)

 

(0.5

)

1.8

 

 

International operating expenses (5)

 

100.0

 

98.9

 

104.8

 

General and administrative expenses

 

9.1

 

7.7

 

7.3

 

Other general expenses

 

0.7

 

0.3

 

1.2

 

Depreciation and amortization

 

3.0

 

3.4

 

3.5

 

Total costs and expenses

 

92.5

 

96.0

 

93.9

 

Operating income

 

7.5

 

4.0

 

6.1

 

Net interest expense

 

(0.3

)

(0.5

)

(0.7

)

Income from continuing operations before income taxes and cumulative  effect of a change in accounting principle

 

7.2

 

3.5

 

5.4

 

Income tax expense

 

2.6

 

1.3

 

2.0

 

Income from continuing operations before cumulative effect  of a change in accounting principle

 

4.6

 

2.2

 

3.4

 

Income from discontinued operations, net of tax

 

0.2

 

0.3

 

0.4

 

Income before cumulative effect of a change in accounting principle*

 

4.8

%

2.5

%

3.8

%

 


*The cumulative effect of a change in accounting principle, as a percentage of sales, had less than a

  10 basis point impact in 2003.

 

27



 

 

 

Year Ended

 

 

 

Dec. 25,
2005

 

Dec. 26,
2004

 

Dec. 28,
2003

 

 

 

 

 

 

 

 

 

Restaurant Data:

 

 

 

 

 

 

 

Percentage increase (decrease) in comparable domestic Company-owned restaurant sales (6)

 

7.4

%

0.5

%

(3.0

)%

Number of Company-owned restaurants included in the respective most recent quarter’s comparable restaurant base

 

472

 

551

 

548

 

Average sales for Company-owned restaurants included in the most recent comparable restaurant base

 

$

818,000

 

$

737,000

 

$

733,000

 

 

 

 

 

 

 

 

 

Papa John’s Restaurant Progression:

 

 

 

 

 

 

 

U.S. Company-owned:

 

 

 

 

 

 

 

Beginning of period

 

568

 

568

 

585

 

Opened

 

7

 

6

 

10

 

Closed

 

(1

)

(5

)

(27

)

Acquired from franchisees

 

20

 

 

 

Sold to franchisees

 

(92

)

(1

)

 

End of period

 

502

 

568

 

568

 

International Company-owned:

 

 

 

 

 

 

 

Beginning of period

 

1

 

2

 

9

 

Opened

 

1

 

 

 

Closed

 

 

 

(1

)

Acquired from franchisees

 

 

 

1

 

Sold to franchisees

 

 

(1

)

(7

)

End of period

 

2

 

1

 

2

 

U.S. franchised:

 

 

 

 

 

 

 

Beginning of period

 

1,997

 

2,006

 

2,000

 

Opened

 

101

 

97

 

56

 

Closed

 

(73

)

(107

)

(50

)

Acquired from Company

 

92

 

1

 

 

Sold to Company

 

(20

)

 

 

End of period

 

2,097

 

1,997

 

2,006

 

International franchised:

 

 

 

 

 

 

 

Beginning of period

 

263

 

214

 

198

 

Opened

 

89

 

70

 

37

 

Closed

 

(28

)

(23

)

(27

)

Converted (7)

 

1

 

1

 

 

Acquired from Company

 

 

1

 

7

 

Sold to Company

 

 

 

(1

)

End of period

 

325

 

263

 

214

 

Total restaurants - end of period

 

2,926

 

2,829

 

2,790

 

 

28



 

 

 

Year Ended

 

 

 

Dec. 25,
2005

 

Dec. 26,
2004

 

Dec. 28,
2003

 

 

 

 

 

 

 

 

 

Perfect Pizza Restaurant Progression (8):

 

 

 

 

 

 

 

Franchised

 

 

 

 

 

 

 

Beginning of period

 

118

 

135

 

144

 

Opened

 

6

 

2

 

2

 

Closed

 

(11

)

(18

)

(11

)

Converted (7)

 

(1

)

(1

)

 

Total restaurants - end of period (8)

 

112

 

118

 

135

 

 


(1)                       As a percentage of Domestic Company-owned Restaurant sales.

(2)                       As a percentage of Domestic Variable interest entities restaurant sales.

(3)                       As a percentage of Domestic Commissary sales and Other sales on a combined basis.

(4)                       The loss (income) is a result of the consolidation of BIBP, a VIE. The sales reported by BIBP are eliminated in consolidation.

(5)                       As a percentage of International Restaurant and commissary sales.

(6)       Includes only Company-owned restaurants open throughout the periods being compared.

(7)                       Represents Perfect Pizza restaurants converted to Papa John’s restaurants.

(8)                        The Perfect Pizza operations are classified as “discontinued operations” and the related assets as “held for sale.” See “Note 4” of “Notes to Consolidated Financial Statements.”

 

2005 Compared to 2004

 

Variable Interest Entities

 

As required by FIN 46, our operating results include BIBP’s operating results. The consolidation of BIBP had a significant impact on our operating results in both 2005 and 2004 and is expected to have a significant ongoing impact on our future operating results and income statement presentation as described below.

 

Consolidation accounting requires the net impact from the consolidation of BIBP to be reflected primarily in three separate components of our statement of income. The first component is the portion of BIBP operating income or loss attributable to the amount of cheese purchased by Company-owned restaurants during the period. This portion of BIBP operating income (loss) is reflected as a reduction (increase) in the “Domestic Company-owned restaurant expenses - cost of sales” line item. This approach effectively reports cost of sales for Company-owned restaurants as if the purchasing arrangement with BIBP did not exist and such restaurants were purchasing cheese at the spot market prices (i.e., the impact of BIBP is eliminated in consolidation).

 

The second component of the net impact from the consolidation of BIBP is reflected in the caption “Loss (income) from the franchise cheese-purchasing program, net of minority interest.” This line item represents BIBP’s income or loss from purchasing cheese at the spot market price and selling to franchised restaurants at a fixed quarterly price, net of any income or loss attributable to the minority interest BIBP shareholders. The amount of income or loss attributable to the BIBP shareholders depends on its cumulative shareholders’ equity balance and the change in such balance during the reporting period. The third component is reflected as investment income or interest expense depending upon whether BIBP is in a net investment or net borrowing position during the reporting period.

 

29



 

In addition, Papa John’s has extended loans to certain franchisees. Under the FIN 46 rules, Papa John’s is deemed to be the primary beneficiary of certain franchisees even though we have no ownership interest in them. Beginning in the second quarter of 2004, FIN 46 required Papa John’s to recognize the operating income (losses) generated by four franchise entities operating a total of 33 restaurants with annual sales approximating $21.0 million. Effective at the beginning of the second quarter of 2005, one of these four franchise entities with 19 restaurants and annual revenues approximating $12.0 million, sold its restaurants to a third party. The loan from Papa John’s was partially repaid and the remainder was written off in connection with this sale. Accordingly, beginning in the second quarter of 2005, we were no longer required to consolidate the operating results of these 19 restaurants. The portion of the loan written off in connection with the second-quarter sale was fully reserved as of the end of the first quarter. The sale of these restaurants and related loan write-off did not have any significant impact on Papa John’s 2005 consolidated statement of income. The consolidation of the applicable franchise entities had no significant net impact on Papa John’s operating results.

 

The following table summarizes the impact of VIEs, prior to required consolidating eliminations, on our consolidated statements of income as of December 25, 2005 and December 26, 2004:

 

 

 

Year Ended December 25, 2005

 

Year Ended December 26, 2004

 

(In thousands)

 

BIBP

 

Franchisees

 

Total

 

BIBP

 

Franchisees

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable interest entities restaurant sales

 

$

 

$

11,713

 

$

11,713

 

$

 

$

14,387

 

$

14,387

 

BIBP sales

 

151,903

 

 

151,903

 

138,202

 

 

138,202

 

Total revenues

 

151,903

 

11,713

 

163,616

 

138,202

 

14,387

 

152,589

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

145,962

 

10,997

 

156,959

 

160,944

 

13,256

 

174,200

 

General and administrative expenses

 

137

 

712

 

849

 

150

 

1,120

 

1,270

 

Other general expenses (income)

 

 

(75

)

(75

)

 

(542

)

(542

)

Depreciation and amortization

 

 

78

 

78

 

 

549

 

549

 

Total costs and expenses

 

146,099

 

11,712

 

157,811

 

161,094

 

14,383

 

175,477

 

Operating income (loss)

 

5,804

 

1

 

5,805

 

(22,892

)

4

 

(22,888

)

Interest expense

 

(1,332

)

(1

)

(1,333

)

(567

)

(4

)

(571

)

Income (loss) before income taxes

 

$

4,472

 

$

 

$

4,472

 

$

(23,459

)

$

 

$

(23,459

)

 

Discontinued Operations

 

In the United Kingdom, the Company manages both the Papa John’s brand (89 units at the end of 2005) and the Perfect Pizza brand (112 units at the end of 2005). The United Kingdom subsidiary has reported deteriorating operating results for the past three years primarily due to lower sales by Perfect Pizza restaurants and a decrease in net franchise units due to restaurant closings. Recently, the Company developed a plan to sell its Perfect Pizza operations, consisting of the franchised units and related distribution operations. The Company believes the sale of the Perfect Pizza operations will be completed within the next 12 months. We have classified the Perfect Pizza operations, including directly associated G&A expenses, as “discontinued operations” and the associated assets as “held for sale”.

 

30



 

The following summarizes the results of the discontinued operations for the last three years (in thousands):

 

 

 

2005

 

2004

 

2003

 

 

 

 

 

 

 

 

 

Net sales

 

$

13,632

 

$

17,080

 

$

17,255

 

Operating expenses

 

8,837

 

10,392

 

10,659

 

G&A expenses

 

1,658

 

1,411

 

1,245

 

Other expenses

 

299

 

182

 

164

 

Income before income taxes

 

2,838

 

5,095

 

5,187

 

Income tax expense

 

1,050

 

1,911

 

1,945

 

Net income from discontinued operations

 

$

1,788

 

$

3,184

 

$

3,242

 

 

Summary of Operating Results from Continuing Operations

 

Total revenues increased 4.7% to $968.8 million in 2005 compared to $925.3 million in 2004 primarily consisting of the following:

 

                  A $21.8 million increase in Company-owned restaurant revenues as compared to the prior year primarily due to an increase in comparable sales of 7.4%, partially offset by a decline in units due to the sale of 84 restaurants at the beginning of the fourth quarter in 2005. “Comparable sales” represents sales generated by restaurants open for the entire twelve-month period reported.

 

                  A $21.7 million increase in domestic commissary sales reflecting the impact of higher commodity prices, principally cheese.

 

                  These increases were partially offset by a decline in the Company’s franchise insurance premium revenue and a $2.7 million reduction in variable interest entities restaurant sales due to the sale of one of the previously-consolidated franchise entities to a third party as of the beginning of the second quarter of 2005.

 

Our income from continuing operations before income taxes and cumulative effect of a change in accounting principle totaled $69.6 million in 2005, as compared to $32.1 million in 2004. Excluding the impact of the consolidation of BIBP (pre-tax gain of $4.5 million or $0.08 per share in 2005 and a pre-tax loss of $23.5 million or $0.42 per share in 2004), 2005 income from continuing operations before income taxes and cumulative effect of a change in accounting principle was $65.2 million, compared to $55.5 million in 2004. This increase of $9.7 million (excluding the consolidation of BIBP) was principally due to the following (analyzed on an operating segment basis – see “Note 22” of “Notes to Consolidated Financial Statements”):

 

                  Domestic Company-owned Restaurant Segment. Domestic Company-owned restaurants’ operating income increased $20.2 million over the prior year primarily due to the fixed cost leverage associated with an increase of 7.4% in comparable sales during 2005 and improved margin from an increase in restaurant pricing, partially offset by increased commodity costs (principally cheese). We implemented a delivery charge for the majority of Company-owned restaurants in June 2005, which allowed additional pricing flexibility that led to increased comparable transactions during the last half of 2005. Additionally, the Company-owned operating results include a gain of $2.2 million from the sale of 92 restaurants from three transactions.

 

                  Domestic Franchising Segment. Domestic franchising operating income increased $3.7 million primarily as a result of higher royalties due to an increase of 4.3% in comparable sales for domestic franchisees and lower administrative costs associated with franchise operations.

 

31



 

                  Domestic Commissary Segment. Domestic commissaries’ operating income increased $5.6 million primarily due to an improved operating margin and lower administrative costs, partially offset by increased distribution costs of $2.0 million as a result of higher fuel costs. The 2005 operating income also includes a pre-tax charge of $925,000 associated with the closing of the Jackson, Mississippi facility at the end of March 2005. The $925,000 pre-tax charge includes severance payments and a write-off of the remaining net book value of the property, net of salvage value.

 

                  International Segment. The international segment, which excludes the Perfect Pizza operations expected to be sold within the next 12 months, reported an operating loss of $5.0 million in 2005 compared to an operating loss of $4.3 million in 2004. The decrease in operating results is principally due to the previously mentioned $1.1 million impairment charge associated with the United Kingdom subsidiary.

 

                  All Others Segment. The operating income for the “All others” reporting segment increased approximately $1.7 million primarily due to increased sales from our print and promotions operations and an incremental $1.0 million charge incurred by the franchise insurance program during the second quarter of 2004 related to claims loss reserves.

 

                  Unallocated Corporate Segment. The favorable year-over-year impact on operating income of the above items was partially offset by an increase in unallocated corporate expenses of $20.1 million, primarily due to the following (in millions):

 

 

 

Increase

 

 

 

(Decrease)

 

 

 

 

 

Business unit and corporate management bonuses

 

$

7.3

 

Equity compensation and executive performance unit incentive plan

 

2.1

 

Professional fees

 

3.7

 

Employee benefits costs

 

1.6

 

Contribution to the Marketing Fund

 

1.8

 

Reduced allocation to operating units and other

 

5.5

 

Lease accounting adjustments recorded in 2004

 

(1.9

)

Total increase

 

$

20.1

 

 

The increase in business unit and corporate management bonuses is the result of meeting pre-established performance goals in 2005 as compared to minimal bonuses earned in 2004. The increased equity compensation charge is primarily related to the performance unit component of the 2005 executive incentive compensation program. The ultimate cost associated with the performance units is based on the Company’s ending stock price and total shareholder return relative to a peer group over a three-year performance period ending in December 2007, with the awards paid in cash at the end of the performance period. There were no such performance units outstanding in 2004.

 

The increased professional fees are primarily related to consulting expenses associated with certain marketing and franchisee effectiveness projects. The increase in employee benefits costs consists primarily of payroll taxes associated with an increased level of stock option exercises and an increase in the employer portion of FICA taxes paid on employee tips and increased health insurance costs. The Company made a discretionary contribution to the Papa John’s Marketing Fund to fund an additional national television advertising flight in the fourth quarter of 2005 related to the launch of Papa’s Perfect Pan Pizza. The fourth-quarter 2004 results included certain lease and leasehold accounting adjustments amounting to $1.9 million.

 

32



 

Diluted earnings per share from continuing operations before cumulative effect of a change in accounting principle were $1.29 (including an $0.08 per share gain from the consolidation of BIBP) in 2005, compared to $0.58 (including a $0.42 per share loss from the consolidation of BIBP) in 2004. In December 1999, we began a repurchase program for our common stock. Through December 25, 2005, an aggregate of $495.9 million of shares have been repurchased (representing 34.7 million shares, at an average price of $14.29 per share, as adjusted for the two-for-one common stock split effective subsequent to year-end). The share repurchase activity during 2005 increased earnings per share from continuing operations by approximately $0.04.

 

Review of Operating Results

 

Revenues . Domestic Company-owned restaurant sales increased 5.3% to $434.5 million in 2005, from $412.7 million for the comparable period in 2004. The 5.3% increase is primarily due to a comparable sales increase of 7.4% in 2005, partially offset by a decrease in equivalent company-owned units due to the sale of 84 restaurants at the beginning of the fourth quarter of 2005. “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.

 

Variable interest entities restaurant sales include restaurant sales for franchise entities to which we have extended loans that qualify as VIEs. We began consolidating the operating results of these entities in the second quarter of 2004. Beginning in the second quarter of 2005, one of the franchise entities with 19 restaurants and annual revenues approximating $12.0 million, sold its restaurants to a third party. Accordingly, beginning in the second quarter of 2005, we were no longer required to consolidate the operating results of these 19 restaurants.

 

Domestic franchise sales increased 6.2% to $1.38 billion in 2005, from $1.30 billion for the comparable period in 2004 primarily resulting from a 4.3% increase in comparable sales, and an increase in equivalent units during 2005. Domestic franchise royalties increased 4.0% to $52.3 million from $50.3 million for the comparable period in 2004 primarily due to an increase in franchise sales, partially offset by an increase in waivers granted to certain franchisees.

 

The comparable sales base and average weekly sales for 2005 and 2004 for domestic Company-owned and domestic franchised restaurants consisted of the following:

 

 

 

Year Ended
December 25, 2005

 

Year Ended
December 26, 2004

 

 

 

Company-owned

 

Franchised

 

Company-owned

 

Franchised

 

 

 

 

 

 

 

 

 

 

 

Total domestic units (end of period)

 

502

 

2,097

 

568

 

1,997

 

Equivalent units

 

550

 

2,008

 

563

 

1,984

 

Comparable sales base units

 

540

 

1,885

 

549

 

1,892

 

Comparable sales base percentage

 

98.2

%

93.9

%

97.5

%

95.4

%

Average weekly sales - comparable units

 

$

15,283

 

$

13,451

 

$

14,172

 

$

12,733

 

Average weekly sales - other units

 

$

10,805

 

$

10,080

 

$

10,880

 

$

10,378

 

Average weekly sales - all units

 

$

15,199

 

$

13,245

 

$

14,089

 

$

12,623

 

 

Domestic franchise and development fees increased to $3.0 million for 2005, including approximately $850,000 recognized upon development cancellation or franchise renewal and transfer, from $2.5 million for the same period in 2004, including approximately $590,000 recognized upon development cancellation or franchise renewal and transfer. There were 101 domestic franchise unit openings in 2005 compared to 97 in 2004.

 

33



 

Domestic commissary sales increased $21.8 million, or 5.8%, to $398.4 million for 2005, from $376.6 million for the comparable period in 2004, primarily due to the impact of an increase in commodity prices, primarily cheese, on commissary sales. Other sales decreased to $50.5 million for 2005, from $53.1 million for the comparable period in 2004, primarily as a result of a decrease in revenues associated with insurance-related services provided to franchisees.

 

International revenues consist primarily of the PJUK continuing operations, denominated in British Pounds Sterling and converted to U.S. dollars (approximately 74% of total 2005 international revenues). International revenues increased 16.7% to $18.4 million in 2005, from $15.8 million in 2004, primarily due to increased unit openings.

 

Costs and Expenses. The restaurant operating margin at domestic Company-owned units was 20.3% for 2005 compared to 15.5% in 2004, consisting of the following differences as a percentage of Company-owned restaurant sales:

 

                  Cost of sales were 2.7% lower as a percentage of sales in 2005 partially due to the impact of consolidating BIBP, which decreased cost of sales 0.3% in 2005 and increased cost of sales 1.5% in 2004. The remaining improvement in cost of sales not explained by the year-over-year impact of consolidating BIBP resulted principally from increases in restaurant pricing, partially offset by increases in commodities (primarily cheese).

 

                  Salaries and benefits were 1.4% lower as a percentage of sales in 2005, due to staffing efficiencies and the benefit of pricing increases.

 

                  Advertising and related costs as a percentage of sales were 0.6% lower in 2005, as compared to the corresponding 2004 period, reflecting leverage from increased sales.

 

                  Occupancy and other operating costs, on a combined basis, as a percentage of sales were 0.1% lower in 2005, reflecting the leverage from increased sales, partially offset by increased utilities.

 

Domestic commissary and other margin was 9.1% in 2005, compared to 8.0% in 2004. Cost of sales was 73.6% of revenues in 2005, compared to 72.1% for the same period in 2004, primarily due to higher cheese costs incurred by our commissaries (cheese has a fixed-dollar as opposed to fixed-percentage mark-up). Salaries and benefits as a percentage of sales were 6.4% in 2005, compared to 6.6% in 2004. Other operating expenses decreased to 10.9% in 2005, compared to 13.3% in 2004, primarily as a result of a decrease in claims loss reserves increases related to the franchise insurance program recorded in 2005 as compared to 2004 and the leverage from increased commissary sales, partially offset by increased distribution costs in 2005 as a result of higher diesel fuel prices.

 

We recorded income from the franchise cheese-purchasing program, net of minority interest, of $4.7 million in 2005, compared to a $16.6 million loss for the comparable period in 2004. These results represent the portion of BIBP’s operating (income) loss related to the proportion of BIBP cheese sales to franchisees. The total impact of the consolidation of BIBP on Papa John’s pre-tax income was a gain of $4.5 million in 2005, compared to a loss of $23.5 million in 2004 (see the previous table which summarizes BIBP’s operating results for 2005 and 2004).

 

General and administrative expenses were $88.5 million, or 9.1% of revenues for 2005, as compared to $71.0 million or 7.7% of revenues for 2004. The increase in 2005 is primarily attributable to the previously mentioned increases in unallocated corporate expenses, including bonuses paid to corporate and restaurant management, equity compensation expenses, employee benefits costs and professional fees.

 

34



 

Other general expenses reflected net expense of $6.9 million in 2005, as compared to $2.6 million in 2004. The 2005 amount included gains of $2.2 million on the sale of 92 Company-owned restaurants from three transactions, $141,000 of pre-opening costs, $2.1 million of disposition and valuation related losses for other assets, a $1.1 million goodwill impairment charge related to our United Kingdom subsidiary and $2.4 million in provisions for uncollectible accounts and notes receivable. The 2005 amount also includes a $1.8 million contribution made to the Marketing Fund and a $925,000 charge associated with the closing of the Jackson, Mississippi commissary facility at the end of March 2005. The 2004 amount included a net gain of $203,000 (primarily composed of a $280,000 gain on the sale of 49% of the Texas market), provisions for uncollectible accounts and notes receivable of $1.8 million, $112,000 of pre-opening costs and $1.8 million of disposition and valuation related losses for other assets, partially offset by a $550,000 gain on the sale of unused property.

 

Depreciation and amortization was $28.8 million (3.0% of revenues) for 2005, as compared to $31.2 million (3.4% of revenues) for 2004.

 

Net interest. Net interest expense was $3.1 million in 2005, compared to $4.6 million in 2004. The interest expense for 2005 and 2004 includes approximately $772,000 and $388,000, respectively, related to BIBP’s debt with a third-party bank. The decline in 2005 net interest expense reflects the decline in our average outstanding debt balance, and an increase in investment income resulting from increased interest rates.

 

Income Tax Expense. The effective income tax rate was 36.4% for 2005 compared to 37.5% for 2004. The decrease in the effective tax rate is primarily related to an increase in FICA tax credits associated with an increase in the employer portion of FICA taxes paid on employee tips, which is reported in general and administrative expenses.

 

2004 Compared to 2003

 

Summary of Operating Results

 

Total revenues increased 2.8% to $925.3 million in 2004 compared to $900.1 million in 2003 primarily consisting of:

 

                  A $14.4 million increase due to the consolidation of 33 franchised restaurants beginning in the second quarter of 2004 resulting from the implementation of FIN 46.

 

                  An increase of $6.8 million in commissary sales reflecting the sales of promotional items (principally DVDs) and the impact of higher commodity prices, primarily cheese, partially offset by lower sales volumes.

 

                  A $3.0 million increase from the first quarter sales of promotional items associated with our March 2004 NCAA national basketball promotion.

 

                  These increases were partially offset by a decline in domestic Company-owned restaurant sales of $3.4 million in 2004, as compared to 2003, primarily as a result of the closing of restaurants during the last quarter of 2003.

 

Our income from continuing operations before income taxes and cumulative effect of a change in accounting principle decreased 34.8% to $32.1 million in 2004, from $49.2 million in 2003. The decrease is principally due to the consolidation of BIBP in 2004, which resulted in a pre-tax loss of $23.5 million ($0.42 per share). The comparison of 2004 to 2003 was also impacted by the following:

 

                  The 2003 results included a $5.5 million restaurant closure, impairment and disposition charge (none of significance in 2004).

 

35



 

                  The 2003 results included a loss of $6.3 million from the franchise insurance program while the loss in 2004 was $1.1 million.

 

                  Net interest expense declined $1.6 million in 2004 due in part to the $625,000 benefit recorded pursuant to SFAS No. 150, associated with a change in a joint venture operating agreement during 2004, which eliminated a mandatory purchase requirement and related liability. The remainder of the decrease in interest expense is due to lower average debt balances and lower effective interest rates.

 

                  The 2003 results included a $1.0 million contribution to the Marketing Fund and a $500,000 sales incentive to franchisees as compared to a contribution of $400,000 to the Marketing Fund in 2004.

 

                  The favorable year over year impact of the above items was partially offset by a reduction in commissary results of approximately $5.1 million in 2004, as compared to 2003, as a result of lower sales volumes due to a reduction in the number of restaurant transactions.

 

                  The favorable impact was further offset by a reduction in full-year 2004 operating income of approximately $1.6 million, as a result of certain lease and leasehold accounting adjustments applicable to prior years.

 

Diluted earnings per share from continuing operations before cumulative effect of a change in accounting principle were $0.58 compared to $0.85 in 2003. Through December 26, 2004, an aggregate of $420.5 million shares had been repurchased (representing 31.4 million shares, at an average price of $13.38 per share). The share repurchase activity increased earnings per share from continuing operations by approximately $0.01 for full year 2004.

 

Review of Operating Results

 

Revenues. Domestic Company-owned restaurant sales decreased 0.8% to $412.7 million in 2004, from $416.0 million for the comparable period in 2003. The 0.8% decrease is primarily due to a 2.3% decrease in equivalent units for 2004, as we closed 27 underperforming restaurants during 2003, partially offset by a 0.5% increase in comparable sales.

 

Variable interest entities restaurant sales include restaurant sales for four franchise entities to which we have extended loans that qualify as VIEs. We began consolidating the operating results of these entities in the second quarter of 2004.

 

Domestic franchise royalties increased 0.9% to $50.3 million from $49.9 million for the comparable period in 2003. Domestic franchise sales increased 0.9% to $1.30 billion in 2004, from $1.29 billion for the comparable period in 2003. The increase for the 2004 period is due to average unit volumes increasing slightly due to new units opening at higher sales levels relative to closed units.

 

36



 

The comparable sales base and average weekly sales for 2004 and 2003 for domestic corporate and franchised restaurants consisted of the following:

 

 

 

Year Ended
December 26, 2004

 

Year Ended
December 28, 2003

 

 

 

Company-owned

 

Franchised

 

Company-owned

 

Franchised

 

 

 

 

 

 

 

 

 

 

 

Total domestic units (end of period)

 

568

 

1,997

 

568

 

2,006

 

Equivalent units

 

563

 

1,984

 

577

 

1,990

 

Comparable sales base units

 

549

 

1,892

 

560

 

1,908

 

Comparable sales base percentage

 

97.5

%

95.4

%

97.1

%

95.9

%

Average weekly sales - comparable units

 

$

14,172

 

$

12,733

 

$

13,959

 

$

12,552

 

Average weekly sales - other units

 

$

10,880

 

$

10,378

 

$

10,956

 

$

10,706

 

Average weekly sales - all units

 

$

14,089

 

$

12,623

 

$

13,872

 

$

12,476

 

 

Domestic franchise and development fees increased to $2.5 million for 2004, from $1.5 million for the same period in 2003. There were 97 domestic franchise unit openings in 2004 compared to 56 in 2003.

 

Domestic commissary sales increased 1.8% to $376.6 million for 2004, from $369.8 million for the comparable period in 2003, as the sales of promotional items (primarily DVDs) and the impact of higher cheese prices was substantially offset by lower volumes due to a decline in restaurant transactions. Other sales increased to $53.1 million for 2004, from $48.5 million for the comparable period in 2003, primarily as a result of an increase in revenues associated with insurance-related services provided to franchisees and the promotional item sales associated with our March 2004 NCAA basketball national promotion.

 

International revenues primarily consist of the PJUK continuing operations, denominated in British Pounds Sterling and converted to U.S. dollars (76% of total 2004 international revenues). International revenues increased 9.6% to $15.8 million in 2004, from $14.4 million in 2003, as revenues from increased franchise unit openings and the impact of a more favorable dollar/pound exchange rate were partially offset by a decrease in corporate restaurant revenues due to the operation of only one Company-owned restaurant during 2004 as compared to an average of five restaurants for the comparable period in 2003.

 

Costs and Expenses. The restaurant operating margin at domestic Company-owned units was 15.5% for 2004 compared to 16.9% in 2003, consisting of the following differences as a percent of Company-owned restaurant sales:

 

                  Cost of sales was 1.9% higher as a percentage of sales in 2004 primarily due to the consolidation of BIBP, which increased cost of sales 1.5% in 2004. The remaining 0.4% increase in cost of sales is due to higher cheese costs, partially offset by lower costs for other commodities as a result of various product cost savings initiatives and the impact of restaurant pricing increases.

 

                  Salaries and benefits were 0.9% lower as a percentage of sales in 2004 due to staffing efficiencies and leverage on restaurant pricing increases.

 

                  Advertising and related costs, occupancy costs and other operating expenses were relatively flat as a percentage of sales.

 

Domestic commissary and other margin was 8.0% for 2004 compared to 9.1% for 2003. Cost of sales was 72.1% of revenues in 2004 compared to 69.8% in 2003 primarily due to higher cheese costs incurred by our commissaries (cheese has a fixed-dollar, as opposed to fixed-percentage, mark-up) and increased sales of lower margin products, such as promotional items (principally DVDs and the items sold in the

 

37



 

first quarter related to the March 2004 NCAA national promotion). Salaries and benefits were lower as a percentage of sales, 6.6% in 2004 as compared to 6.9% in 2003 due to staffing efficiencies and the impact of higher cheese prices on sales. Other operating expenses decreased to 13.3% of sales in 2004 from 14.1% in 2003, primarily as a result of a $6.3 million increase in claims loss reserves in 2003 related to our franchise insurance program compared to a $1.1 million increase for 2004.

 

The loss from the franchise cheese-purchasing program, net of minority interest, was $16.6 million in 2004. This line item represents the portion of BIBP operating margin losses from purchasing cheese at the spot market price and selling to franchised restaurants at a fixed quarterly price, net of any loss attributable to the BIBP shareholders.

 

General and administrative expenses were $71.0 million or 7.7% of revenues for 2004 as compared to $65.9 million or 7.3% of revenues for 2003. This $5.1 million increase was primarily attributable to: the previously mentioned rent expense adjustment associated with leases amounting to $1.5 million (the remaining $400,000 of the adjustment associated with our review of leases was recorded in depreciation expense), a $1.8 million increase in bonuses to restaurant management who met pre-established goals for their operating units, a $1.6 million increase in compensation expense related to stock options awarded in late 2003 that vest over a 12-month period throughout 2004, a $1.1 million increase in administrative costs associated with our expanded domestic franchise sales efforts, $750,000 of severance and other costs associated with staffing reductions during the fourth quarter of 2004 and $1.3 million of administrative expenses associated with variable interest entities now required to be consolidated. These increases were partially offset by lower insurance and benefit costs, and savings related to various administrative efficiencies implemented throughout 2004.

 

Other general expenses reflected net expense of $2.6 million in 2004, as compared to $10.5 million in 2003. The 2004 amount included a net gain of $203,000 (primarily composed of a $280,000 gain on the sale of 49% of the Texas market, which occurred in the third quarter of 2004), provisions for uncollectible accounts and notes receivable of $1.8 million, $112,000 of pre-opening costs and $1.8 million of disposition and valuation related losses for other assets, partially offset by a $550,000 gain on the sale of unused property. The 2003 amount included a charge of $5.5 million, representing $3.2 million for 27 domestic closed restaurants and $2.5 million for 25 impaired domestic restaurants, partially offset by a $275,000 gain on the sale of seven U.K. restaurants, provisions for uncollectible accounts and notes receivable of $3.7 million, $192,000 of pre-opening costs, $346,000 of restaurant relocation costs, $1.1 million related to disposition or valuation losses for other assets, a $1.0 million contribution to the Papa John’s Marketing Fund to assist the system with costs incurred for national advertising and a $500,000 sales incentive program offered to our franchisees. The 2003 expenses were partially offset by $2.0 million of income derived from the settlement of a litigation matter.

 

Depreciation and amortization was $31.2 million (3.4% of revenues) for 2004, as compared to $31.1 million (3.5% of revenues) for 2003.

 

Net interest. Net interest expense was $4.6 million for 2004 as compared to $6.2 million in 2003, due in part to the $625,000 benefit recorded pursuant to Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS No. 150), associated with a change in a joint venture operating agreement during 2004, which eliminated a mandatory purchase requirement and related liability. Lower average debt outstanding during 2004 as compared to 2003 and a lower average effective interest rate for the 2004 outstanding debt also reduced net interest expense.

 

Income Tax Expense. The effective income tax rate was 37.5% for both 2004 and 2003.

 

38



 

Liquidity and Capital Resources

 

Our debt is comprised of the following (in thousands):

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Revolving line of credit

 

$

49,000

 

$

78,500

 

Debt associated with VIEs *

 

6,100

 

15,709

 

Other

 

16

 

21

 

Total debt

 

55,116

 

94,230

 

Less: current portion of debt

 

(6,100

)

(15,709

)

Long-term debt

 

$

49,016

 

$

78,521

 

 


*The VIEs’ third-party creditors do not have any recourse to Papa John’s.

 

In January 2006, we executed a five-year unsecured Revolving Credit Facility (“New Credit Facility”) totaling $175.0 million that replaced a $175.0 million Revolving Credit Facility (“Old Credit Facility”). Under the New Credit Facility, outstanding balances accrue interest at 50.0 to 100.0 basis points over the London Interbank Offered Rate (LIBOR) or other bank developed rates at our option. The commitment fee on the unused balance ranges from 12.5 to 20.0 basis points. The increment over LIBOR and the commitment fee are determined quarterly based upon the ratio of total indebtedness to earnings before interest, taxes, depreciation and amortization (EBITDA), as defined. Under the Old Credit Facility, outstanding balances accrued interest at 62.5 to 100.0 basis points over LIBOR. The commitment fee on the unused balance ranged from 15.0 to 20.0 basis points. The increment over LIBOR and the commitment fee were determined quarterly based upon the ratio of total indebtedness to EBITDA, as defined.

 

Cash flow from operating activitites from continuing operations increased to $82.1 million in 2005, compared to $38.6 million in 2004. The consolidation of BIBP increased cash flow from operations by approximately $4.5 million in 2005 and reduced cash flow from operations by approximately $23.5 million in 2004 (as reflected in the net income and deferred income taxes captions in the accompanying Consolidated Statements of Cash Flows). The primary reasons for the $15.5 million increase in cash flow from continuing operations in 2005 (prior to BIBP consolidation) were the above-noted increases in operating income from continuing operations, net of income taxes, favorable working capital changes, including income taxes, accounts receivable and prepaid expenses, and the tax benefit related to the exercise of non-qualified stock options.

 

Cash flow from operating activities from continuing operations decreased to $38.6 million in 2004 compared to $81.6 million in 2003. Approximately $23.5 million of the decrease is attributable to the consolidation of BIBP and the remaining decrease is primarily due to unfavorable working capital changes, including increased levels of prepaid insurance due to the timing of payments and general premium increases, increased accounts receivable due to an extension of the timing of collections of certain items (such as systems hardware and DVD’s) from franchisees, and increased inventory levels due to a change in payment terms with a significant supplier and generally higher commodity costs (primarily cheese).

 

In the fourth quarter of 2005, we completed the sale of 84 Company-owned restaurants, with annual revenues approximating $53.0 million, in Colorado and Minnesota to a new franchise group, PJCOMN Acquisition Corporation, an affiliate of Washington, DC-based private equity firm Milestone Capital Management, LLC, pursuant to an agreement announced in August 2005. The total consideration was $12.0 million, including $1.0 million for prepaid royalties, and was received in cash at closing. The sale

 

39



 

of the restaurants, which resulted in a one-time gain of $1.1 million, did not have a significant impact on our fourth quarter 2005 recurring operating results.

 

In addition, at the end of the fourth quarter of 2005, we completed the sale of five Company-owned restaurants, with annual revenues approximating $4.0 million, in Florida. Total proceeds from the transaction were $1.3 million, which will be received in cash in fiscal 2006, as assignments from landlords are received. We recorded a gain of approximately $1.0 million in the fourth quarter from the sale of the five restaurants.

 

In the fourth quarter of 2005, Star Papa, our 51% owned joint venture operating Papa John’s restaurants in Texas, completed the acquisition of six independently-owned franchised Papa John’s restaurants located in the Austin, Texas area. We also completed two agreements to purchase 12 Papa John’s franchise restaurants located in the Philadelphia, Pennsylvania area during the fourth quarter. The total consideration for these 18 restaurants was $4.5 million in cash and the forgiveness of accounts receivable approximating $500,000. During the first quarter of 2006, we purchased an additional three restaurants in Philadelphia for $568,000. We plan to consolidate additional franchise units in the Philadelphia market as the opportunity arises and expect to build approximately 20 Company-owned units over the next four to five years in order to more quickly achieve greater market penetration and awareness. This “buy and build” approach may be used in additional under-penetrated domestic markets over time to enhance overall net unit growth and market development.

 

We require capital primarily for the development, acquisition, renovation and maintenance of restaurants, the development, renovation and maintenance of commissary and print and promotions facilities and equipment and the enhancement of corporate systems and facilities. Additionally, we began a common stock repurchase program in December 1999. During 2005, common stock repurchases of $75.3 million, net repayments of $29.5 million on our line of credit and $8.0 million in net payments on VIE associated debt and capital expenditures of $17.5 million were funded primarily by cash flow from operations, proceeds from stock option exercises, proceeds from the previously mentioned restaurant divestitures and available cash and cash equivalents.

 

Total 2006 capital expenditures are expected to be approximately $40.0 million to $50.0 million, compared to $17.5 million in 2005. The planned increase will support growth initiatives including the domestic Company-owned new unit growth, an expansion of printing capacity for the Support Services business unit, accelerated development of Papa John’s branded units in the United Kingdom and technical support assets for numerous areas of the business, including the online ordering function. In addition to the above-mentioned planned capital expenditures, we may consider international investments to accelerate growth of Papa John’s branded units in certain markets.

 

Our Board of Directors has authorized up to an aggregate of $525.0 million for the share repurchase program through December 31, 2006. At December 25, 2005, as adjusted for a two-for-one stock split with a record date of December 23, 2005, a total of 34.7 million shares have been repurchased for $495.9 million at an average price of $14.29 per share since the repurchase program started in 1999 (approximately 3.3 million shares in 2005, 4.3 million shares in 2004, 412,000 shares in 2003 and 26.7 million shares prior to 2003). Subsequent to year-end (through February 21, 2006), we acquired an additional 121,000 shares at an aggregate cost of $3.8 million. As of February 21, 2006, approximately $25.3 million remains available for repurchase of common stock under this authorization.

 

We expect to fund the planned capital expenditures and any additional share repurchases of our common stock for the next twelve months from operating cash flow and the $101.0 million remaining availability under our line of credit, reduced for certain outstanding letters of credit. Our debt, which is primarily due to the share repurchase program, was $55.1 million, including $6.1 million associated with BIBP, at

 

40



 

December 25, 2005, compared to $94.2 million, including $15.7 million associated with BIBP and other consolidated VIEs, at December 26, 2004.

 

Contractual obligations and payments as of December 25, 2005 due by year are as follows (in thousands):

 

 

 

Payments Due by Period

 

 

 

Less than
1 Year

 

1-3
Years

 

3-5
Years

 

After
5 Years

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractual Obligations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term debt

 

$

 

$

16

 

$

 

$

 

$

16

 

Revolving line of credit (1)

 

 

 

49,000

 

 

49,000

 

Total debt

 

 

16

 

49,000

 

 

49,016

 

Operating leases

 

21,945

 

33,672

 

22,281

 

27,286

 

105,184

 

Total contractual obligations

 

$

21,945

 

$

33,688

 

$

71,281

 

$

27,286

 

$

154,200

 

 


(1)                 Excludes a fair value adjustment of $583,000 included in other long-term liabilities in the consolidated balance sheet related to our interest rate swaps that hedge against the effect of rising interest rates on forecasted future borrowings.

 

As a result of assigning our interest in obligations under real estate leases as a condition to the sale of certain Company-owned restaurants, we remain contingently liable for payment under the lease agreements. These leases have varying terms, the latest of which expires in 2016. As of December 25, 2005 and December 26, 2004, the potential amount of undiscounted payments we could be required to make in the event of non-payment by the primary lessee were $1.5 million and $1.9 million, respectively. Our franchisees are the primary lessees under the vast majority of these leases. We generally have cross-default provisions with these franchisees that would put them in default of their franchise agreement in the event of non-payment under the lease. We believe these cross-default provisions significantly reduce the risk that we will be required to make payments under these leases. Accordingly, the liability recorded for our exposure under such leases at December 25, 2005 and December 26, 2004 was not significant.

 

We have certain other commercial commitments where payment is contingent upon the occurrence of certain events. Such commitments include the following by year (in thousands):

 

 

 

Amount of Commitment Expiration Per Period

 

 

 

Less than
1 Year