10-K: Annual report pursuant to Section 13 and 15(d)
Published on March 23, 2000
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
/X/ Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 26, 1999
OR
/ / Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
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 Number)
2002 PAPA JOHN'S BOULEVARD
LOUISVILLE, KENTUCKY 40299-2334
(Address of principal executive offices)
(502) 261-7272
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
(Name of each exchange
(Title of Each Class) 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 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 X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K 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. / /
As of March 13, 2000 there were 25,766,938 shares of the
Registrant's Common Stock outstanding. The aggregate market value of the
shares of Registrant's Common Stock held by non-affiliates of the Registrant
at such date was $478,421,048 based on the last sale price of the Common
Stock on March 13, 2000 as reported by The NASDAQ Stock Market. For purposes
of the foregoing calculation only, all directors and executive officers of
the Registrant have been deemed affiliates.
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 May 24, 2000.
TABLE OF CONTENTS
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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 carry-out restaurants under the trademark "Papa
John's" domestically in 47 states, the District of Columbia and five
international markets, 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 ("Perfect Pizza") in 1999 (see Business - Expansion). At
December 26, 1999, there were 2,280 Papa John's restaurants in operation,
consisting of 573 Company-owned and 1,707 franchised restaurants.
Additionally, there were 206 Perfect Pizza restaurants in operation,
consisting of 12 Company-owned and 194 franchised-owned restaurants.
STRATEGY
Our goal is to build the strongest brand loyalty of all pizzerias
internationally. To accomplish this goal, we have developed a strategy
designed to achieve high levels of customer satisfaction and repeat business,
as well as to establish recognition and acceptance of the Papa John's brand.
The key elements of our strategy include:
FOCUSED, HIGH QUALITY MENU. Papa John's restaurants offer a focused menu of
high quality pizza, breadsticks and cheesesticks. Papa John's traditional
crust pizza is prepared using fresh dough (never frozen), 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 and vegetable toppings. Papa John's thin crust
pizza is made with a prepared crust and the same high quality toppings. We
believe our focused menu creates a strong identity in the marketplace and
simplifies operations.
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 commissary system takes advantage of volume purchasing
of food and supplies, and provides consistency and efficiencies of scale in
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. Because Papa John's restaurants have a focused menu and
specialize in delivery and carry-out services, each team member can
concentrate on a well-defined function in preparing and delivering the
customer's order.
COMMITMENT TO TEAM MEMBER TRAINING AND DEVELOPMENT. We are committed to the
development and motivation of our team members through on going training
programs, incentive compensation and opportunities for advancement. Team
member training programs are conducted for corporate team members, as well as
franchise team members located at training centers across the United States.
We offer performance-based financial incentives and stock option awards to
restaurant team members at various levels. Our growth also provides
significant opportunities for advancement. We believe these factors create an
entrepreneurial spirit throughout Papa John's, resulting in a positive work
environment and motivated, customer-oriented team members.
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TARGETED, COST-EFFECTIVE MARKETING. Our restaurant-level marketing programs
target the delivery area of each restaurant, making extensive use of
distinctive 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. In markets in which we or
our franchisees have a significant presence, local marketing efforts are
supplemented with radio and television advertising. Three national television
campaigns aired in 1999.
FRANCHISE SYSTEM. We are committed to developing a strong franchise system by
attracting experienced operators, allowing them to expand in a controlled
manner and monitoring their compliance with our high standards. We seek to
attract franchisees with experience in multi-unit restaurant operations and
with the financial resources and management capability to open multiple
locations. To ensure consistent food quality, each domestic franchisee is
required to purchase dough and spice mix from us and purchase all other
supplies from us or our approved suppliers. Commissaries outside the U.S. may
be operated by franchisees pursuant to license agreements. 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.
UNIT ECONOMICS
We believe our unit economics are exceptional. In 1999, the 492 restaurants
that were Company-owned and that are included in the most recent comparable
restaurant base generated average sales of $754,000, average cash flow
(operating income plus depreciation) of $154,000 and average restaurant
operating income of $128,000 (or 17.0% of average sales).
The average cash investment for the 36 Company-owned restaurants opened
during the 1999 fiscal year, exclusive of land, was approximately $224,000.
We expect the average cash investment for Company-owned restaurants opening
in 2000 to be approximately $244,000.
EXPANSION
A total of 401 Papa John's restaurants were opened during 1999, consisting of
36 Company-owned and 365 franchised restaurants. During 1999, we acquired
Perfect Pizza, an operator and franchisor of 205 delivery and carry-out pizza
restaurants in the United Kingdom (See "Note 3" of "Notes to Consolidated
Financial Statements"). One Perfect Pizza franchised restaurant was opened in
1999 subsequent to our acquisition. During 2000, we plan to open
approximately 35 restaurants and acquire an additional 60 restaurants from
our franchisees and expect franchisees to open approximately 375 restaurants.
Newer domestic market expansion is planned for the upper Northeast Coast,
West Coast and Rocky Mountain regions, in addition to building out existing
markets throughout the country. International expansion is planned primarily
in Mexico, Puerto Rico, Venezuela, Costa Rica, Guatemala, Saudi Arabia,
Canada, Iceland and the United Kingdom. New restaurants in the United Kingdom
may be opened as either Papa John's or Perfect Pizza units. We expect that
substantially all existing or new Perfect Pizza units will be converted to
Papa John's over a three-year period.
Our ability and the ability of our franchisees to open new restaurants is
affected by a number of factors, many of which are beyond our control and the
control of our franchisees. These factors include, among other things,
selection and availability of suitable restaurant and commissary locations,
increases in food, paper or labor costs, negotiation of suitable lease or
financing terms, constraints on permitting and construction of restaurants
and the hiring, training and retention of management and other personnel.
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Accordingly, there can be no assurance that we or our franchisees will be
able to meet planned growth targets or open restaurants in markets now
targeted for expansion.
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. 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. We have co-developed markets with some
franchisees or divided markets among franchisees, and will continue to
utilize market co-development in the future. In determining which new markets
to develop, we consider many factors, including the size of the market,
demographics and population trends, competition, and availability and costs
of real estate. Before entering a new market, we analyze detailed information
concerning these factors and each market is toured and evaluated by a member
of our Development department.
MENU
Papa John's restaurants offer a focused menu of high quality pizza,
breadsticks and cheesesticks, as well as canned or bottled soft drinks. Papa
John's traditional crust pizza is prepared using fresh dough (never frozen),
and our thin crust pizza is made with a prepared crust. Papa John's pizzas
are made from hard wheat flour, cheese made from 100% real mozzarella,
freshed-packed pizza sauce made with vine-ripened tomatoes (not from
concentrate) and a proprietary mix of savory spices, and a choice of high-
quality meat (no artificial fillers) and vegetable toppings. Fresh onions and
green peppers are purchased from local produce suppliers and sliced daily in
the restaurants. Fresh baby portabella mushrooms are purchased from the
commissary system, which delivers twice weekly. Each traditional crust pizza
is served with a container of our special garlic sauce and two pepperoncinis,
and each thin crust pizza is served with a container of special seasonings
and two pepperoncinis. We believe our focused menu helps create a strong
identity among consumers and simplifies operations, resulting in lower
restaurant operating costs, improved food quality and consistency and
superior customer service.
RESTAURANT DESIGN AND SITE SELECTION
The exterior of most Papa John's restaurants is characterized by backlit
awnings, neon window designs and other visible signage. A typical domestic
Papa John's restaurant averages 1,100 to 1,800 square feet and a typical
international Papa John's restaurant averages 800 to 1,400 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 red and white color scheme with green striping, and includes a
bright menu board, custom counters and a carry-out 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.
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 our development team inspects each potential domestic Company-owned
or franchised restaurant location and the surrounding market before a site is
approved. Our restaurants are typically located in strip shopping centers or
free-standing buildings that provide visibility, curb appeal and
accessibility. Our
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restaurant design may be configured to fit a wide variety of building shapes
and sizes, which increases the number of suitable locations for our
restaurants.
Since 1994, an increasing number of free-standing 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. Free-standing buildings generally provide more signage and better
visibility, accessibility and parking. We believe that these locations
improve Papa John's image and brand awareness. At year-end, free-standing
units represented approximately 24% of Company-owned restaurants. We expect
this ratio to remain fairly consistent in future years. During 1997, we
constructed our first multi-bay unit, housing a Company-owned restaurant in
addition to third party tenants. Management believes that improved site
selection may result from maintaining control of the multi-bay development
process. We have seven multi-bay units open and this strategy will continue
to be evaluated as additional operational and financial results for these
types of units become available for analysis.
All of the equipment, fixtures and smallwares needed to open a Papa John's
restaurant are available for purchase through us. We also provide layout and
design services and recommend subcontractors, signage installers and
telephone systems to Papa John's franchisees. Although not required to do so,
substantially all of Papa John's franchisees purchase most of their equipment
from us.
COMMISSARY SYSTEM; PURCHASING
Our domestic commissary system, comprised of eleven regional quality control
centers, supplies pizza dough, food products, paper products, smallwares and
cleaning supplies twice weekly to each restaurant. Our system enables us to
monitor and control product quality and consistency, while lowering food
costs. We relocated our full service commissary in Louisville, Kentucky and
opened a full-service commissary in Dallas, Texas (replacing the distribution
center) in 1999. A full-service commissary was opened in Pittsburgh,
Pennsylvania in January 2000. A full-service commissary is expected to open
in Phoenix, Arizona in the second quarter of 2000 (to replace our current
distribution center). Our other full-service commissaries are in Orlando,
Florida; Raleigh, North Carolina; Jackson, Mississippi; Denver, Colorado;
Rotterdam, New York; Portland, Oregon and Des Moines, Iowa. The primary
difference between a full-service commissary and a distribution center is
that full-service commissaries produce dough. The commissary system capacity
is continually evaluated in relation to planned restaurant growth, and
facilities are developed or upgraded as operational or economic conditions
warrant.
Four international franchised commissaries located in Costa Rica, Venezuela,
Guatemala and Mexico were opened in 1999. Other international franchised
commissaries are located in Mexico and Puerto Rico. We expect that future
international commissaries will be licensed to franchisees; however, we may
open Company-owned commissaries at our discretion. Perfect Pizza is currently
relocating and expanding its distribution center and the new facility will
accommodate a full-service commissary as the conversion to Papa John's takes
place in the future.
We set quality standards for all products used in our restaurants and
designate approved outside suppliers of food and paper products which must
meet our quality standards. In order to ensure product quality and
consistency, all of our restaurants are required to purchase proprietary
spice mix and dough from our commissaries. Franchisees may purchase other
goods directly from approved suppliers or our commissaries. 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
which we believe are below those generally available in the marketplace.
Within our domestic commissary system, products are distributed
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to restaurants by refrigerated trucks leased and operated by us or transported
by a dedicated logistics company.
Effective December 27, 1999, the commissary entered into a purchasing
arrangement with a third-party entity formed at the direction of the
Franchise Advisory Council (see Franchise Program - Franchise Advisory
Council) for the sole purpose of reducing cheese price volatility. Under this
arrangement, the commissary will purchase cheese at a fixed quarterly price
based in part on historical average cheese prices. Gains and losses incurred
by the selling entity will be passed to the commissary via adjustments to the
selling price over time. Ultimately the commissary will purchase cheese at a
price approximating the actual average market price, but with more
predictability and less volatility than the previous purchasing method.
MARKETING PROGRAMS
Our restaurant-level marketing programs target the delivery area of each
restaurant, making extensive use of distinctive 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 we or Papa John's franchisees have a
significant presence, local marketing efforts are supplemented with radio and
television advertising.
In addition to extensive local store marketing, all Company-owned and
franchised Papa John's restaurants within a developed market are required to
join an 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 billboards. 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"), for
use by us and our franchisees. The Marketing Fund produces Papa John's
national television commercials.
We provide both Company-owned and franchised restaurants with catalogs for
the purchase of uniforms and promotional items and pre-approved print
marketing materials. We also provide direct marketing services to
Company-owned and franchised restaurants utilizing customer information
gathered by our proprietary point-of-sale technology.
COMPANY OPERATIONS
RESTAURANT PERSONNEL. A typical Papa John's restaurant employs a restaurant
manager, two assistant managers and approximately 20 - 25 hourly team
members, most of whom work part-time. The manager is responsible for the
day-to-day operation of the restaurant and for maintaining
Company-established operating standards. The operating standards and other
resources are contained in a comprehensive operations manual supplied to each
restaurant and updated regularly. 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 and stock option
grants.
We employ area supervisors, each of whom has responsibility for overseeing
three to six Company-owned restaurants. We also employ regional vice
presidents and district managers who oversee area supervisors and managers
within their respective markets. These team members are also eligible to earn
performance-based financial incentives, including stock option grants.
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TRAINING AND EDUCATION. We have a department dedicated to training and
developing team members, as well as assisting new restaurant openings. We
have at least one full-time training coordinator in each of our markets and
regional training directors located strategically across the country. 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.
Each regional vice president, district manager, area supervisor and
restaurant manager completes 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 classroom instruction and
hands-on training at an operating Papa John's restaurant or at
Company-certified training centers. 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 substantially all Company-owned and franchised
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 data base 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.
REPORTING. Managers at Company-owned restaurants evaluate daily reports of
sales, cash deposits and operating costs. Physical inventories of all food
and beverage items are taken nightly. Our area supervisors prepare weekly
operating projections for each of the restaurants under their supervision.
HOURS OF OPERATIONS. Our 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 many franchisees with significant restaurant
experience. We consider our franchisees to be a vital part of our system's
continued growth and believe our relationship with our franchisees is
excellent. As of December 26, 1999, there were 1,707 franchised Papa John's
restaurants operating in 46 states, the District of Columbia, and five
international markets, and 194 franchised Perfect Pizza restaurants operating
in the United Kingdom. We had development agreements for approximately 1,321
additional franchised restaurants committed to open through 2009. 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. Formal development agreements for franchised Perfect Pizza
restaurants do not exist, although a pipeline of qualified franchisees
interested in expansion is maintained. During the 1999 fiscal year, 365 (345
domestic and 20 international) franchised Papa John's restaurants were
opened, and one Perfect Pizza franchised restaurant was opened subsequent to
our acquisition.
APPROVAL. Franchisees are approved on the basis of the applicant's business
background, restaurant operating experience and financial resources. We
generally seek franchisees who will enter into development agreements for
multiple restaurants. We seek franchisees who have restaurant experience or,
in the case of franchisees who do not have restaurant experience, we require
the franchisee to hire a
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full-time operator who has either an equity interest or the right to acquire
an equity interest in the franchise operation. We have recently added small
towns and non-traditional locations in our franchising program. These venues
are often sold as a single restaurant location.
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 $5,000
per restaurant covered by the development agreement. This amount is credited
against the standard $20,000 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 current standard domestic franchise agreement provides for a term of 10
years (with one ten-year renewal option) and payment to us of a royalty fee
of 4% of sales. The current agreement, as well as substantially all existing
franchise agreements, permit us to increase the royalty fee up to 5% of sales
after the agreement has been in effect for three years. However, 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.
In 1997, we began developing an international department and opened our first
franchised restaurant outside the U.S. in July 1998. In international
markets, we enter into 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 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, the franchisee is required to pay total fees of $25,000 per
restaurant, $10,000 at the time of signing the agreement, $10,000 ninety days
before the scheduled opening date of each restaurant and $5,000 upon signing
the franchise agreement for a specific location. Under our current 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 for the development agreement, and $15,000 for each
subfranchised restaurant, $10,000 upon signing of the master franchise
agreement and $5,000 on or prior to the date the subfranchised restaurant
opens for business.
Our current standard international master franchise and development
agreements provide for payment to us of a royalty fee of 5% of sales
(including 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.
As a result of our acquisition, we franchise restaurants in the United
Kingdom under Perfect Pizza franchise agreements, which were in effect at the
time of our acquisition. These franchise agreements differ from our standard
international franchise agreements in many respects, with few material
differences. A principal difference is the term of the agreement, which is
five years. The franchisee fee is L8,000 (approximately $13,000 at
current exchange rates), and the royalty rate of 5% is the same as our
standard international agreements. The Perfect Pizza system has been
developed principally through franchising of individual restaurants to single
location franchisees. Thus, the system has no equivalent to our development
agreements or master franchise agreements. It is expected that future
development in
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the United Kingdom will take place pursuant to standard Papa John's
international development and franchise agreements.
We have entered into a limited number of development and franchise agreements
for non-traditional restaurant units. These agreements generally cover venues
or areas not originally targeted for development and have terms differing
from the standard agreement. Although we expect an increase in the number of
franchised units in non-traditional venues in 2000, we do not believe these
contracts will have a significant impact on 2000 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. We provide design plans,
fixtures and equipment for most franchisee locations at competitive prices.
FRANCHISEE LOAN PROGRAM. In 1996, we established a program under which
selected franchisees could borrow funds for use in the construction and
development of their restaurants. Loans made under the program typically bear
interest at fixed or floating rates (ranging from 5.5% to 12.0% at December
26, 1999), and are secured by the fixtures, equipment and signage (and where
applicable, the land) of the restaurant and the ownership interests in the
franchisee. In limited cases, we have obtained a purchase option with respect
to the financed restaurants. At December 26, 1999, loans outstanding under
the franchise loan program totaled $11.7 million, with commitments to lend up
to an additional $2.5 million. We do not expect to significantly expand the
franchise loan program beyond current commitment levels.
FRANCHISE TRAINING AND SUPPORT. 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 franchised restaurant
manager is also required to complete our Company-certified management
training program. We provide an on-site training crew three days before and
three days after the opening of a franchisee's first two restaurants. Ongoing
supervision of training is monitored by the corporate franchise training
team. Multi-unit franchisees are encouraged to 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
franchise consultants, reporting to the Vice President of Franchise Sales and
Operations, maintain open communication with the franchise community,
relaying operating and marketing information and new ideas between us and
franchisees.
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. The Advisory Council
holds quarterly meetings to discuss new marketing ideas, operations, growth
and other relevant issues.
REPORTING. We collect weekly and monthly sales and other operating
information from Papa John's franchisees. We have agreements with most Papa
John's franchisees permitting us to electronically debit the franchisees'
bank accounts for the payment of royalties, Marketing Fund contributions and
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commissary purchases from Papa John's. This system significantly reduces the
resources needed to process receivables, improves cash flow and virtually
eliminates past-due accounts related to these items. Franchisees generally
are required to purchase and install the Papa John's PROFIT System in their
restaurants. See "Company Operations -- Point of Sale Technology."
COMPETITION
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
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 be better established in the markets where our restaurants are, or
may be, located. Within the pizza segment of the restaurant industry, we
believe that our primary competitors are the international pizza chains,
including Pizza Hut, Domino's and Little Caesars, and several regional chains
(Papa Murphy's, Donatos, etc.). A change in the pricing or other marketing
strategies of one or more of these competitors could have an adverse impact
on our sales and earnings.
The restaurant business is often affected by changes in consumer tastes,
national, regional or local economic conditions, demographic trends, traffic
patterns and the type, number and location of competing restaurants. In
addition, factors such as inflation, increased cheese and other commodity
costs, labor and benefits costs and the lack of experienced management and
hourly team members may adversely affect the restaurant industry in general
and our restaurants in particular.
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, capital 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 can delay or prevent the opening of a new restaurant in
a particular area. Our commissary and distribution facilities 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. A number of states in
which we might consider franchising also regulate the sale of franchises and
require registration of the franchise offering circular with state
authorities. 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 (some of which are now
pending) 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
10
franchisor-franchisee relationship. As we expand internationally we will be
subject to applicable laws in each jurisdiction where franchised units are
established.
We are also subject to the Americans With Disabilities Act of 1990, which,
among other things, may require renovations to restaurants to meet
federally-mandated requirements. The cost of these renovations is not
expected to be material. Further government initiatives, if enacted, for
example, a proposed system of mandated health insurance, could adversely
affect us and our franchisees as well as the restaurant industry in general.
TRADEMARKS
Our rights in 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 76 foreign countries and the
European Community. The "Perfect Pizza" trademark is also registered in the
United Kingdom. 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.
On August 12, 1998, Pizza Hut, Inc. filed suit against us in the United
States District Court for the Northern District of Texas, claiming that our
"Better Ingredients. Better Pizza." slogan constitutes false and deceptive
advertising in violation of the Lanham Trademark Act. Pizza Hut also filed
petitions for cancellation in the trademark Trial and Appeal Board of the
United States Department of Commerce Patent and Trademark Office against our
registrations for "Better Ingredients. Better Pizza." and "Pizza Papa John's
Better Ingredients. Better Pizza. and design" as trademarks and service
marks. Proceedings on both of these cancellation petitions were stayed by the
Trademark Trial and Appeal Board pending the outcome of the lawsuit filed by
Pizza Hut, as the issues are substantially the same (see "Legal Proceedings"
and "Note 14" of "Notes to Consolidated Financial Statements").
EMPLOYEES
As of December 26, 1999, we employed 16,619 persons, of whom approximately
14,439 were restaurant team members, 762 were restaurant management and
supervisory personnel, 593 were corporate personnel and 825 were commissary
and support services personnel. Most restaurant team members work part-time
and are paid on an hourly basis. None of our team members are covered by a
collective bargaining agreement. We consider our team member relations to be
excellent.
FORWARD LOOKING STATEMENTS
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:
11
1. Our ability and the ability of our franchisees to continue to expand
through the opening of new restaurants is affected by a number of factors,
many of which are beyond our control and our franchisees' control. These
factors include, among other things, selection and availability of suitable
restaurant locations, increases in food, paper and labor costs, negotiation
of suitable lease or financing terms, constraints on permitting and
construction of other restaurants, higher than anticipated construction
costs, and the hiring, training and retention of management and other
personnel. Accordingly, there can be no assurance that we or the Papa John's
franchisees will be able to meet planned growth targets or open restaurants
in markets now targeted for expansion.
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
Papa John's and our franchisees. Some of these competitors have been in
existence for a substantially longer period than us or our franchisees and
may be better established in the markets where restaurants operated by Papa
John's or our franchisees are, or may be, located. A change in the pricing or
other marketing or promotional strategies of one or more of our major
competitors could have an adverse impact on sales and earnings at restaurants
operated by us and our franchisees.
3. An increase in the cost of cheese or other commodities could adversely
affect the profitability of our restaurant operations. Cheese, representing
approximately 40% of our food cost, and other commodities are subject to
seasonal fluctuations, weather, demand and other factors that are beyond our
control. During the third quarter of 1999, cheese prices reached an all time
high, but have since returned to more normal levels. Additionally, sustained
increases in fuel costs could adversely affect profitability of our
restaurant and commissary businesses.
4. Changes in consumer taste, demographic trends, traffic patterns and the
type, number and location of competing restaurants could adversely affect our
restaurant business.
5. Our 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 us and our
franchisees are paid at rates related to the federal minimum wage.
Accordingly, further increases in the minimum wage will increase labor costs
for us and our franchisees. Additionally, labor shortages in various markets
could result in higher required wage rates.
6. Our international operations are subject to a number of additional
factors, including international economic and political conditions, currency
regulations and fluctuations, differing cultures and consumer preferences,
diverse government regulations and structures, availability and cost of land
and construction, and differing interpretation of the obligations established
in franchise agreements with international franchisees. Accordingly, there
can be no assurance that our international operations will achieve or
maintain profitability or meet planned growth rates.
7. Our acquisition of Perfect Pizza and planned conversion of Perfect Pizza
restaurants to Papa John's restaurants over the next three years represents
the first time we have attempted to expand the Papa John's brand in this
manner. There can be no assurance that all conversion issues will be
identified and successfully addressed in a timely and cost-effective manner
or that the existing Perfect Pizza market share can be successfully converted
to Papa John's.
12
ITEM 2. PROPERTIES
As of December 26, 1999, there were 2,280 Papa John's restaurants and 206
Perfect Pizza restaurants systemwide.
COMPANY-OWNED PAPA JOHN'S RESTAURANTS
13
DOMESTIC FRANCHISED PAPA JOHN'S RESTAURANTS
14
INTERNATIONAL FRANCHISED PAPA JOHN'S RESTAURANTS
Most Papa John's restaurants are located in leased space. The initial term of
most restaurant leases is five years or less 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.
Approximately 134 Company-owned restaurants are located in buildings we own
on land either owned or leased by us. These restaurants range from 1,200 to
1,800 square feet. Seven of the restaurants are located in multi-bay
facilities we own. These multi-bay facilities contain from 2,800 to 5,000
square feet, and the space not utilized by the Papa John's restaurants in
each facility is leased or held for lease to third party tenants.
All 194 franchised and 12 Company-owned Perfect Pizza restaurants are located
in the United Kingdom. In addition to leasing the 12 Company-owned restaurant
sites, we lease and sublease to franchisees 148 of the 194 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 5 to 10 years.
Information with respect to our leased commissaries and other facilities as
of December 26, 1999, is set forth below.
We own approximately five acres in Orlando on which our 63,000 square foot
full-service commissary is located, and eight acres in Dallas on which our
77,500 square foot full-service commissary is located. In
15
addition, the Company owns 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 30-40% of which accommodated the
relocation and expansion of the Louisville commissary operation and
promotional division in 1999. The remainder of the building accommodated the
relocation and consolidation of our corporate offices in 1999.
The Perfect Pizza management team is located in 6,000 square feet of leased
office space in London with a remaining lease term of 16 years. We expanded
and relocated the Perfect Pizza distribution center into a 30,000 square foot
owned facility in March 2000. This new facility will accommodate a
full-service commissary as the conversion to Papa John's restaurants occurs.
ITEM 3. LEGAL PROCEEDINGS
On August 12, 1998, Pizza Hut, Inc. filed suit against us in the United
States District Court for the Northern District of Texas, claiming that our
"Better Ingredients. Better Pizza." slogan constitutes false and deceptive
advertising in violation of the Lanham Trademark Act. The trial began on
October 25, 1999. On November 18, 1999, the jury returned a verdict that our
"Better Ingredients. Better Pizza." slogan is false and deceptive. On January
3, 2000, the court announced its judgment, awarding Pizza Hut $468,000 in
damages and ordering us to cease all use of the "Better Ingredients. Better
Pizza." slogan. Under the judge's order, we were to cease using the slogan in
print and broadcast advertising by January 24, 2000, phase out printed
promotional materials and other items containing the slogan (except signage)
by March 3, 2000 and remove the slogan from restaurant signage by April 3,
2000. We have estimated that the pre-tax costs of complying with the court's
order and certain related costs could approximate $12.0 to $15.0 million, of
which $6.1 million was recorded as a pre-tax charge against 1999 earnings.
However, we filed an appeal of the verdict and the court's order and a motion
for stay of the court's order pending outcome of the appeal. On January 21,
2000, the United States Court of Appeals for the Fifth Circuit granted a stay
of the District Court judgment pending our appeal. Oral arguments related to
the appeal are scheduled to be held in April 2000 (see "Note 14" of "Notes to
Consolidated Financial Statements"). If our appeal is successful, the timing
and possibly the amount of costs to be incurred could be favorably impacted.
We are also 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.
16
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are the current executive officers of Papa John's, together
with their ages, their positions and the years in which they first became an
officer:
John Schnatter created the Papa John's concept and founded Papa John's in
1985. He has served as Chairman of the Board and Chief Executive Officer
since 1990, and from 1985 to 1990, served as President. John Schnatter has
also been a franchisee since 1986.
Blaine Hurst has served as Vice Chairman since 1998 and President since 1996.
From 1995 to 1996, Mr. Hurst served as Chief Information Officer after having
joined Papa John's in January 1995 as Vice President of Information Systems.
From 1993 to 1995, Mr. Hurst was Vice President of Information Systems for
Boston Chicken, Inc. From 1989 to 1993, Mr. Hurst was a consulting partner
with Ernst & Young LLP. Mr. Hurst has been a franchisee since 1996.
Charles Schnatter has served as General Counsel and Secretary since 1991 and
has been a Senior Vice President since 1993. From 1988 to 1991, he was an
attorney with Greenebaum Doll & McDonald
17
PLLC, Louisville, Kentucky, a law firm which provides legal services to us.
Charles Schnatter has been a franchisee since 1989.
Dru Milby has served as Senior Vice President since 1996, Chief Financial
Officer since 1995 and Treasurer since 1993. Ms. Milby held the position of
Vice President - Finance from 1991 to 1995. From 1990 to 1991, Ms. Milby was
Director of Financial Planning for American Air Filter. From 1987 to 1990,
Ms. Milby was Manager of Financial Reporting and Systems Support for KFC
International, the operator and franchisor of KFC restaurants. From 1983 to
1987, Ms. Milby held various positions with KFC International and KFC USA in
the areas of general accounting, financial reporting and financial systems.
Ms. Milby is a licensed Certified Public Accountant and Certified Management
Accountant.
Robert Wadell has served as President of PJ Food Service, Inc. since 1995,
after having served as Vice President of Commissary Operations from 1990 to
1995. From 1988 to 1990, Mr. Wadell was employed with Mr. Gatti's in the
position of Regional Franchise Director, responsible for overseeing the
operations of 65 franchised restaurants in an eight-state area. From 1983 to
1988, Mr. Wadell was an Area Supervisor for Mr. Gatti's, and from 1979 to
1983, was a store operator for Mr. Gatti's.
Barry Barron has served as Senior Vice President of International since 1998.
Mr. Barron also served as Regional Vice President, Southwest Region from 1995
to 1998. The Southwest Region he served included restaurants in Texas, New
Mexico, Colorado, Missouri and Illinois. Prior to joining Papa John's, Mr.
Barron was employed by a major competitor for more than 10 years where he
held various positions overseeing operations and delivery business
development.
Richard Emmett was appointed Senior Vice President and Senior Counsel in
March 1997, after having served as Senior Vice President-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 such firm in 1989. Mr. Emmett has been a franchisee since 1992.
Lou DiFazio has served as Vice President, Corporate Operations since January
1999. From 1994 to 1999, Mr. DiFazio served as Regional Vice President,
Southeast Region, where he was responsible for the operation of 125
restaurants. From 1993 to 1994, Mr. DiFazio served as both a district manager
and senior district manager for the Atlanta and Charlotte markets. A pizza
industry veteran for more than twelve years, Mr. DiFazio started his career
as a supervisor for a major competitor. In addition to his experience as a
supervisor, he has worked in various marketing, real estate and store
development positions in the pizza industry. We announced that Mr. DiFazio
will be resigning this position effective in the second quarter of 2000 to
focus on his Papa John's franchised restaurants.
David Flanery has served as Vice President since 1995 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.
Tom Kish has served as Vice President, Information Services since October
1996 and Vice President, Support Services, since March 1998. From 1995 to
1996, Mr. Kish served as Director of Store Systems. Prior to joining Papa
John's, Mr. Kish held several consulting positions, many of them with Fortune
500 companies. Mr. Kish has been a franchisee since 1998.
Mary Ann Palmer has served as Vice President, People Department since the
department was created in January 1999. Ms. Palmer served as Vice President
of Education and Training from 1997 to 1999. From
18
1996 to 1997, Ms. Palmer held the position of Senior Counsel in our legal
department. Prior to joining Papa John's, Ms. Palmer practiced law as a
partner in the area's largest regional law firm, Wyatt, Tarrant & Combs.
Syl Sosnowski has served as Vice President of Marketing since 1995. Mr.
Sosnowski also served as Vice President of Support Services from 1997 to
1998. From 1990 to 1995, Mr. Sosnowski served as Vice President of Marketing
and Sales for Carvel Corporation.
Hart Boesel has served as Vice President of Franchise Sales and Operations
since 1999. Mr. Boesel held the position of Vice President of Franchise
Operations from 1995 to 1999. In his capacity as Vice President, Mr. Boesel
serves as the primary corporate contact for the Papa John's franchise family.
Prior to joining Papa John's, Mr. Boesel had 17 years of experience in
corporate, franchise and international operations for a major quick service
restaurant chain.
John and Charles Schnatter are brothers. There are no other family
relationships among the executive officers and other key personnel.
19
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock trades on the NASDAQ National Market tier of The NASDAQ
Stock Market under the symbol PZZA. As of March 13, 2000, there were
approximately 932 record holders of common stock. The following table sets
forth for the quarters indicated the high and low sale prices of our common
stock, as reported by The NASDAQ Stock Market.
Since our initial public offering of common stock in 1993, we have not paid
dividends on our common stock, and have no plans to do so in the foreseeable
future.
20
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below for each of the years in the
five-year period ended December 26, 1999 was derived from our audited
consolidated financial statements, restated for the acquisition of Minnesota
Pizza (see "Note 3" of "Notes to 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.
21
(1) We operate on a 52-53 week fiscal year ending on the last Sunday of
December of each year. The 1999, 1998, 1997 and 1996 fiscal years consisted
of 52 weeks and the 1995 fiscal year consisted of 53 weeks.
(2) Reflects the cumulative effect on income and earnings per share of a
change in accounting principle, net of tax, as required by Statement of
Position 98-5 "Reporting the Costs of Start-Up Activities" (see "Note 2" of
"Notes to Consolidated Financial Statements").
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 26, 1999, there were 2,280 Papa John's restaurants in
operation, consisting of 573 Company-owned and 1,707 franchised and 206
Perfect Pizza restaurants in the United Kingdom (consisting of 12
Company-owned and 194 franchised). Our revenues are principally derived from
retail sales of pizza to the general public by Company-owned restaurants,
franchise royalties, sales of franchise and development rights, sales to
franchisees of food and paper products, restaurant equipment, printing and
promotional items, risk management services, and information systems and
related services used in their operations.
We intend to continue to expand the number of Company-owned and franchised
restaurants. 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. We
believe that our expansion strategy has contributed to increases in
comparable annual sales for Company-owned restaurants of 3.5% in 1999, 9.0%
in 1998, and 9.3% in 1997. We anticipate that future comparable sales
increases, if any, will be at a lesser rate than those achieved in the past.
Average sales for the Company's most recent comparable base restaurants
increased to $754,000 for 1999 from $750,000 for 1998. This increase is
attributable to continuing strong sales of maturing restaurants. Average
sales volumes in new markets are generally lower than in those markets in
which we have established a significant market position.
Approximately 45% of our revenues for 1999 and 44% for 1998 were derived from
the sale to franchisees of food and paper products, restaurant equipment,
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., and our support services subsidiary, Papa
John's Support Services, Inc. We believe that, in addition to supporting both
Company and franchised growth, these subsidiaries contribute to product
quality and consistency throughout the Papa John's system.
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 36 Company-owned restaurants opened during 1999,
exclusive of land, decreased to approximately $224,000 from $252,000 for the
70 units opened in 1998. This decrease was primarily due to a change in the
mix of store types built in 1999. In 1999, we built fewer freestanding
restaurants which have a higher cost. We also opened more non-traditional
units in 1999, which have a lower cost than traditional units. We expect the
average cash investment for restaurants opening in 2000 to be approximately
$244,000.
22
We defer certain costs incurred in connection with the development of our
information systems and amortize such costs over periods of up to five years
from the date of completion.
Our fiscal year ends on the last Sunday in December of each year. All fiscal
years presented consist of 52 weeks. Our 2000 fiscal year will consist of 53
weeks.
RESULTS OF OPERATIONS
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.
23
(1) Restated for the March 1999 acquisition of Minnesota Pizza (see "Note 3" of
"Notes to Consolidated Financial Statements").
(2) As a percentage of Restaurant sales.
(3) As a percentage of Commissary sales and Equipment and other sales on a
combined basis.
(4) The 1998 operating results reflect the adoption of an accounting standard
related to the costs of start-up activities (see "Note 2" of "Notes to
Consolidated Financial Statements") which impacts the amount of
depreciation and amortization, general and administrative expenses, and
pre-opening and other general expenses reflected above.
(5) Represents estimated 1999 costs related to complying with the Court's order
in the Pizza Hut litigation (see "Item 3. Legal Proceedings" and "Note 14"
of "Notes to Consolidated Financial Statements").
(6) Includes only Company-owned restaurants open throughout the periods being
compared.
(7) Non-traditional units previously opened but not included in restaurant
progression.
24
1999 COMPARED TO 1998
On March 28, 1999, we acquired Minnesota Pizza Company, LLC ("Minnesota
Pizza"), a franchisee which operated 37 Papa John's restaurants in the
Minneapolis/St. Paul market (see "Note 3" of "Notes to Consolidated Financial
Statements"). The transaction was accounted for as a pooling of interests.
Our operating results for the first quarter of 1999 and previously reported
results of operations and balance sheets have been restated to include
Minnesota Pizza.
On November 29, 1999, we acquired Perfect Pizza Holdings Limited ("Perfect
Pizza"), a company located in the United Kingdom operating 205 restaurants
(See "Note 3" of "Notes to Consolidated Financial Statements"). The
Consolidated Statements of Income contain financial results for the month of
December 1999 for Perfect Pizza, which reflect total revenues of $2.9 million
and net income of $228,000. Due to the immateriality of these operating
results, the discussion below does not include comments related to the impact
of Perfect Pizza.
REVENUES. Total revenues increased 18.1% to $805.3 million in 1999, from
$682.2 million in 1998.
Restaurant sales increased 14.8% to $395.1 million in 1999, from $344.1
million in 1998. This increase was primarily due to a 12.6% increase in the
number of equivalent Company-owned restaurants open during 1999 as compared
to 1998. "Equivalent restaurants" represents the number of restaurants open
at the beginning of a given period, adjusted for restaurants opened or
acquired during the period on a weighted average basis. Also, comparable
sales increased 3.5% in 1999 over 1998 for Company-owned restaurants open
throughout both years in large part due to reduced price discounting.
Franchise royalties increased 28.5% to $41.3 million in 1999, from $32.1
million in 1998. This increase was primarily due to a 25.6% increase in the
number of equivalent franchised restaurants open during 1999 as compared to
1998. Also, comparable sales increased 6.4% in 1999 over 1998 for franchised
restaurants open throughout both years.
Franchise and development fees increased 26.1% to $6.9 million in 1999, from
$5.5 million in 1998. This increase was primarily due to the 365 franchised
restaurants opened during 1999, as compared to 302 opened during 1998, an
increase of 21%. The average dollar amount of fees per franchised restaurant
may vary from period to period, depending on the mix of restaurants opened
pursuant to older development agreements (including "Hometown restaurants"
which generally had lower required fees than traditional restaurants opened
pursuant to standard development agreements) and those opened pursuant to
international development agreements (which may have higher or lower required
fees). Hometown restaurants are located in smaller markets, generally with
less than 9,000 households. Hometown restaurant development agreements
entered into subsequent to March 1998, generally provide for fees equivalent
to those under standard development agreements. The standard international
development agreement requires total fees of $25,000 per restaurant, while
subfranchised restaurants opened pursuant to a master franchise agreement
require total fees of $15,000 per restaurant. This is compared to the
standard domestic development and franchise fee of $20,000 per restaurant.
Commissary sales increased 21.1% to $309.0 million in 1999, from $255.1
million in 1998. This increase was primarily due to the increases in
equivalent franchised restaurants and comparable sales for franchised
restaurants noted above, partially offset by the impact of lower 1999 cheese
costs which resulted in lower cheese pricing and sales relative to 1998
levels.
25
Equipment and other sales increased 16.9% to $53.1 million in 1999, from
$45.4 million in 1998. This increase was primarily due to ongoing equipment,
smallwares, uniforms and print materials related to the increase in
equivalent franchised restaurants open during 1999 as compared to 1998, and
the increase in the number of new restaurant equipment packages sold to
franchisees that opened restaurants in 1999 as compared to 1998.
COSTS AND EXPENSES. Restaurant cost of sales, which consists of food,
beverage and paper costs, decreased as a percentage of restaurant sales to
25.4% in 1999, from 26.9% in 1998. The primary reason for the decrease is
attributable to reduced restaurant menu price discounting and a decrease in
the average cheese block price. The cost of cheese, representing
approximately 40% of food cost, and other commodities are subject to
significant price fluctuations caused by weather, demand and other factors.
Most of the factors affecting the cost of cheese are beyond our control (see
"Item 1. Business - Commissary System; Purchasing" and "Note 9" of "Notes to
Consolidated Financial Statements").
Restaurant salaries and benefits increased as a percentage of restaurant
sales to 27.0% in 1999, from 26.8% in 1998. This increase was primarily due
to higher staffing levels after our 14th Anniversary promotion to support the
demands of new customers and enhanced employee benefits to select restaurant
personnel. Occupancy costs as a percentage of restaurant sales remained
consistent at 5.0% for both 1999 and 1998.
Restaurant advertising and related costs increased as a percentage of
restaurant sales to 9.1% in 1999, from 8.7% in 1998. The increase in 1999 was
primarily the result of increased promotional activities in the second
quarter in response to significant promotional activities by our competitors
and increased activities in the fourth quarter in response to overall market
conditions and sales trends.
Other restaurant operating expenses increased as a percentage of restaurant
sales to 13.6% in 1999, from 13.0% in 1998. Other operating expenses include
an allocation of commissary operating expenses equal to 3% of Company-owned
restaurant sales in order to assess a portion of the costs of dough
production and food and equipment purchasing and storage to Company-owned
restaurants. The increase in other operating expenses as a percentage of
restaurant sales was primarily due to increased costs associated with our
14th Anniversary promotion and increased repair and maintenance costs. Repair
and maintenance costs are expected to increase as existing units mature.
Commissary, equipment and other expenses include cost of sales, salaries and
benefits, and other operating expenses associated with sales of food, paper,
equipment, information systems and printing and promotional items to
franchisees and other customers. These costs decreased as a percentage of
combined commissary sales and equipment and other sales to 90.5% in 1999 from
91.7% in 1998. Cost of sales as a percentage of combined commissary sales and
equipment and other sales decreased to 76.2% in 1999 from 78.5% in 1998,
principally due to the timing of certain favorable commodity price changes
(primarily cheese) and the change in classification of certain expenses to
salaries and benefits previously reported as cost of sales. Salaries and
benefits increased to 6.6% in 1999 from 5.7% in 1998 due to the change in
classification of certain expenses previously reported in cost of sales and
general and administrative expenses. Other operating expenses increased to
7.7% in 1999 compared to 7.5% in 1998 due primarily to higher delivery costs
related to the transition to a new distribution vendor and higher costs
related to the 14th Anniversary promotion, partially offset by a reduction in
rent expense due to the opening of the Dallas, Texas and Louisville, Kentucky
commissaries. Additionally, delivery costs as a percentage of sales will
fluctuate with cheese prices. Although the change in cheese price has an
effect on sales, the costs to deliver remain relatively consistent regardless
of cheese prices.
26
General and administrative expenses decreased as a percentage of total
revenues to 6.8% in 1999 from 7.8% in 1998. This decrease was due to the
following: (1) leveraging expenses on a higher sales base; (2) the resolution
of certain economic incentives related to the construction of the new
corporate headquarters facility; (3) reduction in payroll processing fees due
to bringing payroll processing in-house; and (4) the change in classification
of certain expenses to commissary, equipment and other salaries and benefits
previously reported as general and administrative expenses. The change in
classification represented approximately 0.2% of the total improvement.
Advertising litigation expense represents costs associated with the lawsuit
filed against us by Pizza Hut, Inc. claiming that our "Better Ingredients.
Better Pizza." slogan is false and deceptive advertising. The $6.1 million in
advertising litigation expense consists primarily of legal costs and costs to
discontinue the "Better Ingredients. Better Pizza." slogan. See "Item 3.
Legal Proceedings" and "Note 14" of "Notes to Consolidated Financial
Statements" for additional information.
Pre-opening and other general expenses remained fairly consistent at $3.6
million in 1999, compared to $3.5 million in 1998. Depreciation and
amortization expense as a percentage of total revenues remained consistent at
3.1% in 1999, compared to 3.0% in 1998.
INVESTMENT INCOME. Investment income decreased to $3.4 million in 1999 from
$4.1 million in 1998 due to a lower average balance of franchise loans and a
decrease in our average investment portfolio balance.
INCOME TAX EXPENSE. Income tax expense (exclusive of the cumulative effect of
accounting change and related taxes) reflects a combined federal, state and
local effective tax rate of 37.6% for 1999, compared to 38.8% in 1998. The
effective income tax rate for 1998, including an income tax benefit for the
treatment of Minnesota Pizza as a C Corporation (see "Note 3" of "Notes to
Consolidated Financial Statements"), was 37.0%. The effective income tax rate
in 1999 increased as compared to the 1998 pro forma rate as a result of a
continued decrease in the relative level of tax-exempt investment income to
total pre-tax income.
1998 COMPARED TO 1997
As noted above, our previously reported results of operations and balance
sheets have been restated to include Minnesota Pizza and the following
discussion reflects this restatement.
REVENUES. Total revenues increased 32.3% to $682.2 million in 1998, from
$515.7 million in 1997.
Restaurant sales increased 31.2% to $344.1 million in 1998, from $262.3
million in 1997. This increase was primarily due to a 24.0% increase in the
number of equivalent Company-owned restaurants open during 1998 as compared
to 1997. "Equivalent restaurants" represents the number of restaurants open
at the beginning of a given period, adjusted for restaurants opened or
acquired during the period on a weighted average basis. Also, comparable
sales increased 9.0% in 1998 over 1997 for Company-owned restaurants open
throughout both years.
Franchise royalties increased 34.6% to $32.1 million in 1998, from $23.9
million in 1997. This increase was primarily due to a 26.9% increase in the
number of equivalent franchised restaurants open during 1998 as compared to
1997. Also, comparable sales increased 10.1% in 1998 over 1997 for franchised
restaurants open throughout both years.
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Franchise and development fees increased 5.6% to $5.5 million in 1998, from
$5.2 million in 1997. This increase was primarily due to the 302 franchised
restaurants opened during 1998, as compared to 277 opened during 1997, an
increase of 9.0%. The average dollar amount of fees per franchised restaurant
may vary from period to period, depending on the mix of restaurants opened
pursuant to older development agreements including "Hometown restaurants."
Commissary sales increased 38.3% to $255.1 million in 1998, from $184.4
million in 1997. This increase was primarily due to the increases in
equivalent franchised restaurants and comparable sales for franchised
restaurants noted above. There was an additional impact of higher cheese
prices in 1998 compared to 1997 in response to increased cheese costs during
1998.
Equipment and other sales increased 13.6% to $45.4 million in 1998, from
$40.0 million in 1997. This increase was primarily due to ongoing equipment
and smallwares orders related to the increase in equivalent franchised
restaurants open during 1998 as compared to 1997, and the increase in the
number of new restaurant equipment packages sold to franchisees that opened
restaurants in 1998 as compared to 1997. A portion of the equipment and other
sales increase was also attributable to an increase in sales of the Papa
John's PROFIT system, a proprietary point of sale system.
COSTS AND EXPENSES. Restaurant cost of sales, which consists of food,
beverage and paper costs, increased as a percentage of restaurant sales to
26.9% in 1998, from 26.5% in 1997. The primary reason for the increase is
attributable to increases in the average cheese block market prices,
partially offset by a decrease in the average cost of certain other
commodities.
Restaurant salaries and benefits decreased as a percentage of restaurant
sales to 26.8% in 1998, from 27.1% in 1997. The decrease is primarily due to
increased efficiencies in relation to higher sales volumes, partially offset
by the 1998 full year impact of increases in the federal minimum wage in
September 1997. Occupancy costs decreased as a percentage of restaurant sales
to 5.0% in 1998 from 5.2% in 1997 as a result of leveraging against a higher
sales base.
Restaurant advertising and related costs decreased as a percentage of
restaurant sales to 8.7% in 1998, from 9.4% in 1997. The decrease in 1998 was
primarily the result of efficiencies related to increased market penetration
and higher sales volume. Our advertising often varies based on the timing of
national or market-level promotions.
Other restaurant operating expenses decreased as a percentage of restaurant
sales to 13.0% for 1998 from 13.4% for 1997. The decrease in other operating
expenses as a percentage of restaurant sales was primarily due to a reduction
in worker's compensation costs.
Commissary, equipment and other expenses include cost of sales, salaries and
benefits, and other operating expenses associated with sales of food, paper,
equipment, information systems and printing and promotional items to
franchisees and other customers. These costs were relatively consistent as a
percentage of combined commissary sales and equipment and other sales at
91.7% in 1998 and 91.6% in 1997. Cost of sales as a percentage of combined
commissary sales and equipment and other sales increased to 78.5% in 1998
from 77.7% in 1997, due to the timing of certain unfavorable commodity price
changes (primarily cheese). The increase was offset by a decrease in salaries
and benefits and other operating expenses to 13.2% in 1998 compared to 13.9%
in 1997, due primarily to efficiencies related to an increased number of
restaurants serviced by the overall commissary system without significant
expansion in 1998.
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General and administrative expenses increased slightly as a percentage of
total revenues to 7.8% in 1998 from 7.5% in 1997. This increase is primarily
due to the adoption of the AICPA Statement of Position 98-5 ("SOP") which
required the expensing of certain start-up costs effective in 1998 (see "Note
2" of "Notes to Consolidated Financial Statements"). Certain of these costs
had previously been deferred and, accordingly, were not previously included
in general and administrative costs. Even though the adoption resulted in
significant changes to the amounts reported on individual line items (general
and administrative expenses, pre-opening and other general expenses, and
depreciation and amortization), the effect of the adoption of the SOP did not
have a material impact on 1998 consolidated net income, excluding the one
time cumulative effect adjustment of $2.6 million, net of taxes of $1.5
million. This increase was partially offset by the recognition of $2.0
million in incentives under the Kentucky Jobs Development Act (the "KJDA
incentives") related to the development of a new corporate headquarters
facility and associated employment increases.
Pre-opening and other general expenses increased to $3.5 million in 1998,
compared to $1.5 million in 1997. Pre-opening and other general expenses
consisted primarily of relocation costs in 1997 and of both relocation costs
and pre-opening expenses in 1998 as a result of the adoption of the SOP (see
"Note 2" of "Notes to Consolidated Financial Statements").
Depreciation and amortization decreased as a percentage of total revenues to
3.0% in 1998, from 4.0% in 1997. This decrease was due to the elimination of
pre-opening deferrals and related amortization in 1998 as a result of the
adoption of the SOP (see "Note 2" of "Notes to Consolidated Financial
Statements").
INVESTMENT INCOME. Investment income remained relatively consistent at $4.1
million in 1998 and $4.2 million in 1997 as average invested and loaned
balances and yields were also fairly consistent between years.
INCOME TAX EXPENSE. Income tax expense (exclusive of the cumulative effect of
accounting change and related taxes) reflects a combined federal, state and
local effective tax rate of 38.8% in 1998, compared to 40.1% in 1997. The
effective income tax rates for 1998 and 1997, including an income tax benefit
for the treatment of Minnesota Pizza as a C Corporation (see "Note 3" of
"Notes to Consolidated Financial Statements"), was 37.0% in both years.
LIQUIDITY AND CAPITAL RESOURCES
We require capital primarily for the development and acquisition of
restaurants, the addition of new commissary and support services facilities
and equipment, the enhancement of corporate systems and facilities and the
funding of franchisee loans. Additionally, we began a share repurchase
program in 1999. Capital expenditures of $81.2 million, acquisitions of $32.7
million, loans to franchisees of $6.6 million and share repurchases of $31.7
million for 1999, were primarily funded by cash flow from operations, cash
generated from the exercise of stock options and the liquidation of available
cash and investments.
Total 2000 capital expenditures are expected to be approximately $50.0
million, primarily for the development or relocation of restaurants,
construction of commissary facilities, and the completion of the Louisville
corporate offices. During 2000, we plan to open approximately 35 new
Company-owned restaurants and relocate an additional 15 to 20 restaurants.
In addition to restaurant development and potential acquisitions, significant
capital projects for the next 12 months are expected to include the
completion of the 247,000 square foot commissary and corporate
29
office facility in Louisville, Kentucky. In mid-1999, the Louisville
commissary operations and the majority of the team members in the corporate
offices were relocated to the new facility, which is expected to be completed
in early 2000. A full-service commissary was opened in Pittsburgh,
Pennsylvania in January 2000, and we expect to complete the expansion and
relocation of the Phoenix, Arizona distribution center to a full-service
commissary in mid-2000.
Subsequent to year-end, we acquired an additional $87.4 million of common
stock under our share repurchase program. These purchases have primarily been
funded with short-term bank financing. The Board of Directors has authorized
up to $150.0 million for the share repurchase program through 2000 year-end,
and $30.9 million remains available under this authorization. Also subsequent
to year-end, we acquired PJNJ Foods, Inc., a franchisee of 19 Papa John's
restaurants in New Jersey, for $7.9 million ($6.6 million in cash and $1.3
million of assumed net liabilities).
Through December 1999, we earned approximately $4.9 million of an
expected $13.0 million in incentives under the Kentucky Jobs Development Act
in connection with the relocation of the corporate offices. We expect to earn
the remaining $8.1 million of such incentives through 2007.
Additionally, during 2000 we expect to fund up to $2.5 million in additional
loans under existing franchisee loan program commitments. Approximately $11.7
million was outstanding under this program as of December 26, 1999. At this
time, we do not expect to significantly expand the program beyond existing
commitments.
Substantially all capital resources available at December 26, 1999 were
expended in connection with the $87.4 million share repurchase subsequent to
year-end. Total bank financing of approximately $83.0 million has been
utilized to complete these subsequent repurchases. We expect to fund repayment
of short-term bank financing, planned capital expenditures, acquisitions of
franchised restaurants, disbursements under the franchise loan program and
additional share repurchases for the next twelve months from operating cash
flows and the $67.0 million remaining borrowing capacity under a $150.0
million, three-year, unsecured revolving line of credit agreement entered
into in March 2000.
IMPACT OF YEAR 2000
In prior years, we discussed the nature and progress of our plans to become
Year 2000-ready. In late 1999, we completed testing of our systems and made
modifications as deemed necessary. As a result of our planning and
implementation efforts, we experienced no significant disruptions in business
critical information technology and non-information technology systems and
believe these systems successfully responded to the Year 2000 date change.
The costs incurred during 1999 in connection with necessary modifications of
our systems were not material to our financial position. We are not aware of
any material problems resulting from Year 2000 issues regarding our internal
systems, the products and services of third parties, or the businesses
operated by our franchisees. We will continue to monitor our business
critical computer applications and those of our suppliers and franchisees
throughout the year 2000 to ensure that any Year 2000 matters that may arise
are addressed promptly.
IMPACT OF INFLATION
We do not believe inflation has materially affected earnings during the past
three years. Substantial increases in costs, particularly labor, benefits,
food and fuel costs, could have a significant impact on us.
30
FORWARD LOOKING STATEMENTS
Certain information contained in this annual report, particularly information
regarding future financial performance and plans and objectives of
management, is forward looking. Certain factors could cause actual results to
differ materially from those expressed in forward looking statements. These
factors include, but are not limited to, our ability and the ability of our
franchisees to obtain suitable locations and financing for new restaurant
development; the hiring, training, and retention of management and other
personnel; competition in the industry with respect to price, service,
location, and food quality; an increase in food cost due to seasonal
fluctuations, weather, and demand; changes in consumer tastes and demographic
trends; changes in federal and state laws, such as increases in minimum wage;
and risks inherent to international development, including operational or
market risks associated with the planned conversion of Perfect Pizza
restaurants to Papa John's in the United Kingdom.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We had no significant holdings of derivative financial or commodity
instruments at December 26, 1999.
Our principal exposure to financial market risks in the past has been the
impact that interest rate changes could have on the income from our
investment portfolio. Going forward, our principal exposure is the impact
that interest rate changes could have on the interest expense incurred on
borrowings under our revolving credit agreement (see "Note 8" of "Notes to
Consolidated Financial Statements"). All such borrowings (none at December
26, 1999) bear interest at a variable rate based on the prime rate, the
London Interbank Offered Rate (LIBOR), or certain alternative short-term
rates. A change in interest rates of 100 basis points would not significantly
affect our net income. Furthermore, in connection with our $150.0 million,
three-year revolving credit agreement, we entered into a $100.0 million,
three-year interest rate collar effective March, 2000. The collar establishes
a 6.36% floor and 9.50% ceiling on the LIBOR base rate on a no-fee basis.
Substantially all of our business is transacted in U.S. dollars. Accordingly,
foreign exchange rate fluctuations have not had a significant impact on us,
and are not expected to during 2000.
Cheese, representing approximately 40% of our food cost, is subject to
seasonal fluctuations, weather, demand and other factors that are beyond our
control. Effective December 27, 1999, the commissary entered into a
purchasing arrangement with a third-party entity formed at the direction of
the Franchise Advisory Council for the sole purpose of reducing cheese price
volatility. Under this arrangement, the commissary will purchase cheese at a
fixed quarterly price based, in part, on historical average cheese prices.
Gains and losses incurred by the selling entity will be passed to the
commissary via adjustments to the selling price over time. Ultimately the
commissary will purchase cheese at a price approximating the actual average
market price, but with more predictability and less volatility than the
previous purchasing method.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAPA JOHN'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Note: The Consolidated Statements of Income for the years ended December 27,
1998 and December 28, 1997 have been restated to reflect the acquisition of
Minnesota Pizza Company, LLC, a business combination accounted for as a
pooling of interests (see "Note 3" of "Notes to Consolidated Financial
Statements").
SEE ACCOMPANYING NOTES.
32
PAPA JOHN'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
Note: The Consolidated Balance Sheet at December 27, 1998 has been restated to
reflect the acquisition of Minnesota Pizza Company, LLC, a business combination
accounted for as a pooling of interests (see "Note 3" of "Notes to Consolidated
Financial Statements").
SEE ACCOMPANYING NOTES.
33
PAPA JOHN'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Note: The Consolidated Statements of Stockholders' Equity for the years ended
December 27, 1998 and December 28, 1997 have been restated to reflect the
acquisition of Minnesota Pizza Company, LLC, a business combination accounted
for as a pooling of interests (see "Note 3" of "Notes to Consolidated
Financial Statements").
SEE ACCOMPANYING NOTES.
34
PAPA JOHN'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Note: The Consolidated Statements of Cash Flows for the years ended December
27, 1998 and December 28, 1997 have been restated to reflect the acquisition
of Minnesota Pizza Company, LLC, a business combination accounted for as a
pooling of interests (see "Note 3" of "Notes to Consolidated Financial
Statements").
SEE ACCOMPANYING NOTES.
35
PAPA JOHN'S INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
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 carry-out restaurants under the trademark "Papa
John's," currently in 47 states, the District of Columbia, and five
international markets. We also operate and franchise pizza delivery and
carry-out restaurants under the trademark "Perfect Pizza" in the United
Kingdom. Substantially all revenues are derived from retail sales of pizza to
the general public by Company-owned restaurants, franchise royalties, sales
of franchise and development rights, and sales to franchisees of food and
paper products, restaurant equipment, printing and promotional items, risk
management services, and information systems and related services used in
their operations.
2. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Papa John's and its subsidiaries. All significant intercompany balances and
transactions have been eliminated.
FISCAL YEAR
Our fiscal year ends on the last Sunday in December of each year. All fiscal
years presented consist of 52 weeks.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from these
estimates.
REVENUE RECOGNITION
Franchise fees are recognized when a franchised restaurant begins operations,
at which time we have performed our obligations related to such fees. Fees
received pursuant to development agreements which grant the right to develop
franchised restaurants in future periods in specific geographic areas are
deferred and recognized on a pro rata basis as the franchised restaurants
subject to the development agreements begin operations. Both franchise and
development fees are nonrefundable. Franchise royalties, which are based on a
percentage of franchised restaurants' sales, are recognized as earned.
CASH EQUIVALENTS
Cash equivalents consist of all highly liquid investments with a maturity of
three months or less at date of purchase. These investments are carried at
cost which approximates fair value.
36
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ACCOUNTS RECEIVABLE
Substantially all accounts receivable are due from franchisees for purchases
of food and paper products, restaurant equipment, printing and promotional
items, risk management services, information systems and related services,
and for royalties from December sales. Credit is extended based on an
evaluation of the franchisee's financial condition and, generally, collateral
is not required. We consider substantially all amounts to be collectible.
INVENTORIES
Inventories, which consist of food products, paper goods and supplies,
smallwares, store equipment and printing and promotional items, are stated at
the lower of cost, determined under the first-in, first-out (FIFO) method, or
market.
INVESTMENTS
We determine the appropriate classification of investment securities at
the time of purchase and reevaluate such designation as of each balance sheet
date. All investment securities held at December 26, 1999, have been
classified as available-for-sale. Available-for-sale securities are stated at
fair value as determined primarily through quoted market prices. Unrealized
gains and losses, net of tax, are reported as a separate component of
stockholders' equity and are included in comprehensive income. The cost of
debt securities is adjusted for amortization of premiums and accretion of
discounts to maturity. Such amortization and accretion, along with interest
and dividends earned and realized gains and losses, are included in
investment income. The cost of securities sold is based on the specific
identification method.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is provided using the
straight-line method over the estimated useful lives of the assets (generally
five to ten years for restaurant, commissary and other equipment, and 20 to
40 years for buildings and improvements). Leasehold improvements are
amortized over the terms of the respective leases, including the first
renewal period (generally five to ten years).
Depreciation expense was $22.3 million in 1999, $18.4 million in 1998 and
$13.9 million in 1997.
INTANGIBLE ASSETS
Intangible assets principally represents costs in excess of net assets of
companies acquired (i.e., goodwill). Goodwill is amortized on a straight-line
basis ranging from 15 to 25 years. Accumulated amortization was $3.6 million
at December 26, 1999 and $2.6 million at December 27, 1998.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived and intangible assets are periodically reviewed for recoverability
when impairment indicators are present. Recorded values 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 (assets held for use) or net realizable value (assets
held for sale).
37
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SYSTEMS DEVELOPMENT COSTS
We defer certain systems development and related costs which meet established
criteria. Amounts deferred are amortized over periods not exceeding five
years beginning in the month subsequent to completion of the related systems
project. Total costs deferred were approximately $1.4 million in 1999, $1.2
million in 1998, and $2.0 million in 1997. Unamortized deferred systems
development costs were $4.3 million at December 26, 1999 and December 27,
1998, and are reported in other assets in the accompanying consolidated
balance sheets.
ADVERTISING AND RELATED COSTS
Advertising and related costs include the costs of Company-owned restaurant
activities such as mail coupons, door hangers and promotional items and
contributions to the Papa John's Marketing Fund, Inc. (the "Marketing Fund")
and local market cooperative advertising funds. Contributions by
Company-owned and franchised restaurants to the Marketing Fund and the
cooperative advertising funds are based on an established percentage of
monthly restaurant revenues. The Marketing Fund is responsible for developing
and conducting marketing and advertising for the Papa John's system. The
local market cooperative advertising funds are responsible for developing and
conducting advertising activities in a specific market, including the
placement of electronic and print materials developed by the Marketing Fund.
Such funds are accounted for separately and are not included in our
consolidated financial statements, except as described below beginning with
the first quarter of 1998.
Effective December 29, 1997, we began recognizing Company-owned restaurant
contributions to the Marketing Fund and to those local market cooperative
advertising funds deemed to be controlled by us (collectively, the
"Controlled Funds"), as advertising and related costs at the time the
Controlled Funds actually incurred such expenses. Through December 28, 1997,
Company-owned restaurant contributions to the Marketing Fund and local market
cooperative advertising funds were expensed as incurred. The Controlled Funds
generally incurred expenses as contributions were received; therefore, the
impact of this change was not material.
FOREIGN CURRENCY TRANSLATION
The local currency is the functional currency for our foreign subsidiary,
Perfect Pizza. Earnings are translated into U.S. dollars using monthly
average exchange rates, while balance sheet accounts are translated using
year-end exchange rates. The resulting translation adjustments are included
as a component of accumulated other comprehensive income.
EARNINGS PER SHARE
The calculations of basic and diluted earnings per share before the
cumulative effect of a change in accounting principle for the years ended
December 26, 1999, December 27, 1998 and December 28, 1997 are as follows (in
thousands, except per share data):
38
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Options to purchase common stock with an exercise price greater than the
average market price were not included in the computation of the dilutive
effect of common stock options because the effect would have been
antidilutive. The number of antidilutive options was 986,000 in 1999, 213,000
in 1998, and 695,000 in 1997.
ACCOUNTING CHANGES
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities"
(the "SOP"), which requires that costs related to start-up activities be
expensed as incurred. Prior to 1998, we capitalized our start-up costs
incurred primarily in connection with opening new restaurant and commissary
locations and amortized these costs on a straight line basis over a period of
one year from the facility's opening date. We adopted the provisions of the
SOP in our financial statements for the year ended December 27, 1998. The
adoption resulted in a charge in the first quarter of 1998 for the cumulative
effect of an accounting change of $2.6 million, net of taxes of $1.5 million,
to expense costs that had been previously capitalized prior to 1998.
Excluding the one-time cumulative effect, the adoption of the new accounting
standard did not have a material impact on 1998 operating results.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative
Instruments and Hedging Activities," which is required to be adopted in years
beginning after June 15, 2000. Because of Papa John's minimal use of
derivatives, management does not anticipate that its adoption of SFAS 133
will have a significant effect on our earnings or financial position.
PRIOR YEAR DATA
Certain prior year data has been reclassified to conform to the 1999
presentation.
39
3. BUSINESS COMBINATIONS
On March 28, 1999, we acquired Minnesota Pizza Company, LLC ("Minnesota
Pizza"), a franchisee that operated 37 Papa John's restaurants in the
Minneapolis/St. Paul, Minnesota market. We issued 128,119 shares of our
common stock having a value of $5.4 million in exchange for all of the issued
and outstanding ownership interests of Minnesota Pizza. The transaction was
accounted for as a pooling of interests for financial reporting purposes and
as a taxable transaction for income tax purposes. Our previously reported
results of operations and balance sheets have been restated to include
Minnesota Pizza. Intercompany transactions between the Company and Minnesota
Pizza have been eliminated in the accompanying consolidated financial
statements. The operating results previously reported by the Company and
Minnesota Pizza separately are summarized below:
The Minnesota Pizza pro forma net income (loss) includes an income tax
benefit for the treatment of Minnesota Pizza as a C Corporation rather
than a limited liability company taxed as a partnership, with an assumed
effective income tax rate of 37%, assuming Minnesota Pizza would be able to
record the tax benefit on such losses.
On August 23, 1999, we acquired Great American Pizza, Inc., a franchisee
which operated 18 Papa John's restaurants in the Cleveland, Ohio market for
total consideration of $6.5 million, consisting of $1.5 million in cash and a
$5.0 million short-term note payable due January 2000.
On November 29, 1999, we acquired Perfect Pizza Holdings Limited ("Perfect
Pizza"), a Company located in the United Kingdom, for $32.3 million in cash.
The preliminary Perfect Pizza allocation for this acquisition resulted in
goodwill of $30.9 million, which is being amortized over 20 years. At
December 26, 1999, Perfect Pizza operated and franchised 206 restaurants (12
Company-owned and 194 franchised).
During 1999, we acquired an additional 10 Papa John's restaurants from
franchisees for $4.5 million in cash.
On December 27, 1999, subsequent to year-end, we acquired PJNJ Foods, Inc., a
franchisee of 19 Papa John's restaurants in New Jersey, for $7.9 million
($6.6 million in cash and $1.3 million of assumed net liabilities).
The business combinations in the previous four paragraphs were each accounted
for by the purchase method of accounting, whereby operating results
subsequent to the acquisition date are included in our financial statements.
Also see Note 12, Related Party Transactions, for a discussion of other
business combinations involving related parties.
40
4. INVESTMENTS
A summary of our available-for-sale securities as of December 26, 1999 and
December 27, 1998 follows (in thousands):
The amortized cost and estimated fair value of securities at December 26,
1999, by contractual maturity, are shown below (in thousands). Expected
maturities will differ from contractual maturities because the issuers of
securities may have the right to prepay obligations without prepayment
penalties.
41
5. NET PROPERTY AND EQUIPMENT
Net property and equipment consists of the following (in thousands):
6. FRANCHISEE LOAN PROGRAM
During 1996, we established a program under which selected franchisees may
borrow funds for use in the construction and development of their restaurants.
Loans outstanding to franchisees were approximately $11.7 million as of December
26, 1999 and $9.0 million as of December 27, 1998. As of December 26, 1999,
commitments to lend up to an additional $2.5 million had been made. Such loans
bear interest at fixed or floating rates (ranging from 5.5% to 12.0% at December
26, 1999), and are generally secured by the fixtures, equipment, signage and,
where applicable, land of each restaurant and the ownership interests in the
franchisee. Interest earned on franchisee loans was approximately $762,000 in
1999, $986,000 in 1998 and $815,000 in 1997, and is reported in investment
income in the accompanying consolidated statements of income. Approximately $3.6
million of the loans outstanding as of December 26, 1999 and $4.7 million as of
December 27, 1998 were to franchisees in which we or certain of our directors or
officers had an ownership interest.
7. ACCRUED EXPENSES
Accrued expenses consist of the following (in thousands):
42
8. DEBT AND CREDIT ARRANGEMENTS
As of December 26, 1999, we had a $20.0 million committed line of credit
agreement expiring on June 30, 2000. Subsequent to year-end, in connection
with the authorization of a share repurchase program (see Note 15), available
credit was extended to $100.0 million on an interim basis. Effective March
17, 2000, we entered into a new $150.0 million unsecured revolving line of
credit facility with an expiration date of March 17, 2003. Outstanding
balances for this facility accrue interest at 50.0 to 87.5 basis points over
LIBOR or other bank developed rates at our option. The committed 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). On March 17, 2000, $85.0 million was outstanding under
this facility.
In connection with the new line of credit facility, Papa John's entered into
a no-fee interest rate collar ("Collar") with a notional amount of $100.0
million, a 30-day LIBOR rate range of 6.36% (floor) to 9.50% (ceiling) and an
expiration date of March, 2003. The purpose of the Collar is to provide a
hedge against the effects of rising interest rates. Papa John's will make
payments under the terms of the Collar when the 30-day LIBOR rate is below
the floor to raise the effective rate to 6.36%, and will receive payments
when the 30-day LIBOR rate is above the ceiling, to lower the effective rate
to 9.50%, thus assuring that Papa John's effective 30-day LIBOR rate is
always within the above stated range. When the 30-day LIBOR rate is within
the range, no payments are made or received under the Collar. Amounts payable
or receivable under the Collar will be accounted for as an adjustment to
interest expense.
9. CHEESE PRICING ARRANGEMENT
Papa John's Franchise Advisory Council has initiated a program that allows
the cost of cheese to Papa John's restaurants to be established on a
quarterly basis. An independent franchisee-owned corporation, BIBP
Commodities, Inc. ("BIBP"), was established effective December 27, 1999
through which the program will be administered. BIBP will purchase cheese at
the market price and sell it to our distribution subsidiary, PJ Food Service,
Inc. (PJFS), at a fixed quarterly price based in part upon historical average
market prices. PJFS in turn sells cheese to Papa John's restaurants
(Company-owned and franchised) at a set quarterly price. Gains or losses
incurred by BIBP due to differences in the actual market price of cheese
purchased and the established quarterly sales price are factored into
determining the price for the following quarter. We have agreed to provide a
$17.6 million loan facility to BIBP to fund cash deficits that may arise. No
amounts were advanced under this facility as of December 26, 1999.
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10. INCOME TAXES
A summary of the provision for income taxes (exclusive of the tax effect
related to the cumulative effect of accounting change) follows (in thousands):
The reconciliation of income tax computed at the U.S. federal statutory rate to
income tax expense (exclusive of the tax effect related to the cumulative effect
of accounting change) for the years ended December 26, 1999, December 27, 1998
and December 28, 1997 is as follows (in thousands):
Income taxes paid were $19.4 million in 1999, $15.9 million in 1998 and $11.0
million in 1997.
44
11. PJ AMERICA, INC. STOCK WARRANT
PJ America, Inc. ("PJ America"), a franchisee of Papa John's, completed an
initial public offering ("IPO") of its common stock in October, 1996. In
connection with the IPO, PJ America issued a warrant to us to purchase
225,000 shares of its common stock. The warrant is exercisable in whole or in
part at any time within five years from the closing date of the IPO, and the
purchase price of each share of common stock pursuant to the warrant is
$11.25 per share (90% of the IPO price of $12.50 per share). The warrant was
issued by PJ America to Papa John's in consideration for the grant of rights
to enter into development agreements for certain specified territories and
the waiver by us of certain market transfer fees. Our agreement with PJ
America anticipates that PJ America will pay standard development and
franchise fees in connection with opening restaurants in the specified
territories.
We did not recognize income in connection with receipt of the warrant. The
warrant is classified as an available-for-sale security, and accordingly, is
stated at fair value in the consolidated balance sheets, with unrealized
gains, net of tax, reported within comprehensive income.
The fair value of the warrant was $956,000 on December 26, 1999 and $1.5
million on December 27, 1998, based upon the closing price per share of
$15.50 and $18.13 for PJ America common stock on those respective dates, and
is reported in investments in the accompanying consolidated balance sheets.
The intrinsic value of the warrant (market value of PJ America common stock
less the exercise price of the warrant) is considered a reasonable
approximation of the fair value of the warrant.
Certain of our officers and/or directors are also officers and/or directors
of PJ America.
12. RELATED PARTY TRANSACTIONS
Certain of our officers and directors own equity interests in entities that
operate and/or have rights to develop franchised restaurants. Certain of
these affiliated entities have agreements to acquire area development rights
at reduced development fees and also pay reduced initial franchise fees when
restaurants are opened. All such entities pay royalties at the same rate as
other franchisees. Following is a summary of transactions and balances with
affiliated entities (in thousands):
We paid $1.3 million in 1999, $966,000 in 1998 and $689,000 in 1997 for
charter aircraft services provided by entities owned by certain directors and
officers, including the Chief Executive Officer of Papa John's.
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12. RELATED PARTY TRANSACTIONS (CONTINUED)
We advanced $198,000 in 1999, $183,000 in 1998 and $197,000 in 1997, in
premiums for split-dollar life insurance coverage on the Chief Executive
Officer for the purpose of funding estate tax obligations. Papa John's and
the officer share the cost of the premiums. The premiums advanced by us will
be repaid out of the cash value or proceeds of the policies.
During the fourth quarter of 1999, we sold five restaurants to Capital Pizza,
Inc., for total consideration of $1.6 million ($1.4 million in cash and
$200,000 as a note receivable) and acquired one restaurant from Capital
Pizza, Inc. for total consideration of $190,000, in which we forgave a note
payable to us. Capital Pizza, Inc. is owned by certain of our officers,
including our Vice Chairman and President.
During the fourth quarter of 1997, we acquired a 49% equity ownership
interest in Mountain Pizza Group, L.L.C. ("MPG"), for $150,000 in cash. In
July 1998, we acquired the remaining 51% for $565,000 in cash. In connection
with the 1998 acquisition, we also assumed $2.4 million in MPG debt. MPG, an
entity which operated seven Papa John's restaurants in Denver, Colorado, was
owned by our Vice Chairman and President. The operating results of MPG were
accounted for by the equity method until the remaining 51% was acquired in
1998. Also, during the fourth quarter of 1997, we acquired three Papa John's
restaurants near Denver, Colorado, for $720,000 in cash. These restaurants
were owned by our Chief Executive Officer and his wife.
During the second quarter of 1997, we acquired 16 Papa John's restaurants in
North Carolina for $5.0 million (consisting of $4,960,000 in cash and a
credit of $40,000 towards future development fees). A majority ownership
interest in the franchisee of the North Carolina restaurants was held by
certain of our directors and officers, including our Chief Executive Officer.
The above acquisitions were accounted for by the purchase method of
accounting, whereby operating results subsequent to the acquisition date are
included in our financial statements.
13. LEASE COMMITMENTS
We lease office, retail and commissary space under operating leases with
terms generally ranging from three to five years and providing for at least
one renewal. Certain leases further provide that the lease payments may be
increased annually based on the Consumer Price Index. We also lease certain
equipment under operating leases with terms ranging from three to seven
years. Future minimum lease payments are as follows: 2000 - $16.8 million;
2001 - $14.6 million; 2002 - $12.1 million; 2003 - $10.2 million; 2004 - $8.4
million and thereafter - $30.7 million. Total rent expense was $12.4 million
in 1999, $11.2 million in 1998, and $8.5 million in 1997.
14. ADVERTISING LITIGATION
On August 12, 1998, Pizza Hut, Inc. filed suit against us in the United
States District Court for the Northern District of Texas, claiming that our
"Better Ingredients. Better Pizza." slogan constitutes false and deceptive
advertising in violation of the Lanham Trademark Act. The trial began on
October 25, 1999. On November 18, 1999, the jury returned a verdict that our
"Better Ingredients. Better Pizza." slogan is false and deceptive. On January
3, 2000, the court announced its judgment, awarding Pizza Hut $468,000 in
damages and ordering us to cease all use of the "Better Ingredients. Better
Pizza." slogan. Under the judge's order, we were to cease using the slogan in
print and broadcast advertising by January 24, 2000, phase out printed
46
14. ADVERTISING LITIGATION (CONTINUED)
promotional materials and other items containing the slogan (except signage)
by March 3, 2000 and remove the slogan from restaurant signage by April 3,
2000. However, we filed an appeal of the verdict and the court's order and a
motion for stay of the court's order pending outcome of the appeal. On
January 21, 2000, the United States Court of Appeals for the Fifth Circuit
granted a stay of the District Court judgment pending our appeal. Oral
arguments related to the appeal are scheduled to begin in April 2000.
We estimated that the pre-tax costs of complying with the court's order and
certain related costs could approximate $12.0 to $15.0 million, of which $6.1
million was recorded as a pre-tax charge against 1999 earnings. If our appeal
is successful, the timing, and possibly the amount, of costs to be incurred
could be favorably impacted.
15. SHARE REPURCHASE
The Papa John's Board of Directors has authorized the repurchase of up to
$150.0 million of common stock under a share repurchase program that began
December 9, 1999, and runs through December 31, 2000. Funding for the share
repurchase program will be provided through a combination of our existing
cash and investments, $150.0 million credit facility and operating cash flows.
Through December 26, 1999, a total of 1.3 million shares with an aggregate
cost of $31.7 million were repurchased under this program and placed in
treasury. Subsequent to year-end through March 17, 2000, an additional 3.4
million shares with an aggregate cost of $87.4 million had been repurchased.
16. STOCKHOLDER PROTECTION RIGHTS AGREEMENT
On February 14, 2000, the Board of Directors of the Company adopted a
Stockholder Protection Rights Agreement (the "Rights Plan"). Under the terms
of the Rights Plan, one preferred stock purchase right was distributed as a
dividend on each outstanding share of Papa John's common stock held of record
as of the close of business on March 1, 2000. The rights generally will not
become exercisable until a person or group acquires beneficial ownership of
15% or more of the Company's common stock in a transaction that is not
approved in advance by the Board of Directors. The Company's Founder and CEO,
John Schnatter, who currently owns more than 25% of the outstanding common
stock will be excluded from operation of the Rights Plan unless (together
with his affiliates and family members) he acquires more than 40% of the
Company's common stock.
If the rights are triggered, then each right owned by a stockholder other
than the unapproved acquirer entitles its holder to purchase shares of
Company common stock at 50% of its market price. In addition, after the
rights are triggered, if the Company is acquired by an unapproved acquirer in
a merger or other business combination transaction, each right that has not
previously been exercised will entitle its holder to purchase, at the right's
current exercise price, common shares of such other entity having a value of
twice the right's exercise price. The Company may redeem the rights for a
nominal amount at any time prior to an event that causes the rights to become
exercisable.
47
17. STOCK OPTIONS
In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation"
(SFAS 123), we have elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25), and related
Interpretations in accounting for our employee stock options because, as
discussed below, the alternative fair value accounting provided for under
SFAS 123 requires the use of option valuation models that were not developed
for use in valuing employee stock options. Under APB 25, because the exercise
price of our employee stock options equals or exceeds the market price of the
underlying stock on the date of grant, no compensation expense is recognized.
We award stock options under the Papa John's International, Inc. 1993 Stock
Ownership Incentive Plan (the "1993 Plan"), the Papa John's International,
Inc. 1993 Non-Employee Directors Stock Option Plan (the "Directors Plan") and
the Papa John's International, Inc. 1999 Team Member Stock Ownership Plan
(the "1999 Plan"). Shares of common stock authorized for issuance are
6,400,000 under the 1993 Plan, 370,000 under the Directors Plan and 1,000,000
under the 1999 Plan. Options granted under all plans generally expire ten
years from the date of grant and vest over one to five year periods, except
for certain options awarded under a previous multi-year operations
compensation program that vested immediately upon grant.
Pro forma information regarding net income and earnings per share is required
by SFAS 123, which also requires that the information be determined as if we
have accounted for our employee stock options granted subsequent to December
25, 1994 under the fair value method of that Statement. The fair value for
these options was estimated at the date of grant using a Black-Scholes option
pricing model, which was developed for use in estimating the fair value of
traded options which have no vesting restrictions and are fully transferable.
Option valuation models require the input of highly subjective assumptions
including the expected stock price volatility. Because our employee stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of our employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. Our pro
forma information follows, along with the indicated weighted average
assumptions used:
The pro forma net income before cumulative effect of a change in
accounting principle for 1998 and 1997 has been restated for the March 1999
acquisition of Minnesota Pizza (see Note 3).
48
17. STOCK OPTIONS (CONTINUED)
Because SFAS 123 is applicable only to options granted subsequent to December
25, 1994, our pro forma effect will not be fully reflected until a complete
five years of vesting occurs for 1995 option awards in 2000.
Information pertaining to options for 1999, 1998 and 1997 is as follows (number
of options in thousands):
The number, weighted-average exercise price and weighted-average remaining
contractual life of options outstanding as of December 26, 1999, and the
number and weighted average exercise price of options exercisable as of
December 26, 1999 follow (number of options in thousands):
Plan provisions provide that excess available shares under the 1993 Plan may
be transferred to the 1999 Plan. As of December 26, 1999, 477,000 shares were
available for future issuance under the 1993 and 1999 plans and 106,750
shares under the Directors Plan.
49
18. DEFINED CONTRIBUTION BENEFIT PLAN
We have established the Papa John's International, Inc. 401(k) Plan (the
"Plan"), as a defined contribution benefit plan, in accordance with Section
401(k) of the Internal Revenue Code. The Plan is open to all employees who
meet certain eligibility requirements and allows participating employees to
defer receipt of a portion of their compensation and contribute such amount
to one or more investment funds. Effective July 1, 1999, we began
contributing up to 1.5% of a participating employee's earnings. Our
contributions for 1999 were $220,000 and will vest based upon a participants'
service date. Administrative costs of the Plan are paid by us and are not
significant.
19. SEGMENT INFORMATION
We have defined three reportable segments: restaurants, commissaries, and
franchising. The restaurant segment consists of the operations of all
Company-owned restaurants and derives its revenues from retail sales of
pizza, breadsticks, cheesesticks and soft drinks to the general public. The
commissary segment consists of the operations of our regional dough
production and product distribution centers and derives its revenues from the
sale and distribution of food and paper products to Company-owned and
franchised restaurants. The franchising segment consists of our franchise
sales and support activities and derives its revenues from sales of franchise
and development rights and collection of royalties from our franchisees. All
other business units that do not meet the quantitative thresholds for
determining reportable segments consist of operations that derive revenues
from the sale of restaurant equipment, printing and promotional items, risk
management services, and information systems and related services used in
restaurant operations principally to Company-owned and franchised restaurants.
Generally, we evaluate performance and allocate resources based on profit or
loss from operations before income taxes and eliminations. Certain
administrative and capital costs are allocated to segments based upon
predetermined rates or actual estimated resource usage. The accounting
policies of the segments are the same as those described in the summary of
significant accounting policies. We account for intercompany sales and
transfers as if the sales or transfers were to third parties and eliminate
the related profit in consolidation.
Our reportable segments are business units that provide different products or
services. Separate management of each segment is required because each
business unit is subject to different operational issues and strategies.
Through December 26, 1999, substantially all revenues for each business
segment were derived from business activities conducted with customers
located in the United States. No single external customer accounted for 10%
or more of our consolidated revenues.
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19. SEGMENT INFORMATION (CONTINUED)
Segment information is as follows:
(1) Restated for the March 1999 acquisition of Minnesota Pizza (see Note 3).
(2) Excludes the cumulative effect of a change in accounting principle.
51
20. QUARTERLY DATA (UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE DATA)
All quarterly information above is presented in 13 week periods. Quarterly
amounts for 1998 previously reported have been restated to reflect the March
1999 acquisition of Minnesota Pizza, a business combination accounted for as
a pooling of interests (see Note 3).
52
REPORT OF MANAGEMENT
The consolidated financial statements appearing in this Annual Report have
been prepared by management, which is responsible for their preparation,
integrity and fair presentation. The statements have been prepared in
accordance with generally accepted accounting principles in the United States
and necessarily include some amounts that are based on management's best
estimates and judgments.
Management is responsible for the system of internal controls over financial
reporting at Papa John's International, Inc. and its subsidiaries, a system
designed to provide reasonable assurance regarding the preparation of
reliable published financial statements. This system is augmented by written
policies and procedures and the selection and training of qualified
personnel. Management believes that its system of internal controls over
financial reporting provides reasonable assurance that the financial records
are reliable for preparing financial statements.
The Audit Committee of the Board of Directors meets with the independent
auditors and management periodically to discuss internal controls over
financial reporting and other auditing and financial reporting matters. The
Committee reviews with the independent auditors the scope and results of the
audit effort. The Committee also meets with the independent auditors without
management present to ensure that the independent auditors have free access
to the Committee. The independent auditors are recommended by the Audit
Committee of the Board of Directors and selected by the Board of Directors.
Based upon their audit of the consolidated financial statements, the
independent auditors, Ernst & Young LLP, have issued their Report of
Independent Auditors, which follows.
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Papa John's International, Inc.
We have audited the accompanying consolidated balance sheets of Papa John's
International, Inc. and subsidiaries as of December 26, 1999 and December 27,
1998, and the related consolidated statements of income, stockholders' equity
and cash flows for each of the three years in the period ended December 26,
1999. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Papa John's International, Inc. and subsidiaries at December 26, 1999 and
December 27, 1998, and the consolidated results of their operations and their
cash flows for each of the three years in the period ended December 26, 1999,
in conformity with accounting principles generally accepted in the United
States.
As discussed in Note 2 to the consolidated financial statements, effective
for fiscal year 1998, the Company adopted SOP 98-5, "Reporting on the Costs
of Start-Up Activities."
/s/ Ernst & Young LLP
Louisville, Kentucky
March 17, 2000
53
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEMS 10, 11, 12 AND 13. DIRECTORS AND OFFICERS OF THE REGISTRANT; EXECUTIVE
COMPENSATION; SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT; AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:
The information required by these items, other than the information set forth
in this Report under Part I, "Executive Officers of the Registrant," is
omitted because we are filing a definitive proxy statement pursuant to
Regulation 14A not later than 120 days after the end of the fiscal year
covered by this Report which includes the required information. Such
information is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Consolidated Financial Statements:
The following consolidated financial statements, notes related thereto and
report of independent auditors are included in Item 8 of this Report:
Consolidated Statements of Income for the years ended December 26,
1999, December 27, 1998 and December 28, 1997
Consolidated Balance Sheets as of December 26, 1999 and December 27,
1998
Consolidated Statements of Stockholders' Equity for the years ended
December 26, 1999, December 27, 1998 and December 28, 1997
Consolidated Statements of Cash Flows for the years ended December 26,
1999, December 27, 1998 and December 28, 1997
Notes to Consolidated Financial Statements
Report of Independent Auditors
(a)(2) Consolidated Financial Statement Schedules:
All schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under
the related instructions or are not applicable and therefore have been
omitted.
(a)(3) Exhibits:
54
55
56
57
58
- ------------------
*Compensatory plan required to be filed as an exhibit pursuant to Item 14(c) of
Form 10-K.
(b) Reports on Form 8-K
1. We filed a Current Report on Form 8-K dated December 10, 1999
attaching a press release dated December 9, 1999 announcing
revised fourth quarter 1999 comparable sales estimates and a
$50 million stock repurchase authorization.
2. We filed a Current Report on Form 8-K dated December 10, 1999
attaching a press release dated November 29, 1999 announcing a
205-unit acquisition in the United Kingdom.
(c) Exhibits
The response to this portion of Item 14 is submitted as a separate
section of this report.
(d) Consolidated Financial Statement Schedules
All schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required
under the related instructions or are not applicable and therefore have
been omitted.
59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Date: March 23, 2000 PAPA JOHN'S INTERNATIONAL, INC.
By: /s/ John H. Schnatter
------------------------------
John H. Schnatter, Chairman and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
60
61
EXHIBIT INDEX
62