10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on May 12, 1999
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended March 28, 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 Identification
incorporation or organization) number)
11492 Bluegrass Parkway, Suite 175
Louisville, Kentucky 40299-2334
(Address of principal executive offices)
(502) 266-5200
(Registrant's telephone number, including area code)
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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
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At May 3, 1999, there were outstanding 30,142,253 shares of the
registrant's common stock, par value $.01 per share.
1
Note: The Condensed Consolidated Balance Sheet at December 27, 1998 has been
derived from the audited financial statements at that date restated to
reflect the acquisition of Minnesota Pizza Company, LLC, a business
combination accounted for as a pooling of interests (see note 3).
See accompanying notes.
2
Papa John's International, Inc. and Subsidiaries
Condensed Consolidated Statements of Income
(Unaudited)
Note: The Condensed Consolidated Statement of Income for the three months ended
March 29, 1998, has been restated to reflect the adoption of SOP 98-5 and
the acquisition of Minnesota Pizza Company, LLC, a business combination
accounted for as a pooling of interests (see note 2 and note 3).
See accompanying notes.
3
Papa John's International, Inc. and Subsidiaries
Condensed Consolidated Statements of Stockholders' Equity
(Unaudited)
4
Papa John's International, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Note: The Condensed Consolidated Statement of Cash Flow for the three months
ended March 29, 1998, has been restated to reflect the adoption of SOP
98-5 and the acquisition of Minnesota Pizza Company, LLC, a business
combination accounted for as a pooling of interests (see note 2 and note
3).
See accompanying notes.
5
Papa John's International, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
March 28, 1999
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S - X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments, consisting
of normal recurring accruals, considered necessary for a fair presentation have
been included. Operating results for the three months ended March 28, 1999, are
not necessarily indicative of the results that may be expected for the year
ended December 26, 1999. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Annual Report on Form
10-K for Papa John's International, Inc. (referred to as the "Company," "Papa
John's" or in the first person notations of "we," "us" and "our"), for the year
ended December 27, 1998.
2. Accounting Change
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5, "Reporting 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 at the time we
issued our financial statements for the year ended December 27, 1998 and have
restated all previously reported interim financial statements. 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.
3. Business Combinations
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, Minnesota market. We issued 128,119 shares of our common stock valued at
$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. 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. Intercompany transactions between the Company and Minnesota
Pizza have been eliminated in the accompanying restated condensed 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 38%.
6
Notes to Condensed Consolidated Financial Statements (continued)
(1) Excludes the cumulative effect of a change in accounting principle.
7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Restaurant Progression (1)
(1) Restated for the acquisition of Minnesota Pizza (see Note 3 of Notes to
Condensed Consolidated Financial Statements).
Results of Operations
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, Minnesota market. 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.
Revenues. Total revenues increased 20.5% to $187.4 million for the three months
ended March 28, 1999, from $155.5 million for the comparable period in 1998.
Restaurant sales increased 18.2% to $94.5 million for the three months ended
March 28, 1999, from $79.9 million for the comparable period in 1998. This
increase was primarily due to an increase of 17.5% in the number of equivalent
Company-owned restaurants open during the three months ended March 28, 1999,
compared to the same period in the prior year. "Equivalent restaurants"
represent 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, sales increased 2.9% for the three months ended March 28,
1999, over the comparable period in 1998 for Company-owned restaurants open
throughout both periods due to reduced price discounting during the 1999
quarter.
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Franchise royalties increased 30.6% to $9.4 million for the three months ended
March 28, 1999, from $7.2 million for the comparable period in 1998. This
increase was primarily due to an increase of 25.3% in the number of equivalent
franchised restaurants open during the three months ended March 28, 1999,
compared to the same period in the prior year. Also, sales increased 9.2% for
the three months ended March 28, 1999, over the comparable period in 1998 for
franchised restaurants open throughout both periods.
Franchise and development fees increased 33.4% to $1.5 million for the three
months ended March 28, 1999, from $1.1 million for the comparable period in
1998. This increase was primarily due to the 72 franchised restaurants opened
during the quarter, versus the 61 opened during the comparable period in 1998
and the mix of development agreements under which the restaurants were opened.
The average dollar amount of fees per franchised restaurant opening may vary
from period to period, as restaurants opened pursuant to older development
agreements and certain "Hometown restaurants" generally have lower required fees
than restaurants opened pursuant to more recent development agreements.
"Hometown restaurants" are generally located in smaller markets with fewer 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.
Commissary sales increased 24.3% to $70.0 million for the three months ended
March 28, 1999, from $56.3 million for the comparable period in 1998. This
increase was primarily the result of the increases in equivalent franchised
restaurants previously noted.
Equipment and other sales increased 9.8% to $12.0 million for the three months
ended March 28, 1999, from $10.9 million for the comparable period in 1998. This
increase was primarily due to ongoing equipment and smallwares orders related to
the previously noted increase in equivalent franchised restaurants and the
increase in the number of new restaurant equipment packages sold to franchisees
that opened restaurants during the first quarter of 1999 as compared to the same
period in 1998. The increase was partially offset by the decrease in sales of
the Papa John's PROFIT System, a proprietary point of sale system, for the three
months ended March 28, 1999, compared to the same period in 1998. Substantially
all franchisees had installed the Papa John's PROFIT System by March 29, 1998.
Costs and Expenses. Restaurant cost of sales, which consists of food, beverage
and paper costs, decreased as a percentage of restaurant sales to 24.6% for the
three months ended March 28, 1999, from 26.6% for the comparable period in 1998.
This decrease is primarily attributable to reduced restaurant menu price
discounting during the 1999 quarter.
Restaurant salaries and benefits (26.8% and 26.7%), occupancy costs (4.9% and
4.8%) and advertising and related costs (8.6% and 8.8%) were relatively
consistent as a percentage of restaurant sales for the three months ended March
28, 1999 and March 29, 1998.
Other restaurant operating expenses increased as a percentage of restaurant
sales to 13.5% for the three months ended March 28, 1999, from 13.2% for the
comparable period in 1998. The increase in other operating expenses as a
percentage of restaurant sales was primarily due to costs related to preparation
for the 14th anniversary promotion in April 1999. 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.
Commissary, equipment and other expenses include cost of sales and 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 91.2% for the three months ended March 28, 1999, as compared to
91.9% for the same period in 1998. Cost of sales as a percentage of combined
commissary sales and equipment and other sales decreased to 76.0% for the three
months ended March 28, 1999, from 78.3% for the comparable period in 1998. This
decrease is due primarily to the timing of certain favorable commodity price
changes and the change in classification of certain expenses to salaries and
benefits previously reported as cost of sales. Salaries and benefits increased
to 6.8% for the three months ended March 28, 1999, from 5.8% for the comparable
period in 1998 due primarily to the change in classification of certain expenses
previously reported in cost of sales and general and administrative expenses.
Other operating expenses increased to 8.4% for the three months ended March 28,
1999, from 7.8% for the comparable period in 1998, due primarily to higher
delivery costs related to the transition to a new distribution vendor and costs
related to preparation for the 14th anniversary promotion in April 1999.
9
General and administrative expenses as a percentage of total revenues decreased
to 7.5% for the three months ended March 28, 1999, from 8.1% for the comparable
period in 1998 due to leveraging expenses on a higher sales base and the
classification of certain expenses to commissary, equipment and other salaries
and benefits previously reported as general and administrative expenses.
Pre-opening and other general expenses increased slightly to $1.4 million for
the three months ended March 28, 1999, from $1.2 million for the comparable
period in 1998. The increase was primarily due to losses related to the
divestiture of five stores and closure of one store, partially offset by lower
restaurant pre-opening expenses. Restaurant pre-opening costs decreased due to
the lower number of corporate restaurant openings in the first quarter of 1999
compared to the same period in 1998.
Depreciation and amortization was consistent as a percentage of total revenues
at 3.0% in both quarters.
Investment Income. Investment income decreased to $792,000 at March 28, 1999,
compared to $976,000 for the comparable period in 1998 primarily due to a lower
average balance of franchise loans in the first quarter of 1999 as compared to
the same period in 1998.
Income Tax Expense. Income tax expense, exclusive of Minnesota Pizza operating
results, reflects a combined federal, state and local effective tax rate of
37.5% for the three months ended March 28, 1999, compared to 37.0% for the
comparable period in 1998 (see note 3). The effective tax rate in 1999 increased
as a result of a relative decrease in the level of tax-exempt investment income
to total pre-tax income.
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. Capital expenditures of $25.2 million for the three months
ended March 28, 1999, were funded by cash flow from operations and cash
generated from the exercise of stock options. Subsequent to March 28, 1999, we
have also retired $7.5 million of debt assumed in connection with our
acquisition of Minnesota Pizza.
Cash flow from operations increased to $20.3 million for the three months ended
March 28, 1999, from $17.2 million for the comparable period in 1998, due
primarily to the higher level of net income for the first quarter of 1999
partially offset by increases in other components of working capital.
In addition to restaurant development and potential acquisitions, significant
capital projects for the next 12 months are expected to include a full-service
commissary in Dallas, Texas by mid-1999. In mid-1999, we also expect to open a
247,000 square foot facility in Louisville, Kentucky, approximately 30-40% of
which will accommodate relocation and expansion of the Louisville commissary
operations and Support Services promotional division, and the remainder of which
will accommodate relocation and consolidation of corporate offices. In early-
2000, we expect to open a full-service commissary in Pittsburgh, Pennsylvania
and complete the expansion and relocation of the Phoenix, Arizona distribution
center to a full-service commissary.
We have been approved to receive up to $21.0 million in incentives under the
Kentucky Jobs Development Act in connection with the relocation of our corporate
offices. Based upon the expected timing of completion of the facility, we expect
to earn approximately $14.0 million of such incentives through 2007.
Capital resources available at March 28, 1999, include $37.4 million of cash and
cash equivalents, $47.1 million of investments and $18.5 million under a line of
credit expiring in June 1999. We expect to fund planned capital expenditures for
the next twelve months from these resources and operating cash flows.
Impact of Year 2000
Some of our older purchased software programs were written using two digits
rather than four to define the applicable year. As a result, time-sensitive
software or hardware recognizes a date using "00" as the year 1900 rather than
the year 2000. This could cause a system failure or miscalculations resulting in
disruptions of important administrative and operational processes, including,
among other things, a temporary inability to process transactions, send
invoices, or engage in similar normal business activities.
10
Our year 2000 evaluation has been ongoing since late 1997 and became more
formalized in January 1999 with the formation of a committee comprised of senior
management from various departments within the Company. The primary goal of the
committee is to assess and mitigate risk associated with year 2000 issues by
September 1999. The committee developed a three-phased approach to accomplish
this goal consisting of the following: (1) identifying and documenting the
business components impacted by the year 2000, both internally and externally,
assigning priority to those components identified based on the level of risk,
and determining year 2000 compliance; (2) performing tests for year 2000
compliance; and (3) developing contingency plans based upon the results of the
risk analysis and testing phases. We completed the first phase of our assessment
in April 1999 and are currently in the second phase with a target completion
date of July 1999. The third phase is targeted for completion in September 1999.
As part of the first phase, we completed an assessment of our internal
information technology and will have to modify or replace certain software and
hardware to function properly in the year 2000 and thereafter. Such
modifications started during phase one and will continue through phase two of
our project. Based on our assessment or representations from software suppliers,
or both, we believe the total year 2000 project cost is immaterial to our
financial position, net income and liquidity. Much of the cost related to year
2000 changes coincides with company plans to replace certain systems, including
the financial accounting and payroll/human resource systems, which was upgraded
in January 1999, in order to accommodate our planned growth. About 70% of the
new financial accounting system has been implemented and the remaining portion
is expected to be implemented by June 1999. Based upon the representations from
the manufacturers of these systems, we believe the systems are year 2000
compliant. The timing of implementation was not materially affected by year 2000
concerns.
We have taken action to ensure that our restaurant system is year 2000 compliant
by implementing a single point of sale operating system (Papa John's PROFIT
System) in all Company-owned and substantially all franchised restaurants.
Additionally, we have notified our franchisees of our year 2000 process and have
requested their assistance in ensuring year 2000 compliance with regard to their
business.
We believe that with the planned modifications to existing software and/or
conversions to new software and hardware as described above, the year 2000 issue
will not pose significant operational problems. However, if such modifications
and conversions are not made, or are not completed timely, the year 2000 issue
could have a material impact on certain administrative and operational
processes.
We have queried our significant vendors with respect to year 2000 issues and
have received responses from approximately 95% of the vendors, including our
cheese and tomato sauce vendors. We are not aware of any vendors with a year
2000 issue that would materially impact results of operations, liquidity, or
capital resources. However, we have no means of ensuring that vendors will be
year 2000 ready. The inability of vendors to complete their year 2000 resolution
process in a timely fashion could materially impact us, although the actual
impact of non-compliance by vendors is not determinable.
There can be no assurance that we will be completely successful in our efforts
to address year 2000 issues. We have no contingency plans in place in the event
we do not complete all phases of the year 2000 program. We plan to evaluate the
status of completion in July 1999 to determine whether such contingency plans
are necessary, although at this time we know of no reason our year 2000 program
will not be completed in a timely manner.
Forward Looking Statements
Certain information contained in this quarterly 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 or demand; changes
in consumer tastes or demographic trends; changes in federal or state laws, such
as increases in minimum wage; risks inherent to international development; and
factors associated with the year 2000 evaluation and modifications.
11
PART II. OTHER INFORMATION
Item 1. 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 under the federal Lanham Act
(the "Lawsuit") claiming, among other things, that we engaged in acts of unfair
competition through dissemination of "false, misleading and disparaging
advertising", including without limitation, the use of our "Better Ingredients.
Better Pizza." trademark. Pizza Hut is seeking injunctive relief and damages in
an amount of not less than $12.5 million, attorneys' fees, as well as other
relief. We have filed counterclaims against Pizza Hut (the "Counterclaims")
claiming, among other things, that the Lawsuit was filed primarily, if not
solely, as a competitive ploy and that Pizza Hut had engaged in false,
misleading and disparaging advertising aimed at us. We have asked the court for
an award of our reasonable attorneys' fees, as well as for other relief to which
we may be entitled. This Lawsuit and Counterclaims are in the mid-stages of
pleading and discovery. A trial has been scheduled for October 25, 1999. We do
not believe the Lawsuit has merit and intend to vigorously defend the claims
asserted against us. It is too early to assess the likelihood of success on the
merits of the parties' respective claims.
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 6. Exhibits and Reports on Form 8-K.
a. Exhibits
b. Current Reports on Form 8-K.
There were no reports filed on Form 8-K during the quarterly period ended
March 28, 1999.
12
SIGNATURES
Pursuant to the requirements 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.
PAPA JOHN'S INTERNATIONAL, INC.
(Registrant)
Date: May 11, 1999 /s/ E. Drucilla Milby
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E. Drucilla Milby, Senior Vice
President, Chief Financial Officer
and Treasurer
13