SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

 

Commission File Number:  0-21660

 

PAPA JOHN’S INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

 

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

 

(Title of Each Class)		(Name of each exchange on which registered)
None		None

 

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

 

Common Stock, $.01 par value

The NASDAQ Stock Market

 

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

 

Yes  ý                                                   No  o

 

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

 

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Act).

 

Yes  ý                                                   No  o

 

As of March 1, 2004 there were 17,638,396 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 $411,103,232 based on the last sale price of the Common Stock on March 1, 2004 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 13, 2004.

 

 

TABLE OF CONTENTS

 

PART I
	Item 1.	Business
	Item 2.	Properties
	Item 3.	Legal Proceedings
	Item 4.	Submission of Matters to a Vote of Security Holders
PART II
	Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
	Item 6.	Selected Financial Data
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 7A.	Quantitative and Qualitative Disclosures About Market Risk
	Item 8.	Financial Statements and Supplementary Data
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
	Item 9A.	Controls and Procedures
PART III
	Item 10.	Directors and Executive Officers of the Registrant
	Item 11.	Executive Compensation
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
	Item 13.	Certain Relationships and Related Transactions
	Item 14.	Principal Accountant Fees and Services
PART IV
	Item 15.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K

 

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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 carryout restaurants under the trademark “Papa John’s”. At December 28, 2003, the Company and its franchisees operated domestically in 49 states, the District of Columbia and 15 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 (referred to as “Perfect Pizza” and “Papa John’s UK”) in 1999 as part of our plan to develop restaurants internationally (see Development). At December 28, 2003, there were 2,790 Papa John’s restaurants in operation, consisting of 570 Company-owned and 2,220 franchised restaurants. Additionally, there were 135 franchised Perfect Pizza restaurants in operation.

 

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

 

Strategy

 

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

 

Limited Menu.  Domestic Papa John’s restaurants offer a focused menu of high-quality pizza along with side items, including breadsticks, cheesesticks, chicken strips and canned or bottled soft drinks. Papa John’s traditional crust pizza is prepared using fresh dough (never frozen). Papa John’s pizzas are made from a proprietary blend of wheat flour, cheese made from 100% real mozzarella, fresh-packed pizza sauce made from vine-ripened tomatoes (not from concentrate) and a proprietary mix of savory spices, and a choice of high-quality meat (100% beef and pork with no fillers) and vegetable toppings. All ingredients and toppings can be purchased from the Quality Control Center (“QC Centers”) 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. In international markets, the menu mix (toppings and side items) is adapted to local tastes.

 

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 QC Center 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.

 

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

 

Marketing. Our restaurant-level marketing programs target the delivery area of each restaurant, making extensive use of targeted print materials in direct mail and store-to-door couponing. Local marketing efforts also include a variety of community-oriented activities with schools, sports teams and other organizations. Local marketing efforts are supplemented with radio and television advertising, produced locally and on a national basis.  Six national television campaigns aired in 2003.

 

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

 

Unit Economics

 

In 2003, the 548 domestic Company-owned restaurants included in the most recent quarter’s comparable restaurant base generated average annual sales, based on a 52-week year, of $733,000, average cash flow (operating income plus depreciation) of $129,000 and average restaurant operating income of $103,000. This average operating income represents 14.1% of average sales and 37.9% of the $272,000 average cash investment for these Company-owned restaurants.

 

During 2002 and 2003, we implemented several restaurant initiatives, including certain system-wide quality initiatives. The cost of these initiatives reduced restaurant profitability during 2003 (see Company Operations - Restaurant Initiatives).

 

The average cash investment for the ten domestic Company-owned restaurants opened during the 2003 fiscal year, exclusive of land, was approximately $248,000. We expect the average cash investment for the six Company-owned restaurants expected to open in 2004 to be approximately $260,000. Substantially all domestic restaurants and many of our international restaurants do not offer dine-in areas, which reduces our restaurant capital investment.

 

Development

 

A total of 103 Papa John’s restaurants were opened during 2003, consisting of ten Company-owned and 93 franchised restaurants, while 105 Papa John’s restaurants closed during 2003, consisting of 28 Company-owned and 77 franchised. During 2003, two franchised Perfect Pizza restaurants were opened and 11 franchised restaurants were closed. A cumulative total of 60 (11 Company-owned and 49 franchised) Perfect Pizza restaurants have been converted to Papa John’s restaurants. We will continue to

 

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evaluate the conversion of the remaining 135 franchised Perfect Pizza restaurants to Papa John’s depending on financial performance and future growth opportunities.

 

During 2004, we plan to open approximately six Company-owned restaurants domestically and expect franchisees to open approximately 170 to 200 restaurants (120 to 140 domestically and 50 to 60 internationally). We also expect approximately 70 to 100 restaurants, primarily domestic franchised, to close during 2004. Domestic and international franchise unit expansion is expected to spread throughout markets across North and South America, Europe, Asia and the Middle East.

 

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

 

Restaurant Design and Site Selection

 

Backlit awnings, neon window designs and other visible signage characterize the exterior of most Papa John’s restaurants.  A typical domestic Papa John’s restaurant averages 1,100 to 1,500 square feet and a typical international Papa John’s restaurant averages 900 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 carryout customer area. The counters are designed to allow customers to watch the team members slap out the dough and put sauce and toppings on pizzas.

 

The Company is developing a restaurant image enhancement program that may be implemented in a small number of Company-owned restaurants during 2004. The targeted cost of the image enhancement program is expected to approximate $30,000 to $40,000 per inline unit and $45,000 to $60,000 per freestanding unit. The Company has not yet determined whether to implement the image enhancement program in other Company-owned restaurants, or whether to require franchisees to participate in the program.

 

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 freestanding buildings that provide visibility, curb appeal and accessibility. Our 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.

 

During the past several years, a number of freestanding restaurants have been opened in the Papa John’s system. We seek either existing buildings suitable for conversion, or locations suitable for the construction of our prototype restaurant. Freestanding buildings generally provide more signage and better visibility, accessibility and parking. We believe that these locations improve Papa John’s image

 

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and brand awareness, especially in emerging markets. At December 28, 2003, freestanding units represented approximately 25% of domestic Company-owned restaurants, and a relatively small percentage of domestic franchised restaurants. We do not expect to add many domestic freestanding restaurants in the future.

 

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

 

Quality Control Centers; Strategic Supply Chain Management

 

Our domestic QC Centers, comprised of 11 regional production and distribution centers, supply pizza dough, food products, paper products, smallwares and cleaning supplies twice weekly to each restaurant. This system enables us to monitor and control product quality and consistency, while lowering food costs. Our full-service QC Centers are located in Louisville, Kentucky; Dallas, Texas; Pittsburgh, Pennsylvania; Orlando, Florida; Raleigh, North Carolina; Jackson, Mississippi; Denver, Colorado; Rotterdam, New York; Portland, Oregon; Des Moines, Iowa; and Phoenix, Arizona. The QC Center system capacity is continually evaluated in relation to planned restaurant growth, and facilities are developed or upgraded as operational or economic conditions warrant. A new facility is currently under construction in Raleigh, North Carolina to replace the current QC Center.

 

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

 

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

 

PJ Food Service, Inc. (“PJFS”), our wholly-owned subsidiary that operates our domestic Company-owned QC Centers, has a purchasing arrangement with BIBP Commodities, Inc. (“BIBP”), a third-party entity formed at the direction of the Franchise Advisory Council (see Franchise Program – Franchise Advisory Council) for the sole purpose of reducing cheese price volatility to domestic system-wide restaurants. Under this arrangement, PJFS purchases cheese at a fixed quarterly price based in part on historical average cheese prices. Gains and losses incurred by the selling entity are passed to the QC Centers via adjustments to the selling price over time. Ultimately, PJFS purchases cheese at a price approximating the actual average market price, but with more predictability and less volatility than the previous purchasing method. Effective December 28, 2003, we consolidated BIBP in our financial

 

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statements pursuant to the adoption of Financial Accounting Standards Board Interpretation No. 46 (“FIN 46”). See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Consolidation of BIBP Commodities, Inc. (“BIBP”) as a Variable Interest Entity, and “Note 3” of “Notes to Consolidated Financial Statements” for additional information concerning BIBP and the purchasing arrangement, and the related financial statement treatment thereof.

 

Marketing Programs

 

All Company-owned and franchised Papa John’s restaurants within a co-developed market are required to join an area advertising cooperative (“Co-op”).  Each member restaurant contributes a percentage of sales to the Co-op for market-wide programs, such as radio, television and print advertising. The rate of contribution and uses of the monies collected are determined by a majority vote of the Co-op’s members.  The restaurant-level and Co-op marketing efforts are supported by print and electronic advertising materials that are produced by the Papa John’s Marketing Fund, Inc., a non-profit corporation (the “Marketing Fund”). The Marketing Fund produces and buys air time for Papa John’s national television commercials, in addition to other brand-building activities, such as consumer research. All domestic Company-owned and franchised Papa John’s restaurants are required to contribute a percentage of sales to the Marketing Fund. The contribution percentage was 2.0% in 2003 and 1.25% in 2002 and 2001.

 

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

 

We provide both Company-owned and franchised restaurants with 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 using customer information gathered by our proprietary point-of-sale technology (see Company Operations – Point of Sale Technology).

 

We have developed a system by which all domestic Papa John’s restaurant customers are able to place orders on-line via the internet. We receive a percentage fee based on on-line sales from domestic franchisees, in addition to royalties, for this service.

 

In November 2003, we began offering our customers the opportunity to purchase a reloadable gift card, (“Papa Card”) that can be purchased in any denomination between $10 and $100.  The Papa Card may be redeemed for delivery, carryout and on-line orders and is accepted at substantially all Papa John’s traditional U.S. restaurants.

 

In December 2003, we hired a new Chief Marketing Officer (“CMO”). The CMO is currently evaluating existing marketing programs and may modify or eliminate such programs, or add new programs as deemed appropriate and necessary.

 

Company Operations

 

Restaurant Personnel.  A typical Papa John’s restaurant employs a restaurant manager, one or two assistant managers and approximately 20 to 25 hourly team members, most of whom work part-time. The manager is responsible for the day-to-day operation of the restaurant and maintaining Company-established operating standards. The operating standards and other resources are contained in a comprehensive operations manual supplied to each restaurant. We seek to hire experienced restaurant

 

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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.

 

Historically, we employed area supervisors, each of whom had responsibility for overseeing three to six Company-owned restaurants. We also employed district managers who oversaw area supervisors and managers within their respective markets. Beginning in 2003, we combined the area supervisor and district manager positions into a director of operations position.

 

Restaurant Initiatives. During 2002 and 2003, several restaurant initiatives were undertaken with the ultimate goal of improving the quality and consistency of the customer experience. The first of these initiatives was the development of a systematic approach to monitor and evaluate key components of the total customer experience, the refinement and enhancement of which is ongoing. A second initiative was an across-the-board increase in base pay for restaurant general managers and assistant managers in an effort to attract and retain the desired quality of individuals to these critical positions.  In January 2003, we realigned field operations management by combining the area supervisor and district manager positions into a director of operations position. A director of operations is responsible for seven restaurants on average, thus providing higher-quality direct support to our general managers and their teams. The entire cost savings from the realignment was invested in increased staffing. In addition, during 2003, we implemented a system-wide initiative to increase portions for several core pizza products to enhance our customer experience.

 

We saw improved operational trends during 2003 as a result of these initiatives, including reduced turnover at the general manager and assistant manager positions and improved product quality and consistency. However, for the first nine months of 2003, the improvements did not result in increased sales as the overall restaurant industry, the pizza category and the economy produced a challenging environment. According to industry sources, customer traffic count has been relatively flat or declining in the quick service restaurant pizza segment for the latest reported seven consecutive quarters.

 

Given the current industry and overall economic environment, management cannot predict when operational improvements resulting from these initiatives or otherwise, may result in consistently improving sales trends. However, we are encouraged that our Company-owned restaurants reported a 2.4% increase in comparable sales during the fourth quarter of 2003, a 5.8% increase in January 2004 and a 1.9% increase in February 2004.

 

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

 

Point of Sale Technology.  Point of sale technology (our proprietary PROFIT System^TM) is in place in all domestic traditional Papa John’s restaurants and in substantially all Papa John’s international restaurants. We believe this technology facilitates faster and more accurate order taking and pricing, reduces paperwork and allows the restaurant manager to better monitor and control food and labor costs. We believe the PROFIT System enhances restaurant-level marketing capabilities through the development of a database containing information on customers and their buying habits with respect to our products.

 

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Polling capabilities allow us to obtain restaurant operating information, thereby improving the speed, accuracy and efficiency of restaurant-level reporting. During the next year, we will introduce the next generation of the PROFIT System to the domestic and international Papa John’s system. We believe this updated version will improve operational efficiencies at the restaurant level and improve our data collection process.

 

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

 

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

 

Franchise Program

 

General. We continue to attract franchisees with significant restaurant and retail experience. We consider our franchisees to be a vital part of our system’s continued growth and believe our relationship with our franchisees is good. As of December 28, 2003, there were 2,220 franchised Papa John’s restaurants operating in 49 states, the District of Columbia, and 15 international markets, and 135 franchised Perfect Pizza restaurants operating in the United Kingdom. As of December 28, 2003, we have development agreements with our domestic franchisees for approximately 329 additional franchised restaurants committed to open through 2010 and agreements for 596 additional international franchised restaurants to open through 2012. 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. There are no formal development agreements for franchised Perfect Pizza restaurants and we plan to open very few, if any, Perfect Pizza units in the future. Our plan is to attract new franchisees, and to work with existing franchisees, to open new Papa John’s restaurants in the United Kingdom and evaluate converting existing Perfect Pizza restaurants to the Papa John’s brand over time. During 2003, 93 (56 domestic and 37 international) franchised Papa John’s restaurants were opened, and two Perfect Pizza franchised restaurants were opened. Our franchisees have converted 49 Perfect Pizza restaurants to Papa John’s restaurants since 2000.

 

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

 

Development and Franchise Agreements. We enter into development agreements with our domestic franchisees for the opening of a specified number of restaurants within a defined period of time and specified geographic area.  Under our current standard development agreement, the franchisee is required to pay, at the time of signing the agreement, a non-refundable fee of $20,000 for the first restaurant and $5,000 for any additional restaurants. The non-refundable fee is credited against the standard $20,000 franchise fee payable to us upon signing the franchise agreement for a specific location. The fee is expected to increase to $25,000 in 2004. Generally, a franchise agreement is executed when a franchisee secures a location.

 

Our current standard domestic franchise agreement provides for a term of ten years (with one ten-year renewal option) and payment to us of a royalty fee of 4% of sales. The current agreement, as well as substantially all existing franchise agreements, permits us to increase the royalty fee up to 5% of sales.

 

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The royalty fee cannot be increased to an amount greater than the percentage royalty fee then in effect for new franchisees.

 

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

 

We opened our first franchised restaurant outside the United States in 1998. We define international markets to be all markets outside the contiguous United States in which we have either a development agreement or a master franchise agreement with a franchisee for the opening of a specified number of restaurants within a defined period of time and specified geographic area; therefore, a country could be divided into multiple markets. 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 (except for Hawaii and Alaska in which the initial fees are the same as domestic restaurants), the franchisee is required to pay total fees of $25,000 per restaurant, $5,000 at the time of signing the agreement, and $20,000 when the restaurant opens or the agreed-upon development date, whichever comes first. Under our current standard master franchise agreement, the master franchisee is required to pay total fees of $25,000 per restaurant owned and operated by the master franchisee, under the same terms as the development agreement, and $15,000 for each subfranchised restaurant, $5,000 at the time of signing the agreement and $10,000 when the restaurant opens or the agreed-upon development date, whichever comes first.

 

Our current standard international master franchise and development agreements provide for payment to us of a royalty fee of 5% of sales (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.

 

We franchise restaurants in the United Kingdom under Perfect Pizza franchise agreements, which were in effect at the time of our acquisition in 1999. These franchise agreements differ from our standard international franchise agreements in many respects, although with few material differences. A principal difference is the term of the agreement, which is five years. The franchise fee is £18,500 (approximately $33,000 at an exchange rate of $1.77 as of December 28, 2003), and the royalty rate of 5% is the same as in our standard international agreements. The Perfect Pizza system has been developed principally through franchising of individual restaurants to single location franchisees. Thus, the system historically had no equivalent to our development agreements or master franchise agreements. Recently, PJUK entered into multiple-unit development agreements for territories in Northwest London and in Scotland.

 

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

 

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

 

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Franchisee Loans. Selected franchisees have borrowed funds from our subsidiary, Capital Delivery, Ltd., principally for use in the construction and development of their restaurants. We have also entered into loan agreements with certain franchisees that purchased restaurants from us or other franchisees. Loans made to franchisees typically bear interest at fixed or floating rates (with a stated average interest rate of 4.8% at December 28, 2003) and in most cases are secured by the fixtures, equipment and signage (and where applicable, the land) of the restaurant and the ownership interests in the franchisee. At December 28, 2003, franchisee loans outstanding totaled $11.6 million, net of a $6.4 million reserve for uncollectible amounts. The loans outstanding include a loan of $1.2 million to the Marketing Fund (see Marketing Programs), that was repaid in January 2004. We do not plan to extend significant loans to franchisees in the future. See “Note 9” of “Notes to Consolidated Financial Statements” for additional information.

 

We have a commitment to lend up to $2.6 million to BIBP, a franchisee-owned corporation. During 2003, no amounts were outstanding to BIBP. See “Note 3” of “Notes to Consolidated Financial Statements” for additional information.

 

Franchise Insurance Program.  We provide our franchisees an opportunity to purchase various insurance policies, such as non-owned automobile and workers’ compensation, through our insurance agency, Risk Services Corp. (“Risk Services”). In October 2000, we established a captive insurance company located in Bermuda, RSC Insurance Services, Ltd., to accommodate this business. We have specific and aggregate reinsurance to limit the exposure to the captive insurance company. As of December 28, 2003, approximately 70% of domestic franchise restaurants had obtained insurance coverage through Risk Services. See “Note 10” of “Notes to Consolidated Financial Statements” for additional information.

 

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 franchise 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 appoint training store general managers or hire a full-time training coordinator certified to deliver Company-approved programs in order to train new team members and management candidates for their restaurants. Our area franchise directors maintain open communication with the franchise community, relaying operating and marketing information and new ideas between franchisees and us. Internationally, training is monitored by our international director of training as well as regional directors and international business managers assigned to specific franchisee territories. We also maintain communications with our franchisees through periodic system-wide meetings and newsletters.

 

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

 

Franchise Advisory Council. We have a Franchise Advisory Council that consists of Company and franchisee representatives of domestically owned restaurants. The Advisory Council and subcommittees hold regular meetings to discuss new marketing ideas, operations, growth and other relevant issues. Certain franchisees are exploring the formation of a franchise association, although we are not aware of any formal action that has been taken regarding such formation at this time.

 

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We currently communicate with, and receive input from, our franchisees in several forms, including through the Company’s Franchise Advisory Council, annual operations conferences and various regional meetings conducted with franchisees throughout the year. We are committed to communicating with, and receiving input from, our franchisees regardless of the venue or form such communications may ultimately take.

 

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

 

Industry and 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. Based on independent third-party research, the United States Quick Service Restaurant (“QSR”) Pizza category, which includes dine in, carry out and delivery, had sales of approximately $32.0 billion in 2003, of which Papa John’s share was reported as 5.8%. Within the pizza segment of the restaurant industry, we believe our primary competitors are the international pizza chains, including Pizza Hut, Domino’s and Little Caesars, and several regional chains, including chains executing a “take and bake” concept. A change in the pricing or other marketing strategies of one or more of our competitors could have an adverse impact on our sales and earnings. Additionally, a continued increased emphasis on carryout business by traditional casual dining restaurants, such as Applebee’s and Outback, as well as improved quality of fresh and frozen supermarket offerings, could also have an adverse impact on our sales and earnings.

 

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

 

Government Regulation

 

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

 

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

 

Trademarks

 

Our rights in our principal trademarks and service marks are a significant part of our business. We are the owner of the federal registration of the trademark “Papa John’s.” We have also registered “Pizza Papa John’s and design” (our logo), “Better Ingredients. Better Pizza.” and “Pizza Papa John’s Better Ingredients. Better Pizza. and design” as trademarks and service marks. We also own federal registrations for several ancillary marks, principally advertising slogans. We have also applied to register our primary trademark, “Pizza Papa John’s and design,” in more than 90 foreign countries and the European Community. 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.

 

Employees

 

As of December 28, 2003, we employed 14,610 persons, of whom approximately 12,630 were restaurant team members, 656 were restaurant management and supervisory personnel, 585 were corporate personnel and 739 were QC Center and support services personnel.  Most restaurant team members work part-time and are paid on an hourly basis. None of our team members is covered by a collective bargaining agreement. We consider our team member relations to be excellent.

 

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:

 

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

 

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

 

3.     An increase in the cost of cheese or other commodities could adversely affect the profitability of our system-wide restaurant operations. Cheese costs, historically representing 35% to 40% of our food cost, and other commodities are subject to seasonal fluctuations, weather, availability, demand and other factors that are beyond our control. Additionally, sustained increases in fuel and utility costs could adversely affect the profitability of our restaurant and QC Center businesses.

 

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

 

5.     Health- or disease-related disruptions or consumer concerns about the commodity supply could negatively impact the availability and/or cost of such commodities, thereby adversely impacting restaurant operations and our financial results.

 

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

 

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

 

8.     Domestically, we are dependent on sole suppliers for our cheese, pizza sauce, flour, chicken and meat toppings and our thin crust dough products. Alternative sources for these ingredients may not be available on a timely basis to supply these key ingredients or be available on terms as favorable to us as under our current arrangements. Domestic restaurants purchase substantially all food and related products from our QC Centers. Accordingly, both our corporate and franchised restaurants could be harmed by any prolonged disruption in the supply of products from our QC Centers. Additionally, domestic franchisees are only required to purchase proprietary spice mix and dough from our QC Centers and changes in purchasing practices by domestic franchisees could adversely affect the financial results of our QC Centers.

 

9.     We established a captive insurance company and began the current insurance program with franchisees in 2000. Over the last few years, premium rates charged to franchisees have increased

 

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significantly as a result of increased claims costs. The captive’s relatively immature claims history limits the predictive value of estimating the costs of incurred and future claims. Accordingly, the captive could continue to incur significant fluctuations in financial results as the captive provides insurance coverage to domestic franchisees.

 

10.   Our domestic and international operations could be negatively impacted by significant changes in international economic and political conditions. In addition, our international operations are subject to additional factors, including currency regulations and fluctuations, cultures and consumer preferences, diverse government regulations and structures, availability and cost of land and construction, ability to source ingredients and other commodities in a cost-effective manner, and differing interpretation of the obligations established in franchise agreements with international franchisees. Accordingly, there can be no assurance that our operations will achieve or maintain profitability or meet planned growth rates.

 

11.   Our planned conversion of a majority of Perfect Pizza restaurants to Papa John’s restaurants 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, cost-effective manner or that the existing Perfect Pizza market share can be successfully converted to Papa John’s.

 

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Item 2.  Properties

 

As of December 28, 2003, there were 2,790 Papa John’s restaurants and 135 Perfect Pizza restaurants system-wide.

 

Company-owned Papa John’s Restaurants

 

		Number of Restaurants
Colorado		50
Florida		37
Georgia		67
Illinois		4
Indiana		40
Kentucky		41
Maryland		49
Minnesota		36
Missouri		18
New Jersey		15
New Mexico		10
North Carolina		55
Ohio		16
South Carolina		4
Tennessee		29
Texas		73
Virginia		24
Total Domestic Company-owned Papa John’s Restaurants		568
United Kingdom		2
Total Company-owned Papa John’s Restaurants		570

 

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Domestic Franchised Papa John’s Restaurants

 

		Number of Restaurants
Alabama		60
Arizona		62
Arkansas		15
California		162
Colorado		4
Connecticut		2
Delaware		11
Florida		201
Georgia		63
Idaho		9
Illinois		81
Indiana		80
Iowa		21
Kansas		30
Kentucky		51
Louisiana		45
Maine		7
Maryland		32
Massachusetts		10
Michigan		63
Minnesota		11
Mississippi		21
Missouri		42
Montana		9
Nebraska		16
Nevada		17
New Hampshire		2
New Jersey		8
New Mexico		8
New York		30
North Carolina		59
North Dakota		6
Ohio		143
Oklahoma		27
Oregon		22
Pennsylvania		78
Rhode Island		6
South Carolina		44
South Dakota		7
Tennessee		67
Texas		138
Utah		24
Virginia		86
Washington		56
West Virginia		21
Wisconsin		40
Wyoming		4
Washington, D.C.		5
Total Domestic Franchised Papa John’s Restaurants		2,006

 

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International Franchised Papa John’s Restaurants

 

		Number of Restaurants
Alaska		3
Aruba		1
Bahamas		3
Canada		7
Cayman Islands		1
China		1
Costa Rica		11
Greece		1
Hawaii		16
Korea		4
Mexico		49
Puerto Rico		11
Russia		1
Saudi Arabia		14
Venezuela		17
United Kingdom		74
Total International Franchised Papa John’s Restaurants		214

 

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

 

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

 

Approximately 58 Company-owned restaurants are located in buildings we own on land either owned or leased by us. These restaurants range from 1,100 to 3,000 square feet. Seven of these restaurants are located in multi-bay facilities. These multi-bay facilities contain from 2,800 to 5,000 square feet, and the space not utilized by the Papa John’s restaurant in each facility is leased or held for lease to third party tenants.

 

We have 211 restaurants located in the United Kingdom (74 franchised and two Company-owned Papa John’s restaurants and 135 franchised Perfect Pizza restaurants). In addition to leasing the two Company-owned restaurant sites, we lease and sublease to franchisees 180 of the 209 franchised restaurant sites. The initial lease terms on the Company and franchised sites are generally 10 to 15 years. The initial lease terms of the franchisee subleases are generally five to ten years.

 

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Information with respect to our leased QC Centers and other facilities as of December 28, 2003 is set forth below.

 

Facility		Square Footage
Jackson, MS		30,000
Raleigh, NC (1)		27,000
Denver, CO		32,000
Phoenix, AZ		57,000
Des Moines, IA		43,000
Rotterdam, NY		45,000
Portland, OR		37,000
Pittsburgh, PA		52,000

 

(1)  We recently started construction of a 61,000 square foot site leased in Raleigh, NC to replace the current QC Center. We expect the new site to be complete in late 2004.

 

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

 

The Papa John’s UK management team is located in 6,000 square feet of leased office space in London with a remaining lease term of 12 years. In addition, Papa John’s UK leases a distribution center located in a 30,000 square foot facility in Staffordshire, England.

 

Item 3.  Legal Proceedings

 

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

 

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

 

Not applicable.

 

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EXECUTIVE OFFICERS OF THE REGISTRANT

 

Set forth below are the executive officers of Papa John’s, together with their ages as of January 1, 2004, their positions and the years in which they first became an officer:

 

Name		Age		Position		First Elected Executive Officer
John H. Schnatter		42		Founder, Chairman of the Board, Chief Executive Officer and President		1985
Robert J. Wadell *		48		Former President of PJ Food Service, Inc. and Chief Operating Officer		1990
William M. Van Epps		55		Senior Vice President and Chief Operations Officer		2002
Julie Larner		43		President of PJ Food Service, Inc. and Senior Vice President		2001
Charles W. Schnatter		41		Senior Vice President, Chief Development Officer and Secretary		1991
J. David Flanery		46		Senior Vice President, Chief Financial Officer and Treasurer		1994
Gary L. Langstaff		55		Senior Vice President and Chief Marketing Officer		2003
Michael R. Cortino		47		Senior Vice President of Corporate Operations		2000
Richard J. Emmett		48		Senior Vice President and General Counsel		1992

 

*Officer resigned from the Company in early 2004.

 

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, a position to which he was reappointed in January 2001.  He has been a franchisee since 1986.

 

Robert Wadell served as Chief Operating Officer from February 2001 until January 2004 and as President of PJ Food Service from 1995 until January 2004. Mr. Wadell served in various senior management positions in our QC Center Operation from 1990 to 1995. Mr. Wadell resigned from the Company effective in March 2004.

 

William Van Epps was named Senior Vice President and Chief Operations Officer in January 2004, responsible for domestic corporate and franchised restaurant operations and international operations. Mr. Van Epps served as Managing Director, International from September 2001 to January 2004. Prior to joining Papa John’s, Mr. Van Epps served for two years as President, International Division of Yorkshire Global Restaurants, responsible for the international development of Long John Silver’s and A&W restaurants. From 1993 to 1999, he served in several positions with AFC Enterprises, including President

 

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of its International Division. From 1988 to 1993, he was Vice President, Marketing and International for Western Sizzlin, Inc.

 

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

 

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

 

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

 

Gary Langstaff has served as Senior Vice President and Chief Marketing Officer since December 2003. Prior to joining Papa John’s, Mr. Langstaff spent 13 years consulting with companies, principally in the telecommunications, cable and biotechnology industries, in the areas of corporate strategy and marketing. Since 1998, he has served as a principal at 1919, Inc., a company that specializes in helping its clients identify, develop and leverage the value of their core brand assets. From 1989 to 1991, Mr. Langstaff served as Executive Vice President of Marketing and Brand Strategy for the Burger King Corporation. He served as Executive Vice President of Marketing at Hardee’s Food Systems from 1985 to 1988.

 

Mike Cortino has served as Senior Vice President of Corporate Operations since May 2000 after having served as Vice President of Operations Support since November 1999.  Prior to joining Papa John’s, Mr. Cortino served five years as Vice President of Corporate Operations for AFC Enterprises – Church’s Chicken Brand and ten years as a market manager and other positions with Taco Bell.

 

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

 

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

 

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PART II

 

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

 

Our common stock trades on the NASDAQ National Market tier of The NASDAQ Stock Market under the symbol PZZA. As of March 1, 2004, there were approximately 885 record holders of common stock. The following table sets forth for the quarters indicated the high and low closing sales prices of our common stock, as reported by The NASDAQ Stock Market.

 

2003		High			Low
First Quarter		$	28.04		$	22.95
Second Quarter		28.65			23.21
Third Quarter		28.25			24.38
Fourth Quarter		33.10			23.80

 

2002		High			Low
First Quarter		$	28.50		$	23.42
Second Quarter		34.70			27.86
Third Quarter		33.05			27.35
Fourth Quarter		30.73			24.48

 

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

 

The Papa John’s Board of Directors has authorized the repurchase of up to $400 million of common stock under a share repurchase program that began December 9, 1999, and runs through December 26, 2004. Through December 28, 2003, a total of 13.6 million shares with an aggregate cost of $351.6 million and an average price of $25.92 per share have been repurchased under this program and placed in treasury. The following table summarizes our repurchases by fiscal period during 2003 (in thousands, except per share amounts):

 

Fiscal Period		Total Number of Shares Purchased		Average Price Paid per Share			Total Number of Shares Purchased as Publicly Announced Plans or Programs		Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
12/30/2002 - 01/26/2003		125		$	27.80		13,486		$	50,811
01/27/2003 - 02/23/2003		25		$	25.65		13,511		$	50,170
11/24/2003 - 12/28/2003		56		$	32.06		13,567		$	48,370

 

There were no share repurchases for the fiscal periods of 2/24/2003 through 11/23/2003.

 

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Item 6.  Selected Financial Data

 

The selected financial data presented for each of the years in the five-year period ended December 28, 2003 was derived from our audited consolidated financial statements. The selected financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and Notes thereto included in Item 7 and Item 8, respectively, of this Form 10-K.

 

		Year Ended (1)
(In thousands, except per share data)		Dec. 28, 2003			Dec. 29, 2002			Dec. 30, 2001			Dec. 31, 2000			Dec. 26, 1999
Income Statement Data
Domestic revenues:
Restaurant sales		$	416,049		$	429,813		$	445,849		$	456,637		$	394,636
Franchise royalties (2)		49,851			51,386			50,768			47,145			40,567
Franchise and development fees		1,475			1,734			2,927			5,559			6,511
Commissary sales		369,825			381,217			390,889			356,101			311,005
Other sales		48,541			50,055			52,730			53,233			53,078
International revenues:
Royalties and franchise and development fees (3)		6,297			5,846			5,895			5,302			1,063
Restaurant and commissary sales (4)		25,340			26,168			26,014			25,546			2,561
Total revenues		917,378			946,219			975,072			949,523			809,421
Operating income (5)		60,540			81,427			82,783			57,389			72,484
Investment income		672			1,126			1,958			1,943			3,384
Interest expense		(6,851		)	(7,677		)	(8,857		)	(7,746		)	(151		)
Income before income taxes and cumulative effect of a change in accounting principle		54,361			74,876			75,884			51,586			75,717
Income tax expense		20,385			28,079			28,639			19,762			28,431
Income before cumulative effect of a change in accounting principle		33,976			46,797			47,245			31,824			47,286
Cumulative effect of accounting change, net of tax (6)		(413		)	—			—			—			—
Net income		$	33,563		$	46,797		$	47,245		$	31,824		$	47,286
Basic earnings per common share:
Income before cumulative effect of a change in accounting principle		$	1.89		$	2.33		$	2.09		$	1.29		$	1.57
Cumulative effect of accounting change, net of tax (6)		(0.02		)	—			—			—			—
Basic earnings per common share		$	1.87		$	2.33		$	2.09		$	1.29		$	1.57
Earnings per common share - assuming dilution:
Income before cumulative effect of a change in accounting principle		$	1.88		$	2.31		$	2.08		$	1.28		$	1.52
Cumulative effect of accounting change, net of tax (6)		(0.02		)	—			—			—			—
Earnings per common share - assuming dilution		$	1.86		$	2.31		$	2.08		$	1.28		$	1.52
Basic weighted average shares outstanding		17,938			20,068			22,600			24,703			30,195
Diluted weighted average shares outstanding		18,037			20,300			22,753			24,907			31,080
Balance Sheet Data
Total assets		$	347,214		$	366,832		$	387,439		$	395,658		$	372,051
Total debt		61,250			140,085			105,310			146,607			6,233
Stockholders’ equity		159,272			121,947			195,632			166,321			292,133

 

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(1)     We operate on a 52-53 week fiscal year ending on the last Sunday of December of each year.  All fiscal years presented consisted of 52 weeks, except the 2000 fiscal year, which consisted of 53 weeks.

(2)     Domestic Franchise royalties were derived from franchise restaurant sales of $1.29 billion in 2003, $1.32 billion in 2002, $1.30 billion in 2001, $1.21 billion in 2000 and $1.03 billion in 1999.

(3)     International Royalties were derived from franchise restaurant sales of $111.5 million in 2003, $104.2 million in 2002, $99.7 million in 2001, $78.3 million in 2000 and $12.0 million in 1999.

(4)     We purchased Perfect Pizza in November 1999 (see Business – Development). Restaurant sales for Company-owned United Kingdom restaurants were $2.4 million in 2003, $4.0 million in 2002, $4.5 million in 2001, $4.3 million in 2000 and $455,000 in 1999.

(5)     Operating income includes restaurant closure, impairment and disposition losses (gains) of $5.5 million in 2003, $1.1 million in 2002 and ($1.2 million) in 2001. Fiscal 2000 includes special charges of $20.9 million. Operating income for 1999 includes special charges of $6.1 million. See “Note 6” of “Notes to Consolidated Financial Statements.”

(6)     Reflects the cumulative effect on income and earnings per share of a change in accounting principle, net of tax, as required by Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. 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 28, 2003, there were 2,790 Papa John’s restaurants in operation, consisting of 570 Company-owned and 2,220 franchised, and 135 franchised Perfect Pizza restaurants in the United Kingdom. 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.

 

New unit openings in 2003 were 105 as compared to 115 in 2002 and 210 in 2001. Several factors have resulted in reduced unit openings during the past three years, including the competitive sales environment, operating margin pressures due to increased wages, insurance and other costs and the overall economic environment including franchisees’ access to capital. The rate of future unit expansion will also be impacted by these and other factors. Unit closings in 2003 were 116 as compared to 101 in 2002 and 105 in 2001. The closings during the past three years were due to many of the same factors impacting unit openings and the rate of future closings will also be impacted by these and other factors.

 

We have continued to produce strong average sales from our Company-owned restaurants even with a very competitive market environment. Our expansion strategy is to cluster restaurants in targeted markets, thereby increasing consumer awareness and enabling us to take advantage of operational, distribution and advertising efficiencies. Average sales for our most recent quarter’s comparable base restaurants decreased to $733,000 for 2003, from $747,000 for 2002 and as compared to $739,000 for 2001. Average sales volumes in new markets are generally lower than in those markets in which we have established a significant market position.

 

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The comparable annual sales for Company-owned restaurants decreased 3.0% in 2003, increased 0.2% in 2002 and decreased 2.9% in 2001. We believe the cumulative decrease in comparable sales over the last three years is the result of an increased competitive market.

 

We continually strive to obtain high-quality sites with good access and visibility, and to enhance the appearance and quality of our restaurants. We believe that these factors improve our image and brand awareness. The average cash investment for the restaurants in our most recent comparable sales base is $272,000. The average cash investment for the ten domestic Company-owned restaurants opened during 2003, exclusive of land, decreased to approximately $248,000 from $250,000 for the ten units opened in 2002. We expect the average cash investment for restaurants opening in 2004 to be approximately $260,000.

 

Approximately 48% of our revenues for 2003 and 2002 and 47% for 2001 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. (“PJFS”), our support services subsidiary, Papa John’s Support Services, Inc., our insurance subsidiaries, RSC Insurance Services, Ltd. and Risk Services Corp. and our United Kingdom subsidiary, Papa John’s UK. We believe that, in addition to supporting both Company and franchised growth, these subsidiaries contribute to product quality and consistency and restaurant profitability throughout the Papa John’s system.

 

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

 

Restaurant Initiatives

 

The company announced several restaurant initiatives throughout 2002 and 2003, including certain system-wide quality initiatives, increases in general manager and assistant manager base pay and incentive pay potential, increased restaurant staffing levels, a realignment of the field management structure for company-owned restaurants and a system-wide initiative to increase portions for several core pizza products.

 

During 2003 we saw improved operational trends as a result of these initiatives, including reduced turnover at the general manager and assistant manager positions, and improved product quality and consistency.  However, during most of 2003, the improvements did not translate into increased sales as the overall restaurant industry, the pizza category and the economy continued to produce a very challenging environment. According to industry sources, customer traffic count was relatively flat or declined in the QSR pizza segment for the latest reported seven consecutive quarters, with data for the most recent September-October-November quarter indicating a 4% decline in transactions for the segment. Although the current industry and overall economic environment continue to be challenging, we are encouraged by our recently reported results: Four of the last five reported periods (October 2003 through February 2004) have realized increases in comparable sales.

 

The system-wide cost of these initiatives, when combined with the declining comparable sales trends in 2003, negatively impacted operating margins for both company-owned and franchise restaurants. The Company has begun initiatives, such as focusing on procurement, administrative and marketing costs to identify opportunities for improving restaurant-operating margins. Additionally, we employed a new Chief Marketing Officer in December 2003. We believe the anticipated and realized success of these initiatives will encourage new unit development and reduce future unit closings. Accordingly, annual net unit percentage growth could return to the mid-single digits over the next few years. Further, the combination of net unit growth, a return to consistent

 

24

 

low single digit percentage increases in comparable sales, improved restaurant operating margins and flat to increasing levels of free cash flow could result in annual earnings per share percentage growth in the low double digits over the next few years.

 

Results of Operations and Critical Accounting Policies and Estimates

 

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

 

Allowance for Doubtful Accounts and Notes Receivable

 

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

 

Long-lived and Intangible Assets

 

The recoverability of long-lived and intangible (i.e., goodwill) assets is evaluated annually or more frequently if impairment indicators exist. Indicators of impairment include historical financial performance, operating trends and our future operating plans. If impairment indicators exist, we evaluate the recoverability of long-lived and intangible assets based on forecasted undiscounted cash flows. The estimation of future cash flows requires management’s judgment concerning future operations, economic growth in local or regional markets and the impact of competition. There are inherent uncertainties related to these factors and management’s judgments in applying these factors to the analysis of long-lived and intangible asset impairment. It is possible that the assumptions underlying the impairment analysis will change in such a manner that additional impairment charges may occur.

 

The Company’s restaurant operating profitability declined significantly during 2003 primarily as a result of negative sales trends, coupled with increasing costs, both as a result of management initiatives (e.g., across-the-board salary increases for restaurant general managers and assistant managers) and outside factors (e.g., health care and insurance costs). During 2003, we recorded charges of $2.5 million to reflect the impairment of 25 domestic restaurants. See “Note 6” of “Notes to Consolidated Financial Statements” for additional information.

 

Insurance Reserves

 

Our insurance programs for workers’ compensation, general liability, owned and non-owned automobiles and health insurance coverage provided to our employees, and the captive insurance program provided to our franchisees are self-insured up to certain individual and aggregate reinsurance levels. Losses are accrued based upon estimates of the aggregate retained liability for claims incurred using certain actuarial projections and our claims loss experience. The estimated insurance claims losses could be significantly affected should the frequency or ultimate cost of claims significantly differ from historical trends used to estimate the insurance reserves recorded by the Company.  In 2003, we recorded a $6.3 million increase in existing claims loss reserves, as compared to expected claims costs, at our captive

 

25

 

insurance company, based on updated actuarial valuations. See “Note 10” of “Notes to Consolidated Financial Statements” for additional information.

 

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

 

BIBP is a franchisee-owned corporation through which a cheese-purchasing program is conducted on behalf of domestic-owned and franchised restaurants. As required by the Financial Accounting Standards Board’s (“FASB”) Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (FIN 46), we began consolidating the financial results of BIBP at the end of the fourth quarter of 2003. The consolidation of BIBP could have a significant impact on Papa John’s operating income in future periods due to the volatility of cheese prices. Papa John’s will recognize the operating losses generated by BIBP if the shareholders’ equity is in a net deficit position.  Further, Papa John’s will recognize subsequent operating income generated by BIBP up to the amount of BIBP losses previously recognized.

 

Accounting Changes

 

Statement of Financial Accounting Standards No. 150

 

We adopted Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, (SFAS No. 150) in 2003. SFAS No. 150 requires parent companies to record minority interest liabilities at estimated settlement value if the majority-owned subsidiary has equity instruments that are redeemable at a fixed date and such redemption is certain to occur. We have a majority interest in one subsidiary, which owns and operates 24 Papa John’s restaurants, that meets these provisions. In 2003, we recorded an after-tax cumulative effect adjustment of $413,000 ($660,000 pre-tax) or $0.02 per share, in our consolidated statements of income, related to the adoption of SFAS No. 150. SFAS No. 150 is not expected to have a significant impact on future earnings reported by the Company.

 

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

 

As previously discussed, FIN 46 addresses the potential consolidation of variable interest entities (VIEs). The provisions of FIN 46, as revised during 2003, significantly alter the method for evaluating whether certain VIEs, as defined, should be consolidated in a company’s financial statements. As noted above, we began consolidating BIBP at December 28, 2003. A cumulative effect adjustment was not required with the adoption of FIN 46 as BIBP had a surplus in stockholders’ equity at December 28, 2003. Papa John’s is also the primary beneficiary, as defined by FIN 46, of four franchise entities that qualify as VIEs. We will begin consolidating these four franchise entities at the end of the first quarter of 2004, as required by FIN 46, which will result in the recording of goodwill approximating $3.3 million. The Company’s future operating earnings are not expected to be significantly impacted by consolidating these four entities.

 

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Percentage Relationships and Restaurant Data and Unit Progression

 

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

 

		Year Ended
		Dec. 28, 2003		Dec. 29, 2002		Dec. 30, 2001
Income Statement Data:
Domestic revenues:
Restaurant sales		45.3	%	45.4	%	45.7	%
Franchise royalties		5.4		5.4		5.2
Franchise and development fees		0.2		0.2		0.3
Commissary sales		40.3		40.3		40.1
Other sales		5.3		5.3		5.4
International revenues:
Royalties and franchise and development fees		0.7		0.6		0.6
Restaurant and commissary sales		2.8		2.8		2.7
Total revenues		100.0		100.0		100.0
Costs and expenses:
Domestic restaurant cost of sales (1)		22.2		23.0		24.8
Domestic restaurant operating expenses (1)		60.9		56.1		56.6
Domestic commissary and other expenses (2)		90.9		90.1		89.9
International operating expenses (3)		85.8		83.8		83.6
General and administrative expenses		7.3		7.7		7.1
Provision for uncollectible notes receivable (4)		0.2		0.3		0.1
Restaurant closure, impairment and disposition losses (gains) (5)		0.6		0.1		(0.1	)
Other general expenses		0.4		0.7		0.5
Depreciation and amortization		3.4		3.4		3.6
Total costs and expenses		93.4		91.4		91.5
Operating income		6.6		8.6		8.5
Net interest expense		(0.7	)	(0.7	)	(0.7	)
Income before income taxes and cumulative effect of a change in accounting principle		5.9		7.9		7.8
Income tax expense		2.2		3.0		3.0
Income before cumulative effect of a change in accounting principle *		3.7	%	4.9	%	4.8	%

 

*The cumulative effect of a change in accounting principle, as a percent of sales, had less than a 10 basis point impact.

 

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		Year Ended
		Dec. 28, 2003			Dec. 29, 2002			Dec. 30, 2001
Restaurant Data:
Percentage increase (decrease) in comparable Company-owned restaurant sales (6)		(3.0		)%	0.2		%	(2.9		)%
Number of Company-owned restaurants included in the respective most recent quarter’s comparable restaurant base		548			562			573
Average sales for Company-owned restaurants included in the most recent comparable restaurant base		$	733,000		$	747,000		$	739,000
Papa John’s Restaurant Progression:
U.S. Company-owned:
Beginning of period		585			601			631
Opened		10			10			20
Closed		(27		)	(19		)	(17		)
Acquired from franchisees		—			3			16
Sold to franchisees		—			(10		)	(49		)
End of period		568			585			601
International Company-owned:
Beginning of period		9			10			10
Closed		(1		)	—			—
Converted (7)		—			3			—
Acquired from franchisees		1			—			—
Sold to franchisees		(7		)	(4		)	—
End of period		2			9			10
U.S. franchised:
Beginning of period		2,000			1,988			1,902
Opened		56			76			139
Closed		(50		)	(71		)	(72		)
Acquired from Company		—			10			49
Sold to Company		—			(3		)	(16		)
Reclassification (8)		—			—			(14		)
End of period		2,006			2,000			1,988
International franchised:
Beginning of period		198			130			69
Opened		37			27			48
Closed		(27		)	(5		)	(8		)
Converted (7)		—			42			7
Acquired from Company		7			4			—
Sold to Company		(1		)	—			—
Reclassification (8)		—			—			14
End of period		214			198			130
Total restaurants — end of period		2,790			2,792			2,729

 

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		Year Ended
		Dec. 28, 2003		Dec. 29, 2002		Dec. 30, 2001
Perfect Pizza Restaurant Progression:
Company-owned
Beginning of period		—		3		3
Opened		—		—		1
Sold to franchisees		—		—		(1	)
Converted (7)		—		(3	)	—
End of period		—		—		3
Franchised
Beginning of period		144		190		202
Opened		2		2		2
Closed		(11	)	(6	)	(8	)
Acquired from Company		—		—		1
Converted (7)		—		(42	)	(7	)
End of period		135		144		190
Total restaurants - end of period		135		144		193

 

(1)       As a percentage of Domestic Restaurant sales.

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

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

(4)       See “Note 9” of “Notes to Consolidated Financial Statements.”

(5)       See “Note 6” of “Notes to Consolidated Financial Statements.”

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

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

(8)       Represents the reclassification of 11 Hawaii units and three Alaska units opened prior to 2001 from domestic franchising to international franchising. Effective January 1, 2001, for restaurant unit purposes, “domestic” operations includes only those units located in the contiguous United States.

 

2003 Compared to 2002

 

Revenues. Total revenues decreased 3.0% to $917.4 million in 2003, from $946.2 million in 2002.

 

Domestic Company-owned restaurant sales decreased 3.2% to $416.0 million in 2003 compared to $429.8 million for the same period in 2002. This 3.2% decrease is primarily due to a 3.0% decrease in comparable sales for 2003.

 

Domestic franchise sales decreased 2.2% in 2003 to $1.3 billion primarily resulting from a 3.6% decrease in comparable sales for the 2003 period, partially offset by an increase in average sales volumes for franchise units not included in the comparable sales unit base. Domestic franchise royalties decreased 3.0% to $49.9 million from $51.4 million in 2002 primarily due to the decrease in franchise sales noted above and an increase in the level of reduced royalty arrangements initiated in 2003.

 

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The comparable sales base and average weekly sales for 2003 and 2002 for domestic Company-owned and domestic franchised restaurants consisted of the following:

 

		Year Ended December 28, 2003							Year Ended December 29, 2002
		Company			Franchise					Company			Franchise
Total domestic units (end of year)		568			2,006					585			2,000
Equivalent units		577			1,990					581			1,982
Comparable sales base units		560			1,908					550			1,764
Comparable sales base percentage		97.1		%	95.9			%		94.8		%	89.0		%
Average weekly sales - comparable units		$	13,959		$	12,552				$	14,409		$	13,122
Average weekly sales - other units		$	10,956		$	10,706				$	11,100		$	10,238
Average weekly sales - all units		$	13,872		$	12,476				$	14,236		$	12,805

 

Domestic franchise and development fees, including approximately $430,000 recognized upon development cancellation or franchise renewal and transfer, were $1.5 million in 2003 compared to $1.7 million in 2002. There were 56 domestic franchise unit openings in 2003 as compared to 76 in 2002.

 

Domestic commissary and other sales decreased 3.0% to $418.4 million for 2003 from $431.3 million in 2002, primarily as a result of lower commissary sales due to lower cheese costs, and lower equipment sales in 2003 as a result of outsourcing this function in late 2002, partially offset by an increase in revenues from insurance-related services provided to our franchisees.

 

International revenues consist of the Papa John’s United Kingdom operations which are denominated in British Pounds Sterling and converted to U.S. dollars (92% of total 2003 international revenues) and combined revenues from operations in 14 other international markets denominated in U.S. dollars. International revenues decreased 1.2% to $31.6 million in 2003 compared to $32.0 million in 2002, as lower Company-owned restaurant and commissary sales were substantially offset by a favorable exchange rate impact of $2.4 million and increased royalties.

 

Costs and Expenses.  The restaurant-operating margin at domestic Company-owned units was 16.9% for 2003 compared to 20.9% in 2002, consisting of the following differences as a percent of Company-owned restaurant sales:

 

•      Cost of sales was 0.7% lower in 2003 primarily due to lower cheese costs, partially offset by portion increases for several core pizza products implemented during the second quarter of 2003.

•      Salaries and benefits were 3.3% higher in 2003 reflecting the impact of an across-the-board increase in base pay for general managers and assistant managers implemented during the third quarter of 2002, the loss of leverage on fixed salaries due to the decrease in average unit sales and increased health insurance costs. Additionally, in connection with the field management realignment announced in January 2003, we increased restaurant staffing levels and general manager and assistant manager bonus potential.

•      Advertising and related costs were 0.9% higher in 2003 primarily due to increases in national spending and lower than anticipated sales.

•      Occupancy costs were 0.6% higher in 2003 primarily as a result of increased utility and general insurance costs combined with lower sales.

•      Other operating expenses were relatively consistent as a percentage of sales (0.1% lower in 2003).

 

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Domestic commissary and other margin was 9.1% for 2003 compared to 9.9% in 2002. Cost of sales was 69.8% of revenues in 2003 compared to 71.7% in 2002 primarily due to lower food costs incurred by the commissaries (principally cheese, which has a fixed dollar as opposed to a fixed percentage markup), a decrease in lower margin equipment sales and an increase in the revenues from insurance-related services provided to franchisees. Salaries and benefits as a percentage of sales were relatively consistent between years. Other operating expenses increased to 14.1% in 2003 from 11.6% in 2002, primarily as a result of a $6.3 million increase in claims loss reserves related to the franchise insurance program, as compared to expected claims costs, and lower commissary sales (certain operating costs are fixed in nature).

 

We established a captive insurance company and began the current insurance program with franchisees in 2000. As noted above, during 2003, we recorded a $6.3 million increase in claims loss reserves, as compared to expected claims costs, based upon the results of actuarial valuations performed throughout 2003. During 2003, premium rates were increased substantially in an effort to sufficiently fund expected claims losses. However, the captive’s relatively immature claims history limits the predictive value of actuarial valuations with respect to ultimate claims costs. Accordingly, the captive program could continue to incur significant fluctuations in income or loss from one reporting period to another until such time as the claims history is more mature and predictable. We will attempt to identify opportunities to reduce this volatility to the extent possible and will continue to evaluate this program for the benefit of franchisees.

 

International operating margin decreased to 14.2% in 2003 from 16.2% in 2002 primarily due to lower margins and increased distribution costs associated with the U.K. commissary operation.

 

General and administrative expenses were $67.2 million or 7.3% of revenues for 2003 as compared to $72.4 million or 7.7% of revenues in 2002. The primary components of the $5.2 million decrease are the previously mentioned restaurant field management realignment, which eliminated a layer of management previously included in G&A, and a reduction in corporate and restaurant field management bonuses. These reductions more than offset the incremental costs incurred in 2003 related to the 2002 implementation of certain restaurant quality initiatives, intended to better evaluate and monitor the quality and consistency of the customer experience, and 2003 consulting fees associated with recent initiatives to identify opportunities for improving restaurant operating margins.

 

A provision for uncollectible notes receivable of $1.9 million was recorded in 2003, based on our evaluation of our franchise loan portfolio, and primarily relates to specific loans for which certain scheduled payments have been deferred as part of an overall workout arrangement. The provision for uncollectible notes receivable was $2.8 million in 2002.

 

The net 2003 restaurant closure, impairment and disposition charge was $5.5 million (representing $3.2 million for 27 domestic closed restaurants and $2.5 million for 25 impaired domestic restaurants, partially offset by a $275,000 gain on the sale of seven U.K. restaurants. The net 2002 restaurant closure, impairment and disposition charge was $1.1 million (representing $740,000 for 19 closed restaurants, $208,000 for two impaired restaurants and a loss of $103,000 for 14 disposed of units).

 

Other general expenses were $3.3 million in 2003, as compared to $6.1 million in 2002. The 2003 amount includes $192,000 of pre-opening costs, $346,000 of relocation costs, $1.8 million provision for uncollectible franchisee accounts receivable, $1.1 million of disposition-related costs of other assets, $1.0 million for a contribution to the Papa John’s Marketing Fund to assist the system with costs incurred for national advertising and a $500,000 sales incentive program offered to our franchisees. These expenses were partially offset by $2.0 million of income derived from the settlement of a legal matter during the second quarter of 2003. The 2002 amount includes pre-opening costs of $156,000, relocation costs of $590,000, $2.0 million of disposition-related costs of other assets, $900,000 of costs we agreed

 

31

 

to bear in connection with a refurbishment plan concerning our heated delivery bag systems and $1.7 million of losses related to a terminated vendor contract.

 

Depreciation and amortization was $31.1 million (3.4% of revenues) for 2003, as compared to $31.7 million (3.4% of revenues) for 2002.

 

Net Interest.  Net interest expense was $6.2 million for 2003 as compared to $6.6 million in 2002 as the lower outstanding debt balance and lower effective interest rate on debt were partially offset by lower interest income from investments and franchise notes receivable in 2003.

 

Income Tax Expense. The effective income tax rate was 37.5% for both 2003 and 2002.

 

Operating Income and Earnings per Common Share. Operating income in 2003 was $60.5 million, or 6.6% of total revenues, compared to $81.4 million, or 8.6% of total revenues in 2002. The decrease in operating income is primarily due to the decrease in operating results of our domestic restaurant segment, primarily resulting from lower sales and increased costs associated with our restaurant initiatives, compared to the same periods in 2002, increases in restaurant closure, impairment and disposition charges and the increased claims loss reserves related to the franchise captive insurance program.

 

Diluted earnings per share before cumulative effect of a change in accounting principle for 2003 was $1.88 compared to $2.31 in 2002. In December 1999, we began a repurchase program for our common stock. Through December 28, 2003, an aggregate of $351.6 million had been repurchased (representing 13.6 million shares or approximately 44.5% of shares outstanding at the time the repurchase program was initiated, at an average price of $25.92 per share). The repurchase of our common shares in 2003 and 2002 resulted in an increase in diluted earnings per share of approximately $0.11 in 2003 as compared to 2002.

 

2002 Compared to 2001

 

Revenues. Total revenues decreased 3.0% to $946.2 million in 2002, from $975.1 million in 2001.

 

Domestic Company-owned restaurant sales decreased 3.6% to $429.8 million in 2002, from $445.8 million in 2001. This decrease was primarily due to a 6.2% decrease in the number of equivalent Company-owned units open in 2002 as compared to 2001 as a result of the sale or closure of Company-owned units (the divested restaurants having lower than average sales). “Equivalent units” represents the number of restaurants open at the beginning of a given period, adjusted for restaurants opened, closed, acquired or sold during the period on a weighted average basis. This decrease is partially offset by a 0.2% increase in comparable sales for the 2002 period.

 

Domestic franchise sales increased 1.4% to $1.32 billion in 2002, from $1.30 billion in 2001. This increase primarily resulted from a 2.6% increase in the number of equivalent franchised domestic restaurants open in 2002 compared to 2001, partially offset by a 1.8% comparable sales decrease in 2002. Domestic franchise royalties increased 1.2% to $51.4 million in 2002, from $50.8 million in 2001, due to the increase in domestic franchise sales noted above.

 

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The comparable sales base and average weekly sales for 2002 and 2001 for domestic Company-owned and domestic franchised restaurants consisted of the following:

 

		Year Ended December 29, 2002						Year Ended December 30, 2001
		Company			Franchise			Company			Franchise
Total domestic units (end of year)		585			2,000			601			1,988
Equivalent units		581			1,982			619			1,931
Comparable sales base units		550			1,764			551			1,559
Comparable sales base percentage		94.8		%	89.0		%	89.0		%	80.7		%
Average weekly sales - comparable units		$	14,409		$	13,122		$	14,296		$	13,554
Average weekly sales - other units		$	11,100		$	10,238		$	10,198		$	10,456
Average weekly sales - all units		$	14,236		$	12,805		$	13,844		$	12,957

 

Domestic franchise and development fees, including amounts recognized upon development cancellation, were $1.7 million for 2002 compared to $2.9 million for 2001 as there were 76 domestic franchise unit openings in 2002 as compared to 139 in 2001.

 

Domestic commissary and other sales decreased 2.8% to $431.3 million in 2002, from $443.6 million in 2001, primarily due to lower commissary sales from lower volumes and reduced prices charged for certain commodities such as boxes and meats. In addition, there were lower equipment sales as a result of fewer unit openings in 2002 as compared to 2001, partially offset by an increase in our print and insurance services operations.

 

International revenues consist of the Papa John’s UK operations which are denominated in British Pounds Sterling and converted to U.S. dollars (93.0% of total 2002 international revenues) and combined revenues from operations in eight other international markets denominated in U.S. dollars. Total international revenues were substantially flat in 2002 at $32.0 million as lower Company-owned restaurant and commissary sales and development fees were offset by higher royalties due to an increased number of international franchise units in 2002 as compared to 2001. Additionally, there was a $1.3 million increase in revenues from the exchange rate difference in 2002 as compared to 2001.

 

Costs and Expenses.  The restaurant-operating margin for domestic Company-owned units was 20.9% in 2002 compared to 18.6% in 2001, consisting of the following differences:

 

•      Cost of sales was 1.8% lower in 2002 due to lower prices for certain commodities such as boxes and meats and a higher average sales price point.

•      Salaries and benefits were 0.2% lower in 2002 due to the higher average sales price point, partially offset by the impact of the across-the-board increase in base pay for general managers and assistant managers implemented during the third quarter of 2002, and other general compensation increases.

•      Advertising and related costs were 0.4% ($513,000) higher in 2002 as compared to 2001.

•      Occupancy costs were 0.2% lower in 2002 due primarily to lower utilities.

•      Other operating expenses were 0.5% lower in 2002 primarily due to improved controls over mileage reimbursement and lower training costs, partially offset by an increase in workers’ compensation insurance costs.

 

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Domestic commissary, equipment and other margin was 9.9% for 2002 compared to 10.1% in 2001. Cost of sales was 71.7% of revenues in 2002 compared to 73.0% in 2001 primarily due to a decrease in lower margin equipment sales and an increase in sales of higher margin insurance-related services to franchisees. Salaries and benefits and other operating costs increased to 18.4% in 2002 from 16.9% in 2001, primarily as a result of lower sales by commissaries (certain operating costs are fixed in nature), and expanded insurance-related services provided to franchisees.

 

International operating margin decreased to 16.2% in 2002 from 16.4% in 2001 due primarily to increased food and operating costs associated with the United Kingdom commissary operation.

 

General and administrative expenses were $72.4 million or 7.7% of revenues in 2002 as compared to $69.5 million or 7.1% of revenues in 2001. The primary components of the $2.9 million increase were $3.6 million of additional corporate and restaurant management bonuses and $1.1 million of costs related to the development of certain quality initiatives, intended to better evaluate and monitor the quality and consistency of the customer experience, partially offset by savings in salaries and travel cost.

 

A provision for uncollectible notes receivable of $2.8 million was recorded for 2002 based on our evaluation of our franchise loan portfolio. The provision for uncollectible notes receivable was $537,000 in 2001.

 

The net 2002 restaurant closure, impairment and disposition charge was $1.1 million in 2002 (representing 19 closed, two impaired and 14 disposed of units) as compared to a gain of ($1.2 million) in 2001 (representing 17 closed, six impaired and 50 disposed of units).

 

Other general expenses were $6.1 million for 2002 compared to $4.8 million in 2001. The 2002 amount includes $156,000 of pre-opening costs, $590,000 of relocation costs, $2.0 million of disposition-related costs of other assets, $900,000 of costs related to the refurbishment program for our heated delivery bag system and $1.7 million of losses related to a terminated vendor relationship. The 2001 amount includes pre-opening costs of $246,000, relocation costs of $906,000 and disposition-related costs of $2.4 million. The 2001 amount also includes costs related to certain franchisee support initiatives.

 

Depreciation and amortization was $31.7 million (3.4% of revenues) in 2002 compared to $35.2 million (3.6% of revenues) in 2001, including goodwill amortization of $2.8 million for 2001. There is no goodwill amortization in 2002 with the adoption of SFAS No. 142, Goodwill and Other Intangible Assets. On a pro forma basis, depreciation and amortization for the year ended 2001 would have been $32.4 million (3.3% of revenues) had SFAS No. 142 been adopted at that time. See “Note 5” of the “Notes to Consolidated Financial Statements” for additional information.

 

Net Interest.  Net interest expense was $6.6 million in 2002 compared to $6.9 million in 2001 primarily due to lower effective interest rates in 2002, which were partially offset by lower interest income from reduced franchise notes receivable in 2002.

 

Income Tax Expense. The effective income tax rate was 37.5% in 2002 compared to 37.7% in 2001.

 

Operating Income and Earnings per Common Share.  Operating income in 2002 was $81.4 million, or 8.6% of total revenues, compared to $82.8 million, or 8.5% of total revenues in 2001.

 

Diluted earnings per share were $2.31 in 2002 compared to $2.08 in 2001. On a pro forma basis, assuming the adoption of SFAS No. 142 in 2001, operating income would have been $85.6 million, or 8.8% of total revenues, and diluted earnings per share would have been $2.15 in 2001. The decrease in 2002 operating income as a percentage of sales as compared to the pro forma 2001 percentage is

 

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primarily due to increased general and administrative and other general expenses, partially offset by an increased restaurant operating margin.

 

Liquidity and Capital Resources

 

Cash flow from operations decreased to $84.8 million in 2003 compared to $95.6 million in 2002 primarily reflecting our reduced restaurant sales volumes and operating margins for 2003.

 

Cash flow from operations was relatively consistent at $95.6 million in 2002 compared to $96.4 million in 2001, as unfavorable changes in inventory levels, due primarily to heated delivery bags, and deferred income taxes were substantially offset by favorable changes in accrued expenses, due primarily to insurance claims reserves, and other components of working capital.

 

We have a revolving line of credit facility, which allows us to borrow up to $175.0 million with an expiration date in January 2006. Outstanding balances for the line of credit accrue interest at 62.5 to 100.0 basis points over the London Interbank Offered Rate (LIBOR) or other bank developed rates at our option. The commitment fee on the unused balance ranges from 15.0 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).

 

We require capital primarily for the development, acquisition and maintenance of restaurants, new or replacement QC Centers and Support Services facilities, the enhancement of corporate systems and facilities and the funding of franchisee loans. Additionally, we began a common stock repurchase program in December 1999. During 2003, net loan repayments on our revolving line of credit of $78.6 million, common stock repurchases of $5.9 million and capital expenditures of $16.3 million were primarily funded by cash flow from operations, proceeds from stock option exercises and available cash and cash equivalents.

 

Total 2004 capital expenditures are expected to be approximately $25.0 million to $30.0 million, about one-half of which is for the development, relocation or remodeling of restaurants, including routine replacement of equipment, and about one-half of which is for QC Centers, Support Services and corporate requirements. During 2004, we plan to relocate the Raleigh, North Carolina commissary and open approximately six new domestic Company-owned restaurants.

 

As of December 28, 2003, we had loans to franchisees of $11.6 million (including a loan to the Marketing Fund of $1.2 million), net of allowance for doubtful accounts of $6.4 million. We do not have any additional loan funding commitments related to existing franchisee loans at December 28, 2003. We do not plan to extend loans of any significance to franchisees in the future.

 

The Board of Directors has authorized up to $400 million for the share repurchase program through December 26, 2004. At December 28, 2003, a total of 13.6 million shares have been repurchased for $351.6 million at an average price of $25.92 per share since the repurchase program started in 1999 (approximately 206,000 shares in 2003, 4.5 million shares in 2002, 1.2 million shares in 2001, 6.4 million shares in 2000 and 1.3 million shares in 1999). Subsequent to year-end (through March 1, 2004), we acquired an additional 713,000 shares at an aggregate cost of $24.0 million. As of March 1, 2004, approximately $24.3 million of common stock remains available for repurchase under this authorization.

 

We expect to fund the planned capital expenditures and any additional share repurchases for the next twelve months from operating cash flow and remaining availability under our line of credit, reduced for certain outstanding letters of credit amounting to $18.6 million. Our debt, which is primarily due to the

 

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share repurchase program, was $61.3 million at December 28, 2003, compared to $140.1 million at December 29, 2002.

 

Contractual obligations and payments as of December 28, 2003 due by year are as follows (in thousands):

 

		Payments Due by Period
		Less than 1 Year			1-3 Years			3-5 Years			After 5 Years			Total
Contractual Obligations:
Long-term debt		$	250		$	—		$	—		$	—		$	250
Revolving line of credit (1)		—			61,000			—			—			61,000
Total debt		250			61,000			—			—			61,250
Operating leases		21,686			35,889			20,222			25,458			103,255
Total contractual obligations		$	21,936		$	96,889		$	20,222		$	25,458		$	164,505

 

(1)   Excludes a fair value adjustment of $5.3 million included in other long-term liabilities in the consolidated balance sheet related to our interest rate swap that hedges against the effects of rising interest rates on forecasted future borrowings.

 

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

 

Amount of Commitment Expiration Per Period

Less than 1 Year

1-3 Years

3-5 Years

After 5 Years

Total

Other Commercial Commitments:

Standby letters of credit

$

24,568

$

—

$

—

$

—

$

24,568

 

See “Notes 7, 10 and 15” of “Notes to Consolidated Financial Statements” for additional information related to contractual and other commitments.

 

Impact of Inflation

 

We do not believe inflation has materially affected earnings during the past three years. Substantial increases in costs, particularly commodities, labor, benefits, insurance, utilities and fuel, could have a significant impact on us.

 

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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 the uncertainties associated with litigation; increases in projected claims losses for the Company’s self-insured coverage or within the captive franchise insurance program;  increases in advertising promotions and discounting by competitors which may adversely affect sales; new product and concept developments by food industry competitors; the ability of the Company and its franchisees to open new restaurants and operate new and existing restaurants profitably; increases in food, labor, utilities, fuel, employee benefits, insurance and similar costs; the ability to obtain ingredients from alternative suppliers if needed; health- or disease-related disruptions or consumer concerns about the commodity supply; economic and political and health conditions in the countries in which the Company or its franchisees operate; the selection and availability of suitable restaurant locations; negotiation of suitable lease or financing terms; constraints on permitting and construction of restaurants; higher than anticipated construction costs; the hiring, training and retention of management and other personnel; changes in consumer taste, demographic trends, traffic patterns and the type, number and location of competing restaurants; federal and state laws governing such matters as wages, working conditions, citizenship requirements and overtime; and labor shortages in various markets resulting in higher required wage rates. These factors might be especially harmful to the financial viability of franchises in under-penetrated or emerging markets, leading to greater unit closings than anticipated. Our international operations are subject to additional factors, including currency regulations and fluctuations; differing cultures and consumer preferences; diverse government regulations and structures; ability to source high quality ingredients and other commodities in a cost-effective manner; differing interpretation of the obligations established in franchise agreements with international franchisees; and the successful conversion of Perfect Pizza restaurants to Papa John’s restaurants.

 

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

 

Our debt at December 28, 2003 is principally comprised of a $61.0 million outstanding principal balance on the $175.0 million unsecured revolving line of credit. The interest rate on the revolving line of credit is variable and is based on LIBOR plus a 62.5 to 100.0 basis point spread, tiered based upon debt and cash flow levels. In November 2001, we entered into an interest rate swap agreement that provides for a fixed rate of 5.31%, as compared to LIBOR, on $100.0 million of floating rate debt from March 2003 to March 2004, reducing to a notional value of $80.0 million from March 2004 to March 2005, and reducing to a notional value of $60.0 million in March 2005 with an expiration date of March 2006.

 

The effective interest rate on the line of credit, including the impact of the interest rate swap agreement, was 6.06% as of December 28, 2003. An increase in the present interest rate of 100 basis points on the debt balance outstanding as of December 28, 2003, as mitigated by the interest rate swap, would have no impact on interest expense since the debt balance is less than $100.0 million.

 

Substantially all of our business is transacted in U.S. dollars. Accordingly, foreign exchange rate fluctuations do not have a significant impact on our operating results.

 

Cheese costs, historically representing 35% to 40% of our total food cost, are subject to seasonal fluctuations, weather, availability, demand and other factors that are beyond our control. We have a purchasing arrangement with a third-party entity, BIBP, for the sole purpose of reducing cheese price volatility to domestic system-wide restaurants. Under this arrangement, we are able to purchase cheese at a fixed price per pound throughout a given quarter, based in part on historical average cheese prices. Gains and losses incurred by the selling entity are used as a factor in determining adjustments to the

 

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selling price over time. As a result, for any given quarter, the established price paid by the Company may be less than or greater than the prevailing average market price. Over the long term, we expect to purchase cheese at a price approximating the actual average market price, with less short-term volatility. However, actual cheese market price volatility may significantly impact our operating results beginning in 2004 as a result of the adoption of new accounting guidance effective as of 2003 year-end requiring the consolidation of BIBP. See “Note 3” of “Notes to Consolidated Financial Statements” for further information.

 

The average quarterly block market price and the equivalent block market price paid by Papa John’s through purchases by BIBP by quarter for 2003, 2002 and 2001 are as follows:

 

		Block Market Price									Price Paid by Papa John’s
		2003			2002			2001			2003			2002			2001
Quarter 1		$	1.115		$	1.254		$	1.192		$	1.159		$	1.403		$	1.086
Quarter 2		1.134			1.205			1.536			1.122			1.323			1.102
Quarter 3		1.536			1.129			1.697			1.242			1.450			1.497
Quarter 4		1.474			1.155			1.323			1.217			1.290			1.749
Full Year		$	1.315		$	1.186		$	1.437		$	1.185		$	1.367		$	1.359

 

We do not generally make use of financial instruments to hedge commodity prices, in part because of the purchasing arrangement with BIBP.

 

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Item 8.  Financial Statements and Supplementary Data

 

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Income

 

		Year Ended
(In thousands, except per share amounts)		December 28, 2003			December 29, 2002			December 30, 2001
Domestic revenues:
Restaurant sales		$	416,049		$	429,813		$	445,849
Franchise royalties		49,851			51,386			50,768
Franchise and development fees		1,475			1,734			2,927
Commissary sales		369,825			381,217			390,889
Other sales		48,541			50,055			52,730
International revenues:
Royalties and franchise and development fees		6,297			5,846			5,895
Restaurant and commissary sales		25,340			26,168			26,014
Total revenues		917,378			946,219			975,072
Costs and expenses:
Domestic restaurant expenses:
Cost of sales		92,488			98,717			110,632
Salaries and benefits		135,295			125,473			130,882
Advertising and related costs		38,329			35,810			35,297
Occupancy costs		25,406			23,571			25,326
Other operating expenses		54,405			56,517			60,721
Total domestic restaurant expenses		345,923			340,088			362,858
Domestic commissary and other expenses:
Cost of sales		292,226			309,021			323,954
Salaries and benefits		28,925			29,823			30,124
Other operating expenses		59,127			49,831			44,893
Total domestic commissary and other expenses		380,278			388,675			398,971
International operating expenses		21,736			21,918			21,739
General and administrative expenses		67,191			72,403			69,487
Provision for uncollectible notes receivable		1,868			2,838			537
Restaurant closure, impairment and disposition losses (gains)		5,469			1,051			(1,249		)
Other general expenses		3,314			6,078			4,770
Depreciation and amortization		31,059			31,741			35,176
Total costs and expenses		856,838			864,792			892,289
Operating income		60,540			81,427			82,783
Investment income		672			1,126			1,958
Interest expense		(6,851		)	(7,677		)	(8,857		)
Income before income taxes and cumulative effect of a change in accounting principle		54,361			74,876			75,884
Income tax expense		20,385			28,079			28,639
Income before cumulative effect of a change in accounting principle		33,976			46,797			47,245
Cumulative effect of accounting change, net of tax		(413		)	—			—
Net income		$	33,563		$	46,797		$	47,245
Basic earnings per common share:
Income before cumulative effect of a change in accounting principle		$	1.89		$	2.33		$	2.09
Cumulative effect of accounting change, net of tax		(0.02		)	—			—
Basic earnings per common share		$	1.87		$	2.33		$	2.09
Earnings per common share - assuming dilution:
Income before cumulative effect of a change in accounting principle		$	1.88		$	2.31		$	2.08
Cumulative effect of accounting change, net of tax		(0.02		)	—			—
Earnings per common share - assuming dilution		$	1.86		$	2.31		$	2.08
Basic weighted average shares outstanding		17,938			20,068			22,600
Diluted weighted average shares oustanding		18,037			20,300			22,753
Supplemental data (see Note 14):
Revenues - affiliates		$	88,056		$	108,755		$	114,616
Other income - affiliates		285			264			660

 

See accompanying notes.

 

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