Back to GetFilings.com



 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended June 27, 2004

 

OR

 

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

 

Commission File Number:  0-21660

 

PAPA JOHN’S INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

61-1203323

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer Identification
number)

 

 

 

2002 Papa Johns Boulevard
Louisville, Kentucky  40299-2334

(Address of principal executive offices)

 

 

 

(502) 261-7272

(Registrant’s telephone number, including area code)

 

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

 

Yes  ý

 

No  o

 

At July 30, 2004, there were outstanding 16,801,399 shares of the registrant’s common stock, par value $.01 per share.

 

 



 

INDEX

 

PART I.

 

FINANCIAL INFORMATION

 

 

 

 

 

Item 1.

 

Financial Statements

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets – June 27, 2004 and December 28, 2003

 

 

 

 

 

 

 

Consolidated Statements of Operations – Three and Six Months Ended June 27, 2004 and June 29, 2003

 

 

 

 

 

 

 

Consolidated Statements of Stockholders’ Equity – Six Months Ended June 27, 2004 and June 29, 2003

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows – Six Months Ended June 27, 2004 and June 29, 2003

 

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

 

 

 

 

Item 2.

 

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

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

 

 

 

 

PART II.

 

OTHER INFORMATION

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

 

 

 

 

Item 2.

 

Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

 

 

 

 

 

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

Item 6.

 

Exhibits and Reports on Form 8-K

 

 

1



 

PART I.  FINANCIAL INFORMATION

Item 1. Financial Statements

 

Papa John’s International, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets

 

(In thousands)

 

June 27, 2004

 

December 28, 2003

 

 

 

(Unaudited)

 

(Note)

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

7,456

 

$

7,071

 

Accounts receivable

 

22,331

 

19,717

 

Inventories

 

17,497

 

17,030

 

Prepaid expenses and other current assets

 

13,562

 

11,590

 

Deferred income taxes

 

7,359

 

7,050

 

Total current assets

 

68,205

 

62,458

 

 

 

 

 

 

 

Investments

 

7,692

 

7,522

 

Net property and equipment

 

200,994

 

203,818

 

Notes receivable from franchisees and affiliates

 

6,949

 

11,580

 

Goodwill

 

51,312

 

48,577

 

Other assets

 

16,350

 

13,259

 

 

 

 

 

 

 

Total assets

 

$

351,502

 

$

347,214

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

24,907

 

$

28,309

 

Income and other taxes

 

6,629

 

12,070

 

Accrued expenses

 

42,052

 

40,288

 

Current portion of debt

 

11,234

 

250

 

Total current liabilities

 

84,822

 

80,917

 

 

 

 

 

 

 

Unearned franchise and development fees

 

7,734

 

5,911

 

Long-term debt, net of current portion

 

93,523

 

61,000

 

Deferred income taxes

 

8,172

 

7,881

 

Other long-term liabilities

 

28,594

 

32,233

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock

 

 

 

Common stock

 

321

 

317

 

Additional paid-in capital

 

232,240

 

219,584

 

Accumulated other comprehensive loss

 

(1,576

)

(3,116

)

Retained earnings

 

299,834

 

293,921

 

Treasury stock

 

(402,162

)

(351,434

)

Total stockholders’ equity

 

128,657

 

159,272

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

351,502

 

$

347,214

 

 

Note:                   The balance sheet at December 28, 2003 has been derived from the audited consolidated financial statements at that date but does not include all information and footnotes required by accounting principles generally accepted in the United States for a complete set of financial statements.

 

See accompanying notes.

 

2



 

Papa John’s International, Inc. and Subsidiaries
Consolidated Statements of Operations

(Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

(In thousands, except per share amounts)

 

June 27, 2004

 

June 29, 2003

 

June 27, 2004

 

June 29, 2003

 

Domestic revenues:

 

 

 

 

 

 

 

 

 

Company-owned restaurant sales

 

$

102,271

 

$

103,372

 

$

208,444

 

$

209,614

 

Variable interest entities restaurant sales

 

5,045

 

 

5,045

 

 

Franchise royalties

 

12,120

 

12,480

 

25,031

 

24,997

 

Franchise and development fees

 

474

 

208

 

1,008

 

539

 

Commissary sales

 

89,615

 

90,048

 

184,151

 

183,916

 

Other sales

 

12,897

 

12,207

 

27,621

 

23,764

 

International revenues:

 

 

 

 

 

 

 

 

 

Royalties and franchise and development fees

 

1,570

 

1,614

 

3,334

 

3,098

 

Restaurant and commissary sales

 

6,045

 

6,540

 

12,312

 

12,823

 

Total revenues

 

230,037

 

226,469

 

466,946

 

458,751

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurant expenses:

 

 

 

 

 

 

 

 

 

Cost of sales

 

26,688

 

22,567

 

52,547

 

46,063

 

Salaries and benefits

 

32,638

 

33,383

 

66,157

 

67,577

 

Advertising and related costs

 

9,282

 

9,411

 

18,729

 

19,173

 

Occupancy costs

 

6,400

 

6,500

 

12,801

 

12,594

 

Other operating expenses

 

13,444

 

13,282

 

27,087

 

27,201

 

Total domestic Company-owned restaurant expenses

 

88,452

 

85,143

 

177,321

 

172,608

 

Variable interest entities restaurant expenses

 

4,681

 

 

4,681

 

 

Domestic commissary and other expenses:

 

 

 

 

 

 

 

 

 

Cost of sales

 

73,446

 

70,335

 

152,243

 

144,700

 

Salaries and benefits

 

7,020

 

7,072

 

14,199

 

14,402

 

Other operating expenses

 

14,963

 

15,694

 

29,200

 

28,715

 

Total domestic commissary and other expenses

 

95,429

 

93,101

 

195,642

 

187,817

 

Loss from the franchise cheese purchasing program, net of minority interest

 

13,972

 

 

14,344

 

 

International operating expenses

 

5,006

 

5,527

 

10,208

 

10,943

 

General and administrative expenses

 

17,575

 

16,509

 

36,109

 

33,061

 

Provision for uncollectible notes receivable

 

4

 

375

 

236

 

801

 

Restaurant closure, impairment and disposition losses

 

28

 

407

 

167

 

482

 

Other general expenses (income)

 

434

 

(1,262

)

1,387

 

(771

)

Depreciation and amortization

 

7,817

 

7,807

 

15,378

 

15,717

 

Total costs and expenses

 

233,398

 

207,607

 

455,473

 

420,658

 

Operating income (loss)

 

(3,361

)

18,862

 

11,473

 

38,093

 

Investment income

 

143

 

162

 

284

 

416

 

Interest expense

 

(899

)

(1,659

)

(2,296

)

(3,567

)

Income (loss) before income taxes

 

(4,117

)

17,365

 

9,461

 

34,942

 

Income tax expense (benefit)

 

(1,544

)

6,511

 

3,548

 

13,103

 

Net income (loss)

 

$

(2,573

)

$

10,854

 

$

5,913

 

$

21,839

 

 

 

 

 

 

 

 

 

 

 

Basic earnings (loss) per common share

 

$

(.15

)

$

.61

 

$

.34

 

$

1.22

 

Earnings (loss) per common share - assuming dilution

 

$

(.15

)

$

.60

 

$

.33

 

$

1.21

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

17,402

 

17,905

 

17,617

 

17,912

 

Diluted weighted average shares oustanding

 

17,402

 

17,999

 

17,855

 

18,011

 

 

See accompanying notes.

 

3



 

Papa John’s International, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity
(Unaudited)

 

(In thousands)

 

Common
Stock Shares
Outstanding

 

Common
Stock

 

Additional
Paid-In
Capital

 

Accumulated
Other
Comprehensive
Income (Loss)

 

Retained
Earnings

 

Treasury
Stock

 

Total
Stockholders’
Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 29, 2002

 

18,041

 

$

314

 

$

212,107

 

$

(5,314

)

$

260,358

 

$

(345,518

)

$

121,947

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

21,839

 

 

21,839

 

Change in valuation of interest rate collar and swap agreements, net of tax of $171

 

 

 

 

278

 

 

 

278

 

Other, net

 

 

 

 

132

 

 

 

132

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

22,249

 

Exercise of stock options

 

33

 

1

 

601

 

 

 

 

602

 

Tax benefit related to exercise of non-qualified stock options

 

 

 

96

 

 

 

 

96

 

Acquisition of treasury stock

 

(150

)

 

 

 

 

(4,116

)

(4,116

)

Other

 

 

 

83

 

 

 

 

83

 

Balance at June 29, 2003

 

17,924

 

$

315

 

$

212,887

 

$

(4,904

)

$

282,197

 

$

(349,634

)

$

140,861

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 28, 2003

 

18,113

 

$

317

 

$

219,584

 

$

(3,116

)

$

293,921

 

$

(351,434

)

$

159,272

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

5,913

 

 

5,913

 

Change in valuation of interest rate swap agreement, net of tax of $873

 

 

 

 

1,425

 

 

 

1,425

 

Other, net

 

 

 

 

115

 

 

 

115

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

7,453

 

Exercise of stock options

 

396

 

4

 

10,250

 

 

 

 

10,254

 

Tax benefit related to exercise of non-qualified stock options

 

 

 

1,255

 

 

 

 

1,255

 

Acquisition of treasury stock

 

(1,579

)

 

 

 

 

(50,728

)

(50,728

)

Other

 

 

 

1,151

 

 

 

 

1,151

 

Balance at June 27, 2004

 

16,930

 

$

321

 

$

232,240

 

$

(1,576

)

$

299,834

 

$

(402,162

)

$

128,657

 

 

At June 29, 2003, the accumulated other comprehensive loss of $4,904 was comprised of net unrealized loss on the interest rate swap agreement of $4,750 and unrealized foreign currency translation losses of $154.

 

At June 27, 2004, the accumulated other comprehensive loss of $1,576 was comprised of net unrealized loss on the interest rate swap agreement of $1,773, net unrealized loss on investments of $31 and unrealized foreign currency translation gains of $228.

 

See accompanying notes.

 

4



 

Papa John’s International, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)

 

 

 

Six Months Ended

 

(In thousands)

 

June 27, 2004

 

June 29, 2003

 

 

 

 

 

 

 

Operating activities

 

 

 

 

 

Net cash provided by operating activities

 

$

6,141

 

$

38,785

 

 

 

 

 

 

 

Investing activities

 

 

 

 

 

Purchase of property and equipment

 

(10,341

)

(7,599

)

Proceeds from sale of property and equipment

 

3,402

 

189

 

Purchase of investments

 

(2,180

)

(598

)

Proceeds from sale or maturity of investments

 

1,988

 

 

Loans to franchisees and affiliates

 

(2,100

)

(50

)

Loan repayments from franchisees and affiliates

 

1,733

 

1,460

 

Acquisitions

 

 

(150

)

Proceeds from divestitures of restaurants

 

78

 

400

 

Net cash used in investing activities

 

(7,420

)

(6,348

)

 

 

 

 

 

 

Financing activities

 

 

 

 

 

Net proceeds (repayments) from line of credit facility

 

32,500

 

(34,600

)

Net proceeds from short-term debt - variable interest entities

 

9,557

 

 

Payments on long-term debt

 

(250

)

(235

)

Proceeds from exercise of stock options

 

10,254

 

602

 

Acquisition of treasury stock

 

(50,728

)

(4,116

)

Other

 

(50

)

167

 

Net cash provided by (used in) financing activities

 

1,283

 

(38,182

)

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

127

 

132

 

 

 

 

 

 

 

Change in cash and cash equivalents

 

131

 

(5,613

)

Cash acquired from consolidation of variable interest entities

 

254

 

 

Cash and cash equivalents at beginning of period

 

7,071

 

9,499

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

7,456

 

$

3,886

 

 

See accompanying notes.

 

5



 

Papa John’s International, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

June 27, 2004

 

1.              Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 27, 2004, are not necessarily indicative of the results that may be expected for the year ended December 26, 2004.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K for Papa John’s International, Inc. (referred to as the “Company”, “Papa John’s” or in the first person notations of “we”, “us” and “our”) for the year ended December 28, 2003.

 

2.              Adoption of New Accounting Pronouncement

 

We adopted Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, (SFAS No. 150) during the third quarter of 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 adopted the provisions of SFAS No. 150 for our majority interest in one subsidiary, which owns and operates 24 Papa John’s restaurants. During the third quarter of 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 Operations, related to the adoption of SFAS No. 150.

 

During the second quarter of 2004, we amended the operating agreement with the minority interest holder of the 24 restaurant subsidiary. The amended operating agreement eliminates a mandatory purchase requirement and related liability, and therefore the provisions of SFAS No. 150 are no longer applicable. Due to the amendment to the operating agreement, Papa John’s recorded a reduction in the minority interest liability and a reduction in interest expense of $625,000 during the second quarter of 2004 to adjust the minority interest liability to book value from the previously recorded fair value.

 

3.              Accounting for Variable Interest Entities

 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (FIN 46). In December 2003, the FASB modified FIN 46 to make certain technical corrections and address certain implementation issues that had arisen. FIN 46 provides a new framework for identifying variable interest entities (“VIEs”) and determining when a company should include the assets, liabilities, noncontrolling interests and results of activities of a VIE in its consolidated financial statements.

 

In general, a VIE is a corporation, partnership, limited liability company, trust, or any other legal structure used to conduct activities or hold assets that either (1) has an insufficient amount of equity to carry out its principal activities without additional subordinated financial support, (2) has a group of equity owners that are unable to make significant decisions about its activities, or (3) has a group of equity owners that do not have the obligation to absorb losses or the right to receive returns generated by its operations.

 

FIN 46 requires a VIE to be consolidated if a party with an ownership, contractual or other financial interest in the VIE (a “variable interest holder”) is obligated to absorb a majority of the risk of loss from the VIE’s activities, is entitled to receive a majority of the VIE’s residual returns (if no party absorbs a majority of the VIE’s losses), or both. A variable interest holder that consolidates the VIE is called the primary beneficiary. Upon consolidation, the primary beneficiary generally must initially record all of the VIE’s assets, liabilities and noncontrolling interests at fair value and subsequently account for the VIE as if it were consolidated based on majority voting interest. FIN 46 also requires disclosures about VIEs that the variable interest holder is not required to consolidate but in which it has a significant variable interest.

 

6



 

We have a purchasing arrangement with BIBP Commodities, Inc. (“BIBP”), a special purpose entity formed at the direction of our Franchise Advisory Council in 1999, for the sole purpose of reducing cheese price volatility to domestic system-wide restaurants. BIBP is an independent, franchisee-owned corporation. BIBP purchases cheese at the market price and sells it to our distribution subsidiary, PJ Food Service, Inc. (“PJFS”), at a fixed quarterly price based in part upon historical average market prices.  PJFS in turn sells cheese to Papa John’s restaurants (both Company-owned and franchised) at a set quarterly price. PJFS purchased $33.4 million and $66.3 million of cheese from BIBP for the three and six months ended June 27, 2004, respectively, and $30.1 million and $61.8 million of cheese in the comparable periods in 2003, respectively.

 

As defined by FIN 46, we are the primary beneficiary of BIBP, a VIE, and we began consolidating the balance sheet of BIBP as of December 28, 2003. A cumulative effect adjustment was not required upon initial consolidation because BIBP had a surplus in stockholders’ equity at the December 28, 2003 adoption date, and such surplus was reflected as a minority interest liability in other long-term liabilities in the consolidated balance sheet at December 28, 2003.

 

We will recognize the operating losses generated by BIBP if BIBP’s shareholders’ equity is in a net deficit position. Further, we will recognize the subsequent operating income generated by BIBP up to the amount of any losses previously recognized. We recognized pre-tax losses of $18.3 million ($11.5 million net of tax, or $0.66 per share) and $20.0 million ($12.5 million net of tax, or $0.70 per share) for the three and six months ended June 27, 2004, respectively, from the consolidation of BIBP reflecting BIBP’s 2004 operating losses, net of BIBP’s shareholders’ equity. The impact on future operating income from the consolidation of BIBP could be significant for any given reporting period due to the noted volatility of the cheese market, but is not expected to be cumulatively significant over time.

 

BIBP has a $15.0 million line of credit with a commercial bank. The $15.0 million line of credit is not guaranteed by Papa John’s. If the line of credit is substantially utilized, Papa John’s will provide additional funding in the form of a loan to BIBP. BIBP had borrowings of $9.6 million and a letter of credit of $3.0 million outstanding under the commercial line of credit facility and $11.0 million under the line of credit from Papa John’s at June 27, 2004 (the $11.0 million line of credit is eliminated upon consolidation of the financial results of BIBP with Papa John’s). BIBP had no borrowings at December 28, 2003.

 

In addition, Papa John’s has extended loans to certain franchisees. Under FIN 46, Papa John’s is deemed the primary beneficiary of four of these franchise entities even though we have no ownership interest in them. These entities operate a total of 33 restaurants with annual revenues approximating $20.0 million. Our net loan balance receivable from these four entities is $4.5 million at June 27, 2004, with no further funding commitments. The consolidation of these entities resulted in the recording of goodwill approximating $2.8 million and the elimination of the $4.5 million net loan balance receivable. The consolidation of these four franchise entities had no significant net impact (less than $25,000) on Papa John’s operating results for the second quarter and six months ended June 27, 2004. The impact on future operating income from the consolidation of these or other qualifying entities is not expected to be significant.

 

7



 

The following table summarizes the balance sheets of the VIEs as of June 27, 2004:

 

(In thousands)

 

BIBP

 

Franchisees

 

Total

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

2,380

 

$

150

 

$

2,530

 

Accounts receivable

 

 

144

 

144

 

Accounts receivable - Papa John’s

 

2,382

 

 

2,382

 

Other assets

 

1,540

 

564

 

2,104

 

Net property and equipment

 

 

4,136

 

4,136

 

Income tax receivable

 

7,515

 

6

 

7,521

 

Goodwill

 

 

2,769

 

2,769

 

Total assets

 

$

13,817

 

$

7,769

 

$

21,586

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity (deficit):

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

5,744

 

$

1,566

 

$

7,310

 

Debt - third party

 

9,575

 

1,659

 

11,234

 

Debt - Papa John’s

 

11,000

 

4,530

 

15,530

 

Other liabilities

 

 

25

 

25

 

Total liabilities

 

$

26,319

 

$

7,780

 

$

34,099

 

Stockholders’ equity (deficit)

 

(12,502

)

(11

)

(12,513

)

Total liabilities and stockholders’ equity (deficit)

 

$

13,817

 

$

7,769

 

$

21,586

 

 

4.              Debt

 

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

 

 

 

June 27, 2004

 

December 28, 2003

 

 

 

 

 

 

 

Revolving line of credit

 

$

93,500

 

$

61,000

 

Debt associated with VIEs *

 

11,234

 

 

Other

 

23

 

250

 

Total debt

 

104,757

 

61,250

 

Less: current portion of debt

 

(11,234

)

(250

)

Long-term debt

 

$

93,523

 

$

61,000

 

 


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

 

8



 

5.              Calculation of Earnings (Loss) Per Share

 

The calculations of basic earnings (loss) per common share and earnings (loss) per common share – assuming dilution are as follows (in thousands, except per share data):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 27, 2004

 

June 29, 2003

 

June 27, 2004

 

June 29, 2003

 

 

 

 

 

 

 

 

 

 

 

Basic earnings (loss) per common share:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(2,573

)

$

10,854

 

$

5,913

 

$

21,839

 

Weighted average shares outstanding

 

17,402

 

17,905

 

17,617

 

17,912

 

Basic earnings (loss) per common share

 

$

(0.15

)

$

0.61

 

$

0.34

 

$

1.22

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per common share - assuming dilution:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(2,573

)

$

10,854

 

$

5,913

 

$

21,839

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

17,402

 

17,905

 

17,617

 

17,912

 

Dilutive effect of outstanding common stock options

 

 

94

 

238

 

99

 

Diluted weighted average shares outstanding

 

17,402

 

17,999

 

17,855

 

18,011

 

Earnings (loss) per common share - assuming dilution

 

$

(0.15

)

$

0.60

 

$

0.33

 

$

1.21

 

 

6.              Stock-Based Compensation

 

Effective at the beginning of fiscal 2002, we elected to expense the cost of employee stock options in accordance with the fair value method contained in SFAS No. 123, Accounting for Stock-Based Compensation. Under SFAS No. 123, the fair value for options is estimated at the date of grant using a Black-Scholes option pricing model which requires the input of highly subjective assumptions including the expected stock price volatility. The election was effective as of the beginning of fiscal 2002 and applies to all stock options issued after the effective date. Prior to 2002, we followed Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, in accounting for our employee stock options. Under APB No. 25, no compensation expense is recognized provided the exercise price of employee stock options equals or exceeds the market price of the underlying stock on the date of grant.

 

The following table illustrates the effect on income and earnings per share if the fair value based method had been applied to all outstanding and unvested awards in each period:

 

 

 

Three Months Ended

 

Six Months Ended

 

(In thousands, except per share data)

 

June 27, 2004

 

June 29, 2003

 

June 27, 2004

 

June 29, 2003

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) - as reported

 

$

(2,573

)

$

10,854

 

$

5,913

 

$

21,839

 

Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects

 

376

 

14

 

726

 

27

 

Deduct: Stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects

 

(376

)

(99

)

(729

)

(214

)

Pro forma net income (loss)

 

$

(2,573

)

$

10,769

 

$

5,910

 

$

21,652

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per share:

 

 

 

 

 

 

 

 

 

Basic - as reported

 

$

(0.15

)

$

0.61

 

$

0.34

 

$

1.22

 

Basic - pro forma

 

$

(0.15

)

$

0.60

 

$

0.34

 

$

1.21

 

Assuming dilution - as reported

 

$

(0.15

)

$

0.60

 

$

0.33

 

$

1.21

 

Assuming dilution - pro forma

 

$

(0.15

)

$

0.60

 

$

0.33

 

$

1.20

 

 

9



 

7.              Comprehensive Income (Loss)

 

Comprehensive income (loss) is comprised of the following:

 

 

 

Three Months Ended

 

Six Months Ended

 

(In thousands)

 

June 27, 2004

 

June 29, 2003

 

June 27, 2004

 

June 29, 2003

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(2,573

)

$

10,854

 

$

5,913

 

$

21,839

 

Change in valuation of interest rate collar and swap agreements, net of tax

 

1,222

 

(57

)

1,425

 

278

 

Other, net

 

38

 

156

 

115

 

132

 

Comprehensive income (loss)

 

$

(1,313

)

$

10,953

 

$

7,453

 

$

22,249

 

 

8.              Segment Information

 

We have defined five reportable segments: domestic restaurants, domestic commissaries, domestic franchising, international operations and variable interest entities (VIEs).

 

The domestic restaurant segment consists of the operations of all domestic (“domestic” is defined as contiguous United States) Company-owned restaurants and derives its revenues principally from retail sales of pizza and side items, such as breadsticks, cheesesticks, chicken strips and soft drinks to the general public. The domestic commissary segment consists of the operations of our regional dough production and product distribution centers and derives its revenues principally from the sale and distribution of food and paper products to domestic Company-owned and franchised restaurants. The domestic franchising segment consists of our franchise sales and support activities and derives its revenues from sales of franchise and development rights and collection of royalties from our domestic franchisees. The international operations segment principally consists of our Company-owned restaurants and commissary operation located in the United Kingdom and our franchise sales and support activities, which derive revenues from sales of franchise and development rights and the collection of royalties from our international franchisees. VIEs consist of entities in which we are the primary beneficiary, as defined in Note 3, and include BIBP and certain franchisees to which we have extended loans. All other business units that do not meet the quantitative thresholds for determining reportable segments consist of operations that derive revenues from the sale, principally to Company-owned and franchised restaurants, of printing and promotional items, risk management services, and information systems and related services used in restaurant operations.

 

Generally, we evaluate performance and allocate resources based on profit or loss from operations before income taxes and eliminations. Certain administrative and capital costs are allocated to segments based upon predetermined rates or actual estimated resource usage. We account for intercompany sales and transfers as if the sales or transfers were to third parties and eliminate the related profit in consolidation.

 

Our reportable segments are business units that provide different products or services. Separate management of each segment is required because each business unit is subject to different operational issues and strategies. No single external customer accounted for 10% or more of our consolidated revenues.

 

10



 

Our segment information is as follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

(In thousands)

 

June 27, 2004

 

June 29, 2003

 

June 27, 2004

 

June 29, 2003

 

Revenues from external customers:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

102,271

 

$

103,372

 

$

208,444

 

$

209,614

 

Domestic commissaries

 

89,615

 

90,048

 

184,151

 

183,916

 

Domestic franchising

 

12,594

 

12,688

 

26,039

 

25,536

 

International

 

7,615

 

8,154

 

15,646

 

15,921

 

Variable interest entities (1)

 

5,045

 

 

5,045

 

 

All others

 

12,897

 

12,207

 

27,621

 

23,764

 

Total revenues from external customers

 

$

230,037

 

$

226,469

 

$

466,946

 

$

458,751

 

 

 

 

 

 

 

 

 

 

 

Intersegment revenues:

 

 

 

 

 

 

 

 

 

Domestic commissaries

 

$

27,080

 

$

27,969

 

$

56,213

 

$

57,444

 

Domestic franchising

 

194

 

193

 

388

 

372

 

International

 

44

 

1,081

 

110

 

2,118

 

Variable interest entities (1)

 

33,398

 

 

66,345

 

 

All others

 

2,661

 

3,345

 

6,009

 

6,506

 

Total intersegment revenues

 

$

63,377

 

$

32,588

 

$

129,065

 

$

66,440

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

2,180

 

$

69

 

$

4,115

 

$

960

 

Domestic commissaries (2)

 

3,594

 

5,671

 

9,139

 

11,306

 

Domestic franchising

 

10,846

 

11,879

 

22,683

 

24,097

 

International

 

(49

)

340

 

167

 

4

 

Variable interest entities (1)

 

(18,360

)

 

(20,005

)

 

All others

 

(153

)

(782

)

454

 

61

 

Unallocated corporate expenses (3)

 

(2,094

)

264

 

(7,001

)

(1,338

)

Elimination of intersegment profits

 

(81

)

(76

)

(91

)

(148

)

Total income (loss) before income taxes

 

$

(4,117

)

$

17,365

 

$

9,461

 

$

34,942

 

 

 

 

 

 

 

 

 

 

 

Property and equipment:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

154,701

 

 

 

 

 

 

 

Domestic commissaries

 

71,655

 

 

 

 

 

 

 

International

 

2,661

 

 

 

 

 

 

 

Variable interest entities (4)

 

6,735

 

 

 

 

 

 

 

All others

 

12,230

 

 

 

 

 

 

 

Unallocated corporate assets

 

115,708

 

 

 

 

 

 

 

Accumulated depreciation and amortization

 

(162,696

)

 

 

 

 

 

 

Net property and equipment

 

$

200,994

 

 

 

 

 

 

 

 


(1)          The revenues from external customers for variable interest entities are attributable to the four franchise entities to which we have extended loans that qualify as VIEs. The intersegment revenues for variable interest entities of $33.4 million and $66.3 million for the three and six months ended June 27, 2004, are attributable to BIBP. The income (loss) before income taxes for variable interest entities of $18.4 million and $20.0 for the three and six months ended June 27, 2004 primarily relates to BIBP.

(2)          The results for the domestic commissaries segment are favorably impacted by a reduction in the corporate expense allocations approximating $650,000 and $1.3 million for the second quarter and six months ended June 27, 2004, as compared to the same periods in 2003.

(3)          The increase in 2004 unallocated corporate expenses from 2003 is primarily due to: (1) increases of $1.1 million and $3.0 million, respectively, in G&A expenses for the three and six months ended June 27, 2004, primarily attributable to stock options awarded in 2003 and incentive compensation awarded in 2004; (2) the above-noted reduction in the corporate allocations to domestic commissaries approximating $650,000 and $1.3 million, respectively; and (3) increases in the provision for uncollectible accounts receivable of $185,000 and $600,000, respectively.

(4)          Represents assets of VIE franchisees to which we have extended loans.

 

11



 

9.              Subsequent Event

 

On July 26, 2004, Papa John’s entered into a joint venture arrangement with a third party. Under the terms of the arrangement, Papa John’s effectively sold 49% of 71 Company-owned restaurants located in Texas to a third party for $3.0 million ($2.5 million in cash and $500,000 as a note payable to Papa John’s). No significant gain or loss is anticipated from the sale of Papa John’s 49% interest in the 71 restaurants. Papa John’s will retain a 51% ownership interest and will be required to consolidate the financial results of the joint venture with those of Papa John’s.

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

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. 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.

 

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.

 

We recorded increases of $1.2 million and $1.5 million for the three and six months ended June 27, 2004 and an increase of $2.4 million for the three and six months ended June 29, 2003 in existing claims loss reserves, as compared to expected claims costs, at our captive insurance company based on mid-year actuarial valuations.

 

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

 

BIBP is a franchisee-owned corporation that conducts a cheese-purchasing program on behalf of domestic Company-owned and franchised restaurants.  As required by the Financial Accounting Standards Board’s (“FASB”) Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (FIN 46), we began consolidating the balance sheet of BIBP at the end of the fourth quarter of 2003. We recognized pre-tax losses of $18.3 million and $20.0 million for the three and six months ended June 27, 2004 from the consolidation of BIBP. The consolidation of BIBP could continue to have a significant impact on Papa John’s operating income in future periods due to the volatility of cheese prices. Papa John’s will recognize the operating losses generated by BIBP if the shareholders’

 

12



 

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.

 

The spot market for cheese has experienced significant volatility during 2004 as the price increased from $1.30 per pound at the beginning of 2004 to $2.04 per pound as of March 28, 2004 and decreased to $1.45 per pound as of June 27, 2004. Based on the Chicago Mercantile Exchange milk futures market prices as of July 30, 2004, and the actual third quarter and projected fourth quarter 2004 and first and second quarter 2005 cheese costs to restaurants as determined by the BIBP pricing formula, the consolidation of BIBP is projected to increase (decrease) our operating income as follows (in thousands):

 

Quarter 3 - 2004

 

$

(964

)

Quarter 4 - 2004

 

1,438

 

Quarter 1 - 2005

 

4,102

 

Quarter 2 - 2005

 

4,427

 

 

 

$

9,003

 

 

Restaurant Progression:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 27, 2004

 

June 29, 2003

 

June 27, 2004

 

June 29, 2003

 

 

 

 

 

 

 

 

 

 

 

Papa John’s Restaurant Progression:

 

 

 

 

 

 

 

 

 

U.S. Company-owned:

 

 

 

 

 

 

 

 

 

Beginning of period

 

568

 

585

 

568

 

585

 

Opened

 

1

 

2

 

3

 

5

 

Closed

 

(3

)

(2

)

(5

)

(5

)

End of period

 

566

 

585

 

566

 

585

 

International Company-owned:

 

 

 

 

 

 

 

 

 

Beginning of period

 

2

 

7

 

2

 

9

 

Closed

 

 

(1

)

 

(1

)

Acquired from franchisees

 

 

1

 

 

1

 

Sold to franchisees

 

(1

)

(2

)

(1

)

(4

)

End of period

 

1

 

5

 

1

 

5

 

U.S. franchised:

 

 

 

 

 

 

 

 

 

Beginning of period

 

2,017

 

2,006

 

2,006

 

2,000

 

Opened

 

18

 

10

 

38

 

25

 

Closed

 

(51

)

(12

)

(60

)

(21

)

End of period

 

1,984

 

2,004

 

1,984

 

2,004

 

International franchised:

 

 

 

 

 

 

 

 

 

Beginning of period

 

222

 

202

 

214

 

198

 

Opened

 

7

 

9

 

19

 

17

 

Closed

 

(10

)

(9

)

(14

)

(15

)

Acquired from Company

 

1

 

2

 

1

 

4

 

Sold to Company

 

 

(1

)

 

(1

)

End of period

 

220

 

203

 

220

 

203

 

Total restaurants - end of period

 

2,771

 

2,797

 

2,771

 

2,797

 

 

 

 

 

 

 

 

 

 

 

Perfect Pizza Restaurant Progression:

 

 

 

 

 

 

 

 

 

Franchised

 

 

 

 

 

 

 

 

 

Beginning of period

 

127

 

142

 

135

 

144

 

Opened

 

2

 

1

 

2

 

1

 

Closed

 

(5

)

(2

)

(13

)

(4

)

Total restaurants - end of period

 

124

 

141

 

124

 

141

 

 

13



 

Results of Operations

 

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

 

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

 

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

 

In addition, we have extended loans to certain franchisees. Under the FIN 46 rules, Papa John’s is deemed to be the primary beneficiary of four of these franchisees, even though we have no ownership interest in them. Beginning in the second quarter of 2004, FIN 46 requires us to recognize the operating income (losses) generated by these four franchise entities (representing 33 Papa John’s restaurants). For the second quarter and full year of 2004, the consolidation of these four franchise entities had no significant net impact (less than $25,000) on our operating results, generating revenues of $5.0 million, operating expenses of $4.7 million and other expenses (including G&A, depreciation and interest) totaling $300,000.

 

Revenues. Total revenues increased 1.6% to $230.0 million for the three months ended June 27, 2004, from $226.5 million for the comparable period in 2003, and increased 1.8% to $466.9 million for the six months ended June 27, 2004, from $458.8 million for the comparable period in 2003.

 

Domestic corporate restaurant sales decreased 1.1% to $102.3 million for the three months ended June 27, 2004, from $103.4 million for the same period in 2003, and decreased to $208.4 million for the six months ended June 27, 2004, from $209.6 million for the comparable period in 2003. These decreases are primarily due to decreases of 2.6% and 2.5% in equivalent units, as we closed 22 under performing restaurants in the fourth quarter of 2003, partially offset by 0.3% and 0.8% increases in comparable sales for the three and six month periods in 2004. “Equivalent restaurants” represents the number of restaurants open at the beginning of a given period, adjusted for restaurants opened, closed, acquired or sold during the period on a weighted average basis.

 

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

 

Domestic franchise sales decreased 2.0% to $318.3 million for the three months ended June 27, 2004, from $324.6 million for the same period in 2003, and were essentially the same for both six-month periods at $653.3 million. The decrease for the three months ended June 27, 2004, primarily resulted from a 2.6% decrease in comparable sales for the 2004 quarter and a 0.4% decrease in the number of equivalent franchise units. Domestic franchise royalties decreased 2.9% to $12.1 million for the three months ended June 27, 2004, from $12.5 million for the comparable period in 2003, and were $25.0 million for both six-month periods in 2004 and 2003. The decrease for the three months ended June 27, 2004 is due to the previously mentioned decrease in franchised sales.

 

14



 

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

 

 

 

Three Months Ended

 

 

 

June 27, 2004

 

June 29, 2003

 

 

 

Company

 

Franchise

 

Company

 

Franchise

 

 

 

 

 

 

 

 

 

 

 

Total domestic units (end of period)

 

566

 

1,984

 

585

 

2,004

 

Equivalent units

 

563

 

1,982

 

578

 

1,990

 

Comparable sales base units

 

548

 

1,890

 

563

 

1,906

 

Comparable sales base percentage

 

97.3

%

95.4

%

97.4

%

95.8

%

Average weekly sales - comparable units

 

$

14,054

 

$

12,482

 

$

13,841

 

$

12,626

 

Average weekly sales - other units

 

$

10,976

 

$

9,702

 

$

10,761

 

$

10,853

 

Average weekly sales - all units

 

$

13,972

 

$

12,353

 

$

13,762

 

$

12,552

 

 

 

 

Six Months Ended

 

 

 

June 27, 2004

 

June 29, 2003

 

 

 

Company

 

Franchise

 

Company

 

Franchise

 

 

 

 

 

 

 

 

 

 

 

Total domestic units (end of period)

 

566

 

1,984

 

585

 

2,004

 

Equivalent units

 

563

 

1,988

 

578

 

1,986

 

Comparable sales base units

 

548

 

1,908

 

561

 

1,886

 

Comparable sales base percentage

 

97.2

%

96.0

%

97.1

%

95.0

%

Average weekly sales - comparable units

 

$

14,339

 

$

12,727

 

$

14,055

 

$

12,772

 

Average weekly sales - other units

 

$

10,660

 

$

10,472

 

$

10,775

 

$

10,779

 

Average weekly sales - all units

 

$

14,237

 

$

12,636

 

$

13,961

 

$

12,672

 

 

Domestic franchise and development fees were $474,000 for the three months ended June 27, 2004, including approximately $109,000 recognized upon development cancellation or franchise renewal and transfer, compared to $208,000 for the same period in 2003 and increased to $1.0 million for the six months ended June 27, 2004, including approximately $243,000 recognized upon development cancellation or franchise renewal and transfer, from $539,000 for the same period in 2003. These increases were due to 18 and 38 domestic franchise openings, respectively, during the three and six months ended June 27, 2004, compared to 10 and 25 opened during the same periods in 2003.

 

Domestic commissary sales decreased slightly to $89.6 million for the three months ended June 27, 2004, from $90.0 million for the comparable period in 2003 and were essentially flat for the six months ended June 27, 2004 with the comparable period in 2003, as the impact of higher cheese price increases were substantially offset by lower volumes resulting from decreased restaurant transactions. Other sales increased to $12.9 million for the three months ended June 27, 2004, from $12.2 million for the comparable period in 2003, primarily as a result of an increase in revenues associated with insurance-related services provided to franchisees.  Other sales increased to $27.6 million for the six months ended June 27, 2004 from $23.8 million for the comparable period in 2003, primarily as a result of an increase in revenues associated with insurance-related services to franchisees and the first quarter promotional item sales associated with our March 2004 NCAA national promotion.

 

International revenues consist of the Papa John’s United Kingdom (U.K.) operations, denominated in British Pounds Sterling and converted to U.S. dollars (91% of international revenues for both the three and six-month periods in 2004) and combined revenues from operations in 15 other international markets denominated in U.S. dollars. Total international revenues decreased 6.6% to $7.6 million for the three months ended June 27, 2004, compared to $8.2 million for the comparable period in 2003, reflecting a decrease in restaurant revenues due to the operation of only one Company-owned restaurant during the second quarter of 2004 as compared to an average of six restaurants for the comparable period in 2003. Total international revenues decreased 1.7% to $15.6 million for the six months ended June 27, 2004, compared to $15.9 million for the same period in 2003, as revenues from increased unit openings and the impact of a more favorable dollar/pound exchange rate were more than offset by a decrease in corporate restaurant revenues due to the operation of only one Company-owned restaurant during the first six months of 2004 as compared to an average of six restaurants for the comparable period in 2003.

 

15



 

Costs and Expenses.  The restaurant operating margin at domestic Company-owned units was 13.5% and 14.9% for the three and six months ended June 27, 2004, compared to 17.6% and 17.7% for the same periods in 2003, consisting of the following differences:

 

                  Cost of sales were 4.3% and 3.2% higher as a percentage of sales for the three and six month periods in 2004 compared to the same periods in 2003, due primarily to the consolidation of BIBP, which increased cost of sales 4.1% and 2.6% for the three and six months ended June 27, 2004. The remaining increases in cost of sales is due to higher cheese costs as charged by BIBP, which were substantially offset by lower costs for other commodities as a result of the various product cost savings initiatives, and the impact of an increase in restaurant pricing.

                  Salaries and benefits were 0.4% and 0.5% lower as a percentage of sales in 2004 due to staffing efficiencies and leverage on pricing increases.

                  Advertising and related costs as a percentage of sales were relatively flat.

                  Occupancy costs as a percentage of sales were relatively flat.

                  Other operating expenses were 0.2% higher for the three months ended June 27, 2004 primarily as a result of increased workers’ compensation costs. Other operating expenses for the six-month period in 2004 were flat.

 

Domestic commissary and other margin was 6.9% and 7.6% for the three and six months ended June 27, 2004, compared to 9.0% and 9.6% for the same periods in 2003. Cost of sales was 71.6% of revenues for the three months ended June 27, 2004, compared to 68.8% for the same period in 2003, and 71.9% for the six months ended June 27, 2004, compared to 69.7% for the same period in 2003. The increases are primarily due to higher cheese costs incurred by the commissaries (cheese has a fixed-dollar as opposed to fixed-percentage mark-up) and increased sales of lower-margin products, such as promotional items (principally DVDs). Salaries and benefits as a percentage of sales were substantially the same as the corresponding periods in 2003. Other operating expenses decreased to 14.6% of sales for the three months ended June 27, 2004, from 15.3% for the same period in 2003, primarily as a result of a $1.2 million decrease in claims loss reserves related to the franchise insurance program recorded in the second quarter of 2004 as compared to 2003. Other operating expenses as a percentage of sales were substantially the same in both six-month periods.

 

An updated actuarial valuation completed for our franchise insurance program during the second quarter of 2004 indicated an increase in claims loss reserves of approximately $1.5 million was required in excess of the expected claims losses, of which $300,000 was recorded in the first quarter of 2004. However, an even larger increase in claims loss reserves ($2.4 million over expected levels) was required in the second quarter of 2003. We believe claims loss reserves are at adequate levels as of the end of the second quarter; however the estimated insurance claims losses could be significantly affected should the frequency or ultimate cost of claims significantly differ from the trends used to estimate the recorded insurance reserves.

 

The loss from the franchise cheese purchasing program, net of minority interest, was $14.0 million and $14.3 million for the three and six months ended June 27, 2004. This represents the portion of the total $18.3 million BIBP operating loss related to the proportion of BIBP cheese sales to franchisees (77% for both the three and six-month periods).

 

International operating margin increased to 17.2% and 17.1% for the three and six months ended June 27, 2004, from 15.5% and 14.7% for the same periods in 2003, due to the disposition of Company-owned restaurants, which had a lower margin than our commissary operation.

 

General and administrative expenses were $17.6 million or 7.6% of revenues for the three months ended June 27, 2004, compared to $16.5 million or 7.3% of revenues for the same period in 2003, and $36.1 million or 7.7% of revenues for the six months ended June 27, 2004, compared to $33.1 million or 7.2% of revenues for the same period in 2003. The increase for the three-month period in 2004 is primarily attributable to: a $375,000 increase in bonuses paid to corporate and restaurant management who met pre-established targets for their operating units; a $500,000 increase in compensation expense related to stock options awarded in late 2003 that vest over a 12-month period throughout 2004; and a $540,000 increase in administrative costs associated with our international operations to support our new franchisees. The increase for the six-month period in 2004 is primarily attributable to: a $930,000 increase in bonuses paid to corporate and restaurant management who met pre-established targets for their operating units, a $1.0 million increase in compensation expense related to stock options awarded in late 2003 that vest over a 12-month period throughout 2004, a $600,000 increase in administrative costs associated with our international operations to support our new franchisees and $380,000 of consulting fees associated with our initiatives to identify opportunities for improving restaurant operating margins.

 

Provisions for uncollectible notes receivable of $4,000 and $236,000, respectively, were recorded in the three and six months ended June 27, 2004, compared to $375,000 and $801,000 for the same periods of 2003. The provisions were based on our evaluation of our franchise loan portfolio.

 

16



 

Restaurant closure, impairment and disposition losses of $28,000 and $167,000 were recorded for the three and six months ended June 27, 2004, compared to $407,000 and $482,000 for the comparable periods in 2003. These losses are related to under-performing restaurants that are subject to impairment or identified for closure as required by Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.

 

Other general expenses (income) reflected net expense of $434,000 for the three months ended June 27, 2004, compared to net income of $1.3 million for the comparable period in 2003, and net expense of $1.4 million for the six months ended June 27, 2004, compared to net income of $771,000 for the same period in 2003. The three-month period ended June 27, 2004 included a $455,000 provision for uncollectible accounts receivable and $315,000 related to the disposition or valuation losses for other assets, partially offset by a gain of $550,000 related to the sale of unused property. The three-month period ended June 29, 2003 included $42,000 of pre-opening costs, $192,000 of restaurant relocation costs and $213,000 related to disposition or valuation losses for other assets. These costs were more than offset by $2.0 million of income derived from the settlement of a litigation matter. The six-month period ended June 27, 2004, included $130,000 of restaurant relocation costs, $736,000 of disposition and valuation related costs of other assets and a $898,000 provision for uncollectible accounts receivable, partially offset by the previously mentioned $550,000 gain on the sale of unused property. The six-month period ended June 29, 2003, included $110,000 of pre-opening costs, $242,000 of restaurant relocation costs, and $449,000 related to disposition or valuation losses for other assets. The costs were more than offset by the previously mentioned $2.0 million of income derived from the settlement of a litigation matter.

 

Depreciation and amortization was $7.8 million (3.4% of revenues) for the three months ended June 27, 2004 and June 29, 2003 and $15.4 million (3.3% of revenues) for the six months ended June 27, 2004, compared to $15.7 million (3.4% of revenues) for the same period in 2003.

 

Net interest. Net interest expense was $756,000 in the second quarter of 2004, compared to $1.5 million in 2003, and $2.0 million for the six months ended June 27, 2004, compared to $3.2 million for the comparable period in 2003. The primary reason for the reduction in the three and six months ended June 27, 2004 as compared to prior year is due to a $625,000 benefit we recorded, under the provisions of SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, associated with a change in a joint venture operating agreement eliminating a mandatory purchase requirement and related liability. No such favorable adjustments are expected in future quarters. The six-month period was also impacted by a lower average debt outstanding during the first six months of 2004 as compared to 2003.

 

Income Tax Expense. The effective income tax rate was 37.5% for the three and six months ended June 27, 2004 and June 29, 2003.

 

Operating Income (Loss) and Earnings (Loss) Per Common Share.  The operating loss for the three months ended June 27, 2004 was ($3.4) million or (1.5%) of revenues, compared to operating income of $18.9 million or 8.3% of revenues for the same period in 2003, and operating income decreased to $11.5 million or 2.5% of revenues for the six months ended June 27, 2004, from $38.1 million or 8.3% of total revenues for the same period in 2003. The decreases in operating income are primarily due to: the impact of consolidating BIBP, which reduced pre-tax income approximately $18.3 million and $20.0 million for the three and six months ended June 27, 2004; a decrease in our domestic commissary operations of $2.1 million and $2.2 million for the three and six month periods ended June 27, 2004, respectively, as a result of lower sales volumes; and the previously mentioned increases in general and administrative expenses in 2004 as compared to 2003.

 

Diluted earnings (loss) per share for the three months ended June 27, 2004 were ($0.15) compared to $0.60 in 2003 and $0.33 for the six months ended June 27, 2004 compared to $1.21 in 2003.

 

17



 

Liquidity and Capital Resources

 

Our debt is comprised of the following:

 

 

 

June 27, 2004

 

December 28, 2003

 

 

 

 

 

 

 

Revolving line of credit

 

$

93,500

 

$

61,000

 

Debt associated with VIEs *

 

11,234

 

 

Other

 

23

 

250

 

Total debt

 

104,757

 

61,250

 

Less: current portion of debt

 

(11,234

)

(250

)

Long-term debt

 

$

93,523

 

$

61,000

 

 


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

 

The revolving line of credit allows us to borrow up to $175.0 million with an expiration date of January 2006. Outstanding balances 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).

 

Cash flow from operations decreased to $6.1 million for the six months ended June 27, 2004, from $38.8 million for the comparable period in 2003, reflecting lower net income of $15.9 million in 2004 and unfavorable changes in accounts payable and income and other taxes in 2004. The reduction in accounts payable and income and other taxes were the result of the routine timing of payments.

 

We require capital primarily for the development, acquisition, renovation and maintenance of restaurants, the development, renovation and maintenance of quality control centers and support services facilities and equipment and the enhancement of corporate systems and facilities. Additionally, we began a common stock repurchase program in December 1999. During the six months ended June 27, 2004, common stock repurchases of $50.7 million and capital expenditures of $10.3 million were funded primarily by cash flow from operations, the proceeds from stock option exercises, net proceeds from debt arrangements and available cash and cash equivalents.

 

Our Board of Directors has authorized the repurchase of up to $425.0 million of our common stock through December 26, 2004. Through June 27, 2004, an aggregate of $402.4 million had been repurchased. Approximately 16.9 million shares were outstanding as of June 27, 2004. Subsequent to June 27, 2004, through July 30, 2004, we repurchased an additional 146,000 shares at an aggregate cost of $4.3 million (an average price of $29.20 per share).

 

Capital resources available at June 27, 2004, include $7.5 million of cash and cash equivalents and approximately $59.0 million remaining borrowing capacity, reduced for outstanding letters of credit of $22.5 million, under a $175.0 million, three-year, unsecured revolving line of credit agreement expiring in January 2006. We expect to fund planned capital expenditures and additional discretionary repurchases of our common stock, if any, for the remainder of 2004 from these resources and operating cash flows.

 

18



 

Forward Looking Statements

 

Certain information contained in this quarterly report, particularly information regarding future financial performance and plans and objectives of management, is forward-looking. Certain factors could cause actual results to differ materially from those expressed in forward-looking statements. These factors include, but are not limited to 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. See “Part I. Item 1. – Business Section – Forward-Looking Statements” of the Annual Report on Form 10-K for the fiscal year ended December 28, 2003 for additional factors.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Our debt at June 27, 2004 is principally comprised of a $93.5 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 5.36% as of June 27, 2004. An increase in the present interest rate of 100 basis points on the line of credit debt balance outstanding as of June 27, 2004, as mitigated by the interest rate swap based on present interest rates, would increase annual interest expense approximately $135,000. The annual impact of a 100 basis point increase in interest rates on the debt associated with VIEs would be $112,000.

 

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. As previously discussed in Results of Operations and Critical Accounting Policies and Estimates, we have a purchasing arrangement with a third-party entity, BIBP, formed at the direction of our Franchise Advisory Council for the sole purpose of reducing cheese price volatility to domestic system-wide restaurants. Under this arrangement, domestic Company-owned and franchised restaurants 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 BIBP are used as a factor in determining adjustments to the selling price to restaurants over time. As a result, for any given quarter, the price paid by the domestic Company-owned and franchised restaurants may be less than or greater than the prevailing average market price.

 

As a result of the adoption of FIN 46, Papa John’s began consolidating the operating results of BIBP in 2004. Consolidation accounting requires the portion of BIBP operating income (loss) related to domestic Company-owned restaurants to be reflected as a reduction (increase) in the “Domestic Company-owned restaurant expenses – cost of sales” line item, thus reflecting the actual market price of cheese had the purchasing arrangement not existed. The consolidation of BIBP had a significant impact on our first six months of operating results and is expected to have a significant impact

 

19



 

on future operating results depending on the prevailing spot block market price of cheese as compared to the price charged to domestic restaurants. Over time, we expect BIBP to achieve break-even financial results.

 

The following table presents the actual average block market price for cheese and the BIBP block price by quarter for 2003 and as projected through the end of 2004 (based on the July 30, 2004 Chicago Mercantile Exchange (CME) milk futures market prices):

 

 

 

2003

 

2004

 

 

 

BIBP
Block Price

 

Actual
Block Price

 

BIBP
Block Price

 

Actual
Block Price

 

 

 

 

 

 

 

 

 

 

 

Quarter 1

 

$

1.159

 

$

1.115

 

$

1.220

 

$

1.426

 

Quarter 2

 

1.122

 

1.134

 

1.326

 

2.012

 

Quarter 3

 

1.242

 

1.536

 

1.556

 

1.578

*

Quarter 4

 

1.217

 

1.474

 

1.542

*

1.499

*

Full Year

 

$

1.185

 

$

1.315

 

$

1.411

*

$

1.629

*

 


*amounts are projections.

 

Based on the above-noted CME milk futures market prices and the actual third quarter and projected fourth quarter 2004 and first and second quarter 2005 cheese costs to restaurants as determined by the BIBP pricing formula, the consolidation of BIBP is projected to increase (decrease) our operating income as follows (in thousands):

 

 

 

2004

 

2005

 

 

 

 

 

 

 

Quarter 1

 

$

(1,647

)

$

4,102

*

Quarter 2

 

(18,248

)

4,427

*

Quarter 3

 

(964

)*

N/A

 

Quarter 4

 

1,438

*

N/A

 

Full Year

 

$

(19,421

)*

N/A

 

 


* - amounts are projections

N/A - information not yet available

 

Over the long-term, we expect to purchase cheese at a price approximating the actual average market price and therefore we do not generally make use of financial instruments to hedge commodity prices.

 

Item 4. Controls and Procedures

 

Our Chief Executive Officer (CEO) and Chief Financial Officer (CFO) evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon their evaluation, the CEO and CFO concluded that the disclosure controls and procedures are effective in ensuring all required information relating to the Company is included in this quarterly report.

 

We also maintain a system of internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f)) designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. During our most recent fiscal quarter, there have been no changes in our internal control over financial reporting that occurred that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

20



 

PART II.  OTHER INFORMATION

 

Item 1. 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 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

 

The Papa John’s Board of Directors has authorized the repurchase of up to $425.0 million of common stock under a share repurchase program that began December 9, 1999, and runs through December 26, 2004. Through June 27, 2004, a total of 15.1 million shares with an aggregate cost of $402.4 million and an average price of $26.57 per share have been repurchased under this program and placed in treasury. The following table summarizes our repurchases by fiscal period during 2004 (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

 

 

 

 

 

 

 

 

 

 

 

12/29/2003 - 01/25/2004

 

257

 

$

32.26

 

13,824

 

$

65,074

 

01/26/2004 - 02/22/2004

 

377

 

$

34.28

 

14,201

 

$

52,161

 

02/23/2004 - 03/28/2004

 

94

 

$

35.43

 

14,295

 

$

48,814

 

03/29/2004 - 04/25/2004

 

58

 

$

33.42

 

14,353

 

$

46,876

 

04/26/2004 - 05/23/2004

 

461

 

$

31.73

 

14,814

 

$

32,240

 

05/24/2004 - 06/27/2004

 

332

 

$

28.96

 

15,146

 

$

22,644

 

 

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

 

Our annual meeting of stockholders was held on May 13, 2004 at our corporate offices in Louisville, Kentucky.

 

At the meeting, our stockholders elected three directors to serve until the 2007 annual meeting of stockholders. The vote counts were as follows:

 

 

 

Affirmative

 

Withheld

 

F. William Barnett

 

16,504,705

 

664,216

 

Norborne P. Cole, Jr.

 

16,260,527

 

908,394

 

William M. Street

 

16,925,672

 

243,249

 

 

Our other directors continue to serve until either the 2005 or 2006 annual meetings, in accordance with their previous election: 2005 - John H. Schnatter, Owsley Brown Frazier, and Wade S. Oney; 2006 – Philip Guarascio, Olivia F. Kirtley, and Jack A. Laughery.

 

At the meeting, our stockholders ratified the selection of Ernst & Young LLP as our independent auditors for the fiscal year ending December 26, 2004, by a vote of 16,885,566 affirmative to 277,511 negative, with 5,844 abstention votes. The stockholders also approved the adoption of the Papa John’s International, Inc., 2003 Stock Option Plan for Non-Employee Directors by a vote of 7,684,765 affirmative to 7,633,965 negative, with 11,590 abstention votes.

 

21



 

Item 6.  Exhibits and Reports on Form 8-K

 

a.               Exhibits

 

Exhibit
Number

 

Description

 

 

 

31.1

 

Section 302 Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a -15(e)

 

 

 

31.2

 

Section 302 Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a -15(e)

 

 

 

32.1

 

Section 906 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.2

 

Section 906 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

99.1

 

Cautionary Statements. Exhibit 99.1 to our Annual Report on Form 10-K for the fiscal year ended December 28, 2003 (Commission File No. 0-21660) is incorporated herein by reference.

 

b.              Current Reports on Form 8-K filed in the second quarter of 2004:

 

1.               We filed a Current Report on Form 8-K on May 5, 2004, attaching a press release dated May 4, 2004, announcing our first quarter 2004 financial results.

 

22



 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

PAPA JOHN’S INTERNATIONAL, INC.

 

(Registrant)

 

 

 

 

Date:  August 4, 2004

/s/ J. David Flanery

 

 

J. David Flanery

 

Senior Vice President and Chief Financial
Officer

 

23