SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 10-Q
(Mark One)
Commission File Number: 0–21660
PAPA JOHN'S INTERNATIONAL, INC.(Exact name of registrant as specified in its charter)
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:
Yesý No o
At August 7, 2001, there were outstanding 22,559,250 shares of the registrant’s common stock, par value $.01 per share.
INDEX
PART I. FINANCIAL INFORMATIONItem 1. Financial Statements
Papa John’s International, Inc. and SubsidiariesCondensed Consolidated Balance Sheets
Papa John's International, Inc. and Subsidiaries Condensed Consolidated Statements of Income(Unaudited)
Papa John's International, Inc. and SubsidiariesCondensed Consolidated Statements of Stockholders' Equity(Unaudited)
Papa John's International, Inc. and SubsidiariesCondensed Consolidated Statements of Cash Flows(Unaudited)
Papa John's International, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements(Unaudited)
July 1, 2001
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 July 1, 2001, are not necessarily indicative of the results that may be expected for the year ended December 30, 2001. 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 31, 2000.
2. New Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board issued Statement No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities and its amendments, Statements No. 137 and 138 in June 1999 and June 2000, respectively. The Statement requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives are either offset against the change in fair value of assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings.
In connection with the line of credit facility, in March 2000 Papa John’s entered into a no-fee interest rate collar (“Collar”) with a notional amount of $100.0 million, a 30-day LIBOR rate range of 6.36% (floor) to 9.50% (ceiling) and an expiration date of March 2003. The purpose of the Collar is to provide a hedge against the effects of rising interest rates. The adoption of SFAS 133, as amended, on January 1, 2001, resulted in the cumulative effect of an accounting change of $1.7 million ($1.1 million after tax) in other comprehensive income. The Company recognized a charge of $1.6 million ($980,000 after tax) in other comprehensive income for the six months ended July 1, 2001. The adoption of SFAS 133, as amended, had no impact on earnings.
3. Common Equity Put Options
At July 1, 2001, 175,000 common equity put options sold by the Company were outstanding, of which 125,000 had an exercise price of $19.50 and expired out-of-the-money on July 12, 2001. The remaining 50,000 options have an exercise price of $23.65 and expire October 5, 2001. The $3.6 million total exercise price of the options outstanding at July 1, 2001, was classified as a part of other long-term liabilities, and the related offset was recorded in treasury stock, net of premiums received.
4. Reserve for Special Charge
During the fourth quarter of 2000, the Company incurred a $24.1 million special charge comprised of $20.2 million for the write-down of the carrying value of certain assets and the establishment of accrued liabilities for cash payments of $3.9 million. The accrued liabilities were primarily comprised of the future lease payments pertaining to the closure of certain restaurants and field offices, settlement of vendor litigation and severance of certain employees. As of July 1, 2001, the Company had paid approximately $1.9 million associated with these accrued liabilities. We expect to pay a majority of the remaining exit cost liabilities, which are primarily comprised of future lease payments for closed restaurants, during 2001.
5. Comprehensive Income
Comprehensive income is comprised of the following:
6. Segment Information
We have defined four reportable segments: domestic restaurants, domestic commissaries, domestic franchising and international operations.
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 from retail sales of pizza, breadsticks, cheesesticks 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 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 the collection of royalties from our domestic franchisees. The international operations segment consists of our Company-owned restaurants located in the United Kingdom, our Company-owned commissary operations located outside of the contiguous United States 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. 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 restaurant equipment, printing and promotional items, risk management services, and information systems and related services used in restaurant operations.
Segment information is as follows:
Note: Certain 2000 amounts have been reclassified to conform to the 2001 presentation.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Restaurant Progression:
Results of Operations
Revenues. Total revenues increased 3.3% to $239.2 million for the three months ended July 1, 2001, from $231.5 million for the comparable period in 2000, and 6.2% to $487.2 million for the six months ended July 1, 2001, from $458.6 million for the comparable period in 2000.
Domestic Company-owned restaurant sales were relatively flat at $111.8 million for the three months ended July 1, 2001, compared to $111.6 million for the same period in 2000, and increased 3.3% to $229.1 million for the six months ended July 1, 2001, from $221.8 million for the comparable period in 2000. These increases were primarily due to increases of 7.2% and 6.3% in the number of equivalent Company-owned Papa John’s restaurants open during the three and six months ended July 1, 2001, respectively, compared to the corresponding periods in the prior year. “Equivalent restaurants” represents the number of restaurants open at the beginning of a period, adjusted for restaurants opened, closed, acquired or sold during the period on a weighted average basis. Company-owned restaurant sales were negatively impacted by a 4.8% and 0.6% comparable sales decrease for the three and six months ended July 1, 2001, respectively.
Domestic franchise sales increased 10.2% to $326.9 million for the three months ended July 1, 2001, from $296.7 million for the same period in 2000, and 13.4% to $659.1 million for the six months ended July 1, 2001, from $581.1 million for the comparable period in 2000. These increases primarily resulted from a 10.7% and 12.2% increase in the number of equivalent franchised domestic restaurants open during the three and six months ended July 1, 2001, respectively, over the same periods in 2000. Comparable sales for franchised restaurants decreased 0.5% and increased 2.2% for the three and six months ended July 1, 2001, respectively. Domestic franchise royalties increased 6.6% to $12.4 million for the three months ended July 1, 2001, from $11.6 million for the comparable period in 2000, and increased 12.1% to $25.5 million for the six months ended July 1, 2001, from $22.7 million for the same period in 2000. These increases resulted from the increase in domestic franchise sales previously described.
The comparable sales base and average weekly sales for the three and six months ended July 1, 2001 for domestic Company-owned and domestic franchised restaurants consisted of the following:
Domestic franchise and development fees decreased to $840,000 for the three months ended July 1, 2001, from $1.3 million for the same period in 2000, and decreased to $1.7 million for the six months ended July 1, 2001, from $2.6 million for the comparable period in 2000. These decreases were due to 42 and 78 domestic franchise openings during the three and six months ended July 1, 2001, compared to 67 and 129 opened during the same periods in 2000.
Domestic commissary, equipment and other sales increased 7.0% to $106.3 million for the three months ended July 1, 2001, from $99.3 million for the same period in 2000, and increased 9.9% to $215.7 million for the six months ended July 1, 2001, from $196.3 million for the same period in 2000. The increases were primarily a result of the previously mentioned increase in equivalent units and sales, partially offset by the impact of lower cheese prices.
International revenues, which include the Perfect Pizza operations, increased 10.5% and 9.8% for the three and six months ended July 1, 2001, compared to the same periods in 2000 prior to the impact of unfavorable currency exchange rates. After the impact of exchange rates, international revenues were $7.9 million for the three months ended July 1, 2001, compared to $7.7 million for the same period in 2000, and $15.2 million for the six months ended July 1, 2001, compared to $15.1 million for the same period in 2000.
Costs and Expenses. The restaurant operating margin for domestic company-owned units was 19.2% and 19.0% for the three and six months ended July 1, 2001, compared to 19.9% and 19.5% for the same periods in 2000, consisting of the following differences:
Domestic commissary, equipment and other margin was 10.8% during the second quarter for both 2001 and 2000, and 11.1% for the six months ended July 1, 2001, compared to 10.7% for the same period in 2000. Cost of sales was 72.4% for the three months ended July 1, 2001, compared to 74.9% in 2000, and 72.5% for the six months ended July 1, 2001, compared to 75.1% for the same period in 2000, primarily resulting from the impact of lower cheese costs. Expected increases in cheese costs during the second half of 2001 will result in increased cost of sales and a corresponding decrease in margin during this period. Salaries and other operating costs as a percentage of sales increased to 16.7% for the second quarter of 2001, from 14.3% in 2000, and increased to 16.4% for the six months ended July 1, 2001, from 14.3% for the same period in 2000. The increases are primarily a result of expanded services provided to both franchise and corporate restaurants.
International operating expenses were $5.6 million (85.3% of operating revenues) for the three month period in 2001, compared to $5.1 million (80.4% of operating revenues) in 2000, and increased to $10.8 million (86.8% of operating revenues) for the six months ended July 1, 2001, from $10.3 million (81.5% of operating revenues) for the same period in 2000. The increase in operating costs is primarily due to increased costs associated with the conversion of Perfect Pizza restaurants to Papa John’s restaurants located in the United Kingdom.
General and administrative expenses decreased to 7.0% of revenues in the second quarter of 2001, compared to 7.3% of revenues for the comparable period in 2000, due to the Company’s ongoing efforts to control costs during 2001 primarily through reduced headcount and travel. General and administrative expenses for the six months ended July 1, 2001 were 7.2% of revenues compared to 7.5% of revenues in the same period of 2000, prior to the impact of management bonuses earned this year for exceeding earnings targets. After the impact of such bonuses, the 2001 general and administrative expenses represented 7.4% of revenues.
The special charge of $128,000 and $1.0 million for the three and six months ended June 25, 2000, represents costs (principally legal costs) associated with the lawsuit filed against us by Pizza Hut, Inc. claiming that our "Better Ingredients. Better Pizza." slogan constituted false and deceptive advertising. On March 19, 2001, the United States Supreme Court denied Pizza Hut's Petition for Writ of Certiorari pertaining to this matter.
Pre-opening and other general expenses were $962,000 in the second quarter of 2001, compared to $722,000 for the same period in 2000, and $1.1 million for the first six months of 2001, compared to $940,000 for the same period in 2000. Pre-opening costs of $96,000, relocation costs of $242,000 and disposition-related costs of $420,000 were included in second quarter 2001 amount, compared to pre-opening costs of $320,000, relocation costs of $323,000 and disposition-related costs of $74,000 in the 2000 amount. Pre-opening costs of $156,000, relocation costs of $393,000 and net disposition-related gains of $573,000 were included in the six months ended July 1, 2001. In addition, the 2001 amount also included costs related to franchise support initiatives undertaken during the year. Pre-opening and other general expenses for the six months ended June 25, 2000, included pre-opening costs of $353,000, relocation costs of $652,000 and net disposition-related gains of $151,000.
Depreciation and amortization was $8.8 million (3.7% of revenues) for the three months ended July 1, 2001, compared to $8.4 million (3.6% of revenues) for the same period in 2000, and $17.3 million (3.6% of revenues) for the six months ended July 1, 2001, compared to $16.7 million (3.6% of revenues) in 2000. Goodwill amortization for the three and six months ended July 1, 2001, was $697,000 and $1.4 million, compared to $772,000 and $1.6 million for the same periods in 2000.
Net interest expense was $1.8 million in the second quarter of 2001, compared to $1.1 million in 2000, and $3.8 million for the six months ended July 1, 2001, compared to $1.6 million for the same period in 2000. Net interest expense increased due to an increase in the debt incurred by the Company to fund our stock repurchase program. The average interest rate on our debt was 6.69% for the first six months of 2001 compared to 6.88% for the same period in 2000.
The effective income tax rate was 37.7% for the three and six months ended July 1, 2001, compared to 38.4% for the comparable periods in 2000, due primarily to effective state and local tax planning strategies.
Operating Income and Earnings per Common Share. Operating income for the three months ended July 1, 2001 was $21.9 million or 9.2% of total revenues, compared to $22.1 million or 9.6% of revenues in 2000 ($22.3 million or 9.6% of revenues before special charge), and increased to $44.4 million or 9.1% of total revenues for the six months ended July 1, 2001, from $41.4 million or 9.0% of total revenues for the same period in 2000 ($42.4 million or 9.2% of revenues before special charge). The decline in 2001 operating income as a percentage of sales for the three-months ended July 1, 2001 was principally due to a decrease in restaurant operating margin.
Diluted earnings per share for the three months ended July 1, 2001 was $0.55 compared to $0.51 in 2000 and $1.11 for the six months ended in 2001 compared to $0.93 in 2000 ($0.96 excluding the special charge). In December 1999, the Company began a share repurchase program of its common stock. Through July 1, 2001, a total of 8.3 million shares were repurchased under the program. The repurchase of the Company's common shares resulted in an increase in diluted earnings per share of approximately $0.04 for the three months ended July 1, 2001 and $0.09 for the six months ended July 1, 2001, compared to the same periods for 2000.
Liquidity and Capital Resources
Cash flow from operations was $42.8 million for the six months ended July 1, 2001, compared to $42.4 million for the comparable period in 2000.
We require capital primarily for the development and acquisition of restaurants, the addition of new commissary and support services facilities and equipment, the enhancement of corporate systems and facilities, and the funding of franchisee loans. Additionally, we began a share repurchase program in December 1999. Share repurchases of $14.5 million, capital expenditures of $19.6 million, net payments on debt of $11.4 million, and net loans to franchisees of $3.6 million for the six months ended July 1, 2001, were funded primarily by cash flow from operations, proceeds from stock option exercises, liquidation of investments and available cash and cash equivalents.
The Board of Directors has authorized the repurchase of up to $275.0 million of the Company’s common stock through December 30, 2001, and $72.5 million was remaining for repurchase under this authorization as of July 1, 2001. During the six months ended July 1, 2001, the Company repurchased 657,000 shares for $14.5 million at an average price of $22.14 per share. A total of 8.3 million shares have been repurchased for $202.5 million at an average price of $24.47 since the repurchase program started in 1999.
The Company’s debt at July 1, 2001 was $135.2 million compared to $146.6 million at December 31, 2000. Earnings before interest, taxes, depreciation and amortization (EBITDA) remained consistent at $30.7 million for the three months ended July 1, 2001 and June 25, 2000 (excluding the special charge in 2000), and increased 4.5% to $61.7 million for the six months ended July 1, 2001, compared to $59.1 million (excluding the special charge) for the same period in the prior year.
Capital resources available at July 1, 2001, include $11.5 million of cash and cash equivalents and approximately $65.5 million remaining borrowing capacity under a $200.0 million, three-year, unsecured revolving line of credit agreement expiring in March 2003. We expect to fund planned capital expenditures and additional discretionary repurchases of our common stock, if any, for the remainder of 2001 from these resources and operating cash flows.
Forward Looking Statements
Certain information contained in this quarterly report, particularly information regarding future financial performance and plans and objectives of management, is forward looking. Certain factors could cause actual results to differ materially from those expressed in forward looking statements. These factors include, but are not limited to, our ability and the ability of our franchisees to obtain suitable locations and financing for new restaurant development; the hiring, training, and retention of management and other personnel; competition in the industry with respect to price, service, location and food quality; an increase in food cost due to seasonal fluctuations, weather or demand; changes in consumer tastes or demographic trends; changes in federal or state laws, such as increases in minimum wage; and risks inherent to international development, including operational or market risks associated with the planned conversion of Perfect Pizza restaurants to Papa John’s in the United Kingdom. See “Part I. Item 1. – Business Section - Forward Looking Statements” of the Form 10-K for the fiscal year ended December 31, 2000 for additional factors.
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 4. Submission of Matters to a Vote of Security Holders
Our annual meeting of stockholders was held at 11:00 a.m. on May 17, 2001 at our corporate offices in Louisville, Kentucky.
At the meeting, our stockholders elected two directors to serve until the 2004 annual meeting of stockholders. The vote counts were as follows:
Our other directors continue to serve in accordance with their previous elections: until the 2002 annual meeting – John H. Schnatter and Wade S. Oney; and until the 2003 annual meeting – O. Wayne Gaunce, Jack A. Laughery, and Michael W. Pierce. Blaine E. Hurst resigned from the board effective December 31, 2000.
At the meeting, our stockholders also ratified the selection of Ernst & Young LLP as our independent auditors for the fiscal year ending December 30, 2001 by a vote of 21,600,218 affirmative to 35,320 negative, with 3,884 abstention votes.
Item 6. Exhibits and Reports on Form 8-K.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The Company’s debt at July 1, 2001 is principally comprised of a $134.5 million outstanding principal balance on the $200.0 million unsecured revolving line of credit. The interest rate on the revolving line of credit is variable and is based on the London Interbank Offered Rate (LIBOR). The interest rate on the revolving line of credit was 4.46% as of July 1, 2001. In March 2000, we entered into a $100.0 million interest rate collar, which is effective until March 2003. The collar establishes a 6.36% floor and a 9.50% ceiling on the LIBOR base rate on a no-fee basis. As a result of the collar, the effective interest rate on the line of credit was 6.34% as of July 1, 2001. An increase in the interest rate of 100 basis points, which would be partially mitigated by the interest rate collar based on present interest rates, would increase interest expense approximately $345,000 annually.
Substantially all of our business is transacted in U.S. dollars. Accordingly, foreign exchange rate fluctuations do not have a significant impact on the Company.
Cheese, which historically has represented 40% of food costs, is subject to seasonal fluctuations, weather, availability, demand and other factors that are beyond our control. We have entered into a purchasing arrangement with a third-party entity formed at the direction of the Franchise Advisory Council for the sole purpose of reducing cheese price volatility. Under this arrangement, we are able to purchase cheese at a fixed price per pound throughout the quarter, based in part on historical average cheese prices. Gains and losses incurred by the selling entity will be used as a factor in determining adjustments to the 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 (intra-quarter) volatility.
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.