Item 1. Business
General
PJ America, Inc. (the "Company") is the largest franchisee of "Papa John's" pizza delivery and carry-out restaurants. At December 31, 2000, the Company operated 176 Papa John's restaurants in nine states and Puerto Rico. In late 1998, the Company opened its first restaurants in California, Oregon, Washington and Puerto Rico, and acquired restaurants in Utah ("New Markets"). The Company also opened a commissary in Puerto Rico in December 1998. The Company also has restaurants in Alabama, Louisiana, Ohio, Texas and Virginia ("Core Markets"). In 2000, the Company opened 21 of its 24 restaurants in the New Markets, and since December 31, 1998, the Company has opened 48 of 57 restaurants in the New Markets. At December 31, 2000, Papa John's International, Inc. ("PJI") and its franchisees (including the Company) operated 2,614 Papa John's restaurants in 49 states, the District of Columbia and internationally.
Strategy
The Company's objective is to become the leading chain of pizza delivery restaurants in each of its targeted markets. To accomplish this objective, the Company has developed a strategy designed to achieve high levels of customer satisfaction and repeat business, as well as to establish recognition and acceptance of the Papa John's concept. The key elements of the Company's strategy include:
Focused High Quality Menu. Papa John's restaurants offer a focused menu of high quality pizza, breadsticks and cheesesticks. Papa John's traditional crust pizza is prepared using fresh dough (never frozen), cheese made from 100% real mozzarella, fresh-packed pizza sauce made from vine-ripened tomatoes (not from concentrate) and a proprietary mix of savory spices, and a choice of high quality meat and vegetable toppings. Papa John's thin crust pizza is made with a prepared crust and the same high quality toppings. We believe our focused menu creates a strong identity in the marketplace and simplifies operations.
Purchasing and Distribution. PJI's commissary system supplies pizza dough and other food and paper products twice weekly to each of its franchised restaurants. PJI currently operates eleven regional commissaries across the United States. PJI expects to open new commissaries and distribution centers as PJI and its franchisees expand into new territories. PJI's commissary system enables it to closely monitor and control product quality and consistency, while lowering food and operating costs for its franchisees. All Papa John's restaurants are required to purchase a proprietary mix of savory spices and dough from PJI. Franchisees may purchase other goods from approved suppliers or PJI, which has negotiated purchasing agreements with most of its suppliers. The Company believes that these agreements enable it to benefit from volume discounts which result in prices the Company believes are below those which it could otherwise obtain. In addition, all the equipment, counters and smallwares required to open a Papa John's restaurant are available from PJI. PJI also provides layout and design services and recommends subcontractors, signage installers and telephone systems to its franchisees. Although not required to do so, the Company purchases substantially all of its food products and restaurant equipment from PJI.
Effective December 27, 1999, PJI's commissary entered into a purchasing arrangement with a third-party entity formed for the sole purpose of reducing cheese price volatility. Under this arrangement, the commissary will purchase cheese at a fixed quarterly price based in part on historical average cheese prices. Gains and losses incurred by the selling entity will be passed to the commissary via adjustments to the selling price over time. Ultimately the commissary will purchase cheese at a price approximating the actual average market price, but with more predictability and less volatility than the previous purchasing method. As the Company purchases cheese from PJI's commissary, this arrangement also results in less volatility for cheese prices.
In December 1998, the Company opened its own commissary in Puerto Rico to service its Puerto Rico restaurants. The Company has been purchasing and expects to be able to continue to purchase product from PJI suppliers under the same terms and prices as PJI's commissaries.
Commitment to Employee Training and Development. The Company is committed to the development and motivation of its employees through on-going training programs, incentive compensation and opportunities for advancement. The Company offers financial and stock incentives to employees at various levels based on the achievement of performance goals. The Company's growth also provides significant opportunities for advancement. The Company believes these factors create an entrepreneurial spirit throughout the organization, resulting in a positive work environment and motivated, customer-oriented employees.
Marketing Programs. The Company's restaurant-level marketing programs target the delivery area of each restaurant, making extensive use of distinctive print materials in direct mail and store-to-door couponing. Local marketing efforts also include a variety of community-oriented activities with schools, sports teams and other organizations. In markets in which the Company has a significant presence, local marketing efforts are supplemented with radio and television advertising.
Unit Economics
The Company's unit economics in the Core Markets are significantly better than restaurants in the New Markets. In total, the 152 restaurants that were open throughout the entire 2000 fiscal year (53 weeks) generated average sales of $692,000, average cash flow (operating income plus depreciation) of $113,000 (or 16.3% of average sales) and average restaurant operating income of $90,000 (or 13.0% of average sales). To date, the Company's restaurants in the New Markets have not achieved sufficient profitable sales, thus the New Markets are operating at significant losses.
The average cash investment, including franchise fees for the 24 restaurants opened during the 2000 fiscal year was approximately $320,000, exclusive of land and pre-opening costs. The Company expects the average cash investment for restaurants to be opened in 2001 to be similar to 2000 and anticipates that the new restaurants to be opened in 2001 will primarily be in the New Markets.
Expansion and Site Selection
The Company's growth strategy will focus on further developing the Papa John's concept through (i) building out its existing markets; (ii) acquiring and developing new territories; and (iii)
strategically acquiring existing Papa John's franchisee groups and territories, if available. The Company's objective is to become the leading chain of pizza delivery restaurants in each of its targeted markets. Through a market-by-market expansion strategy focused on clustering restaurants, the Company seeks to increase consumer awareness and take advantage of operational and advertising efficiencies. During fiscal 2000, the Company opened 23 restaurants and acquired one restaurant. In 2001, the Company expects to open approximately 8-10 additional restaurants primarily in New Markets. As part of its overall growth strategy, the Company intends to supplement its new restaurant development through acquisitions of existing Papa John's franchisees.
Effective February, 2001, the Company merged all of its previous U.S. geographic development agreements with PJI into a single development agreement. In the new development agreement, the Company is required to open six restaurants in 2001, then eight restaurants per year through 2006. In connection with the new U.S. development agreement, the Company sold 22 development rights in various geographic area back to PJI. Under the original development agreements, the number of restaurants required to be opened in 2001, 2002, and 2003 was 18, 15 and 15 respectively, therefore the Company's pace of restaurant openings is significantly slower.
The Company is required to open four restaurants per year in Puerto Rico in 2001 and 2002, and three restaurants in 2003.
The Company also has a right of first refusal with a term of five years beginning September 1, 1996 to acquire from an affiliate of the Company, the operations and development rights for Papa John's restaurants in Iowa, including the Moline and Rock Island, Illinois areas (but excluding the Council Bluffs area of Iowa), in which 24 restaurants were open at December 31, 2000 and development rights with respect to such territory provide that a total of 6 additional Papa John's restaurants will be opened through 2002. There are no agreements, however, with respect to the Company's acquisition of such territory, and there can be no assurance that such territories will be acquired. PJI has waived its right of first refusal with respect to the Company's possible acquisition of the Iowa territory described above. In addition, certain officers, directors and stockholders of the Company own interests in Papa John's franchisees that operate in certain areas in Ohio and South Carolina. PJI has waived its right of first refusal with respect to the Company's possible acquisition of such franchisees.
The Company devotes significant resources to the investigation and evaluation of potential sites. The site selection process focuses on trade area demographics, target population density, household income levels and competitive factors. Management inspects each potential Company restaurant location and the surrounding market before a site is approved. The Company's restaurants are typically located in strip shopping centers or free-standing buildings that provide visibility, curb appeal and accessibility. All site selections must be approved by PJI. Papa John's restaurant design may be configured to fit a wide variety of building shapes and sizes, thereby increasing the number of suitable locations for Papa John's restaurants.
Menu
Papa John's restaurants offer a focused menu of high quality pizza, breadsticks and cheesesticks, as well as canned or bottled soft drinks. Papa John's traditional crust pizza is prepared using fresh dough (never frozen), and our thin crust pizza is made with a prepared crust. Papa John's
pizzas are made from hard wheat flour, cheese made from 100% real mozzarella, fresh-packed pizza sauce made with vine-ripened tomatoes (not from concentrate) and a proprietary mix of savory spices, and a choice of high-quality meat (no artificial fillers) and vegetable toppings. Fresh onions and green peppers are purchased from local produce suppliers and sliced daily in the restaurants. Fresh baby portabella mushrooms are purchased from the commissary system, which delivers twice weekly. Each traditional crust pizza is served with a container of our special garlic sauce and two pepperoncinis, and each thin crust pizza is served with a container of special seasonings and two pepperoncinis. We believe our focused menu helps create a strong identity among consumers and simplifies operations, resulting in lower restaurant operating costs, improved food quality and consistency and superior customer service.
Marketing Programs
The Company has restaurant-level marketing programs which target the delivery area of each restaurant, making extensive use of distinctive print materials in direct mail and store-to-door couponing. The Company tailors its store-to-door coupons according to customer buying habits as tracked by the Company's point-of-sale computer systems used in each restaurant. Local marketing efforts also include a variety of community-oriented activities with schools, sports teams and other organizations. The Company currently supplements its local marketing efforts with a limited amount of radio and television advertising. The Company believes that its marketing programs are cost-effective and significantly increase Papa John's visibility among potential customers. The Company's advertising expenditures as a percentage of restaurant sales for 2000 were 8.2%. Advertising expenditures as a percentage of sales are higher in the New Markets, primarily due to lower average sales volumes while brand awareness and market penetration are being generated.
The Company's restaurant-level marketing efforts are supported by print and electronic advertising materials that are produced by the Papa John's Marketing Fund, Inc. (the "Marketing Fund") for use by both PJI and its franchisees. The required Marketing Fund contribution is established from time to time by the governing board of the Marketing Fund and in 2000 was 1.25% of restaurant sales, and it is currently 1.25% of restaurant sales. The maximum required contribution for PJI franchisees is 1.5% of restaurant sales and can be increased above 1.5% only upon approval by not less than 60% of Marketing Fund members. In addition, PJI may require the Company to participate in an advertising cooperative for its designated market area and to contribute a minimum amount of restaurant sales for local advertising. PJI also provides each of its franchisees with catalogs for uniforms and promotional items and pre-approved, print marketing materials that can be ordered from PJI.
Restaurant Operations
Management and Employees. A typical Company restaurant employs a restaurant manager, two assistant managers and approximately 25 hourly employees, most of whom work part-time. The restaurant manager is responsible for the day-to-day operation of the restaurant and for the maintenance of Company established operating standards. The Company seeks to hire experienced restaurant managers and staff and motivate and retain them by providing opportunities for advancement and performance-based financial incentives.
The Company employs area supervisors, each of whom has responsibility for overseeing four to six Company restaurants. The Company also employs regional operations directors who oversee area supervisors and managers within their respective markets. These team members are also eligible to earn performance based financial incentives, including stock option grants.
Training. In February, 2000, the Company hired a Vice President of Training to lead its personnel development. The Company has full-time training coordinators in several of it's Core and New Markets. In addition, PJI provides an on-site training team as needed. Each regional area supervisor and restaurant manager is required to complete PJI's two-week training program in which instruction is given on all aspects of PJI's systems and operations. The program includes classroom instruction and hands-on training at an operating Papa John's restaurant. In addition, the Company has developed a specific education and safety program for its delivery drivers.
Point-of-Sale System. All of the Company's existing restaurants are equipped with the Papa John's PROFIT System. The Company believes that this technology increases speed and accuracy in order taking and pricing, reduces paperwork and allows the restaurant manager to better monitor and control food and labor costs. The point-of-sale system enhances restaurant-level marketing capabilities through a database that provides information on customers and their buying habits with respect to the Company's products. The Company is able to obtain current restaurant reporting information, thereby improving the speed, accuracy and efficiency of restaurant-level reporting.
Reporting. Managers at restaurants evaluate daily reports of sales, cash deposits and operating costs. Physical inventories of all food and beverage items are taken daily. The Company's area supervisors prepare weekly profit and loss statements for each of the restaurants.
Hours of Operation. The Company's restaurants are generally open seven days a week, typically from 11:00 a.m. to 12:00 midnight Sunday through Thursday, and from 11:00 a.m. to 1:30 a.m. on Friday and Saturday.
Development and Franchise Agreements
Franchise and Development Agreements. The Company has entered into development agreements with PJI for the right to construct one or more Papa John's restaurants pursuant to a development schedule within specified geographic areas in nine states and Puerto Rico.
Effective February, 2001, the Company merged all of its previous U.S. geographic development agreements with PJI into a single development agreement. In the new development agreement, the Company is required to open six restaurants in 2001, then eight restaurants per year through 2006. In connection with the new U.S. development agreement, the Company sold 22 development rights in various geographic area back to PJI. Under the original development agreements, the number of restaurants required to be opened in 2001, 2002, and 2003 was 18, 15 and 15 respectively, therefore the Company's pace of restaurant openings is significantly slower.
The Company's current development agreement in Puerto Rico is to open four restaurants per year in 2001 and 2002, and three restaurants in 2003.
Generally, a franchise agreement is executed when the Company secures a restaurant location. Each per restaurant development fee is typically credited against PJI's franchise fee, which is payable to PJI upon signing the franchise agreement for a specific location. The current franchise fee payable with respect to the Company's restaurants is $20,000.
Under each of the Company's franchise agreements, the Company pays PJI a royalty fee of 4% of sales, PJI's current standard royalty fee. Under such agreements, PJI may increase the royalty fee to 5% of sales after the agreement has been in effect for between three to five years. In no event may the royalty fee be increased to an amount greater than the royalty fee currently in effect for new PJI franchisees.
PJI's franchise agreements authorize the Company to use its trade names, trademarks and service marks with respect to specific Papa John's restaurants. PJI also provides general construction specifications, designs, color schemes, signs, equipment, preparation methods for food and beverages, marketing concepts, operations and financial control methods, management training, technical assistance and materials. Each franchise agreement prohibits the Company from transferring a franchise without the prior approval of PJI. PJI has the contractual right to terminate a franchise agreement for a variety of reasons, including a franchisee's failure to make payments when due or failure to adhere to PJI's policies and standards. Many state franchise laws limit the ability of a franchisor to terminate or refuse to renew a franchise.
The development agreement, and each of the franchise agreements, prohibit the Company, during the term of the agreements and for a two-year period following their termination or expiration, from owning or operating any other pizza delivery or take-out restaurant within ten to fifty miles of the franchise granted or any other Papa John's franchise.
Franchise Restaurant Development. PJI assists the Company in selecting sites and developing restaurants. PJI provides the Company with the physical specifications for typical restaurants, both for free-standing restaurants and restaurants located in strip shopping centers. The Company procures virtually all of the design plans, counters and equipment for its restaurants from PJI at prices the Company believes are favorable. The Company is responsible for selecting the location for its restaurants but must obtain PJI's approval of each restaurant design and each location based on accessibility and visibility of the site and targeted demographic factors, including population, density, income, age and traffic. The Company is responsible for all costs and expenses incurred in locating, acquiring and developing restaurant sites.
Franchise Training and Support. Each regional operations director and area supervisor must satisfactorily complete PJI's two-week training program and must also devote his or her full business time and efforts to the operation of the Company's restaurants. Each of the Company's restaurant managers report to an area supervisor and are also required to complete PJI's two-week training program.
Franchise Operations. All Company restaurants are required to operate in compliance with PJI's policies, standards and specifications, including matters such as menu items, ingredients, materials, supplies, services, fixtures, furnishings, decor and signs. The Company has full discretion to determine the prices to be charged to its customers.
Reporting. PJI collects daily, weekly and monthly sales and other operating information from the Company. The Company has agreements with PJI permitting PJI to electronically debit the Company's bank accounts for the payment of royalties, Marketing Fund contributions and purchases from PJI. This system significantly reduces the resources needed to process payables.
Competition
The restaurant industry is intensely competitive with respect to price, service, location and food quality, and there are many well-established competitors with substantially greater financial and other resources than the Company. Competitors include a large number of international, national and regional restaurant chains, as well as local pizza operators. Some of our competitors have been in existence for a substantially longer period than us and may be better established in the markets where our restaurants are, or may be, located. Within the pizza segment of the restaurant industry, we believe that our primary competitors are the international pizza chains, including Pizza Hut, Domino's and Little Caesar's, and several regional chains (Papa Murphy's, Donatos, etc.). A change in the pricing and other marketing strategies of one or more of these competitors could have an adverse impact on our sales and earnings.
The restaurant business is often affected by changes in consumer tastes, national, regional or local economic conditions, demographic trends, traffic patterns and the type, number and location of competing restaurants. In addition, factors such as inflation, increased cheese and other commodity costs, labor and benefits costs and the lack of experienced management and hourly team members may adversely affect the restaurant industry in general and our restaurants in particular.
Government Regulation
The Company is subject to various Federal, state and local laws affecting its business. Each Papa John's restaurant is subject to licensing and regulation by a number of governmental authorities, which include health, safety, sanitation, building and fire agencies in the state or municipality in which the restaurant is located. Difficulties in obtaining or failures to obtain required licenses or approvals can delay or prevent the opening of a new restaurant in a particular area. The Company is also subject to Federal and state environmental regulations.
The Company's relationship with PJI is governed by the laws of several states which regulate substantive aspects of the franchisor-franchisee relationship. Substantive state laws that regulate the franchisor-franchisee relationship presently exist or are being considered in a substantial number of states and bills have been introduced in Congress (some of which are now pending) which would provide for Federal regulation of substantive aspects of the franchisor-franchisee relationship. These current and proposed franchise relationship laws limit, among other things, the duration and scope of non- competition provisions, the ability of a franchisor to terminate or refuse to renew a franchise and the ability of a franchisor to designate sources of supply.
The Company's restaurant operations are also subject to Federal and state laws governing such matters as wages, working conditions, citizenship requirements and overtime. Some states have set minimum wage requirements higher than the Federal level. The Federal government last increased the Federal minimum wage in September 1997. There is also current proposed legislation to increase the
Federal minimum wage by $1.00. The Company has restaurants in California, Oregon and Washington that have higher minimum wages than the Federal level. Significant numbers of hourly personnel at the Company's restaurants are paid at rates related to the Federal minimum wage and, accordingly, increases in the minimum wage increase labor costs at the Company's restaurants. Other governmental initiatives such as mandated health insurance, if implemented, could adversely affect the Company as well as the restaurant industry in general. The Company is also subject to the Americans With Disabilities Act of 1990, which, among other things, may require certain minor renovations to its restaurants to meet Federally-mandated requirements. The cost of these renovations is not expected to be material to the Company.
The Company currently operates Papa John's restaurants in Puerto Rico. The Company's ability to establish international operations is subject to various risks, including changing political and economic conditions, adverse tax consequences, and government regulations relating to, among other things, the preparation and sale of food, building and zoning requirements, wages, working conditions, and the Company's relationship with its employees. There can be no assurance that the Company will be successful in establishing its international operations or that such risks will not have a material adverse effect on the Company in the future.
Trademarks
The Company's rights to use PJI's trademarks and service marks are significant to the Company's business. PJI is the owner of the Federal registration of the trademark "Papa John's." PJI has also registered "Pizza Papa John's" and design (logo), "Better Ingredients, Better Pizza", and "Pizza Papa John's Better Ingredients, Better Pizza", and design as a trademarks and a service marks. PJI owns Federal registrations for several ancillary marks, principally advertising slogans. PJI is aware of the use by other persons in certain geographic areas of names and marks which are the same as or similar to the Company's marks. It is PJI's policy to pursue registration of its marks whenever possible and to vigorously oppose any infringement of its marks.
Employees
At December 31, 2000, the Company had approximately 5,500 employees of which approximately 4,660 were restaurant employees, approximately 800 were restaurant management and supervisory personnel and approximately 40 were corporate personnel. Most restaurant employees are part-time and are paid on an hourly basis. None of the Company's employees are currently represented by a labor union, and the Company is not aware of any union organizing activity among its employees. The Company believes that its relationship with its employees is good.
Cautionary Statements
Information provided in this Form 10-K under the captions "Business - Strategy," "- Expansion and Site Selection," "- Development and Franchise Agreements" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains, and from time to time the Company may disseminate materials and make statements which may contain "forward-looking" information, as that term is defined by the Private Securities Litigation Reform Act of 1995 (the "Act"). These cautionary statements are being made pursuant to the provisions of the Act and with the intention of obtaining the benefits of the "safe harbor" provisions of the Act. The Company
cautions investors that any forward-looking statements made by the Company are not guarantees of future performance and that actual results may differ materially from those in the forward-looking statements as a result of various factors, including but not limited to: (i) the ability to increase sales and operate profitably in New Markets, (ii) the ability to upgrade Company's infrastructure to support its operations and development plans, (iii) the ability of the Company, PJI and PJI's franchisees to expand through the opening of new restaurants which may be affected by the selection and availability of suitable restaurant locations, negotiation of suitable leases or financing terms, constraints on permitting and construction of restaurants, and the hiring, training and retention of management and other personnel, (iv) the Company's ability to acquire existing PJI's franchisees may be hindered by competition from PJI, which has a right to approve and a right of first refusal with respect to the sale of all Papa John's restaurants, (v) the overall success of PJI, (vi) the restaurant industry is intensely competitive with respect to price, service, location and food quality, and there are many well established competitors with substantially greater financial and other resources than the Company, PJI and PJI's franchisees and some of these competitors have been in existence for a substantially longer period than the Company, PJI and PJI's franchisees and may be better established in the markets where restaurants operated by the Company, PJI or PJI's franchisees are, or may be, located (vii) a change in the pricing or other marketing or impact on sales and earnings at restaurants operated by the Company, PJI and PJI's franchisees, (viii) increases in operating costs such as inflation, increased food costs, increased labor and employee benefit costs and the availability of qualified management and hourly employees, (ix) the availability of capital to the Company, PJI and PJI's franchisees and (x) changes in governmental regulations, including further increases in the minimum wage.
Item 2.
Item 2. Properties
At December 31, 2000, the Company operated 176 Papa John's restaurants.
Number of Restaurants
Alabama 24 Louisiana 19 Ohio 9 Texas 9 Virginia 40 --- Core Markets 101 ---
California 22 Oregon 16 Puerto Rico 9 Utah 25 Washington 3 --- New Markets 75 --- Total 176 ===
All but seven of the Company's restaurants are located in leased space. The initial terms of most of the Company's leases are three to five years and provide for one or more options to renew for at least one
additional term. The Company's leases generally specify a fixed annual rent with fixed increases, or increases based on changes in the Consumer Price Index, at various intervals during the lease term.
The Company also leases a commissary facility in Puerto Rico. In addition, the Company leases approximately 7,000 square feet of corporate and operations support space collectively in various states.
Item 3.
Item 3. Legal Proceedings
The Company is involved in lawsuits and claims arising in the normal course of business. In the opinion of management of the Company, although the outcomes of these lawsuits and claims are uncertain, in the aggregate they will not have a material adverse effect on the Company's business, financial condition or results of operations.
Papa John's International, Inc. and Pizza Hut have been involved in litigation since August, 1998, over the use of the "Better Ingredients, Better Pizza" slogan. The case has currently been overturned in PJI's favor; however, Pizza Hut has filed a petition for writ of certiorari with the United States Supreme Court. PJI cannot predict whether the Supreme Court will accept the case for hearing or, in the event it is accepted, what the outcome of any such hearing will be.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are the current executive officers of the Company, together with their ages, their positions with the Company and the year in which they first became an officer of the Company:
Richard F. Sherman has served as a director and Chairman of the Board of the Company or certain predecessors since 1991 and in 1999 he was elected a member of the Executive Committee. Mr. Sherman is a private investor who has been a franchisee and a consultant to PJI since 1991. From 1993 to present, Mr. Sherman has been a director of PJI. From 1987 to 1991, Mr. Sherman was Chairman of the Board and President of Rally's Hamburgers, Inc. From 1984 to 1987, Mr. Sherman was President and a director of Church's Chicken, Inc. From 1971 to 1984, Mr. Sherman was Group Executive Vice President and director of Hardee's Food Systems, Inc. and its parent, Imasco USA, Inc. Mr. Sherman serves on the board of directors of Reed's Jewelers, Inc.
Douglas S. Stephens has served as a director, President and Chief Executive Officer of the Company or certain predecessors since 1991 and in 1999 he was elected a member of the Executive Committee. From 1989 to 1991, Mr. Stephens was the Vice President of Information Systems for the Kentucky Lottery Corporation. From 1986 to 1989, Mr. Stephens was a systems consultant for Andersen Consulting, a division of Arthur Andersen, LLP, an international professional services firm.
Louis M. Romanus became Chief Operating Officer effective January 2001. From 1997 to 2000, Mr. Romanus served as President/COO with PacPizza, L.L.C., a Pizza Hut franchise with 150 restaurants. From 1977 to 1997, Mr. Romanus held various operations positions from Cook and Restaurant Manager to Senior Market Coach and Senior Director of Operations and Customer Satisfaction with Pizza Hut Corporate.
D. Ross Davison has served as Vice President Administration - Chief Financial Officer and Treasurer of the Company since 1996. From 1985 to 1996, Mr. Davison was with Arthur Andersen, LLP, an international professional services firm, and his most recent position was Senior Manager. From 1983 to 1985, Mr. Davison was with Cotton and Allen, P.S.C., a certified public accounting firm. Mr. Davison is a licensed Certified Public Accountant.
John D. Rose has served as Vice President - Real Estate and Development since August 1998. From 1996 to 1998, Mr. Rose was Vice President of Real Estate for Famous Dave's of America. From 1992 to 1996 Mr. Rose held various positions in the real estate department of PJI.
J. Robert Compton has served as Vice President - Training since February 2000. From 1999 to 2000, Mr. Compton was the Training Director for Just for Feet. From 1995 to 1999, Mr. Compton held various positions from Store Director to Facilitator at Just for Feet University.
Anita A. Bray became Controller and Assistant Treasurer in November 2000. From 1995 to November 2000, Ms. Bray was with Caremark, Inc. her most recent position being Director of External Reporting. From 1991 to 1996, Ms. Bray was with Ernst & Young LLP. Ms. Bray is a licensed Certified Public Accountant.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's common stock has traded on the Nasdaq National Market System under the trading symbol "PJAM" since October 25, 1996. At February 8, 2001, there were approximately 70 record holders of the Company's common stock. The following table sets forth the high and low sales prices of the Company's common stock for the quarters indicated, as reported by the Nasdaq National Market System:
Quarter Ended High Low ------------- ---- ---
First Quarter $16.50 $10.00 Second Quarter $11.88 $ 8.75 Third Quarter $13.63 $ 6.63 Fourth Quarter $ 8.31 $ 5.31
Quarter Ended High Low ------------- ---- ---
First Quarter $23.50 $16.00 Second Quarter $25.00 $19.38 Third Quarter $25.63 $18.13 Fourth Quarter $21.63 $12.00
Since its initial public offering of common stock in October 1996, the Company has not paid dividends on its common stock, and has no plans to do so in the foreseeable future.
Item 6.
Item 6. Selected Financial Data (continued)
(1) The Company operates on a 52-53 week year ending on the last Sunday in December each year. Fiscal 2000 was a 53 week year.
(2) Net income reflects a pro forma provision for income taxes assuming the Company's predecessors and an aquisition were C corporations rather than S corporations.
(3) Other charges include asset impairment charges on the Company's long-lived assets. The pre-tax charges were $9,465,000 and $690,000 in 2000 and 1999 respectively. The tax benefit of these charges was $3,288,000 and $235,000, thus the charges net of taxes were $6,177,000 ($1.30 per share) and $455,000 ($0.08 per share) in 2000 and 1999, respectively.
(4) Excluding the charges described in footnote 3, basic earnings per share were $0.75 and $1.06 in 2000 and 1999, respectively. Diluted earnings per share were $0.75 and $1.03 in 2000 and 1999, respectively.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Introduction
The Company is the largest franchisee of Papa John's pizza delivery and carry-out restaurants. At December 31, 2000, the Company operated 176 Papa John's restaurants in nine states and Puerto Rico.
The Company's restaurants operate under separate franchise agreements, which generally have terms between five and ten years (with renewal options between five and ten years) and require payment of monthly royalties equal to 4% of restaurant sales. The Company also has entered into development agreements with PJI to open a certain number of restaurants over a defined period of time within specific geographic areas. The Company's development agreements required it to pay a non-refundable fee per restaurant covered by the respective agreements and which fee is typically credited against the initial franchise fee that the Company is required to pay for each new restaurant opened. The Company amortizes development and franchise fees over a 20-year period, beginning with the opening of a restaurant.
Effective February, 2001, the Company merged all of its previous U.S. geographic development agreements with PJI into a single development agreement. In the new development agreement, the Company is required to open six restaurants in 2001, then eight restaurants per year through 2006. In connection with the new U.S. development agreement, the Company sold 22 development rights in various geographic area back to PJI. Under the original development agreements, the number of restaurants required to be opened in 2001, 2002, and 2003 was 18, 15 and 15 respectively. Therefore, the Company's pace of restaurant openings is significantly slower.
The Company is also required to open four restaurants per year in Puerto Rico in 2001 and 2002, and three restaurants in 2003.
The Company's growth strategy focuses on further developing the Papa John's concept through: (i) building out its existing markets; (ii) acquiring and developing new territories; and (iii) strategically acquiring existing Papa John's franchisee groups and territories, if available.
The average cash investment including franchise fees for the 24 restaurants opened or acquired during 2000 was approximately $320,000, exclusive of land and pre-opening costs. The Company expects the average cash investment for restaurants opened in 2001 to be similar to 2000. The unit openings in 2001 will primarily be in the New Markets. The average cash investment for domestic and international restaurants in 2000 was approximately $280,000 and $450,000 respectively. The Company is focusing on reducing the cash investment of future restaurants, especially international.
For restaurants open throughout 2000, average sales were $692,000, compared to average sales in 1999 of $731,000, with the restaurant base increasing 30% (152 restaurants from 117 restaurants).
2000 Compared to 1999
Restaurant Sales. Restaurant sales increased 16% to $111.1 million in 2000, from $95.5 million in 1999. This increase was primarily due to a 23% increase in the number of equivalent restaurants open during 2000 as compared to 1999. "Equivalent restaurants" represents the number of restaurants open at the beginning of a given period, adjusted for restaurants opened, acquired, or sold during the period on a weighted average basis. Fiscal 2000 was also a 53 week year. Also, comparable sales decreased 0.1% in 2000 over 1999, for restaurants open throughout both years. The total average unit sales decreased 5.0% from the comparable periods in 1999 due to the significant increase in restaurants in the Company's "New Markets", which primarily are restaurants located in Utah, California, Oregon and Puerto Rico. The Company has also increased the level of marketing expenditures; however, aggregate sales in 2000 have been less than management's expectations. The Company's New Markets are experiencing a longer time to mature, and based on the higher operating costs, specifically labor and occupancy, losses in these markets have increased as the number of stores have increased.
Costs and Expenses. Cost of sales, which consists of food, beverage, and paper costs, increased $3.8 million, and decreased as a percentage of restaurant sales to 29.8% in 2000 from 30.7% in 1999. This percentage decrease is primarily attributable to significantly lower average cheese costs in 2000, offset by significant additional discounting, higher box costs and higher meat topping costs. All of the Company's restaurants in the domestic United States receive product from Papa John's International, Inc. ("PJI"), and each restaurant is charged the same price for product, regardless of the location of the restaurant.
Salaries and benefits, which consist of all store level employee wages, taxes and benefits, increased $5.6 million, and increased as a percentage of restaurant sales to 29.1% in 2000 from 27.9% in 1999. The increase in salaries and benefits as a percentage of restaurant sales was primarily due to the increase in the proportion of restaurants in New Markets, a higher minimum wage in California and Oregon, an average wage rate increase of approximately 3%, and less leverage on projected sales.
Other operating expenses include other restaurant level operating costs, the material components of which are automobile mileage reimbursement for delivery drivers, rent, royalties, utility expenses, and advertising expenses. Other operating expenses increased $6.3 million, and increased as a percentage of restaurant sales to 26.3% in 2000 compared to 24.0% in 1999. This percentage increase is primarily attributable to less leverage on projected sales volumes, higher advertising expenses, and a higher proportion of restaurants in New Markets which have higher occupancy costs. Also, utility expenses in the second half of 2000 were significantly higher than the comparable period in 1999.
General and administrative expenses, which includes restaurant support personnel and related costs of operations increased $2.0 million, and increased as a percentage of restaurant sales to 6.1% in 2000 from 5.0% in 1999. This increase was primarily due to additional corporate and field operations support personnel to support current and future growth, and less leverage on sales. In the second half of 2000, the Company also incurred approximately $350,000 of costs associated with operations management restructuring, including recruitment and relocation expenses. Also, in the fourth quarter of 2000, the Company increased salaries for its restaurant supervisory and corporate operations support personnel, to bring base compensation closer to market.
Depreciation and amortization increased by $.9 million, and increased as a percentage of restaurant sales to 3.7% in 2000 from 3.4% in 1999. The dollar and percentage increases were primarily attributable to a higher proportion of newer restaurants in New Markets (thus lower sales and less leverage), and higher costs of restaurants.
Other Charges. The Company periodically reviews the carrying value of its long-lived assets (primarily property, equipment, leasehold improvements and intangible assets) to assess the recoverability of these assets. The Company records impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of those assets. When a determination is made that the carrying value is not recoverable, the assets are written down to their estimated fair value.
During the fourth quarter of fiscal 2000, the Company recorded an impairment charge of $9.5 million of which $.7 million related to goodwill, $1.6 million related to development and franchise fee, and $7.2 million related to property and equipment. Based upon current and future estimated operating results and cash flows, management believed that numerous restaurants would likely continue to generate operating and cash flow losses over the related remaining lease terms and therefore reduced the carrying value of the impaired assets to estimated fair market value. As is the case with all estimates that involve predictions of future outcomes, management's estimates of future operating results, cash flows and fair market value is subject to change. The impairment charge related primarily to restaurants in the New Markets. The Company is evaluating these restaurants to determine an appropriate course of action to improve the operations or potential closure and recently hired a Chief Operating Officer in January 2001, who is assisting in this evaluation. If the Company continues to experience declines in operating and cash flow results, the Company may incur additional asset impairment charges in the future. As a result of the impairment charge, the depreciation and amortization expense will decrease by approximately $400,000.
Other Income (Expense). Other income (expense), which consists primarily of investment income offset by interest expense decreased $.7 million from 1999. During 2000, the Company used its available investment balance to partially fund stock repurchase. At the end of 2000, the Company had no investment balance remaining, and the Company had $4.0 million of debt outstanding on its revolving line of credit.
Income Tax Expense (Benefit). Income tax expense (benefit) reflects a combined federal, state and local effective tax (benefit) rate of 34.3% for 2000, compared to 34.0% in 1999. The effective income tax rate in 2000 increased as compared to the 1999 rate as a result of a significant decrease in the relative level of tax-exempt investment income to total pre-tax income, and that the remaining difference was the result of less state tax benefit in 2000 due to the impairment loss.
1999 Compared to 1998
Restaurant Sales. Restaurant sales increased 39% to $95.5 million in 1999, from $68.6 million in 1998. This increase was primarily due to a 50.5% increase in the number of equivalent restaurants open during 1999 as compared to 1998. "Equivalent restaurants" represents the number of restaurants open at the beginning of a given period, adjusted for restaurants opened, acquired, or sold during the period on a weighted average basis. Also, comparable sales increased 2.3% in 1999 over 1998, for restaurants open throughout both years. The total average unit sales decreased 7.2% from the comparable periods in 1998 due to the significant increase in new and acquired restaurants in the Company's "New Markets".
Costs and Expenses. Cost of sales, which consists of food, beverage, and paper costs, increased $7.1 million, and decreased as a percentage of restaurant sales to 30.7% in 1999 from 32.3% in 1998. This percentage decrease is primarily attributable to significantly lower average cheese costs in the last quarter of 1999, partially offset by a slight shallowing of discounts, and a higher proportion of units in New Markets. For fiscal 2000, the Company anticipates cheese costs, the most volatile food cost, to be less volatile based on the Company's participation in a franchisee-owned cheese cooperative. All of the Company's restaurants in the domestic United States receive product from PJI, and each restaurant is charged the same price for product, regardless of the location of the restaurant. In 1999, the Company's selling prices were higher in California, Oregon, and Puerto Rico, thus cost of sales as a percentage of restaurant sales was lower.
Salaries and benefits, which consist of all store level employee wages, taxes and benefits, increased $8.4 million, and increased as a percentage of restaurant sales to 27.9% in 1999 from 26.6% in 1998. The increase in salaries and benefits as a percentage of restaurant sales was primarily due to the increase in the proportion of new and acquired restaurants in New Markets, and also a higher minimum wage in California, Oregon and Washington.
Other operating expenses include other restaurant level operating costs, the material components of which are automobile mileage reimbursement for delivery drivers, rent, royalties, utility expenses, and advertising expenses. Other operating expenses increased $6.9 million, and increased as a percentage of restaurant sales to 24.0% in 1999 compared to 23.3% in 1998. This percentage increase is primarily attributable to a higher proportion of newer restaurants (thus lower sales and less leverage) and higher occupancy costs in New Markets.
General and administrative expenses increased $1.4 million and decreased as a percentage of restaurant sales to 5.0% in 1999 from 5.1% in 1998.
Depreciation and amortization increased by $1.2 million, and increased as a percentage of restaurant sales to 3.4% in 1999 from 3.0% in 1998. The dollar and percentage increases were primarily attributable to a higher proportion of newer restaurants in New Markets (thus lower sales and less leverage), and amortization of goodwill of acquired businesses in 1998.
Special charges include litigation compliance and asset impairment costs consists of $.3 million related to signage and other costs for the re-imaging of the Papa John's slogan and $.4 million related to asset impairment of restaurants.
Other Income. Other income which consists primarily of investment income decreased $.3 million from 1998. The decrease in investment income is a result of a lower investment balance due to the acquired businesses in 1998 and the Company's stock repurchases in 1999.
Income Tax Expense. Income tax expense (exclusive of the cumulative effect of accounting change and related taxes) reflects a combined federal, state and local effective tax rate of 34.0% in 1999, compared to 33.0% in 1998. The effective income tax rate increased as compared to 1998 as a result of a decrease in tax exempt income compared to total income.
Liquidity and Capital Resources
The Company requires capital primarily for the development of new restaurants, (which include franchise and development fees), and for existing restaurant improvements. In 2000, capital expenditures of $9.7 million and share repurchases of $10.7 million were primarily funded by cash flow from operations, liquidation of available cash and investments, and from increases in the line of credit facility.
Additionally, the Company also may repurchase its common stock from time to time. In September 2000, the Company's Board authorized an additional $10.0 million stock buyback, for a total authorization of $30 million. Through December 31, 2000, the Company had repurchased 1,624,000 shares for a total of $19.0 million; therefore, approximately $11.0 million remained on the buyback authorization.
Capital expenditures are expected to be approximately $4.0 million for 2001, all of which is expected to be for restaurant development and existing restaurant improvements. The Company also may acquire the operations of other Papa John's franchisees if such operations become available on terms satisfactory to the Company. Capital resources at December 31, 2000 include $2.4 million of cash and $6.0 million remaining in the Company's $10.0 million line of credit facility. The Company plans to fund its capital expenditures in 2001 and future years from available cash, cash generated from operations, and credit line availability.
In February 2001, the Company entered into a two year $15 million Revolving Line of Credit Facility with Bank One, Kentucky NA, that matures January 31, 2003, and replaces the above mentioned $10 million credit line.
Impact of Inflation
Excluding labor costs, the Company does not believe inflation has materially affected earnings during the past three years. Substantial increases in costs, particularly labor, employee benefits or food costs, could have a significant impact on the Company in the future. Rising labor costs have pressured margins, especially in 2000. The Company has increased wages to remain competitive in the restaurant industry.
Cheese, representing approximately 40% of our food cost, is subject to seasonal fluctuations, weather, demand and other factors that are beyond our control. Effective December 27, 1999, PJI's commissary entered into a purchasing arrangement with a third-party entity formed at the direction of the PJI's Franchise Advisory Council for the sole purpose of reducing cheese price volatility. Under this arrangement, the commissary will purchase cheese at a fixed quarterly price based, in part, on historical average cheese prices. Gains and losses incurred by the selling entity will be passed to the commissary via adjustments to the selling price over time. Ultimately the commissary will purchase cheese at a price approximating the actual average market price, but with more predictability and less volatility than previous purchasing method.
Impact of Year 2000
The Company is now Year 2000 compliant and there were no adverse events that occurred and no contingency plans were required to be implemented relating to the Year 2000 problem at year-end 1999. The Company spent approximately $10,000 in the year 1999 for its year 2000 readiness efforts. These expenses included replacing some outdated, non-compliant hardware and non-compliant software as well as identifying and remediating known Year 2000 problems. The Company does not anticipate any future exposure related to the year 2000 issue.
Forward Looking Statements
Certain information contained in this annual report, particularly information regarding future financial performance and plans and objectives of management, is forward looking. Certain factors could cause actual results to differ materially from those expressed in forward looking statements. These factors include, but are not limited to, our ability to obtain suitable locations and financing for new restaurant development; the hiring, training, and retention of management and other personnel; competition in the industry with respect to price, service, location, and food quality; an increase in food cost due to seasonal fluctuations, weather, and demand; changes in consumer tastes and demographic trends; changes in federal and state laws, such as increases in minimum wage; and risks inherent to international development.
Item 7a.
Item 7a. Qualitative and Quantitative Disclosures About Market Risk
We had no holdings of derivative financial or commodity instruments at December 31, 2000.
The Company's exposure to financial market risks in 2000 and going forward is the impact that interest rate changes could have on the interest expense incurred on borrowings under our revolving credit agreement (see "Note 8" of "Notes to Consolidated Financial Statement"). All such borrowings bear interest at a variable rate based on the prime rate, the London Interbank Offered Rate (LIBOR), or certain alternative short-term rates. A change in interest rates of 100 basis points would not significantly affect our net income.
Item 8.
Item 8. Financial Statements and Supplementary Data
The following table sets forth the percentage relationship to restaurant sales for certain income statement of operations data for the Company:
(1) The Company operates on a 52-53 week year ending on the last Sunday in December each year. 2000 was a 53 week year.
Index to Financial Statements and Supplementary Data
PJ AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(See accompanying notes)
PJ AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
(See accompanying notes)
PJ AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(See accompanying notes)
PJ AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW
(See accompanying notes)
PJ AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business
The Company operates pizza delivery and carry-out restaurants under the trademark "Papa John's" in nine states and Puerto Rico. At December 31, 2000, the Company operated 176 restaurants.
2. Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of PJ America, Inc. and its wholly-owned subsidiaries (the Company). All significant inter-company transactions between the consolidated companies have been eliminated.
Fiscal Year
The Company's fiscal year ends on the last Sunday in December of each year. Fiscal 2000 was a 53 week year.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.
Cash Equivalents
At December 31, 2000, the Company did not have any significant cash equivalents. Cash equivalents historically consisted of highly liquid investments with a maturity of three months or less at date of purchase. These investments were carried at cost, which approximated fair value.
Inventories
Inventories consist of food products, paper goods and supplies and are stated at the lower of cost, determined under the first-in, first-out (FIFO) method, or market. Virtually all of the Company's food products and supplies are purchased from PJI.
PJ AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Significant Accounting Policies (continued)
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets, which range from three to ten years for restaurant, commissary, and other equipment, 20 to 25 years for restaurant buildings and improvements, and 40 years for the Company's office building. Leasehold improvements are amortized over the terms of the respective leases, including the first renewal period (generally five to ten years). Normal repair and maintenance costs are expensed as incurred.
Investments
At December 31, 2000, the Company did not have any investments. Historically, the Company determined the appropriate classification of investment securities at the time of purchase and reevaluated such designation as of each balance sheet date. All investment securities held by the Company had been classified as held-to-maturity. Held-to-maturity investment securities are stated at amortized cost with any amortization of premiums and accretion of discounts included in other income.
Development and Franchise Fees
Development fees paid by the Company to PJI (or for the acquisition of another franchisee territory) for the right to open restaurants in a geographic area are deferred and amortized to expense on a pro rata basis as each restaurant is opened. Franchise fees are generally paid when each restaurant is opened and are deferred and amortized. Deferred development and franchise fees are amortized over a 20 year period using the straight-line method beginning with the opening of each restaurant.
Goodwill
Goodwill represents the excess of cost over fair value of assets acquired and is being amortized over 20-30 years using the straight-line method. The Company reviews the carrying value of goodwill if the facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable based upon the undiscounted expected future cash flows over the remaining amortization periods, the Company's carrying value of goodwill is reduced by the excess of the carrying value over the estimated fair value of the entity acquired.
PJ AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Significant Accounting Policies (continued)
Advertising and Related Costs
Advertising and related costs include restaurant activities such as mail coupons, doorhangers, promotional items, and required contributions to PJI's production fund (1.25% of restaurant sales). Such amounts are expensed as incurred and were approximately $4.6 million, $7.1 million and $9.3 million in 1998, 1999 and 2000, respectively, and are included in other operating expenses in the consolidated statements of income.
Long-Lived Assets
In accordance with Financial Accounting Standards Board (FASB) Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, the Company records impairment losses on long-lived assets used in operations and intangible assets including allocated goodwill when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amounts. In fiscal 2000, the Company recorded an impairment charge of which $7.2 million related to property and equipment, $1.6 million related to development and franchise fees, and $.7 million related to goodwill. (See Note 3)
Stock-Based Compensation
The Company follows the provisions of Accounting Principles Board Opinion (APB) No. 25 for its stock-based compensation awards (see Note 14).
Net Income (Loss) Per Share
Net income (loss) per share is based on the weighted average number of shares of common stock outstanding (Basic) and common stock equivalents during the period (Diluted). (see Note 14).
Income Taxes
The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." In accordance with the provisions of SFAS No. 109, deferred income taxes reflect the temporary tax consequences on future years of differences between the tax and financial statement basis of assets and liabilities.
Pre-Opening Costs - Restaurants
Restaurant pre-opening costs, which represent expenses incurred before a restaurant opens, are expensed as incurred.
PJ AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Significant Accounting Policies (continued)
Deferred Commissary Start-Up Costs - Accounting Changes
In the first quarter of 1999, the Company adopted the American Institute of CPAs Statement of Position (SOP) 98-5, "Reporting on the Costs of Start-up Activities," which requires entities to expense all start-up and pre-opening costs as they are incurred. The Company previously deferred commissary start-up costs and amortized them over a period of one year from the facility's opening date. The cumulative effect of this change in accounting principle, net of tax, was $181 thousand or $.03 per share and has been recorded in the first quarter of 1999 as required by the SOP.
Prior Year Data
Certain prior year data has been reclassified to conform to the 2000 presentation.
3. Other Charges
During the fourth quarter of 2000, the Company recorded an asset impairment charge of $9.5 million to reduce the carrying value of equipment, leaseholds, and intangible assets of the Company's restaurants to their estimated fair market value (See Note 2). Based upon current and future estimated operating results and cash flows, management believed that numerous restaurants would likely continue to generate operating and cash flow losses over the related remaining lease terms and therefore reduced the carrying value of the impaired assets to estimated fair market value. As is the case with all estimated that involve predictions of future outcomes, management's estimates of future operating results, cash flows and fair market value is subject to change. The impairment charge related primarily to restaurants in New Markets. The Company is evaluating these restaurants to determine an appropriate course of action to improve the operations or potential closure and recently hired a Chief Operating Officer in January 2001, who is assisting in this evaluation.
4. Business Combinations
In May 1998, the Company acquired a 22-restaurant Papa John's territory in Southern Louisiana, which included nine existing restaurants, five restaurants under development, and development rights for eight additional restaurants. The purchase price was $4.3 million in cash and a short term note payable to sellers, plus the assumption of $1.4 million of debt, which was immediately retired. The above acquisition was with certain Company directors and officers, including the Chairman of the Board and Chief Executive Officer.
PJ AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4. Business Combinations (continued)
In September 1998, the Company acquired a 30-restaurant Papa John's territory in Utah, which included 12 existing restaurants and development rights for 18 additional restaurants. The purchase price was $.8 million in cash plus the assumption of $2.5 million of debt, which was immediately retired. The above acquisition was with certain Company directors and officers, including the Chairman of the Board and Chief Executive Officer.
The above business combinations were accounted for by the purchase method of accounting, whereby operating results subsequent to the acquisition date have been included in the Company's consolidated financial statements.
PJ AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
5. Investments
At December 31, 2000, the Company had no investments.
A summary of the Company's held-to-maturity securities, principally corporate debt securities and municipal bonds, as of December 26, 1999 follows (in thousands):
6. Net Property and Equipment
Net property and equipment consists of the following (in thousands):
PJ AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. Accrued Expenses
Accrued expenses consists of the following (in thousands):
1999 2000 ------------------------------
Salaries and wages $ 782 $ 907 Taxes, other than income 655 750 Advertising and royalties 396 518 Other 2,492 2,282 ----------------------------- $4,325 $4,457 =============================
8. Revolving Credit Facility
As of December 31, 2000, the Company had a $10.0 million committed line of credit agreement expiring on May 2, 2001. At December 31, 2000, $4.0 million was outstanding. Effective January 31, 2001, the Company entered into a new $15.0 million unsecured revolving line of credit facility with an expiration date of January 31, 2003. Outstanding balances for this facility currently accrue interest at 100.0 basis points over LIBOR or other developed rates at our option. The commitment fee on the unused balance is 25.0 basis points per annum. The increment over LIBOR and the commitment fee are determined quarterly based upon the ratio of total indebtedness to earnings before interest, taxes, depreciation and amortization (EBITDA). On February 8, 2001, $3.5 million was outstanding under this facility.
9. Cheese Pricing Arrangement
Papa John's Franchise Advisory Council has initiated a program that allows the cost of cheese to Papa John's restaurants to be established on a quarterly basis. An independent franchisee-owned corporation, BIBP Commodities, Inc. ("BIBP"), purchases cheese at the market price and sells it to PJI's 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 (Franchisor-owned and franchised) at a set quarterly price. Gains or losses incurred by BIBP due to differences in the actual market price of cheese purchased and the established quarterly sales price are factored into determining the price for the following quarter.
The company owns 18% of BIBP, and the investment is recorded in other assets and is carried at cost.
PJ AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
10. Income Taxes
A summary of income tax expense is as follows (in thousands):
1998 1999 2000 Current ---- ---- ----
Federal $1,925 $2,283 $ 1,135 State and local 190 229 190 Deferred (federal and state) 380 397 (2,696) ------------------------------- Income tax expense $2,495 $2,909 $(1,371) ===============================
Net deferred tax assets (liabilities) as of December 26, 1999 and December 31, 2000 are comprised of the following (in thousands):
The reconciliation of income tax computed at the U.S. federal statutory rate to income tax expense is as follows (in thousands):
Income tax payments amounted to $1.8 million, $1.8 million and $1.1 million in 1998, 1999, and 2000, respectively.
PJ AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. Related Party Transactions
Franchisor
Under the terms of the current area development agreements between the Company and PJI, the Company paid development fees of $5,000 per restaurant. Currently, franchise fees of $15,000 have been paid as each new restaurant was opened. Royalties in the amount of 4% of restaurant sales are paid monthly to PJI, and a monthly contribution of 1.25% of sales is paid to the Marketing Fund of PJI. The Company is required to buy certain proprietary food products from PJI's commissary subsidiary and has elected to buy substantially all other food products, supplies, marketing materials and equipment from PJI or its subsidiaries.
The Company's franchise and development agreements with PJI contain certain requirements regarding the number of units to be opened in the future. Should the Company fail to comply with the required development schedule or with the requirements of the agreements for restaurants within areas covered by the development agreements, PJI has the right to terminate the exclusive nature of the Company franchises. The franchise agreements also provide PJI with significant rights regarding the business and operations of the Company.
In connection with the Company's Initial Public Offering in October 1996, the Company issued a warrant to PJ USA (a subsidiary of PJI) to purchase 225,000 shares of common stock at $11.25 per share. The warrant was issued in consideration for, among other things, the rights to enter into development agreements and the waiver of rights of first refusal of certain affiliated franchisees. The Company expects to pay all standard development and franchise fees in connection with operating restaurants in these territories. The warrant is exercisable in whole or in part at any time until October 30, 2001.
Affiliate Market
Certain officers and directors of the Company own equity interests in other entities that franchise Papa John's restaurants. The Company has obtained a right of first refusal to acquire franchise and development rights for PJ Iowa, LLC. However, there is no agreement or understanding between the Company and these entities or stockholders to acquire such entities or their assets.
As noted in Note 4, the acquisitions have been made between the Company and certain Company directors and officers.
PJ AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
12. Leases
The Company primarily leases restaurant retail space under operating leases with terms generally ranging from three to five years and providing for at least one renewal. Certain leases further provide that the lease payments may be increased annually based on the Consumer Price Index. Future minimum lease payments are as follows (in thousands):
2001 3,677 2002 3,361 2003 2,623 2004 1,704 2005 1,030 Thereafter 1,307 ------- $13,702 =======
Rent expense was approximately $1.5 million, $2.4 million and $3.2 million in 1998, 1999, and 2000, respectively.
13. Stock Repurchases
In September 2000, the Board of Directors authorized the Company to purchase an additional $10 million of its common stock in both open market purchases as well as private transactions. This brought the total authorization to $30 million. As of December 31, 2000, the Company had repurchased and immediately retired 1,624,000 shares at various prices totaling $19.0 million.
14. Stock Options
In 1996, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). In accordance with SFAS 123, the Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS 123 requires the use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized.
The Company awards stock options under the PJ America, Inc. 1996 Stock Ownership Incentive Plan (the "Incentive Plan") and the PJ America, Inc. 1996 Non-Employee Directors' Stock Option Plan (the "Directors' Plan"). Shares of common stock authorized for issuance are 1,500,000 under the Incentive Plan and 240,000 under the Directors' Plan. Options granted under both plans generally expire ten years from the date of grant and vest over one to four year periods.
PJ AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
14. Stock Options (continued)
The Incentive Plan also provides for awards of restricted stock, however the Company has not granted any such awards.
SFAS 123 requires disclosure of pro forma net income and earnings per share as if the Company had accounted for employee stock options granted subsequent to December 25, 1994 under the fair value method. The fair value for these options was estimated at the dates of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 2000, 1999, and 1998, respectively: risk-free interest rates of 5.75% for 2000 and 6.0% for 1999 and 1998; a dividend yield of 0%; volatility factors of the expected market price of the Company's common stock of .55, .93, and .49, respectively; and a weighted- average expected life of the options of 4.0, 3.5 and 4.0 years, respectively.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair market value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting periods. The Company's pro forma information follows (in thousands, except per share amounts):
1998 1999 2000 - -------------------------------------------------------------------------- Pro forma net income (loss) $4,475 $4,464 $(3,420) Pro forma earnings (loss) per share - Basic 0.77 0.78 (0.72) Pro forma earnings (loss) per share - Diluted 0.75 0.75 (0.72)
PJ AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
14. Stock Options (continued)
Information pertaining to options for 1998, 1999 and 2000 is as follows (number of options in thousands):
At December 31, 2000, approximately 625,000 shares were available for future issuance under the Incentive Plan, and 20,000 shares are available for future issuance under the Directors' Plan.
The following table sets forth the reconciliation of basic and diluted weighted average shares outstanding for 1998 through 2000:
PJ AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
15. Quarterly Data (Unaudited) in thousands, except per share data
(1) Other charges include asset impairment charges on the Company's long-lived assets. The pre-tax charges were $9,465,000 and $690,000 in 2000 and 1999 respectively. The tax benefit of these charges was $3,288,000 and $235,000, thus the charges net of taxes were $6,177,000 ($1.30 per share) and $455,000 ($0.08 per share) in 2000 and 1999, respectively.
PJ AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
16. Defined Contribution Benefit Plan
Effective January 1, 2001, the Company established the PJ America, Inc. 401(k) Plan (the "Plan"), as a defined contribution benefit plan, in accordance with Section 401(k) of the Internal Revenue Code. The Plan is open to all employees who meet certain eligibility requirements (excluding highly compensated employees) and allows participating employees to defer receipt of a portion of their compensation and contribute such amount to one or more investment funds. Effective January 1, 2001, the Company began contributing up to 1.5% of a participating employee's earnings. Administrative costs of the Plan are paid by the Company and are not significant.
Report of Management
The consolidated financial statements appearing in this Annual Report have been prepared by management, which is responsible for their preparation, integrity and fair presentation. The statements have been prepared in accordance with generally accepted accounting principles and necessarily include some amounts that are based on management's best estimates and judgments.
Management is responsible for the system of internal controls over financial reporting at PJ America, Inc. and its subsidiaries, a system designed to provide reasonable assurance regarding the preparation of reliable published financial statements. This system is augmented by written policies and procedures and the selection and training of qualified personnel. Management believes that the Company's system of internal controls over financial reporting provides reasonable assurance that the financial records are reliable for preparing financial statements.
The Audit Committee of the Board of Directors meets with the independent auditors and management periodically to discuss internal controls over financial reporting and other auditing and financial reporting matters. The Committee reviews with the independent auditors the scope and results of the audit effort. The Committee also meets with the independent auditors without management present to ensure that the independent auditors have free access to the Committee. The independent auditors are recommended by the Audit Committee of the Board of Directors and selected by the Board of Directors. Based upon their audit of the consolidated financial statements, the independent auditors, Ernst & Young LLP, have issued their Report of Independent Auditors, which follows.
/s/ Douglas S. Stephens /s/ D. Ross Davison --------------------------- ------------------------------------------- Douglas S. Stephens D. Ross Davison President and C.E.O. Senior Vice President Administration, C.F.O. and Treasurer
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders PJ America, Inc.
We have audited the accompanying consolidated balance sheets of PJ America, Inc. and Subsidiaries as of December 26, 1999 and December 31, 2000, and the related consolidated statements of operations, stockholders' equity, and cash flows for the years ended December 27, 1998, December 26, 1999 and December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of PJ America, Inc. and Subsidiaries, at December 26, 1999 and December 31, 2000, and the consolidated results of their operations and their cash flows for the years ended December 27, 1998, December 26, 1999 and December 31, 2000 in conformity with accounting principles generally accepted in the United States.
As discussed in Note 2 to the consolidated financial statements, in 1999 the Company changed its method of accounting for the costs of start-up activities.
Ernst & Young LLP
Birmingham, Alabama /s/ Ernst & Young LLP February 8, 2001
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None
PART III
Items 10, 11, 12 and 13. Directors and Executive Officers of the Registrant; Executive Compensation; Security Ownership of Certain Beneficial Owners and Management; and Certain Relationships and Related Transactions.
The information required by these items, other than information set forth in this Form 10-K under Item I, "Executive Officers of Registrant," is omitted because the Company is filing a definitive proxy statement pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Form 10-K which includes the required information. The required information contained in the Company's proxy statement is incorporated herein by reference.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) The following consolidated financial statements of PJ America, Inc. and Subsidiaries and the reports of management and independent auditors are included in Item 8:
(a)(2) Consolidated Financial Statement Schedules:
All schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are not applicable and therefore have been omitted.
(a)(3) Exhibits:
3.1 The Company's Certificate of Incorporation. Exhibit 3.1 to the Company's Registration Statements on Form S-1 (Registration No. 333- 11253) is incorporated herein by reference.
3.2 The Company's By-laws. Exhibit 3.2 to the Company's Registration Statement on Form S-1 (Registration No. 333-11253) is incorporated herein by reference.
4 Specimen Stock Certificate. Exhibit 4 to the Company's Registration Statement on Form S-1 (Registration No. 333-11253) is incorporated herein by reference.
10.1 Form of Registration Rights Agreement. Exhibit 10.1 to the Company's Registration Statement on Form S-1 (Registration No. 333-11253) is incorporated herein by reference.
10.2 Form of 1996 Stock Ownership Incentive Plan. Exhibit 10.2 to the Company's Registration Statement on Form S-1 (Registration No. 333- 11253) is incorporated herein by reference.
10.3 Form of Non-Employee Directors 1996 Stock Incentive Plan. Exhibit 10.3 to the Company's Registration Statement on Form S-1 (Registration No. 333-11253) is incorporated herein by reference.
10.8 Warrant issued to PJI. Exhibit 10.8 to the Company's Registration Statement on Form S-1 (Registration No. 333-11253) is incorporated herein by reference.
10.10 Development Agreement relating to the Utah territory. Exhibit 10.10 to the Company's Registration Statement on Form S-1 (Registration No. 333-11253) is incorporated herein by reference.
10.11 Development Agreement relating to the development of an aggregate of ten restaurants in Birmingham, Tuscaloosa and Auburn, Alabama. Exhibit 10.11 to the Company's Registration Statement on Form S-1 (Registration No. 333-11253) is incorporated herein by reference.
10.11(a) First Amendment to the Alabama Development Agreement. Exhibit to the Company's Registration Statement on Form S-1 (Commission File No. 333-11253) is hereby incorporated by reference.
10.11(b) Second Amendment to the Alabama Development Agreement. Exhibit to the Company's Registration Statement on Form S-1 (Commission File No. 333- 11253) is hereby incorporated by reference.
10.11(c) Third Amendment to the Alabama Development Agreement. Exhibit 10.11(c) to the Company's Registration Statement on Form S-1 (Commission File No. 333-11253) is hereby incorporated by reference.
10.17 Development Agreement relating to the Virginia development of an aggregate of 47 restaurants in Virginia Beach, Richmond and Norfolk, Virginia. Exhibit 10.17 to the Company's Registration Statement on Form S-1 (Registration No. 333-11253) is incorporated herein by reference.
10.17(a) First Amendment to the Virginia Development Agreement. Exhibit 10.17(a) to the Company's Registration Statement on Form S-1 (Commission File No. 333-11253) is hereby incorporated by reference.
10.17(b) Second Amendment to the Virginia Development Agreement. Exhibit 10.17(b) to the Company's Registration Statement on Form S-1 (Commission File No. 333-11253) is hereby incorporated by reference.
10.17(c) Third Amendment to the Virginia Development Agreement. Exhibit 10.17(c) to the Company's Registration Statement on Form S-1 (Commission File No. 333-11253) is hereby incorporated by reference.
10.17(d) Fourth Amendment to the Virginia Development Agreement. Exhibit 10.17(d) to the Company's Registration Statement on Form S-1 (Commission File No. 333-11253) is hereby incorporated by reference.
10.19 PJI's Waiver of Right of First Refusal (certain Utah, Iowa markets and other markets). Exhibit 10.19 to the Company's Registration Statement on Form S-1 (Registration No. 333-11253) is incorporated herein by reference.
10.20 The Company's Right of First Refusal relating to certain Iowa territories. Exhibit 10.20 to the Company's Registration Statement on Form S-1 (Registration No. 333-11253) is incorporated herein by reference.
10.30 Development Agreement relating to development of 60 restaurants in California. Exhibit 10.30 is hereby incorporated by reference from the Form 10-K for the fiscal year ended December 27, 1998.
10.31 Commissary License Agreement relating to the Company's agreement to operate a commissary in Puerto Rico. Exhibit 10.31 is hereby incorporated by reference to the Form 10-K for the fiscal year ended December 27, 1998.
10.32 Development Agreement relating to development of 20 restaurants in Puerto Rico. Exhibit 10.32 is hereby incorporated by reference to the Form 10-K for the fiscal year ended December 27, 1998.
10.33 Development Agreement relating to development of 36 restaurants in Portland, Oregon, and surrounding areas. Exhibit 10.33 is hereby incorporated by reference to the Form 10-K for the fiscal year ended December 27, 1998.
10.34 Stock Purchase Agreement among PJ America, Inc., PJ Louisiana, Inc. and Douglas S. Stephens, Robert W. Curtis, Jr., Michael M. Fleishman, Merida Sherman, Nicholas Sherman, Richard F. Sherman, Frank O. Keener, and Stephen P. Langford dated May 13, 1998. Exhibit 10.34 is hereby incorporated by reference to the Form 10-K for the fiscal year ended December 27, 1998.
10.35 Purchase Agreement among PJ America, Inc., Ohio Pizza Delivery Co., Inc., PJ Utah, LLC, and Members dated September 3, 1998. Exhibit 10.35 is hereby incorporated by reference to the Form 10-K for the fiscal year ended December 27, 1998.
10.36 Merger of Development Agreements among PJ America and PJI dated February 1, 2001. (Domestic U.S. restaurants)
10.37 First Amendment to Loan Agreement between PJ America, Inc. and Bank One, Kentucky NA dated January 31, 2001, amending the revolving line of credit to $15.0 million.
21 Subsidiaries of the Company: (a) PJ Cheese, Inc. an Alabama corporation (b) Ohio Pizza Delivery Co., Inc. an Ohio corporation (c) PJ Louisiana, LLC, a Louisiana limited liability corporation (d) PJ Utah, LLC, a Utah limited liability corporation (e) Pizza Caribe, Inc. a Puerto Rico corporation
23 Consent of Ernst & Young LLP, Independent Auditors
99.1 Other Statements.
(a) Reports on Form 8-K
1. The Company filed a Current Report on Form 8-K (Item 5) dated December 13, 2000 attaching a press release dated December 7, 2000 announcing a fourth quarter 2000 charge and anticipated 2001 restaurant openings.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: February 26, 2001 PJ AMERICA, INC.
By: /s/ Douglas S. Stephens --------------------------------------- Douglas S. Stephens Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.