PAPA JOHNS INTERNATIONAL INC 10-K 2005
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File Number: 0-21660
PAPA JOHNS INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Securities registered pursuant to Section 12(b) of the Act:
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Act).
Yes ý No o
As of March 1, 2005 there were 16,478,049 shares of the Registrants Common Stock outstanding. The aggregate market value of the shares of Registrants Common Stock held by non-affiliates of the Registrant at such date was $359,820,294 based on the last sale price of the Common Stock on March 1, 2005 as reported by The NASDAQ Stock Market. For purposes of the foregoing calculation only, all directors and executive officers of the Registrant have been deemed affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Part III are incorporated by reference to the Registrants Proxy Statement for the Annual Meeting of Stockholders to be held May 3, 2005.
TABLE OF CONTENTS
Item 1. Business
Papa Johns International, Inc. (referred to as the Company, Papa Johns or in the first person notations of we, us and our) operates and franchises pizza delivery and carryout restaurants under the trademark Papa Johns. At December 26, 2004, the Company and its franchisees operated domestically in 49 states, the District of Columbia and Puerto Rico and in 17 countries, and under the trademark Perfect Pizza in the United Kingdom. The first Company-owned Papa Johns restaurant opened in 1985 and the first franchised restaurant opened in 1986. We acquired Perfect Pizza Holdings Limited (referred to as Perfect Pizza and Papa Johns UK) in 1999 as part of our plan to develop restaurants internationally (see Development). At December 26, 2004, there were 2,829 Papa Johns restaurants in operation, consisting of 569 Company-owned and 2,260 franchised restaurants. Additionally, there were 118 franchised Perfect Pizza restaurants in operation.
All of our periodic report filings with the Securities and Exchange Commission (SEC) pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended, are available, free of charge, through our web site located at www.papajohns.com, including our annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, and any amendments to those reports. These reports are available through our website as soon as reasonably practicable after we electronically file such reports or amendments with the SEC. Printed copies of such documents are also available free of charge upon written request to Investor Relations, Papa Johns International, Inc., P.O. Box 99900, Louisville, KY 40269-0900.
Our goal is to build the strongest brand loyalty of all pizzerias internationally. The key elements of our strategy include:
Menu. Domestic Papa Johns restaurants offer a menu of high-quality pizza along with side items, including breadsticks, cheesesticks, chicken strips, chicken wings and canned or bottled soft drinks. Papa Johns traditional crust pizza is prepared using fresh dough (never frozen). Papa Johns pizzas are made from a proprietary blend of wheat flour, cheese made from 100% real mozzarella, fresh-packed pizza sauce made from vine-ripened tomatoes (not from concentrate) and a proprietary mix of savory spices, and a choice of high-quality meat (100% beef, pork and chicken with no fillers) and vegetable toppings. Domestically, all ingredients and toppings can be purchased from our Quality Control Center (QC Centers) system, which delivers twice weekly. Each traditional crust pizza offers a container of our special garlic sauce, and each thin crust pizza is served with a packet of special seasonings. In international markets, the menu mix (toppings and side items) is adapted to local tastes.
Efficient Operating System. We believe our operating and distribution systems, restaurant layout and designated delivery areas result in lower restaurant operating costs and improved food quality, and promote superior customer service. Our domestic QC Center system takes advantage of volume purchasing of food and supplies, and provides consistency and efficiencies of scale in dough production. This eliminates the need for each restaurant to order food from multiple vendors and commit substantial labor and other resources to dough preparation.
Commitment to Team Member Training and Development. We are committed to the development and motivation of our team members through training programs, incentive compensation and opportunities
for advancement. Team member training programs are conducted for corporate team members, and offered to our franchisees at training centers across the United States. We offer performance-based financial incentives to restaurant team members at various levels. Our management compensation program is designed to attract and retain highly motivated people.
Marketing. Our restaurant-level marketing programs target the delivery area of each restaurant, making extensive use of targeted print materials in direct mail and store-to-door couponing. Local marketing efforts also include a variety of community-oriented activities with schools, sports teams and other organizations. Local marketing efforts are supplemented with radio and television advertising, produced locally and on a national basis. Eight national television campaigns aired in 2004.
Franchise System. We are committed to maintaining and developing a strong franchise system by attracting experienced operators, partnering with them to expand and grow their business and monitoring their compliance with our high standards. We seek to attract franchisees with experience in restaurant or retail operations and with the financial resources and management capability to open single or multiple locations. To ensure consistent food quality, each domestic franchisee is required to purchase dough and seasoned sauce from our QC Centers and purchase all other supplies from our QC Centers or approved suppliers. QC Centers outside the U.S. or in remote areas may be operated by franchisees pursuant to license agreements or other third parties. We devote significant resources to provide Papa Johns franchisees with assistance in restaurant operations, management training, team member training, marketing, site selection and restaurant design. We also provide significant assistance to licensed international QC Centers in sourcing high-quality in-country or regional suppliers to the extent possible.
In 2004, the 551 domestic Company-owned restaurants included in the most recent quarters comparable restaurant base generated average annual sales, based on a 52-week year, of $737,000, average cash flow (restaurant operating income plus depreciation) of $114,000 and average restaurant operating income of $89,000. This average operating income represents 12.1% of average sales and 32.4% of the $275,000 average cash investment for these Company-owned restaurants.
The average cash investment for the six domestic Company-owned restaurants opened during the 2004 fiscal year, exclusive of land, was approximately $232,000. We expect the average cash investment for the four Company-owned restaurants expected to open in 2005 to be approximately $250,000. Substantially all domestic restaurants and many of our international restaurants do not offer dine-in areas, which reduces our restaurant capital investment.
A total of 173 Papa Johns restaurants were opened during 2004, consisting of six Company-owned and 167 franchised restaurants (97 domestic and 70 international), while 135 Papa Johns restaurants closed during 2004, consisting of five Company-owned and 130 franchised (107 domestic and 23 international). During 2004, two franchised Perfect Pizza restaurants were opened and 18 franchised restaurants were closed.
During 2005, we plan to open approximately four Company-owned restaurants domestically and expect franchisees to open approximately 150 to 190 restaurants (80 to 100 domestically and 70 to 90 internationally). We also expect approximately 115 to 140 restaurants (80 to 100 domestically and 35 to 40 internationally) to close during 2005. Domestic and international franchise unit expansion is expected to spread throughout markets across North and South America, Europe, Asia and the Middle East.
Our Company-owned expansion strategy is to continue to open restaurants in existing markets, thereby increasing consumer awareness and enabling us to take advantage of operational and advertising efficiencies. Our experience in developing markets indicates that market penetration through the opening of multiple restaurants within a particular market results in increased average restaurant sales in that market. We have co-developed markets with some franchisees or divided markets among franchisees, and will continue to utilize market co-development in the future. We continually evaluate the number and market areas of our Company-owned restaurants, and may purchase or sell restaurants from time to time. We also have two joint ventures and may consider entering into more of these arrangements in the future.
Restaurant Design and Site Selection
Backlit awnings, neon window designs and other visible signage characterize the exterior of most Papa Johns restaurants. A typical domestic Papa Johns restaurant averages 1,100 to 1,500 square feet and a typical international Papa Johns restaurant averages 900 to 1,400 square feet. Papa Johns restaurants are designed to facilitate a smooth flow of food orders through the restaurant. The layout includes specific areas for order taking, pizza preparation and routing, resulting in simplified operations, lower training and labor costs, increased efficiency and improved consistency and quality of food products. The typical interior of a Papa Johns restaurant has a vibrant red and white color scheme with green striping, and includes a bright menu board, custom counters and a carryout customer area. The counters are designed to allow customers to watch the team members slap out the dough and put sauce and toppings on pizzas.
We consider the location of a restaurant to be important and therefore devote significant resources to the investigation and evaluation of potential sites. The site selection process includes a review of trade area demographics, target population density, household income levels and competitive factors. A member of our development team inspects each potential domestic Company-owned restaurant location and substantially all franchised restaurant locations and the surrounding market before a site is approved. Our restaurants are typically located in strip shopping centers or freestanding buildings that provide visibility, curb appeal and accessibility. Our restaurant design may be configured to fit a wide variety of building shapes and sizes, which increases the number of suitable locations for our restaurants.
A number of freestanding restaurants have been opened in the Papa Johns system. We seek either existing buildings suitable for conversion, or locations suitable for the construction of our prototype restaurant. Freestanding buildings generally provide more signage and better visibility, accessibility and parking. At December 26, 2004, freestanding units represented approximately 25% of domestic Company-owned restaurants, and a relatively small percentage of domestic franchised restaurants. We do not expect to add many domestic freestanding restaurants in the future.
We provide layout and design services and recommendations for subcontractors, signage installers and telephone systems to Papa Johns franchisees. Our franchisees can purchase complete new store equipment packages through an approved third party supplier under a commission arrangement with the Company. We sell replacement packages, smallwares and related items to our franchisees through our support services subsidiary, Papa Johns Support Services, Inc.
Quality Control Centers; Strategic Supply Chain Management
Our domestic QC Centers, comprised of 11 regional production and distribution centers in 2004, supply pizza dough, food products, paper products, smallwares and cleaning supplies twice weekly to each restaurant. This system enables us to monitor and control product quality and consistency, while lowering food costs. Our full-service QC Centers are located in Louisville, Kentucky; Dallas, Texas; Pittsburgh, Pennsylvania; Orlando, Florida; Raleigh, North Carolina; Jackson, Mississippi; Denver, Colorado; Rotterdam, New York; Portland, Oregon; Des Moines, Iowa; and Phoenix, Arizona. The QC Center system capacity is continually evaluated in relation to planned restaurant growth, and facilities are developed or upgraded as operational or economic conditions warrant. In early February 2005, based on our evaluation of planned restaurant growth, we announced the closing of the Jackson, Mississippi QC Center at the end of March 2005. Restaurants currently serviced by this QC Center will be routed from our other regional QC Centers.
Our subsidiary, Papa Johns UK, leases a distribution center in the United Kingdom. The primary difference between a full-service QC Center and a distribution center is that full-service QC Centers produce fresh pizza dough in addition to providing other food and paper products used in our restaurants. International full-service QC Centers, licensed to franchisees and non-franchisee third parties, are generally located in the markets where our franchisees have restaurants. We expect future international QC Centers to be licensed to franchisees or non-franchisee third parties; however, we may open Company-owned QC Centers at our discretion. We also have the right to acquire licensed QC Centers from our international licensees in certain circumstances.
We set quality standards for all products used in our restaurants and designate approved outside suppliers of food and paper products that meet our quality standards. In order to ensure product quality and consistency, all of our restaurants are required to purchase seasoned sauce and dough from our QC Centers. Franchisees may purchase other goods directly from our QC Centers or approved suppliers. National purchasing agreements with most of our suppliers generally result in volume discounts to us, allowing us to sell products to our restaurants at prices that we believe are below those generally available in the marketplace. Within our domestic QC Center system, products are distributed to restaurants by refrigerated trucks leased and operated by us or transported by a dedicated logistics company.
PJ Food Service, Inc. (PJFS), our wholly-owned subsidiary that operates our domestic Company-owned QC Centers, has a purchasing arrangement with BIBP Commodities, Inc. (BIBP), a third-party entity formed at the direction of the Franchise Advisory Council (see Franchise Program Franchise Advisory Council) for the sole purpose of reducing cheese price volatility to domestic system-wide restaurants. Under this arrangement, PJFS purchases cheese at a fixed quarterly price based in part on historical average cheese prices. Gains and losses incurred by the selling entity are passed to the QC Centers via adjustments to the selling price over time. Ultimately, PJFS purchases cheese at a price approximating the actual average market price, but with more predictability and less volatility than the previous purchasing method. Beginning in fiscal 2004, we began consolidating BIBP in our financial statements pursuant to the adoption of Financial Accounting Standards Board Interpretation No. 46 (FIN 46). See Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Consolidation of BIBP Commodities, Inc. (BIBP) as a Variable Interest Entity, and Note 4 of Notes to Consolidated Financial Statements for additional information concerning BIBP and the purchasing arrangement, and the related financial statement treatment thereof.
All Company-owned and franchised Papa Johns restaurants within a co-developed market are required to join an area advertising cooperative (Co-op). Each member restaurant contributes a percentage of sales to the Co-op for market-wide programs, such as radio, television and print advertising. The rate of contribution and uses of the monies collected are determined by a majority vote of the Co-ops members. The restaurant-level and Co-op marketing efforts are supported by print and electronic advertising materials that are produced by the Papa Johns Marketing Fund, Inc., a non-profit corporation (the Marketing Fund). The Marketing Fund produces and buys air time for Papa Johns national television commercials, in addition to other brand-building activities, such as consumer research. All domestic Company-owned and franchised Papa Johns restaurants are required to contribute a percentage of sales to the Marketing Fund. The contribution percentage was 2.0% from January through May 2004, increasing to 3.25% in June 2004. The contribution percentages in 2003 and 2002 were 2.0% and 1.25%, respectively. Effective at the beginning of fiscal 2005, the contribution percentage to the Marketing Fund decreased to 2.25%.
Restaurant-level marketing programs target the delivery area of each restaurant, making extensive use of targeted print materials in direct mail and store-to-door couponing. The local marketing efforts also include a variety of community-oriented activities with schools, sports teams and other organizations. In markets in which Papa Johns has a significant presence, local marketing efforts are supplemented with radio and television advertising.
We provide both Company-owned and franchised restaurants with catalogs for the purchase of uniforms and promotional items and pre-approved print marketing materials. We also provide direct marketing services to Company-owned and franchised restaurants using customer information gathered by our proprietary point-of-sale technology (see Company Operations Point of Sale Technology).
We have developed a system by which all domestic Papa Johns restaurant customers are able to place orders on-line via the internet. We receive a percentage fee based on on-line sales from domestic franchisees, in addition to royalties, for this service.
In November 2003, we began offering our customers the opportunity to purchase a reloadable gift card, (Papa Card) that can be purchased in any denomination between $10 and $100. The Papa Card may be redeemed for delivery, carryout and on-line orders and is accepted at substantially all Papa Johns traditional U.S. restaurants.
Restaurant Personnel. A typical Papa Johns restaurant employs a restaurant manager, one or two assistant managers and approximately 20 to 25 hourly team members, most of whom work part-time. The manager is responsible for the day-to-day operation of the restaurant and maintaining Company-established operating standards. The operating standards and other resources are contained in a comprehensive operations manual supplied to each restaurant. We seek to hire experienced restaurant managers and staff, provide comprehensive training on operations and managerial skills, and motivate and retain them by providing opportunities for advancement and performance-based financial incentives.
We also employ directors of operations who are responsible for overseeing an average of seven Company-owned restaurants. These team members are eligible to earn performance-based financial incentives.
Training and Education. We have a department dedicated to training and developing team members, as well as assisting with new restaurant openings. With regional training locations across the country, we are capable of training multiple operators during new program or product introductions. We provide an on-site training team three days before and three days after the opening of any Company-owned or franchised restaurant requesting assistance. Operations personnel, both corporate and franchise, complete our management training program and on-going development programs in which instruction is given on all aspects of our systems and operations. The programs include hands-on training and some classroom instruction at an operating Papa Johns restaurant by a Company certified general training manager. Our training includes new team member orientation, in-store and delivery training, core management skills training, new product or program implementation and ongoing developmental programs.
Point of Sale Technology. Point of sale technology (our proprietary PROFIT SystemTM) is in place in all domestic traditional Papa Johns restaurants and in substantially all Papa Johns international restaurants. We believe this technology facilitates faster and more accurate order taking and pricing, reduces paperwork and allows the restaurant manager to better monitor and control food and labor costs. We believe the PROFIT System enhances restaurant-level marketing capabilities through the development of a database containing information on customers and their buying habits with respect to our products. Polling capabilities allow us to obtain restaurant operating information, thereby improving the speed, accuracy and efficiency of restaurant-level reporting. During 2004, we introduced a new generation of the PROFIT System to the domestic and international Papa Johns system. This updated version was designed to improve operational efficiencies at the restaurant level and improve our data collection process. We expect the updated PROFIT System to be installed in substantially all domestic Company-owned and franchised restaurants by mid-2005.
Reporting. Management at Company-owned restaurants evaluates daily reports of sales, cash deposits and operating costs. Physical inventories of all food and beverage items are taken nightly.
Joint Venture. We operate 107 Company-owned restaurants under two joint venture arrangements. Under the first arrangement, we own 70% of 36 Papa Johns restaurants located in Northern Virginia. We entered into the second arrangement during 2004 in which we retained 51% ownership in 71 Company-owned restaurants located in Texas. We will continue to evaluate further joint venture arrangements on an individual basis as opportunities arise.
Hours of Operations. Our domestic restaurants are open seven days a week, typically from 11:00 a.m. to 12:30 a.m. Monday through Thursday, 11:00 a.m. to 1:30 a.m. on Friday and Saturday and 12:00 noon to 11:30 p.m. on Sunday.
General. We continue to attract franchisees with significant restaurant and retail experience. We consider our franchisees to be a vital part of our systems continued growth and believe our relationship with our franchisees is good. As of December 26, 2004, there were 2,260 franchised Papa Johns restaurants operating in 49 states, the District of Columbia, Puerto Rico and 17 countries, and 118 franchised Perfect Pizza restaurants operating in the United Kingdom. As of December 26, 2004, we have development agreements with our domestic franchisees for approximately 373 additional franchised restaurants committed to open through 2009 and agreements for 746 additional international franchised restaurants to open through 2013. There can be no assurance that all of these restaurants will be opened or that the development schedule set forth in the development agreements will be achieved. There are no formal development agreements for franchised Perfect Pizza restaurants and we anticipate opening minimal Perfect Pizza units in the future. Our plan is to attract new franchisees, and to work with existing franchisees, to open new Papa Johns restaurants in the United Kingdom. During 2004, 167 (97 domestic
and 70 international) franchised Papa Johns restaurants were opened, and two Perfect Pizza franchised restaurants were opened. Our franchisees have converted 61 Perfect Pizza restaurants to Papa Johns restaurants since 2000.
Approval. Franchisees are approved on the basis of the applicants business background, restaurant operating experience and financial resources. We seek franchisees to enter into development agreements for single or multiple restaurants. We require the franchisee to either complete our training program or to hire a full-time operator who completes the training and has either an equity interest or the right to acquire an equity interest in the franchise operation.
Development and Franchise Agreements. We enter into development agreements with our domestic franchisees for the opening of a specified number of restaurants within a defined period of time and specified geographic area. Under our current standard development agreement, the franchisee is required to pay, at the time of signing the agreement, a non-refundable fee of $25,000 for the first restaurant and $5,000 for any additional restaurants. The non-refundable fee is credited against the standard $25,000 franchise fee payable to us upon signing the franchise agreement for a specific location. Generally, a franchise agreement is executed when a franchisee secures a location.
Our current standard domestic franchise agreement provides for a term of ten years (with one ten-year renewal option) and payment to us of a royalty fee of 4% of sales. The current agreement, as well as substantially all existing franchise agreements, permits us to increase the royalty fee up to 5% of sales. The royalty fee cannot be increased to an amount greater than the percentage royalty fee then in effect for new franchisees.
We have the right to terminate a franchise agreement for a variety of reasons, including a franchisees failure to make payments when due or failure to adhere to our policies and standards. Many state franchise laws limit the ability of a franchisor to terminate or refuse to renew a franchise.
We opened our first franchised restaurant outside the United States in 1998. We define international markets to be all markets outside the contiguous United States in which we have either a development agreement or a master franchise agreement with a franchisee for the opening of a specified number of restaurants within a defined period of time and specified geographic area; therefore, a country could be divided into multiple markets. Under a master franchise agreement, the franchisee has the right to subfranchise a portion of the development to one or more subfranchisees approved by us. Under our current standard international development agreement (except for Hawaii and Alaska in which the initial fees are the same as domestic restaurants), the franchisee is required to pay total fees of $25,000 per restaurant, $5,000 at the time of signing the agreement, and $20,000 when the restaurant opens or the agreed-upon development date, whichever comes first. Under our current standard master franchise agreement, the master franchisee is required to pay total fees of $25,000 per restaurant owned and operated by the master franchisee, under the same terms as the development agreement, and $15,000 for each subfranchised restaurant, $5,000 at the time of signing the agreement and $10,000 when the restaurant opens or the agreed-upon development date, whichever comes first.
Our current standard international master franchise and development agreements provide for payment to us of a royalty fee of 5% of sales (including sales by subfranchised restaurants), with no provision for increase. The remaining terms applicable to the operation of individual restaurants are substantially equivalent to the terms of our standard domestic franchise agreement. From time to time, development agreements will be negotiated at other than standard terms for fees and royalties.
We franchise restaurants in the United Kingdom under Perfect Pizza franchise agreements, which were in effect at the time of our acquisition in 1999. These franchise agreements differ from our standard
international franchise agreements in many respects, although with few material differences. A principal difference is the term of the agreement, which is five years. The franchise fee is £18,500 (approximately $35,500 at an exchange rate of $1.92 as of December 26, 2004), and the royalty rate of 5% is the same as in our standard international agreements. The Perfect Pizza system has been developed principally through franchising of individual restaurants to single location franchisees. Thus, the system historically had no equivalent to our development agreements or master franchise agreements.
We have entered into a limited number of development and franchise agreements for non-traditional restaurant units and continue to analyze opportunities to expand these types of units. These agreements generally cover venues or areas not originally targeted for development and have terms differing from the standard agreement. These agreements have not had a significant impact on our revenues or earnings.
Franchise Restaurant Development. We provide assistance to Papa Johns franchisees in selecting sites, developing restaurants and evaluating the physical specifications for typical restaurants. Each franchisee is responsible for selecting the location for its restaurants but must obtain our approval of restaurant design and location based on accessibility and visibility of the site and targeted demographic factors, including population, density, income, age and traffic. Our domestic franchisees may purchase complete new store equipment packages through an approved third party supplier under a commission arrangement with the Company. Internationally, our franchisees buy their equipment from approved third party suppliers.
Franchisee Loans. Selected franchisees have borrowed funds from our subsidiary, Capital Delivery, Ltd., principally for use in the construction and development of their restaurants. We have also entered into loan agreements with certain franchisees that purchased restaurants from us or other franchisees. Loans made to franchisees typically bear interest at fixed or floating rates (with a stated average interest rate of 5.6% at December 26, 2004) and in most cases are secured by the fixtures, equipment and signage (and where applicable, the land) of the restaurant and the ownership interests in the franchisee. At December 26, 2004, franchisee loans outstanding totaled $6.8 million ($3.6 million of net loans were eliminated upon consolidating franchisee variable interest entities or VIEs), net of a $1.3 million reserve for uncollectible amounts. See Note 10 of Notes to Consolidated Financial Statements for additional information.
We have a commitment to lend up to $17.6 million to BIBP, a franchisee-owned corporation. We have an outstanding loan of $10.0 million to BIBP at December 26, 2004, which is eliminated in consolidation. See Note 10 of Notes to Consolidated Financial Statements for additional information.
Franchise Insurance Program. Our franchisees have the opportunity to purchase various insurance policies, such as non-owned automobile and workers compensation, through our insurance agency, Risk Services Corp. (Risk Services). In October 2000, we established a captive insurance company located in Bermuda, RSC Insurance Services, Ltd., to accommodate this business. Beginning in October 2004, a third-party commercial insurance company began providing fully-insured coverage to franchisees participating in the franchise insurance program. Accordingly, this new agreement eliminates our risk of loss for franchise insurance coverage written after September 2004. As of December 26, 2004, approximately 49% of domestic franchise restaurants had obtained insurance coverage through Risk Services. See Note 11 of Notes to Consolidated Financial Statements for additional information.
Franchise Training and Support. Every franchisee is required to have a principal operator approved by us who satisfactorily completes our required training program and who devotes his or her full business time and efforts to the operation of the franchisees restaurants. Each franchise restaurant manager is also required to complete our Company-certified management training program. We provide an on-site training crew three days before and three days after the opening of a franchisees first two restaurants.
Ongoing supervision of training is monitored by the franchise training team. Multi-unit franchisees are encouraged to appoint training store general managers or hire a full-time training coordinator certified to deliver Company-approved programs in order to train new team members and management candidates for their restaurants. Our area franchise directors maintain open communication with the franchise community, relaying operating and marketing information and new ideas between franchisees and us. Internationally, training is monitored by our international director of training as well as regional directors and international business managers assigned to specific franchisee territories. We also maintain communications with our franchisees through periodic system-wide meetings and newsletters.
Franchise Operations. All franchisees are required to operate their Papa Johns restaurants in compliance with our policies, standards and specifications, including matters such as menu items, ingredients, materials, supplies, services, fixtures, furnishings, decor and signs. Each franchisee has full discretion to determine the prices to be charged to its customers.
Franchise Advisory Council. We have a Franchise Advisory Council that consists of Company and franchisee representatives of domestically owned restaurants. The Advisory Council and subcommittees hold regular meetings to discuss new marketing ideas, operations, growth and other relevant issues.
We currently communicate with, and receive input from, our franchisees in several forms, including through the Companys Franchise Advisory Council, annual operations conferences and various regional meetings conducted with franchisees throughout the year and participation in an operators exchange best practices forum in which numerous franchisees also participate. We are committed to communicating with, and receiving input from, our franchisees regardless of the venue or form such communications may ultimately take.
Reporting and Business Processes. We collect weekly and monthly sales and other operating information from Papa Johns franchisees. We have agreements with substantially all Papa Johns domestic franchisees permitting us to debit electronically the franchisees bank accounts for substantially all payments to us including the payment of royalties, Marketing Fund contributions, risk management services, and purchases from our Print and Promotions operations and QC Centers. This system significantly reduces the resources needed to process receivables, improves cash flow and mitigates the amount of past-due accounts related to these items. Franchisees generally are required to purchase and install the Papa Johns PROFIT System in their restaurants (see Company Operations Point of Sale Technology).
Industry and Competition
The restaurant industry is intensely competitive with respect to price, service, location and food quality, and there are many well-established competitors with substantially greater financial and other resources than Papa Johns. Competitors include a large number of international, national and regional restaurant chains, as well as local pizza operators. Some of our competitors have been in existence for a substantially longer period than us and may be better established in the markets where our restaurants are, or may be located. Based on independent third-party research, the United States Quick Service Restaurant (QSR) Pizza category, which includes dine in, carry out and delivery, had sales of approximately $33.0 billion in 2004, of which Papa Johns share was reported as 5.1%. Within the pizza segment of the restaurant industry, we believe our primary competitors are the national pizza chains, including Pizza Hut, Dominos and Little Caesars, and several regional chains, including chains executing a take and bake concept. A change in the pricing or other marketing strategies of one or more of our competitors could have an adverse impact on our sales and earnings. Additionally, a continued increased emphasis on carryout business by traditional casual dining restaurants, such as Applebees and
Outback, as well as improved quality of fresh and frozen supermarket offerings, could also have an adverse impact on our sales and earnings.
With respect to the sale of franchises, we compete with many franchisors of restaurants and other business concepts. In general, there is also active competition for management personnel and attractive commercial real estate sites suitable for our restaurants.
We, along with our franchisees, are subject to various federal, state and local laws affecting the operation of our respective businesses. Each Papa Johns restaurant is subject to licensing and regulation by a number of governmental authorities, which include health, safety, sanitation, building and fire agencies in the state or municipality in which the restaurant is located. Difficulties in obtaining, or the failure to obtain, required licenses or approvals could delay or prevent the opening of a new restaurant in a particular area. Our full-service QC Centers are licensed and subject to regulation by state and local health and fire codes, and the operation of our trucks is subject to Department of Transportation regulations. We are also subject to federal and state environmental regulations.
We are subject to Federal Trade Commission (FTC) regulation and various state laws regulating the offer and sale of franchises. Several state laws also regulate substantive aspects of the franchisor-franchisee relationship. The FTC requires us to furnish to prospective franchisees a franchise offering circular containing prescribed information. Substantive state laws that regulate the franchisor-franchisee relationship presently exist in a substantial number of states, and bills have been introduced in Congress from time to time, which would provide for federal regulation of the franchisor-franchisee relationship in certain respects. The state laws often limit, among other things, the duration and scope of non-competition provisions and the ability of a franchisor to terminate or refuse to renew a franchise. Some foreign countries also have disclosure requirements and other laws regulating franchising and the franchisor-franchisee relationship. Further government initiatives, such as living wage or other proposed increases in minimum wage rates, could adversely affect Papa Johns as well as the restaurant industry. As we expand internationally, we will be subject to applicable laws in each jurisdiction where franchised units are established.
Our rights in our principal trademarks and service marks are a significant part of our business. We are the owner of the federal registration of the trademark Papa Johns. We have also registered Pizza Papa Johns and design (our logo), Better Ingredients. Better Pizza. and Pizza Papa Johns Better Ingredients. Better Pizza. and design as trademarks and service marks. We also own federal registrations for several ancillary marks, principally advertising slogans. We have also applied to register our primary trademark, Pizza Papa Johns and design, in more than 90 foreign countries and the European Community. The Perfect Pizza trademark is also registered in the United Kingdom. We are aware of the use by other persons in certain geographical areas of names and marks which are the same as or similar to our marks. It is our policy to pursue registration of our marks whenever possible and to oppose vigorously any infringement of our marks.
As of December 26, 2004, we employed 14,024 persons, of whom approximately 12,161 were restaurant team members, 643 were restaurant management and supervisory personnel, 540 were corporate personnel and 680 were QC Center and support services personnel. Most restaurant team members work part-time and are paid on an hourly basis. None of our team members is covered by a collective bargaining agreement. We consider our team member relations to be excellent.
This Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the Act), including information within Managements Discussion and Analysis of Financial Condition and Results of Operations. The following cautionary statements are being made pursuant to the provisions of the Act and with the intention of obtaining the benefits of the safe harbor provisions of the Act. Although we believe that our expectations are based on reasonable assumptions, actual results may differ materially from those in the forward-looking statements as a result of various factors, including but not limited to, the following:
1. The ability of the Papa Johns system to continue to open new restaurants is affected by a number of factors, many of which are beyond our control. These factors include, among other things, selection and availability of suitable restaurant locations, increases in food, paper, labor, utilities, fuel, employee benefits, insurance and similar costs, negotiation of suitable lease or financing terms, constraints on permitting and construction of restaurants, higher than anticipated construction costs, and the hiring, training and retention of management and other personnel. Accordingly, there can be no assurance that system-wide, Papa Johns will be able to meet planned growth targets, open restaurants in markets now targeted for expansion, or continue to operate in existing markets profitably.
2. The restaurant industry is intensely competitive with respect to price, service, location and food quality, and there are many well-established competitors with substantially greater financial and other resources than the Papa Johns system. Some of these competitors have been in existence for a substantially longer period than Papa Johns and may be better established in the markets where restaurants operated by us or our franchisees are, or may be, located. Experience has shown that a change in the pricing or other marketing or promotional strategies, including new product and concept developments, of one or more of our major competitors can have an adverse impact on sales and earnings of Papa Johns and our system-wide restaurant operations.
3. An increase in the cost of cheese or other commodities could adversely affect the profitability of our system-wide restaurant operations. Cheese costs, historically representing 35% to 40% of our food cost, and other commodities are subject to seasonal fluctuations, weather, availability, demand and other factors that are beyond our control. Additionally, sustained increases in fuel and utility costs could adversely affect the profitability of our restaurant and QC Center businesses.
4. Changes in consumer taste (for example, changes in dietary preferences that could cause consumers to avoid pizza in favor of foods that are perceived as more healthful), demographic trends, traffic patterns and the type, number and location of competing restaurants could adversely affect our restaurant business.
5. Health- or disease-related disruptions or consumer concerns about the commodity supply could negatively impact the availability and/or cost of such commodities, thereby adversely impacting restaurant operations and our financial results.
6. System-wide restaurant operations are subject to federal and state laws governing such matters as wages, working conditions, citizenship requirements and overtime. A significant number of hourly personnel employed by our franchisees and us are paid at rates related to the federal minimum wage. Accordingly, further increases in the federal minimum wage or the enactment of additional state or local living wage proposals will increase labor costs for our system-wide operations. Additionally, labor shortages in various markets could result in higher required wage rates.
7. Any or all of the factors listed in 1. through 6. potentially adversely impacting restaurant sales or costs could be especially harmful to the financial viability of franchisees in under-penetrated or emerging markets. A decline in or failure to improve financial performance for this group of franchisees could lead to unit closings at greater than anticipated levels and therefore impact contributions to marketing funds, our royalty stream, PJFS and support services efficiencies and other system-wide results.
8. Domestically, we are dependent on sole suppliers for our cheese, flour and thin crust dough products. Alternative sources for these ingredients may not be available on a timely basis to supply these key ingredients or be available on terms as favorable to us as under our current arrangements. Domestic restaurants purchase substantially all food and related products from our QC Centers. Accordingly, both our corporate and franchised restaurants could be harmed by any prolonged disruption in the supply of products from our QC Centers. Additionally, domestic franchisees are only required to purchase seasoned sauce and dough from our QC Centers and changes in purchasing practices by domestic franchisees could adversely affect the financial results of our QC Centers.
9. Beginning in October of 2004, a third party commercial insurance company began providing fully-insured coverage to franchisees participating in our franchise insurance program, thus eliminating our risk of loss for franchise insurance coverage written after September 2004. The Captives relatively immature claims history limits the predictive value of estimating the costs of incurred and future claims, thus our operating income is subject to potential significant adjustments for changes in estimated insurance reserves for policies written from the Captives inception in October 2000 through September 2004.
10. Our domestic and international operations could be negatively impacted by significant changes in international economic and political conditions. In addition, our international operations are subject to additional factors, including currency regulations and fluctuations, cultures and consumer preferences, diverse government regulations and structures, availability and cost of land and construction, ability to source ingredients and other commodities in a cost-effective manner, and differing interpretation of the obligations established in franchise agreements with international franchisees. Accordingly, there can be no assurance that our operations will achieve or maintain profitability or meet planned growth rates.
As of December 26, 2004, there were 2,829 Papa Johns restaurants and 118 franchised Perfect Pizza restaurants system-wide.
Company-owned Papa Johns Restaurants
Domestic Franchised Papa Johns Restaurants
International Franchised Papa Johns Restaurants
We define domestic operations as units located in the contiguous United States.
Most Papa Johns restaurants are located in leased space. The initial term of most restaurant leases is generally five years with most leases providing for one or more options to renew for at least one additional term. Virtually all of our leases specify a fixed annual rent. Generally, the leases are triple net leases, which require us to pay all or a portion of the cost of insurance, taxes and utilities. Certain leases further provide that the lease payments may be increased annually, with a small number of escalations based on changes in the Consumer Price Index.
Approximately 53 Company-owned restaurants are located in buildings we own on land either owned or leased by us. These restaurants range from 1,100 to 3,000 square feet. Seven of these restaurants are located in multi-bay facilities. These multi-bay facilities contain from 2,800 to 5,000 square feet, and the space not utilized by the Papa Johns restaurant in each facility is leased or held for lease to third party tenants.
We have 193 restaurants located in the United Kingdom (74 franchised and one Company-owned Papa Johns restaurant and 118 franchised Perfect Pizza restaurants). In addition to leasing the one Company-owned restaurant site, we lease and sublease to franchisees 157 of the 192 franchised restaurant sites. The initial lease terms on the Company and franchised sites are generally 10 to 15 years. The initial lease terms of the franchisee subleases are generally five to ten years.
Information with respect to our leased QC Centers and other facilities as of December 26, 2004 is set forth below.
(1) In early February 2005, we announced the closing of the Jackson, Mississippi QC Center at the end of March 2005. Restaurants previously serviced by this QC Center will be routed from our other regional QC Centers.
(2) The Raleigh location is a replacement facility that opened in late 2004.
We own approximately five acres in Orlando, Florida on which our 63,000 square foot full-service commissary is located. We also own eight acres and a 175,000 square foot facility in Dallas, Texas, of which 77,500 square feet is used by our full-service commissary and the remaining space is available for future production or for leasing. In addition, we own approximately 72 acres in Louisville, Kentucky with a 42,000 square foot building housing our printing operations and a 247,000 square foot building, approximately 30% to 40% of which accommodates the Louisville QC Center operation and promotional division. The remainder of the building houses our corporate offices.
The Papa Johns UK management team is located in 6,000 square feet of leased office space in London with a remaining lease term of 11 years. In addition, Papa Johns UK leases a distribution center located in a 30,000 square foot facility in Staffordshire, England.
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.
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are the executive officers of Papa Johns, together with their ages as of January 1, 2005, their positions and the years in which they first became an officer:
John Schnatter created the Papa Johns concept and founded Papa Johns in 1985. He has served as Chairman of the Board and Chief Executive Officer (CEO) since 1990, and from 1985 to 1990, served as President, a position to which he was reappointed in January 2001. Effective April 1, 2005, Mr. Schnatter will step down as President and CEO, but will continue to serve as Executive Chairman of the Board. He has been a franchisee since 1986.
In January 2005, we announced the employment of Nigel Travis as Executive Vice President and his appointment to the Board of Directors. We further announced that effective April 1, 2005, Mr. Travis will assume the position of President and Chief Executive Officer from John Schnatter, who will continue to serve as Executive Chairman of the Board. Prior to joining Papa Johns, Mr. Travis held various leadership positions at Blockbuster, Inc., from 1994 to 2004, most recently as President and Chief Operating Officer. From 1985 to 1994, Mr. Travis served in various capacities for Grand Metropolitan PLC (London, England), including leadership positions at Burger King Corporation for five years. Mr. Travis is the lead director of the Bombay Company, Inc.
William Van Epps has served as Senior Vice President and Chief Operations Officer since 2004, responsible for domestic corporate and franchised restaurant operations and international operations. Mr. Van Epps served as our Managing Director, International from September 2001 to 2004. Prior to joining Papa Johns, Mr. Van Epps served for two years as President, International Division of Yorkshire Global
Restaurants, responsible for the international development of Long John Silvers and A&W restaurants. From 1993 to 1999, he served in several positions with AFC Enterprises, including President of its International Division. From 1988 to 1993, he was Vice President, Marketing and International for Western Sizzlin, Inc.
Julie Larner has served as President of PJ Food Service, Inc. and Senior Vice President since 2004. Ms. Larner served as Senior Vice President, Chief Administrative Officer and Treasurer from 2001 to 2004. Ms. Larner has been with Papa Johns since 1992, serving as controller for PJ Food Service, Inc. from 1992 to 1997 and its Vice President of Finance and Administration since 1998.
Charles Schnatter has served as Senior Vice President and Chief Development Officer since 2001 and Secretary since 1991. Mr. Schnatter also held the position of General Counsel from 1991 to March 2002; he has been a Senior Vice President since 1993. From 1988 to 1991, he was an attorney with Greenebaum Doll & McDonald PLLC, Louisville, Kentucky, a law firm, which provides legal services to us. Charles Schnatter has been a franchisee since 1989.
David Flanery has served as Senior Vice President, Chief Financial Officer and Treasurer since 2004. He previously served as Senior Vice President of Finance since August 2002. He served as Vice President of Finance from 1995 through August 2002, after having joined Papa Johns in 1994 as Corporate Controller. From 1979 to 1994, Mr. Flanery was with Ernst & Young LLP in a variety of positions, most recently as Audit Senior Manager. Mr. Flanery is a licensed Certified Public Accountant.
Mike Cortino has served as Senior Vice President of Corporate Operations since May 2000 after having served as Vice President of Operations Support since November 1999. Prior to joining Papa Johns, Mr. Cortino served five years as Vice President of Corporate Operations for AFC Enterprises Churchs Chicken Brand and ten years as a market manager and other positions with Taco Bell.
Tim OHern rejoined Papa Johns in early 2005 as Senior Vice President, Development, after spending the past two years managing the operations of a Papa Johns franchisee in which he has an ownership interest. Prior to his departure from Papa Johns in 2002, Mr. OHern held various positions, including Vice President of Global Development from February 2001 to 2002, Vice President of U.S. Development from March 1997 to February 2001, Director of Franchise Development from December 1996 to March 1997 and Construction Manager from November 1995 to December 1996. He has been a franchisee since 1993.
Richard Emmett has served as Senior Vice President and General Counsel since March 2002, after serving as Senior Vice President and Senior Counsel since March 1997. Mr. Emmett is responsible for our legal, risk management and people departments. Mr. Emmett also served as Senior Vice President of Development from August 1996 to March 1997. From 1992 to 1996, Mr. Emmett held the position of Vice President and Senior Counsel. From 1983 to 1992, Mr. Emmett was an attorney with the law firm of Greenebaum Doll & McDonald PLLC, having become a partner of the firm in 1989. Mr. Emmett has been a franchisee since 1992.
John and Charles Schnatter are brothers. There are no other family relationships among the executive officers and other key personnel.
Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock trades on the NASDAQ National Market tier of The NASDAQ Stock Market under the symbol PZZA. As of March 1, 2005, there were approximately 847 record holders of common stock. The following table sets forth for the quarters indicated the high and low closing sales prices of our common stock, as reported by The NASDAQ Stock Market.
Since our initial public offering of common stock in 1993, we have not paid dividends on our common stock, and have no current plans to do so.
The Papa Johns Board of Directors has authorized the repurchase of up to $450.0 million of common stock under a share repurchase program that began December 9, 1999, and runs through December 25, 2005. Through December 26, 2004, a total of 15.7 million shares with an aggregate cost of $420.5 million and an average price of $26.76 per share have been repurchased under this program and placed in treasury. The following table summarizes our repurchase activity by fiscal period during 2004 (in thousands, except per share amounts):
*There were no share repurchases during these periods.
Item 6. Selected Financial Data
The selected financial data presented for each of the years in the five-year period ended December 26, 2004 was derived from our audited consolidated financial statements. The selected financial data should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and Notes thereto included in Item 7 and Item 8, respectively, of this Form 10-K.
(1) We operate on a 52-53 week fiscal year ending on the last Sunday of December of each year. All fiscal years presented consisted of 52 weeks, except the 2000 fiscal year, which consisted of 53 weeks.
(2) We began consolidating variable interest entities (VIEs) restaurants in 2004. See Note 4 of Notes to Consolidated Financial Statements.
(3) Domestic Franchise royalties were derived from franchise restaurant sales of $1.30 billion in 2004, $1.29 billion in 2003, $1.32 billion in 2002, $1.30 billion in 2001 and $1.21 billion in 2000.
(4) International Royalties were derived from franchise restaurant sales of $110.7 million in 2004, $111.5 million in 2003, $104.2 million in 2002, $99.7 million in 2001 and $78.3 million in 2000.
(5) Restaurant sales for Company-owned United Kingdom restaurants were $629,000 in 2004, $2.4 million in 2003, $4.0 million in 2002, $4.5 million in 2001 and $4.3 million in 2000.
(6) The 2004 operating results include the consolidation of BIBP, which reduced operating income approximately $22.9 million. Operating income includes restaurant closure, impairment and disposition losses (gains) of ($203,000) in 2004, $5.5 million in 2003, $1.1 million in 2002 and ($1.2 million) in 2001. Fiscal 2000 included special charges of $20.9 million. See Notes 4 and 7 of Notes to Consolidated Financial Statements.
(7) Reflects the cumulative effect on income and earnings per share of a change in accounting principle, net of tax, as required by Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. See Note 2 of Notes to Consolidated Financial Statements.
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
Papa Johns International, Inc. (referred to as the Company, Papa Johns or in the first person notations of we, us and our) began operations in 1985 with the opening of the first Papa Johns restaurant in Jeffersonville, Indiana. At December 26, 2004, there were 2,829 Papa Johns restaurants in operation, consisting of 569 Company-owned and 2,260 franchised, and 118 franchised Perfect Pizza restaurants in the United Kingdom. Our revenues are principally derived from retail sales of pizza and other food and beverage products to the general public by Company-owned restaurants, franchise royalties, sales of franchise and development rights, sales to franchisees of food and paper products, restaurant equipment, printing and promotional items, risk management services, and information systems and related services used in their operations.
New unit openings in 2004 were 175 as compared to 105 in 2003 and 115 in 2002 and unit closings in 2004 were 153 as compared to 116 in 2003 and 101 in 2002. Several factors have resulted in minimal net unit growth over the past three years, including the competitive sales environment, operating margin pressures due to increased wages, insurance and other costs and the overall economic environment including franchisees access to capital. We expect future unit expansion to be impacted by these and other factors.
We have continued to produce strong average sales from our Company-owned restaurants even with a very competitive market environment. Our expansion strategy is to cluster restaurants in targeted markets, thereby increasing consumer awareness and enabling us to take advantage of operational, distribution and advertising efficiencies. Average Company-owned sales for our most recent quarters comparable base restaurants were $737,000 for 2004, compared to $733,000 for 2003 and $747,000 for 2002. Average sales volumes in new markets are generally lower than in those markets in which we have established a significant market position. The comparable annual sales for Company-owned restaurants increased 0.5% in 2004, decreased 3.0% in 2003 and increased 0.2% in 2002.
We continually strive to obtain high-quality sites with good access and visibility, and to enhance the appearance and quality of our restaurants. We believe that these factors improve our image and brand awareness. The average cash investment for the restaurants in our most recent comparable sales base is $275,000. The average cash investment for the six domestic Company-owned restaurants opened during 2004, exclusive of land, decreased to approximately $232,000 from $248,000 for the ten units opened in 2003. We expect the average cash investment for the anticipated four Company-owned restaurants opening in 2005 to be approximately $250,000.
Approximately 48% of our revenues for 2004, 2003 and 2002 were derived from the sale to franchisees of food and paper products, restaurant equipment, printing and promotional items, risk management services and information systems equipment and software and related services by us, our commissary subsidiary, PJ Food Service, Inc. (PJFS), our support services subsidiary, Papa Johns Support Services, Inc., our insurance subsidiaries, RSC Insurance Services, Ltd. and Risk Services Corp. and our United Kingdom subsidiary, Papa Johns UK. We believe that, in addition to supporting both Company and franchised growth, these subsidiaries contribute to product quality and consistency and restaurant profitability throughout the Papa Johns system.
Our fiscal year ends on the last Sunday in December of each year. All fiscal years presented consist of 52 weeks.
Results of Operations and Critical Accounting Policies and Estimates
The results of operations are based on the preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States. The preparation of consolidated financial statements requires management to select accounting policies for critical accounting areas as well as estimates and assumptions that affect the amounts reported in the consolidated financial statements. The Companys accounting policies are more fully described in Note 2 of Notes to Consolidated Financial Statements. Significant changes in assumptions and/or conditions in our critical accounting policies could materially impact the operating results. We have identified the following accounting policies and related judgments as critical to understanding the results of our operations.
Allowance for Doubtful Accounts and Notes Receivable
We establish reserves for uncollectible accounts and notes receivable based on overall receivable aging levels and a specific evaluation of accounts and notes for franchisees with known financial difficulties. These reserves and corresponding write-offs could significantly increase if the identified franchisees continue to experience deteriorating financial results.
Long-lived and Intangible Assets
The recoverability of long-lived assets is evaluated annually or more frequently if impairment indicators exist. Indicators of impairment include historical financial performance, operating trends and our future operating plans. If impairment indicators exist, we evaluate the recoverability of long-lived assets on an operating unit basis (e.g., an individual restaurant) based on undiscounted expected future cash flows before interest for the expected remaining useful life of the operating unit. Recorded values for long-lived assets that are not expected to be recovered through undiscounted future cash flows are written down to current fair value, which is generally determined from estimated discounted future net cash flows for assets held for use or net realizable value for assets held for sale.
The recoverability of intangible assets (i.e., goodwill) is evaluated annually, or more frequently if impairment indicators exist, on a reporting unit basis by comparing the fair value derived from discounted cash flows of the reporting unit to its carrying value.
At December 26, 2004, we had a net investment of approximately $28.6 million associated with PJUK, our United Kingdom subsidiary, which was substantially composed of goodwill associated with our acquisition of the subsidiary. PJUK has reported deteriorating operating results for the past two years primarily due to lower sales by Perfect Pizza restaurants and a decrease in net franchise units due to restaurant closings. We have developed plans for PJUK to improve its operating results, which include an anticipated increase in net franchise unit openings over the next several years. If these plans are not successful and operating results continue to deteriorate, we may be required to record a significant impairment charge associated with our United Kingdom subsidiary.
See Note 7 of Notes to Consolidated Financial Statements for additional information.
Our insurance programs for workers compensation, general liability, owned and non-owned automobiles and health insurance coverage provided to our employees, and the captive insurance program provided to our franchisees are self-insured up to certain individual and aggregate reinsurance levels. Losses are accrued based upon estimates of the aggregate retained liability for claims incurred using certain third-party actuarial projections and our claims loss experience. The estimated insurance claims losses could be significantly affected should the frequency or ultimate cost of claims significantly differ from historical trends used to estimate the insurance reserves recorded by the Company.
Effective October 2004, a third party commercial insurance company began providing fully-insured coverage to franchisees participating in the franchise insurance program and we ceased providing new coverage via our captive insurance subsidiary. Accordingly, this new arrangement eliminates our risk of loss for franchise insurance coverage written after September 2004. Our operating income will still be subject to potential adjustments for changes in estimated insurance reserves for policies written from October 2000 to September 2004. Such adjustments, if any, will be determined in part based upon semi-annual actuarial valuations. Our captive insurance company recorded increases in existing claims loss reserves of $1.1 million and $6.3 million in 2004 and 2003, respectively, as compared to expected claims costs, based on updated actuarial valuations. See Note 11 of Notes to Consolidated Financial Statements for additional information.
Consolidation of BIBP Commodities Inc. (BIBP) as a Variable Interest Entity
BIBP is a franchisee-owned corporation that conducts a cheese-purchasing program on behalf of domestic Company-owned and franchised restaurants. As required by the Financial Accounting Standards Boards (FASB) Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (FIN 46), we began consolidating the financial results of BIBP in the fourth quarter of 2003. We recognized pre-tax losses of approximately $23.5 million during 2004 from the consolidation of BIBP. We expect the consolidation of BIBP to continue to have a significant impact on Papa Johns operating income in future periods due to the volatility of cheese prices. Papa Johns will recognize the operating losses generated by BIBP if the shareholders equity of BIBP is in a net deficit position. Further, Papa Johns will recognize subsequent operating income generated by BIBP up to the amount of BIBP losses previously recognized by Papa Johns.
Lease Expense Recognition
The Company recently completed a comprehensive review of its accounting for lease expense and depreciation of leasehold improvements. Our review resulted in a cumulative fourth quarter adjustment increasing rent and depreciation expense by $1.9 million (or $0.07 per share, after tax) applicable to prior periods, of which $1.6 million (or $0.06 per share, after tax) was applicable to years prior to 2004. This accounting adjustment does not affect the Companys historical or future cash flows or the timing or amounts of rental payments. Additionally, this correction is not material to prior periods. We do not expect this accounting adjustment to have a significant impact on future operating earnings.
Interpretation No. 46 of Accounting Research Bulletin No. 51 (FIN 46)
As previously discussed, FIN 46 addresses the potential consolidation of variable interest entities (VIEs). The provisions of FIN 46 significantly alter the method for evaluating whether certain VIEs, as defined, should be consolidated in a companys financial statements. As noted above, we began consolidating BIBP at December 28, 2003. A cumulative effect adjustment was not required with the adoption of FIN 46 as BIBP had a surplus in stockholders equity at December 28, 2003. Papa Johns is also the primary beneficiary, as defined by FIN 46, of four franchise entities (representing 33 Papa Johns restaurants) that qualify as VIEs, even though we have no ownership interest in them. We began consolidating these four franchise entities in the second quarter of 2004, as required by FIN 46. The consolidation of these four entities resulted in the recording of goodwill of $2.8 million. The consolidation of the entities had no significant impact on our operating results during 2004 and we do not expect our future operating earnings to be significantly impacted by consolidating these four entities.
Percentage Relationships and Restaurant Data and Unit Progression
The following tables set forth the percentage relationship to total revenues, unless otherwise indicated, of certain income statement data, and certain restaurant data for the years indicated.
*The cumulative effect of a change in accounting principle, as a percent of sales, had less than a 10 basis point impact in 2003.
(1) As a percentage of Domestic Company-owned Restaurant sales.
(2) As a percentage of Domestic Variable interest entities restaurant sales.
(3) As a percentage of Domestic Commissary sales and Other sales on a combined basis.
(4) The loss is a result of the consolidation of BIBP, a VIE. The sales reported by BIBP are eliminated in consolidation.
(5) As a percentage of International Restaurant and commissary sales.
(6) See Note 10 of Notes to Consolidated Financial Statements.
(7) See Note 7 of Notes to Consolidated Financial Statements.
(8) Includes only Company-owned restaurants open throughout the periods being compared.
(9) Represents Perfect Pizza restaurants converted to Papa Johns restaurants.
2004 Compared to 2003
Variable Interest Entities
As required by FIN 46, our 2004 operating results include BIBPs operating results. The consolidation of BIBP had a significant impact on our operating results in 2004 and is expected to have a significant ongoing impact on our future operating results and income statement presentation as described below.
Consolidation accounting requires the net impact from the consolidation of BIBP to be reflected primarily in two separate components of our statement of income. The first component is the portion of BIBP operating income or loss attributable to the amount of cheese purchased by Company-owned restaurants during the period. This portion of BIBP operating income (loss) is reflected as a reduction (increase) in the Domestic Company-owned restaurant expenses - cost of sales line item. This approach effectively reports cost of sales for Company-owned restaurants as if the purchasing arrangement with BIBP did not exist and such restaurants were purchasing cheese at the spot market prices (i.e., the impact of BIBP is eliminated in consolidation).
The second component of the net impact from the consolidation of BIBP is reflected in the caption Loss from the franchise cheese-purchasing program, net of minority interest. This line item represents BIBPs income or loss from purchasing cheese at the spot market price and selling to franchised restaurants at a fixed quarterly price, net of any income or loss attributable to the minority interest BIBP shareholders.
The amount of income or loss attributable to the BIBP shareholders depends on its cumulative shareholders equity balance and the change in such balance during the reporting period.
In addition, we have extended loans to certain franchisees. Under the FIN 46 rules, Papa Johns is deemed to be the primary beneficiary of four of these franchisees, even though we have no ownership interest in them. Beginning in the second quarter of 2004, FIN 46 required us to recognize the operating income (losses) generated by these four franchise entities (representing 33 Papa Johns restaurants). The consolidation of these four franchise entities had no net significant impact on Papa Johns operating results in 2004, generating revenues of $14.4 million and operating expenses (including general and administrative, depreciation and interest) of approximately the same amount.
Summary of Operating Results
Total revenues increased 2.7% to $942.4 million in 2004 compared to $917.4 million in 2003 primarily consisting of: (1) $14.4 million from the consolidation of 33 franchised restaurants beginning in the second quarter of 2004 resulting from the implementation of FIN 46; (2) $6.8 million from commissary sales reflecting the sales of promotional items (principally DVDs) and the favorable impact of higher commodity prices, primarily cheese, partially offset by lower sales volumes and (3) $3.0 million from the first quarter sales of promotional items associated with our March 2004 NCAA national basketball promotion. These increases were partially offset by a decline in domestic Company-owned restaurant sales of $3.4 million in 2004, as compared to 2003, primarily as a result of the closing of restaurants during the last quarter of 2003.
Our income before income taxes and cumulative effect of a change in accounting principle decreased 31.7% to $37.2 million in 2004, from $54.4 million in 2003. The decrease is principally due to the consolidation of BIBP in 2004, which resulted in a pre-tax loss of $23.5 million ($0.84 per share). The comparison of 2004 to 2003 was also impacted by the following:
The 2003 results included a $5.5 million restaurant closure, impairment and disposition charge (none of significance in 2004).
The 2003 results included a loss of $6.3 million from the franchise insurance program while the loss in 2004 was $1.1 million.
Net interest expense declined $1.6 million in 2004 due in part to the $625,000 benefit recorded pursuant to SFAS No. 150, associated with a change in a joint venture operating agreement during 2004, which eliminated a mandatory purchase requirement and related liability. The remainder of the decrease in interest expense is due to lower average debt balances and lower effective interest rates.
The 2003 results included a $1.0 million contribution to the Marketing Fund and a $500,000 sales incentive to franchisees as compared to a contribution of $400,000 to the Marketing Fund in 2004.
The favorable year over year impact of the above items was partially offset by a reduction in commissary results of approximately $5.1 million in 2004, as compared to 2003, as a result of lower sales volumes due to a reduction in the number of restaurant transactions.
The favorable impact was further offset by a reduction in full-year 2004 operating income of approximately $1.6 million, as a result of certain lease and leasehold accounting adjustments applicable to prior years.
Diluted earnings per share before cumulative effect of a change in accounting principle were $1.33 compared to $1.88 in 2003. In December 1999, we began a repurchase program for our common stock. Through December 26, 2004, an aggregate of $420.5 million shares have been repurchased (representing
15.7 million shares, at an average price of $26.76 per share). The share repurchase activity increased earnings per share by approximately $0.02 for full year 2004.
Review of Operating Results
Revenues. Domestic Company-owned restaurant sales decreased 0.8% to $412.7 million in 2004, from $416.0 million for the comparable period in 2003. The 0.8% decrease is primarily due to a 2.3% decrease in equivalent units for 2004, as we closed 27 underperforming restaurants during 2003, partially offset by a 0.5% increase in comparable sales. Equivalent units represents the number of restaurants open at the beginning of a given period, adjusted for restaurants opened, closed, acquired or sold during the period on a weighted average basis.
Variable interest entities restaurant sales include restaurant sales for four franchise entities to which we have extended loans that qualify as VIEs. We began consolidating the operating results of these entities in the second quarter of 2004.
Domestic franchise royalties increased 0.9% to $50.3 million from $49.9 million for the comparable period in 2003. Domestic franchise sales increased 0.9% to $1.30 billion in 2004, from $1.29 billion for the comparable period in 2003. The increase for the 2004 period is due to average unit volumes increasing slightly due to new units opening at higher sales levels relative to closed units.
The comparable sales base and average weekly sales for 2004 and 2003 for domestic corporate and franchised restaurants consisted of the following:
Domestic franchise and development fees increased to $2.5 million for 2004, from $1.5 million for the same period in 2003. There were 97 domestic franchise unit openings in 2004 compared to 56 in 2003.
Domestic commissary sales increased 1.8% to $376.6 million for 2004, from $369.8 million for the comparable period in 2003, as the sales of promotional items (primarily DVDs) and the impact of higher cheese prices was substantially offset by lower volumes due to a decline in restaurant transactions. Other sales increased to $53.1 million for 2004, from $48.5 million for the comparable period in 2003, primarily as a result of an increase in revenues associated with insurance-related services provided to franchisees and the promotional item sales associated with our March 2004 NCAA basketball national promotion.
International revenues primarily consist of the Papa Johns United Kingdom (U.K.) operations, denominated in British Pounds Sterling and converted to U.S. dollars (89% of total 2004 international revenues). International revenues increased 3.8% to $32.8 million in 2004, from $31.6 million 2003, as revenues from increased franchise unit openings and the impact of a more favorable dollar/pound exchange rate were partially offset by a decrease in corporate restaurant revenues due to the operation of
only one Company-owned restaurant during 2004 as compared to an average of five restaurants for the comparable period in 2003.
Costs and Expenses. The restaurant operating margin at domestic Company-owned units was 15.5% for 2004 compared to 16.9% in 2003, consisting of the following differences as a percent of Company-owned restaurant sales:
Cost of sales was 1.9% higher as a percentage of sales in 2004 primarily due to the consolidation of BIBP, which increased cost of sales 1.5% in 2004. The remaining 0.4% increase in cost of sales is due to higher cheese costs charged by BIBP, partially offset by lower costs for other commodities as a result of various product cost savings initiatives and the impact of restaurant pricing increases.
Salaries and benefits were 0.9% lower as a percentage of sales in 2004 due to staffing efficiencies and leverage on restaurant pricing increases.
Advertising and related costs, occupancy costs and other operating expenses were relatively flat as a percentage of sales.
Domestic commissary and other margin was 8.0% for 2004 compared to 9.1% for 2003. Cost of sales was 72.1% of revenues in 2004 compared to 69.8% in 2003 primarily due to higher cheese costs incurred by our commissaries (cheese has a fixed-dollar, as opposed to fixed-percentage, mark-up) and increased sales of lower margin products, such as promotional items (principally DVDs and the items sold in the first quarter related to the March 2004 NCAA national promotion). Salaries and benefits were lower as a percentage of sales, 6.6% in 2004 as compared to 6.9% in 2003 due to staffing efficiencies and the impact of higher cheese prices on sales. Other operating expenses decreased to 13.3% of sales in 2004 from 14.1% in 2003, primarily as a result of a $6.3 million increase in claims loss reserves in 2003 related to our franchise insurance program compared to a $1.1 million increase for 2004.
The loss from the franchise cheese-purchasing program, net of minority interest, was $16.6 million in 2004. This line item represents the portion of BIBP operating margin losses from purchasing cheese at the spot market price and selling to franchised restaurants at a fixed quarterly price, net of any loss attributable to the BIBP shareholders.
International operating margin increased to 17.0% in 2004 from 14.2% in 2003, primarily due to the disposition of Company-owned restaurants, which had a lower operating margin than our commissary operation, expense leverage on the increased franchise unit openings and an improvement in commissary operating margins.
General and administrative expenses were $72.5 million or 7.7% of revenues for 2004 as compared to $67.2 million or 7.3% of revenues for 2003. This $5.3 million increase was primarily attributable to: the previously mentioned $1.5 million rent expense adjustment associated with leases (the remaining $400,000 of the adjustment associated with our review of leases was recorded in depreciation expense), a $1.8 million increase in bonuses to corporate and restaurant management who met pre-established goals for their operating units, a $1.6 million increase in compensation expense related to stock options awarded in late 2003 that vest over a 12-month period throughout 2004, a $1.1 million increase in administrative costs associated with our expanded domestic franchise sales efforts, $750,000 of severance and other costs associated with staffing reductions during the fourth quarter of 2004 and $1.3 million of administrative expenses associated with variable interest entities now required to be consolidated. These increases were partially offset by lower insurance and benefit costs, and savings related to various administrative efficiencies implemented throughout 2004.
A provision for uncollectible notes receivable of $638,000 was recorded in 2004 as compared to $1.9 million in 2003. These provisions were based on our evaluation of our franchise loan portfolio, and
primarily relate to specific loans for which certain scheduled payments have been deferred as part of an overall workout arrangement.
Restaurant closure, impairment and disposition losses (gains) were a net gain of $203,000 (primarily composed of a $280,000 gain on the sale of 49% of the Texas market, which occurred in the third quarter of 2004) recorded for 2004 as compared to a $5.5 million loss for 2003. The 2003 amount included a charge of $5.5 million, representing $3.2 million for 27 domestic closed restaurants and $2.5 million for 25 impaired domestic restaurants, partially offset by a $275,000 gain on the sale of seven U.K. restaurants.
Other general expenses reflected net expense of $2.4 million in 2004, as compared to $3.3 million in 2003. The 2004 amount included $112,000 of pre-opening costs, $1.8 million of disposition and valuation related losses for other assets and a $1.2 million provision for uncollectible accounts receivable, partially offset by a $550,000 gain on the sale of unused property. The 2003 amount included $192,000 of pre-opening costs, $346,000 of restaurant relocation costs, a $1.8 million provision for uncollectible franchisee accounts receivable, $1.1 million related to disposition or valuation losses for other assets, a $1.0 million contribution to the Papa Johns Marketing Fund to assist the system with costs incurred for national advertising and a $500,000 sales incentive program offered to our franchisees. The 2003 expenses were partially offset by $2.0 million of income derived from the settlement of a litigation matter.
Depreciation and amortization was $31.2 million (3.3% of revenues) for 2004, as compared to $31.1 million (3.4% of revenues) for 2003.
Net interest. Net interest expense was $4.6 million for 2004 as compared to $6.2 million in 2003, due in part to the $625,000 benefit recorded pursuant to Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS No. 150), associated with a change in a joint venture operating agreement during 2004, which eliminated a mandatory purchase requirement and related liability. Lower average debt outstanding during 2004 as compared to 2003 and a lower average effective interest rate for the 2004 outstanding debt also reduced net interest expense.
Income Tax Expense. The effective income tax rate was 37.5% for both 2004 and 2003.
2003 Compared to 2002
Summary of Consolidated Operating Results
Total revenues decreased 3.0% to $917.4 million in 2003 compared to $946.2 million in 2002. The primary factors impacting the decrease in revenues were: (1) a 3.0% decrease in domestic Company-owned restaurants comparable sales for 2003; (2) a decrease in franchise royalties of 3.0% in 2003 due to a decrease in franchise sales and an increase in the level of reduced royalty arrangements initiated in 2003; and (3) a decrease in commissary and other sales due to lower cheese costs and lower equipment sales in 2003 as a result of outsourcing this function in late 2002, partially offset by an increase in revenues from insurance-related services provided to our franchisees.
Our income before income taxes and cumulative effect of a change in accounting principle decreased 27.4% to $54.4 million in 2003, from $74.9 million in 2002. The decrease was principally due to the decrease in operating results of our domestic Company-owned restaurant segment, primarily resulting from lower sales and increased costs associated with our restaurant initiatives, compared to the same
periods in 2002, increases in restaurant closure, impairment and disposition charges and the increased claims loss reserves related to the franchise captive insurance program.
Diluted earnings per share before cumulative effect of a change in accounting principle were $1.88 in 2003 compared to $2.31 in 2002. The Companys share repurchase activity increased earnings per share by approximately $0.11 in 2003.
Review of Operating Results
Domestic Company-owned restaurant sales decreased 3.2% to $416.0 million in 2003 compared to $429.8 million for the same period in 2002. This 3.2% decrease is primarily due to a 3.0% decrease in comparable sales for 2003.
Domestic franchise sales decreased 2.2% in 2003 to $1.29 billion primarily resulting from a 3.6% decrease in comparable sales for the 2003 period, partially offset by an increase in average sales volumes for franchise units not included in the comparable sales unit base. Domestic franchise royalties decreased 3.0% to $49.9 million from $51.4 million in 2002 primarily due to the decrease in franchise sales noted above and an increase in the level of reduced royalty arrangements initiated in 2003.
The comparable sales base and average weekly sales for 2003 and 2002 for domestic Company-owned and domestic franchised restaurants consisted of the following:
Domestic franchise and development fees, including approximately $430,000 recognized upon development cancellation or franchise renewal and transfer, were $1.5 million in 2003 compared to $1.7 million in 2002. There were 56 domestic franchise unit openings in 2003 as compared to 76 in 2002.
Domestic commissary and other sales decreased 3.0% to $418.4 million for 2003 from $431.3 million in 2002, primarily as a result of lower commissary sales due to lower cheese costs, and lower equipment sales in 2003 as a result of outsourcing this function in late 2002, partially offset by an increase in revenues from insurance-related services provided to our franchisees.
International revenues primarily consist of the Papa Johns United Kingdom operations, which are denominated in British Pounds Sterling and converted to U.S. dollars (92% of total 2003 international revenues). International revenues decreased 1.2% to $31.6 million in 2003 compared to $32.0 million in 2002, as lower Company-owned restaurant and commissary sales were substantially offset by a favorable exchange rate impact of $2.4 million and increased royalties.
Costs and Expenses. The restaurant-operating margin at domestic Company-owned units was 16.9% for 2003 compared to 20.9% in 2002, consisting of the following differences as a percent of Company-owned restaurant sales:
Cost of sales was 0.7% lower in 2003 primarily due to lower cheese costs, partially offset by portion increases for several core pizza products implemented during the second quarter of 2003.
Salaries and benefits were 3.3% higher in 2003 reflecting the impact of an across-the-board increase in base pay for general managers and assistant managers implemented during the third quarter of 2002, the loss of leverage on fixed salaries due to the decrease in average unit sales and increased health insurance costs. Additionally, in connection with the field management realignment announced in January 2003, we increased restaurant staffing levels and general manager and assistant manager bonus potential.
Advertising and related costs were 0.9% higher in 2003 primarily due to increases in national spending and lower than anticipated sales.
Occupancy costs were 0.6% higher in 2003 primarily as a result of increased utility and general insurance costs combined with lower sales.
Other operating expenses were relatively consistent as a percentage of sales (0.1% lower in 2003).
Domestic commissary and other margin was 9.1% for 2003 compared to 9.9% in 2002. Cost of sales was 69.8% of revenues in 2003 compared to 71.7% in 2002 primarily due to lower food costs incurred by the commissaries (principally cheese, which has a fixed dollar as opposed to a fixed percentage markup), a decrease in lower margin equipment sales and an increase in the revenues from insurance-related services provided to franchisees. Salaries and benefits as a percentage of sales were relatively consistent between years. Other operating expenses increased to 14.1% in 2003 from 11.6% in 2002, primarily as a result of a $6.3 million increase in claims loss reserves related to the franchise insurance program, as compared to expected claims costs, and lower commissary sales (certain operating costs are fixed in nature).
International operating margin decreased to 14.2% in 2003 from 16.2% in 2002 primarily due to lower margins and increased distribution costs associated with the U.K. commissary operation.
General and administrative expenses were $67.2 million or 7.3% of revenues for 2003 as compared to $72.4 million or 7.7% of revenues in 2002. The primary components of the $5.2 million decrease are the previously mentioned restaurant field management realignment, which eliminated a layer of management previously included in G&A, and a reduction in corporate and restaurant field management bonuses. These reductions more than offset the incremental costs incurred in 2003 related to the 2002 implementation of certain restaurant quality initiatives, intended to better evaluate and monitor the quality and consistency of the customer experience, and 2003 consulting fees associated with initiatives to identify opportunities for improving restaurant operating margins.
A provision for uncollectible notes receivable of $1.9 million was recorded in 2003, based on our evaluation of our franchise loan portfolio, and primarily relates to specific loans for which certain scheduled payments have been deferred as part of an overall workout arrangement. The provision for uncollectible notes receivable was $2.8 million in 2002.
The net 2003 restaurant closure, impairment and disposition charge was $5.5 million, representing $3.2 million for 27 domestic closed restaurants and $2.5 million for 25 impaired domestic restaurants, partially offset by a $275,000 gain on the sale of seven U.K. restaurants. The net 2002 restaurant closure, impairment and disposition charge was $1.1 million, representing $740,000 for 19 closed restaurants, $208,000 for two impaired restaurants and a net loss of $103,000 for 14 restaurants that were sold.
Other general expenses were $3.3 million in 2003, as compared to $6.1 million in 2002. The 2003 amount included $192,000 of pre-opening costs, $346,000 of relocation costs, $1.8 million provision for uncollectible franchisee accounts receivable, $1.1 million of disposition-related costs of other assets, $1.0 million for a contribution to the Papa Johns Marketing Fund to assist the system with costs incurred for national advertising and a $500,000 sales incentive program offered to our franchisees. These expenses were partially offset by $2.0 million of income derived from the settlement of a legal matter during the second quarter of 2003. The 2002 amount included pre-opening costs of $156,000, relocation costs of $590,000, $2.0 million of disposition-related costs of other assets, $900,000 of costs we agreed to bear in connection with a refurbishment plan concerning our heated delivery bag systems and $1.7 million of losses related to a terminated vendor contract.
Depreciation and amortization was $31.1 million (3.4% of revenues) for 2003, as compared to $31.7 million (3.4% of revenues) for 2002.
Net Interest. Net interest expense was $6.2 million for 2003 as compared to $6.6 million in 2002 as the lower outstanding debt balance and lower effective interest rate on debt were partially offset by lower interest income from investments and franchise notes receivable in 2003.
Income Tax Expense. The effective income tax rate was 37.5% for both 2003 and 2002.
Liquidity and Capital Resources
Our debt is comprised of the following (in thousands):
*The VIEs third-party creditors do not have any recourse to Papa Johns.
The revolving line of credit allows us to borrow up to $175.0 million with an expiration date of January 2006. Outstanding balances accrue interest at 62.5 to 100.0 basis points over the London Interbank Offered Rate (LIBOR) or other bank developed rates at our option. The commitment fee on the unused balance ranges from 15.0 to 20.0 basis points. The increment over LIBOR and the commitment fee are determined quarterly based upon the ratio of total indebtedness to earnings before interest, taxes, depreciation and amortization (EBITDA).
Cash flow from operations decreased to $41.8 million in 2004 compared to $84.8 million in 2003. Approximately $23.0 million of the decrease is attributable to the consolidation of BIBP (as reflected in the net income and deferred income taxes captions in the accompanying Consolidated Statement of Cash Flows), and the remaining decrease is primarily due to unfavorable working capital changes, including increased levels of prepaid insurance due to the timing of payments and general premium increases, increased accounts receivable due to an extension of the timing of collections of certain items (such as systems hardware and DVDs) from franchisees, and increased inventory levels due to a change in payment terms with a significant supplier and generally higher commodity costs (primarily cheese).
Cash flow from operations decreased to $84.8 million in 2003 compared to $95.6 million in 2002 primarily reflecting our reduced restaurant sales volumes and operating margins for 2003.
We require capital primarily for the development, acquisition and maintenance of restaurants, the development, renovation and maintenance of QC Center and Support Services facilities and equipment and the enhancement of corporate systems and facilities. Additionally, we began a common stock repurchase program in December 1999. During 2004, common stock repurchases of $68.9 million and capital expenditures of $21.0 million were funded primarily by cash flow from operations, the proceeds from stock option exercises, net proceeds from debt arrangements and available cash and cash equivalents.
Total 2005 capital expenditures are expected to be approximately $18.0 million to $20.0 million, of which one-half will be available for the development, relocation or remodeling of restaurants, including routine replacement of equipment, and about one-half of which will be available for QC Centers, Support Services and corporate requirements. During 2005, we plan to open four new domestic Company-owned restaurants.
As of December 26, 2004, we had loans to franchisees of $6.8 million, net of allowance for doubtful accounts of $1.3 million. We do not have any additional loan funding commitments related to existing franchisee loans at December 26, 2004.
The Board of Directors has authorized up to $450.0 million for the share repurchase program through December 25, 2005. At December 26, 2004, a total of 15.7 million shares have been repurchased for $420.5 million at an average price of $26.76 per share since the repurchase program started in 1999 (approximately 2.1 million shares in 2004, 206,000 shares in 2003, 4.5 million shares in 2002 and 8.9 million shares prior to 2002). Subsequent to year-end (through March 1, 2005), we acquired an additional 373,000 shares at an aggregate cost of $12.8 million. As of March 1, 2005, approximately $16.7 million remains available for repurchase of common stock under this authorization.
We expect to fund the planned capital expenditures and any additional share repurchases for the next twelve months from operating cash flow and the $72.5 million remaining availability under our line of credit, reduced for certain outstanding letters of credit. Our debt, which is primarily due to the share repurchase program, was $94.2 million, including $15.7 million associated with BIBP and other consolidated VIEs, at December 26, 2004, compared to $61.3 million at December 28, 2003.
Contractual obligations and payments as of December 26, 2004 due by year are as follows (in thousands):
(1) Excludes a fair value adjustment of $1.8 million included in other long-term liabilities in the consolidated balance sheet related to our interest rate swap that hedges against the effects of rising interest rates on forecasted future borrowings.
We have certain other commercial commitments where payment is contingent upon the occurrence of certain events. Such commitments include the following by year (in thousands):