Papa Johns 2003 Annual Report Download - page 32

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Domestic commissary and other margin was 9.1% for 2003 compared to 9.9% in 2002. Cost of sales was
69.8% of revenues in 2003 compared to 71.7% in 2002 primarily due to lower food costs incurred by the
commissaries (principally cheese, which has a fixed dollar as opposed to a fixed percentage markup), a
decrease in lower margin equipment sales and an increase in the revenues from insurance-related services
provided to franchisees. Salaries and benefits as a percentage of sales were relatively consistent between
years. Other operating expenses increased to 14.1% in 2003 from 11.6% in 2002, primarily as a result of
a $6.3 million increase in claims loss reserves related to the franchise insurance program, as compared to
expected claims costs, and lower commissary sales (certain operating costs are fixed in nature).
We established a captive insurance company and began the current insurance program with franchisees in
2000. As noted above, during 2003, we recorded a $6.3 million increase in claims loss reserves, as
compared to expected claims costs, based upon the results of actuarial valuations performed throughout
2003. During 2003, premium rates were increased substantially in an effort to sufficiently fund expected
claims losses. However, the captive’s relatively immature claims history limits the predictive value of
actuarial valuations with respect to ultimate claims costs. Accordingly, the captive program could
continue to incur significant fluctuations in income or loss from one reporting period to another until
such time as the claims history is more mature and predictable. We will attempt to identify opportunities
to reduce this volatility to the extent possible and will continue to evaluate this program for the benefit of
franchisees.
International operating margin decreased to 14.2% in 2003 from 16.2% in 2002 primarily due to lower
margins and increased distribution costs associated with the U.K. commissary operation.
General and administrative expenses were $67.2 million or 7.3% of revenues for 2003 as compared to
$72.4 million or 7.7% of revenues in 2002. The primary components of the $5.2 million decrease are the
previously mentioned restaurant field management realignment, which eliminated a layer of management
previously included in G&A, and a reduction in corporate and restaurant field management bonuses.
These reductions more than offset the incremental costs incurred in 2003 related to the 2002
implementation of certain restaurant quality initiatives, intended to better evaluate and monitor the
quality and consistency of the customer experience, and 2003 consulting fees associated with recent
initiatives to identify opportunities for improving restaurant operating margins.
A provision for uncollectible notes receivable of $1.9 million was recorded in 2003, based on our
evaluation of our franchise loan portfolio, and primarily relates to specific loans for which certain
scheduled payments have been deferred as part of an overall workout arrangement. The provision for
uncollectible notes receivable was $2.8 million in 2002.
The net 2003 restaurant closure, impairment and disposition charge was $5.5 million (representing $3.2
million for 27 domestic closed restaurants and $2.5 million for 25 impaired domestic restaurants,
partially offset by a $275,000 gain on the sale of seven U.K. restaurants. The net 2002 restaurant closure,
impairment and disposition charge was $1.1 million (representing $740,000 for 19 closed restaurants,
$208,000 for two impaired restaurants and a loss of $103,000 for 14 disposed of units).
Other general expenses were $3.3 million in 2003, as compared to $6.1 million in 2002. The 2003
amount includes $192,000 of pre-opening costs, $346,000 of relocation costs, $1.8 million provision for
uncollectible franchisee accounts receivable, $1.1 million of disposition-related costs of other assets,
$1.0 million for a contribution to the Papa John’s Marketing Fund to assist the system with costs incurred
for national advertising and a $500,000 sales incentive program offered to our franchisees. These
expenses were partially offset by $2.0 million of income derived from the settlement of a legal matter
during the second quarter of 2003. The 2002 amount includes pre-opening costs of $156,000, relocation
costs of $590,000, $2.0 million of disposition-related costs of other assets, $900,000 of costs we agreed