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Table of Contents

 

 

 

GRAPHIC

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended September 27, 2009

 

OR

 

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

 

Commission File Number:  0-21660

 

PAPA JOHN’S INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

61-1203323

(State or other jurisdiction of

 

(I.R.S. Employer Identification

incorporation or organization)

 

number)

 

2002 Papa Johns Boulevard

Louisville, Kentucky  40299-2367

(Address of principal executive offices)

 

(502) 261-7272

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:   Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o No x

 

At October 28, 2009, there were outstanding 28,239,855 shares of the registrant’s common stock, par value $0.01 per share.

 

 

 



Table of Contents

 

INDEX

 

 

 

Page No.

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Balance Sheets – September 27, 2009 and December 28, 2008

2

 

 

 

 

Consolidated Statements of Income – Three and Nine Months Ended September 27, 2009 and September 28, 2008

3

 

 

 

 

Consolidated Statements of Stockholders’ Equity – Nine Months Ended September 27, 2009 and September 28, 2008

4

 

 

 

 

Consolidated Statements of Cash Flows – Nine Months Ended September 27, 2009 and September 28, 2008

5

 

 

 

 

Notes to Condensed Consolidated Financial Statements

6

 

 

 

Item 2.

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

16

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

33

 

 

 

Item 4.

Controls and Procedures

35

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

35

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

35

 

 

 

Item 6.

Exhibits

36

 

1



Table of Contents

 

PART I.  FINANCIAL INFORMATION

Item 1. Financial Statements

 

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

 

(In thousands)

 

September 27, 2009

 

December 28, 2008

 

 

 

(Unaudited)

 

(Note)

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

 42,674

 

$

 10,987

 

Accounts receivable

 

22,533

 

23,775

 

Inventories

 

17,353

 

16,872

 

Prepaid expenses

 

6,173

 

9,797

 

Other current assets

 

3,929

 

5,275

 

Assets held for sale

 

1,019

 

1,540

 

Deferred income taxes

 

8,431

 

7,102

 

Total current assets

 

102,112

 

75,348

 

Investments

 

1,492

 

530

 

Net property and equipment

 

190,413

 

189,992

 

Notes receivable

 

11,232

 

7,594

 

Deferred income taxes

 

10,081

 

17,518

 

Goodwill

 

76,166

 

76,914

 

Other assets

 

21,011

 

18,572

 

Total assets

 

$

 412,507

 

$

 386,468

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

 26,467

 

$

 29,148

 

Income and other taxes

 

12,982

 

9,685

 

Accrued expenses

 

53,763

 

54,220

 

Current portion of debt

 

875

 

7,075

 

Total current liabilities

 

94,087

 

100,128

 

Unearned franchise and development fees

 

5,665

 

5,916

 

Long-term debt, net of current portion

 

99,058

 

123,579

 

Other long-term liabilities

 

19,645

 

18,607

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock

 

 

 

Common stock

 

358

 

352

 

Additional paid-in capital

 

231,230

 

216,553

 

Accumulated other comprehensive income (loss)

 

(1,593

)

(3,818

)

Retained earnings

 

177,514

 

133,759

 

Treasury stock

 

(221,818

)

(216,860

)

Total stockholders’ equity, net of noncontrolling interests

 

185,691

 

129,986

 

Noncontrolling interests in subsidiaries

 

8,361

 

8,252

 

Total stockholders’ equity

 

194,052

 

138,238

 

Total liabilities and stockholders’ equity

 

$

 412,507

 

$

 386,468

 

 

Note:  The balance sheet at December 28, 2008 has been derived from the audited consolidated financial statements at that date, but does not include all information and footnotes required by accounting principles generally accepted in the United States for a complete set of financial statements. See Note 2 for modifications made as a result of adopting recent accounting pronouncements.

 

See accompanying notes.

 

2



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Income

(Unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

(In thousands, except per share amounts)

 

Sept. 27, 2009

 

Sept. 28, 2008

 

Sept. 27, 2009

 

Sept. 28, 2008

 

Domestic revenues:

 

 

 

 

 

 

 

 

 

Company-owned restaurant sales

 

$

 122,023

 

$

 130,662

 

$

 378,694

 

$

 403,332

 

Variable interest entities restaurant sales

 

10,356

 

2,014

 

27,250

 

6,293

 

Franchise royalties

 

15,028

 

14,378

 

45,053

 

44,582

 

Franchise and development fees

 

144

 

194

 

450

 

1,361

 

Commissary sales

 

93,625

 

108,804

 

302,985

 

321,172

 

Other sales

 

11,949

 

13,643

 

40,699

 

46,922

 

International revenues:

 

 

 

 

 

 

 

 

 

Royalties and franchise and development fees

 

3,173

 

3,326

 

9,796

 

9,454

 

Restaurant and commissary sales

 

7,648

 

7,007

 

20,628

 

19,325

 

Total revenues

 

263,946

 

280,028

 

825,555

 

852,441

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurant expenses:

 

 

 

 

 

 

 

 

 

Cost of sales

 

23,990

 

29,750

 

73,784

 

92,125

 

Salaries and benefits

 

35,821

 

39,069

 

110,181

 

120,679

 

Advertising and related costs

 

11,284

 

12,123

 

33,933

 

36,733

 

Occupancy costs

 

8,171

 

9,516

 

23,809

 

26,527

 

Other operating expenses

 

17,455

 

18,203

 

52,264

 

54,582

 

Total domestic Company-owned restaurant expenses

 

96,721

 

108,661

 

293,971

 

330,646

 

Variable interest entities restaurant expenses

 

6,861

 

1,765

 

20,996

 

5,545

 

Domestic commissary and other expenses:

 

 

 

 

 

 

 

 

 

Cost of sales

 

77,839

 

91,891

 

253,375

 

271,873

 

Salaries and benefits

 

8,592

 

8,728

 

26,061

 

26,820

 

Other operating expenses

 

11,523

 

12,428

 

33,140

 

36,072

 

Total domestic commissary and other expenses

 

97,954

 

113,047

 

312,576

 

334,765

 

(Income) loss from the franchise cheese-purchasing program, net of minority interest

 

(4,171

)

(2,587

)

(16,736

)

7,335

 

International operating expenses

 

6,573

 

6,200

 

17,837

 

17,358

 

General and administrative expenses

 

29,990

 

26,170

 

87,755

 

80,621

 

Other general expenses

 

2,214

 

4,673

 

10,264

 

7,425

 

Depreciation and amortization

 

8,130

 

8,590

 

24,266

 

25,000

 

Total costs and expenses

 

244,272

 

266,519

 

750,929

 

808,695

 

Operating income

 

19,674

 

13,509

 

74,626

 

43,746

 

 Investment income

 

149

 

193

 

425

 

640

 

 Interest expense

 

(1,434

)

(1,930

)

(4,290

)

(5,624

)

Income before income taxes

 

18,389

 

11,772

 

70,761

 

38,762

 

Income tax expense

 

5,753

 

3,807

 

24,092

 

13,321

 

Net income, including noncontrolling interests

 

12,636

 

7,965

 

46,669

 

25,441

 

Less: income attributable to noncontrolling interests

 

(897

)

(218

)

(2,914

)

(1,421

)

Net income, net of noncontrolling interests

 

$

 11,739

 

$

 7,747

 

$

 43,755

 

$

 24,020

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

 0.42

 

$

 0.28

 

$

 1.57

 

$

 0.85

 

Earnings per common share - assuming dilution

 

$

 0.42

 

$

 0.28

 

$

 1.57

 

$

 0.84

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

27,919

 

27,787

 

27,783

 

28,286

 

Diluted weighted average shares outstanding

 

28,011

 

27,984

 

27,952

 

28,478

 

 

See accompanying notes.

 

3



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity

(Unaudited)

 

 

 

Papa John’s International, Inc.

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Common

 

 

 

Additional

 

Other

 

 

 

 

 

Noncontrolling

 

Total

 

 

 

Stock Shares

 

Common

 

Paid-In

 

Comprehensive

 

Retained

 

Treasury

 

Interests in

 

Stockholders’

 

(In thousands)

 

Outstanding

 

Stock

 

Capital

 

Income (Loss)

 

Earnings

 

Stock

 

Subsidiaries

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 30, 2007

 

28,777

 

$

 349

 

$

 208,598

 

$

 156

 

$

 96,963

 

$

(179,163

)

$

 8,035

 

$

 134,938

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

24,020

 

 

1,421

 

25,441

 

Change in valuation of interest rate swap agreements, net of tax of ($64)

 

 

 

 

(142

)

 

 

 

(142

)

Foreign currency translation

 

 

 

 

(254

)

 

 

 

(254

)

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

25,045

 

Exercise of stock options

 

259

 

3

 

4,614

 

 

 

 

 

4,617

 

Tax effect related to exercise of non-qualified stock options

 

 

 

770

 

 

 

 

 

770

 

Acquisition of treasury stock

 

(1,397

)

 

 

 

 

(37,659

)

 

(37,659

)

Distributions to noncontrolling interests

 

 

 

 

 

 

 

(1,110

)

(1,110

)

Other

 

 

 

2,997

 

 

 

 

 

2,997

 

Balance at September 28, 2008

 

27,639

 

$

 352

 

$

 216,979

 

$

 (240

)

$

 120,983

 

$

(216,822

)

$

 8,346

 

$

 129,598

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 28, 2008

 

27,637

 

$

 352

 

$

 216,553

 

$

 (3,818

)

$

 133,759

 

$

(216,860

)

$

 8,252

 

$

 138,238

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

43,755

 

 

2,914

 

46,669

 

Change in valuation of interest rate swap agreements, net of tax of $519

 

 

 

 

921

 

 

 

 

921

 

Foreign currency translation

 

 

 

 

1,304

 

 

 

 

1,304

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

48,894

 

Exercise of stock options

 

598

 

6

 

9,649

 

 

 

 

 

9,655

 

Tax effect related to exercise of non-qualified stock options

 

 

 

770

 

 

 

 

 

770

 

Acquisition of treasury stock

 

(275

)

 

 

 

 

(4,958

)

 

(4,958

)

Distributions to noncontrolling interests

 

 

 

 

 

 

 

(2,805

)

(2,805

)

Other

 

 

 

4,258

 

 

 

 

 

4,258

 

Balance at September 27, 2009

 

27,960

 

$

 358

 

$

 231,230

 

$

 (1,593

)

$

 177,514

 

$

(221,818

)

$

 8,361

 

$

 194,052

 

 

At September 28, 2008, the accumulated other comprehensive loss of $240 was comprised of a net unrealized loss on the interest rate swap agreements of $1,442, partially offset by unrealized foreign currency translation gains of $1,202.

 

At September 27, 2009, the accumulated other comprehensive loss of $1,593 was comprised of a net unrealized loss on the interest rate swap agreements of $3,029 and an $88 pension plan liability for PJUK, partially offset by unrealized foreign currency translation gains of $1,524.

 

See accompanying notes.

 

4



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

Nine Months Ended

 

(In thousands)

 

Sept. 27, 2009

 

Sept. 28, 2008

 

Operating activities

 

 

 

 

 

Net income, net of noncontrolling interests

 

$

 43,755

 

$

 24,020

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Restaurant impairment and disposition losses

 

 

5,071

 

Provision for uncollectible accounts and notes receivable

 

2,467

 

1,896

 

Depreciation and amortization

 

24,266

 

25,000

 

Deferred income taxes

 

5,590

 

(5,373

)

Stock-based compensation expense

 

4,258

 

2,997

 

Excess tax benefit related to exercise of non-qualified stock options

 

(987

)

(770

)

Other

 

1,320

 

1,094

 

Changes in operating assets and liabilities, net of acquisitions:

 

 

 

 

 

Accounts receivable

 

(135

)

(2,036

)

Inventories

 

(311

)

1,896

 

Prepaid expenses

 

3,646

 

3,450

 

Other current assets

 

1,938

 

109

 

Other assets and liabilities

 

(1,667

)

(1,359

)

Accounts payable

 

(4,088

)

(1,744

)

Income and other taxes

 

3,297

 

(3,357

)

Accrued expenses

 

(671

)

(3,227

)

Unearned franchise and development fees

 

(251

)

(94

)

Net cash provided by operating activities

 

82,427

 

47,573

 

Investing activities

 

 

 

 

 

Purchase of property and equipment

 

(21,002

)

(24,021

)

Purchase of investments

 

(1,187

)

(632

)

Proceeds from sale or maturity of investments

 

225

 

843

 

Loans issued

 

(11,577

)

(925

)

Loan repayments

 

5,396

 

1,469

 

Acquisitions

 

(464

)

(100

)

Proceeds from divestitures of restaurants

 

830

 

 

Other

 

108

 

206

 

Net cash used in investing activities

 

(27,671

)

(23,160

)

Financing activities

 

 

 

 

 

Net (repayments) proceeds from line of credit facility

 

(24,500

)

11,000

 

Net (repayments) proceeds from short-term debt - variable interest entities

 

(6,200

)

300

 

Excess tax benefit related to exercise of non-qualified stock options

 

987

 

770

 

Proceeds from exercise of stock options

 

9,655

 

4,617

 

Acquisition of Company common stock

 

(4,958

)

(37,659

)

Noncontrolling interests, net of distributions

 

109

 

311

 

Other

 

594

 

91

 

Net cash used in financing activities

 

(24,313

)

(20,570

)

Effect of exchange rate changes on cash and cash equivalents

 

157

 

(42

)

Change in cash and cash equivalents

 

30,600

 

3,801

 

Cash recorded from consolidation of VIEs

 

1,087

 

 

Cash and cash equivalents at beginning of period

 

10,987

 

8,877

 

Cash and cash equivalents at end of period

 

$

 42,674

 

$

 12,678

 

 

See accompanying notes.

 

5



Table of Contents

 

Papa John’s International, Inc. and Subsidiaries

 

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

September 27, 2009

 

1.              Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States (GAAP) for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the nine months ended September 27, 2009 are not necessarily indicative of the results that may be expected for the fiscal year ended December 27, 2009. For further information, refer to the consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K for Papa John’s International, Inc. (referred to as the “Company”, “Papa John’s” or in the first person notations of “we”, “us” and “our”) for the year ended December 28, 2008.

 

2.              Accounting Standards Update

 

Generally Accepted Accounting Principles

 

In June 2009, the Financial Accounting Standards Board (FASB) issued the Accounting Standards Codification (“Codification” or “ASC”), which became the single official source of authoritative, nongovernmental U.S. GAAP, other than rules and interpretive releases issued by the Securities and Exchange Commission. The Codification did not change GAAP but reorganized the literature and changed the naming mechanism by which topics are referenced. Companies must begin using the Codification for interim and annual periods ending after September 15, 2009. As required, references to pre-codification accounting literature have been changed throughout this quarterly report on Form 10-Q to appropriately reference the Codification. The Company’s accounting policies and amounts presented in the financial statements were not impacted by this change.

 

Fair Value Measurements and Disclosures

 

The Fair Value Measurements and Disclosures topic of the FASB’s ASC requires companies to determine fair value based on the price that would be received to sell the asset or paid to transfer the liability to a market participant. The Fair Value Measurements and Disclosures topic emphasizes that fair value is a market-based measurement, not an entity-specific measurement. The new guidance required a phased-in approach: (1) phase one was effective for financial assets and liabilities in our first quarter of fiscal 2008 and (2) phase two was effective for our first quarter of fiscal 2009. The new provisions did not have a significant impact on our 2008 and 2009 financial statements.

 

Business Combinations

 

The Business Combinations topic of the ASC establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable financial statement users to evaluate the nature and financial effects of the business combination. The latest guidance in the Business Combinations topic of the ASC applies to business combinations for which the

 

6



Table of Contents

 

acquisition date is on or after December 15, 2008. The adoption of the new guidance had no impact on our 2009 consolidated financial statements.

 

Consolidation

 

The Consolidation topic of the ASC requires all entities to report noncontrolling (minority) interests in subsidiaries as equity in the consolidated financial statements, but separate from the equity of the parent company. The Consolidation topic further requires that consolidated net income be reported at amounts attributable to the parent and the noncontrolling interest, rather than expensing the income attributable to the minority interest holder. Additionally, sufficient disclosures are required to clearly identify and distinguish between the interests of the parent company and the interests of the noncontrolling owners, including a disclosure on the face of the consolidated statements for income attributable to the noncontrolling interest holder. The presentation and disclosure requirements were applied retrospectively for all periods presented, and thus, the prior year financial statements have been modified to incorporate the new requirements.

 

Papa John’s had two joint venture arrangements as of September 27, 2009 and September 28, 2008, which were as follows:

 

 

 

Restaurants

 

 

 

 

 

Noncontrolling

 

 

 

as of

 

Restaurant

 

Papa John’s

 

Interest

 

 

 

Sept. 27, 2009

 

Locations

 

Ownership *

 

Ownership *

 

 

 

 

 

 

 

 

 

 

 

Star Papa, LP

 

75

 

Texas

 

51

%

49

%

Colonel’s Limited, LLC

 

51

 

Maryland and Virginia

 

70

%

30

%

 


*The ownership percentages were the same for both the 2009 and 2008 periods presented in the accompanying consolidated financial statements.

 

The pre-tax income of the joint ventures totaled $2.3 million and $7.6 million for the three and nine months ended September 27, 2009, respectively, compared to $700,000 and $4.0 million for the three months and nine months ended September 28, 2008, respectively. The portion of pre-tax income attributable to the noncontrolling interest holders was approximately $900,000 and $2.9 million for the three and nine months ended September 27, 2009, respectively, compared to approximately $200,000 and $1.4 million for the three and nine months ended September 28, 2008, respectively. The noncontrolling interest holders’ equity in the joint venture arrangements totaled $8.4 million as of September 27, 2009 and $8.3 million as of December 28, 2008.

 

Derivatives and Hedging

 

In the first quarter of 2009, Papa John’s adopted the latest provisions of the ASC topic, Derivatives and Hedging. The guidance enhances the required disclosures regarding derivatives and hedging activities, including disclosures regarding how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted, and how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. See Note 5 for additional information.

 

Subsequent Events

 

The Subsequent Events topic of the ASC requires public companies to evaluate subsequent events through the date the financial statements are issued. Accordingly, we evaluated for subsequent events occurring after September 27, 2009 (our financial statement date) through November 3, 2009 (the date this report was filed). We determined no subsequent events disclosures were required.

 

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Statement of Financial Accounting Standards (SFAS) No. 167, Amendments to FASB Interpretation No. 46(R)

 

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R). SFAS No. 167 has been deemed authoritative literature even though the provisions of this standard have not yet been integrated into the ASC.

 

The objective of SFAS No. 167 is to improve the financial reporting of companies involved with variable interest entities (VIEs). As required by this statement, the provisions required by FIN 46(R) will be applicable for entities previously considered qualifying special-purpose entities, as the concept of these entities was eliminated from SFAS No. 140 with the issuance of SFAS No. 166, Accounting for Transfers of Financial Assets—an amendment of FASB Statement No. 140. This Statement amends FIN 46(R) to replace the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in the VIE with a qualitative approach focused on identifying which company has the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. Additionally, this statement requires a company to perform ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. Prior to this statement, a company was only required to reassess the status when specific events occurred. We are required to adopt the provisions of SFAS No. 167 for our first quarter of 2010. We have not yet assessed the impact, if any, of the adoption of this statement on our financial statements.

 

Deferred Income Tax Assets and Tax Reserves

 

Papa John’s is subject to income taxes in the United States and several foreign jurisdictions. Significant judgment is required in determining Papa John’s provision for income taxes and the related assets and liabilities. The provision for income taxes includes income taxes paid, currently payable or receivable and those deferred. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities, and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Deferred tax assets are also recognized for the estimated future effects of tax loss carryforwards. The effect on deferred taxes of changes in tax rates is recognized in the period in which the enactment date changes. As a result, our effective tax rate may fluctuate. Valuation allowances are established when necessary on a jurisdictional basis to reduce deferred tax assets to the amounts we expect to realize.

 

As of September 27, 2009, we had a net deferred income tax asset balance of $18.5 million, of which approximately $7.7 million relates to the net operating loss carryforward of BIBP Commodities, Inc. (“BIBP”). We have not provided a valuation allowance for the deferred income tax assets associated with our domestic operations, including BIBP, since we believe it is more likely than not that future earnings will be sufficient to ensure the realization of the net deferred income tax assets for federal and state purposes.

 

Certain tax authorities periodically audit the Company. We provide reserves for potential exposures based on the requirements of the Income Taxes topic of the ASC. We evaluate these issues on a quarterly basis to adjust for events, such as court rulings or audit settlements that may impact our ultimate payment for such exposures.

 

3.              Acquisitions and Dispositions

 

During the second quarter of 2009, we completed the acquisition of 11 restaurants in Florida. The purchase price for those restaurants totaled $2.8 million, which was comprised of cash and the cancellation of a $2.3 million note due to us, of which approximately $1.5 million was recorded as goodwill. The acquisition was accounted for by the purchase method of accounting, whereby operating results subsequent to the acquisition date are included in our consolidated financial results.

 

During the second quarter of 2009, we completed the sale of ten Company-owned restaurants located in New Mexico. The sales price of $1.1 million consisted of a cash payment of $600,000 and notes financed by Papa

 

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John’s to the purchasers, who are current Papa John’s franchisees, for $500,000. We recorded a pre-tax gain of approximately $350,000 associated with the sale of the restaurants.

 

4.              Accounting for Variable Interest Entities

 

The Consolidation topic of the ASC provides a framework for identifying variable interest entities (“VIEs”) and determining when a company should include the assets, liabilities, non-controlling interests and results of activities of a VIE in its consolidated financial statements.

 

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

 

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

 

We have a purchasing arrangement with BIBP Commodities, Inc. (“BIBP”), a special-purpose entity formed at the direction of our Franchise Advisory Council for the sole purpose of reducing cheese price volatility to domestic system-wide restaurants. BIBP is an independent, franchisee-owned corporation. BIBP purchases cheese at the market price and sells it to our distribution subsidiary, PJ Food Service, Inc. (“PJFS”), at a fixed price. PJFS in turn sells cheese to Papa John’s restaurants (both Company-owned and franchised) at a set price. Effective in March 2009, we modified the BIBP formula to establish the price of cheese on a more frequent basis based on projected spot market prices. At the current rate of repayment, BIBP’s cumulative deficit would be substantially repaid at the end of 2011. PJFS purchased $35.5 million and $106.5 million of cheese from BIBP for the three and nine months ended September 27, 2009, respectively, compared to $45.1 million and $125.3 million in the 2008 comparable periods, respectively.

 

We are deemed the primary beneficiary of BIBP, a VIE, for accounting purposes. We recognize the operating losses generated by BIBP if BIBP’s shareholders’ equity is in a net deficit position. Further, we will recognize the subsequent operating income generated by BIBP up to the amount of any losses previously recognized.  We recognized pre-tax income of $5.1 million ($3.2 million net of tax, or $0.12 per share) and $21.0 million ($13.3 million net of tax, or $0.48 per share) for the three and nine months ended September 27, 2009, respectively, and pre-tax income of $2.8 million ($1.8 million net of tax, or $0.07 per share) for the three months ended September 28, 2008 and a pre-tax loss of $11.4 million ($7.4 million net of tax, or $0.27 per share) for the nine months ended September 28, 2008, respectively, from the consolidation of BIBP. The impact on future operating income from the consolidation of BIBP is expected to continue to be significant for any given reporting period due to the volatility of the cheese market.

 

BIBP has a $10.0 million line of credit with a commercial bank, which is guaranteed by Papa John’s. In addition, Papa John’s has agreed to provide additional funding in the form of a loan to BIBP. As of September 27, 2009, BIBP had outstanding borrowings of $875,000 and a letter of credit of $3.0 million outstanding under the commercial line of credit facility and outstanding borrowings of $26.3 million with Papa John’s.

 

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In addition, Papa John’s has extended loans to certain franchisees. Papa John’s was deemed the primary beneficiary of five franchise entities as of September 27, 2009 and three franchise entities as of September 28, 2008, even though we had no ownership in the franchise entities. The five franchise entities at September 27, 2009 operate a total of 65 restaurants with annual revenues approximating $44.0 million. Our net loan balance receivable from those entities was $7.8 million at September 27, 2009, with no further funding commitments. The consolidation of those franchise entities had no significant impact on Papa John’s operating results and is not expected to have a significant impact in future periods.

 

The following table summarizes the balance sheets for our consolidated VIEs as of September 27, 2009 and December 28, 2008:

 

 

 

September 27, 2009

 

December 28, 2008

 

(In thousands)

 

BIBP

 

Franchisees

 

Total

 

BIBP

 

Franchisees

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

 3,068

 

$

 1,931

 

$

 4,999

 

$

 —

 

$

 70

 

$

 70

 

Accounts receivable - Papa John’s

 

1,400

 

 

1,400

 

4,687

 

 

4,687

 

Other current assets

 

3,306

 

690

 

3,996

 

1,089

 

55

 

1,144

 

Net property and equipment

 

 

6,595

 

6,595

 

 

4,314

 

4,314

 

Goodwill

 

 

1,409

 

1,409

 

 

4,556

 

4,556

 

Deferred income taxes

 

7,713

 

 

7,713

 

15,057

 

 

15,057

 

Other noncurrent assets

 

 

9

 

9

 

 

 

 

Total assets

 

$

 15,487

 

$

 10,634

 

$

 26,121

 

$

 20,833

 

$

 8,995

 

$

 29,828

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity (deficit):

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

 2,363

 

$

 1,255

 

$

 3,618

 

$

 5,391

 

$

 381

 

$

 5,772

 

Short-term debt - third party

 

875

 

 

875

 

7,075

 

 

7,075

 

Short-term debt - Papa John’s

 

26,339

 

7,842

 

34,181

 

35,743

 

7,991

 

43,734

 

Total liabilities

 

29,577

 

9,097

 

38,674

 

48,209

 

8,372

 

56,581

 

Stockholders’ equity (deficit)

 

(14,090

)

1,537

 

(12,553

)

(27,376

)

623

 

(26,753

)

Total liabilities and stockholders’ equity (deficit)

 

$

 15,487

 

$

 10,634

 

$

 26,121

 

$

 20,833

 

$

 8,995

 

$

 29,828

 

 

5.              Debt

 

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

 

 

 

September 27,

 

December 28,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Revolving line of credit

 

$

 99,000

 

$

 123,500

 

Debt associated with VIEs *

 

875

 

7,075

 

Other

 

58

 

79

 

Total debt

 

99,933

 

130,654

 

Less: current portion of debt

 

(875

)

(7,075

)

Long-term debt

 

$

 99,058

 

$

 123,579

 

 


*Papa John’s is the guarantor of BIBP’s outstanding debt.

 

In January 2006, we executed a five-year, unsecured revolving credit facility (“Credit Facility”) totaling $175.0 million. Under the Credit Facility, outstanding balances accrue interest at 50.0 to 100.0 basis points over the London Interbank Offered Rate (LIBOR) or other bank-developed rates, at our option.  The commitment fee on

 

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the unused balance ranges from 12.5 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), as defined. The remaining availability under our line of credit, reduced for certain outstanding letters of credit, approximated $58.0 million and $31.1 million as of September 27, 2009 and December 28, 2008, respectively. The fair value of our outstanding debt approximates the carrying value since our debt agreements are variable-rate instruments.

 

The Credit Facility contains customary affirmative and negative covenants, including financial covenants requiring the maintenance of specified fixed charges and leverage ratios. At September 27, 2009 and December 28, 2008, we were in compliance with these covenants.

 

We presently have two interest rate swap agreements (“swaps”) that provide fixed interest rates, as compared to LIBOR, as follows:

 

 

 

Floating
Rate Debt

 

Fixed
Rates

 

The first interest rate swap agreement:

 

 

 

 

 

January 16, 2007 to January 15, 2009

 

$

60 million

 

4.98

%

January 15, 2009 to January 15, 2011

 

$

50 million

 

4.98

%

 

 

 

 

 

 

The second interest rate swap agreement:

 

 

 

 

 

January 31, 2009 to January 31, 2011

 

$

50 million

 

3.74

%

 

Our swaps are derivative instruments that are designated as cash flow hedges because the swaps provide a hedge against the effects of rising interest rates on present and/or forecasted future borrowings. The effective portion of the gain or loss on the swaps is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the swaps affect earnings. Gains or losses on the swaps representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. Amounts payable or receivable under the swaps are accounted for as adjustments to interest expense.

 

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The following tables provide information on the location and amounts of our swaps in the accompanying consolidated financial statements (in thousands):

 

Fair Values of Derivative Instruments

 

 

 

Liability Derivatives

 

 

 

Balance Sheet Location

 

Fair Value
Sept. 27, 2009

 

Fair Value
Dec. 28, 2008

 

 

 

 

 

 

 

 

 

Derivatives designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

Other long-term liabilities

 

$

 4,773

 

$

 6,173

 

 

There were no derivatives that were not designated as hedging instruments under the provisions of the ASC topic, Derivatives and Hedging.

 

Effect of Derivative Instruments on the Consolidated Financial Statements

 

Derivatives - Cash
Flow Hedging
Relationships

 

Amount of Gain or
(Loss) Recognized in
OCI on Derivative
(Effective Portion)

 

Location of Gain
or (Loss)
Reclassified from
Accumulated OCI
into Income
(Effective Portion)

 

Amount of Gain or
(Loss) Reclassified
from Accumulated
OCI into Income
(Effective Portion)

 

Location of Gain
or (Loss)
Recognized in
Income on
Derivative
(Ineffective
Portion and
Amount Excluded
from Effectiveness
Testing)

 

Amount of Gain or
(Loss) Recognized in
Income on
Derivative
(Ineffective Portion
and Amount
Excluded from
Effectiveness
Testing)*

 

 

 

Sept. 27,
2009

 

Sept. 28,
2008

 

 

 

Sept. 27,
2009

 

Sept. 28,
2008

 

 

 

Sept. 27,
2009

 

Sept. 28,
2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps:

 

 

 

 

 

Interest expense:

 

 

 

 

 

Interest expense:

 

 

 

 

 

Quarter to date

 

$

 348

 

$

 87

 

Quarter to date

 

$

 (1,030

)

$

 (586

)

Quarter to date

 

$

 (40

)

$

 —

 

Year to date

 

$

 921

 

$

 (142

)

Year to date

 

$

 (2,996

)

$

 (1,428

)

Year to date

 

$

 (40

)

$

 —

 

 


*A portion of our second interest rate swap became over-hedged during the third quarter of 2009 since the outstanding debt balance associated with this swap was $49 million (floating rate debt of the swap is $50 million).

 

The weighted average interest rates for our Credit Facility, including the impact of the previously mentioned swap agreements, were 4.98% and 4.74% for the three months ended September 27, 2009 and September 28, 2008, respectively, and 4.75% and 5.04% for the nine months ended September 27, 2009 and September 28, 2008, respectively. Interest paid, including payments made or received under the swaps, was $1.3 million and $4.1 million for the three and nine months ended September 27, 2009, respectively, compared to $1.9 million and $5.4 million for the three and nine months ended September 28, 2008, respectively. As of September 27, 2009, the portion of the $4.8 million interest rate swap liability that would be reclassified into earnings during the next 12 months as interest expense approximates $3.6 million.

 

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6.  Calculation of Earnings Per Share

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 27, 2009

 

Sept. 28, 2008

 

Sept. 27, 2009

 

Sept. 28, 2008

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share:

 

 

 

 

 

 

 

 

 

Net income, net of noncontrolling interests

 

$

 11,739

 

$

 7,747

 

$

 43,755

 

$

 24,020

 

Weighted average shares outstanding

 

27,919

 

27,787

 

27,783

 

28,286

 

Basic earnings per common share

 

$

 0.42

 

$

 0.28

 

$

 1.57

 

$

 0.85

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share - assuming dilution:

 

 

 

 

 

 

 

 

 

Net income, net of noncontrolling interests

 

$

 11,739

 

$

 7,747

 

$

 43,755

 

$

 24,020

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

27,919

 

27,787

 

27,783

 

28,286

 

Dilutive effect of outstanding stock compensation awards

 

92

 

197

 

169

 

192

 

Diluted weighted average shares outstanding

 

28,011

 

27,984

 

27,952

 

28,478

 

Earnings per common share - assuming dilution

 

$

 0.42

 

$

 0.28

 

$

 1.57

 

$

 0.84

 

 

Shares subject to options to purchase common stock with an exercise price greater than the average market price of our common stock for the three and nine months ended September 27, 2009 were not included in the computation of the dilutive effect of common stock options because the effect would have been antidilutive.  The weighted average number of shares subject to the antidilutive options were 1.4 million and 1.0 million for the three- and nine-month periods ending September 27, 2009 and September 28, 2008, respectively.

 

7.  Comprehensive Income

 

Comprehensive income is comprised of the following:

 

 

 

Three Months Ended

 

Nine Months Ended

 

(In thousands)

 

Sept. 27, 2009

 

Sept. 28, 2008

 

Sept. 27, 2009

 

Sept. 28, 2008

 

 

 

 

 

 

 

 

 

 

 

Net income, including noncontrolling interests

 

$

12,636

 

$

7,965

 

$

46,669

 

$

25,441

 

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

 

348

 

87

 

921

 

(142

)

Foreign currency translation

 

(956

)

(387

)

1,304

 

(254

)

Comprehensive income

 

$

 12,028

 

$

 7,665

 

$

 48,894

 

$

 25,045

 

 

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8.  Notes Receivable

 

Selected franchisees have borrowed funds from our subsidiary, Capital Delivery, Ltd., principally for use in the acquisition, construction and development of their restaurants. We have also entered into loan agreements with certain franchisees that purchased restaurants from us or from other franchisees. In addition, as part of the 2006 sale of our former Perfect Pizza operations, we have a loan outstanding from the purchaser. Loans outstanding, net of allowance for doubtful accounts, were approximately $11.2 million as of September 27, 2009 and $7.6 million as of December 28, 2008.

 

We have recorded reserves of $7.3 million and $5.4 million as of September 27, 2009 and December 28, 2008, respectively, for potentially uncollectible notes receivable from franchisees and the purchaser of the Perfect Pizza operations. We concluded the reserves were necessary due to certain franchisees’ economic performance and underlying collateral value and credit risk related to the Perfect Pizza operations.

 

In connection with the 2006 sale of our former Perfect Pizza operations, we remain contingently liable for payment under approximately 70 lease arrangements, primarily associated with Perfect Pizza restaurant sites for which the Perfect Pizza franchisor is primarily liable. The leases have varying terms, the latest of which expires in 2017. The potential amount of undiscounted payments we could be required to make in the event of non-payment by Perfect Pizza and associated franchisees is approximately $6.2 million. We have not recorded a liability with respect to such leases as of September 27, 2009, as our cross-default provisions with the Perfect Pizza franchisor substantially reduce the risk that we will be required to make payments under these leases at the present time.

 

9.  Segment Information

 

We have defined six reportable segments: domestic restaurants, domestic commissaries, domestic franchising, international operations, variable interest entities (“VIEs”) and “all other” business units.

 

The domestic restaurant segment consists of the operations of all domestic (“domestic” is defined as contiguous United States) Company-owned restaurants and derives its revenues principally from retail sales of pizza and side items, such as breadsticks, cheesesticks, chicken strips, chicken wings, dessert pizza, and soft drinks to the general public. The domestic commissary segment consists of the operations of our regional dough production and product distribution centers and derives its revenues principally from the sale and distribution of food and paper products to domestic Company-owned and franchised restaurants. The domestic franchising segment consists of our franchise sales and support activities and derives its revenues from sales of franchise and development rights and collection of royalties from our domestic franchisees. The international operations segment principally consists of our Company-owned restaurants and distribution sales to franchised Papa John’s restaurants located in the United Kingdom, China and Mexico and our franchise sales and support activities, which derive revenues from sales of franchise and development rights and the collection of royalties from our international franchisees. VIEs consist of entities in which we are deemed the primary beneficiary, as defined in Note 4, and include BIBP and certain franchisees to which we have extended loans. All other business units that do not meet the quantitative thresholds for determining reportable segments consist of operations that derive revenues from the sale, principally to Company-owned and franchised restaurants, of printing and promotional items, risk management services, and information systems and related services used in restaurant operations and certain partnership development activities.

 

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

 

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

 

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Our segment information is as follows:

 

 

 

Three Months Ended

 

Nine Months Ended

 

(In thousands)

 

Sept. 27, 2009

 

Sept. 28, 2008

 

Sept. 27, 2009

 

Sept. 28, 2008

 

Revenues from external customers:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

 122,023

 

$

 130,662

 

$

 378,694

 

$

 403,332

 

Domestic commissaries

 

93,625

 

108,804

 

302,985

 

321,172

 

Domestic franchising

 

15,172

 

14,572

 

45,503

 

45,943

 

International

 

10,821

 

10,333

 

30,424

 

28,779

 

Variable interest entities (1)

 

10,356

 

2,014

 

27,250

 

6,293

 

All others

 

11,949

 

13,643

 

40,699

 

46,922

 

Total revenues from external customers

 

$

 263,946

 

$

 280,028

 

$

 825,555

 

$

 852,441

 

 

 

 

 

 

 

 

 

 

 

Intersegment revenues:

 

 

 

 

 

 

 

 

 

Domestic commissaries

 

$

 38,642

 

$

 36,443

 

$

 108,869

 

$

 108,519

 

Domestic franchising

 

480

 

463

 

1,494

 

1,407

 

International

 

280

 

324

 

790

 

932

 

Variable interest entities (1)

 

35,483

 

45,057

 

106,483

 

125,290

 

All others

 

2,878

 

3,906

 

8,661

 

12,042

 

Total intersegment revenues

 

$

 77,763

 

$

 86,193

 

$

 226,297

 

$

 248,190

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

 7,439

 

$

 (1,067

)

$

 27,982

 

$

 13,888

 

Domestic commissaries

 

5,767

 

6,142

 

22,635

 

22,199

 

Domestic franchising

 

13,127

 

12,599

 

39,633

 

40,166

 

International

 

(904

)

(1,193

)

(2,528

)

(4,452

)

Variable interest entities (2)

 

5,104

 

2,826

 

20,983

 

(11,427

)

All others

 

(103

)

1,039

 

911

 

5,557

 

Unallocated corporate expenses

 

(11,991

)

(8,523

)

(38,689

)

(26,886

)

Elimination of intersegment profits

 

(50

)

(51

)

(166

)

(283

)

Total income before income taxes

 

$

 18,389

 

$

 11,772

 

$

 70,761

 

$

 38,762

 

Income attributable to noncontrolling interests

 

(897

)

(218

)

(2,914

)

(1,421

)

Total income before income taxes, net of noncontrolling interests

 

$

 17,492

 

$

 11,554

 

$

 67,847

 

$

 37,341

 

 

 

 

 

 

 

 

 

 

 

Property and equipment:

 

 

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

 156,403

 

 

 

 

 

 

 

Domestic commissaries

 

81,357

 

 

 

 

 

 

 

International

 

13,760

 

 

 

 

 

 

 

Variable interest entities

 

10,116

 

 

 

 

 

 

 

All others

 

23,337

 

 

 

 

 

 

 

Unallocated corporate assets

 

121,415

 

 

 

 

 

 

 

Accumulated depreciation and amortization

 

(215,975

)

 

 

 

 

 

 

Net property and equipment

 

$

 190,413

 

 

 

 

 

 

 

 


(1)

The revenues from external customers for variable interest entities are attributable to the franchise entities to which we have extended loans that qualify as consolidated VIEs. The intersegment revenues for variable interest entities are attributable to BIBP.

(2)

Represents BIBP’s operating income (loss), net of minority interest income for each year, if any.

 

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

 

Results of Operations and Critical Accounting Policies and Estimates

 

Papa John’s International, Inc. (referred to as the “Company,” “Papa John’s” or in the first person notations of “we,” “us” and “our”) began operations in 1985. At September 27, 2009, there were 3,458 Papa John’s restaurants (613 Company-owned and 2,845 franchised) operating in all 50 states and in 29 countries. 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, printing and promotional items, risk management services, and information systems and related services used in their operations.

 

The results of operations are based on the preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States (GAAP). The preparation of consolidated financial statements requires management to select accounting policies for critical accounting areas and make estimates and assumptions that affect the amounts reported in the consolidated financial statements. Significant changes in assumptions and/or conditions in our critical accounting policies could materially impact the operating results. We have identified the following accounting policies and related judgments as critical to understanding the results of our operations:

 

Allowance for Doubtful Accounts and Notes Receivable

 

We establish reserves for uncollectible accounts and notes receivable based on overall receivable aging levels and a specific evaluation of accounts and notes for franchisees with known financial difficulties. These reserves and corresponding write-offs could significantly increase if the identified franchisees begin to or continue to experience deteriorating financial results. We have also established a reserve for notes receivable from the purchaser of our former Perfect Pizza operations.

 

Long-Lived and Intangible Assets

 

The recoverability of long-lived assets is evaluated 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 estimated net realizable value for assets held for sale.

 

The recoverability of indefinite-lived intangible assets (i.e., goodwill) is evaluated annually or more frequently if impairment indicators exist, on a reporting unit basis by comparing the estimated fair value to its carrying value. Our estimated fair value for Company-owned restaurants is comprised of two components. The first component is the estimated cash sales price that would be received at the time of the sale and the second component is an investment in the continuing franchise agreement, representing the discounted value of future royalties less any incremental direct operating costs, that would be collected under the ten-year franchise agreement.

 

At September 27, 2009, we had a net investment of approximately $21.1 million associated with our United Kingdom subsidiary (PJUK). During the fourth quarter of 2008, we recorded a goodwill impairment charge of $2.3 million associated with our PJUK operations. We have developed plans for PJUK to continue to improve its operating results. The plans include efforts to increase Papa John’s brand awareness in the United Kingdom, improve sales and profitability for individual restaurants and increase net PJUK franchised unit openings over the next several years. We will continue to periodically evaluate

 

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our progress in achieving these plans. If our initiatives with PJUK are not successful, future impairment charges could occur. Additionally, if financial performance were to deteriorate in certain less profitable domestic markets, future impairment charges could occur.

 

Insurance Reserves

 

Our insurance programs for workers’ compensation, general liability, owned and non-owned automobiles and health insurance coverage provided to our employees 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.

 

From October 2000 through September 2004, our captive insurance company, which provided insurance to our franchisees, was self-insured. In October 2004, a third-party commercial insurance company began providing fully-insured coverage to franchisees participating in the franchise insurance program. Accordingly, this arrangement eliminates our risk of loss for franchise insurance coverage written after September 2004. Our operating income is still subject to potential adjustments for changes in estimated insurance reserves for policies written from the inception of the captive insurance company in October 2000 to September 2004. Such adjustments, if any, will be determined in part based upon periodic actuarial valuations.

 

Deferred Income Tax Assets and Tax Reserves

 

Papa John’s is subject to income taxes in the United States and several foreign jurisdictions. Significant judgment is required in determining Papa John’s provision for income taxes and the related assets and liabilities. Income taxes are accounted for under the Income Taxes topic of the Accounting Standards Codification (“ASC”). The provision for income taxes includes income taxes paid, currently payable or receivable and those deferred. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities, and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Deferred tax assets are also recognized for the estimated future effects of tax loss carryforwards. The effect on deferred taxes of changes in tax rates is recognized in the period in which the enactment date changes.  As a result, our effective tax rate may fluctuate. Valuation allowances are established when necessary on a jurisdictional basis to reduce deferred tax assets to the amounts we expect to realize.

 

As of September 27, 2009, we had a net deferred income tax asset balance of $18.5 million, of which approximately $7.7 million relates to the net operating loss carryforward of BIBP Commodities, Inc. (“BIBP”). We have not provided a valuation allowance for the deferred income tax assets associated with our domestic operations, including BIBP, since we believe it is more likely than not that future earnings will be sufficient to ensure the realization of the net deferred income tax assets for federal and state purposes.

 

Certain tax authorities periodically audit the Company. We provide reserves for potential exposures based on the requirements of the Income Taxes topic of the ASC. We evaluate these issues on a quarterly basis to adjust for events, such as court rulings or audit settlements, which may impact our ultimate payment for such exposures.

 

Consolidation of BIBP Commodities, Inc. 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 Consolidation topic of the ASC, we

 

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consolidate the financial results of BIBP since we qualify as the primary beneficiary, as defined, of BIBP. We recognized pre-tax income of $5.1 million and $21.0 million for the three and nine months ended September 27, 2009 and pre-tax income of $2.8 million for the three months ended September 28, 2008 and a pre-tax loss of $11.4 million for the nine months ended September 28, 2008 from the consolidation of BIBP. We expect the consolidation of BIBP to continue to have a significant impact on Papa John’s operating income in future periods due to the volatility of cheese prices. Papa John’s will recognize the operating losses generated by BIBP if the shareholders’ equity of BIBP is in a net deficit position. Further, Papa John’s will recognize subsequent operating income generated by BIBP up to the amount of BIBP losses previously recognized by Papa John’s.

 

Recent Accounting Pronouncements

 

Fair Value Measurements and Disclosures

The Fair Value Measurements and Disclosures topic of the Financial Accounting Standards Board’s (FASB) ASC requires companies to determine fair value based on the price that would be received to sell the asset or paid to transfer the liability to a market participant. The Fair Value Measurements and Disclosures topic emphasizes that fair value is a market-based measurement, not an entity-specific measurement. The new guidance required a phased-in approach: (1) phase one was effective for financial assets and liabilities in our first quarter of fiscal 2008 and (2) phase two was effective for our first quarter of fiscal 2009. The new provisions did not have a significant impact on our 2008 and 2009 financial statements.

 

Business Combinations

The Business Combinations topic of the ASC establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable financial statement users to evaluate the nature and financial effects of the business combination. The latest guidance in the Business Combinations topic of the ASC applies to business combinations for which the acquisition date is on or after December 15, 2008. The adoption of the new guidance had no impact on our 2009 consolidated financial statements.

 

Consolidation

The Consolidation topic of the ASC requires all entities to report noncontrolling (minority) interests in subsidiaries as equity in the consolidated financial statements, but separate from the equity of the parent company. The Consolidation topic further requires that consolidated net income be reported at amounts attributable to the parent and the noncontrolling interest, rather than expensing the income attributable to the minority interest holder. Additionally, sufficient disclosures are required to clearly identify and distinguish between the interests of the parent company and the interests of the noncontrolling owners, including a disclosure on the face of the consolidated statements for income attributable to the noncontrolling interest holder. The presentation and disclosure requirements were applied retrospectively for all periods presented, and thus, the prior year financial statements have been modified to incorporate the new requirements.

 

We have joint venture arrangements with Colonel’s Limited, LLC (51 restaurants) and Star Papa, LP (75 restaurants). The minority interest holders own 30% and 49% of Colonel’s Limited and Star Papa, respectively.

 

Derivatives and Hedging

In the first quarter of 2009, Papa John’s adopted the latest provisions of the ASC topic, Derivatives and Hedging. The guidance enhances the required disclosures regarding derivatives and hedging activities, including disclosures regarding how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted, and how derivative instruments and related hedged

 

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items affect an entity’s financial position, results of operations and cash flows. See Note 5 for additional information.

 

Subsequent Events

The Subsequent Events topic of the ASC requires public companies to evaluate subsequent events through the date the financial statements are issued. Accordingly, we evaluated for subsequent events occurring after September 27, 2009 (our financial statement date) through November 3, 2009 (the date this report was filed). We determined no subsequent events disclosures were required.

 

SFAS No. 167, Amendments to FASB Interpretation No. 46(R)

In June 2009, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 167, Amendments to FASB Interpretation No. 46(R). SFAS No. 167 has been deemed authoritative literature even though the provisions of this standard have not yet been integrated into the ASC.

 

The objective of SFAS No. 167 is to improve the financial reporting of companies involved with variable interest entities (VIEs). As required by this statement, the provisions required by FIN 46(R) are now applicable for entities previously considered qualifying special-purpose entities, as the concept of these entities was eliminated from SFAS No. 140 with the issuance of SFAS No. 166, Accounting for Transfers of Financial Assets—an amendment of FASB Statement No. 140. This Statement amends FIN 46(R) to replace the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in the VIE with a qualitative approach focused on identifying which company has the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. Additionally, this statement requires a company to perform ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. Prior to this statement, a company was only required to reassess the status when specific events occurred. We are required to adopt the provisions of SFAS No. 167 for our first quarter of 2010. We have not yet assessed the impact, if any, of the adoption of this statement on our financial statements.

 

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Restaurant Progression

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Sept. 27, 2009

 

Sept. 28, 2008

 

Sept. 27, 2009

 

Sept. 28, 2008

 

 

 

 

 

 

 

 

 

 

 

Papa John’s Restaurant Progression:

 

 

 

 

 

 

 

 

 

U.S. Company-owned:

 

 

 

 

 

 

 

 

 

Beginning of period

 

589

 

652

 

592

 

648

 

Opened

 

2

 

 

5

 

9

 

Closed

 

(1

)

(3

)

(6

)

(9

)

Acquired from franchisees

 

 

 

11

 

1

 

Sold to franchisees

 

 

 

(12

)

 

End of period

 

590

 

649

 

590

 

649

 

International Company-owned:

 

 

 

 

 

 

 

 

 

Beginning of period

 

23

 

18

 

23

 

14

 

Opened

 

 

4

 

1

 

9

 

Closed

 

 

(1

)

(1

)

(2

)

End of period

 

23

 

21

 

23

 

21