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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 26, 2010
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 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 x 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 27, 2010, there were outstanding 25,773,729 shares of the registrant’s common stock, par value $0.01 per share.

 
 

 
 
INDEX

 
Page No.
 
         
     
         
       
      2  
           
         
  Months Ended September 26, 2010 and September 27, 2009      3  
 
         
         
  Months Ended September 26, 2010 and September 27, 2009     4  
           
         
      5  
           
      6  
           
    15  
           
    28  
           
    30  
           
       
           
    30  
           
    30  
           
    33  
 
 
1

 

           
           
Papa John’s International, Inc. and Subsidiaries
 
 
             
(In thousands)
 
September 26, 2010
   
December 27, 2009
 
   
(Unaudited)
   
(Note)
 
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 28,180     $ 25,457  
Accounts receivable, net
    24,713       22,119  
Inventories
    16,112       15,576  
Prepaid expenses
    7,398       8,695  
Other current assets
    3,367       3,748  
Deferred income taxes
    9,532       8,408  
Total current assets
    89,302       84,003  
Investments
    1,629       1,382  
Net property and equipment
    186,256       187,971  
Notes receivable, net
    17,379       16,359  
Deferred income taxes
    5,557       6,804  
Goodwill
    75,015       75,066  
Other assets
    22,738       22,141  
Total assets
  $ 397,876     $ 393,726  
                 
Liabilities and stockholders’ equity
               
Current liabilities:
               
Accounts payable
  $ 24,871     $ 26,990  
Income and other taxes payable
    11,353       5,854  
Accrued expenses
    50,035       54,241  
Total current liabilities
    86,259       87,085  
Unearned franchise and development fees
    6,478       5,668  
Long-term debt, net of current portion
    99,023       99,050  
Other long-term liabilities
    12,854       16,886  
Stockholders’ equity:
               
Preferred stock
    -       -  
Common stock
    360       358  
Additional paid-in capital
    242,491       231,720  
Accumulated other comprehensive income (loss)
    680       (1,084 )
Retained earnings
    229,127       191,212  
Treasury stock
    (287,329 )     (245,337 )
Total stockholders' equity, net of noncontrolling interests
    185,329       176,869  
Noncontrolling interests
    7,933       8,168  
Total stockholders’ equity
    193,262       185,037  
Total liabilities and stockholders’ equity
  $ 397,876     $ 393,726  
                 
Note: The balance sheet at December 27, 2009 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

 
 
Papa John's International, Inc. and Subsidiaries
(Unaudited)
 
   
Three Months Ended
   
Nine Months Ended
 
(In thousands, except per share amounts)
 
Sept. 26, 2010
   
Sept. 27, 2009
   
Sept. 26, 2010
   
Sept. 27, 2009
 
Domestic revenues:
                       
Company-owned restaurant sales
  $ 120,414     $ 122,023     $ 374,652     $ 378,694  
Franchise royalties
    16,346       15,028       51,222       45,053  
Franchise and development fees
    94       144       241       450  
Commissary sales
    111,884       96,375       338,460       310,453  
Other sales
    12,138       11,949       39,674       40,699  
International revenues:
                               
Royalties and franchise and development fees
    3,678       3,173       10,770       9,796  
Restaurant and commissary sales
    8,572       7,648       24,540       20,628  
Total revenues
    273,126       256,340       839,559       805,773  
Costs and expenses:
                               
Domestic Company-owned restaurant expenses:
                               
Cost of sales
    27,245       23,990       81,551       73,784  
Salaries and benefits
    33,320       35,821       102,915       110,181  
Advertising and related costs
    11,264       11,284       33,817       33,933  
Occupancy costs
    8,494       8,171       24,264       23,809  
Other operating expenses
    18,184       17,455       54,218       52,264  
Total domestic Company-owned restaurant expenses
    98,507       96,721       296,765       293,971  
Domestic commissary and other expenses:
                               
Cost of sales
    94,422       78,599       284,909       257,707  
Salaries and benefits
    8,533       8,592       25,833       26,061  
Other operating expenses
    12,002       11,523       35,543       33,140  
Total domestic commissary and other expenses
    114,957       98,714       346,285       316,908  
Loss (income) from the franchise cheese-purchasing program,
                         
net of noncontrolling interest
    409       (4,171 )     (4,573 )     (16,736 )
International operating expenses
    7,627       6,573       21,833       17,837  
General and administrative expenses
    27,133       29,303       83,983       86,628  
Other general expenses
    2,643       1,829       6,620       9,244  
Depreciation and amortization
    8,067       7,745       24,122       23,343  
Total costs and expenses
    259,343       236,714       775,035       731,195  
Operating income
    13,783       19,626       64,524       74,578  
Investment income
    173       149       601       425  
Interest expense
    (1,416 )     (1,386 )     (3,993 )     (4,242 )
Income before income taxes
    12,540       18,389       61,132       70,761  
Income tax expense
    4,020       5,753       20,545       24,092  
Net income, including noncontrolling interests
    8,520       12,636       40,587       46,669  
Less: income attributable to noncontrolling interests
    (672 )     (897 )     (2,672 )     (2,914 )
Net income, net of noncontrolling interests
  $ 7,848     $ 11,739     $ 37,915     $ 43,755  
                                 
Basic earnings per common share
  $ 0.30     $ 0.42     $ 1.43     $ 1.57  
Earnings per common share - assuming dilution
  $ 0.30     $ 0.42     $ 1.42     $ 1.57  
                                 
Basic weighted average shares outstanding
    25,951       27,919       26,586       27,783  
Diluted weighted average shares outstanding
    26,081       28,011       26,743       27,952  
                                 
See accompanying notes.
                               
                                 
 
 
3

 
 
 
Papa John's International, Inc. and Subsidiaries
(Unaudited)
 
   
Papa John's International, Inc.
             
                     
Accumulated
                         
   
Common
         
Additional
   
Other
                     
Total
 
   
Stock Shares
   
Common
   
Paid-In
   
Comprehensive
   
Retained
   
Treasury
   
Noncontrolling
   
Stockholders'
 
(In thousands)
 
Outstanding
   
Stock
   
Capital
   
Income (Loss)
   
Earnings
   
Stock
   
Interests
   
Equity
 
                                                 
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  
Other, net
    -       -       -       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 )
Stock-based compensation expense
    -       -       4,258       -       -       -       -       4,258  
Balance at September 27, 2009
    27,960     $ 358     $ 231,230     $ (1,593 )   $ 177,514     $ (221,818 )   $ 8,361     $ 194,052  
                                                                 
Balance at December 27, 2009
    26,930     $ 358     $ 231,720     $ (1,084 )   $ 191,212     $ (245,337 )   $ 8,168     $ 185,037  
Comprehensive income:
                                                               
Net income
    -       -       -       -       37,915       -       2,672       40,587  
Change in valuation of interest rate
                                                               
swap agreements, net of tax of $973
    -       -       -       1,730       -       -       -       1,730  
Other, net
    -       -       -       34       -       -       -       34  
Comprehensive income
                                                            42,351  
Exercise of stock options
    283       2       5,017       -       -       285       -       5,304  
Acquisition of treasury stock
    (1,738 )     -       -       -       -       (43,215 )     -       (43,215 )
Distributions to noncontrolling
                                                               
interests
    -       -       -       -       -       -       (2,907 )     (2,907 )
Stock-based compensation expense
    -       -       4,491       -       -       -       -       4,491  
Other
    121       -       1,263       -       -       938       -       2,201  
Balance at September 26, 2010
    25,596     $ 360     $ 242,491     $ 680     $ 229,127     $ (287,329 )   $ 7,933     $ 193,262  
                                                                 
At September 27, 2009, 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.
 
 
                         
At September 26, 2010, accumulated other comprehensive income of $680 was comprised of unrealized foreign currency translation gains of $1,565, partially offset by a net unrealized loss on the interest rate swap agreements of $833 and a $52 pension plan liability for PJUK.
 
 
                         
                                                                 
See accompanying notes.
                                           
                                                                 
 
 
4

 
 
Papa John's International, Inc. and Subsidiaries
(Unaudited)
 
   
Nine Months Ended
 
(In thousands)
 
Sept. 26, 2010
   
Sept. 27, 2009
 
Operating activities
           
Net income, net of noncontrolling interests
  $ 37,915     $ 43,755  
Adjustments to reconcile net income to net cash provided by operating activities:
         
Provision for uncollectible accounts and notes receivable
    1,257       2,467  
Depreciation and amortization
    24,122       23,343  
Deferred income taxes
    (850 )     5,590  
Stock-based compensation expense
    4,491       4,258  
Excess tax benefit related to exercise of non-qualified stock options
    (242 )     (987 )
Other
    303       1,443  
Changes in operating assets and liabilities, net of acquisitions:
               
Accounts receivable
    (4,094 )     (126 )
Inventories
    (525 )     (329 )
Prepaid expenses
    1,309       3,582  
Other current assets
    381       1,938  
Other assets and liabilities
    (397 )     (1,487 )
Accounts payable
    (2,119 )     (3,556 )
Income and other taxes payable
    5,499       3,297  
Accrued expenses
    (5,701 )     (671 )
Unearned franchise and development fees
    810       (251 )
Net cash provided by operating activities
    62,159       82,266  
Investing activities
               
Purchases of property and equipment
    (23,608 )     (21,002 )
Purchases of investments
    (548 )     (1,187 )
Proceeds from sale or maturity of investments
    301       225  
Loans issued
    (1,736 )     (11,577 )
Loan repayments
    2,444       5,396  
Acquisitions
    -       (464 )
Proceeds from divestitures of restaurants
    1,423       830  
Other
    10       108  
Net cash used in investing activities
    (21,714 )     (27,671 )
Financing activities
               
Net repayments from line of credit facility
    -       (24,500 )
Net repayments from short-term debt - variable interest entities
    -       (6,200 )
Excess tax benefit related to exercise of non-qualified stock options
    242       987  
Proceeds from exercise of stock options
    5,304       9,655  
Acquisition of Company common stock
    (43,215 )     (4,958 )
Noncontrolling interests, net of contributions and distributions
    (235 )     109  
Other
    104       (21 )
Net cash used in financing activities
    (37,800 )     (24,928 )
Effect of exchange rate changes on cash and cash equivalents
    78       157  
Change in cash and cash equivalents
    2,723       29,824  
Cash and cash equivalents at beginning of period
    25,457       10,917  
Cash and cash equivalents at end of period
  $ 28,180     $ 40,741  
                 
See accompanying notes.
               
                 
 
 
5

 
 
Papa John's International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(Unaudited)

September 26, 2010


The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the nine months ended September 26, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ended December 26, 2010. 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 27, 2009.


Recently Adopted Accounting Principle

In 2009, the Financial Accounting Standards Board (“FASB”) amended the consolidation principles associated with variable interest entities (“VIEs”) accounting by replacing 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. The qualitative approach is focused on identifying which company has both the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and the obligation to absorb losses of the entity or the right to receive benefits from the entity.

Based on the amended consolidation principles, beginning in fiscal 2010, we are no longer required to consolidate certain franchise entities to which we have extended loans. Accordingly, we did not consolidate the financial results of certain franchise entities in the accompanying financial statements for the three and nine months ended September 26, 2010 and have retrospectively applied the provisions to prior period financial statements. The retrospective application resulted in the exclusion of $3.4 million of assets in our accompanying consolidated balance sheet at December 27, 2009 (there was no impact on our consolidated statements of stockholders’ equity from this new accounting pronouncement). Additionally, our consolidated income statement has been adjusted to exclude $10.4 million and $27.3 million of revenues for the three and nine months ended September 27, 2009, respectively, associated with these entities. The operating results of these previously consolidated entities had no impact on Papa John’s operating results or earnings per share for the three and nine months ended September 27, 2009.

Noncontrolling Interests

The Consolidation topic of the Accounting Standards Codification (“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, 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.

 
6

 
 
Papa John’s had two joint venture arrangements as of September 26, 2010 and September 27, 2009, which were as follows:

   
Restaurants
           
Noncontrolling
 
   
as of
 
Restaurant
 
Papa John's
   
Interest
 
   
Sept. 26, 2010
 
Locations
 
Ownership *
   
Ownership *
 
                     
Star Papa, LP
    75  
Texas
    51%       49%  
Colonel's Limited, LLC
    52  
Maryland and Virginia
    70%       30%  
                           
                           
*The ownership percentages were the same for both the 2010 and 2009 periods presented in the accompanying consolidated financial statements.
 

The pre-tax income attributable to the joint ventures for the three and nine months ended September 26, 2010 and September 27, 2009 was as follows:
 
   
Three Months Ended
   
Nine Months Ended
 
   
Sept. 26,
   
Sept. 27,
   
Sept. 26,
   
Sept. 27,
 
(In thousands)
 
2010
   
2009
   
2010
   
2009
 
                         
Papa John's International, Inc.
  $ 1,146     $ 1,420     $ 4,240     $ 4,696  
Noncontrolling interests
    672       897       2,672       2,914  
Total pre-tax income
  $ 1,818     $ 2,317     $ 6,912     $ 7,610  

The noncontrolling interest holders’ equity in the joint venture arrangements totaled $7.9 million as of September 26, 2010 and $8.2 million as of December 27, 2009.

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 26, 2010, we had a net deferred tax asset balance of $15.1 million, of which approximately $5.1 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’s income tax filings. We provide reserves for potential exposures. 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.

 
7

 
 
Modification of our Non-qualified Deferred Compensation Plan

During the first quarter of 2010, we modified the provisions of our non-qualified deferred compensation plan. Previously, participants who elected an investment in phantom Papa John’s stock were paid in cash upon settlement of their investment balance. Effective the first quarter of 2010, we began settling future distributions of the deemed investment balances in Papa John’s stock through the issuance of Company stock. Accordingly, during the first quarter of 2010, we reclassified $2.0 million from other long-term liabilities to paid-in capital in the accompanying consolidated financial statements.

Subsequent Events

The Company evaluated subsequent events through the date the financial statements were issued and filed with the Securities and Exchange Commission in this Form 10-Q. There were no subsequent events that required recognition or disclosure.

3.   Accounting for Variable Interest Entities

The Consolidation topic of the ASC provides a framework for identifying VIEs and determining when a company should include the assets, liabilities, noncontrolling 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”) has both of the following characteristics: (1) has the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and (2) is obligated to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. 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 noncontrolling 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 is also required. See Note 2 for the impact on our financial statements from the FASB’s recent amendment to VIE accounting.
 
We have a purchasing arrangement with 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 fixed monthly price. PJFS purchased $37.1 million and $113.6 million of cheese from BIBP for the three and nine months ended September 26, 2010, respectively, compared to $35.5 million and $106.5 million in the 2009 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 recognize the subsequent operating income generated by BIBP up to the amount of any losses previously recognized. We recognized a pre-tax loss of $658,000 ($417,000 net of tax, or $0.02 per diluted share) and pre-tax income of $5.5 million ($3.5 million net of tax, or $0.13 per diluted share) for the three and nine months ended September 26, 2010, respectively, and 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, 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 anticipated volatility of the cheese market, but is not expected to be cumulatively significant over time.
 
 
8

 

At September 26, 2010, BIBP had a $10.0 million line of credit with a commercial bank, which is guaranteed by Papa John’s (no balance was outstanding as of September 26, 2010). In addition, Papa John’s agreed to provide additional funding in the form of a line of credit to BIBP. As of September 26, 2010, BIBP had $18.5 million of short-term debt outstanding under the line of credit from Papa John’s (the $18.5 million outstanding balance under the Papa John’s line of credit is eliminated upon consolidation of the financial results of BIBP with Papa John’s).

The following table summarizes the balance sheets for BIBP as of September 26, 2010 and December 27, 2009:
 
   
September 26,
   
December 27,
 
(In thousands)
 
2010
   
2009
 
             
Assets:
           
Cash and cash equivalents
  $ 2,906     $ 3,857  
Accounts receivable - Papa John's
    916       469  
Inventory and other current assets
    1,534       1,917  
Deferred income taxes
    5,132       7,064  
Total assets
  $ 10,488     $ 13,307  
                 
Liabilities and stockholders' equity (deficit):
               
Accounts payable and accrued expenses
  $ 1,409     $ 1,596  
Short-term debt - Papa John's
    18,538       24,633  
Total liabilities
    19,947       26,229  
Stockholders' equity (deficit)
    (9,459 )     (12,922 )
Total liabilities and stockholders' equity (deficit)
  $ 10,488     $ 13,307  

4.  Debt

Our debt is comprised of the following (in thousands):
 
   
September 26,
   
December 27,
 
   
2010
   
2009
 
             
Revolving line of credit
  $ 99,000     $ 99,000  
Other
    23       50  
Total debt
    99,023       99,050  
Less: current portion of debt
    -       -  
Long-term debt
  $ 99,023     $ 99,050  

In September 2010, we executed a five-year, unsecured Revolving Credit Facility (“New Credit Facility”) totaling $175.0 million that replaced a $175.0 million unsecured Revolving Credit Facility (“Old Credit Facility”). Under the New Credit Facility, outstanding balances accrue interest at 100.0 to 175.0 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 17.5 to 25.0 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 in the New Credit Facility. Outstanding balances under the Old Credit Facility accrued interest at 50.0 to 100.0 basis points over LIBOR or other bank developed rates, at our option. The commitment fee on the unused balance ranged from 12.5 to 20.0 basis points. The remaining availability under our New Credit Facility, reduced for certain outstanding letters of credit, approximated $59.7 million as of September 26, 2010 and $58.0 million as of December 27, 2009. The fair value of our outstanding debt approximates the carrying value since our debt agreements are variable-rate instruments.
 
 
9

 

The New Credit Facility contains customary affirmative and negative covenants, including financial covenants requiring the maintenance of specified fixed charges and leverage ratios. We were in compliance with all covenants at September 26, 2010.

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 accumulated other comprehensive income (loss) (“OCI”) 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.

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
 
     
Fair Value
   
Fair Value
 
Type of Derivative
Balance Sheet Location
 
Sept. 26, 2010
   
Dec. 27, 2009
 
               
Interest rate swaps
 Other long-term liabilities
  $ 1,341     $ 4,044  
                   
There were no derivatives that were not designated as hedging instruments under the provisions of the ASC topic, Derivatives and Hedging.
 
 
 
10

 
 
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)
 
Classification 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)
 
Classification 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)
 
                       
Interest rate swaps:
                     
                       
Three months ended:
                     
   Sept. 26, 2010
  $ 581  
Interest expense
  $ (1,023 )
Not applicable
  $ 0  
   Sept. 27, 2009
  $ 348  
Interest expense
  $ (1,030 )
Interest expense
  $ (40 )
                             
Nine months ended:
                           
   Sept. 26, 2010
  $ 1,730  
Interest expense
  $ (3,094 )
Not applicable
  $ 0  
   Sept. 27, 2009
  $ 921  
Interest expense
  $ (2,996 )
Interest expense
  $ (40 )

The weighted average interest rate for our borrowings under our New Credit Facility and our Old Credit Facility, including the impact of the previously mentioned interest rate swap agreements, was 5.20% and 4.98% for the three months ended September 26, 2010 and September 27, 2009, respectively, and 5.09% and 4.75% for the nine months ended September 26, 2010 and September 27, 2009, respectively. Interest paid, including payments made or received under the swaps, was $1.4 million and $4.0 million for the three and nine months ended September 26, 2010, respectively, compared to $1.3 million and $4.1 million for the three and nine months ended September 27, 2009, respectively. The interest rate swap liability of $1.3 million as of September 26, 2010 will be reclassified into earnings during the next four months as interest expense.
 
 
11

 
 

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. 26,
   
Sept. 27,
   
Sept. 26,
   
Sept. 27,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Basic earnings per common share:
                       
Net income
  $ 7,848     $ 11,739     $ 37,915     $ 43,755  
Weighted average shares outstanding
    25,951       27,919       26,586       27,783  
Basic earnings per common share
  $ 0.30     $ 0.42     $ 1.43     $ 1.57  
                                 
Earnings per common share - assuming dilution:
                               
Net income
  $ 7,848     $ 11,739     $ 37,915     $ 43,755  
                                 
Weighted average shares outstanding
    25,951       27,919       26,586       27,783  
Dilutive effect of outstanding compensation awards
    130       92       157       169  
Diluted weighted average shares outstanding
    26,081       28,011       26,743       27,952  
Earnings per common share - assuming dilution
  $ 0.30     $ 0.42     $ 1.42     $ 1.57  
 
Shares subject to options to purchase common stock with an exercise price greater than the average market price for the quarter 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 was 1.7 million and 1.4 million for the three-month periods ending September 26, 2010 and September 27, 2009, respectively. The weighted average number of shares subject to the antidilutive options for the nine-month periods ending September 26, 2010 and September 27, 2009 was 1.5 million and 1.4 million, respectively.
 
 
Comprehensive income is comprised of the following:
 
   
Three Months Ended
   
Nine Months Ended
 
(In thousands)
 
Sept. 26, 2010
   
Sept. 27, 2009
   
Sept. 26, 2010
   
Sept. 27, 2009
 
                         
Net income, including noncontrolling interests
  $ 8,520     $ 12,636     $ 40,587     $ 46,669  
Change in valuation of interest rate swap
                               
   agreements, net of tax
    581       348       1,730       921  
Foreign currency translation
    1,471       (956 )     34       1,304  
Comprehensive income
  $ 10,572     $ 12,028     $ 42,351     $ 48,894  
 

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.
 
Loans outstanding, net of allowance for doubtful accounts, were approximately $17.4 million as of September 26, 2010 and $16.4 million as of December 27, 2009. We have recorded reserves of $7.4 million and $7.6 million as of September 26, 2010 and December 27, 2009, respectively, for potentially uncollectible notes receivable. We concluded the reserves were necessary due to certain borrowers’ economic performance and underlying collateral value.
 
 
12

 
 
 
In connection with the 2006 sale of our former Perfect Pizza operations in the United Kingdom, we remain contingently liable for payment under 62 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. As of September 26, 2010, the potential amount of undiscounted payments we could be required to make in the event of non-payment by the new owner of Perfect Pizza and associated franchisees was approximately $4.8 million. We have not recorded a liability with respect to such leases at September 26, 2010, as our cross-default provisions with the Perfect Pizza franchisor significantly reduce the risk that we will be required to make payments under these leases.
 
We are subject to claims and legal actions in the ordinary course of 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.
 
 
We have defined six reportable segments: domestic Company-owned restaurants, domestic commissaries, domestic franchising, international, variable interest entities (“VIEs”) and “all other” 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. International franchisees are defined as all franchise operations outside of the 48 contiguous United States. BIBP is a variable interest entity in which we are deemed the primary beneficiary, as defined in Note 3, and is the only activity reflected in the VIE segment for both periods presented. 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, including our online and other technology-based ordering platforms.
 
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.
 
 
13

 
 
Our segment information is as follows:
 
   
Three Months Ended
   
Nine Months Ended
 
(In thousands)
 
Sept. 26, 2010
   
Sept. 27, 2009
   
Sept. 26, 2010
   
Sept. 27, 2009
 
Revenues from external customers:
                       
Domestic Company-owned restaurants
  $ 120,414     $ 122,023     $ 374,652     $ 378,694  
Domestic commissaries
    111,884       96,375       338,460       310,453  
Domestic franchising
    16,440       15,172       51,463       45,503  
International
    12,250       10,821       35,310       30,424  
All others
    12,138       11,949       39,674       40,699  
Total revenues from external customers
  $ 273,126     $ 256,340     $ 839,559     $ 805,773  
                                 
Intersegment revenues:
                               
Domestic commissaries
  $ 32,376     $ 35,892     $ 99,254     $ 101,401  
Domestic franchising
    494       480       1,509       1,494  
International
    163       280       852       790  
Variable interest entities
    37,052       35,483       113,556       106,483  
All others
    2,854       2,878       8,713       8,661  
Total intersegment revenues
  $ 72,939     $ 75,013     $ 223,884     $ 218,829  
                                 
Income (loss) before income taxes:
                               
Domestic Company-owned restaurants
  $ 5,503     $ 7,439     $ 25,604     $ 27,982  
Domestic commissaries
    5,393       5,767       20,577       22,635  
Domestic franchising
    14,361       13,127       45,731       39,633  
International
    (1,007 )     (904 )     (3,180 )     (2,528 )
Variable interest entities
    (658 )     5,104       5,505       20,983  
All others
    60       (103 )     1,187       911  
Unallocated corporate expenses
    (11,004 )     (11,991 )     (33,963 )     (38,689 )
Elimination of intersegment profits
    (108 )     (50 )     (329 )     (166 )
Total income before income taxes
  $ 12,540     $ 18,389     $ 61,132     $ 70,761  
Income attributable to noncontrolling interests
    (672 )     (897 )     (2,672 )     (2,914 )
Total income before income taxes, net
                               
    of noncontrolling interests
  $ 11,868     $ 17,492     $ 58,460     $ 67,847  
                                 
Property and equipment:
                               
Domestic Company-owned restaurants
  $ 164,388                          
Domestic commissaries
    80,527                          
International
    16,357                          
All others
    33,191                          
Unallocated corporate assets
    125,327                          
Accumulated depreciation and amortization
    (233,534 )                        
Net property and equipment
  $ 186,256                          
 
 
14

 
 
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 26, 2010, there were 3,583 Papa John’s restaurants (610 Company-owned and 2,973 franchised) operating in all 50 states and 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 and other customers with known financial difficulties. These reserves and corresponding write-offs could significantly increase if the identified franchisees and other customers begin to or continue to experience deteriorating financial results.

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 26, 2010, we had a net investment of approximately $20.7 million associated with our United Kingdom subsidiary (PJUK). The goodwill allocated to this entity approximated $15.0 million at September 26, 2010. We have previously recorded goodwill impairment charges for this entity. 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 our progress in achieving these plans.
 
 
15

 
 
If our growth initiatives with PJUK and certain domestic markets are not successful, future impairment charges could be recorded.
 
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. 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 26, 2010, we had a net deferred income tax asset balance of $15.1 million, of which approximately $5.1 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. 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.
 
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. We consolidate the financial results of BIBP, since we are the primary beneficiary, as defined. We recognized a pre-tax loss of approximately $700,000 and pre-tax income of $5.5 million for the three and nine months ended September 26, 2010, respectively, compared to pre-tax income of $5.1 million and $21.0 million for the same periods in 2009, respectively, 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, but BIBP’s operating results are not expected to be cumulatively significant over time. Papa John’s will recognize the losses generated by BIBP if the shareholders’ equity of BIBP is in a net deficit position. Further, Papa John’s will recognize subsequent income generated by BIBP up to the amount of BIBP losses previously recognized by Papa John’s.
 
 
16

 
 
Recent Accounting Pronouncements
 
In 2009, the Financial Accounting Standards Board (“FASB”) amended the consolidation principles associated with variable interest entities (“VIEs”) accounting by replacing 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. The qualitative approach is focused on identifying which company has both the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and the obligation to absorb losses of the entity or the right to receive benefits from the entity.
 
Based on the amended consolidation principles, beginning in fiscal 2010, we are no longer required to consolidate certain franchise entities to which we have extended loans. Accordingly, we did not consolidate the financial results of certain franchise entities in the accompanying financial statements for the three and nine months ended September 26, 2010 and have retrospectively applied the provisions to prior period financial statements. The retrospective application resulted in the exclusion of $3.4 million of assets in our accompanying consolidated balance sheet at December 27, 2009 (there was no impact on our consolidated statements of stockholders equity from this new accounting pronouncement). Additionally, our consolidated income statement for the three and nine months ended September 27, 2009 has been adjusted to exclude $10.4 million and $27.3 million of revenues, respectively, associated with these entities. The operating results of the entities had no impact on Papa John’s operating results or earnings per share for the three and nine months ended September 27, 2009.
 
 
17

 
 
Restaurant Progression:
 
   
Three Months Ended
   
Nine Months Ended
 
   
Sept. 26, 2010
   
Sept. 27, 2009
   
Sept. 26, 2010
   
Sept. 27, 2009
 
                         
Papa John's Restaurant Progression:
                       
Domestic Company-owned:
                       
Beginning of period
    590       589       588       592  
Opened
    -       2       4       5  
Closed
    -       (1 )     (2 )     (6 )
Acquired from franchisees
    -       -       -       11  
Sold to franchisees
    -       -       -       (12 )
End of period
    590       590       590       590  
International Company-owned:
                               
Beginning of period
    29       23       26       23  
Opened
    2       -       6       1  
Closed
    (1 )     -       (1 )     (1 )
Acquired from franchisees
    -       -       1       -  
Sold to franchisees
    (10 )     -       (12 )     -  
End of period
    20       23       20       23  
Domestic franchised:
                               
Beginning of period
    2,224       2,192       2,193       2,200  
Opened
    44       33       120       58  
Closed
    (10 )     (13 )     (55 )     (47 )
Acquired from Company
    -       -       -       12  
Sold to Company
    -       -       -       (11 )
End of period
    2,258       2,212       2,258       2,212  
International franchised:
                               
Beginning of period
    673       614       662       565  
Opened
    37       26       90       88  
Closed
    (5 )     (7 )     (48 )     (20 )
Acquired from Company
    10       -       12       -  
Sold to Company
    -       -       (1 )     -  
End of period
    715       633       715       633  
Total restaurants - end of period
    3,583       3,458       3,583       3,458  
 
Results of Operations

Variable Interest Entities