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 April 1, 2007

 

 

 

 

 

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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer  x  Accelerated filer o         Non-accelerated filer 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 May 2, 2007, there were outstanding 29,919,825 shares of the registrant’s common stock, par value $0.01 per share.

 




INDEX

 

 

 

 

PART I.

 

FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Financial Statements

 

 

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets – April 1, 2007 and December 31, 2006

 

 

 

 

 

 

 

 

 

Consolidated Statements of Income – Three Months Ended April 1, 2007 and March 26, 2006

 

 

 

 

 

 

 

 

 

Consolidated Statements of Stockholders’ Equity – Three Months Ended April 1, 2007 and March 26, 2006

 

 

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows – Three Months Ended April 1, 2007 and March 26, 2006

 

 

 

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

 

 

 

 

 

 

Item 2.

 

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

 

 

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

 

 

 

 

 

 

PART II.

 

OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

 

 

 

 

 

 

Item 1.A.

 

Risk Factors

 

 

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

 

 

 

 

Item 6.

 

Exhibits

 

 

 

1




PART I.  FINANCIAL INFORMATION

Item 1. Financial Statements

Papa John’s International, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets

(In thousands)

 

April 1, 2007

 

December 31, 2006

 

 

 

(Unaudited)

 

(Note)

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

5,716

 

$

12,979

 

Accounts receivable

 

20,962

 

23,326

 

Inventories

 

25,874

 

26,729

 

Prepaid expenses

 

6,354

 

7,779

 

Other current assets

 

9,544

 

7,368

 

Deferred income taxes

 

7,458

 

6,362

 

Total current assets

 

75,908

 

84,543

 

Investments

 

986

 

1,254

 

Net property and equipment

 

198,970

 

197,722

 

Notes receivable

 

12,180

 

12,104

 

Deferred income taxes

 

3,431

 

1,643

 

Goodwill

 

68,131

 

67,357

 

Other assets

 

16,023

 

15,016

 

Total assets

 

$

375,629

 

$

379,639

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

24,942

 

$

29,202

 

Income and other taxes

 

22,291

 

15,136

 

Accrued expenses

 

52,057

 

57,233

 

Current portion of debt

 

2,225

 

525

 

Total current liabilities

 

101,515

 

102,096

 

Unearned franchise and development fees

 

7,206

 

7,562

 

Long-term debt, net of current portion

 

99,510

 

96,511

 

Other long-term liabilities

 

28,614

 

27,302

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock

 

 

 

Common stock

 

343

 

341

 

Additional paid-in capital

 

192,549

 

187,990

 

Accumulated other comprehensive income

 

377

 

515

 

Retained earnings

 

77,383

 

63,614

 

Treasury stock

 

(131,868

)

(106,292

)

Total stockholders’ equity

 

138,784

 

146,168

 

Total liabilities and stockholders’ equity

 

$

375,629

 

$

379,639

 

 

Note: The balance sheet at December 31, 2006 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 accompanying notes.

2




Papa John’s International, Inc. and Subsidiaries
Consolidated Statements of Income
(Unaudited)

 

 

Three Months Ended

 

(In thousands, except per share amounts)

 

April 1, 2007

 

March 26, 2006

 

Domestic revenues:

 

 

 

 

 

Company-owned restaurant sales

 

$

122,044

 

$

106,740

 

Variable interest entities restaurant sales

 

1,687

 

2,446

 

Franchise royalties

 

14,452

 

14,238

 

Franchise and development fees

 

762

 

588

 

Commissary sales

 

100,199

 

102,692

 

Other sales

 

14,491

 

10,870

 

International revenues:

 

 

 

 

 

Royalties and franchise and development fees

 

2,448

 

1,457

 

Restaurant and commissary sales

 

4,541

 

3,318

 

Total revenues

 

260,624

 

242,349

 

Costs and expenses:

 

 

 

 

 

Domestic Company-owned restaurant expenses:

 

 

 

 

 

Cost of sales

 

25,088

 

20,878

 

Salaries and benefits

 

36,944

 

31,501

 

Advertising and related costs

 

10,903

 

9,192

 

Occupancy costs

 

7,289

 

6,162

 

Other operating expenses

 

16,393

 

13,803

 

Total domestic Company-owned restaurant expenses

 

96,617

 

81,536

 

Variable interest entities restaurant expenses

 

1,379

 

2,107

 

Domestic commissary and other expenses:

 

 

 

 

 

Cost of sales

 

81,775

 

83,543

 

Salaries and benefits

 

8,798

 

7,465

 

Other operating expenses

 

10,998

 

11,140

 

Total domestic commissary and other expenses

 

101,571

 

102,148

 

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

 

(99

)

(4,576

)

International operating expenses

 

4,038

 

3,423

 

General and administrative expenses

 

25,400

 

24,244

 

Minority interests and other general expenses

 

1,937

 

1,698

 

Depreciation and amortization

 

7,895

 

6,561

 

Total costs and expenses

 

238,738

 

217,141

 

Operating income from continuing operations

 

21,886

 

25,208

 

 Investment income

 

353

 

376

 

 Interest expense

 

(1,526

)

(801

)

Income from continuing operations before income taxes

 

20,713

 

24,783

 

Income tax expense

 

7,558

 

9,170

 

Income from continuing operations

 

13,155

 

15,613

 

Income from discontinued operations, net of tax

 

 

389

 

Net income

 

$

13,155

 

$

16,002

 

 

 

 

 

 

 

Basic earnings per common share:

 

 

 

 

 

Income from continuing operations

 

$

0.44

 

$

0.47

 

Income from discontinued operations, net of tax

 

 

0.01

 

Basic earnings per common share

 

$

0.44

 

$

0.48

 

Earnings per common share assuming dilution:

 

 

 

 

 

Income from continuing operations

 

$

0.43

 

$

0.46

 

Income from discontinued operations, net of tax

 

 

0.01

 

Earnings per common share - assuming dilution

 

$

0.43

 

$

0.47

 

Basic weighted average shares outstanding

 

30,064

 

33,122

 

Diluted weighted average shares outstanding

 

30,563

 

33,983

 

 

See accompanying notes.

3




Papa John’s International, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity
(Unaudited)

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Common

 

 

 

Additional

 

Other

 

 

 

 

 

Total

 

 

 

Stock Shares

 

Common

 

Paid-In

 

Comprehensive

 

Retained

 

Treasury

 

Stockholders'

 

(In thousands)

 

Outstanding

 

Stock

 

Capital

 

Income (Loss)

 

Earnings

 

Stock

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 25, 2005

 

33,081

 

$

331

 

$

160,999

 

$

(290

)

$

239

 

$

 

$

161,279

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

16,002

 

 

16,002

 

Change in valuation of interest rate swap agreement, net of tax of $359

 

 

 

 

611

 

 

 

611

 

Other, net

 

 

 

 

70

 

 

 

70

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

16,683

 

Exercise of stock options

 

437

 

4

 

6,604

 

 

 

 

6,608

 

Tax benefit related to exercise of
non-qualified stock options

 

 

 

1,538

 

 

 

 

1,538

 

Acquisition of treasury stock

 

(716

)

 

 

 

 

(22,108

)

(22,108

)

Other

 

 

 

654

 

 

 

 

654

 

Balance at March 26, 2006

 

32,802

 

$

335

 

$

169,795

 

$

391

 

$

16,241

 

$

(22,108

)

$

164,654

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2006

 

30,696

 

$

341

 

$

187,990

 

$

515

 

$

63,614

 

$

(106,292

)

$

146,168

 

Cumulative effect of adoption of FIN No. 48

 

 

 

 

 

614

 

 

614

 

Adjusted balance at January 1, 2007

 

30,696

 

341

 

187,990

 

515

 

64,228

 

(106,292

)

146,782

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

13,155

 

 

13,155

 

Change in valuation of interest rate
swap agreements, net of tax of $147

 

 

 

 

(256

)

 

 

(256

)

Other, net

 

 

 

 

118

 

 

 

118

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

13,017

 

Exercise of stock options

 

182

 

2

 

2,739

 

 

 

 

2,741

 

Tax benefit related to exercise of
non–qualified stock options

 

 

 

854

 

 

 

 

854

 

Acquisition of treasury stock

 

(880

)

 

 

 

 

(25,576

)

(25,576

)

Other

 

 

 

966

 

 

 

 

966

 

Balance at April 1, 2007

 

29,998

 

$

343

 

$

192,549

 

$

377

 

$

77,383

 

$

(131,868

)

$

138,784

 

 

At March 26, 2006, the accumulated other comprehensive gain of $391 was comprised of net unrealized gain on the interest rate swap agreement of $244, net unrealized gain on investments of $6 and unrealized foreign currency translation gains of $141.

At April 1, 2007, the accumulated other comprehensive gain of $377 was comprised of unrealized foreign currency translation gains of $628 and a net unrealized gain on investments of $12, offset by a net unrealized loss on the interest rate swap agreement of $263.

See accompanying notes.

4




Papa John’s International, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)

 

 

Three Months Ended

 

(In thousands)

 

April 1, 2007

 

March 26, 2006

 

Operating activities

 

 

 

 

 

Net income

 

$

13,155

 

$

16,002

 

Results from discontinued operations (net of income taxes)

 

 

(389

)

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

 

 

 

 

 

Provision for uncollectible accounts and notes receivable

 

788

 

1,085

 

Depreciation and amortization

 

7,895

 

6,561

 

Deferred income taxes

 

(2,733

)

(1,335

)

Stock-based compensation expense

 

966

 

698

 

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

 

(854

)

(2,586

)

Other

 

1,304

 

1,800

 

Changes in operating assets and liabilities, net of acquisitions:

 

 

 

 

 

Accounts receivable

 

1,597

 

(1,478

)

Inventories

 

847

 

3,307

 

Prepaid expenses

 

1,360

 

1,015

 

Other current assets

 

(2,182

)

610

 

Other assets and liabilities

 

(80

)

(2,438

)

Accounts payable

 

(4,299

)

451

 

Income and other taxes

 

7,769

 

7,196

 

Accrued expenses

 

(5,277

)

(4,493

)

Unearned franchise and development fees

 

(356

)

(276

)

Net cash provided by operating activities from continuing operations

 

19,900

 

25,730

 

Operating cash flows from discontinued operations

 

 

414

 

Net cash provided by operating activities

 

19,900

 

26,144

 

Investing activities

 

 

 

 

 

Purchase of property and equipment

 

(9,006

)

(6,094

)

Proceeds from sale of property and equipment

 

16

 

17

 

Purchase of investments

 

 

(2,014

)

Proceeds from sale or maturity of investments

 

268

 

3,129

 

Loans issued

 

(750

)

(820

)

Loan repayments

 

638

 

3,027

 

Acquisitions

 

(1,215

)

(543

)

Proceeds from divestitures of restaurants

 

632

 

 

Net cash from continuing operations used in investing activities

 

(9,417

)

(3,298

)

Proceeds from divestiture of discontinued operations

 

 

8,020

 

Net cash provided by (used in) investing activities

 

(9,417

)

4,722

 

Financing activities

 

 

 

 

 

Net proceeds (repayments) from line of credit facility

 

3,000

 

(29,000

)

Net proceeds from short-term debt - variable interest entities

 

1,700

 

6,350

 

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

 

854

 

2,586

 

Proceeds from exercise of stock options

 

2,741

 

6,608

 

Acquisition of Company common stock

 

(25,576

)

(22,108

)

Other

 

(489

)

159

 

Net cash used in financing activities

 

(17,770

)

(35,405

)

Effect of exchange rate changes on cash and cash equivalents

 

24

 

36

 

Change in cash and cash equivalents

 

(7,263

)

(4,503

)

Cash and cash equivalents at beginning of period

 

12,979

 

22,098

 

Cash and cash equivalents at end of period

 

$

5,716

 

$

17,595

 

 

See accompanying notes.

 

5




Papa John’s International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

April 1, 2007

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 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 three months ended April 1, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ended December 30, 2007. 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 31, 2006.

2.              Accounting for Uncertainty in Income Taxes (FIN 48)

The Company adopted the provisions of the Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) on January 1, 2007. FIN 48 addresses the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. In addition, FIN 48 expands the disclosure requirements concerning unrecognized tax benefits as well as any significant changes that may occur in the next twelve months associated with such unrecognized tax benefits.  As a result of the implementation of FIN 48, the Company recognized an approximate $614,000 decrease in the liability for unrecognized tax benefits, which is accounted for as an increase to the January 1, 2007 balance of retained earnings. As of the adoption date, we had tax affected unrecognized benefits of approximately $9.6 million. To the extent these unrecognized tax benefits are ultimately recognized, the effective tax rate will be impacted in a future period.

The Company files income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions.  The Company, with few exceptions, is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2003.  The Company is currently undergoing examinations by various state and local tax authorities.  The Company anticipates that the finalization of these current examinations and the expiration of the applicable statute of limitations will result in a decrease in the liability for unrecognized tax benefits (and a decrease of income tax expense) of approximately $2.0 million during 2007.

The Company recognizes interest accrued and penalties related to unrecognized tax benefits as a part of income tax expense.  The Company recognized approximately $118,000 and $81,000 for the three months ended April 1, 2007 and March 26, 2006, respectively, in interest and penalties. The Company had approximately $2.3 million and $2.5 million for the payment of interest and penalties accrued at April 1, 2007 and December 31, 2006, respectively.

3.              Acquisitions

During the first quarter of 2007, we completed the acquisition of six restaurants located in Pennsylvania, Texas and Oklahoma.  The purchase price of these restaurants totaled $1.2 million, which was paid in cash and is subject to post-closing adjustments, of which approximately $779,000 was recorded as goodwill.

6




Effective April 2, 2007 (the beginning of our second quarter 2007), we acquired 13 restaurants in Georgia.  The purchase price was $7.4 million, which was paid in cash and is subject to post-closing adjustments, of which approximately $6.4 million was recorded as goodwill.

The business combinations in the previous paragraphs were accounted for by the purchase method of accounting, whereby operating results subsequent to the acquisition date are included in our consolidated financial results. The acquisitions are not expected to significantly impact operating income for 2007 as transition costs are expected to substantially offset incremental unit level income.

4.              Accounting for Variable Interest Entities

In 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (FIN 46), which 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.

FIN 46 requires a VIE to be consolidated 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. FIN 46 also requires disclosures about VIEs that the variable interest holder is not required to consolidate but in which it has a significant variable interest.

We have a purchasing arrangement with BIBP Commodities, Inc. (“BIBP”), a special-purpose entity formed at the direction of our Franchise Advisory Council in 1999 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 quarterly price based in part upon historical average market prices.  PJFS in turn sells cheese to Papa John’s restaurants (both Company-owned and franchised) at a set quarterly price. PJFS purchased $31.6 million and $36.3 million of cheese from BIBP for the three months ended April 1, 2007 and March 26, 2006, respectively.

As defined by FIN 46, we are the primary beneficiary of BIBP, a VIE, and thus we consolidate the financial statements of BIBP. 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.

The consolidation of BIBP did not have a significant impact on Papa John’s net income for the three months ended April 1, 2007.  We recognized a pre-tax loss of $406,000 ($256,000 net of tax, or $0.01 per share) and pre-tax income of $5.4 million ($3.4 million net of tax, or $0.10 per share) for the three months ended April 1, 2007 and March 26, 2006, respectively, from the consolidation of BIBP. The impact on future operating income from the consolidation of BIBP is expected to be significant for any given reporting period due to the noted volatility of the cheese market, but is not expected to be cumulatively significant over time.

BIBP has an $18.0 million line of credit with a commercial bank, which is not guaranteed by Papa John’s. Papa John’s has agreed to provide additional funding in the form of a loan to BIBP. As of April 1, 2007, BIBP had

7




outstanding borrowings of $2.2 million and a letter of credit of $3.0 million outstanding under the commercial line of credit facility.

In addition, Papa John’s has extended loans to certain franchisees. Under FIN 46, Papa John’s was deemed the primary beneficiary of two franchise entities as of April 1, 2007 and three franchise entities as of March 26, 2006, even though we had no ownership in them.  The two franchise entities at April 1, 2007 operated a total of seven restaurants with annual revenues approximating $5.5 million. Our net loan balance receivable from these entities was $476,000 at April 1, 2007, with no further funding commitments. The consolidation of these franchise entities has 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 April 1, 2007 and December 31, 2006:

 

 

April 1, 2007

 

December 31, 2006

 

(In thousands)

 

BIBP

 

Franchisees

 

Total

 

BIBP

 

Franchisees

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,231

 

$

233

 

$

1,464

 

$

144

 

$

150

 

$

294

 

Accounts receivable

 

 

 

 

 

 

 

Accounts receivable - Papa John’s

 

3,842

 

 

3,842

 

3,950

 

 

3,950

 

Other current assets

 

941

 

32

 

973

 

1,397

 

26

 

1,423

 

Net property and equipment

 

 

447

 

447

 

 

464

 

464

 

Goodwill

 

 

460

 

460

 

 

460

 

460

 

Deferred income taxes

 

744

 

 

744

 

 

 

 

Total assets

 

$

6,758

 

$

1,172

 

$

7,930

 

$

5,491

 

$

1,100

 

$

6,591

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity (deficit):

 

 

 

 

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

4,273

 

$

269

 

$

4,542

 

$

3,436

 

$

220

 

$

3,656

 

Income and other taxes

 

503

 

 

503

 

506

 

 

506

 

Short-term debt - third party

 

2,225

 

 

2,225

 

525

 

 

525

 

Short-term debt - Papa John’s

 

 

476

 

476

 

 

517

 

517

 

Total liabilities

 

7,001

 

745

 

7,746

 

4,467

 

737

 

5,204

 

Stockholders’ equity (deficit)

 

(243

)

427

 

184

 

1,024

 

363

 

1,387

 

Total liabilities and stockholders’ equity (deficit)

 

$

6,758

 

$

1,172

 

$

7,930

 

$

5,491

 

$

1,100

 

$

6,591

 

 

5.              Debt

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

 

April 1,

 

December 31,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Revolving line of credit

 

$

99,500

 

$

96,500

 

Debt associated with VIEs *

 

2,225

 

525

 

Other

 

10

 

11

 

Total debt

 

101,735

 

97,036

 

Less: current portion of debt

 

(2,225

)

(525

)

Long-term debt

 

$

99,510

 

$

96,511

 

 


*The VIEs’ third-party creditors do not have any recourse to Papa John’s.

8




6.  Calculation of Earnings Per Share

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

 

Three Months Ended

 

 

 

April 1,

 

March 26,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Basic earnings per common share:

 

 

 

 

 

Income from continuing operations

 

$

13,155

 

$

15,613

 

Weighted average shares outstanding

 

30,064

 

33,122

 

Basic earnings per common share

 

$

0.44

 

$

0.47

 

 

 

 

 

 

 

Earnings per common share - assuming dilution:

 

 

 

 

 

Income from continuing operations

 

$

13,155

 

$

15,613

 

 

 

 

 

 

 

Weighted average shares outstanding

 

30,064

 

33,122

 

Dilutive effect of outstanding common stock options

 

499

 

861

 

Diluted weighted average shares outstanding

 

30,563

 

33,983

 

Earnings per common share - assuming dilution

 

$

0.43

 

$

0.46

 

 

7.              Segment Information

We have defined five reportable segments: domestic restaurants, domestic commissaries, domestic franchising, international operations and variable interest entities (VIEs).

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.

9




Our segment information is as follows:

 

Three Months Ended

 

(In thousands)

 

April 1, 2007

 

March 26, 2006

 

Revenues from external customers:

 

 

 

 

 

Domestic Company-owned restaurants

 

$

122,044

 

$

106,740

 

Domestic commissaries

 

100,199

 

102,692

 

Domestic franchising

 

15,214

 

14,826

 

International

 

6,989

 

4,775

 

Variable interest entities (1)

 

1,687

 

2,446

 

All others

 

14,491

 

10,870

 

Total revenues from external customers

 

$

260,624

 

$

242,349

 

 

 

 

 

 

 

Intersegment revenues:

 

 

 

 

 

Domestic commissaries

 

$

30,845

 

$

27,884

 

Domestic franchising

 

339

 

314

 

International

 

157

 

132

 

Variable interest entities (1)

 

31,587

 

36,253

 

All others

 

3,968

 

2,947

 

Total intersegment revenues

 

$

66,896

 

$

67,530

 

 

 

 

 

 

 

Income (loss) from continuing operations before income taxes:

 

 

 

 

 

Domestic Company-owned restaurants (2)

 

$

8,215

 

$

9,301

 

Domestic commissaries (3)

 

10,014

 

7,353

 

Domestic franchising

 

13,043

 

13,014

 

International (4)

 

(2,320

)

(2,341

)

Variable interest entities

 

(406

)

5,389

 

All others

 

1,045

 

1,499

 

Unallocated corporate expenses (5)

 

(8,295

)

(8,882

)

Elimination of intersegment profits

 

(583

)

(550

)

Total income from continuing operations before income taxes

 

$

20,713

 

$

24,783

 

 

 

 

 

 

 

Property and equipment:

 

 

 

 

 

Domestic Company-owned restaurants

 

$

153,801

 

 

 

Domestic commissaries

 

75,854

 

 

 

International

 

6,021

 

 

 

Variable interest entities

 

1,387

 

 

 

All others

 

21,244

 

 

 

Unallocated corporate assets

 

133,546

 

 

 

Accumulated depreciation and amortization

 

(192,883

)

 

 

Net property and equipment

 

$

198,970

 

 

 

 


(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)   The operating results for domestic Company-owned restaurants decreased approximately $1.1 million for the three months ended April 1, 2007, as compared to the same period of the prior year. This decrease is due to an increase in labor expense as a percentage of sales reflecting the impact of minimum wage increases in certain states.

(3)   The operating results for the domestic commissaries segment improved approximately $2.7 million for the three-month period ended April 1, 2007, as compared to the corresponding period in 2006, primarily due to the increased volumes of higher-margin fresh dough products and improved margin from other commodities.

(4)   The international segment, which excludes the Perfect Pizza operations that were sold in March 2006, reported an operating loss of $2.3 million for the three months ended April 1, 2007, which was substantially the same as the corresponding period in 2006, as increased revenues due to growth in number of units and unit volumes were substantially offset by increased personnel and infrastructure investment costs.

10




(5)   The decrease of approximately $600,000 in unallocated corporate expenses for the three months ended April 1, 2007, as compared to the first quarter of 2006, was primarily due to lower legal costs including the settlement of a litigation matter in 2006. Net interest expense, which is included in the unallocated corporate segment, increased approximately $750,000 for the three months ended April 1, 2007, as compared to the corresponding 2006 period, principally due to a higher average debt balance resulting from our share repurchase program and restaurant acquisitions during the last twelve months. The increase in net interest costs was offset by an increase in allocations to the operating units in the first quarter of 2007, as compared to the first quarter 2006.

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 April 1, 2007, there were 3,044 Papa John’s restaurants (594 Company-owned and 2,450 franchised) operating in all 50 states and 26 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. 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 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 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 fair value derived from discounted expected cash flows of the reporting unit to its carrying value.

At April 1, 2007, our United Kingdom subsidiary, Papa John’s UK (PJUK), had goodwill of approximately $17.2 million. In addition to the sale of the Perfect Pizza operations, which occurred in March 2006, we have restructured management and developed plans for PJUK to improve its future operating results. The plans

11




include efforts to increase Papa John’s brand awareness in the United Kingdom and increase net PJUK franchise unit openings over the next several years. We will continue to periodically evaluate our progress in achieving these plans. If our initiatives are not successful, 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 new arrangement eliminates our risk of loss for franchise insurance coverage written after September 2004. Our operating income will still be subject to potential adjustments for changes in estimated insurance reserves for policies written from 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

As of April 1, 2007, we had a net deferred income tax asset balance of $10.9 million.  We have not provided a valuation allowance for the deferred income tax assets since we believe it is more likely than not that the Company’s future earnings will be sufficient to ensure the realization of the net deferred income tax assets for federal and state purposes.

The Company adopted the provisions of the Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) on January 1, 2007. FIN 48 addresses the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. In addition, FIN 48 expands the disclosure requirements concerning unrecognized tax benefits as well as any significant changes that may occur in the next twelve months associated with such unrecognized tax benefits. As a result of the implementation of FIN 48, the Company recognized an approximate $614,000 decrease in the liability for unrecognized tax benefits, which is accounted for as an increase to the January 1, 2007 balance of retained earnings. As of the adoption date, we had tax affected unrecognized benefits of approximately $9.6 million. To the extent these unrecognized tax benefits are ultimately recognized, the effective tax rate will be impacted in a future period.

Certain tax authorities periodically audit the Company. We provide reserves for potential exposures based on FIN 48 requirements described above.  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. (“BIBP”) as a Variable Interest Entity

BIBP is a franchisee-owned corporation that conducts a cheese-purchasing program on behalf of domestic Company-owned and franchised restaurants. As required by FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (FIN 46), we consolidate the financial results of BIBP since we qualify as the primary beneficiary, as defined by FIN 46, of BIBP.  We recognized a pre-tax loss of $406,000 for the three months ended April 1, 2007 and pre-tax income of $5.4 million for the three months ended March 26, 2006 from the consolidation of BIBP. In future periods, we expect the consolidation of BIBP to have a significant impact on Papa John’s operating income 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

12




will recognize subsequent operating income generated by BIBP up to the amount of BIBP losses previously recognized by Papa John’s.

New Accounting Standard

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements. SFAS No. 157 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. SFAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. The effective date of SFAS No. 157 will be the first quarter of 2008. SFAS No. 157 could impact our future estimates of valuing long-lived and intangible assets such as our annual fair value evaluation of PJUK. We have not determined the impact, if any, of adopting SFAS No. 157.

Restaurant Progression:

 

Three Months Ended

 

 

 

April 1, 2007

 

March 26, 2006

 

 

 

 

 

 

 

Papa John’s Restaurant Progression:

 

 

 

 

 

U.S. Company-owned:

 

 

 

 

 

Beginning of period

 

577

 

502

 

Opened

 

4

 

2

 

Closed

 

 

(1

)

Acquired from franchisees

 

6

 

3

 

Sold to franchisees

 

(1

)

 

End of period

 

586

 

506

 

International Company-owned:

 

 

 

 

 

Beginning of period

 

11

 

2

 

Opened

 

 

1

 

Sold to franchisees

 

(3

)

 

End of period

 

8

 

3

 

U.S. franchised:

 

 

 

 

 

Beginning of period

 

2,080

 

2,097

 

Opened

 

22

 

20

 

Closed

 

(11

)

(13

)

Acquired from Company

 

1

 

 

Sold to Company

 

(6

)

(3

)

End of period

 

2,086

 

2,101

 

International franchised:

 

 

 

 

 

Beginning of period

 

347

 

325

 

Opened

 

18

 

12

 

Closed

 

(4

)

(23

)

Acquired from Company

 

3

 

 

End of period

 

364

 

314

 

Total restaurants - end of period

 

3,044

 

2,924

 

 

 

 

 

 

 

Perfect Pizza Restaurant Progression:

 

 

 

 

 

Franchised:

 

 

 

 

 

Beginning of period

 

 

112

 

Closed

 

 

(3

)

Sold

 

 

(109

)

Total restaurants - end of period

 

 

 

 

13




Results of Operations

Variable Interest Entities

As required by FIN 46, our operating results include BIBP’s operating results.  The consolidation of BIBP had a significant impact on our operating results for the first quarter and full-year of 2006, and is expected to have a significant impact on our future operating results, including the full-year of 2007, and income statement presentation as described below.

Consolidation accounting requires the net impact from the consolidation of BIBP to be reflected primarily in three separate components of our statement of income. The first component is the portion of BIBP operating income or loss attributable to the amount of cheese purchased by Company-owned restaurants during the period. This portion of BIBP operating income (loss) is reflected as a reduction (increase) in the “Domestic Company-owned restaurant expenses - cost of sales” line item. This approach effectively reports cost of sales for Company-owned restaurants as if the purchasing arrangement with BIBP did not exist and such restaurants were purchasing cheese at the spot market prices (i.e., the impact of BIBP is eliminated in consolidation).

The second component of the net impact from the consolidation of BIBP is reflected in the caption “(Income) loss from the franchise cheese-purchasing program, net of minority interest.” This line item represents BIBP’s income or loss from purchasing cheese at the spot market price and selling to franchised restaurants at a fixed quarterly price, net of any income or loss attributable to the minority interest BIBP shareholders. The amount of income or loss attributable to the BIBP shareholders depends on its cumulative shareholders’ equity balance and the change in such balance during the reporting period. The third component is reflected as investment income or interest expense depending upon whether BIBP is in a net investment or net borrowing position during the reporting period.

In addition, Papa John’s has extended loans to certain franchisees. Under the FIN 46 rules, Papa John’s is deemed to be the primary beneficiary of certain franchisees even though we have no ownership interest in them. We consolidated the financial results of two franchise entities operating a total of seven restaurants with annual sales approximating $5.5 million for the three months ended April 1, 2007 and three franchise entities operating a total of 14 restaurants with annual sales approximating $9.0 million for the three months ended March 26, 2006.

The following table summarizes the impact of VIEs, prior to required consolidating eliminations, on our consolidated statements of income for the three months ended April 1, 2007 and March 26, 2006 (in thousands):

 

 

Three Months Ended

 

Three Months Ended

 

 

 

April 1, 2007

 

March 26, 2006

 

 

 

BIBP

 

Franchisees

 

Total

 

BIBP

 

Franchisees

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable interest entities restaurant sales

 

$

 

$

1,688

 

$

1,688

 

$

 

$

2,446

 

$

2,446

 

BIBP sales

 

31,587

 

 

31,587

 

36,253

 

 

36,253

 

Total revenues

 

31,587

 

1,688

 

33,275

 

36,253

 

2,446

 

38,699

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

31,946

 

1,501

 

33,447

 

30,475

 

2,280

 

32,755

 

General and administrative expenses

 

25

 

52

 

77

 

22

 

151

 

173

 

Other general expense

 

 

122

 

122

 

 

(91

)

(91

)

Depreciation and amortization

 

 

13

 

13

 

 

106

 

106

 

Total costs and expenses

 

31,971

 

1,688

 

33,659

 

30,497

 

2,446

 

32,943

 

Operating income (loss)

 

(384

)

 

(384

)

5,756

 

 

5,756

 

Net interest income (expense)

 

(22

)

 

(22

)

(367

)

 

(367

)

Income (loss) before income taxes

 

$

(406

)

$

 

$

(406

)

$

5,389

 

$

 

$

5,389

 

 

14




Discontinued Operations

In March 2006, the Company sold its Perfect Pizza operations in the United Kingdom, consisting of the franchise rights and leases related to the 109 franchised Perfect Pizza restaurants, as well as the distribution operations, with annual revenues in 2005 approximating $13.6 million.  The total proceeds from the sale were approximately $13.0 million, with $8.0 million received in cash at closing, and the balance to be received under the terms of an interest-bearing note through 2011. There was no gain or loss recognized in 2006 in connection with the sale of Perfect Pizza.

We have classified our Perfect Pizza operations as discontinued operations in the accompanying financial statements. For the first quarter of 2006, the net sales and net income of the Perfect Pizza discontinued operations were $2.4 million and $389,000 ($0.01 per diluted share), respectively.

Summary of Operating Results from Continuing Operations

Total revenues were $260.6 million for the first quarter of 2007, representing an increase of 7.5% from revenues of $242.3 million for the same period in 2006. The primary reason for the $18.3 million increase in revenues for the first quarter of 2007 is a  $15.3 million increase in Company-owned restaurant revenues reflecting the acquisition of 54 restaurants during the last five months of 2006.

Our income from continuing operations before income taxes totaled $20.7 million for the first quarter of 2007, compared to $24.8 million for the same period in 2006 as summarized in the following table on an operating segment basis (in thousands):

 

Three Months Ended

 

 

 

April 1,

 

March 26,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Domestic Company-owned restaurants

 

$

8,215

 

$

9,301

 

Domestic commissaries

 

10,014

 

7,353

 

Domestic franchising

 

13,043

 

13,014

 

International

 

(2,320

)

(2,341

)

Variable interest entities

 

(406

)

5,389

 

All others

 

1,045

 

1,499

 

Unallocated corporate expenses

 

(8,295

)

(8,882

)

Elimination of intersegment profits

 

(583

)

(550

)

Total income from continuing operations before income taxes

 

$

20,713

 

$

24,783

 

 

Excluding the impact of the consolidation of BIBP (pretax loss of $406,000 or $0.01 per diluted share in 2007 and a pretax gain of $5.4 million or $0.10 per diluted share in 2006), first quarter 2007 income from continuing operations before taxes was $21.1 million compared to $19.4 million for the same period in 2006. The increase of $1.7 million (excluding the consolidation of BIBP) was principally due to the following:

·                  Domestic Company-owned Restaurant Segment. Domestic Company-owned restaurants’ operating income was $8.2 million for the three-month period ended April 1, 2007 as compared to $9.3 million for the same period in 2006. The $1.1 million decrease is principally due to an increase in labor expense as a percentage of sales, reflecting the impact of minimum wage increases in certain states.  The increase in various operating expenses as a percentage of sales, such as rent and maintenance expenses, was offset by a decrease in food costs, primarily cheese.

·                  Domestic Commissary Segment. Domestic commissaries’ operating income increased approximately $2.7 million for the three months ended April 1, 2007, as compared to the corresponding period in 2006,

15




primarily due to the increased volumes of higher-margin fresh dough products and improved margin from other commodities.

·                  Domestic Franchising Segment. Domestic franchising operating income was $13.0 million for the three months ended April 1, 2007, which was substantially the same as the corresponding period in 2006, as the decrease in royalties from the sale of 54 franchised restaurants to the Company during the last five months of 2006 was substantially offset by new franchise restaurants and a decrease in waivers granted to certain franchisees.

·                  International Segment. The international segment, which excludes the Perfect Pizza operations that were sold in March 2006, reported an operating loss of $2.3 million for the three months ended April 1, 2007, which was substantially the same as the corresponding period in 2006, as increased revenues due to growth in number of units and unit volumes were substantially offset by increased personnel and infrastructure investment costs.

·                  All Others Segment. The operating income for the “All others” reporting segment decreased approximately $450,000 for the three months ended April 1, 2007, as compared to the corresponding 2006 period. The decrease is primarily due to a decline in operating results of our print and promotions operations.

·                  Unallocated Corporate Segment.  Unallocated corporate expenses decreased approximately $600,000 for the three months ended April 1, 2007, as compared to the first quarter of 2006, primarily due to lower legal costs including the settlement of a litigation matter in 2006. Net interest expense, which is included in the unallocated corporate segment, increased approximately $750,000 for the three months ended April 1, 2007, as compared to the corresponding 2006 period, principally due to a higher average debt balance resulting from our share repurchase program and restaurant acquisitions during the last twelve months. The increase in net interest costs was offset in this operating segment by an increase in allocations to the operating units in the first quarter of 2007, as compared to the first quarter 2006.

Diluted earnings per share from continuing operations was $0.43 (including a $0.01 per share loss from the consolidation of BIBP) in the first quarter of 2007, compared to $0.46 (including a $0.10 per share gain from the consolidation of BIBP) in the first quarter of 2006. In December 1999, we began a repurchase program for our common stock. Through April 1, 2007, an aggregate of $627.7 million of shares have been repurchased (representing 39.0 million shares, at an average price of $16.10 per share). The share repurchase activity increased earnings per share from continuing operations by approximately $0.02 for the first quarter of 2007.

Review of Operating Results

Revenues. Domestic Company-owned restaurant sales were $122.0 million for the three months ended April 1, 2007, compared to $106.7 million for the same period in 2006.  The increase of $15.3 million, or 14.3%, is due to an increase in equivalent Company-owned units of 15.8%, reflecting the acquisition of 54 restaurants during the last five months of 2006.  In addition, our Company-owned restaurants reported an increase in comparable sales of 0.6% for the three months ended April 1, 2007.

Variable interest entities restaurant sales include restaurant sales for franchise entities to which we have extended loans. Revenues from these restaurants totaled $1.7 million for the three months ended April 1, 2007 as compared to $2.4 million for the corresponding period in 2006. During the third quarter of 2006, one of the franchisees, with seven restaurants and annual revenues approximating $4.0 million sold its restaurants to a third party.

Domestic franchise sales for the first quarter of 2007 decreased 0.7% to $376.3 million from $379.1 million for the same period in 2006, primarily resulting from a 1.5% decrease in equivalent franchise units for the same

16




2006 period reflecting the previously mentioned divestiture of 54 franchised restaurants during the last five months of 2006.  Domestic franchise comparable sales were substantially flat for the three months ended April 1, 2007.  Domestic franchise royalties were $14.5 million for the first quarter of 2007, a 1.5% increase from $14.2 million for the comparable period in 2006, primarily due to a decrease in waivers granted to certain franchisees.

Average weekly sales for comparable units include restaurants that were open throughout the periods presented below. Average weekly sales for other units include restaurants that were not open throughout the periods presented below and include non-traditional sites such as Six Flags theme parks. The comparable sales base and average weekly sales for 2007 and 2006 for domestic Company-owned and domestic franchised restaurants consisted of the following:

 

Three Months Ended

 

 

 

April 1, 2007

 

March 26, 2006

 

 

 

Company

 

Franchise

 

Company

 

Franchise

 

 

 

 

 

 

 

 

 

 

 

Total domestic units (end of period)

 

586

 

2,086

 

506

 

2,101

 

Equivalent units

 

580

 

2,042

 

501

 

2,074

 

Comparable sales base units

 

556

 

1,938

 

490

 

1,962

 

Comparable sales base percentage

 

95.9

%

94.9

%

97.9

%

94.6

%

Average weekly sales - comparable units

 

$

16,439

 

$

14,275

 

$

16,519

 

$

14,219

 

Average weekly sales - other units

 

$

10,454

 

$

12,394

 

$

10,895

 

$

11,311

 

Average weekly sales - all units

 

$

16,191

 

$

14,180

 

$

16,400

 

$

14,062

 

 

Domestic franchise and development fees were $762,000 in the first quarter of 2007, including approximately $237,000 recognized upon development cancellation or franchise renewal and transfer, compared to $588,000, including $118,000 recognized upon development cancellation or franchise renewal and transfer, for the same period in 2006. There were 22 domestic franchise restaurant openings in the first quarter of 2007 compared to 20 in 2006.

Domestic commissary sales decreased 2.4% to $100.2 million for the first quarter of 2007, from $102.7 million in the comparable 2006 period, as increased volumes of products sold were more than offset by a decline in the prices charged to restaurants for cheese.  Other sales increased $3.6 million for the first quarter of 2007 from $10.9 million for the comparable period in 2006, primarily as a result of an increase in revenues from our print and promotions operations.

International revenues, which exclude the Perfect Pizza discontinued operations sold in March 2006, consist primarily of the PJUK continuing operations, denominated in British Pounds Sterling and converted to U.S. dollars (approximately 62% of international revenues in 2007). International revenues were $7.0 million for the first quarter of 2007, compared to $4.8 million for the comparable period in 2006, reflecting the acquisition of five restaurants in Beijing, China in December 2006, an increase in revenues from additional Company-owned units in the United Kingdom and higher royalty revenue from additional franchise units.

Costs and Expenses.  The restaurant operating margin for domestic Company-owned units was 20.8% in the first quarter of 2007 compared to 23.6% for the same period in 2006.  Excluding the impact of consolidating BIBP, the restaurant operating margin decreased 1.3% to 21.2% in the first quarter of 2007 from 22.5% in the same quarter of the prior year, consisting of the following differences:

·                  Cost of sales decreased 0.5% primarily due to a decline in commodities (principally cheese).

·                  Salaries and benefits were 0.8% higher as a percentage of sales in the first quarter of 2007, compared to the first quarter of 2006, reflecting increased labor costs, including the impact of minimum wage increases in certain states.

17




·                  Advertising and related costs as a percentage of sales were 0.3% higher in the first quarter of 2007 as compared to the first quarter of 2006.

·                  Occupancy costs and other operating costs, on a combined basis, as a percentage of sales, were 0.7% higher for the first quarter of 2007, as compared to the first quarter of 2006, due to increases in rent and maintenance expense as well as an increase in credit card expenses associated with increased use by our customers.

Domestic commissary and other margin was 11.4% in the first quarter of 2007, compared to 10.1% for the same period in 2006. Cost of sales was 71.3% of revenues in the first quarter of 2007, compared to 73.6% for the same period in 2006.  The decrease is primarily due to lower cheese costs incurred by the commissaries (cheese has a fixed-dollar as opposed to a fixed-percentage mark-up) and an increase in the mix of higher-margin fresh dough products sold during the first quarter of 2007.  Salaries and benefits were 7.7% of revenues in the first quarter of 2007 as compared to 6.6% for the same period in 2006.  The increase is due to additional staff to support additional volumes for our commissary and print operations. Other operating expenses decreased to 9.6% of sales in 2007 from 9.8% in 2006.

The income from the franchise cheese-purchasing program, net of minority interest, was $99,000 during the first quarter of 2007 compared to $4.6 million for the corresponding quarter in 2006. These results only represent the portion of BIBP’s operating income related to the proportion of BIBP cheese sales to franchisees. The total impact of the consolidation of BIBP on Papa John’s pre-tax income from continuing operations was a loss of $406,000 in the first quarter of 2007, compared to a $5.4 million gain in the same period of 2006.

International operating margin was approximately $500,000 in the first quarter of 2007 as compared to a loss of $105,000 for the corresponding period in 2006. The increased margin reflects an improvement in our United Kingdom subsidiary and the acquisition of the five restaurants in Beijing, China.

General and administrative expenses were $25.4 million or 9.7% of revenues for 2007 as compared to $24.2 million or 10.0% of revenues in the same period of 2006. The increase of $1.2 million in 2007 is primarily attributable to the continued development of our support infrastructure for our commissary, international and print and promotions operations.

Minority interests and other general expenses reflected net expense of $1.9 million in the first quarter of 2007 compared to $1.7 million for the comparable period in 2006 as detailed below (in thousands):

 

 

 

March 26,

 

Increase

 

 

 

April 1, 2007

 

2006

 

(Decrease)

 

 

 

 

 

 

 

 

 

Minority interests

 

$

587

 

$

489

 

$

98

 

Disposition and valuation-related costs of other assets

 

368

 

475

 

(107

)

Provision for uncollectible accounts and notes receivable

 

456

 

580

 

(124

)

Pre-opening costs

 

58

 

100

 

(42

)

Contribution to Marketing Fund

 

400

 

 

400

 

Other

 

68

 

54

 

14

 

Total minority interests and other general expenses

 

$

1,937

 

$

1,698

 

$

239

 

 

The Company made a $400,000 contribution to the Papa John’s Marketing Fund in the first quarter of 2007 to assist the system with certain national advertising costs.

Depreciation and amortization was $7.9 million (3.0% of revenues) for the first quarter of 2007 as compared to $6.6 million (2.7% of revenues) for the comparable period in 2006.  The increase in depreciation expense is principally due to the capital additions we have made within our restaurant operations, including the previously mentioned 54 acquired restaurants during the last five months of 2006, and with our print and promotions operations.

18




Net interest. Net interest expense was $1.2 million in the first quarter of 2007 as compared to $425,000 in 2006. The increase in net interest expense reflects the increase in our average outstanding debt balance resulting from our share repurchase program and restaurant acquisitions during the last 12 months.

Income Tax Expense.  The effective income tax rate was 36.5% for the first quarter 2007 and 37.0% for the same period in 2006.

Liquidity and Capital Resources

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

 

April 1,

 

December 31,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Revolving line of credit

 

$

99,500

 

$

96,500

 

Debt associated with VIEs *

 

2,225

 

525

 

Other

 

10

 

11

 

Total debt

 

101,735

 

97,036

 

Less: current portion of debt

 

(2,225

)

(525

)

Long-term debt

 

$

99,510

 

$

96,511

 

 


*The VIEs’ third-party creditors do not have any recourse to Papa John’s.

The revolving line of credit allows us to borrow up to $175.0 million with an expiration date of January 2011. 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 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.

Cash flow from operating activities from continuing operations was $19.9 million in the first three months of 2007 compared to $25.7 million for the same period in 2006. The consolidation of BIBP decreased cash flow from operations by $406,000 in the first quarter of 2007 and increased cash flow from operations by $5.4 million in the corresponding 2006 period (as reflected in the income from continuing operations and deferred income taxes captions in the accompanying Consolidated Statements of Cash Flows). Excluding the impact of the consolidation of BIBP, cash flow from continuing operations was $20.3 million in both the 2007 and 2006 quarterly periods as increased net income was offset by unfavorable working capital changes.

We require capital primarily for the development, acquisition, renovation and maintenance of restaurants, the development, renovation and maintenance of commissary and print and promotions facilities and equipment and the enhancement of corporate systems and facilities. Additionally, we began a common stock repurchase program in December 1999. During the three months ended April 1, 2007, common stock repurchases of $25.6 million, capital expenditures of $9.0 million and acquisitions of $1.2 million were funded primarily by cash flow from operations, proceeds from stock option exercises and from available cash and cash equivalents.

Our Board of Directors has authorized the repurchase of up to an aggregate $675.0 million of our common stock through December 30, 2007. As of April 1, 2007, a total of 39.0 million shares have been repurchased for $627.7 million at an average price of $16.10 per share since the repurchase program started in 1999. Subsequent to April 1, 2007 (through May 2, 2007), we acquired an additional 95,200 shares at an aggregate cost of $2.9 million. As of May 2, 2007, approximately $44.4 million remains available for repurchase of common stock under this authorization.

19




We expect to fund planned capital expenditures and any additional share repurchases of our common stock for the remainder of 2007 from operating cash flows and the $51.4 million remaining availability under our line of credit, reduced for certain outstanding letters of credit.

Forward-Looking Statements

Certain information contained in this quarterly report, particularly information regarding future financial performance and plans and objectives of management, is forward-looking. Certain factors could cause actual results to differ materially from those expressed in forward-looking statements. These factors include, but are not limited to: the uncertainties associated with litigation; changes in pricing or other marketing or promotional strategies by competitors which may adversely affect sales; new product and concept developments by food industry competitors; the ability of the Company and its franchisees to meet planned growth targets and operate new and existing restaurants profitably; increases in or sustained high cost levels of food, paper, utilities, fuel, employee compensation and benefits, insurance and similar costs; the ability to obtain ingredients from alternative suppliers, if needed; health- or disease-related disruptions or consumer concerns about commodities supplies; the selection and availability of suitable restaurant locations; negotiation of suitable lease or financing terms; constraints on permitting and construction of restaurants; local governmental agencies’ restrictions on the sale of certain food products; higher-than-anticipated construction costs; the hiring, training and retention of management and other personnel; changes in consumer taste, demographic trends, traffic patterns and the type, number and location of competing restaurants; franchisee relations; the possibility of impairment charges if PJUK or recently acquired restaurants perform below our expectations; federal and state laws governing such matters as wages, benefits, working conditions, citizenship requirements and overtime, including pending legislation to increase the federal and state minimum wage; and labor shortages in various markets resulting in higher required wage rates. The above factors might be especially harmful to the financial viability of franchisees or Company-owned operations in under-penetrated or emerging markets, leading to greater unit closings than anticipated. Increases in projected claims losses for the Company’s self-insured coverage or within the captive franchise insurance program could have a significant impact on our operating results. Additionally, domestic franchisees are only required to purchase seasoned sauce and dough from our QC Centers and changes in purchasing practices by domestic franchisees could adversely affect the financial results of our QC Centers.  Our international operations are subject to additional factors, including economic, political and health conditions in the countries in which the Company or its franchisees operate; currency regulations and fluctuations; differing business and social cultures and consumer preferences; diverse government regulations and structures; ability to source high-quality ingredients and other commodities in a cost-effective manner; and differing interpretation of the obligations established in franchise agreements with international franchisees. See “Part I. Item 1A. - Risk Factors” of the Annual Report on Form 10-K for the fiscal year ended December 31, 2006 for additional factors.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our debt at April 1, 2007 was principally comprised of a $99.5 million outstanding principal balance on the $175.0 million unsecured revolving line of credit. The interest rate on the revolving line of credit is variable and is based on LIBOR plus a 50.0 to 100.0 basis point spread, tiered based upon debt and cash flow levels.

20




We have two interest rate swap agreements that provide for fixed rates of 4.98% and 5.18%, as compared to LIBOR, on the following amount of floating rate debt:

 

Floating

 

Fixed

 

 

 

Rate Debt

 

Rates

 

The first interest rate swap agreement:

 

 

 

 

 

March 15, 2006 to January 16, 2007

 

$

50 million

 

4.98

%

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:

 

 

 

 

 

March 1, 2007 to January 31, 2009

 

$

30 million

 

5.18

%

 

The effective interest rate on the line of credit, including the impact of the two interest rate swap agreements, was 5.70% as of April 1, 2007. An increase in the present interest rate of 100 basis points on the line of credit balance outstanding as of April 1, 2007, as mitigated by the interest rate swap based on present interest rates, would increase interest expense approximately $95,000. The annual impact of a 100 basis point increase in interest rates on the debt associated with BIBP would be $22,000.

Substantially all of our business is transacted in U.S. dollars. Accordingly, foreign exchange rate fluctuations do not have a significant impact on our operating results.

Cheese costs, historically representing 35% to 40% of our total food cost, are subject to seasonal fluctuations, weather, availability, demand and other factors that are beyond our control. As previously discussed in Results of Operations and Critical Accounting Policies and Estimates, we have a purchasing arrangement with a third-party entity, BIBP, formed at the direction of our Franchise Advisory Council for the sole purpose of reducing cheese price volatility to domestic system-wide restaurants. Under this arrangement, domestic Company-owned and franchised restaurants are able to purchase cheese at a fixed price per pound throughout a given quarter, based in part on historical average cheese prices. Gains and losses incurred by BIBP are used as a factor in determining adjustments to the selling price to restaurants over time. Accordingly, for any given quarter, the price paid by the domestic Company-owned and franchised restaurants may be less than or greater than the prevailing average market price.

As a result of the adoption of FIN 46, Papa John’s began consolidating the operating results of BIBP in 2004. Consolidation accounting requires the portion of BIBP operating income (loss) related to domestic Company-owned restaurants to be reflected as a reduction (increase) in the “Domestic Company-owned restaurant expenses — cost of sales” line item, thus reflecting the actual market price of cheese had the purchasing arrangement not existed. The consolidation of BIBP had a significant impact on our first quarter 2006 operating results (no significant impact on first quarter 2007 operating results) and is expected to have a significant impact on future operating results depending on the prevailing spot block market price of cheese as compared to the price charged to domestic restaurants. Over time, we expect BIBP to achieve break-even financial results.

21




The following table presents the actual average block price for cheese and the BIBP block price by quarter as projected through the first quarter of 2008 (based on the May 2, 2007 Chicago Mercantile Exchange (CME) milk futures market prices) and the actual prices in 2006 and 2007 to date:

 

 

2008

 

2007

 

2006

 

 

 

BIBP

 

Actual

 

BIBP

 

Actual

 

BIBP

 

Actual

 

 

 

Block Price

 

Block Price

 

Block Price

 

Block Price

 

Block Price

 

Block Price

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Quarter 1

 

$

1.486

*

$

1.605

*

$

1.344

 

$

1.341

 

$

1.548

 

$

1.268

 

Quarter 2

 

N/A

 

N/A

 

1.379

 

1.605

*

1.482

 

1.182

 

Quarter 3

 

N/A

 

N/A

 

1.497

*

1.745

*

1.525

 

1.215

 

Quarter 4

 

N/A

 

N/A

 

1.507

*

1.691

*

1.447

 

1.306

 

Full Year

 

N/A

 

N/A

 

$

1.432

*

$

1.596

*

$

1.501

 

$

1.243

 

 


*amounts are estimates based on futures prices

N/A - not available

The following table presents the 2006 impact by quarter on our pre-tax income due to consolidating BIBP (in thousands):

 

Actual

 

 

 

2006

 

Quarter 1

 

$

5,389

 

Quarter 2

 

6,303

 

Quarter 3

 

5,336

 

Quarter 4

 

1,959

 

Full Year

 

$

18,987

 

 

Additionally, based on the CME milk futures market prices as of May 2, 2007, and the actual second quarter and projected third and fourth quarter of 2007 and first quarter of 2008, cheese costs to restaurants as determined by the BIBP pricing formula, the consolidation of BIBP is projected to decrease our pre-tax income as follows (in thousands):

Quarter 1 - 2007

 

$

(406)

 

Quarter 2 - 2007

 

(5,604)

*

Quarter 3 - 2007

 

(6,024)

*

Quarter 4 - 2007

 

(4,902)

*

Full Year - 2007

 

$

(16,936)

*

 

 

 

 

Quarter 1 - 2008

 

$

(2,816)

*

 


*The projections above are based upon current futures market prices. Historically, actual results have been subject to large fluctuations and have differed significantly from previous projections using the futures market prices.

Over the long-term, we expect to purchase cheese at a price approximating the actual average market price and therefore we do not generally make use of financial instruments to hedge commodity prices.

22




Item 4. Controls and Procedures

Our Chief Executive Officer (CEO) and Chief Financial Officer (CFO) evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (“1934 Act”)), as of the end of the period covered by this report. Based upon their evaluation, the CEO and CFO concluded that the disclosure controls and procedures are effective in ensuring all required information relating to the Company is included in this quarterly report.

We also maintain a system of internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the 1934 Act) designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. During our most recent fiscal quarter, there have been no changes in our internal control over financial reporting that occurred that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II.  OTHER INFORMATION

Item 1. Legal Proceedings

We are subject to claims and legal actions in the ordinary course of our business. We believe that all such claims and actions currently pending against us are either adequately covered by insurance or would not have a material adverse effect on us if decided in a manner unfavorable to us.

Item 1.A. Risk Factors

In addition to the other information set forth in this report, the factors discussed in Part I, “Item 1.A. Risk Factors” in our Annual Report on Form 10-K for our 2006 fiscal year could materially affect the Company’s business, financial condition or operating results. The risks described in our Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to the Company or that it currently deems to be immaterial also may adversely affect our business, financial condition or operating results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The Papa John’s Board of Directors has authorized the repurchase of up to $675.0 million of common stock under a share repurchase program that began December 9, 1999, and runs through December 30, 2007. Through April 1, 2007, a total of 39.0 million shares with an aggregate cost of $627.7 million and an average price of $16.10 per share have been repurchased under this program. The following table summarizes our repurchases by fiscal period during the first three months of 2007 (in thousands, except per-share amounts):

 

 

 

 

 

Total Number

 

Maximum Dollar

 

 

 

Total

 

Average

 

of Shares

 

Value of Shares

 

 

 

Number

 

Price

 

Purchased as

 

that May Yet Be

 

 

 

of Shares

 

Paid per

 

Publicly Announced

 

Purchased Under the

 

Fiscal Period

 

Purchased

 

Share

 

Plans or Programs

 

Plans or Programs

 

 

 

 

 

 

 

 

 

 

 

01/01/2007 - 01/28/2007

 

732

 

$

29.00

 

38,837

 

$

51,598

 

01/29/2007 - 02/25/2007

 

61

 

$

27.93

 

38,898

 

$

49,897

 

02/26/2007 - 04/01/2007

 

87

 

$

30.31

 

38,985

 

$

47,267

 

 

23




Item 6.  Exhibits

Exhibit
Number

 

Description

 

 

 

10.1

 

Separation and General Release Agreement dated January 27, 2007 between Papa John’s USA, Inc., Papa John’s International, Inc. and Michael Cortino. Exhibit 10.1 to our report on Form 8-K dated January 27, 2007 is incorporated herein by reference.

 

 

 

10.2

 

Summary of Terms of Short-term Incentive Compensation Program for Papa John’s International, Inc. Exhibit 10.1 to our report on Form 8-K dated February 21, 2007 is incorporated herein by reference.

 

 

 

31.1

 

Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a-15(e), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.2

 

Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-15(e), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.1

 

Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.2

 

Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

24




SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

PAPA JOHN’S INTERNATIONAL, INC.

 

 

(Registrant)

 

 

 

 

 

 

 

 

 

Date: May 8, 2007

 

/s/ J. David Flanery

 

 

J. David Flanery

 

 

Senior Vice President and

 

 

Chief Financial Officer

 

25