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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-K

(Mark One)

For the fiscal year ended December 28, 2008

or

For the transition period from                                            to

Commission File Number:  0-21660

PAPA JOHN’S INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)

2002 Papa Johns Boulevard
Louisville, Kentucky  40299-2367

(Address of principal executive offices)

(502) 261-7272

(Registrant’s telephone number, including area code)

                Securities registered pursuant to Section 12(b) of the Act:

                Securities registered pursuant to Section 12(g) of the Act:   None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.                                                                                                                                    Yes x    No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.                                                                                                                                Yes o    No x

          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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.        x

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.

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

The aggregate market value of the common stock held by non-affiliates of the Registrant, computed by reference to the closing sale price on The NASDAQ Stock Market as of the last business day of the Registrant’s most recently completed second fiscal quarter, June 29, 2008, was approximately $574,220,073.

As of February 17, 2009, there were 27,832,557 shares of the Registrant’s Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Part III are incorporated by reference to the Registrant’s Proxy Statement for the Annual Meeting of Stockholders to be held April 30, 2009.

 

Table of Contents

 

TABLE OF CONTENTS

 

PART I
Item 1.	Business
Item 1A.	Risk Factors
Item 1B.	Unresolved Staff Comments
Item 2.	Properties
Item 3.	Legal Proceedings
Item 4.	Submission of Matters to a Vote of Security Holders
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6.	Selected Financial Data
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk
Item 8.	Financial Statements and Supplementary Data
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.	Controls and Procedures
Item 9B.	Other Information
PART III
Item 10.	Directors, Executive Officers and Corporate Governance
Item 11.	Executive Compensation
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.	Certain Relationships and Related Transactions, and Director Independence
Item 14.	Principal Accounting Fees and Services
PART IV
Item 15.	Exhibits, Financial Statement Schedules

 

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PART I

 

Item 1.  Business

 

General

 

Papa John’s International, Inc. (referred to as the “Company”, “Papa John’s” or in the first person notations of “we”, “us” and “our”) operates and franchises pizza delivery and carryout restaurants and, in certain international markets, dine-in and restaurant-based delivery restaurants under the trademark “Papa John’s”. The first Company-owned Papa John’s restaurant opened in 1985 and the first franchised restaurant opened in 1986. At December 28, 2008, there were 3,380 Papa John’s restaurants in operation, consisting of 615 Company-owned and 2,765 franchised restaurants operating domestically in all 50 states, the District of Columbia and Puerto Rico and in 29 countries.

 

Papa John’s has defined five reportable segments: domestic restaurants, domestic commissaries (Quality Control Centers), domestic franchising, international operations and variable interest entities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Note 21” of “Notes to Consolidated Financial Statements” for financial information about these segments for the fiscal years ended December 28, 2008, December 30, 2007 and December 31, 2006.

 

All of our periodic and current reports filed with the Securities and Exchange Commission (“SEC”) pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended, are available, free of charge, through our web site located at www.papajohns.com, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports. Those documents are available through our website as soon as reasonably practicable after we electronically file them with the SEC. We also make available free of charge on our website our Corporate Governance Guidelines; Board Committee Charters; and our Code of Ethics, which applies to Papa John’s directors, officers and employees. Printed copies of such documents are also available free of charge upon written request to Investor Relations, Papa John’s International, Inc., P.O. Box 99900, Louisville, KY 40269-0900.  You may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC  20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. This information is also available at www.sec.gov. The references to these website addresses do not constitute incorporation by reference of the information contained on the websites, which should not be considered part of this document.

 

Management Changes

 

In early December 2008, our Board of Directors (the “Board”) appointed John H. Schnatter, our Founder and Chairman of the Board, as Interim Chief Executive Officer. Mr. Schnatter succeeds Nigel Travis, who served as Papa John’s President and Chief Executive Officer and a member of the Board since 2005. Mr. Travis left the Company to accept another opportunity. Mr. Travis resigned as a member of the Board on December 4, 2008. The Board also formed a search committee to undertake a search for a permanent Chief Executive Officer. The search committee process is underway.

 

 

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Strategy

 

Our goal is to build the strongest brand loyalty of all pizza restaurants. The key elements of our strategy include:

 

Menu. Domestic Papa John’s restaurants offer a menu of high-quality pizza along with side items, including breadsticks, cheesesticks, chicken strips and wings, dessert items and canned or bottled beverages. Papa John’s traditional crust pizza is prepared using fresh dough (never frozen). Papa John’s pizzas are made from a proprietary blend of wheat flour, cheese made from 100% real mozzarella, fresh-packed pizza sauce made from vine-ripened tomatoes (not from concentrate) and a proprietary mix of savory spices, and a choice of high-quality meat (100% beef, pork and chicken with no fillers) and vegetable toppings. Domestically, all ingredients and toppings can be purchased from our Quality Control Center (“QC Center”) system, which delivers to individual restaurants twice weekly. Internationally, the menu may be more diverse than in our domestic operations to meet local tastes and customs.

 

In addition to our fresh dough traditional crust pizza, we offer a thin crust pizza, Papa’s Perfect Pan Pizza, and in 2008 we introduced a 100% whole-wheat hand-tossed crust pizza to our menu. Both the thin and pan crusts are par-baked products produced by third-party vendors, while our whole-wheat crust is a fresh-dough product produced at our QC Centers. Each traditional crust, pan and wheat crust pizza offers a container of our special garlic sauce and a pepperoncini pepper. Each thin crust pizza is served with a packet of special seasonings and a pepperoncini pepper.

 

We will continue to test new product offerings both domestically and internationally.  The new products can become a part of the permanent menu if they meet certain established guidelines.

 

Efficient Operating System. We believe our operating and distribution systems, restaurant layout and designated delivery areas result in lower restaurant operating costs and improved food quality, and promote superior customer service. Our domestic QC Center system takes advantage of volume purchasing of food and supplies, and provides consistency and efficiencies of scale in fresh dough production.  This eliminates the need for each restaurant to order food from multiple vendors and commit substantial labor and other resources to dough preparation.

 

Commitment to Team Member Training and Development. We are committed to the development and motivation of our team members through training programs, incentive compensation and opportunities for advancement. Team member training programs are conducted for corporate team members, and offered to our franchisees at training locations across the United States and internationally. We offer performance-based financial incentives to corporate and restaurant team members at various levels.

 

Marketing. Our marketing strategy consists of both national and local components. Our domestic national strategy includes national advertising on television, through print, direct mail and online. Nine national television campaigns aired in 2008.

 

Our local restaurant-level marketing programs target consumers within the delivery area of each restaurant, making extensive use of print materials including targeted direct mail and store-to-door couponing. Local marketing efforts also include a variety of community-oriented activities within schools, sports venues and other organizations. Local marketing efforts are supplemented with radio and television advertising, produced both locally and on a national basis.

 

Additionally, we have developed joint cross-marketing plans with certain third-party companies. For example, we entered into marketing and partnership agreements providing cross-marketing activities with

 

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Six Flags theme parks and Live Nation amphitheaters. We will continue to explore additional cross-marketing opportunities with third-party companies.

 

In international markets, we target customers who live or work within a small radius of a Papa John’s restaurant. Certain markets can effectively use television and radio as part of their marketing strategies. The majority of the marketing efforts use print materials such as flyers, newspaper inserts and in-store marketing materials. Local marketing efforts, such as sponsoring or participating in community events, sporting events and school programs, are also used to build customer awareness.

 

Franchise System. We are committed to maintaining and developing a strong franchise system by attracting experienced operators, supporting them to expand and grow their business and monitoring their compliance with our high standards. We seek to attract franchisees with experience in restaurant or retail operations and with the financial resources and management capability to open single or multiple locations. To ensure consistent food quality, each domestic franchisee is required to purchase dough and tomato sauce from our QC Centers and to purchase all other supplies from our QC Centers or approved suppliers. QC Centers outside the U.S. or in remote areas may be operated by franchisees pursuant to license agreements or by other third parties. We devote significant resources to provide Papa John’s franchisees with assistance in restaurant operations, management training, team member training, marketing, site selection and restaurant design. We also provide significant assistance to licensed international QC Centers in sourcing high-quality suppliers located in-country or regional suppliers to the extent possible.

 

International Operations.  As of December 28, 2008, we had 588 Papa John’s restaurants operating in 29 countries, Puerto Rico, Hawaii, and Alaska (Hawaii and Alaska units are included in our international operations). Substantially all of the Papa John’s international units are franchised operations (we own and operate 8 restaurants in the United Kingdom and 15 in Beijing, China). During 2008 and 2007 we opened 140 and 90 international net new units (new unit openings less unit closings), respectively. We plan to continue to grow our international franchise units during the next several years. Our total international development pipeline as of December 28, 2008 included approximately 1,200 restaurants scheduled to open over the next ten years.

 

Unit Sales and Investment Costs

 

In 2008, the 566 domestic Company-owned restaurants included in the full year’s comparable restaurant base generated average sales of $867,000. Domestic franchise sales on average are lower than Company-owned restaurants as a higher percentage of our Company-owned restaurants are located in more heavily penetrated markets.

 

The average cash investment for the 14 domestic Company-owned restaurants opened during the 2008 fiscal year, exclusive of land, was approximately $270,000 per unit, excluding tenant allowances that we received. We expect the average cash investment for the 10 to 15 domestic Company-owned restaurants expected to open in 2009 to be similar to the 2008 level of $270,000 per unit. Substantially all domestic restaurants do not offer dine-in areas, which reduces our restaurant capital investment.

 

Development

 

A total of 267 Papa John’s restaurants were opened during 2008, consisting of 24 Company-owned (14 domestic and 10 international) and 243 franchised restaurants (98 domestic and 145 international), while 95 Papa John’s restaurants closed during 2008, consisting of 11 Company-owned restaurants (nine domestic and two international) and 84 franchised restaurants (71 domestic and 13 international).

 

 

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During 2009, we plan to open approximately 100 to 140 worldwide net new units. We expect to open 15 to 20 Company-owned restaurants (10 to 15 domestic and five international) and 230 to 265 franchise restaurants (50 to 60 domestic and 180 to 205 international). We also expect approximately 145 Papa John’s restaurants to close during 2009, the majority of which are expected to be domestic franchised units. Domestic and international franchised unit expansion is expected to continue with an emphasis on markets in North America, the United Kingdom, the Middle East and Asia. We expect our expansion in Asia to include a significant focus in China.

 

The Company implemented a refranchising initiative during 2008 in an effort to increase the percentage of franchise units in our domestic restaurant portfolio. The Company believes shifting the domestic restaurant portfolio mix more toward franchise units will improve the absolute level and consistency of operating margin percentage and be more consistent with the trend in franchise business models in the domestic restaurant category. As part of the refranchising strategy, the Company divested 62 domestic restaurants during 2008, including Company-owned units in Philadelphia, New Jersey, Cleveland and Chicago.  In addition, the Company has designated approximately 17 restaurants in two markets as held for sale. We plan to sell these Company-owned units during 2009.

 

For our other markets in which we operate Company-owned units, our expansion strategy is to continue to open domestic restaurants in existing markets as appropriate, thereby increasing consumer awareness and enabling us to take advantage of operational and marketing efficiencies. Our experience in developing markets indicates that market penetration through the opening of multiple restaurants in a particular market results in increased average restaurant sales in that market over time. We have co-developed markets with some franchisees or divided markets among franchisees, and will continue to utilize market co-development in the future, where appropriate. During 2007 and 2006, we acquired 128 restaurants with a total purchase price of $56.9 million for a variety of reasons including taking advantage of opportunities to purchase restaurants in markets where we have a significant Company-owned restaurant presence, to improve operational execution of the acquired restaurants, and opportunities to expand in growing areas.

 

Of the total 2,792 domestic units open as of December 28, 2008, 592 or 21.2% were Company-owned (including 128 units owned in joint venture arrangements with franchisees in which the Company has a majority ownership position). The Company believes that through a combination of net openings more heavily weighted toward franchise units and the selective refranchising of certain Company-owned markets, the percentage of Company-owned units can be decreased below 20% over the next few years. However, given the current and anticipated economic issues impacting consumers and the credit markets, we do not expect to aggressively pursue refranchising opportunities during 2009.

 

Restaurant Design and Site Selection

 

Backlit awnings, neon window designs and other visible signage characterize the exterior of most Papa John’s restaurants. A typical domestic Papa John’s restaurant averages 1,100 to 1,500 square feet. Papa John’s restaurants are designed to facilitate a smooth flow of food orders through the restaurant. The layout includes specific areas for order taking, pizza preparation and routing, resulting in simplified operations, lower training and labor costs, increased efficiency and improved consistency and quality of food products.  The typical interior of a Papa John’s restaurant has a vibrant color scheme, and includes a bright menu board, custom counters and a carryout customer area. The counters are designed to allow customers to watch the team members slap out the dough and put sauce and toppings on pizzas.

 

 

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Most of our international Papa John’s restaurants are between 900 and 1,400 square feet; however, in order to meet certain local customer preferences, several international restaurants have been opened in larger spaces to accommodate both dine-in and restaurant-based delivery service, with an average of 35 to 100 seats. We will utilize dine-in service as part of our international growth strategy based on a country-by-country evaluation of consumer preferences and trends.

 

We consider the location of a restaurant to be important and therefore devote significant resources to the investigation and evaluation of potential sites. The site selection process includes a review of trade area demographics, target population density and competitive factors.  A member of our development team inspects each potential domestic Company-owned restaurant location and substantially all franchised restaurant locations and the surrounding market before a site is approved. Our restaurants are typically located in strip shopping centers or freestanding buildings that provide visibility, curb appeal and accessibility. Our restaurant design can be configured to fit a wide variety of building shapes and sizes, which increases the number of suitable locations for our restaurants.

 

We provide layout and design services and recommendations for subcontractors, signage installers and telephone systems to Papa John’s franchisees. Our franchisees can purchase complete new store equipment packages through an approved third-party supplier. We sell replacement smallwares and related items to our franchisees through our support services subsidiary, Preferred Marketing Solutions, Inc.

 

Quality Control (“QC”) Centers; Strategic Supply Chain Management

 

Our domestic QC Centers, comprised of ten regional production and distribution centers in 2008, supply pizza dough, food products, paper products, smallwares and cleaning supplies twice weekly to each restaurant. This system enables us to monitor and control product quality and consistency, while lowering food costs. Our full-service QC Centers are located in Louisville, Kentucky; Dallas, Texas; Pittsburgh, Pennsylvania; Orlando, Florida; Raleigh, North Carolina; Denver, Colorado; Rotterdam, New York; Portland, Oregon; Des Moines, Iowa; and Phoenix, Arizona. The QC Center system capacity is continually evaluated in relation to planned restaurant growth, and facilities are developed or upgraded as operational or economic conditions warrant. We consider the current QC Center system capacity sufficient to accommodate domestic restaurant development for the next several years.

 

Our subsidiary, Papa John’s UK (“PJUK”), purchases its products from a third-party distribution center. We own full-service QC Centers in Mexico City, Mexico; Cancun, Mexico and Beijing, China. The primary difference between a full-service QC Center and a distribution center is that full-service QC Centers produce fresh pizza dough in addition to providing other food and paper products used in our restaurants. International full-service QC Centers, licensed to franchisees and non-franchisee third parties, are generally located in the markets where our franchisees have restaurants. We expect future international QC Centers to be licensed to franchisees or non-franchisee third parties; however, we may open Company-owned QC Centers at our discretion. We also have the right to acquire licensed QC Centers from our international licensees in certain circumstances.

 

We set quality standards for all products used in our restaurants and designate approved outside suppliers of food and paper products that meet our quality standards. In order to ensure product quality and consistency, all domestic Papa John’s restaurants are required to purchase tomato sauce and dough from our QC Centers. Franchisees may purchase other goods directly from our QC Centers or approved suppliers. National purchasing agreements with most of our suppliers generally result in volume discounts to us, allowing us to sell products to our restaurants at prices we believe are below those generally available in the marketplace. Within our domestic QC Center system, products are distributed

 

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to restaurants by refrigerated trucks leased and operated by us or transported by a dedicated logistics company.

 

PJ Food Service, Inc. (“PJFS”), our wholly owned subsidiary that operates our domestic Company-owned QC Centers, has a purchasing arrangement with BIBP Commodities, Inc. (“BIBP”), a third-party entity formed by franchisees for the sole purpose of reducing cheese price volatility to domestic system-wide restaurants. Historically, under this arrangement, PJFS purchased cheese from BIBP at a fixed quarterly price based in part on historical average cheese prices. Gains and losses incurred by BIBP are passed to the QC Centers and Company-owned and franchise restaurants through adjustments to the selling price. Over time, PJFS purchases cheese at a price approximating the actual average market price, but with more predictability and less price volatility. As a result of margin pressures in late third quarter and early fourth quarter 2008, a reduction in cheese pricing to restaurants was implemented in Period 11 (“Q4-08 modified price”). See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Consolidation of BIBP Commodities, Inc. (“BIBP”) as a Variable Interest Entity,” and “Note 4” of “Notes to Consolidated Financial Statements” for additional information concerning BIBP and the purchasing arrangement, and the related financial statement treatment of BIBP’s results.

 

Marketing Programs

 

All domestic Company-owned and franchised Papa John’s restaurants within a defined market are required to join an area advertising cooperative (“Co-op”).  Each member restaurant contributes a percentage of sales to the Co-op for market-wide programs, such as radio, television and print advertising. The rate of contribution and uses of the monies collected are determined by a majority vote of the Co-op’s members (in most cases the contribution rate cannot be below 2.0% without approval from Papa John’s). The restaurant-level and Co-op marketing efforts are supported by print and electronic advertising materials that are produced by the Papa John’s Marketing Fund, Inc., a non-profit corporation (the “Marketing Fund”). The Marketing Fund produces and buys air time for Papa John’s national television commercials, in addition to other brand-building activities, such as consumer research and public relations activities. All domestic Company-owned and franchised Papa John’s restaurants are required to contribute a certain percentage of sales to the Marketing Fund. The contribution rate to the Marketing Fund can be increased above the required contribution rate if a majority of the domestic restaurants agree to such increase. The contribution percentage was 2.7% during 2008 and 2007 and 2.6% during 2006. The contribution percentage to the Marketing Fund is currently set at 2.7% for the first three months of 2009 and 2.82% for the remainder of the year.

 

Restaurant-level marketing programs target the delivery area of each restaurant, making extensive use of targeted print materials including direct mail and store-to-door couponing. The local marketing efforts also include a variety of community-oriented activities with schools, sports teams and other organizations.  In markets in which Papa John’s has a significant presence, local marketing efforts are supplemented with local radio and television advertising.

 

We provide both Company-owned and franchised restaurants with pre-approved print marketing materials and with catalogs for the purchase of uniforms and promotional items. We also provide direct marketing services to Company-owned and franchised restaurants using customer information gathered by our proprietary point-of-sale technology (see “Company Operations — Point of Sale Technology”).

 

We have developed joint cross-marketing plans with certain third-party companies. For example, in 2006 we entered into a five-year marketing and partnership agreement with Six Flags theme parks and in 2007, we entered into a four-year agreement with Live Nation amphitheaters.  Both agreements provide for

 

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cross-marketing activities. We will continue to explore additional cross-marketing opportunities with third-party companies.

 

We have developed a system by which domestic Papa John’s restaurant customers in areas we service are able to place orders online at papajohns.com, including the “plan ahead ordering” advance ordering feature and Spanish-language ordering capability. In addition, our customers can order via text messaging and mobile web.  We receive a percentage-based fee from domestic franchisees for online sales, in addition to royalties, for this service.

 

We offer our customers the opportunity to purchase a reloadable gift card marketed as the “Papa Card,” in any denomination from $10 to $100. We also offer Papa Cards for sale to consumers through third-party outlets and continue to explore other Papa Card distribution opportunities. The Papa Card may be redeemed for delivery, carryout and online orders and is accepted at substantially all Papa John’s traditional domestic restaurants.

 

Company Operations

 

Restaurant Personnel.  A typical Papa John’s restaurant employs a restaurant manager, one or two assistant managers and approximately 20 to 25 hourly team members, most of whom work part-time. The manager is responsible for the day-to-day operation of the restaurant and maintaining Company-established operating standards. The operating standards and other resources are contained in a comprehensive operations manual supplied to each restaurant. We seek to hire experienced restaurant managers and staff, provide comprehensive training on operations and managerial skills, and motivate and retain them by providing opportunities for advancement and performance-based financial incentives.

 

We also employ directors of operations who are responsible for overseeing an average of seven Company-owned restaurants. The directors of operations report to operations vice presidents, who are each responsible for the management of approximately 100 Company-owned restaurants in specific geographic regions. The operations vice presidents report to four division vice presidents, who also have responsibility for franchise restaurant operations in their respective regions. These team members are eligible to earn performance-based financial incentives.

 

Training and Education. The Operations Support and Training (“OST”) department is responsible for creating the tools and materials for the training and development of team members. With these tools and materials, our field-based trainers train and certify training general managers in all markets. Operations personnel, both corporate and franchise, complete our management training program and ongoing development programs in which instruction is given on all aspects of our systems and operations. The program includes hands-on training at an operating Papa John’s restaurant by a Company-certified training general manager. Our training includes new team member orientation, in-store and delivery training, core management skills training and new product or program implementation. Our ongoing developmental workshops include operating partner training, advanced operator training and senior operator training. We provide on-site training and operating support before, during and after the opening of all Company-owned restaurants and for the first two restaurants per franchise group with additional support available upon request.

 

Point of Sale Technology.  Point of sale technology (our proprietary PROFIT SystemTM) is in place in all domestic traditional Papa John’s restaurants. We believe this technology facilitates faster and more accurate order-taking and pricing, reduces paperwork and allows the restaurant manager to better monitor and control food and labor costs. We believe the PROFIT System enhances restaurant-level marketing capabilities through the development of a database containing information on customers and their buying habits with respect to our products. Polling capabilities allow us to obtain restaurant operating

 

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information, thereby improving the speed, accuracy and efficiency of restaurant-level reporting. The PROFIT System is also closely integrated with our online ordering system in all domestic traditional Papa John’s restaurants, enabling Papa John’s to offer nationwide online ordering to our customers.

 

Joint Ventures. We operate 128 Company-owned restaurants under two joint venture arrangements. Under the first arrangement, we own 70% of an entity operating 51 Papa John’s restaurants located in Virginia and Maryland. Under the second arrangement, we own 51% of an entity operating 77 Papa John’s restaurants located in Texas. We will continue to evaluate further joint venture arrangements on an individual basis as opportunities arise.

 

Hours of Operation.  Our domestic restaurants are open seven days a week, typically from 11:00 a.m. to 12:30 a.m. Monday through Thursday, 11:00 a.m. to 1:30 a.m. on Friday and Saturday and 12:00 noon to 11:30 p.m. on Sunday.

 

Franchise Program

 

General. We continue to attract franchisees with significant restaurant and retail experience. We consider our franchisees to be a vital part of our system’s continued growth and believe our relationship with our franchisees is good. As of December 28, 2008, there were 2,765 franchised Papa John’s restaurants operating in all 50 states, the District of Columbia, Puerto Rico and 29 countries. As of December 28, 2008, we have development agreements with our franchisees for over 300 additional domestic franchised restaurants committed to open through 2018 and agreements for over 1,200 additional international franchised restaurants to open through 2018. There can be no assurance that all of these restaurants will be opened or that the development schedule set forth in the development agreements will be achieved. During 2008, 243 (98 domestic and 145 international) franchised Papa John’s restaurants were opened.

 

Approval.  Franchisees are approved on the basis of the applicant’s business background, restaurant operating experience and financial resources. We seek franchisees to enter into development agreements for single or multiple restaurants. We require each franchisee to complete our training program or to hire a full-time operator who completes the training and has either an equity interest or the right to acquire an equity interest in the franchise operation.

 

Domestic Development and Franchise Agreements. We enter into development agreements with our domestic franchisees for the opening of a specified number of restaurants within a defined period of time and specified geographic area. Substantially all existing franchise agreements have an initial 10-year term with a 10-year renewal option. Many state franchise laws limit the ability of a franchisor to terminate or refuse to renew a franchise. In October 2007, the Company initiated its domestic Franchise Agreement Renewal Program (the “Renewal Program”), which was executed with substantially all of our domestic franchisees by the first quarter of 2008. Key provisions of the revised form of the franchise agreement (the “Negotiated Agreement”) are as follows:

 

Royalty Rate - Under the form of the franchise agreement to which substantially all franchisees were subject prior to the Renewal Program, the royalty rate could have been increased from 4% to 5% at any time at the discretion of the Company.  The Negotiated Agreement limits the royalty rate increase to a maximum of one-quarter percent per year beginning in 2008, reaching 5% no earlier than 2011, and further limits the royalty rate to a maximum of 5% through 2020. Royalty rate increases subsequent to 2020 are also limited to one-quarter percent per year and cannot exceed 5.5% through 2025, with a maximum rate of 6% thereafter.

 

Marketing Expenditures - The Negotiated Agreement provides for certain minimum contributions as a percentage of sales to the national Marketing Fund and a minimum level of spending as a percentage of

 

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sales on all marketing activities, consisting of contributions to both the national Marketing Fund and local marketing cooperatives, as well as local store marketing initiatives.

 

Online Ordering System Fees - The Negotiated Agreement limits the fee charged for online transactions to 3% of the amount of the transaction. Additionally, once we have recovered a certain portion of our initial investment in the development of the online system via net operating profits of the system, the online business unit will be operated at a break-even level through either a reduction in the fee percentage or a contribution of any net operating profits into the National Marketing Fund.

 

The Negotiated Agreement also addressed several other issues, including sharing of profits from partnership marketing or alternative sales channels activities, development of a process for defining trade areas for alternative ordering methodologies and marketing contribution requirements for non-traditional units.

 

The financial implications of this Negotiated Agreement for the Company are as follows:

 

·                  We collected franchise fees of approximately $2.0 million in the fourth quarter of 2007 due to the renewal program.

·                  The royalty rate increased to 4.25% effective December 31, 2007 (beginning of fiscal 2008) for domestic franchisees. The annual impact of a one-quarter percent royalty increase is approximately $3.5 to $4.0 million. However, during 2008, the Company contributed a portion of this incremental royalty increase to increased marketing support for the domestic system.

·                  Given the current economic climate, the Company recently elected to defer an increase in the royalty rate of 0.25% (i.e. increase the rate to 4.50%) for six months in 2009 (the royalty rate will remain at 4.25% for the first six months of 2009 with the Company deciding whether to continue to suspend collection of the royalty rate increase at mid-year). Currently, the Company has the ability to increase the royalty rate to 4.75% in 2010 and 5.00% in 2011, in accordance with the terms of the Negotiated Agreement. Facts and circumstances existing at such future dates may impact the Company’s final determination as to whether to implement such royalty rate increases or defer them for the benefit of the system.

·                  The Company recognized approximately $3.0 million of operating income from the online ordering system business unit in 2008 and 2007. This business unit will be operated at a break-even level in 2009 and future years. Accordingly, the amount of operating income recognized by the Company related to this business unit is expected to be approximately $3.0 million less in 2009 than in 2008.

 

Franchise Support Initiatives

 

In late 2008, the Company announced a comprehensive package of domestic franchise system support initiatives in response to the current economic and consumer climate. The initiatives included:

 

·                  Providing cheese cost relief to our system in late 2008 and 2009 by modifying the cheese pricing formula used by BIBP Commodities, Inc.;

·                  Providing additional system-wide national marketing support for 2009;

·                  Providing expanded targeted royalty relief and local marketing support for struggling franchisees or markets;

·                  Convening a lender summit, principally of regional banks and other lenders, to educate them on the Papa John’s model with the goal of expanding credit availability to franchisees;

·                  Providing financing on a selected basis to assist new or existing franchisees with the acquisition of troubled franchise restaurants; and

 

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·                  For the first six months of 2009, suspending collection of the 0.25% royalty rate increase that was scheduled for January 2009 with the effect that the royalty rate will remain at 4.25% for the first six months of 2009 (with the Company deciding whether to continue to suspend collection of the royalty rate increase at mid-year).

 

With respect to the BIBP cheese cost relief for 2009, for the first two months of the year the price per pound was set at a level approximately equal to the Q4-08 modified price, and substantially less than the price as would have been determined by the standard formula. Effective in March 2009, we will modify the BIBP formula to establish the price of cheese on a more frequent basis at the projected spot market price plus a certain mark-up. The amount of the mark-up depends on the projected spot market prices. The modification of the BIBP formula in 2008 and 2009 could delay the recoupment of the BIBP deficit. However, the Franchise Advisory Council has acknowledged a domestic system responsibility to continue to buy cheese from our QC Centers so long as the BIBP cheese purchasing entity remains in a deficit position. Under this new price formula, we anticipate BIBP will substantially repay its cumulative deficit by the end of 2011.

 

The Company estimates the gross incremental impact of these and certain other support initiatives and non-recurring costs on the Company’s operating income, excluding the impact of consolidating BIBP’s operating results, to be $12.0 million to $14.0 million for 2009 (excluding any favorable impact to sales and profits resulting from the increased marketing).

 

The Company believes the support program will produce long-term shareholder value for the Papa John’s system by mitigating potential unit closures and strengthening our brand during this challenging economic environment. In addition to reducing unit closures, other important objectives of the support program include growing market share in a consolidating category, stabilizing transaction levels and targeting a substantial multi-year increase in online ordering percentage.

 

International Development and Franchise Agreements.  We opened our first franchised restaurant outside the United States in 1998. We define “international” to be all markets outside the contiguous United States in which we have either a development agreement or a master franchise agreement with a franchisee for the opening of a specified number of restaurants within a defined period of time and specified geographic area. Under a master franchise agreement, the franchisee has the right to subfranchise a portion of the development to one or more subfranchisees approved by us. Under our current standard international development agreement (except for Hawaii and Alaska, in which the initial fees are the same as for domestic restaurants), the franchisee is required to pay total fees of $25,000 per restaurant:  $5,000 at the time of signing the agreement and $20,000 when the restaurant opens or the agreed-upon development date, whichever comes first. Under our current standard master franchise agreement, the master franchisee is required to pay total fees of $25,000 per restaurant owned and operated by the master franchisee, under the same terms as the development agreement, and $15,000 for each subfranchised restaurant — $5,000 at the time of signing the agreement and  $10,000 when the restaurant opens or the agreed-upon development date, whichever comes first.

 

Our current standard international master franchise and development agreement provides for payment to us of a royalty fee of 5% of sales (3% of sales by subfranchised restaurants), with no provision for increase during the initial term. The remaining terms applicable to the operation of individual restaurants are substantially equivalent to the terms of our domestic franchise agreement. From time to time, development agreements will be negotiated at other than standard terms for fees and royalties.

 

Non-traditional Restaurant Development.   We have entered into a limited number of development and franchise agreements for non-traditional restaurants. For example, a total of 17 franchised net units opened in Six Flags theme parks in 2006, 2007 and 2008 as part of a five-year marketing and partnership

 

 

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agreement, and 27 franchised units opened in Live Nation amphitheaters in 2007 and 2008 as part of a four-year marketing and partnership agreement. These agreements generally cover venues or areas not originally targeted for development and have terms differing from the standard agreement. To date, these agreements have not had a significant, direct impact on our pre-tax earnings.

 

Franchise Restaurant Development. We provide assistance to Papa John’s franchisees in selecting sites, developing restaurants and evaluating the physical specifications for typical restaurants. Each franchisee is responsible for selecting the location for its restaurants but must obtain our approval of restaurant design and location based on accessibility and visibility of the site and targeted demographic factors, including population, density, income, age and traffic. Our domestic and international franchisees may purchase complete new store equipment packages through an approved third-party supplier.

 

Franchisee Loans. Selected franchisees have borrowed funds from our subsidiary, Capital Delivery, Ltd., principally for the purchase of restaurants from us or other franchisees or for use in the construction and development of new restaurants. Loans made to franchisees typically bear interest at fixed or floating rates and in most cases are secured by the fixtures, equipment and signage (and where applicable, the land) of the restaurant and/or guarantees from the franchisee’s owners. At December 28, 2008, loans outstanding totaled $7.6 million, which were composed of loans to franchisees and a loan with the purchaser of the Perfect Pizza operations. See “Note 10” of “Notes to Consolidated Financial Statements” for additional information.

 

We have a commitment to lend up to $40.0 million to BIBP, a franchisee-owned corporation with an outstanding balance of $35.7 million at December 28, 2008. See “Notes 4 and 10” of “Notes to Consolidated Financial Statements” for additional information.

 

Franchise Insurance Program. Our franchisees have the opportunity to purchase various insurance policies, such as non-owned automobile and workers’ compensation, through our insurance agency, Risk Services Corp. (“Risk Services”). In October 2000, we established a captive insurance company (“Captive”) domiciled in Bermuda, RSC Insurance Services, Ltd., to accommodate this business. Beginning in October 2004, a third-party commercial insurance company began providing fully-insured coverage to franchisees participating in the franchise insurance program. Accordingly, in 2004 we eliminated our risk of loss for franchise insurance coverage written after September 2004. As of December 28, 2008, approximately 46% of domestic franchised restaurants had obtained insurance coverage through Risk Services. See “Note 11” of “Notes to Consolidated Financial Statements” for additional information concerning the Captive.

 

Franchise Training and Support. Our domestic field support structure consists of Franchise Business Directors (“FBDs”), each of whom is responsible for serving an average of approximately 100 franchised units. Our FBDs maintain open communication with the franchise community, relaying operating and marketing information and new ideas between franchisees and us.

 

Every franchisee is required to have a principal operator approved by us who satisfactorily completes our required training program and who devotes his or her full business time and efforts to the operation of the franchisee’s restaurants. Each franchised restaurant manager is also required to complete our Company-certified management training program. Domestically, we provide an on-site training team three days before and three days after the opening of a franchisee’s first two restaurants. Internationally, we provide on-site training personnel five days before and five days after the opening of a franchisee’s first two stores. Ongoing supervision of training is monitored by the franchise training team. Multi-unit franchisees are encouraged to appoint training store general managers or hire a full-time training coordinator certified to deliver Company-approved programs in order to train new team members and management candidates for their restaurants. Internationally, training is monitored by our international

 

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operations services and support team, as well as regional vice presidents and international business managers assigned to specific franchisee territories.

 

Franchise Operations. All franchisees are required to operate their Papa John’s restaurants in compliance with our policies, standards and specifications, including matters such as menu items, ingredients, materials, supplies, services, fixtures, furnishings, decor and signs. Each franchisee has full discretion to determine the prices to be charged to its customers.

 

Franchise Advisory Council. We have a Franchise Advisory Council that consists of Company and franchisee representatives of domestic restaurants. The Franchise Advisory Council and subcommittees hold regular meetings to discuss new marketing ideas, operations, growth and other relevant issues. Certain franchisees have formed an operators’ exchange group for the purpose of communicating and addressing issues, needs and opportunities among its members and the Company.

 

We currently communicate with, and receive input from, our franchisees in several forms, including through the Company’s Franchise Advisory Council, annual operations conferences, newsletters, national conference calls and various regional meetings conducted with franchisees throughout the year. Monthly webcasts are also conducted by the Company to discuss current operational, marketing or other issues affecting the franchisees’ business. We are committed to communicating with our franchisees and receiving input from them.

 

Reporting and Business Processes. We collect sales and other operating information from domestic Papa John’s franchisees daily. We have agreements with substantially all Papa John’s domestic franchisees permitting us to debit electronically the franchisees’ bank accounts for substantially all required payments, including the payment of royalties, Marketing Fund contributions, risk management services, online ordering fees and purchases from our print and promotions operations and QC Centers. This system significantly reduces the resources needed to process receivables, improves cash flow and mitigates the amount of past-due accounts related to these items. Domestic franchisees are required to purchase and install the Papa John’s PROFIT System in their traditional restaurants (see “Company Operations — Point of Sale Technology”).

 

Comprehensive Restaurant Measurement Program.  As part of our effort to deliver on our brand promise of “Better Ingredients. Better Pizza.”, we have implemented a comprehensive measurement program for all domestic and international restaurants. The measurement program focuses on the quality of the pizza and the customer service experience.

 

Industry and Competition

 

The United States Quick Service Restaurant pizza industry (“QSR Pizza”) is mature and highly competitive with respect to price, service, location, food quality and variety. There are well-established competitors with substantially greater financial and other resources than Papa John’s. Competitors include international, national and regional chains, as well as a large number of local independent pizza operators. Some of our competitors have been in existence for substantially longer periods than Papa John’s and can have higher levels of restaurant penetration and a stronger, more developed brand awareness in markets where we have restaurants. Based on independent third-party information, the QSR Pizza category, which includes dine-in, carry-out and delivery, had sales of approximately $33.9 billion in 2008, of which Papa John’s share was reported at 5.9%, an increase from 5.6% reported for 2007. Within the QSR Pizza category, we believe our primary competitors are the national pizza chains, including Pizza Hut, Domino’s and Little Caesars, as well as several regional chains and “take and bake” concepts. A change in pricing or other marketing strategies of one or more of our competitors could have an adverse impact on our sales and earnings. The QSR Pizza category has experienced little or no growth

 

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over the past few years. There are several factors contributing to the growth stagnation for the QSR pizza category, including consumers shifting of dine-out occasions toward breakfast and lunch and away from dinner. Many non-pizza restaurant chains, including chains focusing on fresh sandwiches, have begun to emphasize dinner meals. In addition, many casual diners and other restaurants are emphasizing carryout and curbside offerings. Finally, supermarkets continue to increase fresh and frozen pizza offerings to consumers.

 

With respect to the sale of franchises, we compete with many franchisors of restaurants and other business concepts. In general, there is also active competition for management personnel and attractive commercial real estate sites suitable for our restaurants.

 

Government Regulation

 

We, along with our franchisees, are subject to various federal, state and local laws affecting the operation of our respective businesses. Each Papa John’s restaurant is subject to licensing and regulation by a number of governmental authorities, which include health, safety, sanitation, building and fire agencies in the state or municipality in which the restaurant is located. Difficulties in obtaining, or the failure to obtain, required licenses or approvals could delay or prevent the opening of a new restaurant in a particular area. Our full-service QC Centers are licensed and subject to regulation by state and local health and fire codes, and the operation of our trucks is subject to Department of Transportation regulations. We are also subject to federal and state environmental regulations.

 

We are subject to Federal Trade Commission (“FTC”) regulation and various state laws regulating the offer and sale of franchises. Several state laws also regulate substantive aspects of the franchisor-franchisee relationship. The FTC requires us to furnish to prospective franchisees a franchise disclosure document containing prescribed information. Substantive state laws that regulate the franchisor-franchisee relationship presently exist in a substantial number of states, and bills have been introduced in Congress from time to time, which would provide for federal regulation of the franchisor-franchisee relationship in certain respects if enacted. The state laws often limit, among other things, the duration and scope of non-competition provisions and the ability of a franchisor to terminate or refuse to renew a franchise. Some foreign countries also have disclosure requirements and other laws regulating franchising and the franchisor-franchisee relationship. Further national, state and local government initiatives, such as mandatory health insurance coverage, “living wage” or other proposed increases in minimum wage rates, could adversely affect Papa John’s as well as the restaurant industry. As we expand internationally, we will be subject to applicable laws in each jurisdiction where franchised units are established.

 

Trademarks

 

Our rights in our principal trademarks and service marks are a significant part of our business. We are the owner of the federal registration of the trademark “Papa John’s.” We have also registered “Pizza Papa John’s and design” (our logo), “Better Ingredients. Better Pizza.” and “Pizza Papa John’s Better Ingredients. Better Pizza.” and design as trademarks and service marks. We also own federal registrations for several ancillary marks, principally advertising slogans. We have also applied to register our primary trademark, “Pizza Papa John’s and design,” in more than 90 foreign countries and the European Community. We are aware of the use by other persons in certain geographical areas of names and marks that are the same as or similar to our marks. It is our policy to pursue registration of our marks whenever possible and to oppose vigorously any infringement of our marks.

 

 

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Employees

 

As of December 28, 2008, we employed approximately 16,700 persons, of whom 14,500 were restaurant team members, 800 were restaurant management personnel, 600 were corporate personnel and 800 were QC Center and Preferred Marketing Solutions, Inc. personnel. Most restaurant team members work part-time and are paid on an hourly basis. None of our team members is covered by a collective bargaining agreement. We consider our team member relations to be excellent.

 

Item 1A. Risk Factors

 

We are subject to various risks, which could have a negative effect on our business, financial condition and results of operations. These risks could cause actual operating results to differ from those expressed in certain “forward looking statements” contained in this Form 10-K as well as in other Company communications. Although we believe that our expectations are based on reasonable assumptions, actual results may differ materially from those in the forward-looking statements as a result of various factors, including but not limited to, the following:

 

Our growth strategy requires the opening of new Papa John’s restaurants. We may not be able to achieve our planned growth targets due to factors outside of our control, including the current economic environment.

 

Our growth strategy depends on our ability and the ability of our franchisees to open new restaurants and to operate these new restaurants on a profitable basis. Planned growth targets and our ability and our franchisees’ ability to operate new and existing restaurants profitably are affected by the current economic conditions and the resulting impact on consumer buying habits. Our business is susceptible to adverse changes in domestic and global economic conditions, which could make it difficult and uncertain for us to forecast operating results. Continuing weakness in the residential real estate and mortgage markets, volatility in commodity and fuel costs, difficulties in the financial sector and credit markets, and other factors affecting consumer spending could cause reduced sales of our products or make it difficult for us to execute our strategy. Other effects on our business from these factors could include insolvency of key suppliers.

 

The ability of the Papa John’s system to continue to open new restaurants is affected by a number of factors, many of which are beyond our control. These factors include, among other things, the availability of financing, the selection and availability of suitable restaurant locations, increases in the cost of or sustained high levels of cost of food ingredients and other commodities, paper, utilities, fuel, employee compensation and benefits, insurance and similar costs, availability and negotiation of suitable lease or financing terms, constraints on permitting and construction of restaurants, higher than anticipated construction costs, and the hiring, training and retention of management and other personnel. Accordingly, there can be no assurance that, system-wide, Papa John’s will be able to meet planned growth targets, open restaurants in markets now targeted for expansion or continue to operate in existing markets profitably.

 

We face substantial competition from other food industry competitors, and our results of operations can be negatively impacted by the actions of one or more of our major competitors.

 

The restaurant industry is intensely competitive with respect to price, service, location and food quality, and there are many well-established competitors with substantially greater financial and other resources than the Papa John’s system. Some of these competitors have been in existence for a substantially longer period than Papa John’s and may be better established in the markets where restaurants operated by us or our franchisees are, or may be, located. Experience has shown that a change in the pricing or other

 

 

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marketing or promotional strategies, including new product and concept developments, by one or more of our major competitors can have an adverse impact on our sales and earnings and our system-wide restaurant operations.

 

Our results of operations and the operating results of our franchisees may be adversely impacted by any increases in the cost of food ingredients and other commodities.

 

An increase in the cost or sustained high levels of the cost of cheese or other commodities could adversely affect the profitability of our system-wide restaurant operations. Cheese costs, historically representing 35% to 40% of our food cost, and other commodities are subject to fluctuations, weather, availability, demand and other factors that are beyond our control. Additionally, sustained increases in fuel and utility costs could adversely affect the profitability of our restaurant and QC Center businesses. Higher commodity costs (primarily cheese and wheat) have resulted in operating margin pressure on our franchisees. Given the current commodity cost environment, we chose to mitigate commodity cost increases at domestic restaurants by supporting the entire domestic system via reduced commissary margins. For example, we did not pass through higher fuel charges incurred during 2008 by our QC Centers to our domestic restaurants. Additionally, for the last two months of 2008, in an effort to assist franchisees through this difficult period, we decided not to pass along the higher price of cheese that would have been required under the pricing formula for cheese sales from BIBP to franchisees. Instead, we allowed domestic restaurants to pay the expected futures spot market price for cheese plus an interest carry cost (Q4-08 modified price), which was approximately $0.28 per pound less than the pre-established fourth quarter price paid by domestic restaurants during October 2008. Our decision during the fourth quarter to reduce the BIBP formula price will result in a delay in the recovery of the BIBP cheese purchasing entity deficit. Additionally, further delays in the recovery of the BIBP deficit will occur as we have decided to continue to assist the domestic franchise system in 2009 or beyond by maintaining a lower BIBP price than would otherwise be called for by the pricing formula.

 

Changes in consumer preferences or discretionary consumer spending or negative publicity could adversely impact our results.

 

Changes in consumer taste (for example, changes in dietary preferences that could cause consumers to avoid pizza in favor of foods that are perceived as more healthful), demographic trends, traffic patterns and the type, number and location of competing restaurants could adversely affect our restaurant business. Also, our success depends to a significant extent on numerous factors affecting discretionary consumer spending, including economic conditions, disposable consumer income and consumer confidence. Further adverse changes in these factors could reduce sales or impose practical limits on pricing, either of which could materially adversely affect our results of operations.  Like other food industry competitors, we can also be materially adversely affected by negative publicity concerning food quality, illness, injury, publication of government or industry findings concerning food products served by us, or other health concerns or operating issues stemming from one restaurant or a limited number of restaurants.

 

We are subject to federal and state laws governing our workforce. Changes in these laws, including minimum wage increases, or additional laws could increase costs for our system-wide operations.

 

System-wide restaurant operations are subject to federal and state laws governing such matters as wage benefits, working conditions, citizenship requirements and overtime. A significant number of hourly personnel employed by our franchisees and us are paid at rates related to the federal and state minimum wage requirements.  Accordingly, further increases in the federal minimum wage or the enactment of additional state or local minimum wage increases above federal wage rates will increase labor costs for our system-wide operations. Additionally, proposed legislation which may make it easier for workers to

 

 

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form unions and labor shortages in various markets could result in higher costs. Local government agencies have also implemented ordinances which restrict the sale of certain food products. Additional government ordinances, including proposed menu labeling legislation, could increase costs and be harmful to system-wide restaurant sales.

 

Current credit markets may adversely impact the ability of our franchisees to obtain financing, which may hinder our ability to achieve our planned growth in restaurant openings.

 

Our growth strategy depends in large part on our ability and the ability of our franchisees to expand or open new restaurants and to operate those restaurants on a profitable basis. Delays or failures in opening new restaurants could materially and adversely affect our planned growth. In recent months, the credit markets have experienced instability, resulting in declining real estate values, credit and liquidity concerns and increased loan default rates. Many lenders have subsequently reduced their willingness to make new loans and have tightened their credit requirements. Our franchisees depend on the availability of financing to expand existing locations or construct and open new restaurants. If our franchisees experience difficulty in obtaining adequate financing for these purposes, our growth strategy and franchise revenues may be adversely affected. The unavailability of credit may require the Company to provide financing to certain franchisees and prospective franchisees in order to mitigate store closings, allow new units to open and continue to execute our refranchising strategy. If we are unable or unwilling to provide such financing, our results of operations may be adversely impacted.

 

Our expansion into emerging or under-penetrated markets may present increased risks.

 

Any or all of the risks listed above potentially adversely impacting restaurant sales or costs could be especially harmful to the financial viability of franchisees in under-penetrated or emerging markets. A decline in or failure to improve financial performance for this group of franchisees could lead to unit closings at greater than anticipated levels and therefore impact contributions to marketing funds, our royalty stream, PJFS and support services efficiencies and other system-wide results.

 

We may be subject to impairment charges.

 

Impairment charges for Company-owned operations are possible if PJUK or previously acquired domestic restaurants perform below our expectations. This would result in a decrease in our assets and reduction in our net income.

 

Our dependence on a sole or limited number of suppliers for some ingredients could result in disruptions to our business.

 

Domestically, we are dependent on sole suppliers for our cheese, flour, and thin and pan crust dough products. Alternative sources for these ingredients may not be available on a timely basis to supply these key ingredients or be available on terms as favorable to us as under our current arrangements. Domestic restaurants purchase substantially all food and related products from our QC Centers. Accordingly, both our corporate and franchised restaurants could be harmed by any prolonged disruption in the supply of products from our QC Centers.

 

Changes in purchasing practices by our domestic franchisees could harm our commissary business.

 

Although our domestic franchisees currently purchase substantially all food products from our QC Centers, they are only required to purchase tomato sauce and dough from our QC Centers. Any changes in purchasing practices by domestic franchisees, such as seeking alternative suppliers of food products,

 

 

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including cheese, could adversely affect the financial results of our QC Centers, including the recoverability of the BIBP cheese purchasing entity deficit.

 

We may be required to resort to litigation to protect our intellectual property rights, which could negatively affect our results of operations.

 

We depend on our Papa John’s brand name and we rely on a combination of trademarks, copyrights, service marks and similar intellectual property rights to protect our brand.  We believe that the success of our business depends on our continued ability to use our existing trademarks and service marks to increase brand awareness and further develop our brand, both domestically and abroad.  We may not be able to adequately protect our intellectual property rights and we may be required to resort to litigation to enforce such rights. Litigation could result in high costs and diversion of resources, which could negatively affect our results of operations, regardless of the outcome.

 

Our international operations are subject to increased risks and other factors that may make it more difficult to achieve or maintain profitability or meet planned growth rates.

 

Our international operations could be negatively impacted by significant changes in international economic, political and health conditions in the countries in which the Company or its franchisees operate. In addition, our international operations are subject to additional factors, including compliance with foreign laws, currency regulations and fluctuations, differing business and social cultures and consumer preferences, diverse government regulations and structures, availability and cost of land and construction, 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. Accordingly, there can be no assurance that our international operations will achieve or maintain profitability or meet planned growth rates.

 

Item 1B. Unresolved Staff Comments

 

None.

 

 

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Item 2.  Properties

 

As of December 28, 2008, there were 3,380 Papa John’s restaurants system-wide.

 

Company-owned Papa John’s Restaurants

 

 

Note: Company-owned Papa John’s restaurants include restaurants owned by majority-owned joint ventures. There were 128 such restaurants at December 28, 2008 (77 in Texas, 26 in Virginia and 25 in Maryland).

 

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Domestic Franchised Papa John’s Restaurants

 

 

 

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International Franchised Papa John’s Restaurants

 

 

(a) We define “domestic” operations as units located in the contiguous United States and “international” operations as units located outside the contiguous United States.

 

Most Papa John’s restaurants are located in leased space. The initial term of most restaurant leases is generally five years with most leases providing for one or more options to renew for at least one additional term. Virtually all of our leases specify a fixed annual rent. Generally, the leases are triple net leases, which require us to pay all or a portion of the cost of insurance, taxes and utilities. Certain leases further provide that the lease payments may be increased annually, with a small number of escalations based on changes in the Consumer Price Index.

 

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Approximately 48 Company-owned restaurants are located in buildings we own on land either owned or leased by us. These restaurants range from 1,100 to 3,000 square feet. Four of these restaurants are located in multi-bay facilities. These multi-bay facilities contain from 2,800 to 5,000 square feet, and the space not utilized by the Papa John’s restaurant in each facility is leased or held for lease to third-party tenants.

 

At December 28, 2008, we had 103 Papa John’s restaurants located in the United Kingdom (95 franchised and eight Company-owned). In addition to leasing the eight Company-owned restaurant sites, we lease and sublease to franchisees 72 of the 95 franchised Papa John’s restaurant sites and five sites to former Perfect Pizza franchisees. The initial lease terms on the Company and franchised sites are generally 10 to 15 years. The initial lease terms of the franchisee subleases are generally five to ten years. Additionally, we leased 15 Company-owned restaurant sites in Beijing, China as of December 28, 2008.

 

Information with respect to our leased domestic QC Centers as of December 28, 2008 is set forth below:

 

 

We own land in Orlando, Florida on which our 63,000 square foot full-service QC Center is located. We also own land and a 175,000 square foot facility in Dallas, Texas, of which 77,500 square feet is used by our full-service QC Center and the remaining space is leased to a third-party tenant. In addition, we own land in Louisville, Kentucky, on a portion of which is located a 42,000 square foot building housing our printing operations and a 247,000 square foot building, approximately 30% to 40% of which accommodates the Louisville QC Center operation and promotions division. The remainder of the larger building houses our corporate offices.

 

The Papa John’s UK management team is located in a leased office near London with a remaining lease term of seven years.

 

The Papa John’s China management team leases an office and a QC Center in Beijing, China. The Papa John’s Mexico management team and QC Center lease a facility in Mexico City, Mexico and another QC Center leases a facility in Cancun, Mexico.

 

Item 3.  Legal Proceedings

 

We are subject to claims and legal actions in the ordinary course of our business. We believe that none of the claims and actions currently pending against us would have a material adverse effect on us if decided in a manner unfavorable to us.

 

Item 4.  Submission of Matters to a Vote of Security Holders

 

Not applicable.

 

 

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EXECUTIVE OFFICERS OF THE REGISTRANT

 

Set forth below are the current executive officers of Papa John’s:

 

Name		Age (a)		Position		First Elected Executive Officer
John H. Schnatter		47		Founder Chairman and Interim Chief Executive Officer		1985
J. David Flanery		51		Senior Vice President, Chief Financial Officer and Treasurer		1994
Julie L. Larner		48		Senior Vice President and President — PJ Food Service, Inc.		2001
William M. Mitchell		44		Senior Vice President, Domestic Operations		2007
Charles W. Schnatter		46		Senior Vice President and Chief Development Officer		1991
Christopher J. Sternberg		43		Senior Vice President, Corporate Communications and Interim General Counsel		2008
William M. Van Epps		60		President, USA		2002

 

(a) Ages are as of January 1, 2009.

 

John H. Schnatter created the Papa John’s concept in 1984 and the first Papa John’s restaurant opened in 1985. He currently serves as Founder Chairman and was appointed Interim Chief Executive Officer in December 2008, upon the resignation of Nigel Travis as President and Chief Executive Officer. He served as Executive Chairman of the Company from 2005 until May 2007, as Chairman of the Board and Chief Executive Officer from 1990 until 2005, and as President from 1985 to 1990 and from 2001 until 2005.

 

J. David Flanery has served as Senior Vice President, Chief Financial Officer and Treasurer since 2004. He previously served as Senior Vice President of Finance since August 2002. He served as Vice President of Finance from 1995 through August 2002, after having joined Papa John’s in 1994 as Corporate Controller. From 1979 to 1994, Mr. Flanery was with Ernst & Young LLP in a variety of positions, most recently as Audit Senior Manager.  Mr. Flanery is a licensed Certified Public Accountant.

 

Julie L. Larner has served as Senior Vice President and President - PJ Food Service, Inc. since 2004. Ms. Larner served as Senior Vice President, Chief Administrative Officer and Treasurer from 2001 to 2004. Ms. Larner has been with Papa John’s since 1992, serving as controller for PJ Food Service, Inc. from 1992 to 1997 and Vice President of Finance and Administration from 1998 to 2001.

 

William M. Mitchell has served as Senior Vice President, Domestic Operations since 2007. Mr. Mitchell served from 2005 to 2007 as a Division Vice President responsible for corporate and franchised restaurant operations in the Midwest. He served as one of our Operations Vice Presidents from 2000 to

 

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2005. Prior to joining Papa John’s, Mr. Mitchell served as Senior Director of Operations for AFCE/Popeye’s from 1996 to 2000, responsible for company and franchise operations as well as Popeye’s related acquisitions. From 1993 to 1996, he served as Vice President of Operations for RTM Restaurant Group.

 

Charles W. Schnatter has served as Senior Vice President and Chief Development Officer since 2001 and served as Secretary from 1991 until October 2005; he has been a Senior Vice President since 1993. Mr. Schnatter also held the position of General Counsel from 1991 to 2002. From 1988 to 1991, he was an attorney with Greenebaum, Doll & McDonald PLLC. Mr. Schnatter has been a franchisee since 1989.

 

Christopher J. Sternberg was appointed Interim General Counsel in December 2008 concurrent with the resignation of Lou H. Jones. Mr. Sternberg has served as Senior Vice President, Corporate Communications, since 2005, after serving as Vice President and Assistant to the Chairman from 2000 to 2005. Mr. Sternberg served as Vice President, Corporate Communications from 1997 to 2000. Mr. Sternberg joined the company in 1994 as Assistant Counsel in our Legal Department. From 1990 to 1994, he was an attorney with Greenebaum, Doll & McDonald PLLC.

 

William M. Van Epps has served as President, USA since 2006, responsible for domestic corporate and franchised restaurant operations. Mr. Van Epps served as Senior Vice President and Chief Operations Officer from 2004 to 2006 and Managing Director, International from September 2001 to 2004. Prior to joining Papa John’s, Mr. Van Epps served for two years as President, International Division of Yorkshire Global Restaurants, responsible for the international development of Long John Silver’s and A&W restaurants. From 1993 to 1999, he served in several positions with AFC Enterprises, including President of its International Division. From 1988 to 1993, he was Vice President, Marketing and International for Western Sizzlin, Inc.

 

Charles Schnatter is the brother of John Schnatter, Founder Chairman and Interim Chief Executive Officer. There are no other family relationships among our executive officers and other key personnel.

 

 

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PART II

 

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Our common stock trades on The NASDAQ Global Select Market tier of The NASDAQ Stock Market under the symbol PZZA. As of February 17, 2009, there were approximately 862 record holders of common stock. However, there are significantly more beneficial owners of our common stock than there are record holders. The following table sets forth, for the quarters indicated, the high and low closing sales prices of our common stock, as reported by The NASDAQ Stock Market.

 

2008		High			Low
First Quarter		$	27.00		$	20.93
Second Quarter		29.79			24.21
Third Quarter		30.48			25.36
Fourth Quarter		27.65			13.11
2007		High			Low
First Quarter		$	30.88		$	27.03
Second Quarter		33.92			28.53
Third Quarter		29.19			24.03
Fourth Quarter		26.91			21.95

 

Since our initial public offering of common stock in 1993, we have not paid cash dividends on our common stock, and have no current plans to do so.

 

Papa John’s Board of Directors has authorized the repurchase of up to $775.0 million of common stock under a share repurchase program that began December 9, 1999, and runs through December 31, 2009. Through December 28, 2008, a total of 42.2 million shares with an aggregate cost of $712.7 million and an average price of $16.89 per share have been repurchased under this program. Subsequent to year-end (through February 17, 2009), we acquired an additional 264,000 shares at an aggregate cost of $4.8 million. As of February 17, 2009, approximately $57.5 million remained available for repurchase of common stock under this authorization.

 

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The following table summarizes our repurchase activity by fiscal period during 2008 (in thousands, except per-share amounts):

 

							Total Number		Maximum Dollar
		Total		Average			of Shares Purchased		Value of Shares
		Number		Price			as Part of Publicly		that May Yet Be
		of Shares		Paid per			Announced Plans		Purchased Under the
Fiscal Period		Purchased		Share			or Programs		Plans or Programs
12/31/2007 - 01/27/2008		104		$	21.74		40,893		$	97,700
01/28/2008 - 02/24/2008		—	*	—			40,893		$	97,700
02/25/2008 - 03/30/2008		—	*	—			40,893		$	97,700
03/31/2008 - 04/27/2008		203		$	25.51		41,096		$	92,523
04/28/2008 - 05/25/2008		214		$	27.29		41,310		$	86,690
05/26/2008 - 06/29/2008		247		$	28.32		41,557		$	79,685
06/30/2008 - 07/27/2008		223		$	26.72		41,780		$	73,735
07/28/2008 - 08/24/2008		213		$	28.38		41,993		$	67,698
08/25/2008 - 09/28/2008		193		$	27.84		42,186		$	62,313
09/29/2008 - 10/26/2008		—	*	—			42,186		$	62,313
10/27/2008 - 11/23/2008		—	*	—			42,186		$	62,313
11/24/2008 - 12/28/2008		3		$	16.65		42,189		$	62,275

 

*There were no share repurchases during this period.

 

Our share repurchase authorization increased from $725.0 million to $775.0 million in August 2008. For presentation purposes, the maximum dollar value of shares that may be purchased was adjusted retroactively to December 31, 2007.

 

From March through September, 2008, the Company utilized a written trading plan under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, to facilitate the repurchase of shares of our common stock under this share repurchase program. We adopted another trading plan in December 2008, effective January 2, 2009. There can be no assurance that we will repurchase shares of our common stock either through our Rule 10b5-1 trading plan or otherwise. The trading plan includes predetermined criteria and limitations and is scheduled to expire December 31, 2009, unless terminated sooner under plan provisions.

 

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Stock Performance Graph

 

The following performance graph compares the cumulative total return of the Company’s common stock to the NASDAQ Stock Market (U.S.) Index and a group of the Company’s peers consisting of U.S. companies listed on NASDAQ with standard industry classification (SIC) codes 5800-5899 (eating and drinking places).  Relative performance is compared for the five-year period extending through the end of fiscal 2008. The graph assumes that the value of the investments in the Company’s common stock and in each index was $100 at the end of fiscal 2003, and, with respect to the index and peer group, that all dividends were reinvested.

 

 

 

 

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Item 6. Selected Financial Data

 

The selected financial data presented for each of the years in the five-year period ended December 28, 2008 was derived from our audited consolidated financial statements. The selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the “Consolidated Financial Statements” and Notes thereto included in Item 7 and Item 8, respectively, of this Form 10-K.

 

		Year Ended (1)
		Dec. 28,			Dec. 30,			Dec. 31,			Dec. 25,			Dec. 26,
(In thousands, except per share data)		2008			2007			2006			2005			2004
Income Statement Data		52 weeks			52 weeks			53 weeks			52 weeks			52 weeks
Domestic revenues:
Company-owned restaurant sales		$	533,255		$	504,330		$	447,938		$	434,525		$	412,676
Variable interest entities restaurant sales		8,328			7,131			7,859			11,713			14,387
Franchise royalties (2)		59,704			55,283			56,374			52,289			50,292
Franchise and development fees		1,600			4,758			2,597			3,026			2,475
Commissary sales		429,068			399,099			413,075			398,372			376,642
Other sales		61,415			61,820			50,505			50,474			53,117
International revenues:
Royalties and franchise and development fees (3)		12,868			10,314			7,551			6,529			5,010
Restaurant and commissary sales (4)		25,849			20,860			15,658			11,860			10,747
Total revenues		1,132,087			1,063,595			1,001,557			968,788			925,346
Operating income (5)		63,464			52,047			97,955			72,700			36,682
Investment income		848			1,446			1,682			1,248			689
Interest expense		(7,536		)	(7,465		)	(3,480		)	(4,316		)	(5,313		)
Income from continuing operations before income taxes		56,776			46,028			96,157			69,632			32,058
Income tax expense		19,980			13,293			33,171			25,364			12,021
Income from continuing operations		36,796			32,735			62,986			44,268			20,037
Income from discontinued operations, net of tax (6)		—			—			389			1,788			3,184
Net income		$	36,796		$	32,735		$	63,375		$	46,056		$	23,221
Basic earnings per common share:
Income from continuing operations		$	1.31		$	1.10		$	1.95		$	1.32		$	0.58
Income from discontinued operations, net of tax (6)		—			—			0.01			0.05			0.09
Basic earnings per common share		$	1.31		$	1.10		$	1.96		$	1.37		$	0.67
Earnings per common share - assuming dilution:
Income from continuing operations		$	1.30		$	1.09		$	1.91		$	1.29		$	0.58
Income from discontinued operations, net of tax (6)		—			—			0.01			0.05			0.09
Earnings per common share - assuming dilution		$	1.30		$	1.09		$	1.92		$	1.34		$	0.67
Basic weighted average shares outstanding		28,124			29,666			32,312			33,594			34,414
Diluted weighted average shares outstanding		28,264			30,017			33,046			34,316			34,810
Balance Sheet Data
Total assets		$	386,468		$	401,817		$	379,639		$	350,562		$	374,487
Total debt		130,654			142,706			97,036			55,116			94,230
Total stockholders’ equity		129,986			126,903			146,168			161,279			139,223

 

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(1)               We operate on a 52-53 week fiscal year ending on the last Sunday of December of each year.  The 2008, 2007, 2005 and 2004 fiscal years consisted of 52 weeks, and the 2006 fiscal year consisted of 53 weeks. The additional week resulted in additional revenues of approximately $20.0 million and additional pre-tax income of approximately $3.5 million, or $0.07 per diluted share for 2006.

 

(2)               Domestic Franchise royalties were derived from franchised restaurant sales of $1.50 billion in 2008, $1.46 billion in 2007, $1.51 billion in 2006, $1.38 billion in 2005 and $1.30 billion in 2004.

 

(3)               International Royalties were derived from franchised restaurant sales of $221.0 million in 2008, $176.2 million in 2007, $139.3 million in 2006, $104.2 million in 2005 and $67.6 million in 2004.

 

(4)                Restaurant sales for International Company-owned restaurants were $8.1 million in 2008, $4.0 million in 2007, $1.7 million in 2006, $642,000 in 2005 and $629,000 in 2004.

 

(5)                The operating results include the consolidation of BIBP, which reduced operating income approximately $8.6 million in 2008, $31.0 million in 2007 and $22.9 million in 2004 and increased operating income $19.7 million in 2006 and $5.8 million in 2005. The 2006 operating results include the benefit of the 53rd week, which increased operating income approximately $3.5 million. Operating income includes domestic and international restaurant closure, impairment and disposition losses of $8.8 million in 2008 and $1.8 million in 2007 and a gain of $989,000 in 2005 (the amounts recorded in 2006 and 2004 were not significant). See “Notes 4 and 7” of “Notes to Consolidated Financial Statements.”

 

(6)               The Perfect Pizza operations, which were sold in March 2006, are classified as “discontinued operations.”

 

 

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Introduction

 

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 with the opening of the first Papa John’s restaurant in Jeffersonville, Indiana. At December 28, 2008, there were 3,380 Papa John’s restaurants in operation, consisting of 615 Company-owned and 2,765 franchised restaurants. 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.

 

New unit openings in 2008 were 267 as compared to 263 in 2007 and 211 in 2006 and unit closings in 2008 were 95 as compared to 70 in 2007 and 125 in 2006. We expect net unit growth of approximately 100 to 140 units during 2009.

 

We have continued to produce strong average sales from our domestic Company-owned restaurants even in a very competitive market environment. Our expansion strategy is to cluster restaurants in targeted markets, thereby increasing consumer awareness and enabling us to take advantage of operational, distribution and advertising efficiencies. Average annual Company-owned sales for our most recent comparable restaurant base were $867,000 for 2008 (52 weeks), compared to $836,000 for 2007 (52 weeks) and $865,000 for 2006 (53 weeks). Average sales volumes in new markets are generally lower than in those markets in which we have established a significant market position. The comparable sales for domestic Company-owned restaurants increased 1.7% in 2008, 0.5% in 2007 and 3.6% in 2006. The comparable sales for domestic franchised units increased 0.6% in 2008, 0.3% in 2007 and 2.9% in 2006.

 

We continually strive to obtain high-quality sites with good access and visibility, and to enhance the appearance and quality of our restaurants. We believe that these factors improve our image and brand awareness. The average property and equipment investment cost for the restaurants in our most recent

 

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comparable sales base is $266,000. The average cash investments for the 14 domestic Company-owned restaurants opened during 2008 and the 20 units opened in 2007, exclusive of land, were approximately $270,000 per unit in both periods, excluding tenant improvement allowances that we received in both years.

 

Approximately 41% of our revenues for 2008, compared to 43% of our revenues for 2007 and 46% of our revenues for 2006, were derived from the sale to our domestic and international franchisees of food and paper products, printing and promotional items, risk management services and information systems equipment and software and related services by us. The decline in the percentage of revenues is due to the acquisition of over 100 domestic franchise restaurants during late 2006 and 2007. We expect the percentage of revenues in 2009 to be consistent with 2008. We believe that, in addition to supporting both Company and franchised growth, these activities contribute to product quality and consistency and restaurant profitability throughout the Papa John’s system.

 

Our fiscal year ends on the last Sunday in December of each year. All fiscal years presented consist of 52 weeks except for the 2006 fiscal year, which consisted of 53 weeks.

 

Results of Operations and Critical Accounting Policies and Estimates

 

The results of operations are based on our consolidated financial statements, which were prepared in conformity with accounting principles generally accepted in the United States. The preparation of consolidated financial statements requires management to select accounting policies for critical accounting areas as well as estimates and assumptions that affect the amounts reported in the consolidated financial statements. The Company’s significant accounting policies are more fully described in “Note 2” of “Notes to Consolidated Financial Statements.” Significant changes in assumptions and/or conditions in our critical accounting policies could materially impact the operating results. We have identified the following accounting policies and related judgments as critical to understanding the results of our operations.

 

Allowance for Doubtful Accounts and Notes Receivable

 

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

 

Long-lived and Intangible Assets

 

The recoverability of long-lived assets is evaluated if impairment indicators exist. Indicators of impairment include historical financial performance, operating trends and our future operating plans. If impairment indicators exist, we evaluate the recoverability of long-lived assets on an operating unit basis (e.g., an individual restaurant) based on undiscounted expected future cash flows before interest for the expected remaining useful life of the operating unit. Recorded values for long-lived assets that are not expected to be recovered through undiscounted future cash flows are written down to current fair value, which is generally determined from estimated discounted future net cash flows for assets held for use or estimated net realizable value for assets held for sale.

 

The recoverability of indefinite-lived intangible assets (i.e., goodwill) is evaluated annually or more frequently if impairment indicators exist, on a reporting unit basis by comparing the estimated fair value to its carrying value. Our estimated fair value for Company-owned restaurants is comprised of two components. The first component is the estimated cash sales price that would be received at the time of

 

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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.

 

During 2008, we sold to domestic franchisees a total of 62 Company-owned restaurants located primarily in three markets. As part of the sales of these restaurants, we recorded a $3.6 million intangible asset for the investment in the continuing franchise agreement, representing the discounted value of the royalties we will receive over the next ten years from the purchaser/franchisee. The intangible asset is recorded in other assets in the accompanying consolidated balance sheet at December 28, 2008. The $3.6 million intangible asset will be amortized over the ten-year franchise agreement as a reduction in the royalty income of $360,000 annually.

 

At December 28, 2008, we had a net investment of approximately $15.7 million associated with our United Kingdom subsidiary (PJUK), excluding the $3.5 million loan due from the purchaser of Perfect Pizza. During 2008, we recorded a goodwill impairment charge of $2.3 million associated with our PJUK operations. We have developed plans for PJUK to continue to improve in 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.

 

If our initiatives with PJUK and certain domestic markets are not successful, future impairment charges could occur.

 

Insurance Reserves

 

Our insurance programs for workers’ compensation, general liability, owned and non-owned automobiles and health insurance coverage provided to our employees are self-insured up to certain individual and aggregate reinsurance levels. Losses are accrued based upon estimates of the aggregate retained liability for claims incurred using certain third-party actuarial projections and our claims loss experience. The estimated insurance claims losses could be significantly affected should the frequency or ultimate cost of claims significantly differ from historical trends used to estimate the insurance reserves recorded by the Company.

 

From October 2000 through September 2004, our franchisee insurance program, which provides insurance to our franchisees, was self-insured. Beginning in October 2004, a third-party commercial insurance company began providing fully-insured coverage to franchisees participating in the franchise insurance program. Accordingly, this new agreement eliminates our risk of loss for franchise insurance coverage written after September 2004. 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. During 2008, we recorded a $1.7 million decrease in existing claims losses, as compared to the previous year’s expected claims costs, based on updated actuarial valuations.

 

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Deferred Tax Assets and Tax Reserves

 

Papa John’s is subject to income taxes in the United States and several foreign jurisdictions.  Significant judgment is required in determining Papa John’s provision for income taxes and the related assets and liabilities. Income taxes are accounted for under Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.” The provision for income taxes includes income taxes paid, currently payable or receivable and those deferred. Under SFAS 109, 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 December 28, 2008, we had a net deferred income tax asset balance of $24.6 million, of which approximately $15.1 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 since we believe it is more likely than not that our future earnings will be sufficient to ensure the realization of the net deferred income tax assets for federal and state purposes.

 

Certain tax authorities periodically audit the Company. We provide reserves for potential exposures based on Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) requirements. We evaluate these issues on a quarterly basis to adjust for events, such as court rulings or audit settlements, which may impact our ultimate payment for such exposures. We recognized reductions of $1.7 million, $3.4 million and $2.5 million in our customary income tax expense associated with the finalization of certain income tax issues in 2008, 2007 and 2006, respectively (see “Note 14” of “Notes to Consolidated Financial Statements”).

 

Consolidation of BIBP Commodities, Inc. (“BIBP”) as a Variable Interest Entity

 

BIBP is a franchisee-owned corporation that conducts a cheese-purchasing program on behalf of domestic Company-owned and franchised restaurants. As required by the 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 are deemed to be the primary beneficiary, as defined by FIN 46, of BIBP. We recognized pre-tax losses of approximately $10.5 million during 2008 and $31.7 million during 2007 and pre-tax income of $19.0 million during 2006 from the consolidation of BIBP. We expect the consolidation of BIBP to continue to have a significant impact on Papa John’s operating income in future periods due to the volatility of cheese prices. Papa John’s will recognize the operating losses generated by BIBP if the shareholders’ equity of BIBP is in a net deficit position. Further, Papa John’s will recognize subsequent operating income generated by BIBP up to the amount of BIBP losses previously recognized by Papa John’s.

 

Many domestic franchisees are facing financial challenges due to a recent decline in sales and continued operating margin pressures from higher commodity costs (primarily cheese and wheat) as well as increased utility costs. In addition, due to the recent events impacting credit availability, many franchisees are having difficulty obtaining credit from third-party lending institutions for working capital and development purposes. In an effort to assist franchisees through this difficult period, the BIBP formula was modified for the last two months of 2008. The modified formula resulted in domestic restaurants paying the expected futures spot market price for cheese plus an interest carry cost (Q4-08 modified price), which was approximately $0.28 per pound less than the pre-established fourth quarter price paid by domestic restaurants during October 2008. The modified price reduced the food cost and

 

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increased operating margin for the average restaurant approximately 1.4% for the last two months of 2008.

 

With respect to the BIBP cheese cost relief for 2009, for the first two months of the year the price per pound was set at a level approximately equal to the Q4-08 modified price, and substantially less than the price as would have been determined by the standard formula. Effective in March 2009, we will modify the BIBP formula to establish the price of cheese on a more frequent basis at the projected spot market price plus a certain mark-up. The amount of the mark-up depends on the projected spot market prices. Under this new price formula, we anticipate BIBP will substantially repay its cumulative deficit by the end of 2011.

 

Franchise Support Initiatives

 

In late 2008, the Company announced a comprehensive package of domestic franchise system support initiatives in response to the current economic and consumer climate. The initiatives included:

 

·                  As previously discussed, providing cheese cost relief to our system in late 2008 and 2009 by modifying the cheese pricing formula used by BIBP Commodities, Inc.;

·                  Providing additional system-wide national marketing support for 2009;

·                  Providing expanded targeted royalty relief and local marketing support for struggling franchisees or markets;

·                  Convening a lender summit, principally of regional banks and other lenders, to educate them on the Papa John’s model with the goal of expanding credit availability to franchisees;

·                  Providing financing on a selected basis to assist new or existing franchisees with the acquisition of troubled franchised restaurants; and

·                  For the first six months of 2009, suspending collection of the 0.25% royalty rate increase that was scheduled for January 2009 with the effect that the royalty rate will remain at 4.25% for the first six months of 2009 (with the Company deciding whether to continue to suspend collection of the royalty rate increase at mid-year).

 

We estimate the gross incremental impact of these and certain other support initiatives and non-recurring costs on the Company’s operating income, excluding the impact of consolidating BIBP’s operating results, to be $12.0 million to $14.0 million for 2009 (excluding any favorable impact from increased marketing).

 

We believe the support program will produce long-term shareholder benefits for the Papa John’s system by mitigating potential unit closures and strengthening our brand during these challenging times. In addition to reducing unit closures, other important objectives of the support program include growing market share in a consolidating category, stabilizing transaction levels and targeting a substantial multi-year increase in online ordering percentage.

 

Recent Accounting Standards

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of SFAS No. 115. SFAS No. 159 is effective for fiscal years beginning after November 15, 2008 or our first quarter of fiscal 2009. This statement provides companies with the option to measure, at specified election dates, many financial instruments and certain other items at fair value that are not currently measured at fair value. Companies electing to adopt SFAS No. 159 will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The Company does not intend to elect the SFAS No. 159 fair value measurement option.

 

 

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In September 2006, the FASB issued 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. We adopted the provisions of SFAS No. 157 in two phases: (1) phase one was effective for financial assets and liabilities in our first quarter of 2008 and (2) phase two is effective for non-financial assets and liabilities for fiscal years beginning after November 15, 2008, or our first quarter of fiscal 2009. The adoption of phase one during the first quarter of 2008 did not have a significant impact on our financial statements.

 

SFAS No. 157 requires that assets and liabilities carried at fair value be classified and disclosed in one of the following categories:

 

·                  Level 1: Quoted market prices in active markets for identical assets or liabilities.

·                  Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data.

·                  Level 3: Unobservable inputs that are not corroborated by market data.

 

Our financial assets and liabilities that are measured at fair value on a recurring basis as of December 28, 2008 are as follows:

 

Carrying

Fair Value Measurements

(In thousands)

Value

Level 1

Level 2

Level 3

Financial assets:

Investments

$

530

$

530

$

—

$

—

Non-qualified deferred compensation plan

8,887

8,887

—

—

Financial liabilities:

Interest rate swaps

6,173

—

6,173

—

 

 

The adoption for non-financial assets and liabilities in fiscal 2009 is not expected to significantly impact our estimates of value related to long-lived and intangible assets such as our annual fair value evaluation of our United Kingdom subsidiary, Papa John’s UK (“PJUK”) and domestic Company-owned restaurants.

 

In December 2007, the FASB issued SFAS No. 141 - revised 2007 (SFAS No. 141R), Business Combinations. SFAS No. 141R establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable financial statement users to evaluate the nature and financial effects of the business combination. SFAS No. 141R applies to business combinations for which the acquisition date is on or after December 15, 2008 or our first quarter of fiscal 2009. Early adoption is prohibited. The adoption of this statement is not expected to have a significant impact on Papa John’s consolidated financial statements.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment to ARB No. 51. SFAS No. 160 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 statement further requires that consolidated net income be reported at amounts attributable to the parent and the noncontrolling interest, rather than expensing the income

 

 

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attributable to the minority interest holder. This statement also requires that companies provide sufficient disclosures 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. This statement is effective for fiscal years beginning on or after December 15, 2008 or for our first quarter of 2009. Early adoption is prohibited. The adoption of this statement is not expected to have a significant impact on Papa John’s consolidated financial statements.

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — An Amendment of FASB Statement No. 133. SFAS No. 161 enhances the required disclosures regarding derivatives and hedging activities, including disclosures regarding how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008 or our first quarter of fiscal 2009.

 

 

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Percentage Relationships and Restaurant Data and Unit Progression

 

The following tables set forth the percentage relationship to total revenues, unless otherwise indicated, of certain income statement data, and certain restaurant data for the years indicated:

 

		Year Ended (1)
		Dec. 28,		Dec. 30,		Dec. 31,
		2008		2007		2006
Income Statement Data:		52 weeks		52 weeks		53 weeks
Domestic revenues:
Company-owned restaurant sales		47.1	%	47.4	%	44.7	%
Variable interest entities restaurant sales		0.7		0.7		0.8
Franchise royalties		5.3		5.2		5.6
Franchise and development fees		0.2		0.4		0.3
Commissary sales		37.9		37.5		41.2
Other sales		5.4		5.8		5.0
International revenues:
Royalties and franchise and development fees		1.1		1.0		0.8
Restaurant and commissary sales		2.3		2.0		1.6
Total revenues		100.0		100.0		100.0
Costs and expenses:
Domestic Company-owned restaurant cost of sales (2)		22.6		22.4		19.7
Domestic Company-owned restaurant operating expenses (2)		58.9		59.3		57.9
Variable interest entities restaurant expenses (3)		88.4		84.4		85.4
Domestic commissary and other expenses (4)		90.5		89.1		89.3
Loss (income) from the franchise cheese purchasing program, net of minority interest (5)		0.6		2.1		(1.5	)
International operating expenses (6)		88.3		89.7		101.1
General and administrative expenses		8.8		9.5		10.3
Minority interests and other general expenses		1.9		0.7		0.4
Depreciation and amortization		2.9		3.0		2.7
Total costs and expenses		94.4		95.1		90.2
Operating income		5.6		4.9		9.8
Net interest expense		(0.6	)	(0.6	)	(0.2	)
Income before income taxes		5.0		4.3		9.6
Income tax expense		1.7		1.2		3.3
Net income		3.3	%	3.1	%	6.3	%

 

 

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Table of Contents

 

 

		Year Ended (1)
		Dec. 28,			Dec. 30,			Dec. 31,
		2008			2007			2006
Restaurant Data:		52 weeks			52 weeks			53 weeks
Percentage increase in comparable domestic
Company-owned restaurant sales (7)		1.7		%	0.5		%	3.6		%
Number of Company-owned restaurants included in the
most recent full year’s comparable restaurant base		566			541			485
Average sales for Company-owned restaurants included
in the most recent comparable restaurant base		$	867,000		$	836,000		$	865,000
Papa John’s Restaurant Progression:
U.S. Company-owned:
Beginning of period		648			577			502
Opened		14			20			19
Closed		(9		)	(9		)	(1		)
Acquired from franchisees		1			61			57
Sold to franchisees		(62		)	(1		)	—
End of period		592			648			577
International Company-owned:
Beginning of period		14			11			2
Opened		10			4			1
Closed		(2		)	—			—
Acquired from franchisees		1			2			8
Sold to franchisees		—			(3		)	—
End of period		23			14			11
U.S. franchised:
Beginning of period		2,112			2,080			2,097
Opened		98			140			105
Closed		(71		)	(48		)	(65		)
Acquired from Company		62			1			—
Sold to Company		(1		)	(61		)	(57		)
End of period		2,200			2,112			2,080
International franchised:
Beginning of period		434			347			325
Opened		145			99			86
Closed		(13		)	(13		)	(56		)
Acquired from Company		—			3			—
Sold to Company		(1		)	(2		)	(8		)
End of period		565			434			347
Total Papa John’s restaurants - end of period		3,380			3,208			3,015
Perfect Pizza Restaurant Progression (8):
Franchised:
Beginning of period		—			—			112
Opened		—			—			—
Closed		—			—			(3		)
Sold		—			—			(109		)
Total Perfect Pizza restaurants - end of period		—			—			—

 

 

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