UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

 

For the quarterly period ended September 24, 2006

 

OR

 

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

 

Commission File Number: 0-21660

 

PAPA JOHN’S INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

Delaware	61-1203323
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification number)
2002 Papa Johns Boulevard Louisville, Kentucky 40299-2334
(Address of principal executive offices)
(502) 261-7272
(Registrant’s telephone number, including area code)

 

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

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

Large accelerated filer o         Accelerated filer x         Non-accelerated filer o

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

At October 25, 2006, there were outstanding 32,019,411 shares of the registrant’s common stock, par value $.01 per share.

 

INDEX

				Page No.
PART I.		FINANCIAL INFORMATION
Item 1.		Financial Statements
		Condensed Consolidated Balance Sheets — September 24, 2006 and December 25, 2005		2
		Consolidated Statements of Income — Three Months and Nine Months Ended September 24, 2006 and September 25, 2005		3
		Consolidated Statements of Stockholders’ Equity — Nine Months Ended September 24, 2006 and September 25, 2005		4
		Consolidated Statements of Cash Flows — Nine Months Ended September 24, 2006 and September 25, 2005		5
		Notes to Condensed Consolidated Financial Statements		6
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		15
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		27
Item 4.		Controls and Procedures		28
PART II.		OTHER INFORMATION
Item 1.		Legal Proceedings		29
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		29
Item 6.		Exhibits		30

 

1

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

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

(In thousands)		Sept. 24, 2006			Dec. 25, 2005
		(Unaudited)			(Note)
Assets
Current assets:
Cash and cash equivalents		$	10,395		$	22,098
Accounts receivable		21,131			21,300
Inventories		26,892			26,030
Prepaid expenses and other current assets		9,181			13,456
Deferred income taxes		8,146			7,085
Assets of discontinued operations held for sale		—			2,039
Total current assets		75,745			92,008
Investments		2,637			6,282
Net property and equipment		188,810			178,447
Notes receivable		12,679			7,667
Deferred income taxes		—			1,899
Goodwill		55,771			41,878
Other assets		14,302			13,772
Assets of discontinued operations held for sale		—			8,609
Total assets		$	349,944		$	350,562
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	27,554		$	28,937
Income and other taxes		16,361			16,862
Accrued expenses		55,129			49,634
Current portion of debt		4,025			6,100
Total current liabilities		103,069			101,533
Unearned franchise and development fees		6,891			7,256
Long-term debt, net of current portion		49,512			49,016
Deferred income taxes		135			—
Other long-term liabilities		27,298			31,478
Stockholders’ equity:
Preferred stock		—			—
Common stock		340			331
Additional paid-in capital		181,255			160,999
Accumulated other comprehensive income (loss)		798			(290		)
Retained earnings		44,615			239
Treasury stock		(63,969		)	—
Total stockholders’ equity		163,039			161,279
Total liabilities and stockholders’ equity		$	349,944		$	350,562

Note:                   The balance sheet at December 25, 2005 has been derived from the audited consolidated financial statements at that date but does not include all information and footnotes required by accounting principles generally accepted in the United States for a complete set of financial statements.

See accompanying notes.

2

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Income

(Unaudited)

		Three Months Ended						Nine Months Ended
(In thousands, except per share amounts)		Sept. 24, 2006			Sept. 25, 2005			Sept. 24, 2006			Sept. 25, 2005
Domestic revenues:
Company-owned restaurant sales		$	107,793		$	107,241		$	319,957		$	328,513
Variable interest entities restaurant sales		1,320			2,121			6,457			9,581
Franchise royalties		13,186			12,312			41,388			38,585
Franchise and development fees		792			688			1,973			2,198
Commissary sales		98,272			94,787			301,932			291,195
Other sales		12,529			11,512			35,601			36,963
International revenues:
Royalties and franchise and development fees		1,906			1,574			5,202			4,601
Restaurant and commissary sales		3,894			2,865			11,124			8,776
Total revenues		239,692			233,100			723,634			720,412
Costs and expenses:
Domestic Company-owned restaurant expenses:
Cost of sales		21,309			22,051			61,837			70,876
Salaries and benefits		32,291			32,494			95,044			100,838
Advertising and related costs		10,385			9,396			29,398			28,953
Occupancy costs		7,209			7,016			19,735			20,177
Other operating expenses		14,580			14,736			42,157			42,827
Total domestic Company-owned restaurant expenses		85,774			85,693			248,171			263,671
Variable interest entities restaurant expenses		1,112			1,781			5,443			8,324
Domestic commissary and other expenses:
Cost of sales		79,957			78,706			245,366			239,611
Salaries and benefits		7,991			7,195			23,307			21,738
Other operating expenses		11,549			11,583			33,971			37,987
Total domestic commissary and other expenses		99,497			97,484			302,644			299,336
(Income) from the franchise cheese purchasing program, net of minority interest		(4,337		)	(2,649		)	(14,102		)	(1,807		)
International operating expenses		3,936			2,860			11,242			8,402
General and administrative expenses		26,427			23,121			77,057			66,326
Minority interests and other general expenses		182			564			3,207			3,786
Depreciation and amortization		6,674			7,249			19,838			21,857
Total costs and expenses		219,265			216,103			653,500			669,895
Operating income from continuing operations		20,427			16,997			70,134			50,517
Net interest expense		(629		)	(485		)	(1,321		)	(2,554		)
Income from continuing operations before income taxes		19,798			16,512			68,813			47,963
Income tax expense		6,690			6,109			24,826			17,746
Income from continuing operations		13,108			10,403			43,987			30,217
Income from discontinued operations, net of tax		—			410			389			1,431
Net income		$	13,108		$	10,813		$	44,376		$	31,648
Basic earnings per common share:
Income from continuing operations		$	0.41		$	0.30		$	1.35		$	0.90
Income from discontinued operations, net of tax		—			0.01			0.01			0.04
Basic earnings per common share		$	0.41		$	0.31		$	1.36		$	0.94
Earnings per common share - assuming dilution:
Income from continuing operations		$	0.40		$	0.30		$	1.32		$	0.88
Income from discontinued operations, net of tax		—			0.01			0.01			0.04
Earnings per common share - assuming dilution		$	0.40		$	0.31		$	1.33		$	0.92
Basic weighted average shares outstanding		31,957			34,432			32,556			33,648
Weighted average shares outstanding - assuming dilution		32,583			35,044			33,296			34,232

 

See accompanying notes.

 

3

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity

(Unaudited)

(In thousands)		Common Stock Shares Outstanding		Common Stock			Additional Paid-In Capital			Accumulated Other Comprehensive Income (Loss)			Retained Earnings			Treasury Stock			Total Stockholders’ Equity
Balance at December 26, 2004		33,460		$	650		$	242,331		$	(555	)	$	317,142		$	(420,345	)	$	139,223
Comprehensive income:
Net income		—		—			—			—			31,648			—			31,648
Change in valuation of interest rate swap agreement, net of tax of $553		—		—			—			852			—			—			852
Other, net		—		—			—			(142		)	—			—			(142		)
Comprehensive income																			32,358
Issuance of common stock from treasury stock		55		—			—			—			—			1,000			1,000
Exercise of stock options		2,362		24			34,884			—			—			—			34,908
Tax benefit related to exercise of non-qualified stock options		—		—			4,309			—			—			—			4,309
Acquisition of treasury stock		(1,768	)	—			—			—			—			(36,824		)	(36,824		)
Other		—		—			1,614			—			—			—			1,614
Balance at September 25, 2005		34,109		$	674		$	283,138		$	155		$	348,790		$	(456,169	)	$	176,588
Balance at December 25, 2005		33,081		$	331		$	160,999		$	(290	)	$	239		—			$	161,279
Comprehensive income:
Net income		—		—			—			—			44,376			—			44,376
Change in valuation of interest rate swap agreements, net of tax of $148		—		—			—			253			—			—			253
Other, net		—		—			—			835			—			—			835
Comprehensive income																			45,464
Exercise of stock options		893		9			13,125			—			—			—			13,134
Tax benefit related to exercise of non-qualified stock options		—		—			4,128			—			—			—			4,128
Acquisition of treasury stock		(2,025	)	—			—			—			—			(63,969		)	(63,969		)
Other		—		—			3,003			—			—			—			3,003
Balance at September 24, 2006		31,949		$	340		$	181,255		$	798		$	44,615		$	(63,969	)	$	163,039

 

At September 25, 2005, the accumulated other comprehensive gain of $155 was comprised of unrealized foreign currency translation gains of $309, offset by net unrealized loss on investments of $41 and net unrealized loss on the interest rate swap agreement of $113.

At September 24, 2006, the accumulated other comprehensive gain of $798 was comprised of unrealized foreign currency translation gains of $907 and a net unrealized gain on investments of $6, offset by a net unrealized loss on the interest rate swap agreement of $115.

See accompanying notes.

 

4

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

		Nine Months Ended
(In thousands)		Sept. 24, 2006			Sept. 25, 2005
Operating activities
Income from continuing operations		$	43,987		$	30,217
Adjustments to reconcile income from continuing operations to net cash provided by operating activities:
Provision for uncollectible accounts and notes receivable		2,423			2,245
Depreciation and amortization		19,838			21,857
Deferred income taxes		803			(1,292		)
Stock-based compensation expense		3,069			1,636
Excess tax benefit related to exercise of non-qualified stock options		(5,717		)	—
Other		4,199			4,703
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable		(2,717		)	(947		)
Inventories		(862		)	(213		)
Prepaid expenses and other current assets		4,322			6,217
Other assets and liabilities		(5,087		)	(2,393		)
Accounts payable		(1,383		)	(5,523		)
Income and other taxes		(501		)	1,125
Accrued expenses		4,257			4,506
Unearned franchise and development fees		(360		)	(633		)
Net cash provided by operating activities from continuing operations		66,271			61,505
Operating cash flows from discontinued operations		414			1,793
Net cash provided by operating activities		66,685			63,298
Investing activities
Purchase of property and equipment		(26,606		)	(9,974		)
Proceeds from sale of property and equipment		69			47
Purchase of investments		(2,014		)	(6,597		)
Proceeds from sale or maturity of investments		5,599			7,773
Loans to franchisees and affiliates		(5,008		)	(3,085		)
Loan repayments from franchisees and affiliates		6,848			6,414
Acquisitions		(18,858		)	—
Proceeds from divestiture of discontinued operations		8,020			—
Net cash used in investing activities		(31,950		)	(5,422		)
Financing activities
Net proceeds (repayments) from line of credit facility		500			(42,500		)
Net repayments from short-term debt — variable interest entities		(2,075		)	(1,325		)
Proceeds from issuance of common stock		—			1,000
Excess tax benefit related to exercise of non-qualified stock options		5,717			—
Proceeds from exercise of stock options		13,134			34,908
Acquisition of common stock		(63,969		)	(36,824		)
Other		177			(352		)
Net cash used in financing activities		(46,516		)	(45,093		)
Effect of exchange rate changes on cash and cash equivalents		78			(124		)
Change in cash and cash equivalents		(11,703		)	12,659
Cash and cash equivalents at beginning of period		22,098			14,698
Cash and cash equivalents at end of period		$	10,395		$	27,357

 

See accompanying notes.

 

5

Papa John’s International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(Unaudited)

September 24, 2006

1.              Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the nine months ended September 24, 2006, are not necessarily indicative of the results that may be expected for the year ended December 31, 2006. For further information, refer to the consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K for Papa John’s International, Inc. (referred to as the “Company”, “Papa John’s” or in the first person notations of “we”, “us” and “our”) for the year ended December 25, 2005.

Our significant interim accounting policies include the recognition of income taxes using an estimated annual effective income tax rate. The Company finalized certain income tax examination issues during the third quarter of 2006, which reduced the effective income tax rate to 33.8% and 36.1% for the three- and nine-month periods ended September 24, 2006, respectively.

2.              Two-for-One Common Stock Split

In December 2005, our Board of Directors approved a two-for-one stock split of our outstanding shares of common stock. The stock split was effected in the form of a stock dividend and entitled each shareholder of record at the close of business on December 23, 2005 to receive one additional share for every outstanding share of common stock held on the record date. The stock dividend was distributed on January 13, 2006 with approximately 16.5 million shares of common stock distributed. All per share and share amounts in the accompanying condensed consolidated financial statements and notes to the financial statements have been adjusted to reflect the stock split.

In conjunction with the stock split, we retired all shares held in treasury as of December 23, 2005.

3.              New Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 addresses the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. In addition, FIN 48 expands the disclosure requirements concerning unrecognized tax benefits as well as any significant changes that may occur in the next twelve months associated with such unrecognized tax benefits. FIN 48 is effective for the Company in fiscal 2007. We have not determined the impact, if any, of adopting FIN 48.

In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements. SFAS No. 157 requires companies to determine fair value based on the price that would be received to sell the asset or paid to transfer the liability to a market participant. SFAS No. 157 emphasizes that fair value is a market-based measurement; not an entity-specific measurement. The effective date of SFAS No. 157 will be the first quarter of 2008. We have not determined the impact, if any, of adopting SFAS No. 157.

6

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4.              Discontinued Operations

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

We have classified our Perfect Pizza operations as discontinued operations in the accompanying financial statements. The following summarizes the results of the discontinued operations for the three and nine months ended September 24, 2006 and September 25, 2005 (in thousands, except per share data):

		Three Months Ended						Nine Months Ended
		Sept. 24,			Sept. 25,			Sept. 24,			Sept. 25,
		2006			2005			2006			2005
Net sales		$	—		$	3,235		$	2,421		$	10,431
Operating expenses		—			2,104			1,449			6,670
G&A expenses		—			408			330			1,261
Other expenses		—			72			25			228
Income before income taxes		—			651			617			2,272
Income tax expense		—			241			228			841
Net income from discontinued operations		$	—		$	410		$	389		$	1,431
Basic earnings per common share		$	—		$	0.01		$	0.01		$	0.04
Earnings per common share—assuming dilution		$	—		$	0.01		$	0.01		$	0.04

 

5.              Acquisitions

Effective July 24, 2006, we completed the acquisition of 43 franchised Papa John’s restaurants located in the Phoenix and Flagstaff, Arizona markets. The purchase price was $17.7 million, which was paid in cash and is subject to post-closing adjustments, of which approximately $14.2 million was recorded as goodwill.

Effective September 25, 2006 (the beginning of our fourth quarter), we completed the acquisition of 11 franchised Papa John’s restaurants located in the Raleigh, North Carolina market. The purchase price was approximately $8.8 million, which was paid in cash. The allocation of purchase price, including the amount assigned to goodwill, will be completed during the fourth quarter of 2006.

The business combinations in the previous paragraphs were accounted for by the purchase method of accounting, whereby operating results subsequent to the acquisition date are included in our consolidated financial results. The acquisitions are not expected to significantly impact operating income for the remainder of 2006 as transition costs are expected to substantially offset incremental unit level income.

6.              Accounting for Variable Interest Entities

The FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (FIN 46), which provides a framework for identifying variable interest entities (“VIEs”) and determining when a company should include the assets, liabilities, non-controlling interests and results of activities of a VIE in its consolidated financial statements.

7

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

FIN 46 requires a VIE to be consolidated if a party with an ownership, contractual or other financial interest in the VIE (“a variable interest holder”) is obligated to absorb a majority of the risk of loss from the VIE’s activities, is entitled to receive a majority of the VIE’s residual returns (if no party absorbs a majority of the VIE’s losses), or both. A variable interest holder that consolidates the VIE is called the primary beneficiary. Upon consolidation, the primary beneficiary generally must initially record all of the VIE’s assets, liabilities and non-controlling interests at fair value and subsequently account for the VIE as if it were consolidated based on majority voting interest. FIN 46 also requires disclosures about VIEs that the variable interest holder is not required to consolidate but in which it has a significant variable interest.

We have a purchasing arrangement with BIBP Commodities, Inc. (“BIBP”), a special-purpose entity formed at the direction of our Franchise Advisory Council in 1999 for the sole purpose of reducing cheese price volatility to domestic system-wide restaurants. BIBP is an independent, franchisee-owned corporation. BIBP purchases cheese at the market price and sells it to our distribution subsidiary, PJ Food Service, Inc. (“PJFS”), at a fixed quarterly price based in part upon historical average market prices. PJFS in turn sells cheese to Papa John’s restaurants (both Company-owned and franchised) at a set quarterly price. PJFS purchased $34.0 million and $105.9 million of cheese from BIBP for the three and nine months ended September 24, 2006, respectively, and $37.1 million and $111.5 million of cheese for the comparable periods in 2005, respectively.

As defined by FIN 46, we are the primary beneficiary of BIBP, a VIE, and we began consolidating the balance sheet of BIBP as of December 28, 2003. We recognize the operating losses generated by BIBP if BIBP’s shareholders’ equity is in a net deficit position. Further, we will recognize the subsequent operating income generated by BIBP up to the amount of any losses previously recognized. We recognized pre-tax income of $5.3 million ($3.0 million net of tax, or $0.09 per share) and $17.0 million ($10.4 million net of tax, or $0.31 per share) for the three and nine months ended September 24, 2006, respectively, and pre-tax income of $3.0 million ($1.9 million net of tax, or $0.11 per share) and $1.3 million ($797,000 net of tax, or $0.05 per share) for the comparable periods in 2005, respectively, from the consolidation of BIBP. The impact on future operating income from the consolidation of BIBP is expected to continue to be significant for any given reporting period due to the noted volatility of the cheese market, but is not expected to be cumulatively significant over time.

BIBP has an $18.0 million line of credit with a commercial bank, which is not guaranteed by Papa John’s. Papa John’s has agreed to provide additional funding in the form of a loan to BIBP. As of September 24, 2006, BIBP had outstanding borrowings of $4.0 million and a letter of credit of $3.0 million outstanding under the commercial line of credit facility.

In addition, Papa John’s has extended loans to certain franchisees. Under FIN 46, Papa John’s is deemed the primary beneficiary of two franchise entities as of September 24, 2006 and three franchise entities as of December 25, 2005, even though we had no ownership in them. During the third quarter, one of the franchisees, with seven restaurants and approximate annual revenues of $4.0 million, sold its restaurants to a third party. The loan from Papa John’s was partially repaid and the remainder was written off in connection with the sale. The portion of the loan written off in connection with the third quarter sale was fully reserved as of the end of the second quarter. Accordingly, the financial statements exclude the operating results of this entity for the third quarter of 2006 as well as the financial position of this entity as of September 24, 2006.

The two remaining entities operate a total of seven restaurants with annual revenues approximating $5.0 million. Our net loan balance receivable from these entities is $555,000 at September 24, 2006, with no further funding commitments. The consolidation of these franchise entities has had no significant impact on Papa John’s operating results and is not expected to have a significant impact in future periods.

 

8

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The following table summarizes the balance sheets for our consolidated VIEs as of September 24, 2006 and December 25, 2005:

		September 24, 2006									December 25, 2005
(In thousands)		BIBP			Franchisees			Total			BIBP			Franchisees			Total
Assets:
Cash and cash equivalents		$	1,799		$	78		$	1,877		$	—		$	174		$	174
Accounts receivable		—			9			9			—			30			30
Accounts receivable—Papa John’s		4,569			—			4,569			5,484			—			5,484
Other assets		858			36			894			1,315			435			1,750
Net property and equipment		—			472			472			—			1,195			1,195
Goodwill		—			460			460			—			460			460
Deferred income taxes		1,063			—			1,063			7,153			—			7,153
Total assets		$	8,289		$	1,055		$	9,344		$	13,952		$	2,294		$	16,246
Liabilities and stockholders’ equity (deficit):
Accounts payable and accrued
expenses		$	5,744		$	153		$	5,897		$	6,693		$	440		$	7,133
Income and other taxes		66			—			66			—			—			—
Short-term debt—third party		4,025			—			4,025			6,100			—			6,100
Short-term debt—Papa John’s		—			555			555			13,053			1,532			14,585
Total liabilities		9,835			708			10,543			25,846			1,972			27,818
Stockholders’ equity (deficit)		(1,546		)	347			(1,199		)	(11,894		)	322			(11,572		)
Total liabilities and stockholders’ equity (deficit)		$	8,289		$	1,055		$	9,344		$	13,952		$	2,294		$	16,246

 

7.              Debt

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

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

 

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8.   Calculation of Earnings Per Share

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

		Three Months Ended						Nine Months Ended
		Sept. 24, 2006			Sept. 25, 2005			Sept. 24, 2006			Sept. 25, 2005
Basic earnings per common share:
Income from continuing operations		$	13,108		$	10,403		$	43,987		$	30,217
Weighted average shares outstanding		31,957			34,432			32,556			33,648
Basic earnings per common share		$	0.41		$	0.30		$	1.35		$	0.90
Earnings per common share—assuming dilution:
Income from continuing operations		$	13,108		$	10,403		$	43,987		$	30,217
Weighted average shares outstanding		31,957			34,432			32,556			33,648
Dilutive effect of outstanding common stock options		626			612			740			584
Diluted weighted average shares outstanding		32,583			35,044			33,296			34,232
Earnings per common share—assuming dilution		$	0.40		$	0.30		$	1.32		$	0.88

 

9.   Stock-Based Compensation

We award stock options from time to time under the Papa John’s International, Inc. 1999 Team Member Stock Ownership Plan (the “1999 Plan”) and the Papa John’s International, Inc. 2003 Stock Option Plan for Non-Employee Directors (the “Directors Plan”) and other such agreements as may arise. Shares of common stock authorized for issuance under the 1999 Plan are approximately 6.3 million, which includes shares transferred in from the Papa John’s International, Inc. 1993 Stock Ownership Incentive Plan (the “1993 Plan”), which terminated on April 15, 2003, and 700,000 shares under the Directors Plan. Options granted prior to 2003 generally expire ten years from the date of grant and vest over one to five-year periods, except for certain options awarded under a previous, multi-year operations compensation program that vested immediately upon grant. The options granted in 2003 and 2004 under the 1999 Plan and the Directors Plan generally expire 30 months from the date of grant and vest over a 12-month period. Options granted in 2005 and 2006 generally expire five years from the date of grant and vest over a 24-month period. Options to purchase 608,000 shares were granted during the first nine months of 2006.

Effective at the beginning of fiscal 2002, we elected to expense the cost of employee stock options in accordance with the fair value method contained in SFAS No. 123, Accounting and Disclosure of Stock-Based Compensation. Under SFAS No. 123, the fair value for options is estimated at the date of grant using a Black-Scholes-Merton (“Black-Scholes”) option-pricing model, which requires the input of highly subjective assumptions including the expected stock price volatility. The election was effective as of the beginning of fiscal 2002 and applies to all stock options issued after the effective date.

In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment, which is a revision of FASB Statement No. 123. As required, we adopted the provisions of SFAS No. 123(R) effective at the beginning of our fiscal 2006, using the modified-prospective method. Upon adoption of SFAS No. 123(R), we elected to continue using the Black-Scholes option-pricing model. If we had adopted SFAS No. 123(R) in prior years, the impact on our 2005 operating income of that standard would have been minimal. SFAS No. 123(R) requires the benefit of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow in the accompanying consolidated statements of cash flows. Operating income and cash flow operating results for 2005 have not been restated for the adoption of SFAS No. 123(R).

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We recorded stock-based employee compensation expense, net of tax effects, of $748,000 and $1.9 million for the three and nine months ended September 24, 2006, respectively, and $456,000 and $1.0 million for the comparable periods in 2005, respectively. At September 24, 2006, there was $5.5 million of unrecognized compensation cost related to nonvested option awards, of which the Company expects to recognize $1.4 million during the remainder of 2006, $3.2 million in 2007 and $850,000 in 2008.

During the nine months ended September 24, 2006 and September 25, 2005, options for a total of 893,000 and 2.4 million shares were exercised, respectively. The total intrinsic value of the options exercised during the nine months ended September 24, 2006 and September 25, 2005 was $16.2 million and $13.1 million, respectively. Cash received upon the exercise of stock options was $13.1 million and $34.9 million during the nine months ended September 24, 2006 and September 25, 2005 and the related tax benefits realized were $6.0 million and $4.8 million during the corresponding periods.

The weighted average fair values per option at the date of grant for options granted in the first nine months of 2006 and 2005 were $8.95 and $4.44, respectively, as valued using the Black-Scholes option-pricing model with the following weighted average assumptions:

 

The estimated volatility is based on the historical volatility of our stock and other factors. The expected term of options represents the period of time that options granted are expected to be outstanding. The risk-free rate for the periods within the contractual life of an option is based on the U.S. Treasury yield curve in effect at the time of grant.

Information pertaining to option activity for the nine months ended September 24, 2006 is as follows (number of options and aggregate intrinsic value in thousands):

		Number of Options		Weighted Average Exercise Price			Weighted Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value
Outstanding-beginning of year		3,185		$	16.09
Granted		608		32.69
Exercised		893		14.70
Cancelled		99		21.71
Outstanding at September 24, 2006		2,801		$	19.96		3.29		$	42,964	*
Exercisable at September 24, 2006		944		$	15.07				$	19,094	*

 

*                    The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option. The market value of our stock was $35.30 at September 24, 2006.

 

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The number, weighted average exercise price and weighted average remaining contractual life of options outstanding as of September 24, 2006, and the number and weighted average exercise price of options exercisable as of September 24, 2006 follow (number of options in thousands):

		Range of Exercise Prices			Number of Options		Weighted Average Exercise Price			Weighted Average Remaining Life
Outstanding options:		$	11.13 – $14.99		363		$	12.16		3.34
		15.00 – 17.99			1,479		16.80			2.86
		18.00 – 29.99			372		20.03			2.94
		30.00 – 34.45			587		32.69			4.59
Total					2,801		$	19.96		3.29
Exercisable options:		$	11.13 – $14.99		362		$	12.15
		15.00 – 17.99			390		15.47
		18.00 – 34.45			192		19.75
Total					944		$	15.07

 

Activity related to unexercisable options as of September 24, 2006 is summarized as follows (number of options in thousands):

 

During the first nine months of 2006, we granted options for 608,000 shares to employees and the non-employee members of our Board of Directors with a five-year life, a two-year vesting period and an estimated fair value of $8.95 per option share. In addition, during the second quarter of 2006, we granted approximately 28,000 shares of performance-based restricted stock to employees with a performance period of three years.

10.   Comprehensive Income

Comprehensive income is comprised of the following:

		Three Months Ended						Nine Months Ended
(In thousands)		Sept. 24, 2006			Sept. 25, 2005			Sept. 24, 2006			Sept. 25, 2005
Net income		$	13,108		$	10,813		$	44,376		$	31,648
Change in valuation of swap agreement, net of tax		(939		)	174			253			852
Other, net		332			(57		)	835			(142		)
Comprehensive income		$	12,501		$	10,930		$	45,464		$	32,358

 

 

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