UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-K

(Mark One)

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

 

For the fiscal year ended December 31, 2006

OR

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

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 40299-2334

(Address of principal executive offices)

(502) 261-7272

(Registrant’s telephone number, including area code)

 

Indicate by check mark if the registrant is a wellknown 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. o

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

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b2 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 25, 2006, was approximately $756,679,114.

As of February 20, 2007 there were 29,921,643 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 May 10, 2007.

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

 

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”. At December 31, 2006, the Company and its franchisees operated domestically in 49 states, the District of Columbia and Puerto Rico and in 26 countries. The first Company-owned Papa John’s restaurant opened in 1985 and the first franchised restaurant opened in 1986. We acquired Perfect Pizza Holdings Limited (referred to as “Perfect Pizza” and “Papa John’s UK”) in 1999 as part of our plan to develop restaurants internationally (see “Development”). In March 2006, the Company sold its Perfect Pizza operations, consisting of the franchised units and related distribution operations. At December 31, 2006, there were 3,015 Papa John’s restaurants in operation, consisting of 588 Company-owned and 2,427 franchised restaurants.

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 22” of “Notes to Consolidated Financial Statements” for financial information about these segments for the years ended December 31, 2006, December 25, 2005 and December 26, 2004.

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. 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.

Strategy

Our goal is to build the strongest brand loyalty of all pizzerias internationally. 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 pizza and canned or bottled soft drinks. 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 broader than in our domestic operations to meet local tastes and customs.

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We have offered a thin crust pizza since 1999. In 2005, we introduced Papa’s Perfect Pan Pizza, which features a square, thick buttery-tasting crust made with olive oil, and a zesty robusto pizza sauce with chunks of tomato and flavored with garlic, Italian herbs and spices. Both the thin and pan crusts are par-baked products produced by third-party vendors. Each traditional crust and pan 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. In international markets, the menu mix (toppings and side items) is adapted to local tastes.

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. Our management compensation program is designed to attract and retain highly motivated people.

Marketing. Our marketing strategy consists of both national and local components. Our domestic national strategy includes national advertising on television and via the internet. Seven national television campaigns aired in 2006. Our local restaurant-level marketing programs target consumers within the delivery area of each restaurant, extensively using 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 a five-year marketing and partnership agreement with Six Flags theme parks, which provides for cross-marketing activities. We will continue to explore additional cross-marketing opportunities with third-party companies. In the international markets, our marketing strategy consists of targeting 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 include using 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, partnering with 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 seasoned 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.

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Unit Economics

In 2006, the 485 domestic Company-owned restaurants included in the full year’s comparable restaurant base generated average annual sales, based on a 53-week year, of $865,000, average cash flow (restaurant operating income plus depreciation) of $198,000 and average restaurant operating income of $175,000. Average cash flow and average restaurant operating income includes food costs as purchased directly from suppliers (i.e. excludes margin earned by our QC Centers). This average operating income represents 20.2% of average sales and the average cash flow represents 74.4% of the $266,000 average investment in property and equipment for these Company-owned restaurants.

The average cash investment for the 19 domestic Company-owned restaurants opened during the 2006 fiscal year, exclusive of land, was approximately $249,000. We expect the average cash investment for the 20 to 25 domestic Company-owned restaurants expected to open in 2007 to be approximately $250,000. Substantially all domestic restaurants do not offer dine-in areas, which reduces our restaurant capital investment.

Development

A total of 211 Papa John’s restaurants were opened during 2006, consisting of 20 Company-owned (19 domestic and one international) and 191 franchised restaurants (105 domestic and 86 international), while 122 Papa John’s restaurants closed during 2006, consisting of one domestic Company-owned and 121 franchised restaurants (65 domestic and 56 international, 34 of which were in Mexico in response to the termination of the master franchise agreement with the previous master franchisee).

During 2007, we plan to open approximately 35 to 40 Company-owned restaurants (20 to 25 domestically and 15 internationally) and expect franchisees to open approximately 240 to 260 restaurants (130 to 145 domestically and 110 to 115 internationally). We also expect approximately 50 Papa John’s restaurants to close during 2007, 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 and Asia. We expect our expansion in Asia to include a significant focus in China, Korea and India.

Our Company-owned expansion strategy is to continue to open domestic restaurants in existing markets, thereby increasing consumer awareness and enabling us to take advantage of operational and advertising efficiencies. Our experience in developing markets indicates that market penetration through the opening of multiple restaurants within 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. During 2006, we purchased 57 domestic Papa John’s franchised restaurants. We continually evaluate the number and market areas of our Company-owned restaurants and expect to purchase additional Papa John’s restaurants during 2007. We also are partners in two domestic joint ventures operating Papa John’s restaurants and may consider entering into more of these arrangements in the future.

We implemented a “buy and build” strategy in one large metropolitan market in late 2005.  Under this strategy, the Company will purchase franchised restaurants in an under-penetrated or emerging domestic market with the intention of building additional Company-owned restaurants to increase market awareness.  We plan to explore implementing this strategy in other markets, including the possible use of joint venture partners.

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During 2006, we also completed the acquisition of five restaurants and a QC Center in Beijing, China. We plan to build approximately 25 additional restaurants in this market over the next several years.

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. Most of our international Papa John’s restaurants are between 900 and 1400 square feet; however, several international restaurants have been opened in larger spaces to include dine-in and restaurant-based delivery service, which average 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, household income levels 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.

A number of freestanding restaurants have been opened in the Papa John’s system. We seek either existing buildings suitable for conversion, or locations suitable for the construction of our prototype restaurant. At December 31, 2006, freestanding units represented approximately 21% of domestic Company-owned restaurants, and a relatively small percentage of domestic franchised restaurants. We do not expect to add a significant number of domestic freestanding restaurants in the future.

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.

We have designed a re-image package for the interior of our domestic restaurants. During 2006, we completed the re-imaging of 455 Company-owned restaurants at a total cost of approximately $1.7 million. Franchisees are generally required to re-image their restaurants when they renew their franchise agreement and when a restaurant is transferred to a new owner. We also offer the re-image package to all franchisees on an elective basis.

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

Our domestic QC Centers, comprised of ten regional production and distribution centers in 2006, 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 unit development for the next several years.

Our subsidiary, Papa John’s UK (“PJUK”), leased a distribution center in the United Kingdom until it was sold in March 2006. Our PJUK subsidiary presently purchases its products from our previously owned distribution center. In addition, we acquired full-service QC Centers in Mexico City, Mexico and Beijing, China in 2006. 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 seasoned 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 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. Under this arrangement, PJFS purchases cheese 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 via adjustments to the selling price over time. Ultimately, PJFS purchases cheese at a price approximating the actual average market price, but with more predictability and less price volatility. 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 5” 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 given 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

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(the 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 2.6% during 2006, 2.25% during 2005, 3.25% for the period June through December 2004 and 2.0% from January through May 2004. Effective at the beginning of fiscal 2007, the contribution percentage to the Marketing Fund increased to 2.7% and is expected to remain at that level throughout 2007.

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, which provides for 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 via the internet, including a new “plan ahead ordering” advance ordering feature and Spanish language ordering capability. 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.

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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 individually responsible for the management of approximately 100 Company-owned restaurants in specific geographic regions. The operations vice presidents report to one of four division vice presidents. These team members are eligible to earn performance-based financial incentives.

Training and Education. The Operations Support Services and Training 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 and in several of our international markets. 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 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. This enables Papa John’s to offer nationwide online ordering to our customers.

Reporting.  Management at Company-owned restaurants reviews and evaluates daily reports of sales, cash deposits and operating costs.  Physical inventories of all food and beverage items are taken nightly.

Joint Ventures. We operate 117 Company-owned restaurants under two joint venture arrangements. Under the first arrangement, we own 70% of 38 Papa John’s restaurants located in Virginia and Maryland. Under the second arrangement, we own 51% of 79 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 31, 2006, there were 2,427 franchised Papa John’s restaurants operating in 49 states, the District of Columbia, Puerto Rico and 26 countries. As of December 31, 2006, we have development agreements with our franchisees for approximately 300 additional domestic franchised restaurants committed to open through 2013 and agreements for 847 additional international

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franchised restaurants to open through January 2016. 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 2006, 191 (105 domestic and 86 international) franchised Papa John’s restaurants were opened. Our franchisees converted 62 Perfect Pizza restaurants to Papa John’s restaurants from 2000 until March 2006, the date of the sale of Perfect Pizza.

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 the franchisee either 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.

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.  Under our current standard development agreement, the franchisee is required to pay, at the time of signing the agreement, a non-refundable fee of $25,000 for the first restaurant and $5,000 for any additional restaurants. The non-refundable fee is credited against the standard $25,000 franchise fee payable to us upon signing the franchise agreement for a specific location. Generally, a franchise agreement is executed when a franchisee secures a location.

Our standard domestic franchise agreement provides for a term of ten years (with one ten-year renewal option) and payment to us of a royalty fee of 4% of sales. Substantially all existing franchise agreements permit us to increase the royalty fee up to 5% of sales. The royalty fee cannot be increased to an amount greater than the percentage royalty fee then in effect for new franchisees.

We have the right to terminate a franchise agreement for a variety of reasons, including a franchisee’s failure to make payments when due or failure to adhere to our policies and standards. Many state franchise laws limit the ability of a franchisor to terminate or refuse to renew a franchise.

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. The remaining terms applicable to the operation of individual restaurants are substantially equivalent to the terms of our standard domestic franchise agreement. From time to time, development agreements will be negotiated at other than standard terms for fees and royalties.

We have entered into a limited number of development and franchise agreements for non-traditional restaurants.  During 2006, we added internal resources in order to expand these types of restaurants. As

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an example, during 2006, 17 franchised units opened in Six Flags theme parks as a part of our five-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 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 franchisees may purchase complete new store equipment packages through an approved third-party supplier. Internationally, our franchisees buy their equipment from approved third-party suppliers.

Franchisee Loans. Selected franchisees have borrowed funds from our subsidiary, Capital Delivery, Ltd., principally for use in the construction and development of their restaurants. We have also entered into loan agreements with certain franchisees that purchased restaurants from us or other franchisees. 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 the ownership interests in the franchisee. At December 31, 2006, loans outstanding totaled $12.1 million, which were composed of $7.3 million of loans to franchisees and a loan balance of $4.8 million with the purchaser of our Perfect Pizza operations. See “Note 11” of “Notes to Consolidated Financial Statements” for additional information.

We have a commitment to lend up to $17.6 million to BIBP, a franchisee-owned corporation, but there was no outstanding balance at December 31, 2006. See “Notes 5 and 11” 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”) located 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, this new agreement eliminates our risk of loss for franchise insurance coverage written after September 2004. As of December 31, 2006, approximately 50% of domestic franchised restaurants had obtained insurance coverage through Risk Services. See “Note 12” of “Notes to Consolidated Financial Statements” for additional information concerning the Captive.

Franchise Training and Support. The 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 an on-site training crew 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

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deliver Company-approved programs in order to train new team members and management candidates for their restaurants. Our FBD’s maintain open communication with the franchise community, relaying operating and marketing information and new ideas between franchisees and us. Internationally, training is monitored by our international director of training as well as regional vice presidents and international business managers assigned to specific franchisee territories. We also maintain communications with our franchisees through periodic system-wide meetings, newsletters and regional or national conference calls.

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 domestically owned restaurants. The Franchise Advisory Council and subcommittees hold regular meetings to discuss new marketing ideas, operations, growth and other relevant issues. A task force appointed by the Franchise Advisory Council has been working with management to address proposed modifications to the current franchise agreement. In addition, the Company is aware that 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 and participation in an operators’ exchange best practices forum in which numerous franchisees also participate. Monthly web conferences 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, 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”).

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 billion in 2006, of which Papa John’s share was reported at 5.4%. 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

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strategies of one or more of our competitors could have an adverse impact on our sales and earnings. Additionally, a continued increased emphasis on drive-through, carryout and curbside pickup availability by casual dining restaurants, such as Applebee’s and Outback Steakhouse, as well as improved quality of fresh and frozen supermarket offerings, could also have an adverse impact on our sales and earnings.

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 offering circular 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 “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 31, 2006, we employed 14,743 persons, of whom 12,734 were restaurant team members, 653 were restaurant management personnel, 602 were corporate personnel and 754 were QC Center and support services 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

This Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”), including information within Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following cautionary statements are being made pursuant to the provisions of the Act and with the intention of obtaining the benefits of the “safe harbor” provisions of the Act. 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:

1.               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, litigation, selection and availability of suitable restaurant locations, increases in the cost of or sustained high levels of cost of food, paper, utilities, fuel, employee compensation and benefits, insurance and similar costs, 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.

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

3.               An increase in 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 seasonal 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.

4.               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.

5.               Health- or disease-related disruptions or consumer concerns about the commodity supply or the Company’s food products could negatively impact the availability and/or cost of commodities and adversely impact restaurant operations and our financial results.

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6.               System-wide restaurant operations are subject to federal and state laws governing such matters as wages, 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 minimum wage.  Accordingly, the pending legislation to increase the federal minimum wage and any 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, labor shortages in various markets could result in higher required wage rates. Local government agencies have also implemented ordinances which restrict the sale of certain food products. Additional local government ordinances could be harmful to system-wide restaurant sales.

7.               Any or all of the factors listed in 1. through 6. 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.

8.               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.

9.               Domestic franchisees are only required to purchase seasoned sauce and dough from our QC Centers and changes in purchasing practices by domestic franchisees could adversely affect the financial results of our QC Centers.

10.         Beginning in October 2004, a third-party commercial insurance company began providing fully-insured coverage to franchisees participating in our franchise insurance program, thus eliminating our risk of loss for franchise insurance coverage written after September 2004. However, with respect to self-insurance coverage by our captive insurance company prior to October 2004, the Captive’s relatively immature claims history limits the predictive value of estimating the costs of incurred and future claims; accordingly, our operating income is subject to potential significant adjustments for changes in estimated insurance reserves for policies written from the Captive’s inception in October 2000 through September 2004.

11.         Our domestic and 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 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 31, 2006, there were 3,015 Papa John’s restaurants system-wide.

Company-owned Papa John’s Restaurants

(a) The three Company-owned restaurants in Mexico were sold in January 2007.

Note: Company-owned Papa John’s restaurants include restaurants owned by majority-owned joint ventures. There were 117 such restaurants at December 31, 2006 (79 in Texas, 25 in Virginia and 13 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.

Approximately 45 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. Three of these restaurants are located in multi-bay facilities. These multi-bay facilities contain from 2,800 to 5,000 square feet, and the

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space not utilized by the Papa John’s restaurant in each facility is leased or held for lease to third-party tenants.

At December 31, 2006, we had 85 Papa John’s restaurants located in the United Kingdom (82 franchised and three Company-owned). In addition to leasing the three Company-owned restaurant sites, we lease and sublease to franchisees 65 of the 82 franchised Papa John’s restaurant sites and 36 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 five Company-owned restaurant sites in Beijing and three Company-owned restaurant sites in Mexico as of December 31, 2006.

Information with respect to our leased domestic QC Centers as of December 31, 2006 is set forth below:

 

We own approximately five acres in Orlando, Florida on which our 63,000 square foot full-service commissary is located. We also own eight acres and a 175,000 square foot facility in Dallas, Texas, of which 77,500 square feet is used by our full-service commissary and the remaining space is leased to a third-party tenant. In addition, we own approximately 72 acres in Louisville, Kentucky with 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 promotional division. The remainder of the building houses our corporate offices.

The Papa John’s UK management team is located in 6,000 square feet of leased office space near London with a remaining lease term of nine years.

The Papa John’s China management team leases 4,822 square feet of office space and a QC Center located in a 6,135 square foot facility in Beijing, China. The Papa John’s Mexico management team and QC Center lease a 4,088 square foot facility in Mexico City, Mexico.

Item 3.  Legal Proceedings

We are subject to claims and legal actions in the ordinary course of our business. We believe that all such claims and actions currently pending against us would not 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		45		Founder and Executive Chairman		1985
Nigel Travis		57		President and Chief Executive Officer		2005
Robb S. Chase		48		President, International		2006
Richard J. Emmett		51		Senior Vice President, General Counsel and Secretary		1992
J. David Flanery		49		Senior Vice President, Chief Financial Officer and Treasurer		1994
Julie L. Larner		46		Senior Vice President and President — PJ Food Service, Inc.		2001
Peter McCue		52		Senior Vice President, People		2006
William M. Mitchell		42		Senior Vice President, Domestic Operations		2007
Timothy C. O’Hern		43		Senior Vice President, Development		2005
Charles W. Schnatter		44		Senior Vice President and Chief Development Officer		1991
William M. Van Epps		58		President, USA		2002

(a) Ages are as of January 1, 2007.

John H. Schnatter created the Papa John’s concept and founded Papa John’s in 1985. He has served as Executive Chairman since April 2005. From 1990 to April 2005, he served as Chairman of the Board and Chief Executive Officer and as President from 1985 to 1990 and from January 2001 to April 2005.

Nigel Travis has served as President and Chief Executive Officer since April 1, 2005 after joining Papa John’s in January 2005 as Executive Vice President. He also serves as a member of our Board of Directors. Prior to joining Papa John’s, Mr. Travis held various leadership positions at Blockbuster, Inc., from 1994 to 2004, most recently as President and Chief Operating Officer. From 1985 to 1994, Mr. Travis served in various capacities for Grand Metropolitan PLC (London, England), including leadership positions at Burger King Corporation for five years. Mr. Travis is the lead director of the Bombay Company, Inc.

Robb S. Chase has served as President, International since August 2006. From 2003 to 2005, Mr. Chase served as President and Chief Executive Officer of Famous Players, Inc., a theatrical exhibition companylocated in Canada and an operating division of Viacom, Inc. From 2000 to 2003, he served as Famous

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Players’ President and Chief Operating Officer. Mr. Chase held various senior management positions with Tricon Restaurants International from 1990 to 2000.

Richard J. Emmett has served as Senior Vice President and General Counsel since March 2002, after serving as Senior Vice President and Senior Counsel since March 1997, and has served as Secretary since October 2005. Mr. Emmett is responsible for our legal and risk management departments. Mr. Emmett also served as Senior Vice President of Development from August 1996 to March 1997. From 1992 to 1996, Mr. Emmett held the position of Vice President and Senior Counsel.  From 1983 to 1992, Mr. Emmett was an attorney with the law firm of Greenebaum Doll & McDonald PLLC, having become a partner of the firm in 1989.  Mr. Emmett has been a franchisee since 1992.

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 its Vice President of Finance and Administration from 1998 to 2001.

Peter McCue has served as Senior Vice President, Human Resources since October 2006. Prior to joining Papa John’s, Mr. McCue served as Senior Vice President, Human Resources for Spectrum Brands, a global manufacturer and marketer of consumer products from January 2005 to June 2006. Prior to that, Mr. McCue held several senior-level human resources positions with Hewlett-Packard, including Vice President, Human Resources for the personal systems group after its 2001 merger with Compaq Computer Corp. Mr. McCue also spent 17 years with Motorola, Inc. during two separate stints with the company.

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

Timothy C. O’Hern rejoined Papa John’s in early 2005 as Senior Vice President, Development, after spending two years managing the operations of a Papa John’s franchisee in which he has an ownership interest. Prior to his departure from Papa John’s in 2002, Mr. O’Hern held various positions, including Vice President of Global Development from February 2001 to 2002, Vice President of U.S. Development from March 1997 to February 2001, Director of Franchise Development from December 1996 to March 1997 and Construction Manager from November 1995 to December 1996. He has been a franchisee since 1993.

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 March 2002. From 1988 to 1991, he was an attorney with Greenebaum Doll & McDonald PLLC. Mr. Schnatter has been a franchisee since 1989.

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William M. Van Epps has served as President, USA since May 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.

John and Charles Schnatter are brothers. There are no other family relationships among the executive officers and other key personnel.

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 20, 2007, there were approximately 796 record holders of common stock. However, there may be 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. All sales prices have been adjusted to reflect a two-for-one split of the Company’s 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 of approximately 16.5 million shares of common stock was distributed on January 13, 2006.

2006		High			Low
First Quarter		$	35.15		$	29.66
Second Quarter		34.84			29.68
Third Quarter		36.56			30.54
Fourth Quarter		37.80			28.85

 

2005		High			Low
First Quarter		$	18.28		$	15.81
Second Quarter		20.36			16.99
Third Quarter		24.64			19.71
Fourth Quarter		29.98			24.74

 

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 $675.0 million of common stock under a share repurchase program that began December 9, 1999, and runs through December 30, 2007. Through December 31, 2006, a total of 38.1 million shares with an aggregate cost of $602.2 million and an average price of $15.80 per share have been repurchased under this program. Subsequent to year-end (through February 20, 2007), we acquired an additional 793,000 shares at an aggregate cost of $22.9 million. As of February 20, 2007, approximately $50.0 million of common stock remains available for repurchase of common stock under this authorization.

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The following table summarizes our repurchase activity by fiscal period during 2006 (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
12/26/2005 - 01/22/2006		58		$	30.11		34,758		$	177,393
01/23/2006 - 02/19/2006		63		$	32.39		34,821		$	175,335
02/20/2006 - 03/26/2006		595		$	30.77		35,416		$	157,027
03/27/2006 - 04/23/2006		221		$	32.26		35,637		$	149,897
04/24/2006 - 05/21/2006		207		$	33.29		35,844		$	143,017
05/22/2006 - 06/25/2006		500		$	31.18		36,344		$	127,407
06/26/2006 - 07/23/2006		217		$	31.82		36,561		$	120,521
07/24/2006 - 08/20/2006		128		$	32.25		36,689		$	116,398
08/21/2006 - 09/24/2006		36		$	33.61		36,725		$	115,166
09/25/2006 - 10/22/2006		—	*	—			36,725		$	115,166
10/23/2006 - 11/19/2006		328		$	31.27		37,053		$	104,901
11/20/2006 - 12/31/2006		1,052		$	30.50		38,105		$	72,843

*There were no share repurchases during this period.

Our share repurchase authorization increased from $525.0 million to $575.0 million in April 2006, increased to $625.0 million in November 2006 and increased to $675.0 million in February 2007. For presentation purposes, the maximum dollar value of shares that may be purchased was adjusted retroactively to December 26, 2005.

In connection with a two-for-one stock dividend issued to shareholders of record as of December 23, 2005, we retired all shares held in treasury at that date. Common shares repurchased after December 23, 2005 are held in treasury.

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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 2006. 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 2001, and, with respect to the index and peer group, that all dividends were reinvested.

Comparison of Five-Year Cumulative Total Returns
Performance Graph for
Papa John’s International, Inc.

 

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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 31, 2006 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.

(In thousands, except per share data)		Year Ended (1)
		Dec. 31,			Dec. 25,			Dec. 26,			Dec. 28,			Dec. 29,
		2006			2005			2004			2003			2002
Income Statement Data
Domestic revenues:
Company-owned restaurant sales		$	447,938		$	434,525		$	412,676		$	416,049		$	429,813
Variable interest entities restaurant sales (2)		7,859			11,713			14,387			—			—
Franchise royalties (3)		56,374			52,289			50,292			49,851			51,386
Franchise and development fees		2,597			3,026			2,475			1,475			1,734
Commissary sales		413,075			398,372			376,642			369,825			381,217
Other sales		50,505			50,474			53,117			48,541			50,055
International revenues:
Royalties and franchise and development fees (4)		7,551			6,529			5,010			3,810			3,032
Restaurant and commissary sales (5)		15,658			11,860			10,747			10,572			9,521
Total revenues		1,001,557			968,788			925,346			900,123			926,758
Operating income (6)		97,955			72,700			36,682			55,353			74,914
Investment income		1,682			1,248			689			672			1,126
Interest expense		(3,480		)	(4,316		)	(5,313		)	(6,851		)	(7,677		)
Income from continuing operations before income taxes and cumulative effect of a change in accounting principle		96,157			69,632			32,058			49,174			68,363
Income tax expense		33,171			25,364			12,021			18,440			25,637
Income from continuing operations before cumulative effect of a change in accounting principle		62,986			44,268			20,037			30,734			42,726
Income from discontinued operations, net of tax (7)		389			1,788			3,184			3,242			4,071
Cumulative effect of accounting change, net of tax (8)		—			—			—			(413		)	—
Net income		$	63,375		$	46,056		$	23,221		$	33,563		$	46,797
Basic earnings per common share:
Income from continuing operations before cumulative effect of a change in accounting principle		$	1.95		$	1.32		$	0.58		$	0.86		$	1.07
Income from discontinued operations, net of tax (7)		0.01			0.05			0.09			0.09			0.10
Cumulative effect of accounting change, net of tax (8)		—			—			—			(0.01		)	—
Basic earnings per common share		$	1.96		$	1.37		$	0.67		$	0.94		$	1.17
Earnings per common share - assuming dilution		:
Income from continuing operations before cumulative effect of a change in accounting principle		$	1.91		$	1.29		$	0.58		$	0.85		$	1.05
Income from discontinued operations, net of tax (7)		0.01			0.05			0.09			0.09			0.10
Cumulative effect of accounting change, net of tax (8)		—			—			—			(0.01		)	—
Earnings per common share - assuming dilution		$	1.92		$	1.34		$	0.67		$	0.93		$	1.15
Basic weighted average shares outstanding		32,312			33,594			34,414			35,876			40,136
Diluted weighted average shares outstanding		33,046			34,316			34,810			36,074			40,600
Balance Sheet Data
Total assets		$	379,639		$	350,562		$	374,487		$	347,214		$	366,832
Total debt		97,036			55,116			94,230			61,250			140,085
Total stockholders’ equity		146,168			161,279			139,223			159,272			121,947

 

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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 2006 fiscal year consisted of 53 weeks, and the 2005, 2004, 2003 and 2002 fiscal years consisted of 52 weeks.

(2)               We began consolidating variable interest entities (VIEs) restaurants in 2004. See “Note 5” of “Notes to Consolidated Financial Statements.”

(3)               Domestic Franchise royalties were derived from franchised restaurant sales of $1.51 billion in 2006, $1.38 billion in 2005, $1.30 billion in 2004, $1.29 billion in 2003 and $1.32 billion in 2002.

(4)               International Royalties were derived from franchised restaurant sales of $139.3 million in 2006, $104.2 million in 2005, $67.6 million in 2004, $65.0 million in 2003 and $52.2 million in 2002.

(5)                Restaurant sales for International Company-owned restaurants located in the United Kingdom and Mexico were $1.7 million in 2006, $642,000 in 2005, $629,000 in 2004, $2.4 million in 2003 and $4.0 million in 2002.

(6)                The operating results include the consolidation of BIBP beginning in 2004, which increased operating income approximately $19.7 million in 2006, $5.8 million in 2005 and reduced operating income approximately $22.9 million in 2004. 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 (gains) of ($2.0 million) in 2005, $5.5 million in 2003 and $1.1 million in 2002 (the amounts recorded in 2006 and 2004 were not significant). See “Notes 5 and 8” of “Notes to Consolidated Financial Statements.”

(7)               The Perfect Pizza operations, which were sold in March 2006, are classified as “discontinued operations” and the related assets as “held for sale.” See “Note 4” of “Notes to Consolidated Financial Statements.”

(8)               Reflects the cumulative effect on income and earnings per share of a change in accounting principle, net of tax, as required by Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.

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 31, 2006, there were 3,015 Papa John’s restaurants in operation, consisting of 588 Company-owned and 2,427 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 2006 were 211 as compared to 204 in 2005 and 175 in 2004 and unit closings in 2006 were 125 as compared to 113 in 2005 and 153 in 2004. We expect net unit growth of approximately 225 to 250 units during 2007.

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 $865,000 for 2006, compared to $818,000 for 2005 and $737,000 for 2004. Average sales volumes in new markets are generally lower than in those markets in which we have

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established a significant market position. The comparable annual sales for Company-owned restaurants increased 3.6% in 2006, 7.4% in 2005 and 0.5% in 2004.

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 for the restaurants in our most recent comparable sales base is $266,000. The average cash investment for the 19 domestic Company-owned restaurants opened during 2006, exclusive of land, increased to approximately $249,000 from $241,000 for the seven units opened in 2005. We expect the average cash investment for the anticipated 20 to 25 Company-owned restaurants opening in 2007 to be approximately $250,000.

Approximately 46% of our revenues for 2006 and 2005, compared to 47% of our revenues for 2004, 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. We believe that, in addition to supporting both Company and franchised growth, these subsidiaries 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. The 2006 fiscal year consists of 53 weeks, and all other fiscal years presented consist of 52 weeks.

Results of Operations and Critical Accounting Policies and Estimates

The results of operations are based on the preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States. The preparation of consolidated financial statements requires management to select accounting policies for critical accounting areas as well as estimates and assumptions that affect the amounts reported in the consolidated financial statements. The Company’s 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 the identified franchisees continue to experience deteriorating financial results.

Long-lived and Intangible Assets

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

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The recoverability of intangible assets (i.e., goodwill) is evaluated annually, or more frequently if impairment indicators exist, on a reporting unit basis by comparing the fair value derived from discounted expected cash flows of the reporting unit to its carrying value. We recorded a goodwill impairment charge of $1.1 million associated with PJUK during 2005, reflecting our updated estimated fair value of PJUK. A goodwill impairment charge was not deemed necessary in 2006 based on our forecasted future cash flows.

At December 31, 2006, PJUK had goodwill of approximately $17.2 million. In addition to the sale of the Perfect Pizza operations, which occurred in March 2006, we have restructured management and developed plans for PJUK to improve its future operating results. The plans include efforts to increase Papa John’s brand awareness in the United Kingdom 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 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. Such adjustments, if any, will be determined in part based upon periodic actuarial valuations.

Income Tax Reserves

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 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 when we consider it probable that a taxing authority may take a sustainable position on a matter contrary to our filed position. 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.

During 2006, we settled certain previously filed tax returns that resulted in an increase in net income (reduction of income tax expense) of approximately $2.5 million.

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 Financial Accounting

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Standards Board’s (“FASB”) Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (FIN 46), we began consolidating the financial results of BIBP in the fourth quarter of 2003, since we qualify as the primary beneficiary, as defined by FIN 46, of BIBP. We recognized pre-tax income of approximately $19.0 million during 2006, $4.5 million during 2005 and pre-tax losses of approximately $23.5 million during 2004 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.

New Accounting Standards

In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment, which is a revision of SFAS 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. Under the modified-prospective method, compensation cost recognized in 2006 includes (a) compensation cost for all share-based payments granted prior to, but not yet vested as of December 25, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted subsequent to December 25, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). Results for prior periods have not been restated. 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 and 2004 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. The $6.5 million excess tax benefit in 2006, classified as a financing cash inflow, would have been classified as an operating cash inflow if the Company had not adopted SFAS No. 123(R). Operating income and cash flow operating results for 2005 and 2004 have not been restated for the adoption of SFAS No. 123(R).

The effect on income and earnings per share as if the fair value based method had been applied to all outstanding and unvested awards in 2005 and 2004 was not significant since the Company adopted SFAS No. 123 in 2002

In May 2005, the FASB issued Statement of Financial Accouting Standards (“SFAS”) No. 154, Accounting Changes and Error Corrections — a Replacement of APB Opinion No. 20 and FASB Statement No.3. This statement requires that an entity apply the retrospective method in reporting a change in an accounting principle of the reporting entity. The standard only allows for a change in accounting principle if it is required by a newly issued accounting pronouncement or the entity can justify the use of an allowable alternative accounting principle on the basis that it is preferable. This statement also requires that corrections for errors discovered in prior period financial statements be reported as a prior period adjustment by restating the prior period financial statements. Additional disclosures are required when a change in accounting principle or reporting entity occurs, as well as when a correction for an error is reported. The adoption of SFAS No. 154 in fiscal 2006 did not have a material impact on our financial statements.

In June 2006, the 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. The adoption of FIN 48 during the first quarter of 2007 is not expected to have a significant impact on our net income, financial condition or effective tax rate.

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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. 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.

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
		Dec. 31,		Dec. 25,		Dec. 26,
		2006		2005		2004
Income Statement Data:
Domestic revenues:
Company-owned restaurant sales		44.7	%	44.9	%	44.6	%
Variable interest entities restaurant sales		0.8		1.2		1.6
Franchise royalties		5.6		5.4		5.4
Franchise and development fees		0.3		0.3		0.3
Commissary sales		41.2		41.1		40.7
Other sales		5.0		5.2		5.7
International revenues:
Royalties and franchise and development fees		0.8		0.7		0.5
Restaurant and commissary sales		1.6		1.2		1.2
Total revenues		100.0		100.0		100.0
Costs and expenses:
Domestic Company-owned restaurant cost of sales (1)		19.7		21.5		24.2
Domestic Company-owned restaurant operating expenses (1)		57.9		58.2		60.3
Variable interest entities restaurant expenses (2)		85.4		87.0		88.0
Domestic commissary and other expenses (3)		89.3		90.9		92.0
Loss (income) from the franchise cheese purchasing program, net of minority interest (4)		(1.5	)	(0.5	)	1.8
International operating expenses (5)		101.1		100.0		98.9
General and administrative expenses		10.3		9.1		7.7
Minority interests and other general expenses		0.4		0.7		0.3
Depreciation and amortization		2.7		3.0		3.4
Total costs and expenses		90.2		92.5		96.0
Operating income		9.8		7.5		4.0
Net interest expense		(0.2	)	(0.3	)	(0.5	)
Income from continuing operations before income taxes		9.6		7.2		3.5
Income tax expense		3.3		2.6		1.3
Income from continuing operations		6.3		4.6		2.2
Income from discontinued operations, net of tax (6)		0.0		0.2		0.3
Net income		6.3	%	4.8	%	2.5	%

 

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		Year Ended
		Dec. 31,			Dec. 25,			Dec. 26,
		2006			2005			2004
Restaurant Data:
Percentage increase in comparable domestic Company-owned restaurant sales (7)		3.6		%	7.4		%	0.5		%
Number of Company-owned restaurants included in the most recent full year’s comparable restaurant base		485			472			551
Average sales for Company-owned restaurants included in the most recent comparable restaurant base		$	865,000		$	818,000		$	737,000
Papa John’s Restaurant Progression:
U.S. Company-owned:
Beginning of period		502			568			568
Opened		19			7			6
Closed		(1		)	(1		)	(5		)
Acquired from franchisees		57			20			—
Sold to franchisees		—			(92		)	(1		)
End of period		577			502			568
International Company-owned:
Beginning of period		2			1			2
Opened		1			1			—
Acquired from franchisees		8			—			—
Sold to franchisees		—			—			(1		)
End of period		11			2			1
U.S. franchised:
Beginning of period		2,097			1,997			2,006
Opened		105			101			97
Closed		(65		)	(73		)	(107		)
Acquired from Company		—			92			1
Sold to Company		(57		)	(20		)	—
End of period		2,080			2,097			1,997
International franchised:
Beginning of period		325			263			214
Opened		86			89			70
Closed		(56		)	(28		)	(23		)
Converted (8)		—			1			1
Acquired from Company		—			—			1
Sold to Company		(8		)	—			—
End of period		347			325			263
Total restaurants - end of period		3,015			2,926			2,829

 

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		Year Ended
		Dec. 31,		Dec. 25,		Dec. 26,
		2006		2005		2004
Perfect Pizza Restaurant Progression (6):
Franchised
Beginning of period		112		118		135
Opened		—		6		2
Closed		(3	)	(11	)	(18	)
Converted (8)		—		(1	)	(1	)
Sold		(109	)	—		—
Total restaurants - end of period (6)		—		112		118

(1)                      As a percentage of Domestic Company-owned restaurant sales.

(2)                      As a percentage of Domestic Variable interest entities restaurant sales.

(3)                      As a percentage of Domestic Commissary sales and Other sales on a combined basis.

(4)                      As a percentage of total Company revenues; the loss (income) is a result of the consolidation of BIBP, a VIE. The sales reported by BIBP are eliminated in consolidation.

(5)                      As a percentage of International Restaurant and commissary sales.

(6)                      The Perfect Pizza operations are classified as “discontinued operations,” as the operations were sold in March 2006. See “Note 4” of “Notes to Consolidated Financial Statements.”

(7)                      Includes only Company-owned restaurants open throughout the periods being compared.

(8)                       Represents Perfect Pizza restaurants converted to Papa John’s restaurants.

2006 Compared to 2005

Variable Interest Entities

As required by FIN 46, Papa John’s is deemed the primary beneficiary of BIBP; accordingly, our operating results include BIBP’s operating results. The consolidation of BIBP had a significant impact on our operating results in both 2006 and 2005 (pre-tax income of $19.0 million and $4.5 million in 2006 and 2005, respectively) and is expected to have a significant ongoing impact on our future operating results and income statement presentation as described below.

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

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

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period. The third component is reflected as investment income or interest expense depending upon whether BIBP is in a net investment or net borrowing position during the reporting period.

In addition, Papa John’s has extended loans to certain franchisees. Under the FIN 46 rules, Papa John’s is deemed to be the primary beneficiary of certain franchisees even though we have no ownership interest in them. Beginning in the second quarter of 2004, FIN 46 required Papa John’s to recognize the operating income (losses) generated by four franchise entities operating a total of 33 restaurants with annual sales approximating $21.0 million. Effective at the beginning of the second quarter of 2005, one of these four franchise entities, with 19 restaurants and annual revenues approximating $12.0 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 this sale. Accordingly, beginning in the second quarter of 2005, we were no longer required to consolidate the operating results as well as the financial position of these 19 restaurants. During the third quarter of 2006, another 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.  Accordingly, beginning in the third quarter of 2006, we were no longer required to consolidate the operating results as well as the financial position of this entity. The sale of these 26 restaurants and related loan write-off did not have any significant impact on Papa John’s 2006 and 2005 consolidated statements of income. The consolidation of the applicable franchise entities had no significant net impact on Papa John’s operating results.

The following tables summarize the impact of VIEs, prior to required consolidating eliminations, on our consolidated statements of income for the years ended December 31, 2006 and December 25, 2005 (in thousands):

		Year Ended December 31, 2006									Year Ended December 25, 2005
		BIBP			Franchisees			Total			BIBP			Franchisees			Total
Variable interest entities restaurant sales		$	—		$	7,859		$	7,859		$	—		$	11,713		$	11,713
BIBP sales		144,123			—			144,123			151,903			—			151,903
Total revenues		144,123			7,859			151,982			151,903			11,713			163,616
Operating expenses		122,153			7,284			129,437			145,962			10,997			156,959
General and administrative expenses		140			398			538			137			712			849
Loss from the franchise cheese-purchasing program, net of minority interest		2,101			—			2,101			—			—			—
Other general expenses (income)		—			35			35			—			(75		)	(75		)
Depreciation and amortization		—			142			142			—			78			78
Total costs and expenses		124,394			7,859			132,253			146,099			11,712			157,811
Operating income		19,729			—			19,729			5,804			1			5,805
Interest expense		(742		)	—			(742		)	(1,332		)	(1		)	(1,333		)
Income before income taxes		$	18,987		$	—		$	18,987		$	4,472		$	—		$	4,472

 

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 related distribution operations. 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

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note to be retired by the purchaser over the next five years. There was no gain or loss recognized during 2006 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 years ended December 31, 2006 and December 25, 2005 (in thousands, except per share data):

 

Summary of Operating Results from Continuing Operations

The company follows a fiscal year ending on the last Sunday of December, generally consisting of 52 weeks made up of four 13-week quarters, which are in turn made up of two four-week periods followed by one five-week period. In 2006, the company’s fiscal year consisted of 53 weeks, with the additional week added to the fourth quarter (14 weeks) results. 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 both the fourth quarter and full year of 2006.

Total revenues increased 3.4% to $1.0 billion in 2006 compared to $968.8 million in 2005 primarily consisting of the following:

·                  Company-owned restaurant sales increased $13.4 million as an increase in comparable sales of 3.6% and the impact of the 53rd week of operations more than offset a reduction in equivalent units. “Comparable sales” represents sales generated by restaurants open for the entire twelve-month period reported. “Equivalent units” represents the number of restaurants open at the beginning of a given period, adjusted for restaurants opened, closed, acquired or sold during the period on a weighted average basis.

·                  Domestic commissary sales increased $14.7 million, or 3.7% from 2005, primarily due to increased volumes, which more than offset the impact of lower year-over-year cheese costs.

·                  Domestic franchise royalties increased $4.1 million due to a 2.9% increase in comparable sales and additional equivalent units in 2006.

·                  International revenues increased $4.8 million primarily as a result of additional Company-owned restaurants located in the United Kingdom and Mexico.

·                  The above increases were partially offset by a $3.9 million decrease in revenues for restaurants consolidated as variable interest entities (VIEs). The decrease in revenues from VIE restaurants is a result of the sale of restaurants by two franchisees to third parties during 2005 and 2006, which eliminated the VIE consolidation of such restaurants under FIN 46, and the related consolidation of their operating results at the time of the respective sales.

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