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

FORM 10-Q

 

Commission File Number:  0-21660

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

 

2002 Papa Johns Boulevard
Louisville, Kentucky  40299-2367
(Address of principal executive offices)

(502) 261-7272
(Registrant’s telephone number, including area code)

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

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

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

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

At August 1, 2007, there were outstanding 29,872,378 shares of the registrant’s common stock, par value $0.01 per share.

 

 

INDEX

PART I.		FINANCIAL INFORMATION
Item 1.		Financial Statements
		Condensed Consolidated Balance Sheets — July 1, 2007 and December 31, 2006
		Consolidated Statements of Income — Three Months and Six Months Ended July 1, 2007 and June 25, 2006
		Consolidated Statements of Stockholders’ Equity — Six Months Ended July 1, 2007 and June 25, 2006
		Consolidated Statements of Cash Flows — Six Months Ended July 1, 2007 and June 25, 2006
		Notes to Condensed Consolidated Financial Statements
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.		Quantitative and Qualitative Disclosures About Market Risk
Item 4.		Controls and Procedures
PART II.		OTHER INFORMATION
Item 1.		Legal Proceedings
Item 1.A.		Risk Factors
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds
Item 4.		Submission of Matters to a Vote of Security Holders
Item 6.		Exhibits

 

 

PART I.  FINANCIAL INFORMATION

Item 1. Financial Statements

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

		July 1, 2007			December 31, 2006
(In thousands)		(Unaudited)			(Note)
Assets
Current assets:
Cash and cash equivalents		$	19,933		$	12,979
Accounts receivable		21,495			23,326
Inventories		24,936			26,729
Prepaid expenses		9,407			7,779
Other current assets		6,557			7,368
Deferred income taxes		7,507			6,362
Total current assets		89,835			84,543
Investments		583			1,254
Net property and equipment		199,723			197,722
Notes receivable		14,287			12,104
Deferred income taxes		5,997			1,643
Goodwill		74,580			67,357
Other assets		17,577			15,016
Total assets		$	402,582		$	379,639
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	26,804		$	29,202
Income and other taxes		13,294			15,136
Accrued expenses		53,246			57,233
Current portion of debt		10,775			525
Total current liabilities		104,119			102,096
Unearned franchise and development fees		7,211			7,562
Long-term debt, net of current portion		116,009			96,511
Other long-term liabilities		28,238			27,302
Stockholders’ equity:
Preferred stock		—			—
Common stock		347			341
Additional paid-in capital		203,187			187,990
Accumulated other comprehensive income		1,198			515
Retained earnings		84,392			63,614
Treasury stock		(142,119		)	(106,292		)
Total stockholders’ equity		147,005			146,168
Total liabilities and stockholders’ equity		$	402,582		$	379,639

 

Note:  The balance sheet at December 31, 2006 has been derived from the audited consolidated financial statements at that date, but does not include all information and footnotes required by accounting principles generally accepted in the United States for a complete set of financial statements.

 

See accompanying notes.

 

 

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Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Income

(Unaudited)

		Three Months Ended						Six Months Ended
(In thousands, except per share amounts)		July 1, 2007			June 25, 2006			July 1, 2007			June 25, 2006
Domestic revenues:
Company-owned restaurant sales		$	119,633		$	105,424		$	241,677		$	212,164
Variable interest entities restaurant sales		1,602			2,691			3,289			5,137
Franchise royalties		13,746			13,964			28,198			28,202
Franchise and development fees		541			593			1,303			1,181
Commissary sales		96,224			100,968			196,423			203,660
Other sales		17,355			12,202			31,846			23,072
International revenues:
Royalties and franchise and development fees		2,223			1,839			4,671			3,296
Restaurant and commissary sales		4,932			3,912			9,473			7,230
Total revenues		256,256			241,593			516,880			483,942
Costs and expenses:
Domestic Company-owned restaurant expenses:
Cost of sales		25,829			19,650			50,917			40,528
Salaries and benefits		35,928			31,252			72,872			62,753
Advertising and related costs		11,159			9,821			22,062			19,013
Occupancy costs		7,520			6,364			14,809			12,526
Other operating expenses		16,411			13,774			32,804			27,577
Total domestic Company-owned restaurant expenses		96,847			80,861			193,464			162,397
Variable interest entities restaurant expenses		1,352			2,224			2,731			4,331
Domestic commissary and other expenses:
Cost of sales		80,944			81,866			162,719			165,409
Salaries and benefits		9,006			7,851			17,804			15,316
Other operating expenses		11,147			11,282			22,145			22,422
Total domestic commissary and other expenses		101,097			100,999			202,668			203,147
Loss (income) from the franchise cheese purchasing program, net of minority interest		6,277			(5,189		)	6,178			(9,765		)
International operating expenses		4,426			3,883			8,464			7,306
General and administrative expenses		25,221			26,386			50,621			50,630
Minority interests and other general expenses		999			1,327			2,936			3,025
Depreciation and amortization		7,589			6,603			15,484			13,164
Total costs and expenses		243,808			217,094			482,546			434,235
Operating income from continuing operations		12,448			24,499			34,334			49,707
Investment income		368			364			721			740
Interest expense		(1,706		)	(631		)	(3,232		)	(1,432		)
Income from continuing operations before income taxes		11,110			24,232			31,823			49,015
Income tax expense		4,101			8,966			11,659			18,136
Income from continuing operations		7,009			15,266			20,164			30,879
Income from discontinued operations, net of tax		—			—			—			389
Net income		$	7,009		$	15,266		$	20,164		$	31,268
Basic earnings per common share:
Income from continuing operations		$	0.23		$	0.47		$	0.67		$	0.94
Income from discontinued operations, net of tax		—			—			—			0.01
Basic earnings per common share		$	0.23		$	0.47		$	0.67		$	0.95
Earnings per common share - assuming dilution:
Income from continuing operations		$	0.23		$	0.46		$	0.66		$	0.92
Income from discontinued operations, net of tax		—			—			—			0.01
Earnings per common share - assuming dilution		$	0.23		$	0.46		$	0.66		$	0.93
Basic weighted average shares outstanding		30,054			32,589			30,059			32,855
Diluted weighted average shares outstanding		30,600			33,309			30,623			33,632

 

See accompanying notes.

3

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity

(Unaudited)

										Accumulated
		Common					Additional			Other									Total
		Stock Shares		Common			Paid-In			Comprehensive			Retained			Treasury			Stockholders’
(In thousands)		Outstanding		Stock			Capital			Income (Loss)			Earnings			Stock			Equity
Balance at December 25, 2005		33,081		$	331		$	160,999		$	(290	)	$	239		$	—		$	161,279
Comprehensive income:
Net income		—		—			—			—			31,268			—			31,268
Change in valuation of interest rate swap agreement, net of tax of $707		—		—			—			1,192			—			—			1,192
Other, net		—		—			—			503			—			—			503
Comprehensive income																			32,963
Exercise of stock options		710		7			10,443			—			—			—			10,450
Tax benefit related to exercise of non-qualified stock options		—		—			3,151			—			—			—			3,151
Acquisition of Company common stock		(1,645	)	—			—			—			—			(51,728		)	(51,728		)
Other		—		—			1,827			—			—			—			1,827
Balance at June 25, 2006		32,146		$	338		$	176,420		$	1,405		$	31,507		$	(51,728	)	$	157,942
Balance at December 31, 2006		30,696		$	341		$	187,990		$	515		$	63,614		$	(106,292	)	$	146,168
Cumulative effect of adoption of FIN No. 48		—		—			—			—			614			—			614
Adjusted balance at January 1, 2007		30,696		341			187,990			515			64,228			(106,292		)	146,782
Comprehensive income:
Net income		—		—			—			—			20,164			—			20,164
Change in valuation of interest rate swap agreements, net of tax of $209		—		—			—			363			—			—			363
Other, net		—		—			—			320			—			—			320
Comprehensive income																			20,847
Exercise of stock options		647		6			10,317			—			—			—			10,323
Tax benefit related to exercise of non-qualified stock options		—		—			3,025			—			—			—			3,025
Acquisition of Company common stock		(1,223	)	—			—			—			—			(35,827		)	(35,827		)
Other		—		—			1,855			—			—			—			1,855
Balance at July 1, 2007		30,120		$	347		$	203,187		$	1,198		$	84,392		$	(142,119	)	$	147,005

 

At June 25, 2006, the accumulated other comprehensive gain of $1,405 was comprised of net unrealized foreign currency translation gains of $573, a net unrealized gain on investments of $7 and a net unrealized gain on the interest rate swap agreement of $825.

 

At July 1, 2007, the accumulated other comprehensive gain of $1,198 was comprised of unrealized foreign currency translation gains of $1,419, a net unrealized gain on investments of $5 and a net unrealized gain on the interest rate swap agreements of $358, partially offset by a $584 pension plan liability for PJUK.

 

See accompanying notes.

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Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

		Six Months Ended
(In thousands)		July 1, 2007			June 25, 2006
Operating activities
Net income		$	20,164		$	31,268
Results from discontinued operations (net of income taxes)		—			(389		)
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for uncollectible accounts and notes receivable		1,034			1,887
Depreciation and amortization		15,484			13,164
Deferred income taxes		(5,709		)	212
Stock-based compensation expense		1,855			1,882
Excess tax benefit related to exercise of non-qualified stock options		(3,025		)	(4,500		)
Other		3,260			3,556
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable		1,048			(2,274		)
Inventories		1,785			1,586
Prepaid expenses		(1,723		)	1,156
Other current assets		908			(218		)
Other assets and liabilities		(892		)	(4,885		)
Accounts payable		(2,437		)	(3,709		)
Income and other taxes		(1,228		)	(430		)
Accrued expenses		(3,929		)	(354		)
Unearned franchise and development fees		(351		)	(747		)
Net cash provided by operating activities from continuing operations		26,244			37,205
Operating cash flows from discontinued operations		—			414
Net cash provided by operating activities		26,244			37,619
Investing activities
Purchase of property and equipment		(16,433		)	(14,068		)
Proceeds from sale of property and equipment		27			26
Purchase of investments		—			(2,014		)
Proceeds from sale or maturity of investments		671			4,472
Loans issued		(4,263		)	(4,616		)
Loan repayments		2,029			6,410
Acquisitions		(8,615		)	(1,200		)
Proceeds from divestiture of restaurants		632			—
Net cash from continuing operations used in investing activities		(25,952		)	(10,990		)
Proceeds from divestiture of discontinued operations		—			8,020
Net cash used in investing activities		(25,952		)	(2,970		)
Financing activities
Net proceeds (repayments) from line of credit facility		19,500			(13,500		)
Net proceeds from short-term debt - variable interest entities		10,250			3,800
Excess tax benefit related to exercise of non-qualified stock options		3,025			4,500
Proceeds from exercise of stock options		10,323			10,450
Acquisition of Company common stock		(35,827		)	(51,728		)
Other		(675		)	172
Net cash provided by (used in) financing activities		6,596			(46,306		)
Effect of exchange rate changes on cash and cash equivalents		66			53
Change in cash and cash equivalents		6,954			(11,604		)
Cash and cash equivalents at beginning of period		12,979			22,098
Cash and cash equivalents at end of period		$	19,933		$	10,494

 

See accompanying notes.

5

Papa John’s International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

July 1, 2007

1.              Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the six months ended July 1, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ended December 30, 2007. For further information, refer to the consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K for Papa John’s International, Inc. (referred to as the “Company”, “Papa John’s” or in the first-person notations of “we”, “us” and “our”) for the year ended December 31, 2006.

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

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

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

The Company recognizes interest accrued and penalties related to unrecognized tax benefits as a part of income tax expense.  The Company recognized interest and penalties of approximately $163,000 and $296,000 for the three months ended July 1, 2007 and June 25, 2006, respectively, and $281,000 and $377,000 for the six months ended July 1, 2007 and June 25, 2006, respectively. The Company had approximately $2.4 million and $2.5 million for the payment of interest and penalties accrued at July 1, 2007 and December 31, 2006, respectively.

3.              Acquisitions

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

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During the second quarter, we completed the acquisition of 13 restaurants in Georgia.  The purchase price for these restaurants totaled $7.4 million, which was paid in cash, of which approximately $6.4 million was recorded as goodwill.

Effective July 2, 2007 (the beginning of our third quarter 2007), we acquired 31 restaurants located in Missouri and Kansas.  The purchase price for these restaurants totaled $10.2 million, which was paid in cash and is subject to post-closing adjustments. Approximately $7.4 million of the purchase price was recorded as goodwill. Effective July 30, 2007, we acquired 11 restaurants located in the Washington D.C. area.  The purchase price for these restaurants was $6.1 million, which was paid in cash and is subject to post-closing adjustments. Approximately $4.7 million of the purchase price was recorded as goodwill.

The business combinations in the previous paragraphs were accounted for by the purchase method of accounting, whereby operating results subsequent to the acquisition date are included in our consolidated financial results.

4.              Accounting for Variable Interest Entities

In 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (FIN 46), which provides a framework for identifying variable interest entities (“VIEs”) and determining when a company should include the assets, liabilities, non-controlling interests and results of activities of a VIE in its consolidated financial statements.

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

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

We have a purchasing arrangement with BIBP Commodities, Inc. (“BIBP”), a special-purpose entity formed at the direction of our Franchise Advisory Council in 1999 for the sole purpose of reducing cheese price volatility to domestic system-wide restaurants. BIBP is an independent, franchisee-owned corporation. BIBP purchases cheese at the market price and sells it to our distribution subsidiary, PJ Food Service, Inc. (“PJFS”), at a fixed quarterly price based in part upon historical average market prices.  PJFS in turn sells cheese to Papa John’s restaurants (both Company-owned and franchised) at a set quarterly price. PJFS purchased $29.4 million and $61.0 million of cheese from BIBP for the three and six months ended July 1, 2007, respectively, and $35.6 million and $71.9 million of cheese for the comparable periods in 2006, respectively.

As defined by FIN 46, we are the primary beneficiary of BIBP, a VIE, and thus we consolidate the financial statements of BIBP. We recognize the operating losses generated by BIBP if BIBP’s shareholders’ equity is in a net deficit position. Further, we will recognize the subsequent operating income generated by BIBP up to the amount of any losses previously recognized.

We recognized pre-tax losses of $8.3 million ($5.3 million net of tax, or $0.17 per share) and $8.7 million ($5.5 million net of tax, or $0.18 per share) for the three and six months ended July 1, 2007, respectively, and pretax income of $6.3 million ($4.0 million net of tax, or $0.12 per share) and $11.7 million ($7.4 million net of tax, or

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$0.22 per share) for the three and six months ended June 25, 2006, respectively, from the consolidation of BIBP. The impact on future operating income from the consolidation of BIBP is expected to be significant for any given reporting period due to the noted volatility of the cheese market, but is not expected to be cumulatively significant over time.

BIBP has an $18.0 million line of credit with a commercial bank, which is not guaranteed by Papa John’s. Papa John’s has agreed to provide additional funding in the form of a loan to BIBP. As of July 1, 2007, BIBP had outstanding borrowings of $10.8 million and a letter of credit of $3.0 million outstanding under the commercial line of credit facility.

In addition, Papa John’s has extended loans to certain franchisees. Under FIN 46, Papa John’s was deemed the primary beneficiary of two franchise entities as of July 1, 2007 and three franchise entities as of June 25, 2006, even though we had no ownership in them.  The two franchise entities at July 1, 2007 operated a total of seven restaurants with annual revenues approximating $6.0 million. Our net loan balance receivable from these entities was $439,000 at July 1, 2007, with no further funding commitments. The consolidation of these franchise entities has had no significant impact on Papa John’s operating results and is not expected to have a significant impact in future periods.

The following table summarizes the balance sheets for our consolidated VIEs as of July 1, 2007 and December 31, 2006:

		July 1, 2007									December 31, 2006
(In thousands)		BIBP			Franchisees			Total			BIBP			Franchisees			Total
Assets:
Cash and cash equivalents		$	4,279		$	245		$	4,524		$	144		$	150		$	294
Accounts receivable—Papa John’s		372			—			372			3,950			—			3,950
Other current assets		979			41			1,020			1,397			26			1,423
Net property and equipment		—			435			435			—			464			464
Goodwill		—			460			460			—			460			460
Deferred income taxes		3,259			—			3,259			—			—			—
Total assets		$	8,889		$	1,181		$	10,070		$	5,491		$	1,100		$	6,591
Liabilities and stockholders’ equity (deficit):
Accounts payable and accrued expenses		$	3,653		$	260		$	3,913		$	3,436		$	220		$	3,656
Income and other taxes		—			—			—			506			—			506
Short-term debt—third party		10,775			—			10,775			525			—			525
Short-term debt—Papa John’s		—			439			439			—			517			517
Total liabilities		14,428			699			15,127			4,467			737			5,204
Stockholders’ equity (deficit)		(5,539		)	482			(5,057		)	1,024			363			1,387
Total liabilities and stockholders’ equity (deficit)		$	8,889		$	1,181		$	10,070		$	5,491		$	1,100		$	6,591

 

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5.  Debt                 

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

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

6.  Calculation of Earnings Per Share

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

		Three Months Ended						Six Months Ended
		July 1, 2007			June 25, 2006			July 1, 2007			June 25, 2006
Basic earnings per common share:
Income from continuing operations		$	7,009		$	15,266		$	20,164		$	30,879
Weighted average shares outstanding		30,054			32,589			30,059			32,855
Basic earnings per common share		$	0.23		$	0.47		$	0.67		$	0.94
Earnings per common share - assuming dilution:
Income from continuing operations		$	7,009		$	15,266		$	20,164		$	30,879
Weighted average shares outstanding		30,054			32,589			30,059			32,855
Dilutive effect of outstanding common stock options		546			720			564			777
Diluted weighted average shares outstanding		30,600			33,309			30,623			33,632
Earnings per common share - assuming dilution		$	0.23		$	0.46		$	0.66		$	0.92

 

7.  Comprehensive Income

Comprehensive income is comprised of the following:

		Three Months Ended						Six Months Ended
(In thousands)		July 1, 2007			June 25, 2006			July 1, 2007			June 25, 2006
Net income		$	7,009		$	15,266		$	20,164		$	31,268
Change in valuation of interest rate swap agreements, net of tax		619			581			363			1,192
Other, net		202			433			320			503
Comprehensive income		$	7,830		$	16,280		$	20,847		$	32,963

 

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8.  Segment Information

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

The domestic restaurant segment consists of the operations of all domestic (“domestic” is defined as contiguous United States) Company-owned restaurants and derives its revenues principally from retail sales of pizza and side items, such as breadsticks, cheesesticks, chicken strips, chicken wings, dessert pizza, and soft drinks to the general public. The domestic commissary segment consists of the operations of our regional dough production and product distribution centers and derives its revenues principally from the sale and distribution of food and paper products to domestic Company-owned and franchised restaurants. The domestic franchising segment consists of our franchise sales and support activities and derives its revenues from sales of franchise and development rights and collection of royalties from our domestic franchisees. The international operations segment principally consists of our Company-owned restaurants and distribution sales to franchised Papa John’s restaurants located in the United Kingdom, China and Mexico and our franchise sales and support activities, which derive revenues from sales of franchise and development rights and the collection of royalties from our international franchisees. VIEs consist of entities in which we are deemed the primary beneficiary, as defined in Note 4, and include BIBP and certain franchisees to which we have extended loans. All other business units that do not meet the quantitative thresholds for determining reportable segments consist of operations that derive revenues from the sale, principally to Company-owned and franchised restaurants, of printing and promotional items, risk management services, and information systems and related services used in restaurant operations and certain partnership development activities.

Generally, we evaluate performance and allocate resources based on profit or loss from operations before income taxes and eliminations. Certain administrative and capital costs are allocated to segments based upon predetermined rates or actual estimated resource usage. We account for intercompany sales and transfers as if the sales or transfers were to third parties and eliminate the related profit in consolidation.

Our reportable segments are business units that provide different products or services. Separate management of each segment is required because each business unit is subject to different operational issues and strategies. No single external customer accounted for 10% or more of our consolidated revenues.

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Our segment information is as follows:

		Three Months Ended						Six Months Ended
(In thousands)		July 1, 2007			June 25, 2006			July 1, 2007			June 25, 2006
Revenues from external customers:
Domestic Company-owned restaurants		$	119,633		$	105,424		$	241,677		$	212,164
Domestic commissaries		96,224			100,968			196,423			203,660
Domestic franchising		14,287			14,557			29,501			29,383
International		7,155			5,751			14,144			10,526
Variable interest entities(1)		1,602			2,691			3,289			5,137
All others		17,355			12,202			31,846			23,072
Total revenues from external customers		$	256,256		$	241,593		$	516,880		$	483,942
Intersegment revenues:
Domestic commissaries		$	29,684		$	27,381		$	60,529		$	55,265
Domestic franchising		338			316			677			630
International		149			146			306			278
Variable interest entities(1)		29,430			35,634			61,017			71,887
All others		3,447			3,181			7,415			6,128
Total intersegment revenues		$	63,048		$	66,658		$	129,944		$	134,188
Income (loss) from continuing operations before income taxes:
Domestic Company-owned restaurants(2)		$	7,535		$	8,149		$	15,750		$	17,450
Domestic commissaries(3)		7,917			8,512			17,931			15,865
Domestic franchising(4)		12,065			12,737			25,108			25,751
International(5)		(2,032		)	(2,418		)	(4,352		)	(4,759		)
Variable interest entities		(8,257		)	6,303			(8,663		)	11,692
All others		1,679			1,218			2,724			2,717
Unallocated corporate expenses(6)		(7,486		)	(9,936		)	(15,781		)	(18,818		)
Elimination of intersegment profits		(311		)	(333		)	(894		)	(883		)
Total income from continuing operations before income taxes		$	11,110		$	24,232		$	31,823		$	49,015
Property and equipment:
Domestic Company-owned restaurants		$	158,056
Domestic commissaries		76,405
International		6,067
Variable interest entities		1,368
All others		22,579
Unallocated corporate assets		134,740
Accumulated depreciation and amortization		(199,492		)
Net property and equipment		$	199,723

(1)             The revenues from external customers for variable interest entities are attributable to the franchise entities to which we have extended loans that qualify as consolidated VIEs. The intersegment revenues for variable interest entities are attributable to BIBP.

(2)             The operating results for domestic Company-owned restaurants decreased approximately $614,000 and $1.7 million for the three and six months ended July 1, 2007, respectively, primarily due to the impact of negative comparable sales, an increase in salaries for our general and assistant managers and the impact of minimum wage increases in certain states, partially offset by a $594,000 pre-tax gain associated with the termination of a lease arrangement in the second quarter of 2007.

(3)             The operating results for the domestic commissaries segment decreased approximately $595,000 for the second quarter of 2007 principally due to an increase in delivery, utility and labor costs.  Operating income increased $2.1 million for the six-month period ended July 1, 2007 due to increased volumes of higher-margin fresh dough products and improved margin from other commodities during the first quarter of 2007, partially offset by an increase in delivery, utility and labor costs.

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(4)             The operating results for the domestic franchising segment decreased $672,000 and $643,000 for the three- and six-month periods ended July 1, 2007, respectively, principally due to a decrease in royalties as a result of the acquisition of franchise restaurants during late 2006 and the first half of 2007.

(5)             The international segment, which excludes the Perfect Pizza operations that were sold in March 2006, reported operating losses of $2.0 million and $4.4 million for the three- and six-month periods ended July 1, 2007, respectively, compared to losses of $2.4 million and $4.8 million, respectively, in the same periods of the prior year.  The improvements are due to the prior year results including a $470,000 charge incurred in the second quarter related to costs associated with management reorganization in one of our international operating units.  Increased current year revenues, which were due to growth in number of units and unit volumes, were substantially offset by increased personnel and infrastructure investment costs.

(6)             The decrease of approximately $2.4 million and $3.0 million in unallocated corporate expenses for the three and six months ended July 1, 2007, respectively, as compared to the corresponding periods in 2006, are   primarily due to lower general and administrative costs, including management incentives (bonuses and executive performance unit incentive plan), health insurance and legal costs.

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations and Critical Accounting Policies and Estimates

Papa John’s International, Inc. (referred to as the “Company,” “Papa John’s” or in the first-person notations of “we,” “us” and “our”) began operations in 1985. At July 1, 2007, there were 3,090 Papa John’s restaurants (614 Company-owned and 2,476 franchised) operating in all 50 states and 27 countries. Our revenues are principally derived from retail sales of pizza and other food and beverage products to the general public by Company-owned restaurants, franchise royalties, sales of franchise and development rights, sales to franchisees of food and paper products, printing and promotional items, risk management services, and information systems and related services used in their operations.

We enter into agreements with our domestic franchisees upon the opening of a Papa John’s restaurant, which are generally ten years, with an option to renew.  A substantial number of our domestic franchise agreements were entered into in the late 1990’s and are beginning to come up for renewal.  We have recently modified certain aspects of our domestic franchise agreement in consultation with a task force of our Franchise Advisory Council.  The completion of the revisions in the franchise agreement was a first step in the renewal process for all franchise agreements, especially those coming up for renewal over the next few years.

The results of operations are based on the preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States. The preparation of consolidated financial statements requires management to select accounting policies for critical accounting areas and make estimates and assumptions that affect the amounts reported in the consolidated financial statements. Significant changes in assumptions and/or conditions in our critical accounting policies could materially impact the operating results. We have identified the following accounting policies and related judgments as critical to understanding the results of our operations.

Allowance for Doubtful Accounts and Notes Receivable

We establish reserves for uncollectible accounts and notes receivable based on overall receivable aging levels and a specific evaluation of accounts and notes for franchisees with known financial difficulties. These reserves and corresponding write-offs could significantly increase if the identified franchisees continue to experience deteriorating financial results.

Long-Lived and Intangible Assets

The recoverability of long-lived assets is evaluated if impairment indicators exist. Indicators of impairment include historical financial performance, operating trends and our future operating plans. If impairment indicators exist, we evaluate the recoverability of long-lived assets on an operating unit basis (e.g., an individual

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restaurant) based on undiscounted expected future cash flows before interest for the expected remaining useful life of the operating unit. Recorded values for long-lived assets that are not expected to be recovered through undiscounted future cash flows are written down to current fair value, which is generally determined from estimated discounted future net cash flows for assets held for use or net realizable value for assets held for sale.

The recoverability of indefinite-lived intangible assets (i.e., goodwill) is evaluated annually, or more frequently if impairment indicators exist, on a reporting unit basis by comparing the fair value derived from discounted expected cash flows of the reporting unit to its carrying value.

At July 1, 2007, our United Kingdom subsidiary, Papa John’s UK (PJUK), had goodwill of approximately $17.2 million. In addition to the sale of the Perfect Pizza operations, which occurred in March 2006, we have restructured management and developed plans for PJUK to improve its future operating results. The plans include efforts to increase Papa John’s brand awareness in the United Kingdom and increase net PJUK franchise unit openings over the next several years. We will continue to periodically evaluate our progress in achieving these plans. If our initiatives are not successful, impairment charges could occur.

Insurance Reserves

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

From October 2000 through September 2004, our captive insurance company, which provided insurance to our franchisees, was self-insured. In October 2004, a third-party commercial insurance company began providing fully-insured coverage to franchisees participating in the franchise insurance program. Accordingly, this new arrangement eliminates our risk of loss for franchise insurance coverage written after September 2004. Our operating income will still be subject to potential adjustments for changes in estimated insurance reserves for policies written from the inception of the captive insurance company in October 2000 to September 2004. Such adjustments, if any, will be determined in part based upon periodic actuarial valuations.

Deferred Income Tax Assets and Tax Reserves

As of July 1, 2007, we had a net deferred income tax asset balance of $13.5 million, of which approximately $3.3 million relates to BIBP’s net operating loss carryforward.  We have not provided a valuation allowance for the deferred income tax assets since we believe it is more likely than not that the Company’s future earnings, including BIBP, will be sufficient to ensure the realization of the net deferred income tax assets for federal and state purposes.

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

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Certain tax authorities periodically audit the Company. We provide reserves for potential exposures based on FIN 48 requirements described above.  We evaluate these issues on a quarterly basis to adjust for events, such as court rulings or audit settlements that may impact our ultimate payment for such exposures.

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

BIBP is a franchisee-owned corporation that conducts a cheese-purchasing program on behalf of domestic Company-owned and franchised restaurants. As required by FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (FIN 46), we consolidate the financial results of BIBP since we qualify as the primary beneficiary, as defined by FIN 46, of BIBP.  We recognized pre-tax losses of $8.3 million and $8.7 million for the three and six months ended July 1, 2007, respectively, and pre-tax income of approximately $6.3 million and $11.7 million for the three and six months ended June 25, 2006, respectively, from the consolidation of BIBP. In future periods, we expect the consolidation of BIBP to have a significant impact on Papa John’s operating income in any given reporting period due to the volatility of cheese prices, but is not expected to be cumulatively significant over time. 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 Standard

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

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