Edgar Filing: PAPA JOHNS INTERNATIONAL INC

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 29, 2008

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

Commission File Number: 0-21660

PAPA JOHN’S INTERNATIONAL, INC.

Exact name of registrant as specified in its charter)

Delaware	61-1203323
(State or other jurisdiction of	(I.R.S. Employer Identification
incorporation or organization)	number)

2002 Papa Johns Boulevard

Louisville, Kentucky 40299-2367

(Address of principal executive offices)

(502) 261-7272

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x		Accelerated filer o

Non-accelerated filer o		Smaller reporting company 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 July 30, 2008, there were outstanding 28,103,498 shares of the registrant’s common stock, par value $0.01 per share.

INDEX

		Page No.

PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets – June 29, 2008 and December 30, 2007	2

	Consolidated Statements of Income – Three and Six Months Ended June 29, 2008 and July 1, 2007	3

	Consolidated Statements of Stockholders’ Equity – Six Months Ended June 29, 2008 and July 1, 2007	4

	Consolidated Statements of Cash Flows – Six Months Ended June 29, 2008 and July 1, 2007	5

	Notes to Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	25

Item 4.	Controls and Procedures	28

PART II.	OTHER INFORMATION	28

Item 1.	Legal Proceedings	28

Item 1.A.	Risk Factors	29

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	29

Item 4.	Submission of Matters to a Vote of Security Holders	29

Item 6.	Exhibits	30

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Papa John’s International, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(In thousands)	June 29, 2008			December 30, 2007
	(Unaudited)			(Note)
Assets
Current assets:
Cash and cash equivalents	$	8,356		$	8,877
Accounts receivable	23,427			22,539
Inventories	16,981			18,806
Prepaid expenses	9,685			10,711
Other current assets	6,087			5,581
Assets held for sale	4,450			—
Deferred income taxes	8,430			7,147
Total current assets	77,416			73,661
Investments	855			825
Net property and equipment	196,689			198,957
Notes receivable	11,597			11,804
Deferred income taxes	18,400			12,384
Goodwill	83,194			86,505
Other assets	17,255			17,681
Total assets	$	405,406		$	401,817

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	31,450		$	31,157
Income and other taxes	12,570			10,866
Accrued expenses	54,923			56,466
Current portion of debt	12,225			8,700
Total current liabilities	111,168			107,189
Unearned franchise and development fees	5,791			6,284
Long-term debt, net of current portion	135,195			134,006
Other long-term liabilities	26,810			27,435
Stockholders’ equity:
Preferred stock	—			—
Common stock	350			349
Additional paid-in capital	212,246			208,598
Accumulated other comprehensive income	60			156
Retained earnings	113,236			96,963
Treasury stock	(199,450		)	(179,163		)
Total stockholders’ equity	126,442			126,903
Total liabilities and stockholders’ equity	$	405,406		$	401,817

Note: The balance sheet at December 30, 2007 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.

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Income

(Unaudited)

	Three Months Ended						Six Months Ended
(In thousands, except per share amounts)	June 29, 2008			July 1, 2007			June 29, 2008			July 1, 2007
Domestic revenues:
Company-owned restaurant sales	$	133,815		$	119,633		$	272,670		$	241,677
Variable interest entities restaurant sales	2,239			1,602			4,279			3,289
Franchise royalties	14,759			13,746			30,204			28,198
Franchise and development fees	247			541			1,167			1,303
Commissary sales	106,321			96,224			212,368			196,423
Other sales	16,434			17,355			33,279			31,846
International revenues:
Royalties and franchise and development fees	3,108			2,223			6,128			4,671
Restaurant and commissary sales	6,485			4,932			12,318			9,473
Total revenues	283,408			256,256			572,413			516,880
Costs and expenses:
Domestic Company-owned restaurant expenses:
Cost of sales	30,803			25,829			62,375			50,917
Salaries and benefits	40,050			35,928			81,610			72,872
Advertising and related costs	11,913			11,159			24,610			22,062
Occupancy costs	8,540			7,520			17,011			14,809
Other operating expenses	18,072			16,411			36,379			32,804
Total domestic Company-owned restaurant expenses	109,378			96,847			221,985			193,464
Variable interest entities restaurant expenses	1,987			1,352			3,780			2,731
Domestic commissary and other expenses:
Cost of sales	89,976			80,944			179,982			162,719
Salaries and benefits	9,127			9,006			18,092			17,804
Other operating expenses	12,112			11,147			23,644			22,145
Total domestic commissary and other expenses	111,215			101,097			221,718			202,668
Loss from the franchise cheese-purchasing program, net of minority interest	4,364			6,277			9,922			6,178
International operating expenses	5,818			4,426			11,158			8,464
General and administrative expenses	27,237			25,221			54,451			50,621
Minority interests and other general expenses	1,198			999			3,955			2,936
Depreciation and amortization	8,404			7,589			16,410			15,484
Total costs and expenses	269,601			243,808			543,379			482,546
Operating income	13,807			12,448			29,034			34,334
Investment income	181			368			447			721
Interest expense	(1,802		)	(1,706		)	(3,694		)	(3,232		)
Income before income taxes	12,186			11,110			25,787			31,823
Income tax expense	4,538			4,101			9,514			11,659
Net income	$	7,648		$	7,009		$	16,273		$	20,164

Basic earnings per common share	$	0.27		$	0.23		$	0.57		$	0.67
Earnings per common share - assuming dilution	$	0.27		$	0.23		$	0.57		$	0.66

Basic weighted average shares outstanding	28,372			30,054			28,536			30,059
Diluted weighted average shares outstanding	28,705			30,600			28,754			30,623

See accompanying notes.

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 31, 2006	30,696		$	341	$	187,990	$	515		$	63,614	$	(106,292	)	$	146,168
Cumulative effect of adoption of FIN 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 treasury 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

Balance at December 30, 2007	28,777		$	349	$	208,598	$	156		$	96,963	$	(179,163	)	$	126,903
Comprehensive income:
Net income	—		—		—		—			16,273		—			16,273
Change in valuation of interest rate swap agreements, net of tax of $113	—		—		—		(229		)	—		—			(229		)
Other, net	—		—		—		133			—		—			133
Comprehensive income															16,177
Exercise of stock options	50		1		964		—			—		—			965
Tax benefit related to exercise of non-qualified stock options	—		—		117		—			—		—			117
Acquisition of treasury stock	(768	)	—		—		—			—		(20,287		)	(20,287		)
Other	—		—		2,567		—			—		—			2,567
Balance at June 29, 2008	28,059		$	350	$	212,246	$	60		$	113,236	$	(199,450	)	$	126,442

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 liability for PJUK.

At June 29, 2008, the accumulated other comprehensive gain of $60 was comprised of unrealized foreign currency translation gains of $1,588, offset by a net unrealized loss on the interest rate swap agreements of $1,528.

See accompanying notes.

Papa John’s International, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

	Six Months Ended
(In thousands)	June 29, 2008			July 1, 2007
Operating activities
Net income	$	16,273		$	20,164
Adjustments to reconcile net income to net cash provided by operating activities:
Restaurant closure, impairment and disposition losses (gains)	1,167			(434		)
Provision for uncollectible accounts and notes receivable	1,264			1,034
Depreciation and amortization	16,410			15,484
Deferred income taxes	(7,178		)	(5,709		)
Stock-based compensation expense	2,567			1,855
Excess tax benefit related to exercise of non-qualified stock options	(117		)	(3,025		)
Other	137			3,694
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable	(2,251		)	1,048
Inventories	1,825			1,785
Prepaid expenses	1,026			(1,723		)
Other current assets	(256		)	908
Other assets and liabilities	(1,233		)	(892		)
Accounts payable	293			(2,437		)
Income and other taxes	1,704			(1,228		)
Accrued expenses	(1,885		)	(3,929		)
Unearned franchise and development fees	(494		)	(351		)
Net cash provided by operating activities	29,252			26,244
Investing activities
Purchase of property and equipment	(16,010		)	(16,433		)
Purchase of investments	(437		)	—
Proceeds from sale or maturity of investments	407			671
Loans issued	(681		)	(4,263		)
Loan repayments	1,078			2,029
Acquisitions	(100		)	(8,615		)
Proceeds from divestitures of restaurants	—			632
Other	156			27
Net cash used in investing activities	(15,587		)	(25,952		)
Financing activities
Net proceeds from line of credit facility	1,102			19,500
Net proceeds from short-term debt - variable interest entities	3,525			10,250
Excess tax benefit related to exercise of non-qualified stock options	117			3,025
Proceeds from exercise of stock options	965			10,323
Acquisition of Company common stock	(20,287		)	(35,827		)
Other	339			(675		)
Net cash (used in) provided by financing activities	(14,239		)	6,596
Effect of exchange rate changes on cash and cash equivalents	53			66
Change in cash and cash equivalents	(521		)	6,954
Cash and cash equivalents at beginning of period	8,877			12,979
Cash and cash equivalents at end of period	$	8,356		$	19,933

See accompanying notes.

Papa John’s International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

June 29, 2008

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 June 29, 2008 are not necessarily indicative of the results that may be expected for the fiscal year ended December 28, 2008. 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 30, 2007.

2. Recent Accounting Pronouncements

SFAS No. 157, Fair Value Measurements

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

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

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

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

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

Our financial assets and liabilities that are measured at fair value on a recurring basis as of June 29, 2008 are as follows:

	Carrying		Fair Value Measurements
(In thousands)	Value		Level 1		Level 2		Level 3

Financial assets:
Investments	$	855	$	855	$	—	$	—
Non-qualified deferred compensation plan	10,985		10,985		—		—

Financial liabilities:
Interest rate swaps	2,390		—		2,390		—

The adoption for non-financial assets and liabilities in fiscal 2009 could impact our future estimates of value related to long-lived and intangible assets such as our annual fair value evaluation of our United Kingdom subsidiary, Papa John’s UK (“PJUK”) and domestic Company-owned restaurants.

SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities – An Amendment of FASB Statement No. 133

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — An Amendment of FASB Statement No. 133. SFAS No. 161 enhances the required disclosures regarding derivatives and hedging activities, including disclosures regarding how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008 or our first quarter of fiscal 2009. We are currently evaluating the requirements of SFAS No. 161 and have not yet determined the impact, if any, on disclosures included in our consolidated financial statements.

3. Accounting for Variable Interest Entities

FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (FIN 46), 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 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 $40.6 million and $80.2 million of cheese from BIBP for the three and six months ended June 29, 2008, respectively, and $29.4 million and $61.0 million of cheese for the comparable periods in 2007, respectively.

As defined by FIN 46, we are the primary beneficiary of BIBP, a VIE. 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 $6.3 million ($4.1 million net of tax, or $0.14 per share) and $14.3 million ($9.3 million net of tax, or $0.32 per share) for the three months and six months ended June 29, 2008, respectively,

and 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, 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 a $20.0 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 June 29, 2008, BIBP had outstanding borrowings of $12.2 million and a letter of credit of $3.0 million outstanding under the commercial line of credit facility. In addition, as of June 29, 2008, BIBP had outstanding borrowings of $34.1 million with Papa John’s (the $34.1 million outstanding balance under the Papa John’s line of credit is eliminated upon consolidation of the financial results of BIBP with Papa John’s).

In addition, Papa John’s has extended loans to certain franchisees. Under FIN 46, Papa John’s was deemed the primary beneficiary of three franchise entities as of June 29, 2008 and two franchise entities as of July 1, 2007, even though we had no ownership in them. The three franchise entities at June 29, 2008 operated a total of thirteen restaurants with annual revenues approximating $9.0 million. Our net loan balance receivable from these entities was $584,000 at June 29, 2008, 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 June 29, 2008 and December 30, 2007:

	June 29, 2008								December 30, 2007
(In thousands)	BIBP			Franchisees		Total			BIBP			Franchisees		Total

Assets:
Cash and cash equivalents	$	947		$	78	$	1,025		$	1,789		$	235	$	2,024
Accounts receivable - Papa John’s	4,979			—		4,979			4,424			—		4,424
Other current assets	1,156			35		1,191			968			46		1,014
Investments	437			—		437			—			—		—
Net property and equipment	—			881		881			—			756		756
Goodwill	—			455		455			—			455		455
Deferred income taxes	16,355			—		16,355			11,324			—		11,324
Total assets	$	23,874		$	1,449	$	25,323		$	18,505		$	1,492	$	19,997

Liabilities and stockholders’ equity (deficit):
Accounts payable and accrued expenses	$	7,361		$	362	$	7,723		$	9,785		$	319	$	10,104
Short-term debt - third party	12,225			—		12,225			8,700			—		8,700
Short-term debt - Papa John’s	34,077			584		34,661			20,538			560		21,098
Total liabilities	53,663			946		54,609			39,023			879		39,902
Stockholders’ equity (deficit)	(29,789		)	503		(29,286		)	(20,518		)	613		(19,905		)
Total liabilities and stockholders’ equity (deficit)	$	23,874		$	1,449	$	25,323		$	18,505		$	1,492	$	19,997

4. Debt

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

	June 29,			December 30,
	2008			2007

Revolving line of credit	$	135,101		$	134,000
Debt associated with VIEs *	12,225			8,700
Other	94			6
Total debt	147,420			142,706
Less: current portion of debt	(12,225		)	(8,700		)
Long-term debt	$	135,195		$	134,006

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

5. Calculation of Earnings Per Share

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

	Three Months Ended				Six Months Ended
	June 29,		July 1,		June 29,		July 1,
	2008		2007		2008		2007

Basic earnings per common share:
Net income	$	7,648	$	7,009	$	16,273	$	20,164
Weighted average shares outstanding	28,372		30,054		28,536		30,059
Basic earnings per common share	$	0.27	$	0.23	$	0.57	$	0.67

Earnings per common share - assuming dilution:
Net income	$	7,648	$	7,009	$	16,273	$	20,164

Weighted average shares outstanding	28,372		30,054		28,536		30,059
Dilutive effect of outstanding stock compensation awards	333		546		218		564
Diluted weighted average shares outstanding	28,705		30,600		28,754		30,623
Earnings per common share - assuming dilution	$	0.27	$	0.23	$	0.57	$	0.66

6. Comprehensive Income

Comprehensive income is comprised of the following:

	Three Months Ended				Six Months Ended
(In thousands)	June 29, 2008		July 1, 2007		June 29, 2008			July 1, 2007

Net income	$	7,648	$	7,009	$	16,273		$	20,164
Change in valuation of interest rate swap agreements, net of tax	1,116		619		(229		)	363
Other, net	9		202		133			320
Comprehensive income	$	8,773	$	7,830	$	16,177		$	20,847

7. Segment Information

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

The domestic restaurant segment consists of the operations of all domestic (“domestic” is defined as contiguous United States) Company-owned restaurants and derives its revenues principally from retail sales of pizza and side items, such as breadsticks, cheesesticks, chicken strips, chicken wings, dessert pizza, and soft drinks to the general public. The domestic commissary segment consists of the operations of our regional dough production and product distribution centers and derives its revenues principally from the sale and distribution of food and paper products to domestic Company-owned and franchised restaurants. The domestic franchising segment consists of our franchise sales and support activities and derives its revenues from sales of franchise and development rights and collection of royalties from our domestic franchisees. The international operations segment principally consists of our Company-owned restaurants and distribution sales to franchised Papa John’s restaurants located in the United Kingdom, China and Mexico and our franchise sales and support activities, which derive revenues from sales of franchise and development rights and the collection of royalties from our international franchisees. VIEs consist of entities in which we are deemed the primary beneficiary, as defined in Note 3, 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.

Our segment information is as follows:

	Three Months Ended						Six Months Ended
(In thousands)	June 29, 2008			July 1, 2007			June 29, 2008			July 1, 2007
Revenues from external customers:
Domestic Company-owned restaurants	$	133,815		$	119,633		$	272,670		$	241,677
Domestic commissaries	106,321			96,224			212,368			196,423
Domestic franchising	15,006			14,287			31,371			29,501
International	9,593			7,155			18,446			14,144
Variable interest entities (1)	2,239			1,602			4,279			3,289
All others	16,434			17,355			33,279			31,846
Total revenues from external customers	$	283,408		$	256,256		$	572,413		$	516,880

Intersegment revenues:
Domestic commissaries	$	35,851		$	29,684		$	72,076		$	60,529
Domestic franchising	478			338			944			677
International	307			149			608			306
Variable interest entities (1)	40,572			29,430			80,233			61,017
All others	4,027			3,447			8,136			7,415
Total intersegment revenues	$	81,235		$	63,048		$	161,997		$	129,944

Income (loss) before income taxes:
Domestic Company-owned restaurants	$	7,157		$	7,535		$	14,955		$	15,750
Domestic commissaries	7,624			7,917			16,057			17,931
Domestic franchising	13,095			12,065			27,567			25,108
International	(1,520		)	(2,032		)	(3,259		)	(4,352		)
Variable interest entities (2)	(6,302		)	(8,257		)	(14,253		)	(8,663		)
All others	1,993			1,679			4,518			2,724
Unallocated corporate expenses	(9,144		)	(7,486		)	(18,363		)	(15,781		)
Elimination of intersegment profits	(717		)	(311		)	(1,435		)	(894		)
Total income before income taxes	$	12,186		$	11,110		$	25,787		$	31,823

Property and equipment:
Domestic Company-owned restaurants	$	167,848
Domestic commissaries	77,634
International	9,864
Variable interest entities	1,842
All others	23,606
Unallocated corporate assets	137,340
Accumulated depreciation and amortization	(221,445		)
Net property and equipment	$	196,689

(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) Represents BIBP’s operating income (loss), net of minority interest income for each year.

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

Overview

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 June 29, 2008, there were 3,270 Papa John’s restaurants (670 Company-owned and 2,600 franchised) operating in all 50 states and 28 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.

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 and make estimates and assumptions that affect the amounts reported in the consolidated financial statements. Significant changes in assumptions and/or conditions in our critical accounting policies could materially impact the operating results. We have identified the following accounting policies and related judgments as critical to understanding the results of our operations.

Allowance for Doubtful Accounts and Notes Receivable

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

Long-Lived and Intangible Assets

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

The recoverability of indefinite-lived intangible assets (i.e., goodwill) is evaluated annually, or more frequently if impairment indicators exist, on a reporting unit basis by comparing the fair value derived from discounted expected cash flows of the reporting unit to its carrying value. We purchased 118 domestic restaurants during 2007 and 2006 in several markets, which resulted in recording $41.7 million of goodwill. If our plans for increased sales, unit growth and profitability of these restaurants are not met, future impairment charges could occur.

At June 29, 2008, 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. This arrangement eliminates our risk of loss for franchise insurance coverage written after September 2004, but 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

We are subject to income taxes in the United States and several foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and the related assets and liabilities. Income taxes are accounted for under Statement of Financial Accounting Standards (“SFAS”) No. 109, Accounting for Income Taxes. The provision for income taxes includes income taxes paid, currently payable or receivable and those deferred. Under SFAS No. 109, deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities, and are measured using enacted tax rates and laws that are expected to be in effect when the differences reverse. Deferred tax assets are also recognized for the estimated future effects of tax loss carryforwards. The effect on deferred taxes of changes in tax rates is recognized in the period in which the enactment date changes. As a result, our effective tax rate may fluctuate. Valuation allowances are established when necessary on a jurisdictional basis to reduce deferred tax assets to the amounts we expect to realize.

As of June 29, 2008, we had a net deferred income tax asset balance of $26.8 million, of which approximately $16.4 million relates to the net operating loss carryforward of BIBP Commodities, Inc. (“BIBP”). We have not provided a valuation allowance for the deferred income tax assets associated with our domestic operations, including BIBP, 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 based on Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) requirements. We evaluate these issues on a quarterly basis to adjust for events, such as court rulings or audit settlements, which may impact our ultimate payment for such exposures.

Consolidation of BIBP Commodities, Inc. 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 $6.3 million and $14.3 million for the three and six months ended June 29, 2008, respectively, and pre-tax losses of $8.3 million and $8.7 million for the three and six months ended July 1, 2007, respectively, 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, but BIBP’s operating results are 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.

Recent Accounting Pronouncements

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

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

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

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

Our financial assets and liabilities that are measured at fair value on a recurring basis as of June 29, 2008 are as follows:

	Carrying		Fair Value Measurements
(In thousands)	Value		Level 1		Level 2		Level 3

Financial assets:
Investments	$	855	$	855	$	—	$	—
Non-qualified deferred compensation plan	10,985		10,985		—		—

Financial liabilities:
Interest rate swaps	2,390		—		2,390		—

Restaurant Progression

	Three Months Ended				Six Months Ended
	June 29, 2008		July 1, 2007		June 29, 2008		July 1, 2007

Papa John’s Restaurant Progression:
U.S. Company-owned:
Beginning of period	648		586		648		577
Opened	5		9		9		13
Closed	(1	)	(2	)	(6	)	(2	)
Acquired from franchisees	—		13		1		19
Sold to franchisees	—		—		—		(1	)
End of period	652		606		652		606
International Company-owned:
Beginning of period	17		8		14		11
Opened	2		—		5		—
Closed	(1	)	—		(1	)	—
Sold to franchisees	—		—		—		(3	)
End of period	18		8		18		8
U.S. franchised:
Beginning of period	2,122		2,086		2,112		2,080
Opened	24		38		46		60
Closed	(29	)	(15	)	(40	)	(26	)
Acquired from Company	—		—		—		1
Sold to Company	—		(13	)	(1	)	(19	)
End of period	2,117		2,096		2,117		2,096
International franchised:
Beginning of period	451		364		434		347
Opened	36		18		55		36
Closed	(4	)	(2	)	(6	)	(6	)
Acquired from Company	—		—		—		3
End of period	483		380		483		380
Total restaurants - end of period	3,270		3,090		3,270		3,090

Results of Operations

Variable Interest Entities

As required by FIN 46, our operating results include BIBP’s operating results. The consolidation of BIBP had a significant impact on our operating results for the first six months of 2008 and the first six months and full year of 2007, and is expected to have a significant impact on our future operating results, including the full year of 2008, and income statement presentation as described below. However, the impact is not expected to be cumulatively significant over time.

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 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, we have extended loans to certain franchisees. Under the FIN 46 rules, we are deemed to be the primary beneficiary of certain franchisees even though we have no ownership interest in them. We consolidated the financial results of three franchise entities operating a total of thirteen restaurants with annual sales approximating $9.0 million for the three and six months ended June 29, 2008 and two franchise entities operating a total of seven restaurants with annual sales approximating $6.0 million for the three and six months ended July 1, 2007.

The following table summarizes the impact of VIEs, prior to required consolidating eliminations, on our consolidated statements of income for the three and six months ended June 29, 2008 and July 1, 2007 (in thousands):

	Three Months Ended									Three Months Ended
	June 29, 2008									July 1, 2007
	BIBP			Franchisees			Total			BIBP			Franchisees		Total

Variable interest entities restaurant sales	$	—		$	2,239		$	2,239		$	—		$	1,601	$	1,601
BIBP sales	40,572			—			40,572			29,430			—		29,430
Total revenues	40,572			2,239			42,811			29,430			1,601		31,031

Operating expenses	46,370			2,153			48,523			37,607			1,464		39,071
General and administrative expenses	23			82			105			22			56		78
Other general expense (income)	—			(12		)	(12		)	—			70		70
Depreciation and amortization	—			16			16			—			11		11
Total costs and expenses	46,393			2,239			48,632			37,629			1,601		39,230
Operating loss	(5,821		)	—			(5,821		)	(8,199		)	—		(8,199		)
Interest expense	(481		)	—			(481		)	(58		)	—		(58		)
Loss before income taxes	$	(6,302	)	$	—		$	(6,302	)	$	(8,257	)	$	—	$	(8,257	)

	Six Months Ended									Six Months Ended
	June 29, 2008									July 1, 2007
	BIBP			Franchisees			Total			BIBP			Franchisees		Total

Variable interest entities restaurant sales	$	—		$	4,279		$	4,279		$	—		$	3,289	$	3,289
BIBP sales	80,233			—			80,233			61,017			—		61,017
Total revenues	80,233			4,279			84,512			61,017			3,289		64,306

Operating expenses	93,445			4,094			97,539			69,553			2,965		72,518
General and administrative expenses	46			164			210			47			108		155
Other general expense (income)	—			(9		)	(9		)	—			192		192
Depreciation and amortization	—			30			30			—			24		24
Total costs and expenses	93,491			4,279			97,770			69,600			3,289		72,889
Operating loss	(13,258		)	—			(13,258		)	(8,583		)	—		(8,583		)
Interest expense	(995		)	—			(995		)	(80		)	—		(80		)
Loss before income taxes	$	(14,253	)	$	—		$	(14,253	)	$	(8,663	)