10-K 1 a50172641.htm PAPA JOHN'S INTERNATIONAL, INC. 10-K a50172641.htm
 
 
GRAPHIC
 
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 25, 2011
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)

Delaware
(State or other jurisdiction of
incorporation or organization)
61-1203323
(I.R.S. Employer
Identification No.)
   
2002 Papa Johns Boulevard
Louisville, Kentucky
(Address of principal executive offices)
 
40299-2367
       (Zip Code)
 
(502) 261-7272
(Registrant's telephone number, including area code)


 
Securities registered pursuant to Section 12(b) of the Act:
(Title of Each Class)
Common Stock, $.01 par value
(Name of each exchange on which registered)
The NASDAQ Stock Market LLC
   
Securities registered pursuant to Section 12(g) of the Act:
None
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes x    No o

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

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

 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x    No o

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

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

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 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 26, 2011, was approximately $633,919,944.
 
As of February 14, 2011, there were 24,242,254 shares of the Registrant’s Common Stock outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of Part III are incorporated by reference to the Registrant’s Proxy Statement for the Annual Meeting of Stockholders to be held April 26, 2012.

 
 

 
 
TABLE OF CONTENTS


   
Page
   
1
12
16
17
20
20
     
   
 
 
23
26
 
 
27
50
52
 
 
84
84
85
     
   
85
85
 
 
86
86
86
     
   
87
 
 
 

 
 

Item 1.  Business

General

Papa John’s International, Inc. (referred to as the “Company”, “Papa John’s” or in the first person notations of “we”, “us” and “our”) operates and franchises pizza delivery and carryout restaurants and, in certain international markets, dine-in and restaurant-based delivery restaurants under the trademark “Papa John’s”. The first Company-owned Papa John’s restaurant opened in 1985 and the first franchised restaurant opened in 1986. At December 25, 2011, there were 3,883 Papa John’s restaurants in operation, consisting of 628 Company-owned and 3,255 franchised restaurants operating domestically in all 50 states, the District of Columbia and Puerto Rico and in 33 countries. Our Company-owned restaurants include 128 restaurants operated under two joint venture arrangements. Under the first arrangement, we own 70% of an entity operating 52 Papa John’s restaurants located in Virginia and Maryland. Under the second arrangement, we own 51% of an entity operating 76 Papa John’s restaurants located in Texas. We also own and operate restaurants in Beijing and North China (30 units at December 25, 2011).

Papa John’s has defined six reportable segments: domestic Company-owned restaurants, domestic commissaries (Quality Control Centers), North America franchising, international operations, variable interest entities (“VIEs”) and “all other” business units. Beginning in fiscal 2011, we realigned management responsibility for Hawaii, Alaska and Canada from international to domestic operations in order to better leverage existing infrastructure and systems. We renamed our domestic franchised segment “North America franchising”. Throughout this report we use “domestic” when referring to the contiguous United States. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Note 19” of “Notes to Consolidated Financial Statements” for financial information about these segments for the fiscal years ended December 25, 2011, December 26, 2010 and December 27, 2009.

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 website located at www.papajohns.com, including our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports. Those documents are available through our website as soon as reasonably practicable after we electronically file them with the SEC. We also make available free of charge on our website our Corporate Governance Guidelines; Board Committee Charters; and our Code of Ethics, which applies to Papa John's directors, officers and employees. Printed copies of such documents are also available free of charge upon written request to Investor Relations, Papa John’s International, Inc., P.O. Box 99900, Louisville, KY 40269-0900. You may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC  20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. This information is also available at www.sec.gov. The references to these website addresses do not constitute incorporation by reference of the information contained on the websites, which should not be considered part of this document.
 
Strategy
 
Our goal is to build the strongest brand loyalty of all pizza restaurants. The key elements of our strategy include:
 
 
1

 

High Quality Menu Offerings. Domestic Papa John’s restaurants offer a menu of high-quality pizza along with side items, including breadsticks, cheesesticks, chicken strips and wings, dessert items and canned or bottled beverages. Papa John’s traditional crust pizza is prepared using fresh dough (never frozen). Papa John’s pizzas are made from a proprietary blend of wheat flour, cheese made from 100% real mozzarella, fresh-packed pizza sauce made from vine-ripened tomatoes (not from concentrate) and a proprietary mix of savory spices, and a choice of high-quality meat (100% beef, pork and chicken with no fillers) and vegetable toppings. Domestically, all ingredients and toppings can be purchased from our Quality Control Center (“QC Center”) system, which delivers to individual restaurants twice weekly. To ensure consistent food quality, each domestic franchisee is required to purchase dough and tomato sauce from our QC Centers and to purchase all other supplies from our QC Centers or other approved suppliers. Internationally, the menu may be more diverse than in our domestic operations to meet local tastes and customs. QC Centers outside the U.S. may be operated by franchisees pursuant to license agreements or by other third parties. We provide significant assistance to licensed international QC Centers in sourcing approved quality suppliers.

In addition to our fresh dough traditional crust pizza, we offer a thin crust pizza, which is a par-baked product produced by a third-party vendor. Our traditional crust pizza offers a container of our special garlic sauce and a pepperoncini pepper. Each thin crust pizza is served with a packet of special seasonings and a pepperoncini pepper.

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

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

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

Marketing. Our marketing strategy consists of both national and local components. Our domestic national strategy includes national advertising via television, print, direct mail, digital and social media channels. Our online and digital marketing activities have increased significantly over the past several years in response to increasing consumer use of online and mobile web technology.
 
Our local restaurant-level marketing programs target consumers within the delivery area of each restaurant through the use of local TV, print materials, targeted direct mail, store-to-door flyers, email marketing, text messages and local social media. Local marketing efforts also include a variety of community-oriented activities within schools, sports venues and other organizations supported with some of the same advertising vehicles mentioned above.

In international markets, we target customers who live or work within a small radius of a Papa John’s restaurant. Certain markets can effectively use television and radio as part of their marketing strategies. The majority of the marketing efforts 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.
 
 
2

 

Strong  Franchise System. We are committed to developing and maintaining a strong franchise system by attracting experienced operators, supporting them to expand and grow their business and monitoring their compliance with our high standards. We seek to attract franchisees with experience in restaurant or retail operations and with the financial resources and management capability to open single or multiple locations. 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.

Growth in International Operations.  As of December 25, 2011, we had 822 Papa John's restaurants operating in 32 countries and Puerto Rico, excluding Canada, which is included in North America franchising. Substantially all of the Papa John's international units are franchised operations (we own and operate 30 restaurants in Beijing and North China). During 2011 and 2010, we opened 113 and 74 international net new units (new unit openings less unit closings), respectively. We plan to continue to grow our international franchise units during the next several years. Our total international development pipeline as of December 25, 2011 included approximately 1,200 restaurants with approximately 40% scheduled to open in the next three years.

Unit Sales and Investment Costs

In 2011, the 582 domestic Company-owned restaurants included in the full year’s comparable restaurant base generated average unit sales of $897,000. North America franchise sales per unit on average are lower than Company-owned restaurants as a higher percentage of our Company-owned restaurants are located in more heavily penetrated markets.

The average cash investment for the eight domestic Company-owned restaurants opened during the 2011 fiscal year, exclusive of land, was approximately $260,000 per unit, excluding tenant allowances that we received. With few exceptions, domestic restaurants do not offer a dine-in area, which reduces our restaurant capital investment.
 
Development

A total of 321 Papa John’s restaurants were opened during 2011, consisting of 17 Company-owned (eight domestic and nine international) and 304 franchised restaurants (166 in North America and 138 international), while 84 Papa John’s restaurants closed during 2011, consisting of one domestic Company-owned restaurant and 83 franchised restaurants (49 in North America and 34 international).

During 2012, we expect net unit growth of approximately 240 to 280 units (110 to 130 net openings for North America and 130 to 150 net openings for international). North America and international franchised unit expansion is expected to continue with an emphasis on markets in the Americas, the United Kingdom, the Middle East and Asia. We expect our expansion in Asia to include a significant focus in China.

Although most of our Company-owned markets are well penetrated, our Company-owned growth strategy is to continue to open domestic restaurants in existing markets as appropriate, thereby increasing consumer awareness and enabling us to take advantage of operational and marketing efficiencies. Our experience in developing markets indicates that market penetration through the opening of multiple restaurants in a particular market results in increased average restaurant sales in that market over time. We have co-developed domestic markets with some franchisees or divided markets among franchisees, and will continue to utilize market co-development in the future, where appropriate.
 
 
3

 
 
Of the total 3,061 North American restaurants open as of December 25, 2011, 598 or 20% were Company-owned (including 128 units owned in joint venture arrangements with franchisees in which the Company has a majority ownership position). The Company expects the percentage of domestic Company-owned units to decline over the next several years, because future net openings will be more heavily weighted toward franchise units.

Restaurant Design and Site Selection

A typical inline or end cap domestic Papa John’s restaurant averages 1,100 to 1,500 square feet with visible exterior signage. Papa John’s restaurants are designed to facilitate a smooth flow of food orders through the restaurant from order taking to delivery. The typical interior of a Papa John’s restaurant has a vibrant color scheme, and includes a bright menu board, custom counters and a customer carryout area. The counters are designed to allow customers to watch the team members slap out the dough and put sauce and toppings on pizzas. During 2011, a substantial majority of restaurants in the United States installed a lobby enhancement re-design package. The cost of the lobby enhancement re-design package approximated $10,000 to $15,000 per restaurant. We expect the remaining domestic franchisees to complete the lobby enhancement program during 2012.

Most of our international Papa John’s restaurants are between 900 and 1,400 square feet; however, in order to meet certain local customer preferences, many international restaurants have been opened in larger spaces to accommodate both dine-in and restaurant-based delivery service, typically with 35 to 100 seats.
 
We define a “traditional” domestic Papa John’s restaurant as a delivery and carryout unit that services a defined trade area. We consider the location of a traditional restaurant to be important and therefore devote significant resources to the investigation and evaluation of potential sites. The site selection process includes a review of trade area demographics, target population density and competitive factors.  A member of our development team inspects each potential domestic Company-owned restaurant location and substantially all franchised restaurant locations 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.

“Non-traditional” Papa John’s restaurants do not generally provide delivery to a defined trade area but rather serve a captive customer group with continuous operations or an event-driven service, such as university food service, stadiums, entertainment venues, military bases and airports. Non-traditional units are designed to fit the unique requirements of the venue.

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. In addition, we sell replacement smallwares and related items to our franchisees.
 
 
4

 
 
QC Center System and Supply Chain Management

Our domestic QC Centers, comprised of nine full-service regional production and distribution centers and one distribution-only center, supply pizza dough, food products, paper products, smallwares and cleaning supplies twice weekly to each restaurant throughout the contiguous United  States. The primary difference between a full-service QC Center and a distribution-only center is that full-service QC Centers produce fresh pizza dough in addition to providing other food and paper products used in our restaurants. This system enables us to monitor and control product quality and consistency, while lowering food and other costs. 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 own full-service international QC Centers in the United Kingdom, Mexico City, Mexico and Beijing, China. Other international full-service QC Centers are licensed to franchisees or non-franchisee third parties, and are generally located in the markets where our franchisees have restaurants.

We set quality standards for all products used in our restaurants and designate approved outside suppliers of food and paper products that meet our quality standards. In order to ensure product quality and consistency, all domestic Papa John’s restaurants are required to purchase tomato sauce and dough from our QC Centers. Franchisees may purchase other goods directly from our QC Centers or other 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, had a purchasing agreement 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 through February 2011. Under this agreement, PJFS purchased cheese from BIBP on a monthly basis at the projected spot market price, plus a certain adjustment based on BIBP’s cumulative financial position. Gains and losses incurred by BIBP were passed on to PJFS and therefore to Company-owned and franchised restaurants through adjustments to the selling price. Over time, PJFS purchased cheese at a price approximating the actual average market price, but with more short-term predictability. See also “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 3” of “Notes to Consolidated Financial Statements” for additional information concerning BIBP and the related financial statement treatment of BIBP’s results.

Beginning in fiscal 2011, for franchisees who signed a new cheese purchasing agreement, PJFS continues to lock in the price of cheese to the system on a period-by-period basis. The cheese purchasing agreement requires the franchisee to commit to purchase cheese through PJFS, or to pay the franchisee’s pro rata portion of any accumulated cheese liability upon ceasing to purchase cheese from PJFS when a cheese liability exists.

Marketing Programs

All domestic Company-owned and franchised Papa John’s restaurants within a defined market are required to join an area advertising cooperative (“Co-op”). Each member restaurant contributes a percentage of sales to the Co-op for market-wide programs, such as radio, television and print advertising. The rate of contribution and uses of the monies collected are determined by a majority vote of the Co-op’s members. The contribution rate for Co-ops may generally not be below 2.0% without approval from Papa John’s.
 
 
5

 
 
The restaurant-level and Co-op marketing efforts are supported by print, digital and electronic advertising materials that are produced by Papa John’s Marketing Fund, Inc., an unconsolidated non-profit corporation (the “Marketing Fund”). The Marketing Fund buys air time for Papa John’s national television commercials, buys digital media such as banner advertising, paid search-engine advertising, social media advertising and marketing and email, in addition to other brand-building activities, such as consumer research and public relations activities. Domestic Company-owned and franchised Papa John’s restaurants are required to contribute a certain minimum percentage of sales to the Marketing Fund. The contribution rate to the Marketing Fund can be increased above the required minimum contribution rate if approved by the governing board of the Marketing Fund up to certain levels, and beyond those levels if approved by a supermajority of domestic restaurants. The contribution rate was 4.0% in 2011 and averaged 3.05% in 2010 and 2.79% in 2009. The contribution rate for 2012 is 4.0%.

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 coupons. 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 marketing materials and 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”). In addition, we provide database tools, templates and training that allow operators to set their own local email marketing, text messaging and social media.

Our digital ordering platform allows customers to order online. Our platform includes “plan ahead ordering”, Spanish-language ordering capability, and enhanced mobile web ordering for our customers, including Papa John's iPhone® and Android® applications. During 2010, we implemented the Papa Rewards program, which is an online customer loyalty program designed to increase consumer use of our online/digital ordering platform. We receive a percentage-based fee from U.S. franchisees for online sales, in addition to royalties, to cover the cost of this service, although the aggregate fees collected in both 2010 and 2011 were not sufficient to cover these costs due primarily to incremental costs associated with the re-design of the platform in 2010 and increased maintenance costs with the new platform.

We also offer our customers the opportunity to purchase a reloadable gift card marketed as the “Papa Card.” Additionally, we sell Papa Cards to consumers through third-party retailers and continue to explore other Papa Card distribution opportunities. The Papa Card may be redeemed for delivery, carryout, online and mobile web orders and is accepted at all Papa John’s traditional domestic restaurants.

Company Operations

Restaurant Personnel.  A typical Papa John’s Company-owned domestic restaurant employs a restaurant manager 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. We seek to hire experienced restaurant managers and staff and provide comprehensive training on operations and managerial skills. We also employ directors of operations who are responsible for overseeing an average of seven Company-owned restaurants. Operations senior management and corporate staff support the field teams in many areas, including but not limited to quality assurance, training, marketing and technology.  We seek to motivate and retain personnel by providing opportunities for advancement and performance-based financial incentives.
 
 
6

 
 
Training and Education. The Operations Support and Training (“OST”) department is responsible for creating tools and materials for the training and development of both corporate and franchise team members. We believe training is very important to delivering consistent operational execution. Operations personnel complete our management training program and ongoing development programs, including multi-unit training in which instruction is given on all aspects of our systems and operations.

Point-of-Sale Technology.  Our proprietary PROFIT SystemTM, point-of-sale technology (“POS”), is in place in all North America traditional Papa John’s restaurants. We believe this technology facilitates fast and accurate order-taking and pricing, reduces paperwork and allows the restaurant manager to better monitor and control food and labor costs, including facilitation of managing food inventory and placing orders from the domestic QC Centers. We believe the PROFIT System also enhances restaurant-level marketing capabilities. Polling capabilities allow us to obtain restaurant operating information, providing us with timely access to financial sales and marketing information. The PROFIT System is also closely integrated with our online ordering system in all domestic traditional Papa John’s restaurants enabling Papa John’s to offer nationwide online and mobile web ordering to our customers.

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. Carryout hours are generally more limited for late night, for security purposes.

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 25, 2011, there were 3,255 franchised Papa John’s restaurants operating in all 50 states, the District of Columbia, Puerto Rico and 33 countries. As of December 25, 2011, we have development agreements with our franchisees for approximately 350 additional North America restaurants, the majority of which are committed to open over the next six years, and agreements for approximately 1,200 additional international franchised restaurants, the majority of which are scheduled to open over the next six years. 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 2011, 304 (166 North America and 138 international) franchised Papa John’s restaurants were opened.

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

North America Development and Franchise Agreements. We enter into development agreements with our franchisees in North America for the opening of a specified number of restaurants within a defined period of time and specified geographic area. Substantially all existing franchise agreements have an initial 10-year term with a 10-year renewal option. 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 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 North America franchisees may purchase complete new store equipment packages through an approved third-party supplier.
 
 
7

 
 
Under our standard domestic 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 current standard development agreement requires the franchisee to pay a royalty fee of 5% of sales and the majority of our existing franchised restaurants also have a 5% royalty rate in effect.

Domestic Franchise Development Incentives. Beginning in 2009, we started offering certain development incentives to domestic franchisees to increase unit openings. Such incentives included the following for 2011 traditional openings: (1) no franchise fee (standard fee is $25,000); (2) the waiver of some or all of the 5% royalty fee for a limited amount of time, not to exceed 18 months; (3) a credit for the purchase of ovens; and (4) a credit to be applied toward a future food purchase, under certain circumstances. Our 2012 incentives will be similar to those offered in 2011. We believe the development incentive programs have increased unit openings since 2009 and expect they will continue to do so in 2012.

Marketing Fund. The Marketing Fund contribution rate for 2012 has been set by the system at 4.0%, the same rate as in 2011. In consideration of agreeing to set the rate over a multi-year period, during 2012 and 2013 franchisees may earn up to a 45 basis point royalty rebate (against our standard 5.0% royalty rate) by meeting certain sales growth targets and/or capital investment initiatives.

Franchise Support Initiatives. From time to time, we offer additional discretionary support initiatives to our franchisees, including:
 
Food cost relief by lowering the commissary margin on certain commodities sold by PJFS to the franchise system and by providing incentive rebate opportunities;
Targeted royalty relief and local marketing support to assist certain identified franchisees or markets; and
Restaurant opening incentives.
 
In 2010 (none in 2011), we provided additional system-wide national marketing contributions, additional system-wide local print marketing contributions and certain other system-wide incentives.

In 2012, we plan to continue domestic franchise support initiatives. We believe the support programs have mitigated potential unit closures and strengthened our brand during this challenging economic environment. In addition to reducing unit closures, other important objectives of the support program include growing market share.

International Development and Franchise Agreements.  We opened our first franchised restaurant outside the United States in 1998. We define “international” as all markets outside the United States and Canada 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, 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.
 
 
8

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

Non-traditional Restaurant Development. We had approximately 130 development and franchise agreements for non-traditional restaurants at December 25, 2011. These agreements generally cover venues or areas not originally targeted for traditional unit development and have terms differing from the standard agreement.

Franchisee Loans. Selected franchisees have borrowed funds from us, principally for the purchase of restaurants from us or other franchisees or for use in the construction and development of new restaurants. Loans made to franchisees typically bear interest at fixed or floating rates and in most cases are secured by the fixtures, equipment and signage of the restaurant and/or are guaranteed by the franchisees’ owners. At December 25, 2011, net loans outstanding totaled $15.7 million. See “Note 9” of “Notes to Consolidated Financial Statements” for additional information.

Franchise Insurance Program. Our franchisees have the opportunity to purchase various insurance policies, such as health insurance, non-owned automobile and workers’ compensation, through our wholly-owned insurance agency, Risk Services Corp. (“Risk Services”). A third-party commercial insurance company provides fully-insured coverage to franchisees participating in the franchise insurance program offered by Risk Services. Approximately 50% of domestic franchised restaurants have insurance coverage through Risk Services.

Franchise Training and Support. Our domestic field support structure consists of franchise business directors, each of whom is responsible for serving an average of approximately 100 franchised units. Our franchise business directors maintain open communication with the franchise community, relaying operating and marketing information and new initiatives between franchisees and us. Franchise business directors report to one of three regional division vice presidents, who report to the Senior Vice President, North American Operations.

Every franchisee is required to have a principal operator approved by us who satisfactorily completes our required training program. Principal operators for traditional restaurants are required to devote their full business time and efforts to the operation of the franchisee’s traditional restaurants. Each franchised restaurant manager is also required to complete our Company-certified management training program. Ongoing supervision of training is monitored by the OST team. Multi-unit franchisees are encouraged to appoint training store general managers or hire a full-time training coordinator certified to deliver Company-approved programs in order to train new team members and management candidates for their restaurants.

International Franchise Operations Support. We employ international business managers who are responsible for supporting one or more franchisees. The international business managers report to one of three regional vice presidents or report directly to the Senior Vice President, International. Various support functions for the international business such as marketing, supply chain, research and development, training and quality assurance are managed centrally as global functions, with regional field support personnel as appropriate.
 
 
9

 
 
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. Franchisees generally have full discretion to determine the prices to be charged to customers.

Franchise Advisory Council. We have a Franchise Advisory Council (“FAC”) that consists of Company and franchisee representatives of domestic restaurants. We also have an FAC in the United Kingdom. The FAC and subcommittees hold regular meetings to discuss new product and marketing ideas, operations, growth and other relevant issues. Certain domestic franchisees have also formed a separate franchise association for the purpose of communicating and addressing issues, needs and opportunities among its members.

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

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

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

Industry and Competition

The United States Quick Service Restaurant pizza industry (“QSR Pizza”) is mature and highly competitive with respect to price, service, location, food quality and variety. There are well-established competitors with substantially greater financial and other resources than Papa John’s. The category is largely fragmented and 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 stronger, more developed brand awareness in markets where we compete. According to industry sources, QSR Pizza category sales, which includes dine-in, carry-out and delivery, had sales of approximately $32.4 billion in 2011, or an increase of 0.76% from the prior year.

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.
 
 
10

 
 
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 can 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. The laws of several states also regulate substantive aspects of the franchisor-franchisee relationship. The FTC requires us to furnish to prospective franchisees a franchise disclosure document containing prescribed information. Substantive state laws that regulate the franchisor-franchisee relationship presently exist in a substantial number of states, and bills have been introduced in Congress from time to time that would provide for federal regulation of the franchisor-franchisee relationship in certain respects if such bills were enacted. The state laws often limit, among other things, the duration and scope of non-competition provisions and the ability of a franchisor to terminate or refuse to renew a franchise. Some foreign countries also have disclosure requirements and other laws regulating franchising and the franchisor-franchisee relationship. Further national, state and local government initiatives, such as mandatory health insurance coverage, “living wage” or other proposed increases in minimum wage rates and nutritional guidelines or disclosure requirements, could adversely affect Papa John’s as well as others within the restaurant industry. As we expand internationally, we are 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 100 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 vigorously oppose any infringement of our marks.

Employees

As of December 25, 2011, we employed approximately 16,500 persons, of whom approximately 14,400 were restaurant team members, approximately 700 were restaurant management personnel, approximately 600 were corporate personnel and approximately 800 were QC Center and our wholly-owned print and promotions subsidiary, Preferred Marketing Solutions, Inc. (“Preferred”) 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 good.
 
 
11

 

Item 1A. Risk Factors

We are subject to various risks that could have a negative effect on our business, financial condition and results of operations. These risks could cause actual operating results to differ from those expressed in certain “forward looking statements” contained in this Form 10-K as well as in other Company communications. Although we believe that our expectations are based on reasonable assumptions, actual results may differ materially from those in the forward-looking statements as a result of various factors:

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

The QSR Pizza category and the restaurant industry in general are 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 pricing or other marketing initiatives or promotional strategies, including new product and concept developments, by one or more of our major competitors can have a rapid and adverse impact on our sales and earnings and our system-wide restaurant operations.

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

Changes in consumer taste (for example, changes in dietary preferences that could cause consumers to avoid pizza in favor of foods that are perceived as more healthful, and continuing focus on weight management), demographic trends, traffic patterns and the type, number and location of competing restaurants could adversely affect our restaurant business. Also, our success depends to a significant extent on numerous factors affecting discretionary consumer spending, including disposable consumer income, consumer confidence and economic conditions, such as continued higher levels of unemployment. Further adverse changes in these factors could reduce sales or inhibit our ability to increase pricing, either of which could materially adversely affect our results of operations.

Our brand could be impacted by negative publicity concerning food quality and other health issues.

Like other food industry competitors, we could be materially adversely affected by food safety issues and negative publicity concerning food quality, product recalls, customer service, illness, injury, publication of government or industry findings concerning food products served by us or competitors, or other health concerns or operating issues stemming from one or more restaurants. Reports of food safety issues, perceived health impact of ingredients in the products we serve and customer service issues could reduce our sales and transactions. This risk is heightened by the impact of social media.

Our success depends on the differentiation of our brand.

Our results depend upon our ability to differentiate our brand and our reputation for quality. If we fail in either of these areas, demand for our products could fall or we could otherwise be unable to operate our restaurants profitably.
 
We may not be able to execute our growth strategy or achieve our planned growth targets.

Our growth strategy depends on the Company and our franchisees’ ability to open new restaurants and to operate them on a profitable basis. Planned growth targets and the ability to operate new and existing restaurants profitably are affected by economic and competitive conditions and the resulting impact on consumer buying habits. High food costs or other increased commodity or operating costs, including but not limited to employee compensation and benefits and insurance costs, could slow down the rate of new store openings. Our business is susceptible to adverse changes in domestic and global economic conditions, which could make it difficult for us to meet our growth targets. Additionally, we or our franchisees may face challenges securing financing, finding suitable store locations at acceptable terms or securing required domestic or foreign government permits and approvals.
 
 
12

 
 
Our franchisees remain dependent on the availability of financing to expand existing locations or construct and open new restaurants. The reduced availability of credit has required, and may continue to require, the Company to provide financing to certain franchisees and prospective franchisees in order to mitigate store closings or allow new units to open. If we are unable or unwilling to provide such financing, our results of operations may be adversely impacted. To the extent we provide financing to franchisees in domestic and international markets, our results could be negatively impacted by the credit performance of our franchise loan program, particularly if our franchisees encounter worsening economic or political conditions in their markets.

There can be no assurance that, system-wide, Papa John’s will be able to meet planned growth targets or continue to operate in existing markets profitably.

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

An increase in the cost, or sustained high levels of the cost, of cheese or other commodities could adversely affect the profitability of our system-wide restaurant operations, particularly if we are unable to reflect increased costs into the selling price of our products. Cheese, historically representing 35% to 40% of our food cost, and other commodities can be subject to significant cost fluctuations due to weather, availability, global demand and other factors that are beyond our control. Additionally, increases in fuel and utility costs could adversely affect the profitability of our restaurant and QC Center businesses. Our domestic franchisees buy substantially all of their food products from our QC Center business.

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

Domestically, we are dependent on sole suppliers for our cheese, flour, fresh-packed sauce and thin crust dough products. Alternative sources 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 or to our QC Centers. Insolvency of key suppliers could also negatively impact our business.
 
Our international operations are subject to increased risks and other factors that may make it more difficult to achieve or maintain profitability or meet planned growth rates.

Our international operations could be negatively impacted by 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 the Foreign Corrupt Practices Act, other anti-corruption laws in the countries in which we and our franchisees operate, other foreign laws, currency regulations and fluctuations, differing business and social cultures and consumer preferences, diverse and sometimes uncertain or unstable government regulations and structures, availability and cost of land and construction, ability to source high-quality ingredients and other commodities in a cost-effective manner, and differing interpretation of the obligations established in franchise agreements with international franchisees. Accordingly, there can be no assurance that our international operations will achieve or maintain profitability or meet planned growth rates.
 
 
13

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

System-wide restaurant operations are subject to federal and state laws governing such matters as wages, benefits, working conditions, citizenship requirements and overtime. A significant number of hourly personnel employed by our franchisees and us are paid at rates closely related to the federal and state minimum wage requirements. Accordingly, further increases in the federal minimum wage or the enactment of additional state or local minimum wage increases above federal wage rates would increase labor costs for our system-wide operations. Additionally, current and proposed legislation and regulations may make it easier for workers to form unions, resulting in higher costs. Local government agencies have also implemented ordinances that restrict the sale of certain food products. National health care legislation could negatively impact our domestic system in future years as our Company-owned and franchised restaurants may have to provide health care coverage that was not previously offered to certain part-time team members. Compliance with additional government mandates, including menu labeling requirements, could increase costs and be harmful to system-wide restaurant sales.

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

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

Our business and brand may be harmed should the services of our Founder, John Schnatter, as Chief Executive Officer, Chairman or brand spokesman terminate for any reason. Failure to effectively execute succession planning could harm our Company and brand.

John H. Schnatter, our Founder, Chairman and Chief Executive Officer (CEO), does not serve under an employment agreement and we do not maintain key man life insurance on Mr. Schnatter. We also depend on Mr. Schnatter’s image and his services as spokesman in our advertising and promotion materials. While we have entered into a license agreement with Mr. Schnatter related to the use of certain intellectual property related to his name, likeness and image, our business and brand may be harmed if Mr. Schnatter’s services as CEO, Chairman or brand spokesman were not available for any reason. Failure to effectively execute succession planning could harm our Company and brand.

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

Although our domestic franchisees currently purchase substantially all food products from our QC Centers, they are required to purchase only tomato sauce, dough and other items we may designate as proprietary or integral to our system from our QC Centers. Any changes in purchasing practices by domestic franchisees, such as seeking alternative approved suppliers of food products or ingredients, could adversely affect the financial results of our QC Centers and the Company.
 
 
14

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

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

We rely heavily on information systems, including online and digital ordering, point-of-sale processing in our restaurants, payment of obligations, collection of cash, credit and debit card transactions and other processes and procedures. Our ability to efficiently and effectively manage our business depends on the reliability and capacity of these technology systems. Domestically and internationally, we are dependent on our technology systems operating correctly, including our enhanced online ordering system launched in 2010 through which a significant portion of our domestic sales originates.
 
Our systems could be damaged or interrupted by power loss, telecommunication failures, acts of God, computer viruses, physical or electronic break-ins, hacking or similar attacks. In particular, we may experience occasional interruptions of our online ordering system, which makes online ordering unavailable or slow to respond, negatively impacting sales and the experience of our customers. If our online ordering system does not perform with adequate speed, our customers may be less inclined to return to our online ordering system, as frequently or at all. If our systems do not operate properly, we may need to upgrade or replace these systems, which could require material capital investment from us and our franchisees. Part of our technology infrastructure is specifically designed for us and our operational systems, which could cause unexpected costs, delays or inefficiencies when infrastructure upgrades are needed. Much of our technology infrastructure is provided by third parties, and the performance of these systems is largely beyond our control. Failure of our third party systems to adequately perform, particularly as our online sales grow, could harm our business and the satisfaction of our customers. In addition, we may not have or be able to obtain adequate protection or insurance to mitigate the risks of these events or compensate for losses related to these events, which could damage our business and reputation and be expensive and difficult to remedy or repair.

We may incur significant costs resulting from a security breach, including a breach of confidential customer information from our online ordering business.
 
We are subject to a number of privacy and protection laws and regulations. Our business requires the collection and retention of large volumes of internal and customer data, including credit card numbers and other personally identifiable information of our employees and customers as such information is entered into, processed, summarized and reported by the various information systems we use. The integrity and protection of that customer, employee and Company data is critical to us. Although we take steps to prevent security breaches, such as theft of customer and Company information, failure to prevent fraud or security breaches could result in significant costs to us and have a material adverse effect on our business.
 
 
15

 
 
We have been and will continue to be subject to various types of litigation, including class action litigation, which could subject us to significant damages or other remedies.

We face the risk of litigation from various parties, including our customers, franchisees and employees, in the ordinary course of our business. We are party to various legal proceedings, including employment and tort claims. We evaluate these claims and proceedings to assess the expected outcome and where necessary to estimate the amount of potential losses to us. These assessments are based on the information available to us at the time the estimates are made and require the use of a significant amount of judgment, and actual outcomes or losses may materially differ from our estimates. Even if claims against us do not have merit, the costs of defending or settling any such existing or future claims, or costs related to damages should such claims be upheld in court, could significantly impact the Company’s earnings and financial condition.
 
We may be subject to impairment charges.

Impairment charges are possible if our subsidiary located in the United Kingdom (“PJUK”) or previously acquired domestic restaurants perform below our expectations. This would result in a decrease in our reported asset value and reduction in our net income.
 
Our results of operations could be materially impacted as a result of the credit risk of operators of leases for which we remain contingently liable.

We remain contingently liable for certain restaurant and commissary leases previously operated by us and subsequently sold or refranchised in the ordinary course of business. While the new operators are the primary obligors under such assigned leases, we could be liable in the event that an operator is unwilling or unable to make any required payments under a lease. Continuing weakness in the economy and difficulty in credit markets could make it difficult for operators to meet their contractual commitments. If those operators default on the leases and we are unable to sublease the properties for which we remain contingently liable, it could have a material impact on our results of operations.

Item 1B.  Unresolved Staff Comments

None.
 
 
16

 
 
Item 2.  Properties

As of December 25, 2011, there were 3,883 Papa John’s restaurants system-wide. The following tables provide the locations of our restaurants. We define “North America” as the United States and Canada and “domestic” as the contiguous United States.

Company-owned Papa John’s Restaurants

 
Number of
 
Restaurants
     
Arizona
46
 
Florida
45
 
Georgia
86
 
Illinois
7
 
Indiana
41
 
Kansas
12
 
Kentucky
42
 
Maryland
60
 
Missouri
40
 
North Carolina
82
 
South Carolina
6
 
Tennessee
29
 
Texas
76
 
Virginia
26
 
     
  Total Domestic Company-owned Papa John’s Restaurants
598
 
     
China (Beijing and North China)
30
 
     
  Total Company-owned Papa John’s Restaurants
628
 

Note: Company-owned Papa John’s restaurants include restaurants owned by majority-owned joint ventures. There were 128 such restaurants at December 25, 2011 (76 in Texas, 26 in Virginia and 26 in Maryland).
 
 
17

 

North America Franchised Papa John’s Restaurants
 
Number of
 
Restaurants
Alaska
6
 
Alabama
72
 
Arizona
33
 
Arkansas
23
 
California
202
 
Colorado
49
 
Connecticut
5
 
Delaware
13
 
District of Columbia
10
 
Florida
207
 
Georgia
55
 
Hawaii
14
 
Idaho
10
 
Illinois
94
 
Indiana
80
 
Iowa
23
 
Kansas
19
 
Kentucky
70
 
Louisiana
59
 
Maine
7
 
Maryland
39
 
Massachusetts
18
 
Michigan
40
 
Minnesota
47
 
Mississippi
27
 
Missouri
30
 
Montana
10
 
Nebraska
15
 
Nevada
22
 
New Hampshire
3
 
New Jersey
84
 
New Mexico
15
 
New York
118
 
North Carolina
68
 
North Dakota
5
 
Ohio
151
 
Oklahoma
29
 
Oregon
16
 
Pennsylvania
89
 
Rhode Island
5
 
South Carolina
50
 
South Dakota
10
 
Tennessee
72
 
Texas
141
 
Utah
32
 
Vermont
1
 
Virginia
111
 
Washington
50
 
 
 
18

 
 
North America Franchised Papa John’s Restaurants (continued)
   
 
Number of
 
Restaurants
     
West Virginia
23
 
Wisconsin
25
 
Wyoming
6
 
    Total U.S. Franchised Papa John’s Restaurants
2,403
 
Canada
60
 
    Total North America Franchised Papa John’s Restaurants
2,463
 
 

 
International Franchised Papa John’s Restaurants
   
 
Number of
 
Restaurants
     
Bahrain
15
 
Cayman Islands
1
 
Chile
10
 
China
128
 
Colombia
9
 
Costa Rica
15
 
Cyprus
9
 
Dominican Republic
7
 
Ecuador
10
 
Egypt
13
 
El Salvador
7
 
India
35
 
Ireland
40
 
Jordan
5
 
Korea
71
 
Kuwait
23
 
Malaysia
13
 
Mexico
51
 
Morocco
1
 
Nicaragua
2
 
Oman
6
 
Panama
1
 
Peru
16
 
Philippines
11
 
Puerto Rico
11
 
Qatar
10
 
Russia
30
 
Saudi Arabia
6
 
Trinidad
6
 
Turkey
10
 
United Arab Emirates
19
 
United Kingdom
176
 
Venezuela
25
 
     
    Total International Franchised Papa John’s Restaurants
792
 
 
 
 
19

 
 
Most Papa John’s restaurants are located in leased space. The initial term of most domestic 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. Additionally, we leased 30 Company-owned restaurant sites in Beijing and North China as of December 25, 2011.

We have 43 Company-owned restaurants that are located in buildings we own. The buildings are located on land either owned or leased by us. These restaurants range from 1,000 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 space not utilized by the Papa John’s restaurant in each facility is leased or held for lease to third-party tenants.

At December 25, 2011, we had 176 Papa John’s franchised restaurants located in the United Kingdom. We leased and subleased to franchisees 119 of the 176 franchised Papa John’s restaurant sites in the United Kingdom. The initial lease terms on the franchised sites are generally 10 to 15 years. The initial lease terms of the franchisee subleases are generally five to ten years. In connection with the 2006 sale of our former Perfect Pizza operations in the United Kingdom, we remain contingently liable for payment under approximately 40 lease arrangements, primarily associated with Perfect Pizza restaurant sites for which the Perfect Pizza franchisor is primarily liable.

Information with respect to our leased domestic QC Centers as of December 25, 2011 is set forth below:

Facility
Square Footage
Raleigh, NC
61,000
Denver, CO
32,000
Phoenix, AZ
57,000
Des Moines, IA
43,000
Portland, OR
37,000
Pittsburgh, PA
52,000
Cranbury, NJ
59,000

We own land in Orlando, Florida on which our 63,000 square foot full-service QC Center is located. We also own land and a 175,000 square foot facility in Dallas, Texas, of which 77,500 square feet is used by our full-service QC Center. The remaining space is currently vacant and being utilized for additional storage as needed. In addition, we own land in Louisville, Kentucky, on a portion of which is located a 42,000 square foot building housing our printing operations and a 247,000 square foot building, approximately 30% to 40% of which accommodates the Louisville QC Center operation and promotions division. The remainder of the larger building houses our corporate offices. We own a 49,000 square foot full-service QC Center in the United Kingdom. The Papa John’s UK management team is located in a leased office near London with a remaining lease term of six years. The Papa John’s China management team leases an office and a QC Center in Beijing, China. The Papa John’s Mexico management team and QC Center lease a facility in Mexico City, Mexico.

Item 3.  Legal Proceedings
We are subject to claims and legal actions in the ordinary course of our business. We believe that none of the claims and actions currently pending against us would have a material adverse effect on us if decided in a manner unfavorable to us.

Item 4.  Mine Safety Disclosures
None.
 
 
20

 
 

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
50
Founder, Chairman and Chief Executive Officer
 
1985
 
Timothy C. O’Hern
48
Senior Vice President, Development
 
2005
Christopher J. Sternberg
46
Senior Vice President, Corporate Communications and General Counsel
 
2008
Thomas V. Sterrett
51
Senior Vice President, International
 
2010
Anthony N. Thompson
45
Executive Vice President, Global Operations and President, Global PJ Food Service
 
2009
Lance F. Tucker
42
Senior Vice President, Chief Financial
Officer and Treasurer
 
2011
Andrew M. Varga
46
Senior Vice President and Chief Marketing Officer
2009
 
(a) Ages are as of January 1, 2012.

John H. Schnatter created the Papa John’s concept. The first Papa John’s Company-owned restaurant opened in 1985. He currently serves as Founder, Chairman and Chief Executive Officer. He previously served as Interim Chief Executive Officer from December 2008 to April 2009, Executive Chairman of the Company from 2005 until May 2007, as Chairman of the Board and Chief Executive Officer from 1990 until 2005, and as President from 1985 to 1990 and from 2001 until 2005.

Timothy C. O’Hern has served as Senior Vice President, Development since June 2009, a position he previously held from 2005 until 2007.  From 2002 until 2005 and from 2007 until 2009, he managed 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.

Christopher J. Sternberg was named General Counsel in June 2009, having previously served as Interim General Counsel from December 2008. Mr. Sternberg has served as Senior Vice President, Corporate Communications, since 2005, after serving as Vice President and Assistant to the Chairman from 2000 to 2005. Mr. Sternberg served as Vice President, Corporate Communications from 1997 to 2000. Mr. Sternberg joined the Company in 1994 as Assistant Counsel in our Legal Department. From 1990 to 1994, he was an attorney with Greenebaum, Doll & McDonald PLLC.
 
 
21

 

 
Thomas V. Sterrett was named Senior Vice President, International in August 2010.  Mr. Sterrett has served as Division Vice President from 2007 to 2010 (Midwest and South Divisions), Operations Vice President for the Company’s Midwest Division from 2005 to 2007, Director of Operations in the Nashville, Tennessee market from 2003 to 2005 and District Manager of the South Florida market from 1995 to 2003.  Prior to joining Papa John’s, Mr. Sterrett spent eleven years with Dominos both as an employee and a franchisee.

Anthony N. Thompson was promoted to Executive Vice President, Global Operations in July 2011 and continues to serve as President, Global PJ Food Service, a position in which he was appointed in May 2010. Mr. Thompson joined Papa John’s in 2006 and has held the positions of Executive Vice President, North American Operations from December 2010 to July 2011, Senior Vice President, PJ Food Service from 2009 to May 2010 and Vice President, QCC Operations from 2006 to 2009. Prior to joining Papa John’s, Mr. Thompson worked for the Scotts Company for six years as Plant Manager, Director of Marysville Operations and Director of Lawn and Controls Operations. Before joining the Scotts Company, Mr. Thompson spent four years with Conagra Grocery Products Company where he held positions as Operations Leader, Manufacturing Manager and Plant Manager. He also spent seven years in various roles with Gulf Coast Coca Cola.

Lance F. Tucker was promoted to Senior Vice President, Chief Financial Officer and Treasurer in February 2011.  Mr. Tucker previously held the positions of Chief of Staff and Senior Vice President, Strategic Planning from June 2010 to February 2011, after serving as Chief of Staff and Vice President, Strategic Planning since June 2009. Mr. Tucker was previously employed by the Company from 1994 to 1999 working in its finance department. From 2003 to 2009, Mr. Tucker served as Chief Financial Officer of Evergreen Real Estate, a company owned by John Schnatter. Mr. Tucker is a licensed Certified Public Accountant.

Andrew M. Varga was appointed Senior Vice President and Chief Marketing Officer in August 2009. Mr. Varga joined Papa John’s after 21 years with Brown-Forman Corporation. Mr. Varga served as Senior Vice President/Director of Marketing for Brown-Forman from 2007 until 2009, responsible for the company’s Wines and Spirits portfolio in the North American Region. From 2004 to 2007, Mr. Varga was Senior Vice President/Managing Director, Wines Marketing, with global responsibility for the wine portfolio.

There are no family relationships among our executive officers and other key personnel.
 
 
 
22

 


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 14, 2012, there were 753 record holders of common stock. However, there are significantly more beneficial owners of our common stock than there are record holders. The following table sets forth, for the quarters indicated, the high and low closing sales prices of our common stock, as reported by The NASDAQ Stock Market.
 
2011
 
High
   
Low
 
First Quarter
  $ 30.55     $ 27.54  
Second Quarter
    34.27       29.62  
Third Quarter
    33.79       27.47  
Fourth Quarter
    37.92       29.54  
                 
2010
 
High
   
Low
 
First Quarter
  $ 25.82     $ 21.77  
Second Quarter
    28.76       23.43  
Third Quarter
    26.30       22.78  
Fourth Quarter
    27.74       25.49  
 
Since our initial public offering of common stock in 1993, we have not paid cash dividends on our common stock.

Papa John’s Board of Directors has authorized the repurchase of up to $925.0 million of common stock under a share repurchase program that began December 9, 1999, and expires December 31, 2012. Through December 25, 2011, a total of 47.5 million shares with an aggregate cost of $853.5 million and an average price of $17.98 per share have been repurchased under this program. Subsequent to year-end (through February 14, 2012), we acquired an additional 60,000 shares at an aggregate cost of $2.2 million. As of February 14, 2012, approximately $69.3 million remained available for repurchase of common stock under this authorization.
 
 
 
23

 
 
The following table summarizes our repurchase activity by fiscal period during 2011 (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
 
                         
12/27/2010 - 01/23/2011
    66     $ 27.93       45,455     $ 135,030  
01/24/2011 - 02/20/2011
    -       - *     45,455     $ 135,030  
02/21/2011 - 03/27/2011
    77     $ 29.57       45,532     $ 132,742  
03/28/2011 - 04/24/2011
    15     $ 30.01       45,547     $ 132,288  
04/25/2011 - 05/22/2011
    140     $ 31.39       45,687     $ 127,892  
05/23/2011 - 06/26/2011
    519     $ 33.11       46,206     $ 110,699  
06/27/2011 - 07/24/2011
    96     $ 32.04       46,302     $ 107,636  
07/25/2011 - 08/21/2011
    223     $ 29.48       46,525     $ 101,052  
08/22/2011 - 09/25/2011
    479     $ 28.77       47,004     $ 87,282  
09/26/2011 - 10/23/2011
    242     $ 30.65       47,246     $ 79,865  
10/24/2011 - 11/20/2011
    17     $ 33.25       47,263     $ 79,303  
11/21/2011 - 12/25/2011
    210     $ 36.86       47,473     $ 71,539  
                                 
* There were no share repurchases during this period.
         
 
Our share repurchase authorization increased from $825 million to $875 million in May 2011 and increased to $925 million in December 2011. For presentation purposes, the maximum dollar value of shares that may be purchased was adjusted retroactively to December 27, 2010.

The Company utilizes a written trading plan under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, from time to time to facilitate the repurchase of shares of our common stock under this share repurchase program. There can be no assurance that we will repurchase shares of our common stock either through a Rule 10b5-1 trading plan or otherwise.

In May 2011, 34,000 shares of the Company’s common stock were acquired from employees to satisfy minimum tax withholding obligations that arose upon (i) vesting of restricted stock granted pursuant to approved plans, and (ii) distribution of shares of common stock issued pursuant to deferred compensation obligations.

 
24

 

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 2011. The graph assumes the value of the investments in the Company's common stock and in each index was $100 at the end of fiscal 2006, and, with respect to the index and peer group, that all dividends were reinvested.
 
 

GRAPHIC  
 
 
25

 

Item 6.  Selected Financial Data

The selected financial data presented for each of the fiscal years in the five-year period ended December 25, 2011, 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. 25,
   
Dec. 26,
   
Dec. 27,
   
Dec. 28,
   
Dec. 30,
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
                               
Income Statement Data
                             
North America revenues:
                             
  Domestic Company-owned restaurant sales
  $ 525,841     $ 503,272     $ 503,818     $ 533,255     $ 504,330  
  Franchise royalties (2) (3)
    73,694       69,631       62,083       60,592       56,278  
  Franchise and development fees (2)
    722       610       912       1,722       4,767  
  Domestic commissary sales
    508,155       454,506       417,689       431,650       401,081  
  Other sales
    50,912       51,951       54,045       61,415       61,820  
International revenues:
                                       
  Royalties and franchise and development fees (2) (4)
    16,327       13,265       11,780       11,858       9,310  
  Restaurant and commissary sales (5)
    42,231       33,162       28,223       25,849       20,860  
Total revenues
    1,217,882       1,126,397       1,078,550       1,126,341       1,058,446  
Operating income (6)
    87,017       86,744       95,218       65,486       53,072  
Investment income
    755       875       629       848       1,446  
Interest expense
    (1,497 )     (5,338 )     (5,653 )     (7,536 )     (7,465 )
Income before income taxes
    86,275       82,281       90,194       58,798       47,053  
Income tax expense
    26,888       26,856       28,985       19,980       13,293  
Net income, including noncontrolling interests
    59,387       55,425       61,209       38,818       33,760  
Income attributable to noncontrolling interests (7)
    (3,732 )     (3,485 )     (3,756 )     (2,022 )     (1,025 )
Net income, net of noncontrolling interests
  $ 55,655     $ 51,940     $ 57,453     $ 36,796     $ 32,735  
Basic earnings per common share
  $ 2.22     $ 1.97     $ 2.07     $ 1.31     $ 1.10  
Earnings per common share - assuming dilution
  $ 2.20     $ 1.96     $ 2.06     $ 1.30     $ 1.09  
Basic weighted average shares outstanding
    25,043       26,328       27,738       28,124       29,666  
Diluted weighted average shares outstanding
    25,310       26,468       27,909       28,264       30,017  
                                         
Balance Sheet Data
                                       
Total assets
  $ 390,382     $ 415,941     $ 393,726     $ 385,464     $ 400,885  
Total debt
    51,489       99,017       99,050       130,654       142,706  
Total stockholders’ equity
    218,222       207,200       185,037       138,238       134,938  
 
(1)
We operate on a 52-53 week fiscal year ending on the last Sunday of December of each year.  All fiscal years presented consisted of 52 weeks.
(2)
Prior years’ financial data has been adjusted to reclassify revenues for restaurants operating in Hawaii, Alaska and Canada from international to North America franchising in order to conform to the current year presentation.
(3)
North America franchise royalties were derived from franchised restaurant sales of $1.71 billion in 2011, $1.62 billion in 2010, $1.58 billion in 2009, $1.53 billion in 2008 and $1.49 billion in 2007.
(4)
International royalties were derived from franchised restaurant sales of $320.0 million in 2011, $258.8 million in 2010, $222.2 million in 2009, $196.5 million in 2008 and $152.5 million in 2007.
(5)
Restaurant sales for international Company-owned restaurants were $12.4 million in 2011, $11.0 million in 2010, $10.3 million in 2009, $8.1 million in 2008 and $4.0 million in 2007.
 
 
26

 
 
(6)
The operating results include the consolidation of BIBP, which increased operating income approximately $21.4 million in 2010 (including a reduction in BIBP’s cost of sales of $14.2 million associated with PJFS’s agreement to pay to BIBP for past cheese purchases an amount equal to its accumulated deficit). BIBP increased operating income by $23.3 million in 2009 and reduced operating income by $8.6 million in 2008 and $31.0 million in 2007 (breakeven results in 2011). Operating income includes domestic and international restaurant closure, impairment and disposition gains of $86,000 in 2011 and losses of $253,000 in 2010, $657,000 in 2009, $8.8 million in 2008 and $1.8 million in 2007. See “Notes 3 and 6” of “Notes to Consolidated Financial Statements” for additional information.
(7)
Represents the noncontrolling interests’ ownership in two joint venture arrangements.

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 25, 2011, there were 3,883 Papa John’s restaurants in operation, consisting of 628 Company-owned and 3,255 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 2011 were 321 as compared to 325 in 2010 and 216 in 2009 and unit closings in 2011 were 84 as compared to 148 in 2010 and 127 in 2009. We expect net unit growth of approximately 240 to 280 units during 2012.

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 $897,000 for 2011, compared to $863,000 for 2010 and $869,000 for 2009. Average sales volumes in new markets are generally lower than in those markets in which we have established a significant market position. The comparable sales for domestic Company-owned restaurants increased 4.1% in 2011, decreased 0.6% in 2010, and decreased 0.5% in 2009. The comparable sales for North America franchised units increased 3.1% in 2011, 0.3% in 2010 and 0.1% in 2009. “Comparable sales” represents sales generated by restaurants open for the entire twelve-month period reported.

We strive to obtain high-quality restaurant 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 cash investment for the eight domestic Company-owned restaurants opened during 2011 was approximately $260,000, compared to the $250,000 investment for the five units opened in 2010, exclusive of land and any tenant improvement allowances that we received in both years.

Approximately 47% of our revenues for 2011, compared to 45% of our revenues for 2010 and 40% of our revenues for 2009, 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 activities contribute to product quality and consistency and restaurant profitability throughout the Papa John’s system.
 
 
27

 
 
Critical Accounting Policies and Estimates

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

Accounting Policies

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 and other customers with known financial difficulties.

Intangible Assets - Goodwill

In September 2011, the Financial Accounting Standards Board (“FASB”) approved Accounting Standards Update 2011-08, “Testing Goodwill for Impairment,” (“ASU 2011-08”) which is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, however, early adoption is permitted.  We elected to early adopt the provisions of ASU 2011-08 in 2011.

ASU 2011-08 permits us to first assess qualitative factors to determine whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step quantitative goodwill impairment test. Under the two-step quantitative goodwill impairment test, the fair value of the reporting unit is compared to its respective carrying amount including goodwill. If the fair value exceeds the carrying amount, then no impairment exists.  If the carrying amount exceeds the fair value, further analysis is performed to assess impairment.  Because market prices of our reporting units are not readily available, we make various estimates and assumptions in determining the estimated fair values of our reporting units. The estimated fair value is based on an income approach, with an appropriate risk adjusted discount rate, and a market approach where appropriate.  Significant assumptions inherent in the methodologies are employed and include such estimates as discount rates, growth rates and certain market transaction multiples.

In accordance with ASU 2011-08, we evaluate goodwill annually in the fourth quarter or whenever we identify certain triggering events or circumstances that would more-likely-than-not reduce the fair value of a reporting unit below its carrying amount. Such tests are completed separately with respect to the goodwill of each of our reporting units. Events or circumstances that might indicate an interim evaluation is warranted include, among other factors, unexpected adverse business conditions, macro and reporting unit specific economic factors (for example, worsening results in comparison to projections, commodity inflation, or loss of key personnel), unanticipated competitive activities, and acts by governments or courts.

As defined in the authoritative guidance, a reporting unit is an operating segment, or one level below an operating segment.  During 2011, in connection with a restructuring of our components in our domestic Company-owned restaurant segment, changes were made in the discrete financial information that was made available to the segment manager of our domestic Company-owned restaurant segment, which resulted in the identification of new components in 2011. Additionally, because components meet the aggregation provision of Accounting Standards Codification 280, “Segment Reporting,” we now aggregate the components of our domestic Company-owned restaurant segment into one reporting unit. Prior to 2011, the components were treated as individual reporting units.
 
 
28

 
 
Under ASU 2011-08, companies can bypass the qualitative assessment and move directly to the quantitative assessment for any reporting unit in any period if management believes that it is more efficient or there is a risk of impairment.  All companies can elect to resume performing the qualitative assessment in any subsequent period.  We applied the qualitative assessment for our domestic Company-owned restaurants and China reporting units, which is included in our international reporting segment.  As a result of our qualitative analysis, we determined that it was more-likely-than-not that the fair value of our domestic Company-owned restaurants and China reporting units was greater than the carrying amounts.

With respect to our PJUK reporting unit (which represents $14.8 million of goodwill as of December 25, 2011), we bypassed the qualitative assessment and performed the two-step quantitative goodwill impairment test, which indicated the fair value exceeded the carrying amount by 7%.  The fair value was calculated using an income approach that projected net cash flow over a 10-year discrete period and a terminal value, which were discounted using appropriate rates.  The selected discount rate considers the risk and nature of our PJUK reporting unit’s cash flow and the rates of return market participants would require to invest their capital in the PJUK reporting unit.  We believe our PJUK reporting unit will continue to improve its operating results through ongoing growth initiatives, by increasing Papa John’s brand awareness in the United Kingdom, improving sales and profitability for individual franchised restaurants and increasing PJUK franchised net unit openings over the next several years. Future impairment charges could be required if adverse economic events occur in the United Kingdom.

Subsequent to completing our annual qualitative and quantitative goodwill impairment tests, no indications of impairment were identified.

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 undiscounted 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.

Deferred Income Tax Accounts and Tax Reserves

Papa John’s is subject to income taxes in the United States and several foreign jurisdictions. Significant judgment is required in determining Papa John’s provision for income taxes and the related assets and liabilities. The provision for income taxes includes income taxes paid, currently payable or receivable and those deferred. We use an estimated annual effective rate based on expected annual income to determine our quarterly provision for income taxes. Discrete income tax items are recorded in the quarter in which they occur.

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 new tax rate is enacted. As a result, our effective tax rate may fluctuate. Valuation allowances are established when necessary on a jurisdictional basis to reduce deferred tax assets to the amounts we expect to realize. As of December 25, 2011, we had a net deferred income tax liability of $1.5 million.
 
 
29

 
 
Tax authorities periodically audit the Company. We record reserves for identified exposures. We evaluate these issues on a quarterly basis to adjust for events, such as court rulings or audit settlements, which may impact our ultimate payment for such exposures. We recognized reductions of $1.9 million, $550,000 and $1.2 million in our income tax expense associated with the finalization of certain income tax issues in 2011, 2010 and 2009, respectively (see “Note 13” of “Notes to Consolidated Financial Statements”).

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

BIBP was a franchisee-owned corporation that conducted a cheese-purchasing program on behalf of Company-owned and franchised restaurants operating in the United States through February 2011. As the primary beneficiary, we consolidated the operating results of BIBP. BIBP operated at breakeven for the first two months of 2011 and recognized income before income taxes of $21.0 million in 2010 and $22.5 million in 2009. Income before income taxes in 2010 included a reduction in BIBP’s cost of sales of $14.2 million associated with PJFS’s agreement to pay to BIBP for past cheese purchases an amount equal to its accumulated deficit (“BIBP Settlement”). Accordingly, BIBP recorded a decrease of $14.2 million in cost of sales and PJFS recorded a corresponding increase in cost of sales in 2010. This transaction did not have any impact on the Company’s 2010 consolidated income statement results since both PJFS and BIBP are fully consolidated.

Consolidation accounting required the net impact from the consolidation of BIBP to be reflected primarily in three separate components of our statement of income. The first component was 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 was reflected as a reduction in the “Domestic Company-owned restaurant expenses - cost of sales” line item. This approach effectively reported cost of sales for Company-owned restaurants as if the purchasing agreement 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 was reflected in the caption “Loss (income) from the franchise cheese-purchasing program, net of noncontrolling interest.” This line item represented BIBP’s income or loss from purchasing cheese at the spot market price and selling to franchised restaurants at a fixed monthly price, net of any income or loss attributable to the noncontrolling interest BIBP shareholders. The amount of income or loss attributable to the BIBP shareholders depended on its cumulative shareholders’ equity balance and the change in such balance during the reporting period. The third component was reflected as interest expense, when BIBP was in a net borrowing position during the reporting period.

In February 2011, we terminated the purchasing arrangement with BIBP and BIBP no longer has operating activities. Over 99% of our domestic franchisees have entered into a cheese purchasing agreement with PJFS. The cheese purchasing agreement requires participating domestic franchisees to purchase cheese through PJFS, or to pay the franchisee’s portion of any accumulated cheese liability upon ceasing to purchase cheese from PJFS when a liability exists. The cheese purchasing agreement specifies that PJFS will charge the franchisees a predetermined price for cheese on a monthly basis. Any difference between the amount charged to franchisees and the actual price paid by PJFS for cheese will be recorded as a receivable from or a payable to the franchisees, to be repaid based upon a predetermined formula outlined in the agreement.
 
 
30

 
 
Non-GAAP Measures

The financial measures we present in this report excluding the impact of the consolidation of BIBP are not measures defined within accounting principles generally accepted in the United States (“GAAP”). These non-GAAP measures should not be construed as a substitute for or a better indicator of the Company’s performance than the Company’s GAAP measures. We believe the financial information excluding the impact of the consolidation of BIBP is important for purposes of comparison to prior periods and development of future projections and earnings growth prospects. We analyze our business performance and trends excluding the impact of the consolidation of BIBP because the results of BIBP are not indicative of the principal operating activities of the Company. In addition, annual cash bonuses and certain long-term incentive programs for various levels of management were based on financial measures that exclude BIBP. The presentation of the non-GAAP measures in this report is made alongside the most directly comparable GAAP measures.

In addition, we present free cash flow in this report, which is not a term defined by GAAP. Free cash flow is defined as net cash provided by operating activities (from the consolidated statements of cash flows) excluding the impact of BIBP, less the purchases of property and equipment. We view free cash flow as an important measure because it is one factor that management uses in determining the amount of cash available for discretionary investment. Free cash flow is not a term defined by GAAP and as a result our measure of free cash flow might not be comparable to similarly titled measures used by other companies. Free cash flow should not be construed as a substitute for or a better indicator of our performance than the Company’s GAAP measures.

Segment Reporting Change

In 2011, we realigned management responsibility and financial reporting for Hawaii, Alaska and Canada from our international business segment to our domestic franchising segment in order to better leverage existing infrastructure and systems. As a result, we renamed the domestic franchising segment “North America franchising” in the first quarter of 2011. Certain prior year amounts have been reclassified in our consolidated statements of income, segment information, and restaurant unit progression to conform to the current year presentation.

Fiscal Year

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. The 13-week quarters consist of two four-week periods followed by one five-week period.

 
31

 

Percentage Relationships and Restaurant Data and Unit Progression

The following tables set forth the percentage relationship to total revenues, unless otherwise indicated, of certain income statement data, and certain restaurant data for the years indicated:
 
   
Year Ended (1)
 
   
Dec. 25,
   
Dec. 26,
   
Dec. 27,
 
   
2011
   
2010
   
2009
 
                   
Income Statement Data:
                 
North America revenues:
                 
Domestic Company-owned restaurant sales
    43.2 %     44.7 %     46.7 %
Franchise royalties
    6.1       6.2       5.8  
Franchise and development fees
    0.1       0.0       0.1  
Domestic commissary sales
    41.7       40.4       38.7  
Other sales
    4.2       4.6       5.0  
International revenues:
                       
Royalties and franchise and development fees
    1.3       1.2       1.1  
Restaurant and commissary sales
    3.4       2.9       2.6  
Total revenues
    100.0       100.0       100.0  
Costs and expenses:
                       
Domestic Company-owned restaurant cost of sales (2)
    24.1       22.1       20.0  
Domestic Company-owned restaurant operating expenses (2)
    56.9       57.7       58.2  
Domestic commissary and other expenses (3)
    92.2       91.4       90.2  
Income from the franchise cheese purchasing
                       
   program, net of minority interest (4)
    0.0       (0.5 )     (1.7 )
International operating expenses (5)
    84.5       88.7       86.3  
General and administrative expenses
    9.2       9.8       10.3  
Other general expenses
    0.8       0.8       1.3  
Depreciation and amortization
    2.7       2.9       2.9  
Total costs and expenses
    92.9       92.3       91.2  
Operating income
    7.1       7.7       8.8  
Net interest expense
    0.0       (0.4 )     (0.4 )
Income before income taxes
    7.1       7.3       8.4  
Income tax expense
    2.2       2.4       2.7  
Net income, including noncontrolling interests
    4.9       4.9       5.7  
Less:  income attributable to noncontrolling interests
    (0.3 )     (0.3 )     (0.4 )
Net income, net of noncontrolling interests
    4.6 %     4.6 %     5.3 %
 
 
32

 
 
   
Year Ended (1)
 
   
Dec. 25,
   
Dec. 26,
   
Dec. 27,
 
   
2011
   
2010
   
2009
 
                   
Restaurant Data:
                 
  Percentage increase (decrease) in comparable domestic
                 
   Company-owned restaurant sales (6)
    4.1 %     (0.6 %)     (0.5 %)
  Number of Company-owned restaurants included in the
                       
   most recent full year's comparable restaurant base
    582       578       559  
  Average sales for Company-owned restaurants included
                       
   in the most recent comparable restaurant base
  $ 897,000     $ 863,000     $ 869,000  
                         
Papa John's Restaurant Progression:
                       
North America Company-owned:
                       
Beginning of period
    591       588       592  
Opened
    8       5       5  
Closed
    (1 )     (2 )     (8 )
Acquired from franchisees
    -       -       11  
Sold to franchisees
    -       -       (12 )
End of period
    598       591       588  
International Company-owned:
                       
Beginning of period
    21       26       23  
Opened
    9       8       4  
Closed
    -       (2 )     (1 )
Acquired from franchisees
    -       1       -  
Sold to franchisees
    -       (12 )     -  
End of period
    30       21       26  
North America franchised (7):
                       
Beginning of period
    2,346       2,246       2,243  
Opened
    166       182       93  
Closed
    (49 )     (82 )     (91 )
Acquired from Company
    -       -       12  
Sold to Company
    -       -       (11 )
End of period
    2,463       2,346       2,246  
International franchised (7):
                       
Beginning of period
    688       609       522  
Opened
    138       130       114  
Closed
    (34 )     (62 )     (27 )
Acquired from Company
    -       12       -  
Sold to Company
    -       (1 )     -  
End of period
    792       688       609  
Total Papa John's restaurants - end of period
    3,883       3,646       3,469  
 
(1)
We operate on a fiscal year ending on the last Sunday of December of each year.
(2)
As a percentage of domestic Company-owned 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 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)
Includes only Company-owned restaurants open throughout the periods being compared.
(7)
Restaurant unit data for 2010 and 2009 has been adjusted to reflect the reclassification of restaurants operating in Hawaii, Alaska and Canada from international franchised to North America franchised in order to conform to the current year presentation.
 
 
33

 
 
Results of Operations

2011 Compared to 2010

Discussion of Revenues

Consolidated revenues increased 8.1% to $1.22 billion in 2011 compared to $1.13 billion in 2010, primarily consisting of the following:

Domestic Company-owned restaurant sales increased $22.6 million, or 4.5%, in 2011 primarily due to an increase in comparable sales of 4.1%.
North America franchise royalty revenues increased approximately $4.1 million, or 5.8% in 2011 due to an increase in comparable sales of 3.1%, and an increase in the number of franchised restaurants.
Domestic commissary sales increased $53.6 million, or 11.8% in 2011 primarily due to an increase in the prices of certain commodities, most notably cheese, and an increase in sales volumes.
International revenues increased $12.1 million, or 26.1% in 2011, primarily due to an increase in the number of restaurants and an increase in comparable sales of 5.1%, calculated on a constant dollar basis. In 2010, the international segment included revenues from Company-owned restaurants located in the United Kingdom, which were sold in the third quarter of 2010.
 
Discussion of Operating Results

Our income before income taxes totaled $86.3 million in 2011, as compared to $82.3 million in 2010, an increase of approximately $4.0 million. Excluding the impact of BIBP (income before income taxes of $6.8 million, excluding the BIBP Settlement), our income before income taxes increased approximately $10.8 million, or 14.3%. Income before income taxes is summarized in the following table on an operating segment basis (in thousands):
 
               
Increase
 
   
2011
   
2010
   
(Decrease)
 
                   
Domestic Company-owned restaurants
  $ 28,980     $ 31,619     $ (2,639 )
Domestic commissaries *
    30,532       14,188       16,344  
North America franchising
    66,222       62,229       3,993  
International
    (165 )     (4,771 )     4,606  
All others
    (441 )     1,847       (2,288 )
Unallocated corporate expenses
    (38,243 )     (43,266 )     5,023  
Elimination of intersegment profits
    (610 )     (519 )     (91 )
Income before income taxes, excluding BIBP
    86,275       61,327       24,948  
BIBP, a variable interest entity *
    -       20,954       (20,954 )
Total income before income taxes
  $ 86,275     $ 82,281     $ 3,994  
 
 
*
The full-year 2010 results for domestic commissaries were reduced by the BIBP Settlement and the full-year 2010 results for BIBP were increased by the BIBP Settlement. There was no impact on the consolidated results of operations since PJFS and BIBP are fully consolidated into the Company’s results.
 
 
34

 
 
Changes in income before income taxes for 2011, excluding the impact of BIBP (income before income taxes of $6.8 million, excluding the BIBP Settlement), are summarized on a segment basis as follows:

Domestic Company-owned Restaurant Segment. Domestic Company-owned restaurants’ income before income taxes decreased $2.6 million from the prior comparable period. The decrease was due to increased commodity costs, primarily cheese, partially offset by incremental profits from higher comparable sales.
   
Domestic Commissary Segment. Domestic commissaries’ income before income taxes increased $16.3 million in 2011 over the comparable 2010 period comprised of the following (in thousands):

     
Year Ended December 25, 2011
   
Year Ended December 26, 2010
   
Increase
 
                     
 
Income before income taxes, excluding the
                 
 
BIBP Settlement
  $ 30,532     $ 28,338     $ 2,194  
 
BIBP Settlement
    -       (14,150 )     14,150  
 
Total segment income before income taxes
  $ 30,532     $ 14,188     $ 16,344  
 

 
Domestic commissaries’ income before income taxes, excluding the BIBP Settlement, increased $2.2 million over the prior year. The increase was due to a higher operating income dollar margin attributable to higher sales volumes, partially offset by increased costs attributable to higher fuel prices.
   
North America Franchising Segment. North America franchising income before income taxes increased approximately $4.0 million in 2011 as compared to the comparable 2010 period. The increase was due to the previously mentioned royalty revenue increase.
   
International Segment. The international segment reported operating losses of $165,000 in 2011 and approximately $4.8 million in 2010. The improvement in operating results of $4.6 million was primarily due to increased royalties due to growth in the number of units and a comparable sales increase of 5.1%, and improved operating results in our Beijing and North China restaurants as well as our United Kingdom commissary. Additionally, the prior year results included start-up costs associated with our Company-owned commissary in the United Kingdom that opened in 2010.
   
All Others Segment. The “All others” segment reported an operating loss of approximately $400,000 in 2011, representing a decrease of approximately $2.3 million, as compared to the corresponding 2010 period. The decrease was primarily due to a decline in the operating results of our online and mobile ordering (“eCommerce”) business, partially offset by improvements in operating income at our wholly-owned print and promotions subsidiary, Preferred Marketing Solutions (“Preferred”). The decline in the operating results of our eCommerce business was primarily due to an increase in infrastructure and support costs attributable to the new online ordering system. Additionally, online revenues decreased in 2011 due to lower online and mobile fees charged.
 
 
35

 
 
Unallocated Corporate Segment. Unallocated corporate expenses decreased $5.0 million in 2011, as compared to prior year. The components of unallocated corporate expenses were as follows (in thousands):

     
Year Ended
   
Year Ended
       
     
December 25,
   
December 26,
   
Increase
 
     
2011
   
2010
   
(Decrease)
 
                     
 
General and administrative (a)
  $ 24,807     $ 25,823     $ (1,016 )
 
Net interest (b)
    816       4,120       (3,304 )
 
Depreciation
    8,021       8,873       (852 )
 
Franchise incentives and initiatives (c)
    3,234       6,489       (3,255 )
 
Perfect Pizza lease obligation (d)
    832       -       832  
 
Other expense (income) (e)
    533       (2,039 )     2,572  
 
Total unallocated corporate expenses
  $ 38,243     $ 43,266     $ (5,023 )
 
 
(a)
The decrease in unallocated corporate general and administrative costs for 2011 was due to lower short- and long-term incentive compensation costs, and lower sponsorship fees, partially offset by increased travel costs.
     
 
(b)
The decrease in net interest expense reflects the decrease in our average outstanding debt balance and lower interest rates.
     
 
(c)
In 2010, we provided discretionary contributions to the Marketing Fund and other local advertising cooperatives. In 2011, we offered incentives to domestic franchisees for meeting certain sales targets, including driving comparable sales, transactions and online sales.
     
 
(d)
The Perfect Pizza lease obligation relates to rents, taxes and insurance associated with the former Perfect Pizza operations in the United Kingdom. See the notes to the consolidated financial statements for additional information.
     
 
(e)
The increase in other expense (income) is primarily due to increases in our online customer loyalty program costs and disposition and valuation-related costs.

Variable Interest Entities.  BIBP generated income before income taxes of $21.0 million in 2010, which primarily consisted of the BIBP Settlement and income associated with cheese sold to domestic Company-owned and franchise restaurants of $1.7 million and $5.6 million, respectively. BIBP reported breakeven results for the first two months of 2011, at which time we terminated the purchasing arrangement with BIBP.
 
 
36

 
 
 
The following table summarizes the impact of BIBP prior to the required consolidating eliminations on our consolidated statements of income for the years ended December 25, 2011 and December 26, 2010 (in thousands):
 
     
Year Ended
 
     
December 25, 2011
   
December 26, 2010
 
               
 
BIBP sales
  $ 25,117     $ 153,014  
                   
 
Cost of sales
    25,100       131,549  
 
General and administrative expenses
    17       91  
 
Total costs and expenses
    25,117       131,640  
 
Operating income
    -       21,374  
 
Interest expense
    -       (420 )
 
Income before income taxes (a)
  $ -     $ 20,954  
 
 
(a)
BIBP’s income before income taxes for the year ended December 26, 2010, was $6.8 million, excluding the BIBP Settlement.

Diluted earnings per share were $2.20 in 2011, compared to $1.96 per diluted share in 2010 (including a $0.16 per share gain from the consolidation of BIBP). Excluding the impact of BIBP in 2010, diluted earnings per share increased $0.40, or 22.2% ($2.20 in 2011 compared to $1.80 in 2010). Diluted weighted average shares outstanding decreased 4.4% in 2011 from the prior year period. Diluted earnings per share increased $0.10 due to the reduction in shares outstanding.

Review of Consolidated Operating Results

Revenues. Domestic Company-owned restaurant sales were $525.8 million for 2011 compared to $503.3 million for 2010. The 4.5% increase was primarily due to a 4.1% increase in comparable sales.

North America franchise sales increased 6.1% to $1.71 billion, from $1.62 billion in 2010, as domestic franchise comparable sales increased 3.1% and equivalent units increased 4.5%. “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. North America franchise sales are not included in our consolidated statements of income; however, our North America franchise royalty revenue is derived from these sales. North America franchise royalties were $73.7 million, representing an increase of 5.8% from the comparable period. The increase in royalties was primarily due to the previously noted increase in franchise sales. The impact of the royalty rate increase to 5.0% (0.25% increase over 2010) was substantially offset by the franchisees’ ability to earn up to a 0.25% royalty rebate by meeting certain sales growth targets and an additional 0.20% royalty rebate by making specified re-imaging restaurant lobby investments.

Average weekly sales for comparable units include restaurants that were open throughout the periods presented below. The comparable sales base for domestic Company-owned and North America franchised restaurants, respectively, includes restaurants acquired by the Company or divested to franchisees during the previous twelve months. Average weekly sales for non-comparable units include restaurants that were not open throughout the periods presented below and include non-traditional sites. Average weekly sales for non-traditional units not subject to continuous operation are calculated based upon actual days open.

 
37

 

The comparable sales base and average weekly sales for 2011 and 2010 for domestic Company-owned and North America franchised restaurants consisted of the following:

   
Year Ended
   
Year Ended
 
   
December 25, 2011
   
December 26, 2010
 
   
Domestic
Company-owned
   
North
America Franchised
   
Domestic
Company-owned
   
North
America Franchised
 
                         
Total domestic units (end of period)
    598       2,463       591       2,346  
Equivalent units
    589       2,332       586       2,231  
Comparable sales base units
    581       2,135       577       2,074  
Comparable sales base percentage
    98.6 %     91.6 %     98.5 %     93.0 %
Average weekly sales - comparable units
  $ 17,248     $ 14,459     $ 16,599     $ 14,057  
Average weekly sales - total non-comparable units
  $ 11,218     $ 10,708     $ 11,562     $ 12,177  
Average weekly sales - all units
  $ 17,164     $ 14,142     $ 16,521     $ 13,924  

North America franchise and development fees were approximately $700,000 in 2011 or an increase of approximately $100,000 from 2010. The increase was due to an increase in transfer and cancellation fees, partially offset by a decrease in opening fees as there were a greater number of restaurants opening with no fee in 2011 in accordance with our development incentive programs.

Domestic commissary sales increased 11.8% to $508.2 million in 2011 from $454.5 million in the prior comparable period. The increase was primarily due to an increase in the prices of certain commodities, most notably cheese, and an increase in sales volumes. Our commissaries charge a fixed dollar mark-up on the cost of cheese. Cheese prices are based upon the block price, which increased to an average price of $1.80 per pound in 2011 from the $1.59 BIBP block price in 2010.

Other sales decreased $1.0 million to $50.9 million in 2011. The decrease primarily resulted from a decline in sales at Preferred, and a reduction in the online fee charged to our domestic franchisees.

International franchise sales were $332.3 million in 2011, compared to $269.7 million in 2010.  International franchise sales are not included in our consolidated statements of income; however, our international royalty revenue is derived from these sales. Total international revenues were $58.6 million for 2011 compared to $46.4 million in 2010, reflecting an increase in the number of restaurants in addition to the 5.1% increase in comparable sales, calculated on a constant dollar basis. These increases were partially offset by the prior year’s inclusion of revenues from Company-owned restaurants located in the United Kingdom, which were sold in the third quarter of 2010. Our PJUK operations represented 51% of international revenues in both 2011 and 2010.

Costs and Expenses.  The restaurant operating margin at domestic Company-owned units was 19.0% in 2011 compared to 20.2% (19.9% excluding BIBP) in 2010. Excluding the impact of consolidating BIBP, restaurant operating margin decreased 0.9% in 2011 as compared to the corresponding period in 2010, consisting of the following differences:

Cost of sales were 1.7% higher as a percentage of sales in 2011 as compared to 2010 due to the impact of higher commodities costs, principally cheese, wheat and meats.
Salaries and benefits were 0.4% lower as a percentage of sales in 2011 compared to 2010, reflecting the benefit of increased sales.
Advertising and related costs as a percentage of sales were relatively flat year-over-year.
Occupancy costs and other operating costs, on a combined basis, as a percentage of sales, were 0.4% lower in 2011 reflecting the benefit of increased sales.
 
 
38

 
 
Domestic commissary and other operating margin was 7.8% in 2011, compared to 8.6% in 2010. Domestic commissary and other operating margin decreased 0.8% in 2011, consisting of the following differences:

Cost of sales was 0.9% higher as a percentage of revenues in 2011, as compared to 2010. Cost of sales increased primarily due to the impact of higher commodities costs, primarily cheese, wheat and meats. In addition, a reduction in online fee revenue from franchisees and an increase in eCommerce support costs contributed to the increases in cost of sales.
Salaries and benefits were 0.4% lower as a percentage of revenues in 2011, as compared to the same period of 2010, reflecting the benefit of increased sales.
Other operating expenses were 0.3% higher as a percentage of revenues in 2011, as compared to 2010, primarily due to an increase in distribution costs from increased fuel prices.

We recorded income before income taxes from the franchise cheese-purchasing program, net of noncontrolling interest, of $5.6 million in 2010 (no impact in 2011 through February, at which time the purchasing agreement with BIBP was terminated). The results in 2010 only represented the portion of BIBP’s operating income related to the proportion of BIBP cheese sales to franchisees. The total impact of the consolidation of BIBP on Papa John’s income before income taxes was $21.0 million in 2010 (including the BIBP Settlement). See the summary of BIBP’s operating results in the Variable Interest Entities caption for additional information on BIBP’s 2011 and 2010 results.

International operating expenses in 2011 were 84.5% of international restaurant and commissary sales as compared to 88.7% in 2010.  The improvement in operating expenses, as a percentage of sales, was due to both improvements in operating results in our Beijing and North China restaurants and our PJUK commissary. Our 2010 results also included start-up costs associated with our PJUK commissary.

General and administrative expenses were $111.6 million, or 9.2% of revenues for 2011, as compared to $110.0 million, or 9.8% of revenues for 2010. The increase in general and administrative expenses is due to an increase in travel costs, payroll and other taxes, and employee incentives, partially offset by lower short- and long-term incentive compensation costs and lower sponsorship fees.

Other general expenses reflected net expense of $9.8 million in 2011, as compared to $9.0 million in 2010 as detailed below (in thousands):
 
               
Increase
 
   
2011
   
2010
   
(Decrease)
 
                   
Disposition and impairment losses (a)
  $ 1,745     $ 894     $ 851  
Provision (credit) for uncollectible accounts and notes receivable
    379       (27 )     406  
Pre-opening restaurant costs
    273       149       124  
Franchise and development incentives and initiatives (b)
    4,921       7,533       (2,612 )
Perfect Pizza lease obligation (c)
    832       -       832  
Other expense (d)
    1,617       481       1,136  
Total other general expenses
  $ 9,767     $ 9,030     $ 737  

 
(a)
Disposition and impairment losses include costs associated with the disposition of certain systems and other equipment.
(b)
The 2010 amounts include discretionary contributions to the Marketing Fund and other local advertising cooperatives of $6.5 million and incentives to franchisees for opening new restaurants of $1.0 million. The 2011 amounts include approximately $3.2 million in incentives offered to domestic franchisees for meeting certain sales targets, including driving comparable sales, transactions and online sales in 2011 and $1.7 million in incentives to franchisees for opening new restaurants.
 
 
39

 
 
(c)
The Perfect Pizza lease obligation relates to rents, taxes and insurance associated with the former Perfect Pizza operations in the United Kingdom.
(d)
Other expense increased primarily due to costs associated with our online customer loyalty program.

Depreciation and amortization was $32.7 million, or 2.7% of revenues, for 2011 as compared to $32.4 million, or 2.9% of revenues, for 2010.

Net interest. Net interest expense was approximately $740,000 in 2011, compared to $4.5 million in 2010.  The decrease in net interest costs reflects a lower average outstanding debt balance and lower effective interest rates.

Income Tax Expense.  We recognized reductions of $1.9 million and $550,000 in our income tax expense associated with the finalization of certain income tax issues in 2011 and 2010, respectively. Our effective income tax rate was 31.2% in 2011 compared to 32.6% in 2010 (32.3% in 2010, excluding BIBP). Our effective income tax rate may fluctuate for various reasons, including the settlement or resolution of specific federal and state issues.

2010 Compared to 2009

Discussion of Revenues

Total revenues, which increased 4.4% to $1.13 billion in 2010 compared to $1.08 billion in 2009, primarily consisted of the following:

Franchise royalties revenue increased $7.5 million primarily due to an increase in the royalty rate (the standard royalty rate for the majority of domestic franchise restaurants increased from 4.25% at the beginning of 2009 to 4.50% in September 2009 and increased to 4.75% in the first quarter of 2010).
Domestic commissary sales increased $36.8 million primarily due to an increase in sales volumes.
International revenues increased $6.4 million primarily due to an increase in the number of our franchised international restaurants.

The increases noted above were partially offset by a $2.1 million decline in domestic other sales primarily due to a decline in sales at Preferred. Additionally, domestic Company-owned restaurant sales decreased approximately $550,000 primarily due to a decrease of 0.6% in comparable sales for domestic Company-owned restaurants for the year.

 
40

 

Discussion of Operating Results

Our income before income taxes totaled $82.3 million in 2010, as compared to $90.2 million in 2009 as summarized in the following table on an operating segment basis (in thousands):
 
               
Increase
 
   
2010
   
2009
   
(Decrease)
 
                   
Domestic Company-owned restaurants
  $ 31,619     $ 34,894     $ (3,275 )
Domestic commissaries *
    14,188       29,393       (15,205 )
North America franchising
    62,229       55,008       7,221  
International
    (4,771 )     (4,368 )     (403 )
All others
    1,847       2,697       (850 )
Unallocated corporate expenses
    (43,266 )     (49,755 )     6,489  
Elimination of intersegment profits
    (519 )     (218 )     (301 )
Income before income taxes, excluding BIBP
    61,327       67,651       (6,324 )
BIBP, a variable interest entity *
    20,954       22,543       (1,589 )
Total income before income taxes
  $ 82,281     $ 90,194     $ (7,913 )

 
*
The full-year 2010 results for domestic commissaries were reduced by the BIBP Settlement and the full-year 2010 results for BIBP were increased by the BIBP Settlement. There was no impact on the consolidated results of operations since PJFS and BIBP are fully consolidated into the Company’s results.

Excluding the impact of the consolidation of BIBP (income before income taxes of $6.8 million, excluding the BIBP Settlement, or $0.16 per diluted share in 2010, and income before income taxes of $22.5 million or $0.52 per diluted share in 2009), 2010 income before income taxes was $75.5 million (6.7% of total revenues), compared to $67.7 million (6.3% of total revenues) in 2009. The $7.8 million increase in income before income taxes, excluding the consolidation of BIBP, was principally due to the following:

Domestic Company-owned Restaurant Segment. Domestic Company-owned restaurants’ income before income taxes decreased $3.3 million from the prior comparable period. The decrease was primarily due to a decline in operating margin from lower average ticket prices due to increased levels of discounting, partially offset by increased customer traffic and reductions in labor costs as a result of labor efficiencies from implemented initiatives. The 2009 period included restaurant closure costs of approximately $700,000. There were no significant closure costs in 2010.
   
Domestic Commissary Segment. Domestic commissaries’ income before income taxes decreased $15.2 million in 2010 over the prior year, comprised of the following (in thousands):
 
     
Year Ended December 26, 2010
   
Year Ended December 27, 2009
   
Decrease
 
                     
 
Income before income taxes, excluding the
                 
 
   BIBP Settlement
  $ 28,338     $ 29,393     $ (1,055 )
 
BIBP Settlement
    (14,150 )     -       (14,150 )
 
Total segment income before income taxes
  $ 14,188     $ 29,393     $ (15,205 )
 
 
41

 
 
 
Domestic commissaries’ income before income taxes, excluding the BIBP Settlement, was $28.3 million in 2010, as compared to $29.4 million in 2009. The decrease of $1.1 million in income before income taxes was primarily due to increased fuel costs, partially offset by an increase in sales volumes, although at a lower gross margin percentage. The full-year 2010 gross margin percentage included the impact of commodities cost increases we absorbed for certain vegetable products resulting from harsh Florida winter weather and various rebate programs available to restaurants for achieving certain sales improvement targets. Full-year 2009 included approximately $800,000 of management transition costs and $400,000 of costs associated with the closure of one of our commissaries.
   
North America Franchising Segment. North America franchising income before income taxes increased approximately $7.2 million to $62.2 million in 2010, from $55.0 million in 2009. The increase was primarily due to an increase in franchise royalties (the standard royalty rate increased from 4.25% to 4.50% in September 2009, and increased to 4.75% in the first quarter of 2010). The impact of the royalty rate increase was partially offset by the impact of development incentive programs offered by the Company in 2009 and 2010. Franchise and development fees were approximately $200,000 lower in 2010 than in the corresponding period, despite an increase of 90 domestic unit openings during 2010 due to development incentive programs in place. Additionally, we incurred incentive costs of $1.0 million in 2010, compared to $440,000 in 2009.
   
International Segment. The international segment reported operating losses of approximately $4.8 million in 2010 and $4.4 million in 2009. The increase in operating losses was due to increased personnel and franchise support costs as well as from costs associated with the opening of our new commissary in the United Kingdom, partially offset by increased revenues due to growth in the number of international units.
   
All Others Segment. Income before income taxes for the “All others” reporting segment decreased approximately $850,000 in 2010 as compared to 2009. The decrease was primarily due to increased costs in our online ordering business due to increased infrastructure and support attributable to the new online ordering system introduced in October 2010. This decline was partially offset by an improvement in operating results at Preferred, primarily due to cost reductions implemented in 2009 and 2010.
   
Unallocated Corporate Segment. Unallocated corporate expenses decreased approximately $6.5 million in 2010 as compared to 2009. The components of unallocated corporate expenses were as follows (in thousands):
 
                     
      Year Ended     Year Ended      Increase  
     
December 26, 2010
   
December 27, 2009
   
(Decrease)
 
                     
 
General and administrative (a)
  $ 25,823     $ 26,893     $ (1,070 )
 
Net interest
    4,120       4,251       (131 )
 
Depreciation
    8,873       8,684       189  
 
Franchise support initiatives (b)
    6,489       9,556       (3,067 )
 
Provision (credit) for uncollectible
                       
 
   accounts and notes receivable (c)
    (340 )     1,172       (1,512 )
 
Other income (d)
    (1,699 )     (801 )     (898 )
 
Total unallocated corporate expenses
  $ 43,266     $ 49,755     $ (6,489 )
 
 
42

 
 
 
(a)
Unallocated general and administrative costs decreased in 2010 due to lower salaries and benefits, resulting from fewer employees and the fact that the prior year included $800,000 in litigation settlement costs. Severance costs, net of forfeitures of unvested stock awards, were also approximately $400,000 lower in 2010. These reductions were partially offset by an increase in short-term incentive compensation expense.

 
(b)
Franchise support initiatives primarily consist of discretionary contributions to the Marketing Fund and other local advertising cooperatives.

 
(c)
The reduction in the provision for uncollectible accounts and notes receivable was primarily due to the collection of certain accounts that were previously reserved.

 
(d)
The increase in other income was primarily due to sales of point-of-sale systems associated with additional domestic openings.

 
Variable Interest Entities.  BIBP generated income before income taxes of $21.0 million in 2010, compared to $22.5 million in 2009. The following table summarizes the impact of BIBP prior to the required consolidating eliminations on our consolidated statements of income for the years ended December 26, 2010 and December 27, 2009 (in thousands):
 
     
Year Ended
 
     
December 26,
2010
   
December 27,
2009
 
               
 
BIBP sales
  $ 153,014     $ 142,407  
                   
 
Cost of sales
    131,549       118,825  
 
General and administrative expenses
    91       233  
 
Total costs and expenses
    131,640       119,058  
 
Operating income
    21,374       23,349  
 
Interest expense
    (420 )     (806 )
 
Income before income taxes (a)
  $ 20,954     $ 22,543  
 
 
(a)
Income before income taxes for the year ended December 26, 2010, was $6.8 million, excluding the BIBP Settlement.
 
Diluted earnings per share were $1.96 in 2010 (including a $0.16 per share gain from the consolidation of BIBP, excluding the BIBP Settlement), compared to $2.06 per diluted share in 2009 (including a $0.52 gain from the consolidation of BIBP and a $0.04 gain from the finalization of certain income tax issues). Diluted weighted average shares outstanding decreased 5.2% in 2010 from the prior year period. Diluted earnings per share, excluding BIBP, increased $0.09 due to the reduction in shares outstanding.

Review of Consolidated Operating Results

Revenues. Domestic Company-owned restaurant sales were $503.3 million for 2010 compared to $503.8 million for 2009. The 0.1% decrease was primarily due to a 0.6% decrease in comparable sales.

North America franchise sales increased 2.1% to $1.62 billion, from $1.58 billion in 2009, as comparable sales increased 0.3% and equivalent units increased 4.3%. North America franchise royalties were $69.6 million, representing an increase of 12.2% from the comparable period. The increase in royalties was primarily due to the previously mentioned increase in the standard royalty rate.
 
 
43

 
 
The comparable sales base and average weekly sales for 2010 and 2009 for domestic Company-owned and North America franchised restaurants consisted of the following:
 
   
Year Ended
   
Year Ended
 
   
December 26, 2010
   
December 27, 2009
 
   
Domestic
Company-
owned
   
North
America
Franchised
   
Domestic
Company-
owned
   
North
America
Franchised
 
                         
Total domestic units (end of period)
    591       2,346       588       2,193  
Equivalent units
    586       2,231       585       2,140  
Comparable sales base units
    577       2,074       569       2,026  
Comparable sales base percentage
    98.5 %     93.0 %     97.3 %     94.7 %
Average weekly sales - comparable units
  $ 16,599     $ 14,057     $ 16,628     $ 13,948  
Average weekly sales - total non-comparable units
  $ 11,562     $ 12,177     $ 13,902     $ 14,234  
Average weekly sales - all units
  $ 16,521     $ 13,924     $ 16,551     $ 13,963  
 
Domestic franchise and development fees were approximately $600,000 in 2010, or a decrease of approximately $300,000 from 2009. The decrease was primarily due to a greater number of restaurants opening with no opening fees in accordance with our development incentive programs.

Domestic commissary sales increased 8.8% to $454.5 million in 2010 from $417.7 million in the prior comparable period. The increase was primarily due to an increase in sales volumes. Our commissaries charge a fixed dollar mark-up on the cost of cheese. Cheese cost based upon the BIBP block price increased from $1.55 per pound in 2009 to $1.59 per pound in 2010, or a 2.6% increase.

Other sales decreased $2.1 million to $52.0 million. The decrease was primarily due to a decline in sales at Preferred.

International revenues increased 16.1% to $46.4 million in 2010, from $40.0 million in 2009, reflecting the increase in the number of franchised restaurants over the past year.

Costs and Expenses.  The restaurant operating margin at domestic Company-owned units was 20.2% in 2010 compared to 21.8% in 2009. Excluding the impact of consolidating BIBP, restaurant operating margin decreased 0.8% to 19.9% for the year ended December 26, 2010 as compared to the corresponding period in 2009, consisting of the following differences:

 
Cost of sales were 1.3% higher (excluding the consolidation of BIBP) in 2010 as compared to 2009 due to increased discounting of prices to customers.
 
Salaries and benefits were 1.6% lower as a percentage of sales in 2010 compared to 2009, primarily due to labor efficiencies from implemented initiatives, and a change in pay practices for certain team members.
 
Advertising and related costs as a percentage of sales were 0.3% higher in 2010 due to an increase in local marketing initiatives.
 
Occupancy costs and other operating costs, on a combined basis, as a percentage of sales, were 0.8% higher in 2010 primarily due to increased reimbursement rates for certain team members, in connection with previously noted labor initiatives.
 
Domestic commissary and other margin was 8.6% in 2010, compared to 9.8% in 2009. Cost of sales was 75.5% of revenues in 2010, compared to 73.8% in 2009. Cost of sales increased primarily due to our commissaries’ absorbing an increase in prices of certain commodities, including increases in vegetable products due to the impact from harsh Florida winter weather during 2010. Salaries and benefits were relatively consistent for both periods at $34.1 million and $33.9 million for 2010 and 2009, respectively. Other operating expenses increased approximately $3.3 million in 2010 as compared to 2009, primarily due to higher distribution costs, reflecting increased volumes and an increase in fuel costs.

 
44

 
 
We recorded income before income taxes from the franchise cheese-purchasing program, net of noncontrolling interest, of $5.6 million and $18.1 million in 2010 and 2009, respectively. These results only represent the portion of BIBP’s operating income or loss related to the proportion of BIBP cheese sales to franchisees. The total impact of the consolidation of BIBP on Papa John’s income before income taxes was income of $21.0 million in 2010 (including the BIBP Settlement) and $22.5 million in 2009.

International operating expenses in 2010 were 88.7% of international restaurant and commissary sales as compared to 86.3% in 2009. The increase in operating expenses as a percentage of sales is primarily due to the start-up costs associated with our PJUK commissary.

General and administrative expenses were $110.0 million, or 9.8% of revenues for 2010, as compared to $111.4 million, or 10.3% of revenues for 2009. The decrease is primarily due to the items noted as comprising the decreases in unallocated general and administrative expenses for the Unallocated Corporate Segment in the Discussion of Operating Results section, as well as 2009 including certain management transition costs recorded by our domestic commissaries segment.

Other general expenses reflected net expense of $9.0 million in 2010, as compared to $14.3 million in 2009 as detailed below (in thousands):
 
               
Increase
 
   
2010
   
2009
   
(Decrease)
 
                   
Impairment and disposition losses
  $ 894     $ 1,829     $ (935 )
Provision (credit) for uncollectible accounts and notes receivable (a)
    (27 )     1,378       (1,405 )
Pre-opening restaurant costs
    149       75       74  
Franchise support initiatives (b)
    6,489       9,556       (3,067 )
Franchise incentives (c)
    1,044       440       604  
Commissary closing costs
    -       369       (369 )
Other
    481       699       (218 )
Total other general expenses
  $ 9,030     $ 14,346     $ (5,316 )
 
(a)
The reduction in provision (credit) for uncollectible accounts and notes receivable was primarily due to the collection of certain accounts that were previously reserved.
(b)
Franchise support initiatives primarily consist of discretionary contributions to the Marketing Fund and other local advertising cooperatives.
(c)
Franchise incentives include incentives to franchisees for opening new restaurants.

Depreciation and amortization was $32.4 million, or 2.9% of revenues, for 2010 as compared to $31.4 million, or 2.9% of revenues, for 2009.

Net interest. Net interest expense was $4.5 million in 2010, compared to $5.0 million in 2009. The interest expense for 2009 includes approximately $169,000 related to BIBP’s debt with a third-party bank (none in 2010). The decrease in net interest costs for 2010 is primarily due to interest earned on increased cash investments and a decrease in the average outstanding debt balance.

Income Tax Expense.  We recognized reductions of $550,000 and $1.2 million in our income tax expense associated with the finalization of certain income tax issues in 2010 and 2009, respectively. Our effective income tax rates were 32.6% in 2010 compared to 32.1% in 2009 (32.3% in 2010 and 31.1% in 2009, excluding BIBP).
 
 
45

 
 
Liquidity and Capital Resources

Debt and credit arrangements consist of the following (in thousands):
 
   
2011
   
2010
 
             
Revolving line of credit
  $ 51,489     $ 99,000  
Other
    -       17  
Total long-term debt
  $ 51,489     $ 99,017  
 
In September 2010, we entered into a five-year, $175.0 million unsecured Revolving Credit Facility (“New Credit Facility”) that replaced a $175.0 million unsecured Revolving Credit Facility (“Old Credit Facility”). The New Credit Facility was amended in November 2011 (the “Amended Credit Facility”), which extended the maturity date of the New Credit Facility to November 30, 2016. Under the Amended Credit Facility, outstanding balances are charged interest at 75 basis points to 150 basis points over LIBOR or other bank developed rates at our option (previously charged 100 basis points to 175 basis points above LIBOR). Outstanding balances under the Old Credit Facility were charged interest at 50 to 100 basis points over LIBOR or other bank developed rates, at our option.

We have used interest rate swaps to hedge against the effects of potential interest rate increases on borrowings under our revolving credit facility. We currently have a swap with a fixed rate of 0.53%, as compared to LIBOR, with a notional amount of $50.0 million. See “Note 7” of “Notes to Consolidated Financial Statements” for additional information.
 
The New Credit Facility, as amended, contains customary affirmative and negative covenants, including the following financial covenants, as defined by the New Credit Facility (the covenants exclude the impact of consolidating BIBP’s operations):
 
 
Permitted Ratio
 
Actual Ratio for the
Year Ended
December 25, 2011
       
Leverage Ratio
Not to exceed 2.5 to 1.0
 
0.5 to 1.0
       
Interest Coverage Ratio
Not less than 3.5 to 1.0
 
5.4 to 1.0
 
Our leverage ratio is defined as outstanding debt divided by consolidated EBITDA for the most recent four fiscal quarters. Our interest coverage ratio is defined as the sum of consolidated EBITDA and consolidated rental expense for the most recent four fiscal quarters divided by the sum of consolidated interest expense and consolidated rental expense for the most recent four fiscal quarters. We were in compliance with all covenants at December 25, 2011.

Cash flow provided by operating activities was $101.0 million for the full-year 2011 as compared to $92.6 million in 2010. The consolidation of BIBP increased cash flow from operations by approximately $6.8 million in 2010.  Excluding the impact of the consolidation of BIBP, cash flow from operations was $101.0 million in 2011, as compared to $85.8 million in 2010, primarily due to higher net income and favorable working capital changes, including deferred income taxes.
 
 
46

 
 
Cash flow provided by operating activities decreased to $92.6 million in 2010 from $103.8 million in 2009. The consolidation of BIBP increased cash flow from operations by approximately $6.8 million in 2010 and $22.5 million in 2009.  Excluding the impact of the consolidation of BIBP, cash flow was $85.8 million in 2010 as compared to $81.3 million in 2009, primarily due to higher net income.

The Company’s free cash flow for the last three years was as follows (in thousands):
 
   
Year Ended
 
   
Dec. 25,
   
Dec. 26,
   
Dec. 27,
 
   
2011
   
2010
   
2009
 
                   
Net cash provided by operating activities
  $ 101,008     $ 92,581     $ 103,826  
Gain from BIBP cheese purchasing entity
    -       (6,804 )     (22,543 )