Papa Johns 2008 Annual Report Download - page 38

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Deferred Tax Assets 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. Income taxes are accounted for under Statement of Financial Accounting Standards (“SFAS”)
No. 109, “Accounting for Income Taxes.” The provision for income taxes includes income taxes paid,
currently payable or receivable and those deferred. Under SFAS 109, deferred tax assets and liabilities
are determined based on differences between financial reporting and tax basis of assets and liabilities,
and are measured using enacted tax rates and laws that are expected to be in effect when the differences
reverse. Deferred tax assets are also recognized for the estimated future effects of tax loss carryforwards.
The effect on deferred taxes of changes in tax rates is recognized in the period in which the enactment
date changes. As a result, our effective tax rate may fluctuate. Valuation allowances are established
when necessary on a jurisdictional basis to reduce deferred tax assets to the amounts we expect to realize.
As of December 28, 2008, we had a net deferred income tax asset balance of $24.6 million, of which
approximately $15.1 million relates to the net operating loss carryforward of BIBP Commodities, Inc.
("BIBP"). We have not provided a valuation allowance for the deferred income tax assets associated with
our domestic operations since we believe it is more likely than not that our future earnings will be
sufficient to ensure the realization of the net deferred income tax assets for federal and state purposes.
Certain tax authorities periodically audit the Company. We provide reserves for potential exposures
based on Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for
Uncertainty in Income Taxes (FIN 48) requirements. We evaluate these issues on a quarterly basis to
adjust for events, such as court rulings or audit settlements, which may impact our ultimate payment for
such exposures. We recognized reductions of $1.7 million, $3.4 million and $2.5 million in our
customary income tax expense associated with the finalization of certain income tax issues in 2008, 2007
and 2006, respectively (see “Note 14” of “Notes to Consolidated Financial Statements”).
Consolidation of BIBP Commodities, Inc. (“BIBP”) as a Variable Interest Entity
BIBP is a franchisee-owned corporation that conducts a cheese-purchasing program on behalf of
domestic Company-owned and franchised restaurants. As required by the FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51
(FIN 46), we consolidate the financial results of BIBP, since we are deemed to be the primary
beneficiary, as defined by FIN 46, of BIBP. We recognized pre-tax losses of approximately $10.5 million
during 2008 and $31.7 million during 2007 and pre-tax income of $19.0 million during 2006 from the
consolidation of BIBP. We expect the consolidation of BIBP to continue to have a significant impact on
Papa John’s operating income in future periods due to the volatility of cheese prices. Papa John’s will
recognize the operating losses generated by BIBP if the shareholders’ equity of BIBP is in a net deficit
position. Further, Papa John’s will recognize subsequent operating income generated by BIBP up to the
amount of BIBP losses previously recognized by Papa John’s.
Many domestic franchisees are facing financial challenges due to a recent decline in sales and continued
operating margin pressures from higher commodity costs (primarily cheese and wheat) as well as
increased utility costs. In addition, due to the recent events impacting credit availability, many
franchisees are having difficulty obtaining credit from third-party lending institutions for working capital
and development purposes. In an effort to assist franchisees through this difficult period, the BIBP
formula was modified for the last two months of 2008. The modified formula resulted in domestic
restaurants paying the expected futures spot market price for cheese plus an interest carry cost (Q4-08
modified price), which was approximately $0.28 per pound less than the pre-established fourth quarter
price paid by domestic restaurants during October 2008. The modified price reduced the food cost and