Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 28, 2020
OR
☐Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number: 0-21660
PAPA JOHN’S INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Delaware
61-1203323
(State or other jurisdiction of
(I.R.S. Employer Identification
incorporation or organization)
number)
2002 Papa John’s Boulevard
Louisville, Kentucky 40299-2367
(Address of principal executive offices)
(502) 261-7272
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
Trading Symbol
Name of each exchange on which registered:
Common stock, $0.01 par value
PZZA
The NASDAQ Stock Market LLC
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 ⌧ No ◻
Indicate by check mark whether the registrant has submitted electronically every interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☒
Accelerated filer ☐
Non-accelerated filer ☐
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
At July 30, 2020, there were outstanding 32,814,222 shares of the registrant’s common stock, par value $0.01 per share.
INDEX
Page No.
PART I.
FINANCIAL INFORMATION
Item 1.
Financial Statements
Condensed Consolidated Balance Sheets — June 28, 2020 and December 29, 2019
3
Condensed Consolidated Statements of Operations — Three and Six months ended June 28, 2020 and June 30, 2019
4
Condensed Consolidated Statements of Comprehensive Income (Loss) — Three and Six months ended June 28, 2020 and June 30, 2019
5
Condensed Consolidated Statements of Stockholders’ Deficit — Three and Six months ended June 28, 2020 and June 30, 2019
6
Condensed Consolidated Statements of Cash Flows — Six months ended June 28, 2020 and June 30, 2019
8
Notes to Condensed Consolidated Financial Statements
9
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
24
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
41
Item 4.
Controls and Procedures
42
PART II.
OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
43
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Papa John’s International, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
June 28,
December 29,
(In thousands, except per share amounts)
2020
2019
(Unaudited)
Assets
Current assets:
Cash and cash equivalents
$
75,699
27,911
Accounts receivable, net
73,530
80,921
Notes receivable, current portion
9,651
7,790
Income tax receivable
755
4,024
Inventories
32,546
27,529
Prepaid expenses and other current assets
33,292
33,371
Total current assets
225,473
181,546
Property and equipment, net
200,581
211,741
Finance lease right-of-use assets, net
8,978
9,383
Operating lease right-of-use assets
141,861
148,229
Notes receivable, less current portion, net
32,158
33,010
Goodwill
79,634
80,340
Deferred income taxes
4,978
1,839
Other assets
64,074
64,633
Total assets
757,737
730,721
Liabilities, Series B Convertible Preferred Stock, Redeemable noncontrolling interests and Stockholders’ deficit
Current liabilities:
Accounts payable
30,699
29,141
Income and other taxes payable
11,200
7,599
Accrued expenses and other current liabilities
134,989
120,566
Current deferred revenue
5,382
5,624
Current finance lease liabilities
3,879
1,789
Current operating lease liabilities
22,663
23,226
Current portion of long-term debt
20,107
20,000
Total current liabilities
228,919
207,945
Deferred revenue
13,543
14,722
Long-term finance lease liabilities
5,265
7,629
Long-term operating lease liabilities
118,946
125,297
Long-term debt, less current portion, net
327,932
347,290
859
2,649
Other long-term liabilities
95,627
84,927
Total liabilities
791,091
790,459
Series B Convertible Preferred Stock; $0.01 par value; 260.0 shares authorized, 252.5 shares issued and outstanding at June 28, 2020 and December 29, 2019
251,827
251,133
Redeemable noncontrolling interests
6,667
5,785
Stockholders’ deficit:
Common stock ($0.01 par value per share; issued 45,122 at June 28, 2020 and 44,748 at December 29, 2019)
451
447
Additional paid-in capital
243,577
219,047
Accumulated other comprehensive loss
(21,104)
(10,185)
Retained earnings
212,104
205,697
Treasury stock (12,773 shares at June 28, 2020 and 12,854 shares at December 29, 2019, at cost)
(742,600)
(747,327)
Total stockholders’ deficit
(307,572)
(332,321)
Noncontrolling interests in subsidiaries
15,724
15,665
Total Stockholders’ deficit
(291,848)
(316,656)
Total liabilities, Series B Convertible Preferred Stock, Redeemable noncontrolling interests and Stockholders’ deficit
See accompanying notes.
Condensed Consolidated Statements of Operations
Three Months Ended
Six Months Ended
June 30,
Revenues:
Domestic Company-owned restaurant sales
186,506
163,656
347,946
325,459
North America franchise royalties and fees
24,174
19,761
43,614
37,291
North America commissary revenues
167,619
147,128
323,041
296,032
International revenues
28,093
25,497
54,152
51,164
Other revenues
54,231
43,581
101,729
88,082
Total revenues
460,623
399,623
870,482
798,028
Costs and expenses:
Operating costs (excluding depreciation and amortization shown separately below):
Domestic Company-owned restaurant expenses
145,168
131,950
274,279
265,003
North America commissary expenses
154,467
136,744
298,739
275,301
International expenses
18,304
14,652
33,405
28,957
Other expenses
51,345
41,970
97,302
86,067
General and administrative expenses
48,428
48,718
96,079
99,853
Depreciation and amortization
12,377
11,521
24,672
23,270
Total costs and expenses
430,089
385,555
824,476
778,451
Refranchising gains
—
163
Operating income
30,534
14,231
46,006
19,740
Net interest expense
(3,627)
(4,272)
(7,594)
(10,548)
Income before income taxes
26,907
9,959
38,412
9,192
Income tax expense
4,956
1,283
7,468
2,114
Net income before attribution to noncontrolling interests
21,951
8,676
30,944
7,078
Net income attributable to noncontrolling interests
(1,337)
(322)
(1,887)
(455)
Net income attributable to the Company
20,614
8,354
29,057
6,623
Calculation of net income for earnings per share:
Preferred stock dividends and accretion
(3,347)
(3,486)
(6,818)
(5,556)
Net income attributable to participating securities
(1,560)
(1,306)
Net income attributable to common shareholders
15,707
4,868
20,933
1,067
Basic earnings per common share
0.49
0.15
0.65
0.03
Diluted earnings per common share
0.48
Basic weighted average common shares outstanding
32,335
31,587
32,214
31,570
Diluted weighted average common shares outstanding
32,619
31,773
32,444
31,746
Dividends declared per common share
0.225
0.450
Condensed Consolidated Statements of Comprehensive Income (Loss)
(In thousands)
Other comprehensive loss, before tax:
Foreign currency translation adjustments
(334)
(1,537)
(3,159)
196
Interest rate swaps (1)
(103)
(6,699)
(11,022)
(10,654)
Other comprehensive loss, before tax
(437)
(8,236)
(14,181)
(10,458)
Income tax effect:
77
354
727
(45)
Interest rate swaps (2)
1,532
2,535
2,450
Income tax effect
101
1,886
3,262
2,405
Other comprehensive loss, net of tax
(336)
(6,350)
(10,919)
(8,053)
Comprehensive income (loss) before attribution to noncontrolling interests
21,615
2,326
20,025
(975)
Less: comprehensive (income) loss, redeemable noncontrolling interests
(707)
(32)
(883)
87
Less: comprehensive (income), nonredeemable noncontrolling interests
(630)
(290)
(1,004)
(542)
Comprehensive income (loss) attributable to the Company
20,278
2,004
18,138
(1,430)
Condensed Consolidated Statements of Stockholders’ Deficit
Papa John’s International, Inc.
Common
Accumulated
Stock
Additional
Other
Noncontrolling
Total
Shares
Paid-In
Comprehensive
Retained
Treasury
Interests in
Stockholders’
For the three months ended June 28, 2020
Outstanding
Capital
Loss
Earnings
Subsidiaries
Deficit
Balance at March 29, 2020
31,971
448
220,187
(20,768)
202,287
(744,463)
16,009
(326,300)
Net income (2)
630
21,244
Other comprehensive loss
Cash dividends on common stock
(7,360)
(7,283)
Cash dividends on preferred stock
(3,412)
Exercise of stock options
346
20,460
20,463
Stock-based compensation expense
4,792
Issuance of restricted stock
30
(1,760)
1,760
Tax effect of restricted stock awards
(196)
Distributions to noncontrolling interests
(915)
17
(25)
103
95
Balance at June 28, 2020
32,349
For the six months ended June 28, 2020
Balance at December 29, 2019
31,894
Cumulative effect of adoption of ASU 2016-13 (1)
(1,066)
Adjusted Balance at December 30, 2019
204,631
(317,722)
1,004
30,061
132
(14,652)
(14,520)
(6,825)
373
21,700
21,704
8,742
(4,468)
4,468
(1,579)
(945)
(107)
259
155
At June 28, 2020, the accumulated other comprehensive loss of $21,104 was comprised of net unrealized foreign currency translation loss of $8,031 and net unrealized loss on the interest rate swap agreements of $13,073.
Condensed Consolidated Statements of Stockholders’ Deficit (continued)
For the three months ended June 30, 2019
Balance at March 31, 2019
31,420
443
193,243
(4,846)
231,439
(748,995)
15,458
(313,258)
Net income (1)
290
8,644
59
(7,203)
(7,144)
(3,428)
1
3,800
(116)
116
(26)
(164)
(75)
(329)
222
(182)
Balance at June 30, 2019
31,427
196,927
(11,196)
228,833
(748,657)
15,584
(318,066)
For the six months ended June 30, 2019
Balance at December 30, 2018
31,372
192,984
(3,143)
242,182
(751,704)
15,225
(304,013)
542
7,165
(14,364)
(14,269)
(5,470)
93
7,531
44
(2,570)
2,570
(895)
(183)
7
(311)
(138)
477
28
At June 30, 2019, the accumulated other comprehensive loss of $11,196 was comprised of net unrealized foreign currency translation loss of $6,709 and net unrealized loss on the interest rate swap agreements of $4,487.
Condensed Consolidated Statements of Cash Flows
Operating activities
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for uncollectible accounts and notes receivable
1,051
676
(1,502)
(3,096)
Preferred stock option mark-to-market adjustment
5,914
Gain on refranchising
(163)
1,090
1,999
Changes in operating assets and liabilities:
Accounts receivable
(8,571)
(1,092)
4,278
11,699
(5,017)
326
9,657
(5,383)
Other assets and liabilities
8,065
(2,094)
1,558
5,410
3,601
565
10,269
(17,297)
(1,179)
(3,168)
Net cash provided by operating activities
87,658
32,175
Investing activities
Purchases of property and equipment
(13,795)
(17,836)
Notes issued
(9,596)
(4,757)
Repayments of notes issued
6,462
2,234
Proceeds from divestitures of restaurants
225
14
568
Net cash used in investing activities
(16,915)
(19,566)
Financing activities
Proceeds from issuance of preferred stock
252,530
Repayments of term loan
(10,000)
Net (repayments) proceeds of revolving credit facilities
(9,884)
(230,776)
Dividends paid to common stockholders
Dividends paid to preferred stockholders
Issuance costs associated with preferred stock
(7,250)
Tax payments for equity award issuances
Proceeds from exercise of stock options
Contributions from noncontrolling interest holders
840
Distributions to noncontrolling interest holders
(704)
168
Net cash used in financing activities
(22,753)
(15,212)
Effect of exchange rate changes on cash and cash equivalents
(202)
Change in cash and cash equivalents
47,788
(2,602)
Cash and cash equivalents at beginning of period
33,258
Cash and cash equivalents at end of period
30,656
Notes to Condensed Consolidated Financial Statements (Unaudited)
June 28, 2020
1.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete annual financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 28, 2020 are not necessarily indicative of the results that may be expected for the fiscal year ending December 27, 2020. For further information, refer to the consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K for Papa John’s International, Inc. (referred to as the “Company”, “Papa John’s” or in the first-person notations of “we”, “us” and “our”) for the year ended December 29, 2019.
2.
Update to Significant Accounting Policies
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Significant items that are subject to such estimates and assumptions include allowance for doubtful accounts and notes receivable, intangible assets, contract assets and contract liabilities, including the online customer loyalty program obligation, right-of-use assets and lease liabilities, gift card breakage, insurance reserves and tax reserves. Although management bases its estimates on historical experience and assumptions that are believed to be reasonable under the circumstances, actual results could significantly differ from these estimates.
Variable Interest Entity
Papa John’s domestic restaurants, both Company-owned and franchised, participate in Papa John’s Marketing Fund, Inc. (“PJMF”), a nonstock corporation designed to operate at break-even as it spends all annual contributions received from the system. PJMF collects a percentage of revenues from Company-owned and franchised restaurants in the United States for the purpose of designing and administering advertising and promotional programs. PJMF is a variable interest entity (“VIE”) that funds its operations with ongoing financial support and contributions from the domestic restaurants, of which approximately 80% are franchised, and does not have sufficient equity to fund its operations without these ongoing financial contributions. Based on an assessment of the governance structure and operating procedures of PJMF, the Company determined it has the power to control certain significant activities of PJMF, and therefore, is the primary beneficiary. The Company has consolidated PJMF in its financial results in accordance with Accounting Standards Codification (“ASC”) 810, “Consolidations.”
Noncontrolling Interests
Papa John’s has four joint venture arrangements in which there are noncontrolling interests held by third parties that include 192 restaurants at both June 28, 2020 and June 30, 2019.
Consolidated net income is required to be reported separately at amounts attributable to both the Company and the noncontrolling interests. Additionally, disclosures are required to clearly identify and distinguish between the interests of the Company and the interests of the noncontrolling owners, including a disclosure on the face of the Condensed Consolidated Statements of Operations of income attributable to the noncontrolling interest holders.
Net income attributable to these joint ventures for the three and six months ended June 28, 2020 and June 30, 2019 was as follows (in thousands):
2,320
708
3,451
1,172
Noncontrolling interests
1,337
322
1,887
455
Total net income
3,657
1,030
5,338
1,627
The following summarizes the redemption feature, location and related accounting within the Condensed Consolidated Balance Sheets for these joint venture arrangements:
Type of Joint Venture Arrangement
Location within the Balance Sheets
Recorded Value
Joint ventures with no redemption feature
Permanent equity
Carrying value
Joint ventures with option to require the Company to purchase the noncontrolling interest - not currently redeemable or redemption not probable
Temporary equity
Deferred Income Tax Accounts and Tax Reserves
We are 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. The effective income tax rate includes the estimated domestic state effective income tax rate and applicable foreign income tax rates. The effective income tax rate is also impacted by various permanent items and credits, net of any related valuation allowances, and can vary based on changes in estimated annual income. Discrete 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 attribute carryforwards (e.g., net operating losses, capital losses, and foreign tax credits). The effect on deferred taxes of changes in tax rates is recognized in the period in which the new tax rate is enacted. Valuation allowances are established when necessary on a jurisdictional basis to reduce deferred tax assets to the amounts we expect to realize.
Tax authorities periodically audit the Company. We record reserves and related interest and penalties for identified exposures as income tax expense. We evaluate these issues on a quarterly basis to adjust for events, such as statute of limitations expirations, court or state rulings or audit settlements, which may impact our ultimate payment for such exposures.
Fair Value Measurements and Disclosures
The Company is required to determine the fair value of financial assets and liabilities based on the price that would be received to sell the asset or paid to transfer the liability to a market participant. Fair value is a market-based measurement, not an entity-specific measurement. The fair value of certain assets and liabilities approximates carrying value because of the short-term nature of the accounts, including cash and cash equivalents, accounts receivable, net of allowances, and accounts payable. The carrying value of notes receivable, net of allowances, also approximates fair value. The fair value of the amount outstanding under our term debt approximates the carrying value due to the variable market-based interest rate (Level 2).
10
Certain assets and liabilities are measured at fair value on a recurring basis and are required to be classified and disclosed in one of the following categories:
Our financial assets and liabilities that were measured at fair value on a recurring basis as of June 28, 2020 and December 29, 2019 are as follows (in thousands):
Carrying
Fair Value Measurements
Value
Level 1
Level 2
Level 3
Financial assets:
Cash surrender value of life insurance policies (a)
32,155
Financial liabilities:
Interest rate swaps (b)
17,050
December 29, 2019
33,220
6,168
11
Accounting Standards Adopted
Financial Instruments – Credit Losses
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which requires measurement and recognition of expected versus incurred losses for financial assets held. The Company adopted ASU 2016-13 as of December 30, 2019 (the first day of fiscal 2020) under the modified retrospective transition method. Financial instruments subject to ASU 2016-13 include trade accounts receivable, notes receivable and interest receivable (classified as Other assets in the Condensed Consolidated Balance Sheet) from franchisees. The impact of the adoption was not material to our condensed consolidated financial statements. Upon adoption, the Company recorded a cumulative effect adjustment to retained earnings of $1.1 million, net of $0.3 million of income taxes, on the opening Condensed Consolidated Balance Sheet as of December 30, 2019.
Estimates of expected credit losses, even if remote, are based upon historical account write-off trends, facts about the current financial condition of the debtor, forecasts of future operating results based upon current trends of select operating metrics, and macroeconomic factors. Credit quality is monitored through the timing of payments compared to the prescribed payment terms and known facts regarding the financial condition of the franchisee or customer. Account and note balances are charged off against the allowance after recovery efforts have ceased.
The following table summarizes changes in our allowances for credit losses for accounts receivable, notes receivable and interest receivable:
(in thousands)
Accounts Receivable
Notes Receivable
Interest Receivable
7,341
3,572
910
Cumulative effect of adoption of ASU 2016-13
912
463
-
Balance at December 30, 2019
8,253
4,035
Current period provision for expected credit losses
833
74
144
Write-offs charged against the allowance
(431)
(10)
Recoveries collected
(56)
Transfers
1,054
(1,054)
8,655
5,097
Accounting Standards to be Adopted in Future Periods
Reference Rate Reform – Hedging
In March 2020, the FASB issued ASU 2020-04, “Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” The ASU is intended to provide temporary optional expedients and exceptions to the US GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens related to the expected market transition from LIBOR and other interbank offered rates to alternative reference rates. This guidance was effective beginning on March 12, 2020, and the Company may elect to apply the amendments prospectively through December 31, 2022. The Company is currently evaluating the impact this guidance may have on its condensed consolidated financial statements and related disclosures.
12
3. Leases
Lessor Operating Leases
We sublease certain retail space to our franchisees in the United Kingdom which are primarily operating leases. At June 28, 2020, we leased and subleased approximately 370 Papa John’s restaurants to franchisees in the United Kingdom. The initial lease terms on the franchised sites in the United Kingdom are generally 15 years. The Company has the option to negotiate an extension toward the end of the lease term at the landlord’s discretion. Rental income, primarily derived from properties leased and subleased to franchisees in the United Kingdom, is recognized on a straight-line basis over the respective operating lease terms. We recognized total sublease income of $5.0 million and $4.8 million for the six months ended June 28, 2020 and June 30, 2019, respectively.
Lease Guarantees
As a result of assigning our interest in obligations under property leases as a condition of the refranchising of certain restaurants, we are contingently liable for payment of approximately 89 domestic leases. These leases have varying terms, the latest of which expires in 2036. As of June 28, 2020, the estimated maximum amount of undiscounted payments the Company could be required to make in the event of nonpayment by the primary lessees was $15.9 million. This contingent liability is not included in the Condensed Consolidated Balance Sheet as it is not probable to occur. The fair value of the guarantee is not material.
Supplemental Cash Flow & Other Information
Supplemental cash flow information related to leases for the periods reported is as follows:
June 30, 2019
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from finance leases
295
Financing cash flows from finance leases
939
Operating cash flows from operating leases (a)
18,744
20,307
Right-of-use assets obtained in exchange for new finance lease liabilities
19
Right-of-use assets obtained in exchange for new operating lease liabilities
13,370
6,180
Cash received from sublease income
5,014
4,662
(a) Included within the change in Other assets and liabilities within the Condensed Consolidated Statements of Cash Flows offset by non-cash operating lease asset amortization and liability accretion.
13
4. Papa John’s Marketing Fund, Inc.
PJMF collects a percentage of revenues from Company-owned and franchised restaurants in the United States, for the purpose of designing and administering advertising and promotional programs for all participating domestic restaurants. Contributions and expenditures are reported on a gross basis in the Condensed Consolidated Statements of Operations within Other revenues and Other expenses.
Assets and liabilities of PJMF, which are restricted in their use, included in the Condensed Consolidated Balance Sheets were as follows (in thousands):
3,465
4,569
11,824
11,196
112
Prepaid expenses
434
1,316
15,835
17,184
Deferred income taxes, net
458
410
16,293
17,594
Liabilities
4,045
764
10,884
14,287
3,070
3,252
Debt
107
18,106
18,303
1,591
2,094
19,697
20,397
5. Revenue Recognition
Contract Balances
Our contract liabilities primarily relate to franchise fees and unredeemed gift card liabilities, which we classify as Deferred revenue, and customer loyalty program obligations which are classified as Accrued expenses and other current liabilities. During the three and six months ended June 28, 2020, the Company recognized $8.4 million and $16.3 million in revenue, respectively, related to deferred revenue and the customer loyalty program, compared to $8.4 million and $15.8 million for the three and six months ended June 30, 2019, respectively.
The contract liability balances are included in the following (in thousands):
Contract Liabilities
Change
18,925
20,346
(1,421)
Customer loyalty program
12,269
12,049
220
Total contract liabilities
31,194
32,395
(1,201)
Our contract assets consist primarily of equipment incentives provided to franchisees. Equipment incentives are related to the future value of commissary revenue the Company will receive over the term of the agreement. As of June 28, 2020, and December 29, 2019, the contract assets were approximately $4.9 million and $6.0 million, respectively. For the three and six months ended June 28, 2020, revenue was reduced approximately $0.7 million and $1.6 million, respectively, for
the amortization of contract assets over the applicable contract terms. Contract assets are included in Prepaid expenses and other current assets and Other assets on the Condensed Consolidated Balance Sheets.
Transaction Price Allocated to the Remaining Performance Obligations
The following table (in thousands) includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied at the end of the reporting period.
Performance Obligations by Period
Less than 1 Year
1-2 Years
2-3 Years
3-4 Years
4-5 Years
Thereafter
Franchise fees
2,312
2,110
1,883
1,612
1,382
3,153
12,452
Approximately $1.8 million of area development fees related to unopened stores and international unearned royalties are included in Deferred revenue. Timing of revenue recognition is dependent upon the timing of store openings and franchisees’ revenues. Gift card liabilities of approximately $4.7 million, included in Deferred revenue, will be recognized in Company-owned restaurant revenues when gift cards are redeemed. The Company will recognize redemption fee revenue in Other revenues when cards are redeemed at franchised restaurant locations.
The Company applies the practical expedient in ASC 606-10-50-14 and does not disclose information about remaining performance obligations that have original expected durations of one year or less.
6. Common Stock and Series B Convertible Preferred Stock
Shares Authorized and Outstanding
The Company has authorized 5.0 million shares of preferred stock, 100.0 million shares of common stock, and 260,000 shares of Series B Convertible Preferred Stock (the “Series B Preferred Stock”). The Company’s outstanding shares of common stock were 32.3 million shares at June 28, 2020 and 31.9 million shares at December 29, 2019.
There were 252,530 shares of Series B Preferred Stock outstanding at both June 28, 2020 and December 29, 2019. The Series B Preferred Stock is classified as temporary equity on the Condensed Consolidated Balance Sheets as of June 28, 2020 and December 29, 2019.
Dividends
The Company recorded dividends of approximately $21.3 million in the six months ended June 28, 2020 consisting of the following:
On July 31, 2020, our Board of Directors declared a third quarter dividend of $0.225 per common share (of which approximately $7.4 million will be paid to common stockholders and $1.1 million will be paid as “pass through” dividends to holders of Series B Preferred Stock on an “as converted basis”). The third quarter preferred dividend was also declared on July 31, 2020. The common share dividend will be paid on August 21, 2020 to stockholders of record as of the close of business on August 11, 2020. The third quarter preferred dividend of $2.3 million will be paid to holders of Series B Preferred Stock on October 1, 2020.
15
7. Earnings Per Share
We compute earnings per share using the two-class method. The two-class method requires an earnings allocation formula that determines earnings per share for common stockholders and participating security holders according to dividends declared and participating rights in undistributed earnings. The Series B Preferred Stock and time-based restricted stock awards are participating securities because holders of such shares have non-forfeitable dividend rights and participate in undistributed earnings with common stock. Under the two-class method, total dividends provided to the holders of Series B Preferred Stock, including common stock dividends and undistributed earnings allocated to participating securities, are subtracted from net income attributable to the Company in determining net income attributable to common stockholders. Additionally, any accretion to redemption value for the Series B Preferred Stock is treated as a deemed dividend in the two-class EPS calculation.
The calculations of basic and diluted earnings per common share are as follows (in thousands, except per-share data):
Weighted average common shares outstanding
Dilutive effect of outstanding equity awards (a)
284
186
230
176
Diluted weighted average common shares outstanding (b)
16
8.
Long-term debt, net, consists of the following (in thousands):
Outstanding debt
350,107
370,000
Unamortized debt issuance costs
(2,068)
(2,710)
(20,107)
(20,000)
Total long-term debt, net
The Company has a secured revolving credit facility with available borrowings of $400.0 million (the “Revolving Facility”), of which no balance was outstanding as of June 28, 2020, and a secured term loan facility with an outstanding balance of $350.0 million (the “Term Loan Facility”) and together with the Revolving Facility, the “PJI Facilities”. The PJI Facilities mature on August 30, 2022. The loans under the PJI Facilities accrue interest at a per annum rate equal to, at the Company’s election, either LIBOR plus a margin ranging from 125 to 250 basis points or a base rate (generally determined by a prime rate, federal funds rate or LIBOR plus 1.00%) plus a margin ranging from 25 to 150 basis points. In each case, the actual margin is determined according to a ratio of the Company’s total indebtedness to earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the then most recently ended four-quarter period (the “Leverage Ratio”). The Credit Agreement governing the PJI Facilities (the “PJI Credit Agreement”) places certain customary restrictions upon the Company based on its financial covenants. These include limiting the repurchase of common stock and not increasing the cash dividend above the lesser of $0.225 per share per quarter or $35 million per fiscal year if the Company’s leverage ratio is above 3.75 to 1.0. Quarterly amortization payments are required to be made on the Term Loan Facility in the amount of $5.0 million. Loans outstanding under the PJI Facilities may be prepaid at any time without premium or penalty, subject to customary breakage costs in the case of borrowings for which a LIBOR rate election is in effect. Up to $35.0 million of the Revolving Facility may be advanced in certain agreed foreign currencies, including Euros, Pounds Sterling, Canadian Dollars, Japanese Yen, and Mexican Pesos.
The PJI Credit Agreement contains customary affirmative and negative covenants, including financial covenants requiring the maintenance of the Leverage Ratio and a specified fixed charge coverage ratio. The PJI Credit Agreement allows for a permitted Leverage Ratio of 5.00 to 1.0, decreasing over time to 4.00 to 1.0 by 2022; and a fixed charge coverage ratio of 2.25 to 1.0, which increases over time to 2.50 to 1.0 in 2021 and thereafter. We were in compliance with these financial covenants at June 28, 2020.
Under the PJI Credit Agreement, we have the option to increase the Revolving Facility or the Term Loan Facility in an aggregate amount of up to $300.0 million, subject to the Leverage Ratio of the Company not exceeding 4.00 to 1.00. The Company and certain direct and indirect domestic subsidiaries are required to grant a security interest in substantially all of the capital stock and equity interests of their respective domestic and first tier material foreign subsidiaries to secure the obligations owed under the PJI Facilities.
Our outstanding debt of $350.0 million at June 28, 2020 under the PJI Facilities was composed of $350.0 million outstanding under the Term Loan Facility. Including outstanding letters of credit, the Company’s remaining availability under the PJI Facilities at June 28, 2020 was approximately $353.8 million.
As of June 28, 2020, the Company had approximately $2.1 million in unamortized debt issuance costs, which are being amortized into interest expense over the term of the PJI Facilities.
We attempt to minimize interest rate risk exposure by fixing our rate through the utilization of interest rate swaps, which are derivative financial instruments. Our swaps are entered into with financial institutions that participate in the PJI Credit Agreement. By using a derivative instrument to hedge exposures to changes in interest rates, we expose ourselves to credit risk due to the possible failure of the counterparty to perform under the terms of the derivative contract. We use interest rate swaps to hedge against the effects of potential interest rate increases on borrowings under our PJI Facilities.
As of June 28, 2020, we have the following interest rate swap agreements with a total notional value of $350 million:
Effective Dates
Floating Rate Debt
Fixed Rates
April 30, 2018 through April 30, 2023
55
million
2.33
%
35
2.36
2.34
January 30, 2018 through August 30, 2022
100
1.99
75
50
2.00
The gain or loss on the swaps is recognized in Accumulated other comprehensive loss (“AOCL”) and reclassified into earnings as adjustments to interest expense in the same period or periods during which the swaps affect earnings. Gains or losses on the swaps representing hedge components excluded from the assessment of effectiveness are recognized in current earnings.
The following table provides information on the location and amounts of our swaps in the accompanying condensed consolidated financial statements (in thousands):
Interest Rate Swap Derivatives
Fair Value
Balance Sheet Location
Other current and long-term liabilities
The effect of derivative instruments on the accompanying condensed consolidated financial statements is as follows (in thousands):
Location of Gain
Amount of Gain
Derivatives -
Amount of Gain or
or (Loss)
Total Net Interest Expense
Cash Flow
(Loss) Recognized
Reclassified from
on Condensed
Hedging
in AOCL
AOCL into
Consolidated Statements
Relationships
on Derivative
Income
of Operations
Interest rate swaps for the three months ended:
(79)
Interest expense
(1,372)
(5,167)
231
Interest rate swaps for the six months ended:
(8,487)
(1,702)
(8,204)
688
The weighted average interest rates on our PJI Facilities, including the impact of the interest rate swap agreements, were 3.8% for the three- and six-month periods ended June 28, 2020, compared to 4.3% and 4.4 % for the three- and six-month periods ended June 30, 2019, respectively. Interest paid, including payments made or received under the swaps, was $4.0 million and $4.4 million for the three months ended June 28, 2020 and June 30, 2019, respectively, and $8.1 million and $11.1 million for the six months ended June 28, 2020 and June 30, 2019, respectively. As of June 28, 2020, the portion of the aggregate $17.1 million interest rate swap liability that would be reclassified into net interest expense during the next twelve months approximates $7.2 million.
PJMF has a $20.0 million revolving line of credit (the “PJMF Revolving Facility”) pursuant to a Revolving Loan Agreement, dated September 30, 2015 (as amended, the “PJMF Loan Agreement”) with U.S. Bank National Association, as lender (“U.S. Bank”). The PJMF Revolving Facility is secured by substantially all assets of PJMF. The PJMF Revolving Facility matures on September 30, 2020. The borrowings under the PJMF Revolving Facility accrue interest at a variable rate of the one-month LIBOR plus 1.75%. The applicable interest rates on the PJMF Revolving Facility were 2.3% and 2.8% for the three and six months ended June 28, 2020, respectively, compared to 4.2% for both the three and
18
six months ended June 30, 2019. As of June 28, 2020, there was approximately $100,000 of debt outstanding under the PJMF Revolving Facility (none at December 29, 2019). The PJMF operating results and the related debt outstanding do not impact the financial covenants under the PJI Credit Agreement.
9.
Commitments and Contingencies
Litigation
The Company is involved in a number of lawsuits, claims, investigations and proceedings, including those specifically identified below, consisting of intellectual property, employment, consumer, commercial and other matters arising in the ordinary course of business. In accordance with ASC 450, “Contingencies” the Company has made accruals with respect to these matters where appropriate, which are reflected in the Company’s condensed consolidated financial statements. We review these provisions at least quarterly and adjust them to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case.
Durling et al v. Papa John’s International, Inc., is a conditionally certified collective action filed in May 2016 in the United States District Court for the Southern District of New York, alleging that corporate restaurant delivery drivers were not properly reimbursed for vehicle mileage and expenses in accordance with the Fair Labor Standards Act. In July 2018, the District Court granted a motion to certify a conditional corporate collective class and the opt-in notice process has been completed. As of the close of the opt-in period on October 29, 2018, 9,571 drivers opted into the collective class. The Company continues to deny any liability or wrongdoing in this matter and intends to vigorously defend this action. The Company has not recorded any liability related to this lawsuit as of June 28, 2020 as it does not believe a loss is probable or reasonably estimable.
Danker v. Papa John’s International, Inc. et al. On August 30, 2018, a class action lawsuit was filed in the United States District Court, Southern District of New York on behalf of a class of investors who purchased or acquired stock in Papa John's through a period up to and including July 19, 2018. The complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The District Court appointed the Oklahoma Law Enforcement Retirement System to lead the case. An amended complaint was filed on February 13, 2019, which the Company moved to dismiss. On March 16, 2020, the Court granted the Company’s motion to dismiss, on the ground that the complaint failed to state any viable cause of action. The Plaintiffs subsequently filed a second amended complaint on April 30, 2020, which the Company moved to dismiss. The Company believes that it has valid and meritorious defenses to the second amended complaint and intends to vigorously defend against the case. The Company has not recorded any liability related to this lawsuit as of June 28, 2020 as it does not believe a loss is probable or reasonably estimable.
10.
Segment Information
We have four reportable segments: domestic Company-owned restaurants, North America commissaries, North America franchising and international operations. The domestic Company-owned restaurant segment consists of the operations of all domestic (“domestic” is defined as contiguous United States) Company-owned restaurants and derives its revenues principally from retail sales of pizza and side items, including breadsticks, cheesesticks, chicken poppers and wings, dessert items and canned or bottled beverages. The North America commissary segment consists of the operations of our regional dough production and product distribution centers and derives its revenues principally from the sale and distribution of food and paper products to domestic Company-owned and franchised restaurants in the United States and Canada. The North America franchising segment consists of our franchise sales and support activities and derives its revenues from sales of franchise and development rights and collection of royalties from our franchisees located in the United States and Canada. The international segment principally consists of distribution sales to franchised Papa John’s restaurants located in the United Kingdom and our franchise sales and support activities, which derive revenues from sales of franchise and development rights and the collection of royalties from our international franchisees. International franchisees are defined as all franchise operations outside of the United States and Canada. All other business units that do not meet the quantitative thresholds for determining reportable segments, which are not operating segments, we refer to as “all other,” which consists of operations that derive revenues from the sale, principally to Company-owned and franchised restaurants, of printing and promotional items, franchise contributions to marketing funds and information systems and related services used in restaurant operations, including our point-of-sale system, online and other technology-based ordering platforms.
Generally, we evaluate performance and allocate resources based on income before income taxes and intercompany eliminations. Certain administrative and capital costs are allocated to segments based upon predetermined rates or actual estimated resource usage. We account for intercompany sales and transfers as if the sales or transfers were to third parties and eliminate the activity in consolidation.
Our reportable segments are business units that provide different products or services. Separate management of each segment is required because each business unit is subject to different operational issues and strategies. No single external customer accounted for 10% or more of our consolidated revenues.
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Our segment information is as follows:
Domestic Company-owned restaurants
North America commissaries
North America franchising
International
34,366
66,518
62,920
All others
47,958
37,658
89,363
76,326
Intersegment revenues:
47,357
46,962
91,863
92,517
793
787
1,467
1,460
94
191
18,386
17,985
39,341
33,396
Total intersegment revenues
66,536
65,828
132,671
127,564
16,746
7,712
25,413
12,309
8,567
7,792
16,076
15,304
22,176
17,910
39,502
33,601
4,589
5,403
9,088
10,720
1,983
(1,209)
1,724
(1,715)
Unallocated corporate expenses
(26,430)
(27,891)
(52,481)
(60,356)
Elimination of intersegment (profits) losses
(724)
242
(910)
(671)
Total income before income taxes
Property and equipment:
226,404
143,474
15,493
88,602
Unallocated corporate assets
213,517
Accumulated depreciation and amortization
(486,909)
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Disaggregation of Revenue
In the following tables, revenues are disaggregated by major product/service line. The tables also include a reconciliation of the disaggregated revenues by the reportable segment (in thousands):
Reportable Segments
Three Months Ended June 28, 2020
Major Products/Services Lines
Company-owned restaurant sales
Commissary sales
214,976
20,350
235,326
Franchise royalties and fees
24,967
7,743
32,710
6,273
66,344
72,617
Eliminations
(47,357)
(793)
(18,386)
(66,536)
Total segment revenues
International other revenues (1)
(6,273)
Three Months Ended June 30, 2019
194,090
15,948
210,038
20,548
9,549
30,097
6,017
55,643
61,660
(46,962)
(787)
(94)
(17,985)
(65,828)
(6,017)
International eliminations (1)
Six Months Ended June 28, 2020
414,904
36,893
451,797
45,081
17,259
62,340
12,366
128,704
141,070
(91,863)
(1,467)
(39,341)
(132,671)
(12,366)
Six Months Ended June 30, 2019
388,549
31,814
420,363
38,751
19,350
58,101
11,947
109,722
121,669
(92,517)
(1,460)
(191)
(33,396)
(127,564)
(11,947)
22
23
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Papa John’s International, Inc. (referred to as the “Company,” “Papa John’s” or in the first-person notations of “we,” “us” and “our”) began operations in 1984. As of June 28, 2020, there were 5,347 Papa John’s restaurants (598 Company-owned and 4,749 franchised) operating in 48 countries and territories. 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, contributions received from franchisees for domestic and international marketing funds we control, revenues for printing and promotional items, and information systems and related services used in their operations.
Recent Developments and Trends
Coronavirus (“COVID-19”). The COVID-19 outbreak has presented evolving risks and developments domestically and internationally, as well as new opportunities for our business. In response to the outbreak, governments and other authorities around the world have imposed measures to attempt to control the spread of COVID-19, including restrictions on freedom of movement and business operations such as travel bans, social distancing requirements, including limitations on gatherings, shelter-in-place orders and quarantines, and mandated business closures, which have resulted in significant changes in commercial activity and consumer behavior. Our delivery and carryout model has positioned us to continue to experience strong demand for our products. To ensure we can continue to meet the demand of our customers, we continue to monitor our supply chain and have not experienced material disruptions.
Our primary focus continues to be the safety of our team members, franchisees, and customers. The Company has taken steps to mitigate the impact of the COVID-19 pandemic by implementing extra health and safety measures across our business, including No Contact Delivery and enhanced cleaning and sanitization measures, for the protection of both our customers and team members. We have expanded our employee benefits to include free virtual doctor visits. This is in addition to existing employee benefits of no-cost mental health support, affordable health plan options and access to the Papa John’s Team Member Emergency Relief Fund, if and when needed. In addition, the Company has hired thousands of new restaurant team members to help serve our customers.
Of the Company’s 2,063 international franchised stores, 225 stores were temporarily closed as of June 28, 2020, principally in Latin America and Europe, in accordance with government policies. In North America, almost all traditional restaurants remain open and fully operational. A number of non-traditional restaurants located in universities and stadiums are temporarily closed; these non-traditional locations are not significant to our revenues and operating results.
The demand for carry-out and delivery across our markets has increased over the past several months. Our second quarter comparable sales information and our preliminary, estimated Period 7 comparable sales are as follows:
Quarter 2
Period 7
March 30, 2020, to
June 29, 2020, to
July 26, 2020
Comparable sales growth (a):
22.6%
23.6%
North America franchised restaurants
29.7%
32.4%
System-wide North America restaurants
28.0%
30.3%
System-wide international restaurants (b)
5.3%
13.9%
Although our sales have improved during the pandemic, due to the substantial uncertainty related to and the rapidly changing nature of the pandemic, we are unable to predict the specific impacts of the outbreak on our results of operations, liquidity or long-term financial condition. For a discussion of the risks to our business presented by the COVID-19 pandemic, please see the risk factors disclosed in the Company’s Annual Report on Form-10-K for the fiscal year ended December 29, 2019 and Quarterly Report on Form 10-Q for the quarterly period ended March 29, 2020.
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Restaurant Progression
North America Company-owned:
Beginning of period
599
645
598
Opened
Closed
(1)
(2)
Sold to franchisees
End of period
643
North America franchised:
2,686
2,691
2,690
2,692
(9)
(33)
(28)
(61)
Acquired from Company
2,676
International franchised:
2,093
2,000
2,107
1,966
34
83
(55)
(8)
(87)
(23)
2,063
2,026
Total restaurants – end of period
5,347
5,345
Note: Temporary closures as a result of the COVID-19 outbreak are not reflected as “closed” in the restaurant progression above.
26
Items Impacting Comparability; Non-GAAP Measures
Effective as of the first quarter of 2020, the Company modified its presentation of adjusted (non-GAAP) financial results to no longer present certain financial assistance provided to the North America system in the form of royalty relief and discretionary marketing fund investments as Special charges. This financial assistance, which began in the third quarter of 2018 in response to declining sales in North America, will continue through the third quarter of 2020, as announced in a formal plan in July 2019. The adjusted financial results for the three and six months ended June 30, 2019 have been revised to remove these items. See “Temporary Franchise Support” for additional information regarding this change in presentation.
The table below reconciles our GAAP financial results to our adjusted financial results, which are non-GAAP measures (collectively defined as “Special items”). We present these non-GAAP measures because we believe the Special items in 2019 impact the comparability of our results of operations.
GAAP income before income taxes
Special charges:
Legal and advisory fees (1)
396
5,463
Mark-to-market adjustment on option valuation (2)
Adjusted income before income taxes
10,192
20,406
GAAP net income attributable to common shareholders
Tax effect of Non-GAAP items (3)
(22)
(1,197)
Adjusted net income attributable to common shareholders
5,079
11,084
GAAP diluted earnings per share
0.01
0.17
0.19
(0.04)
Adjusted diluted earnings per share
0.16
0.35
The 2019 non-GAAP adjusted results shown above and within this document, which exclude the Special items, should not be construed as a substitute for or a better indicator of the Company’s performance than the Company’s GAAP results. Management believes presenting certain financial information excluding the Special items is important for purposes of comparison to prior year results. In addition, management uses these metrics to evaluate the Company’s underlying operating performance and to analyze trends.
27
Temporary Franchise Support. As previously mentioned, effective as of the first quarter of 2020, the Company no longer presents certain royalty relief and discretionary marketing fund investments, included herein as “Temporary Franchise Support,” as Special charges within its adjusted financial results. The prior period adjusted financial measures presented above in “Items Impacting Comparability; Non-GAAP Measures” have also been revised to remove the impact of these items.
Temporary Franchise Support investments were $5.1 million (or approximately $0.12 per diluted share) and $15.8 million (or approximately $0.38 per diluted share) for the three and six months ended June 28, 2020, respectively, compared to $5.0 million (or approximately $0.12 per diluted share) and $9.8 million (or approximately $0.24 per diluted share) for the three and six months ended June 30, 2019, as follows (in thousands):
Royalty relief (a)
5,145
2,466
10,801
7,339
Marketing fund investments (b)
2,500
5,000
Total Temporary Franchise Support (c)
4,966
15,801
9,839
Results of Operations
Discussion of Revenues. Consolidated revenues increased $61.0 million, or 15.3%, and $72.5 million, or 9.1%, for the three and six months ended June 28, 2020, respectively. Revenues are summarized in the following table (dollars in thousands).
Jun. 28,
Jun. 30,
Percent
Increase
22,850
14.0
4,413
22.3
North America commissary
20,491
13.9
2,596
10.2
10,650
24.4
Total Revenues
61,000
15.3
22,487
6.9
6,323
17.0
27,009
9.1
2,988
5.8
13,647
15.5
72,454
Domestic Company-owned restaurant sales increased $22.9 million, or 14.0%, and $22.5 million, or 6.9%, for the three and six months ended June 28, 2020, respectively, compared to the prior year comparable period. Excluding the impact of refranchising 46 restaurants in 2019 primarily located in South Florida and Georgia, domestic Company-owned restaurant sales increased $33.7 million, or 22.0%, and $44.3 million, or 14.6% for the three and six months ended June 28, 2020, respectively. The increases were primarily due to positive comparable sales increases of 22.6% and 14.4% for the three and six months ended June 28, 2020, respectively. “Comparable sales” represents the change in year-over-year sales for the same base of restaurants for the same fiscal periods.
North America franchise royalties and fees increased $4.4 million, or 22.3%, and $6.3 million, or 17.0%, for the three and six months ended June 28, 2020, respectively, compared to the prior year comparable periods. Excluding the impact of refranchising, North America franchise royalties and fees increased $3.7 million and $5.0 million for the three and six months ended June 28, 2020, respectively. The increases were primarily due to positive comparable sales increases of 29.7% and 17.2% for the three and six months ended June 28, 2020, respectively.
North America franchise restaurant sales increased 29.4% to $662.7 million and 17.5% to $1.2 billion for the three and six months ended June 28, 2020, respectively, compared to the prior year comparable periods. North America franchise restaurant sales are not included in Company revenues; however, our North America franchise royalties are derived from these sales.
North America commissary sales increased $20.5 million, or 13.9%, and $27.0 million, or 9.1%, for the three and six months ended June 28, 2020, respectively, primarily due to higher volumes. The six-month period also increased due to pricing associated with higher commodities costs.
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International revenues increased $2.6 million, or 10.2%, and $3.0 million, or 5.8%, for the three and six months ended June 28, 2020, respectively, compared to the prior year comparable period. Excluding the impact of refranchising our Quality Control Center in Mexico in the first quarter of 2019, International revenues increased $4.0 million, or 7.9%, for the six months ended June 28, 2020. The increases of $2.6 million and $4.0 million were primarily due to higher United Kingdom commissary revenues and higher royalties from increased equivalent units and higher comparable sales of 5.3% and 3.8% for the three and six months ended June 28, 2020, respectively. The higher revenues were partially offset by royalty support provided to certain franchisees and unfavorable foreign exchange rates. “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.
International franchise restaurant sales increased 5.5% to $232.0 million and 6.8% to $467.5 million for the three and six months ended June 28, 2020, respectively, excluding the impact of foreign currency, primarily due to increases in equivalent units and positive comparable sales. International franchise restaurant sales are not included in Company revenues; however, our international royalty revenue is derived from these sales.
Other revenues increased $10.7 million, or 24.4%, and $13.6 million, or 15.5%, for the three and six months ended June 28, 2020, respectively, compared to the prior year comparable period. The increases were primarily due to higher marketing fund revenue primarily due to an increase in franchise sales and an increase in the national marketing fund contribution rate in 2020 and higher online revenues.
Discussion of Operating Results
Income before income taxes is summarized in the following table on a reporting segment basis. Income before income taxes increased approximately $16.9 million and $29.2 million for the three and six months ended June 28, 2020, respectively, compared to the prior year comparable periods. Alongside the GAAP income before income taxes data, we have included “adjusted” income before income taxes for the three and six months ended June 30, 2019 to exclude Special items. We believe this non-GAAP measure is important for purposes of comparing to 2020 results.
Reported
Special
Adjusted
items
in 2019
(Decrease)
7,549
9,197
775
4,266
(814)
3,192
(27,495)
1,065
(966)
233
16,715
12,146
13,267
772
5,901
(1,632)
3,439
11,377
(48,979)
(3,502)
Elimination of intersegment profits
(239)
11,214
18,006
The increases in adjusted income before income taxes of $16.7 million, or 164.0%, and $18.0 million, or 88.2%, for the three- and six-month periods in 2020, respectively, excluding Special items in 2019, were primarily due to the following:
31
32
Review of Consolidated Results
Revenues. For the reasons discussed above, consolidated revenues increased $61.0 million, or 15.3%, to $460.6 million and $72.5 million, or 9.1%, to $870.5 million for the three and six months ended June 28, 2020, respectively.
% of Related
($ in thousands)
Revenues
77.8%
80.6%
(2.8%)
92.2%
92.9%
(0.7%)
65.2%
57.5%
7.7%
94.7%
96.3%
(1.6%)
10.5%
12.2%
(1.7%)
2.7%
2.9%
(0.2%)
93.4%
96.5%
(3.1%)
0.0%
6.6%
3.6%
3.0%
(0.8%)
(1.1%)
0.3%
5.8%
2.5%
3.3%
78.8%
81.4%
(2.6%)
92.5%
93.0%
(0.5%)
61.7%
56.6%
5.1%
95.6%
97.7%
(2.1%)
11.0%
12.5%
(1.5%)
2.8%
(0.1%)
97.5%
(0.9%)
(1.3%)
0.4%
4.4%
1.2%
3.2%
33
Costs and expenses. Total costs and expenses were approximately $430.1 million, or 93.4% of total revenues, for the three months ended June 28, 2020 as compared to $385.6 million, or 96.5% of total revenues, for the prior year comparable period. For the six months ended June 28, 2020, total costs and expenses were approximately $824.5 million, or 94.7% of total revenues, as compared to $778.5 million, or 97.5% of total revenues for the prior year comparable period. The increases in total costs and expenses, as a percentage of revenues, were primarily due to the following:
Domestic Company-owned restaurant expenses were $145.2 million, or 77.8% of related revenues, for the three months ended June 28, 2020, as compared to expenses of $132.0 million, or 80.6% of related revenues, for the prior year comparable period, primarily due to lower operating expenses on higher sales and lower food costs including the favorable impact of current year promotions, partially offset by higher labor and bonus expense. For the six months ended June 28, 2020, Domestic Company-owned restaurant expenses were $274.3 million, or 78.8% of related revenues, compared to expenses of $265.0 million, or 81.4% or related revenues, for the prior year comparable period. The 2.6% decrease was primarily due to the lower operating expenses on higher sales and lower food costs including the favorable impact of current year promotions, which more than offset higher commodities costs. These increases were partially offset by previously mentioned higher labor and bonus expense.
North America commissary expenses were $154.5 million, or 92.2% of related revenues, for the three months ended June 28, 2020, compared to $136.7 million, or 92.9% of related revenues for the comparable period in 2019. North America commissary expenses were $298.7 million, or 92.5% of related revenues, for the six months ended June 28, 2020, compared to $275.3 million, or 93.0% of related revenues, for the prior year comparable period. The 0.7% and 0.5% decreases in expenses, as a percentage of related revenues, for the three- and six-month periods, respectively, were primarily due to lower operating costs on higher volumes and lower delivery costs.
International expenses were $18.3 million, or 65.2% of related revenues, for the three months ended June 28, 2020 compared to expenses of $14.7 million, or 57.5% of related revenues, for the prior year comparable period. International expenses were $33.4 million, or 61.7% of related revenues, for the six months ended June 28, 2020, compared to $29.0 million, or 56.6% of related revenues for the prior year comparable period. The 7.7% and 5.1% increases in expenses as a percentage of revenues were primarily due to lower margins at our United Kingdom commissary and lower revenues from royalty support provided to certain franchisees.
Other expenses were $51.3 million, or 94.7% of related revenues, for the three months ended June 28, 2020 compared to expenses of $42.0 million, or 96.3% of related revenues for the prior year comparable period. For the six months ended June 28, 2020, Other expenses were $97.3 million, or 95.6% of related revenues, as compared to $86.1 million, or 97.7% of related revenues, for the prior year comparable period. The 1.6% and 2.1% decreases for the three- and six- month periods, respectively, were primarily due to higher margins from our online and mobile ordering business, partially offset by lower revenues at our printing subsidiary.
General and administrative expenses (“G&A”) were $48.4 million, or 10.5%, and $96.1 million, or 11.0% of revenues, for the three and six months ended June 28, 2020, respectively, compared to $48.7 million, or 12.2%, and $99.9 million, or 12.5%, for the corresponding 2019 periods, respectively. G&A consisted of the following (in thousands):
Other general expenses (a)
553
3,713
5,227
3,613
Special charges (b)
11,015
Administrative expenses (c)
47,875
44,609
90,852
85,225
Depreciation and Amortization. Depreciation and amortization expense was $12.4 million, or 2.7% of revenues, and $24.7 million, or 2.8% of revenues, for the three and six months ended June 28, 2020, respectively, compared to $11.5 million, or 2.9%, and $23.3 million, or 2.9% of revenues, for the corresponding periods in 2019, respectively.
Net interest expense. Net interest expense decreased approximately $645,000 and $3.0 million for the three and six months ended June 28, 2020, respectively, due to lower interest rates and a decrease in the average debt balance. Total debt outstanding was $350.0 million as of June 28, 2020 and there was no significant outstanding debt balance associated with Papa John’s Marketing Fund, Inc. (“PJMF”).
Income before income taxes. For the reasons discussed above, income before income taxes increased approximately $17.0 million, or 170.2%, and $29.2 million, or 317.9%, for the three and six months ended June 28, 2020, respectively, over the prior year comparable periods.
Income tax expense. The effective income tax rates were 18.4% and 19.4% for the three and six months ended June 28, 2020, representing an increase of 5.5% and a decrease of 3.6%, respectively, from the prior year comparable periods. The six months ended June 30, 2019 included a non-deductible $5.9 million expense associated with the one-time mark-to-market increase in the fair value of the Starboard Value LP (“Starboard”) option to purchase Series B convertible preferred stock in the first quarter of 2019, as previously mentioned. Excluding the $5.9 million expense for the six months ended June 30, 2019, the effective rates were higher for the three and six months ended June 28, 2020 due to the impact of similar tax credits on higher income before income taxes in the current periods.
Diluted earnings per common share. Diluted earnings per common share was $0.48 for the second quarter of 2020, compared to diluted earnings per common share of $0.15 for the second quarter of 2019, an increase of 220%. For the six months ended June 28, 2020, diluted earnings per share was $0.65, compared to diluted earnings per share of $0.03 ($0.35 excluding Special items mentioned above) for the prior year period, an increase of 85.7% excluding special items in 2019. Diluted earnings per common share was reduced by approximately $0.05 and $0.04 for the three and six months ended June 28, 2020, respectively, due to additional income attributable to participating securities, including Series B Preferred Stockholders, based on the amount of undistributed earnings for the periods.
Liquidity and Capital Resources
As previously mentioned, the coronavirus (COVID-19) outbreak has presented evolving developments domestically and internationally, including an overall contraction in global economic activity and volatility in the financial markets. Despite these recent developments, our liquidity position remains strong. Our cash flow has increased, and we have no borrowings on our secured revolving credit facility. As of June 28, 2020, we had approximately $353.8 million available for borrowing under our secured revolving credit facility, as described below. We plan to closely monitor our liquidity needs in response to the evolving situation.
The Company has a secured revolving credit facility with available borrowings of $400.0 million (the “Revolving Facility”), of which no balance was outstanding as of June 28, 2020 and a secured term loan facility with an outstanding balance of $350.0 million (the “Term Loan Facility”) and together with the Revolving Facility, the “PJI Facilities”. The PJI Facilities mature on August 30, 2022. The loans under the PJI Facilities accrue interest at a per annum rate equal to, at the Company’s election, either LIBOR plus a margin ranging from 125 to 250 basis points or a base rate (generally determined by a prime rate, federal funds rate or LIBOR plus 1.00%) plus a margin ranging from 25 to 150 basis points. In each case, the actual margin is determined according to a ratio of the Company’s total indebtedness to earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the then most recently ended four-quarter period (the “Leverage Ratio”). The Credit Agreement governing the PJI Facilities (the “PJI Credit Agreement”) places certain customary restrictions upon the Company based on its financial covenants. These include limiting the repurchase of common stock and not increasing the cash dividend above the lesser of $0.225 per share per quarter or $35 million per fiscal year if the Company’s leverage ratio is above 3.75 to 1.0. Quarterly amortization payments are required to be made on the Term Loan Facility in the amount of $5.0 million. Loans outstanding under the PJI Facilities may be prepaid at any time without premium or penalty, subject to customary breakage costs in the case of borrowings for which a LIBOR rate election is in effect. Up to $35.0 million of the Revolving Facility may be advanced in certain agreed foreign currencies, including Euros, Pounds Sterling, Canadian Dollars, Japanese Yen, and Mexican Pesos.
We attempt to minimize interest rate risk exposure by fixing our rate through the utilization of interest rate swaps, which are derivative financial instruments. Our swaps are entered into with financial institutions that participate in the PJI Credit Agreement. By using a derivative instrument to hedge exposures to changes in interest rates, we expose ourselves to credit risk due to the possible failure of the counterparty to perform under the terms of the derivative contract.
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We use interest rate swaps to hedge against the effects of potential interest rate increases on borrowings under our PJI Facilities.
55 million
35 million
100 million
75 million
50 million
The gain or loss on the swaps is recognized in Accumulated other comprehensive loss and reclassified into earnings as adjustments to interest expense in the same period or periods during which the swaps affect earnings. Gains or losses on the swaps representing hedge components excluded from the assessment of effectiveness are recognized in current earnings.
The weighted average interest rates on our PJI Facilities, including the impact of the interest rate swap agreements, were 3.8% for the three- and six-month periods ended June 28, 2020, compared to 4.3% and 4.4% for the three- and six-month periods ending June 30, 2019, respectively.
Our PJI Credit Agreement contains affirmative and negative covenants, including the following financial covenants, as defined by the Amended Credit Agreement:
Actual Ratio as of
Permitted Ratio
Leverage ratio
Not to exceed 5.00 to 1.0
2.9 to 1.0
Interest coverage ratio
Not less than 2.25 to 1.0
3.3 to 1.0
As stated above, our leverage ratio is defined as outstanding debt divided by consolidated EBITDA, as defined, 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 financial covenants as of June 28, 2020.
PJMF has a $20.0 million revolving line of credit (the “PJMF Revolving Facility”) pursuant to a Revolving Loan Agreement, dated September 30, 2015 (as amended, the “PJMF Loan Agreement”) with U.S. Bank National Association, as lender (“U.S. Bank”). The PJMF Revolving Facility is secured by substantially all assets of PJMF. The PJMF Revolving Facility matures on September 30, 2020. The borrowings under the PJMF Revolving Facility accrue interest at a variable rate of the one-month LIBOR plus 1.75%. The applicable interest rates on the PJMF Revolving Facility were 2.3% and 2.8% for the three and six months ended June 28, 2020, respectively, compared to 4.2% for both the three and six months ended June 30, 2019. As of June 28, 2020, there was approximately $100,000 of debt outstanding under the PJMF Revolving Facility (none at December 29, 2019). The PJMF operating results and the related debt outstanding do not impact the financial covenants under the PJI Credit Agreement.
37
Cash Flows
Cash flow provided by operating activities was $87.7 million for the six months ended June 28, 2020 compared to $32.2 million in the corresponding period in 2019. The increase of $55.5 million was primarily due to higher net income and favorable working capital changes including timing of payments.
The Company’s free cash flow, a non-GAAP financial measure, was as follows for the six-month periods of 2020 and 2019 (in thousands):
Dividends paid to preferred shareholders
Free cash flow (a)
67,038
8,869
Cash flow used in investing activities was $16.9 million for the six months ended June 28, 2020 compared to $19.6 million for the same period in 2019, or a decrease of $2.7 million. The decrease in cash flow used in investing activities was primarily due to lower purchases of property and equipment.
Cash flow used in financing activities was $22.8 million for the six months ended June 28, 2020 compared to $15.2 million for the same period in 2019. We require capital for the payment of cash dividends, which are funded by cash flow from operations, borrowings from our Credit Agreement and, in 2019, proceeds from the issuance of preferred stock. In the first quarter of 2019, we received gross proceeds of $252.5 million from the issuance of Series B Preferred Stock and incurred $7.2 million of direct costs associated with the issuance. The net proceeds of the Series B Preferred Stock were primarily used for debt repayments of $240.8 million, resulting in a net cash inflow of $4.5 million. In the first six months ended June 28, 2020, net debt repayments were $19.9 million. Additionally, we received $21.7 million of proceeds from the exercise of stock options in the first six months of 2020.
The additional borrowing availability under the Revolving Facility as a result of the debt repayment provides financial flexibility that enables the Company to make investments in the business and to use for general corporate purposes.
The Company recorded dividends of approximately $21.3 million for the six months ended June 28, 2020 consisting of the following:
On July 31, 2020, our Board of Directors declared a third quarter dividend of $0.225 per common share (of which approximately $7.4 million will be paid to common stockholders and $1.1 million will be paid as “pass through” dividends to holders of Series B Preferred Stock on an “as converted basis”). The third quarter preferred dividend was also declared
38
on July 31, 2020. The common share dividend will be paid on August 21, 2020 to stockholders of record as of the close of business on August 11, 2020. The third quarter preferred dividend of $2.3 million will be paid to holders of Series B Preferred Stock on October 1, 2020.
Forward-Looking Statements
Certain matters discussed in this report, including information within Management’s Discussion and Analysis of Financial Condition and Results of Operations constitute forward-looking statements within the meaning of the federal securities laws. Generally, the use of words such as “expect,” “intend,” “estimate,” “believe,” “anticipate,” “will,” “forecast,” “plan,” “project,” or similar words identify forward-looking statements that we intend to be included within the safe harbor protections provided by the federal securities laws. Such forward-looking statements include or may relate to the preliminary estimated same store sales growth and related trends, projections or guidance concerning business performance, revenue, earnings, cash flow, earnings per share, the financial impact of the temporary business opportunities, disruptions and temporary changes in demand we are experiencing related to the current outbreak of the novel coronavirus disease (COVID-19), including the projections for sales trends and comparable sales, our cash on hand and access to our credit facilities, commodity costs, currency fluctuations, profit margins, unit growth, unit level performance, capital expenditures, restaurant and franchise development, the duration of changes in consumer behavior caused by the pandemic, the duration and number of temporary store closures, royalty relief, the effectiveness of our strategic turnaround efforts and other business initiatives, marketing efforts, liquidity, compliance with debt covenants, stockholder and other stakeholder engagement, strategic decisions and actions, dividends, effective tax rates, regulatory changes and impacts, adoption of new accounting standards, and other financial and operational measures. Such statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict and many of which are beyond our control. Therefore, actual outcomes and results may differ materially from those matters expressed or implied in such forward-looking statements. The risks, uncertainties and assumptions that are involved in our forward-looking statements include, but are not limited to:
39
For a discussion of these and other risks that may cause actual results to differ from expectations, refer to “Part I. Item 1A. – Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 29, 2019, as updated by “Part II. Item 1A – Risk Factors” of our Quarterly Report on Form 10-Q for the quarter ended March 29, 2020, as well as subsequent filings. We undertake no obligation to update publicly any forward-looking statements, whether as a result of future events, new information or otherwise, except as required by law.
40
Item 3.Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We are exposed to the impact of interest rate changes on our secured revolving credit facility and our secured term loan facility, which comprise the PJI Credit Facilities. We attempt to minimize interest rate risk exposure by fixing our rate through the utilization of interest rate swaps, which are derivative financial instruments. Our swaps are entered into with financial institutions that participate in the PJI Facilities. By using a derivative instrument to hedge exposures to changes in interest rates, we expose ourselves to credit risk due to the possible failure of the counterparty to perform under the terms of the derivative contract. We do not enter into contracts for trading purposes and do not use leveraged instruments. The market risks associated with our debt obligations as of June 28, 2020 have not changed from those reported in “Part II. Item 7A. Quantitative and Qualitative Disclosure About Market Risk” in our Annual Report on Form 10-K for the fiscal year ended December 29, 2019. See Note 8 of “Notes to Condensed Consolidated Financial Statements” for additional information on our debt obligations and derivative instruments.
Foreign Currency Exchange Rate Risk
We are exposed to foreign currency exchange rate fluctuations from our operations outside of the United States, which can adversely impact our revenues, net income and cash flows. Our international operations principally consist of distribution sales to franchised Papa John’s restaurants located in the United Kingdom and our franchise sales and support activities, which derive revenues from sales of franchise and development rights and the collection of royalties from our international franchisees. For each of the periods presented, approximately 6% of our revenues were derived from these operations.
We have not historically hedged our exposure to foreign currency fluctuations. Foreign currency exchange rate fluctuations had an unfavorable impact of approximately $1.7 million and $2.3 million on International revenues for the three and six months ended June 28, 2020, respectively, and a $1.3 million and $3.0 million unfavorable impact for the three and six months ended June 30, 2019, respectively. Foreign currency exchange rate fluctuations had no significant impact on income before income taxes for the three and six months ended June 28, 2020 and June 30, 2019.
Commodity Price Risk
In the ordinary course of business, the food and paper products we purchase, including cheese (our largest individual food cost item), are subject to seasonal fluctuations, weather, availability, demand and other factors that are beyond our control. We have pricing agreements with some of our vendors, including forward pricing agreements for a portion of our cheese purchases for our domestic Company-owned restaurants, which are accounted for as normal purchases; however, we remain exposed to on-going commodity volatility.
The following table presents the actual average block price for cheese by quarter through the second quarter of 2020 and the projected average block price for cheese by quarter through 2020 (based on the July 30, 2020 Chicago Mercantile Exchange cheese futures market prices):
Projected
Actual
Block Price
Quarter 1
1.857
1.490
1.679
1.696
Quarter 3
2.202
1.853
Quarter 4
1.803
1.840
Full Year
1.885
*
1.720
*The full year estimate is based on futures prices and does not include the impact of forward pricing agreements we have for a portion of our cheese purchases for our domestic Company-owned restaurants. Additionally, the price charged to restaurants can vary somewhat by quarter from the actual block price based upon our monthly pricing mechanism.
Item 4. Controls and Procedures.
Under the supervision and with the participation of the Company’s management, including its chief executive officer and interim principal financial and accounting officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based upon this evaluation, the chief executive officer and interim principal financial and accounting officer have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective.
Changes in Internal Control Over Financial Reporting
During the most recently completed fiscal quarter, there was no change made in the Company’s internal control over financial reporting (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved in a number of lawsuits, claims, investigations and proceedings consisting of intellectual property, employment, consumer, commercial and other matters arising in the ordinary course of business. In accordance with Financial Accounting Standards Board Accounting Standards Codification 450, “Contingencies”, the Company has made accruals with respect to these matters, where appropriate, which are reflected in the Company’s Condensed Consolidated Financial Statements. We review these provisions at least quarterly and adjust these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. The legal proceedings described in Note 9 of “Notes to the Condensed Consolidated Financial Statements” are incorporated herein by reference.
Item 1A. Risk Factors
There have been no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 29, 2019, as supplemented by the risk factors disclosed in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 29, 2020.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
During the fiscal quarter ended June 28, 2020, the Company acquired 2,779 shares of its common stock 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.
Item 6. Exhibits
Exhibit
Number
Description
31.1
Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a-15(e), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Interim Principal Financial and Accounting Officer Pursuant to Exchange Act Rule 13a-15(e), As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Interim Principal Financial and Accounting Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Financial statements from the quarterly report on Form 10-Q of Papa John’s International, Inc. for the quarter ended June 28, 2020, filed on August 6, 2020, formatted in iXBRL: (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Comprehensive Income (Loss), (iv) the Condensed Consolidated Statements of Stockholders’ Deficit, (v) the Condensed Consolidated Statements of Cash Flows and (vi) the Notes to Condensed Consolidated Financial Statements.
104
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
Date: August 6, 2020
/s/ Steven R. Coke
Steven R. Coke
Interim Principal Financial and Accounting Officer