Papa Murphys Holdings, Inc.
Papa Murphy's Holdings, Inc. (Form: 10-Q, Received: 08/09/2017 17:06:53)
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
–––––––––––––––––––––––––––––––––––––
FORM 10-Q
–––––––––––––––––––––––––––––––––––––
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended July 3, 2017
OR
[ ] 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 001-36432
–––––––––––––––––––––––––––––––––––––
LOGO.JPG
Papa Murphy’s Holdings, Inc.
(Exact name of registrant as specified in its charter)
–––––––––––––––––––––––––––––––––––––
Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
 
27-2349094
(IRS Employer
Identification No.)
8000 NE Parkway Drive, Suite 350
Vancouver, WA
(Address of principal executive offices)
 
98662
(Zip Code)
(360) 260-7272
(Registrant’s telephone number, including area code)
–––––––––––––––––––––––––––––––––––––
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X]. No [ ].
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X]. 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 “accelerated filer,” “large accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ]
 
Accelerated filer [X]
Non-accelerated filer [ ]
 
Smaller reporting company [ ]
 
 
Emerging growth company [X]
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. [X]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ]. No [X].
At August 4, 2017 , there were 16,948,969 shares of the Registrant’s common stock, $0.01 par value, outstanding.



Table of Contents

TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2

Table of Contents

PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Papa Murphy’s Holdings, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Operations
 
Three Months Ended
 
Six Months Ended
(In thousands, except share and per share data)
July 3, 2017
 
June 27, 2016
 
July 3, 2017
 
June 27, 2016
Revenues
 
 
 
 
 
 
 
Franchise royalties
$
9,101

 
$
9,538

 
$
19,135

 
$
20,034

Franchise and development fees
837

 
574

 
1,438

 
1,528

Company-owned store sales
18,715

 
19,470

 
39,490

 
40,144

Other
449

 
312

 
1,033

 
1,173

Total revenues
29,102

 
29,894

 
61,096

 
62,879

 
 
 
 
 
 
 
 
Costs and Expenses
 
 
 
 
 
 
 
Store operating costs:
 
 
 
 
 
 
 
Cost of food and packaging
6,303

 
6,781

 
13,518

 
14,053

Compensation and benefits
5,923

 
5,577

 
12,257

 
11,311

Advertising
2,113

 
1,897

 
4,241

 
4,063

Occupancy
2,314

 
1,503

 
4,015

 
2,878

Other store operating costs
1,955

 
2,555

 
4,177

 
4,846

Selling, general, and administrative
3,408

 
5,912

 
20,621

 
14,967

Depreciation and amortization
2,906

 
2,915

 
6,023

 
5,630

Loss (gain) on disposal or impairment of property and equipment
11,041

 
(59
)
 
11,050

 
(5
)
Total costs and expenses
35,963

 
27,081

 
75,902

 
57,743

Operating (Loss) Income
(6,861
)
 
2,813

 
(14,806
)
 
5,136

 
 
 
 
 
 
 
 
Interest expense, net
1,286

 
1,208

 
2,513

 
2,387

Other expense, net
48

 
43

 
92

 
85

(Loss) Income Before Income Taxes
(8,195
)
 
1,562

 
(17,411
)
 
2,664

 
 
 
 
 
 
 
 
(Benefit from) provision for income taxes
(2,008
)
 
610

 
(5,810
)
 
1,070

Net (Loss) Income
$
(6,187
)
 
$
952

 
$
(11,601
)
 
$
1,594

 
 
 
 
 
 
 
 
(Loss) earnings per share of common stock
 
 
 
 
 
 
 
Basic
$
(0.37
)
 
$
0.06

 
$
(0.69
)
 
$
0.10

Diluted
$
(0.37
)
 
$
0.06

 
$
(0.69
)
 
$
0.10

Weighted average common stock outstanding
 
 
 
 
 
 
 
Basic
16,867,929

 
16,744,553

 
16,853,587

 
16,730,581

Diluted
16,867,929

 
16,766,587

 
16,853,587

 
16,760,578

See accompanying notes.

3

Table of Contents

Papa Murphy’s Holdings, Inc. and Subsidiaries
Unaudited Condensed Consolidated Balance Sheets
(In thousands, except par value and share data)
July 3, 2017
 
January 2, 2017
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
1,539

 
$
2,069

Accounts receivable, net
2,957

 
5,330

Current portion of notes receivable
73

 
92

Inventories
809

 
917

Prepaid expenses and other current assets
2,402

 
4,708

Total current assets
7,780

 
13,116

Property and equipment, net
15,677

 
28,516

Notes receivable, net of current portion
34

 
57

Goodwill
107,751

 
108,470

Trade name and trademarks
87,002

 
87,002

Definite-life intangibles, net
33,928

 
36,313

Other assets
363

 
398

Total assets
$
252,535

 
$
273,872

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
5,024

 
$
6,160

Accrued expenses and other current liabilities
8,652

 
7,503

Current portion of unearned franchise and development fees
1,091

 
1,358

Current portion of long-term debt
8,400

 
7,879

Total current liabilities
23,167

 
22,900

Long-term debt, net of current portion
96,432

 
100,965

Unearned franchise and development fees, net of current portion
450

 
410

Deferred tax liability
38,023

 
44,179

Other long-term liabilities
4,167

 
3,922

Total liabilities
162,239

 
172,376

Commitments and contingencies (Note 15)


 


 
 
 
 
Stockholders’ Equity
 
 
 
Preferred stock ($0.01 par value; 15,000,000 shares authorized; no shares issued)

 

Common stock ($0.01 par value; 200,000,000 shares authorized; 16,948,969 and 16,955,970 shares issued, respectively)
169

 
170

Additional paid-in capital
120,334

 
119,932

Accumulated deficit
(30,207
)
 
(18,606
)
Total stockholders’ equity
90,296

 
101,496

Total liabilities and stockholders’ equity
$
252,535

 
$
273,872

See accompanying notes.

4

Table of Contents

Papa Murphy’s Holdings, Inc. and Subsidiaries
Unaudited Condensed Consolidated Statements of Cash Flows
 
Six Months Ended
(In thousands)
July 3, 2017
 
June 27, 2016
Operating Activities
 
 
 
Net (loss) income
$
(11,601
)
 
$
1,594

Adjustments to reconcile to cash from operating activities
 
 
 
Depreciation and amortization
6,023

 
5,630

Loss (gain) on disposal/impairment of property and equipment
11,050

 
(5
)
Deferred taxes
(6,156
)
 
232

Stock-based compensation
405

 
427

Other non-cash items
259

 
158

Change in operating assets and liabilities
 
 
 
Accounts receivable
2,373

 
1,984

Prepaid expenses and other assets
1,620

 
1,072

Unearned franchise and development fees
(226
)
 
(347
)
Accounts payable
(1,481
)
 
(3,840
)
Accrued expenses and other liabilities
1,398

 
(1,520
)
Net cash from operating activities
3,664

 
5,385

 
 
 
 
Investing Activities
 
 
 
Acquisition of property and equipment
(2,259
)
 
(9,533
)
Acquisition of stores, less cash acquired

 
(2,449
)
Proceeds from sale of stores
2,206

 
136

Payments received on notes receivable
42

 
37

Net cash from investing activities
(11
)
 
(11,809
)
 
 
 
 
Financing Activities
 
 
 
Payments on term loan
(5,779
)
 
(3,321
)
Advances on revolver
10,500

 
10,300

Payments on revolver
(8,900
)
 
(7,300
)
Repurchases of common stock
(4
)
 
(80
)
Proceeds from exercise of stock options

 
293

Payments received on subscription receivables

 
100

Net cash from financing activities
(4,183
)
 
(8
)
 
 
 
 
Net change in cash and cash equivalents
(530
)
 
(6,432
)
Cash and Cash Equivalents, beginning of year
2,069

 
6,867

Cash and Cash Equivalents, end of period
$
1,539

 
$
435

 
 
 
 
Supplemental Disclosures of Cash Flow Information
 
 
 
Cash paid during the period for interest
$
2,389

 
$
2,243

Cash (received) paid during the period for income taxes
(275
)
 
136

Non-cash Supplemental Disclosures of Investing and Financing Activities
 
 
 
Acquisition of property and equipment in accounts payable
$
259

 
$
2,509

See accompanying notes.

5

Table of Contents

Papa Murphy’s Holdings, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements

Note 1 — Description of Business and Basis of Presentation
Description of business
Papa Murphy’s Holdings, Inc. (“Papa Murphy’s” or the “Company”), together with its subsidiaries, is a franchisor and operator of a Take ‘N’ Bake pizza chain. The Company franchises the right to operate Papa Murphy’s Take ‘N’ Bake pizza franchises and operates Papa Murphy's Take ‘N’ Bake pizza stores owned by the Company. As of July 3, 2017 , the Company had 1,550 stores consisting of 1,507 domestic stores ( 1,358 franchised stores and 149 Company-owned stores) across 39 states, plus 43 franchised stores in Canada and the United Arab Emirates.
Substantially all of the Company’s revenues are derived from retail sales of pizza and other food and beverage products to the general public by Company-owned stores and the collection of franchise royalties and fees associated with franchise and development rights.
Basis of presentation
The accompanying interim unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “ SEC ”). Accordingly, they do not include all information and footnotes required by generally accepted accounting principles in the United States (“ GAAP ”) for complete financial statements. In the Company’s opinion, all necessary adjustments, consisting of only normal recurring adjustments, have been made for the fair statement of the results of the interim periods presented. The results of operations for such interim periods are not necessarily indicative of the results to be expected for the full year. The accompanying interim unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements and the related notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 2, 2017 .
Principles of consolidation
The interim unaudited condensed consolidated financial statements include the accounts of Papa Murphy’s Holdings, Inc., its subsidiaries and certain entities which the Company consolidates as variable interest entities. All significant intercompany transactions and balances have been eliminated.
Throughout the interim unaudited condensed consolidated financial statements and the related notes thereto, “Papa Murphy’s” and “the Company” refer to Papa Murphy’s Holdings, Inc. and its consolidated subsidiaries.
Fiscal year
The Company uses a 52- or 53-week fiscal year, ending on the Monday nearest to December 31. Fiscal year 2017 is a 52-week year and fiscal 2016 was a 53-week year. All three month periods presented herein contain 13 weeks. All references to years and quarters relate to fiscal periods rather than calendar periods. References to fiscal 2017 and 2016 are references to fiscal years ending January 1, 2018 and ended January 2, 2017 , respectively.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“ FASB ”) issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ ASU 2014-09 ”), a new standard to achieve a consistent application of revenue recognition within the U.S., resulting in a single revenue model to be applied by reporting companies under GAAP. The new standard, as amended, requires adoption by the first quarter of fiscal 2018. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (" ASU 2016-08 ") which is an amendment to the new revenue recognition standard on assessing whether an entity is a principal or an agent in a revenue transaction. This amendment addresses implementation issues that were discussed by the Revenue Recognition Transition Resource Group to clarify the principal versus agent assessment and lead to more consistent application. ASU 2016-08 has the same effective date and transition requirements as ASU 2014-09 .
The new revenue standard is required to be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application. The Company anticipates adopting the standard in the first quarter of fiscal 2018 using the full retrospective method to restate each prior reporting period presented.

6


The Company anticipates this standard will have a material impact on its consolidated financial statements. While the Company continues to assess all potential impacts of the standard, it currently believes the most significant effects will relate to its: (i) accounting for franchise and development fees, and (ii) accounting for its advertising funds. The Company expects revenue related to its franchise royalties, which are based on a percentage of franchise sales, and revenue from Company-owned restaurants to remain substantially unchanged. Specifically, under the new standard the Company expects to recognize franchise fees ratably over the life of the contract rather than at the time the store is opened or a successive contract commences. In addition, the Company expects to account for advertising fund revenues on a gross basis, instead of net, as the Company has determined that it is the principal since it controls the funds and determines how the funds collected will be spent. The Company continues to evaluate the impact the adoption of this standard will have on the recognition of other revenue transactions such as the refranchising of Company-owned restaurants.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ ASU 2016-02 ”). This update requires that lessees recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than twelve months. ASU 2016-02 also will require disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include both qualitative and quantitative information. The effective date for ASU 2016-02 is for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with earlier adoption permitted. The Company is still evaluating the impact of ASU 2016-02 on its financial position and results of operations, but expects there will be an increase in assets and liabilities on its Consolidated Balance Sheets at adoption due to the recording of right-of-use assets and corresponding lease liabilities, which may be material.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 320) (“ ASU 2016-15 ”). This update clarifies the presentation of certain cash receipts and cash payments in the statement of cash flows. The effective date for ASU 2016-15 is for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. The Company is still evaluating the impact of ASU 2016-15 on its Consolidated Statements of Cash Flows.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other: Simplifying the Test for Goodwill Impairment (“ ASU 2017-04 ”). The new standard simplifies how an entity measures goodwill impairment by removing the second step of the two-step quantitative goodwill impairment test. An entity will no longer perform a hypothetical purchase price allocation to measure goodwill impairment. Instead, impairment will be measured at the amount by which the carrying value exceeds the fair value of a reporting unit; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity still has the option to perform a qualitative assessment of whether it is more-likely-than-not that a reporting unit’s fair value is less than its carrying amount. ASU 2017-04 requires prospective adoption and is effective for the annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019, with early adoption permitted. The Company is still evaluating the impact of ASU 2017-04 on its financial position and results of operations.
Note 2 — Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist of the following:
(in thousands)
July 3, 2017
 
January 2, 2017
Prepaid media production costs
$

 
$
606

Prepaid software and support
1,010

 
985

Prepaid rents
560

 
622

Prepaid insurance
59

 
453

Taxes receivable

 
547

Assets held for sale
525

 
1,406

Advertising cooperative assets, restricted
78

 
48

Other
170

 
41

Total prepaid expenses and other current assets
$
2,402

 
$
4,708

Note 3 — Property and Equipment
Property and equipment are net of accumulated depreciation of $20.2 million and $17.1 million at July 3, 2017 , and January 2, 2017 , respectively. Depreciation expense amounted to $1.7 million and $1.7 million during the three months ended

7


July 3, 2017 , and June 27, 2016 , respectively. Depreciation expense amounted to $3.6 million and $3.1 million during the six months ended July 3, 2017 , and June 27, 2016 , respectively.
During the three months ended July 3, 2017, the Company decided to replace its current online ordering system with a new online and mobile ordering system. As part of this decision, the Company recognized an impairment of the software component of its property and equipment of $9.1 million during the three months ended July 3, 2017.
During the three months ended July 3, 2017, the Company made the decision to close 13 underperforming Company-owned stores, 12 of which were closed during the second quarter of 2017. In connection with the closures, the Company recognized asset impairment charges of $1.9 million during the three months ended July 3, 2017, and the remaining $0.5 million of store property and equipment was transferred to assets held for sale on the Company's Condensed Consolidated Balance Sheets .
Note 4 — Divestitures
On May 1, 2017 , the Company completed the sale and refranchise of six Company-owned stores in Colorado. On May 8, 2017 , the Company completed the sale and refranchise of one Company-owned store in Colorado in an unrelated transaction. The aggregate sale price for the seven stores was $2.5 million , paid in cash, and the Company recognized a pre-tax gain of $0.1 million . In connection with the sale, the buyers paid $0.3 million in franchise fees. The assets sold were classified as assets held for sale on the Company's Condensed Consolidated Balance Sheets . These dispositions did not meet the criteria for accounting as a discontinued operation.
Note 5 — Goodwill
The following summarizes changes to the Company’s goodwill, by reportable segment:
(in thousands)
Domestic
Company Stores
 
Domestic
Franchise
 
Total
Balance at January 2, 2017
$
26,924

 
$
81,546

 
$
108,470

Disposition
(719
)
 

 
(719
)
Balance at July 3, 2017
$
26,205

 
$
81,546

 
$
107,751

There is no goodwill associated with the International segment. The Company has determined that during the three months ended July 3, 2017 , there were no triggering events that would require an updated impairment review. The Company recorded goodwill disposals in 2017 from the sale of Company-owned stores to franchise owners.
Note 6 — Intangible Assets
Definite-lived intangible assets are net of accumulated amortization of $29.0 million and $26.6 million as of July 3, 2017 , and January 2, 2017 , respectively. Amortization expense amounted to $1.2 million and $1.3 million during the three months ended July 3, 2017 , and June 27, 2016 , respectively. Amortization expense amounted to $2.4 million and $2.5 million during the six months ended July 3, 2017 , and June 27, 2016 , respectively.
Note 7 — Receivables
Notes Receivable
Notes receivable consist of a note maturing in 2020 that is collateralized by store assets. Changes in the account balance represent amortization payments collected pursuant to the terms of the note.
Accounts Receivable
Allowance for doubtful accounts amounted to $23,000 and $37,000 as of July 3, 2017 , and January 2, 2017 , respectively.

8


Note 8 — Financing Arrangements
Long-term debt consists of the following:
(in thousands)
July 3, 2017
 
January 2, 2017
Term loan
$
100,100

 
$
105,879

Revolving line of credit
2,400

 
800

Notes payable
3,000

 
3,000

Total principal amount of long-term debt
105,500

 
109,679

Unamortized debt issuance costs
(668
)
 
(835
)
Total long-term debt
104,832

 
108,844

Less current portion
(8,400
)
 
(7,879
)
Total long-term debt, net of current portion
$
96,432

 
$
100,965

Senior secured credit facility
On August 28, 2014, PMI Holdings, Inc., a wholly-owned subsidiary of Papa Murphy’s Holdings, Inc., entered into a $132.0 million senior secured credit facility (the “ Senior Credit Facility ”) consisting of a $112.0 million term loan and a $20.0 million revolving credit facility, which includes a $2.5 million letter of credit subfacility and a $1.0 million swing-line loan subfacility. The term loan and any loans made under the revolving credit facility mature in August 2019 . As of July 3, 2017 , the term loan was subject to the LIBOR rate option at 4.48% . As of July 3, 2017 , the revolving credit facility was subject to the LIBOR rate option at 4.46% .
With a maturity date of over one year from July 3, 2017 , balances outstanding under the Senior Credit Facility are classified as non-current on the Condensed Consolidated Balance Sheets , except for mandatory, minimum term loan amortization payments of $2.1 million due on the last day of each fiscal quarter.
The weighted average interest rate for all borrowings under our Senior Credit Facility for the second quarter of 2017 was 4.29% .
Notes payable
Papa Murphy’s Company Stores, Inc., a wholly owned subsidiary of Papa Murphy’s Holdings, Inc., has a $3.0 million note payable which bears interest at 5.0% and matures in December 2018 . This note is subordinated to the Senior Credit Facility .
Note 9 — Fair Value Measurement
The Company determines the fair value of 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. GAAP defines a fair value hierarchy that prioritizes the assumptions used to measure fair value. The three levels of the fair value hierarchy are defined as follows:
Level 1    —    Quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
Level 2    —    Observable inputs other than prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated with observable market data.
Level 3    —    Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities. This includes certain pricing models, discounted cash flow methodologies, and similar techniques that use significant unobservable inputs.
The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis:
 
July 3, 2017
 
January 2, 2017
 
 
(in thousands)
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
 
Fair Value Measurement
Financial assets
 
 
 
 
 
 
 
 
 
Notes receivable (1)
$
107

 
$
103

 
$
149

 
$
150

 
Level 3
(1)
The fair value of notes receivable was estimated primarily using a discounted cash flow method based on a discount rate, reflecting the applicable credit spread.
Financial instruments not included in the table above consist of cash and cash equivalents, accounts receivable, accounts payable, and long-term debt. The fair values of cash and cash equivalents, accounts receivable, and accounts payable

9


approximate carrying value because of the short-term nature of the accounts. The fair value of long-term debt approximates carrying value because the borrowings are made with variable market rates and negotiated terms and conditions that are consistent with current market rates.
Note 10 — Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consist of the following:
(in thousands)
July 3, 2017
 
January 2, 2017
Accrued compensation and related costs
$
3,951

 
$
2,192

Gift cards payable
2,344

 
3,033

Accrued interest and non-income taxes payable
382

 
524

Convention fund balance
827

 
1,025

Advertising cooperative liabilities
148

 
204

Income taxes payable
75

 

Other
925

 
525

Total accrued expenses and other current liabilities
$
8,652

 
$
7,503

Note 11 — Income Taxes
Information on the Company’s income taxes for the periods reported is as follows:
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 3, 2017
 
June 27, 2016
 
July 3, 2017
 
June 27, 2016
(Benefit from) provision for income taxes
$
(2,008
)
 
$
610

 
$
(5,810
)
 
$
1,070

(Loss) income before income taxes
(8,195
)
 
1,562

 
(17,411
)
 
2,664

Effective income tax rate
24.5
%
 
39.1
%
 
33.4
%
 
40.2
%
The effective income tax rate for the three months ended July 3, 2017 , includes the effect of a switch during the quarter from an expected full year provision rate to a full year benefit rate. The effective income tax rate for the three months ended June 27, 2016 , includes the effect of an adjustment for a tax benefit shortfall created by share-based payments at settlement that were made during the period.
The effective income tax rate for the six months ended July 3, 2017 , includes the effect of a discrete adjustment for the share-based compensation expense recorded for vesting restricted common shares. The effective tax rate for the six months ended June 27, 2016 , includes the effect of an adjustment for a tax benefit shortfall created by share-based payments at settlement that were made during the period.
Note 12 — Share-based Compensation
In May 2010, the Company’s Board of Directors approved the 2010 Amended Management Incentive Plan (the “ 2010 Plan ”). In May 2014, the Company’s Board of Directors adopted the 2014 Equity Incentive Plan (the “ 2014 Plan ,” and together with the 2010 Plan , the “ Incentive Plans ”). The Incentive Plans reserve 2,116,747 common shares for equity incentive awards consisting of incentive stock options, non-qualified stock options, restricted stock awards, and unrestricted stock awards. Equity incentive awards may be issued from either the 2014 Plan or the 2010 Plan .

10


Restricted common shares
Information with respect to restricted stock awards is as follows:
 
Number of Shares of Restricted Common Stock
 
Weighted Average
Award Date
Fair Value Per Share
 
Time Vesting
 
Market Condition
 
Unvested, January 2, 2017
30,670

 
148,946

 
$
2.70

Granted
11,333

 

 
4.41

Vested
(20,580
)
 
(94,866
)
 
4.78

Repurchased

 
(3,772
)
 
0.19

Unvested, July 3, 2017
21,423

 
50,308

 
$
4.09

Stock options
Information with respect to stock option activity is as follows:
 
Number of Shares
Subject to Options
 
Weighted
Average
Exercise
Price Per Share
 
Weighted
Average Remaining
Contractual Term
 
Aggregate
Intrinsic
Value
(thousands)
 
Time
Vesting
 
Market
Condition
 
 
 
Outstanding, January 2, 2017
951,688

 
171,495

 
$
11.48

 
 
 
 
Granted
308,000

 

 
4.01

 
 
 
 
Forfeited
(506,808
)
 
(83,276
)
 
11.34

 
 
 
 
Outstanding, July 3, 2017
752,880

 
88,219

 
$
8.84

 
8.1 years
 
$
118

Exercisable, July 3, 2017
285,500

 

 
$
11.36

 
7.2 years
 
$

Compensation cost
Stock-based compensation expense recognized in connection with the Incentive Plans for the three months ended July 3, 2017 and June 27, 2016 amounted to $175,000 and $196,000 , respectively. Stock-based compensation expense recognized in connection with the Incentive Plans for the six months ended July 3, 2017 and June 27, 2016 amounted to $405,000 and $427,000 , respectively.
As of July 3, 2017 , the total unrecognized stock-based compensation expense was $1.3 million , with $1.1 million associated with time vesting awards and $0.2 million associated with market condition awards. The remaining weighted average vesting period for unrecognized stock-based compensation expense was 2.2 years as of July 3, 2017 .
Note 13 — Advertising Fund
Franchised and Company-owned stores in the United States contribute to an advertising fund that the Company manages on behalf of these stores. In addition, certain suppliers contribute to the advertising fund. Under our franchise agreements and other agreements, contributions received by the advertising fund must be spent on marketing, creative efforts, media support, or other related purposes specified in the agreements and result in no profit recognized. Contributions to the advertising fund are netted against the related expense. Expenditures of the advertising fund are primarily amounts paid to third-parties, but may also include personnel expenses and allocated costs. At each reporting date, to the extent contributions to the advertising fund exceed expenditures on a cumulative basis, the excess contributions are accounted for as a deferred liability and are recorded in accrued expenses in the Company’s Condensed Consolidated Balance Sheets . However, if expenditures exceed contributions on a cumulative basis, the excess is recorded as an expense within selling, general and administrative expenses. In subsequent periods, previously recognized expenses may be recovered if subsequent contributions exceed expenditures.
Information on the Company’s advertising fund balance for the periods reported is as follows:
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 3, 2017
 
June 27, 2016
 
July 3, 2017
 
June 27, 2016
Opening fund balance (deficit)
$
(9,872
)
 
$
(2,324
)
 
$
(1,586
)
 
$
(1,200
)
Net activity during the period
2,792

 
387

 
(5,494
)
 
(737
)
Ending fund balance (deficit)
$
(7,080
)
 
$
(1,937
)
 
$
(7,080
)
 
$
(1,937
)

11


As of July 3, 2017 , previously recognized expenses of $7.1 million may be recovered in future periods if subsequent advertising fund contributions exceed expenditures.
Note 14 — Earnings per Share (EPS)
The number of shares and earnings per share (“ EPS ”) data for all periods presented are based on the historical weighted-average shares of common stock outstanding. Basic EPS is calculated by dividing income available to common stockholders by the weighted-average number of shares of common stock outstanding during each period. Diluted EPS is calculated using income available to common stockholders divided by diluted weighted-average shares of common stock outstanding during each period, which includes unvested restricted common stock and outstanding stock options. Diluted EPS considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the common shares underlying such securities would have an anti-dilutive effect.
The following table sets forth the computations of basic and diluted EPS :
 
Three Months Ended
 
Six Months Ended
(in thousands, except per share data)
July 3, 2017
 
June 27, 2016
 
July 3, 2017
 
June 27, 2016
Earnings:
 
 
 
 
 
 
 
Net (loss) income
$
(6,187
)
 
$
952

 
$
(11,601
)
 
$
1,594

Shares:
 
 
 
 
 
 
 
Weighted average common shares outstanding
16,868

 
16,745

 
16,854

 
16,731

Dilutive effect of restricted equity awards (1)

 
22

 

 
30

Diluted weighted average number of shares outstanding
16,868

 
16,767

 
16,854

 
16,761

(Loss) earnings per share:
 
 
 
 
 
 
 
Basic (loss) earnings per share
$
(0.37
)
 
$
0.06

 
$
(0.69
)
 
$
0.10

Diluted (loss) earnings per share
$
(0.37
)
 
$
0.06

 
$
(0.69
)
 
$
0.10

(1)
The Company’s securities that provide a right to receive common stock in the future such as stock options and restricted stock were not included in the computation of diluted EPS for the three and six months ended July 3, 2017, as the effect of including these shares in the calculation would have been anti-dilutive.
For the three months ended July 3, 2017 , and June 27, 2016 , an aggregated total of 0.9 million shares and 0.5 million shares, respectively, have been excluded from the diluted EPS calculation because their effect would have been anti-dilutive. For the six months ended July 3, 2017 , and June 27, 2016 , an aggregated total of 1.1 million shares and 0.4 million shares, respectively, have been excluded from the diluted EPS calculation because their effect would have been anti-dilutive.
Note 15 — Commitments and Contingencies
Operating lease commitments
The Company leases facilities and various office equipment under non-cancelable operating leases which expire through December 2025 . Lease terms for its Company-owned stores are generally for five years with renewal options and generally require the Company to pay a proportionate share of real estate taxes, insurance, common area maintenance, and other operating costs.
The Company has entered into operating leases that it has subleased to two franchised stores. These operating leases have minimum base rent terms, contingent rent terms if individual franchised store sales exceed certain levels and have terms expiring on various dates from May 2020 to October 2020 .
Lease guarantees
The Company is the guarantor for operating leases of 22 franchised stores that have terms expiring on various dates from January 2018 to November 2021 . The obligations from these leases will generally continue to decrease over time as the leases expire. The applicable franchise owners continue to have primary liability for these operating leases. As of July 3, 2017 , the Company does not believe it is probable it would be required to perform under the outstanding guarantees.

12


Legal proceedings
There have been no material developments in the legal proceedings described in Part I, Item 3, of the Company’s Annual Report on Form 10-K for the fiscal year ended January 2, 2017 .
Note 16 — Segment Information
The Company has the following reportable segments: (i) Domestic Franchise; (ii) Domestic Company Stores; and (iii) International. The Domestic Franchise segment includes operations with respect to franchised stores in the United States and derives its revenues primarily from franchise and development fees and franchise royalties from franchised stores in the United States. The Domestic Company Stores segment includes operations with respect to Company-owned stores in the United States and derives its revenues from retail sales of pizza and side items to the general public. The International segment includes operations related to the Company’s operations outside the United States and derives its revenues from franchise and development fees and franchise royalties from franchised stores outside the United States.
The Company measures the performance of its segments based on segment adjusted EBITDA and allocates resources based primarily on this measure. “ EBITDA ” is calculated as net (loss) income before interest expense, income taxes, depreciation, and amortization. Segment adjusted EBITDA excludes certain unallocated and corporate expenses. Although segment adjusted EBITDA is not a measure of financial condition or performance determined in accordance with GAAP , the Company uses segment adjusted EBITDA to compare the operating performance of its segments on a consistent basis and to evaluate the performance and effectiveness of its operational strategies. The Company’s calculation of segment adjusted EBITDA may not be comparable to that reported by other companies.

13


The following tables summarize information on revenues, segment adjusted EBITDA and assets for each of the Company’s reportable segments and includes a reconciliation of segment adjusted EBITDA to (loss) income before income taxes:
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 3, 2017
 
June 27, 2016
 
July 3, 2017
 
June 27, 2016
Revenues
 
 
 
 
 
 
 
Domestic Franchise
$
10,292

 
$
10,337

 
$
21,421

 
$
22,552

Domestic Company Stores
18,714

 
19,470

 
39,490

 
40,144

International
96

 
87

 
185

 
183

Total
$
29,102

 
$
29,894

 
$
61,096

 
$
62,879

Segment Adjusted EBITDA
 
 
 
 
 
 
 
Domestic Franchise
$
8,491

 
$
6,059

 
$
8,650

 
$
11,349

Domestic Company Stores
363

 
591

 
937

 
1,742

International
91

 
78

 
160

 
142

Total reportable segments adjusted EBITDA
8,945

 
6,728

 
9,747

 
13,233

Corporate and unallocated
(1,062
)
 
(1,043
)
 
(4,538
)
 
(2,552
)
Depreciation and amortization
(2,906
)
 
(2,915
)
 
(6,023
)
 
(5,630
)
Interest expense, net
(1,286
)
 
(1,208
)
 
(2,513
)
 
(2,387
)
CEO transition and restructuring (1)
(131
)
 

 
(2,329
)
 

E-commerce impairment (2)
(9,124
)
 

 
(9,124
)
 

Store closures (3)
(2,631
)
 

 
(2,631
)
 

(Loss) Income Before Income Taxes
$
(8,195
)
 
$
1,562

 
$
(17,411
)
 
$
2,664

(1)
Represents non-recurring management transition and restructuring costs in connection with the recruitment of a new Chief Executive Officer and other executive positions.
(2)
Represents impairment charges on the write-down of our e-commerce platform based on the decision to move to a third-party developed and hosted solution.
(3)
Represents primarily non-cash charges associated with the impairment and disposal of store assets upon the decision to close stores, plus lease loss reserves associated with related contractual lease obligations.
(in thousands)
July 3, 2017
 
January 2, 2017
Total Assets
 
 
 
Domestic Franchise
$
119,805

 
$
133,466

Domestic Company Stores
45,403

 
52,531

International
295

 
318

Other (1)
87,032

 
87,557

Total
$
252,535

 
$
273,872

(1)
Other assets which are not allocated to the individual segments primarily include trade names and trademarks and taxes receivable.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and related notes in Item 1 and with the audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended January 2, 2017 . To match our operating cycle, we use a 52- or 53-week fiscal year, ending on the Monday nearest to December 31. Our fiscal quarters each contain 13 operating weeks, with the exception of the fourth quarter of a 53-week fiscal year, which contains 14 operating weeks. Fiscal year 2017 is a 52-week period ending on January 1, 2018 , and 2016 was a 53-week period ended on January 2, 2017 .
Cautionary Note Regarding Forward-Looking Statements
In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors including, but not limited to, those discussed in the section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended January 2, 2017 . All statements other than statements of historical fact or relating to present

14

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facts or current conditions included in this discussion and analysis are forward-looking statements. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. Examples of forward-looking statements include those regarding our future financial or operating results, cash flows, sufficiency of liquidity, financing resources, business strategies and priorities, effects of advertising cost increases and shift in mix of marketing efforts, decrease in the advertising fund deficit over the remainder of 2017, resolution of litigation and claims, expansion and growth opportunities, the number and mix of new store openings, our refranchising initiative and its effects on our operating results, reduction in the number of Company-owned stores, adoption of new accounting standards, our qualification as an “emerging growth company,” exposure to foreign currency and interest rate risk, as well as industry trends and outlooks. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “should,” “can have,” “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events .
The forward-looking statements contained in this discussion and analysis are based on assumptions that we have made in light of our industry experience and our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. As you read and consider this discussion and analysis, you should understand that these statements are not guarantees of performance or results. They involve risks, uncertainties (many of which are beyond our control) and assumptions. Although we believe that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual operating and financial performance and cause our performance to differ materially from the performance anticipated in the forward-looking statements. We believe these factors include, but are not limited to, those described under the section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended January 2, 2017 . Should one or more of these risks or uncertainties materialize, or should any of these assumptions prove incorrect, our actual operating and financial performance may vary in material respects from expectations based on these forward-looking statements.
Any forward-looking statement made by us in this discussion and analysis speaks only as of the date on which we make it. Factors or events that could cause our actual operating and financial performance to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.
2017 Highlights
Revenue
Total revenues for the three months ended July 3, 2017 , compared to the three months ended June 27, 2016 , declined 2.6% from $29.9 million to $29.1 million , primarily due to a decline in comparable store sales and the sale of seven company-owned stores during the three months ended July 3, 2017 , partially offset by increased fees from refranchising and transfers. Total revenues for the six months ended July 3, 2017 , compared to the six months ended June 27, 2016 , declined 2.8% from $62.9 million to $61.1 million primarily due to a decline in comparable store sales and lower fees from fewer franchise store openings. Comparable store sales in 2017 compared to 2016 for selected segments were as follows:
 
Three Months Ended
 
Six Months Ended
 
July 3, 2017
 
June 27, 2016
 
July 3, 2017
 
June 27, 2016
Domestic Franchise
(4.1
)%
 
(3.7
)%
 
(4.3
)%
 
(3.3
)%
Domestic Company Stores
(6.6
)%
 
(6.6
)%
 
(8.4
)%
 
(4.7
)%
Total domestic stores
(4.3
)%
 
(4.0
)%
 
(4.7
)%
 
(3.4
)%
Comparable store sales for the three and six months ended July 3, 2017 were lower due to a variety of competitive actions, including lower advertising spending in the three months ended July 3, 2017 compared to the same period last year. Results for the six months ended July 3, 2017 were further impacted due to the unsatisfactory results of our first test of national advertising during the first quarter of 2017 .
Store Development
Our franchise owners opened 13 stores, including 11 in the United States, in the three months ended July 3, 2017 . In the six months ended July 3, 2017 , we and our franchise owners opened 20 stores, including 17 in the United States. While we operate a small percentage of stores as Company-owned stores, we expect the majority of our new store expansion to continue to come from new franchised store openings.

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Table of Contents

Refranchising
During the past several years, we have focused our financial resources on accelerating the build out of several markets with Company-owned stores. Consistent with our strategy, we are now working to refranchise more than 100 of our Company-owned stores to experienced and well-capitalized franchisees who can further grow these markets. In May 2017, we successfully refranchised seven Company-owned stores pursuant to this strategy. Our target is to continue reducing the number of Company-owned stores to no more than 50 stores by 2020.
Company-owned Store Closures
In the second quarter of 2017, we made the decision to close 13 underperforming Company-owned stores, 12 of which were closed during the second quarter of 2017. In connection with the closures, we recognized asset impairment charges of $1.9 million before taxes and recorded lease loss reserves related to remaining contractual lease obligations of $0.7 million before taxes.
National Media
During the first quarter of 2017, we aired a national media campaign for all domestic stores. Several of our markets that historically receive no television media were provided with a few weeks of national cable advertising. This campaign resulted in a large deficit within our advertising fund, of which $2.8 million was recovered during the second quarter of 2017. We anticipate that the remaining $7.1 million advertising fund deficit, as of July 3, 2017 , will be recovered over the next 12 to 18 months.
E-commerce
We began the system-wide roll-out of our online ordering platform in early 2016 and have seen positive results to date as the average transaction amount continues to be about 20% higher with online orders than in-store orders. We strategically use online-only promotions communicated through text and email messaging. On June 5, 2017, the Company announced plans to accelerate its convenience strategy by moving to a third-party's platform, which will enable online and mobile ordering to be fully integrated with third-party marketplace and delivery services, where available. As part of the transition, the Company recognized a non-cash charge of $9.1 million before taxes related to the impairment of its current online ordering platform in the three months ended July 3, 2017.
Our Segments
We operate in three business segments: Domestic Franchise, Domestic Company Stores, and International. Our Domestic Franchise segment consists of our domestic franchised stores, which represent the majority of our system-wide stores. Our Domestic Company Stores segment consists of our Company-owned stores in the United States. Our International segment consists of our stores outside of the United States, all of which are franchised.
We measure the performance of our segments based on segment adjusted EBITDA and allocate resources based primarily on this measure. “ EBITDA ” is calculated as net (loss) income before interest expense, income taxes, depreciation, and amortization. Segment adjusted EBITDA excludes certain unallocated and corporate expenses, which include costs related to our board of directors, CEO, CFO and certain legal expenses. Although segment adjusted EBITDA is not a measure of financial condition or performance determined in accordance with GAAP , we use segment adjusted EBITDA to compare the operating performance of our segments on a consistent basis and to evaluate the performance and effectiveness of our operational strategies. Our calculation of segment adjusted EBITDA may not be comparable to that reported by other companies.
Our measure of segment performance has changed beginning in fiscal year 2017 . Previously, segment operating income was used as the measure of segment performance. Our Chief Operating Decision Maker (“CODM”) now uses segment adjusted EBITDA as the primary measure of segment performance to allocate resources. The CODM believes this measure provides an enhanced basis for consistently measuring segment performance against operational objectives and strategies.

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The following table sets forth our revenues and segment adjusted EBITDA for each of our segments for the periods presented:  
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 3, 2017
 
June 27, 2016
 
July 3, 2017
 
June 27, 2016
Revenues
 
 
 
 
 
 
 
Domestic Franchise
$
10,292

 
$
10,337

 
$
21,421

 
$
22,552

Domestic Company Stores
18,714

 
19,470

 
39,490

 
40,144

International
96

 
87

 
185

 
183

Total
$
29,102

 
$
29,894

 
$
61,096

 
$
62,879

Segment Adjusted EBITDA
 
 
 
 
 
 
 
Domestic Franchise
$
8,491

 
$
6,059

 
$
8,650

 
$
11,349

Domestic Company Stores
363

 
591

 
937

 
1,742

International
91

 
78

 
160

 
142

Total reportable segments adjusted EBITDA
8,945

 
6,728

 
9,747

 
13,233

Corporate and unallocated
(1,062
)
 
(1,043
)
 
(4,538
)
 
(2,552
)
Depreciation and amortization
(2,906
)
 
(2,915
)
 
(6,023
)
 
(5,630
)
Interest expense, net
(1,286
)
 
(1,208
)
 
(2,513
)
 
(2,387
)
CEO transition and restructuring (1)
(131
)
 

 
(2,329
)
 

E-commerce impairment (2)
(9,124
)
 

 
(9,124
)
 

Store closures (3)
(2,631
)
 

 
(2,631
)
 

(Loss) Income Before Income Taxes
$
(8,195
)
 
$
1,562

 
$
(17,411
)
 
$
2,664

(1)
Represents non-recurring management transition and restructuring costs in connection with the recruitment of a new Chief Executive Officer and other executive positions.
(2)
Represents impairment charges on the write-down of our e-commerce platform based on the decision to move to a third-party developed and hosted solution.
(3)
Represents primarily non-cash charges associated with the impairment and disposal of store assets upon the decision to close stores, plus lease loss reserves associated with related contractual lease obligations.
Key Operating Metrics
We evaluate the performance of our business using a variety of operating and performance metrics. Set forth below is a description of our key operating metrics.
 
Three Months Ended
 
Six Months Ended
 
July 3, 2017
 
June 27, 2016
 
July 3, 2017
 
June 27, 2016
Domestic store average weekly sales
$
10,167

 
$
10,759

 
$
10,656

 
$
11,342

Domestic comparable store sales
(4.3
)%
 
(4.0
)%
 
(4.7
)%
 
(3.4
)%
Domestic comparable stores
1,440

 
1,410

 
1,440

 
1,410

System-wide sales (in thousands)
$
204,536

 
$
215,253

 
$
430,146

 
$
452,104

System-wide stores
1,550

 
1,570

 
1,550

 
1,570

Adjusted EBITDA (in thousands)
$
7,883

 
$
5,685

 
$
5,209

 
$
10,681

Average Weekly Sales
Average Weekly Sales (“ AWS ”) consists of the average weekly sales of domestic franchised and Company-owned stores over a specified period of time. AWS is calculated by dividing the total net sales of our domestic system-wide stores for the relevant time period by the number of weeks these stores were open in such time period. This measure allows management to assess changes in customer traffic and spending patterns in our domestic stores.
Comparable Store Sales
Comparable store sales represents the change in year-over-year sales for comparable stores. A comparable store is a store open for at least 52 full weeks from the comparable date (the Tuesday following the opening date). Comparable store sales

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reflects changes in the number of transactions and in customer spend per transaction at existing stores. Customer spend per transaction is affected by changes in menu prices, sales mix, and the number of items sold per customer.
System-Wide Sales
System-wide sales include net sales by all of our system-wide stores. This measure allows management to assess the health of our brand, our relative position to competitors, and changes in our royalty revenues.
Store Openings, Closures, Acquisitions, and Divestitures
We review the number of new stores, the number of closed stores, and the number of acquired and divested stores to assess growth in system-wide sales, royalty revenues, and Company-owned store sales. We operate through a footprint of 1,550 stores as of July 3, 2017 , of which 90.4% are franchised, located in 39 states plus Canada and the Middle East. The following table presents the changes in the number of stores in our system for the six months ended July 3, 2017 .
 
Domestic Company Stores
 
Domestic Franchise
 
Total Domestic
 
International
 
Total
Store count at January 2, 2017
168

 
1,369

 
1,537

 
40

 
1,577

Openings

 
17

 
17

 
3

 
20

Closings
(12
)
 
(35
)
 
(47
)
 

 
(47
)
Net transfers (1)
(7
)
 
7

 

 

 

Store count at July 3, 2017
149

 
1,358

 
1,507

 
43

 
1,550

(1)
Net transfers are the number of franchised stores acquired by the Company, less the number of Company-owned stores refranchised.
EBITDA and Adjusted EBITDA
To supplement our condensed consolidated financial statements presented in accordance with generally accepted accounting principles in the U.S. (“ GAAP ”), we consider certain financial measures that are not prepared in accordance with GAAP . These non- GAAP financial measures are not based on any standardized methodology prescribed by GAAP and are not necessarily comparable to similarly-titled measures presented by other companies.
Adjusted “ EBITDA ” is calculated as net (loss) income before interest expense, income taxes, depreciation, and amortization (“ EBITDA ”) as adjusted for the effects of items that we do not consider indicative of our operating performance. Adjusted EBITDA is a supplemental measure of operating performance that does not represent and should not be considered as an alternative to net (loss) income , as determined by GAAP , and our calculation of Adjusted EBITDA may not be comparable to that reported by other companies.
Adjusted EBITDA is a non- GAAP financial measure. Management believes that this financial measure, when viewed with our results of operations in accordance with GAAP and our reconciliation of Adjusted EBITDA to net (loss) income , provides additional information to investors about certain material or unusual items that we do not expect to continue at the same level in the future. By providing this non- GAAP financial measure, we believe we are enhancing investors’ understanding of our business and our results of operations, and assisting investors in evaluating how well we are executing strategic initiatives. We believe Adjusted EBITDA is used by investors as a supplemental measure to evaluate the overall operating performance of companies in our industry.
Management uses Adjusted EBITDA and other similar measures:
in comparing our operating performance on a consistent basis;
to calculate incentive compensation for our employees;
for planning purposes, including the preparation of our internal annual operating budget; and
to evaluate the performance and effectiveness of our operational strategies.
Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reported under GAAP . Some of the limitations are:
Adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;
Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect the cash requirements for such replacements; and
Adjusted EBITDA does not reflect our tax expense or the cash requirements to pay our taxes.
To address these limitations, we reconcile Adjusted EBITDA to the most directly comparable GAAP measure, net income. Further, we also review GAAP measures and evaluate individual measures that are not included in Adjusted EBITDA .

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The following table provides a reconciliation of our net (loss) income to Adjusted EBITDA for the periods presented:
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 3, 2017
 
June 27, 2016
 
July 3, 2017

June 27, 2016
Net (Loss) Income
$
(6,187
)
 
$
952

 
$
(11,601
)
 
$
1,594

Depreciation and amortization
2,906

 
2,915

 
6,023

 
5,630

(Benefit from) provision for income taxes
(2,008
)
 
610

 
(5,810
)
 
1,070

Interest expense, net
1,286

 
1,208

 
2,513

 
2,387

EBITDA
$
(4,003
)
 
$
5,685

 
$
(8,875
)
 
$
10,681

CEO transition and restructuring (1)
131

 

 
2,329

 

E-commerce impairment (2)
9,124

 

 
9,124

 

Store closures (3)
2,631

 

 
2,631

 

Adjusted EBITDA
$
7,883

 
$
5,685

 
$
5,209

 
$
10,681

(1)
Represents non-recurring management transition and restructuring costs in connection with the recruitment of a new Chief Executive Officer and other executive positions.
(2)
Represents impairment charges on the write-down of our e-commerce platform based on the decision to move to a third-party developed and hosted solution.
(3)
Represents primarily non-cash charges associated with the impairment and disposal of store assets upon the decision to close stores, plus lease loss reserves associated with related contractual lease obligations.

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Results of Operations
The following table sets forth our results of operations in dollars and as a percentage of total revenues for the three and six months ended July 3, 2017 , and June 27, 2016 .  
 
Three Months Ended
 
Six Months Ended
 
July 3, 2017
 
June 27, 2016
 
July 3, 2017
 
June 27, 2016
(in thousands)
$
 
Total
% of
Revenues
 
$
 
Total
% of
Revenues
 
$
 
Total
% of
Revenues
 
$
 
Total
% of
Revenues
Revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Franchise royalties
$
9,101

 
31.3
 %
 
$
9,538

 
32.0
 %
 
$
19,135

 
31.3
 %
 
$
20,034

 
31.9
%
Franchise and development fees
837

 
2.9
 %
 
574

 
1.9
 %
 
1,438

 
2.4
 %
 
1,528

 
2.4
%
Company-owned store sales
18,715

 
64.3
 %
 
19,470

 
65.1
 %
 
39,490

 
64.6
 %
 
40,144

 
63.8
%
Other
449

 
1.5
 %
 
312

 
1.0
 %
 
1,033

 
1.7
 %
 
1,173

 
1.9
%
Total revenues
29,102

 
100.0
 %
 
29,894

 
100.0
 %
 
61,096

 
100.0
 %
 
62,879

 
100.0
%
Costs and Expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Store operating costs:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of food and packaging  (1)
6,303

 
21.5
 %
 
6,781

 
22.8
 %
 
13,518

 
22.1
 %
 
14,053

 
22.3
%
Compensation and benefits  (1)
5,923

 
20.4
 %
 
5,577

 
18.7
 %
 
12,257

 
20.1
 %
 
11,311

 
18.0
%
Advertising (1)
2,113

 
7.3
 %
 
1,897

 
6.3
 %
 
4,241

 
6.9
 %
 
4,063

 
6.5
%
Occupancy (1)
2,314

 
8.0
 %
 
1,503

 
5.0
 %
 
4,015

 
6.6
 %
 
2,878

 
4.6
%
Other store operating costs (1)
1,955

 
6.7
 %
 
2,555

 
8.5
 %
 
4,177

 
6.8
 %
 
4,846

 
7.7
%
Selling, general, and administrative (2)
3,408

 
11.8
 %
 
5,912

 
19.7
 %
 
20,621

 
33.7
 %
 
14,967

 
23.7
%
Depreciation and amortization
2,906

 
10.0
 %
 
2,915

 
9.8
 %
 
6,023

 
9.9
 %
 
5,630

 
9.0
%
Loss (gain) on disposal or impairment of property and equipment
11,041

 
37.9
 %
 
(59
)
 
(0.2
)%
 
11,050

 
18.1
 %
 
(5
)
 
0.0
%
Total costs and expenses
35,963

 
123.6
 %
 
27,081

 
90.6
 %
 
75,902

 
124.2
 %
 
57,743

 
91.8
%
Operating (Loss) Income
(6,861
)
 
(23.6
)%
 
2,813

 
9.4
 %
 
(14,806
)
 
(24.2
)%
 
5,136

 
8.2
%
Interest expense, net
1,286

 
4.4
 %
 
1,208

 
4.1
 %
 
2,513

 
4.1
 %
 
2,387

 
3.9
%
Other expense, net
48

 
0.2
 %
 
43

 
0.1
 %
 
92

 
0.2
 %
 
85

 
0.1
%
(Loss) Income Before Income Taxes
(8,195
)
 
(28.2
)%
 
1,562

 
5.2
 %
 
(17,411
)
 
(28.5
)%
 
2,664

 
4.2
%
(Benefit from) provision for income taxes
(2,008
)
 
(6.9
)%
 
610

 
2.0
 %
 
(5,810
)
 
(9.5
)%
 
1,070

 
1.7
%
Net (Loss) Income
(6,187
)
 
(21.3
)%
 
952

 
3.2
 %
 
(11,601
)
 
(19.0
)%
 
1,594

 
2.5
%
(1)
Please see the table presented in Costs and Expenses below, which presents Company-owned store expenses as a percentage of Company-owned store sales for the three and six months ended July 3, 2017 , and June 27, 2016 .
(2)
To the extent the advertising fund expenditures exceed contributions on a cumulative basis, the excess is recorded as an expense within selling, general and administrative expenses. In subsequent periods, previously recognized expenses will be recovered when contributions exceed expenditures on a cumulative basis, resulting in a reduction to selling, general, and administrative expenses. See "Costs and Expenses—Selling, general, and administrative" below for further discussion on current impacts of this policy.
Revenues
Total revenues. In the three months ended July 3, 2017 , total revenues decreased compared to the three months ended June 27, 2016 , primarily due to a decline in domestic comparable store sales of 4.3% . In the six months ended July 3, 2017 , total revenues decreased compared to the six months ended June 27, 2016 , primarily due to a decline in domestic comparable store sales of 4.7% .
Franchise royalties. Franchise royalties decreased in the three months ended July 3, 2017 , compared to the three months ended June 27, 2016 , primarily due to a decline in Domestic Franchise comparable store sales of 4.1% and a reduction in the number of franchised stores period-over-period.
Franchise royalties decreased in the six months ended July 3, 2017 , compared to the six months ended June 27, 2016 , primarily due to a decline in Domestic Franchise comparable store sales of 4.3% and a reduction in the number of franchised stores period-over-period.
Franchise and development fees. Franchise and development fees increased in the three months ended July 3, 2017 , compared to the three months ended June 27, 2016 , primarily due to the increase in revenues from store transfer fees.

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Franchise and development fees decreased in the six months ended July 3, 2017 , compared to the six months ended June 27, 2016 , primarily due to reduced revenues from franchised store openings and fewer forfeitures, partially offset by an increase in revenues from store transfer fees.
Company-owned store sales. Company-owned store sales decreased in the three months ended July 3, 2017 , compared to the three months ended June 27, 2016 , due to a decline in comparable store sales of 6.6% in the three months ended July 3, 2017 , compared to the three months ended June 27, 2016 , partially offset by an increase in the number of Company-owned stores period-over-period.
Company-owned store sales decreased in the six months ended July 3, 2017 , compared to the six months ended June 27, 2016 , due a decline in comparable store sales of 8.4% in the six months ended July 3, 2017 , compared to the six months ended June 27, 2016 , partially offset by an increase in the number of Company-owned stores period-over-period.
Costs and Expenses
Total costs and expenses. Total costs and expenses increased in the three months ended July 3, 2017 , compared to the three months ended June 27, 2016 , primarily as a result of impairments related to the announced discontinuation of our online ordering system and the closure of certain Company-owned stores. Total costs and expenses increased in the six months ended July 3, 2017 , compared to the six months ended June 27, 2016 , primarily as a result of the aforementioned impairments and an increase in advertising costs associated with our national media campaign.
Store operating costs. Store operating costs as a percentage of total revenues increased in the three and six months ended July 3, 2017 , compared to the three and six months ended June 27, 2016 . The following table presents the components of store operating costs as a percentage of Company-owned store sales for the periods reported:
 
Three Months Ended
 
Six Months Ended
 
July 3, 2017
 
June 27, 2016
 
July 3, 2017
 
June 27, 2016
Store operating costs as a % of Company-owned store sales:
 
 
 
 
 
 
Cost of food and packaging
33.7
%
 
34.8
%
 
34.2
%
 
35.0
%
Compensation and benefits
31.6
%
 
28.6
%
 
31.0
%
 
28.2
%
Advertising
11.3
%
 
9.7
%
 
10.7
%
 
10.1
%
Occupancy
12.4
%
 
7.7
%
 
10.2
%
 
7.2
%
Other store operating costs
10.4
%
 
13.3
%
 
10.7
%
 
12.0
%
Total store operating costs
99.4
%
 
94.1
%
 
96.8
%
 
92.5
%
Total store operating costs as a percentage of Company-owned store sales increased 530 and 430 basis points overall in the three and six months ended July 3, 2017 , compared to the three and six months ended June 27, 2016 , due primarily to the effect of Company-owned store portfolio changes in select markets, as further explained below:
Occupancy. As a result of the increase in the number of Company-owned stores period-over-period, which was mostly in markets with lower AWS, costs that are primarily fixed at the individual store level, such as Occupancy, increased overall on an absolute dollar basis and as a percentage of Company-owned store sales. Additionally, $0.7 million in net charges were incurred in the three and six months ended July 3, 2017 related to contractual lease obligations associated with store closures.
Compensation and benefits. Compensation and benefits as a percentage of Company-owned store sales increased due to an increase in fixed labor costs such as store manager salaries, driven by the increase in the number of Company-owned stores period-over-period, mostly in markets with lower AWS. In addition, increases in the minimum wage has negatively affected several of our established markets.
Other store operating costs. Other store operating costs declined in the three and six months ended July 3, 2017 , compared to the three and six months ended June 27, 2016 , due primarily to a decrease in store pre-opening costs because the Company has not built or opened any Company-owned stores in 2017.
Selling, general, and administrative. Selling, general, and administrative costs decreased in the three months ended July 3, 2017 , compared to the three months ended June 27, 2016 , primarily due to the recovery of advertising fund contributions in excess of advertising fund expenses of $2.8 million in the three months ended July 3, 2017 compared to a recovery of $0.4 million in the three months ended June 27, 2016 .
Selling, general, and administrative costs increased in the six months ended July 3, 2017 , compared to the six months ended June 27, 2016 , primarily due to advertising fund expenses associated with our first national media program. Advertising fund expenses exceeded fund contributions by $5.5 million and $0.8 million in the six months ended July 3, 2017 and June 27, 2016 , respectively. Since our national media test did not provide the desired results, advertising funds will be

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redirected back to regional advertising, enhanced with increasing digital media advertising. Additionally, severance and restructuring costs of $2.3 million were recorded in the six months ended July 3, 2017 .
In accordance with our accounting policy, when advertising expenditures exceed contributions on a cumulative basis, the change in the fund balance during the period is recorded to selling, general, and administrative costs. The table below shows the impact of the advertising fund on selling, general, and administrative costs and the current advertising fund deficit which we expect to continue to reverse over the next 12 to 18 months.
 
Three Months Ended
 
Six Months Ended
(in thousands)
July 3, 2017
 
June 27, 2016
 
July 3, 2017
 
June 27, 2016
Opening fund balance (deficit)
$
(9,872
)
 
$
(2,324
)
 
$
(1,586
)
 
$
(1,200
)
Net activity during the period
2,792

 
387

 
(5,494
)
 
(737
)
Ending fund balance (deficit)
$
(7,080
)
 
$
(1,937
)
 
$
(7,080
)
 
$
(1,937
)
Depreciation and amortization. Depreciation and amortization was largely unchanged in the three months ended July 3, 2017 , compared to the three months ended June 27, 2016 . Depreciation and amortization increased in the six months ended July 3, 2017 , compared to the six months ended June 27, 2016 , primarily due to the depreciation associated with an increased number of Company-owned stores and increased capital expenditures for business technology projects.
Interest expense, net. Interest expense, net increased in the three and six months ended July 3, 2017 , compared to the three and six months ended June 27, 2016 , due to increased average borrowing rates and draws on our revolving credit facility.
Income taxes. Income taxes decreased in the three and six months ended July 3, 2017 , compared to the three and six months ended June 27, 2016 , due to the impact of a switch during the second quarter of 2017 from an expected full year provision rate to a full year benefit rate.
The effective tax rate for the three months ended July 3, 2017 , was 24.5% compared to 39.1% for the three months ended June 27, 2016 . The effective tax rate for the six months ended July 3, 2017 , was 33.4% compared to 40.2% for the six months ended June 27, 2016 . The effective tax rates decreased as a result of switching to a benefit rate from a provision rate and from the negative impact of a discrete adjustment for share-based compensation expense recorded for vesting restricted common shares recorded earlier in the year. Our income taxes have varied from what would be expected from the application of prevailing statutory rates mainly due to the impact of meal and entertainment expenses and share-based compensation expenses.
Segment Results
Domestic Franchise. Total revenues for the Domestic Franchise segment were flat in the three months ended July 3, 2017 , compared to the three months ended June 27, 2016 . Total revenues for the Domestic Franchise segment decreased $1.1 million in the six months ended July 3, 2017 , compared to the six months ended June 27, 2016 , primarily due to a decline in Domestic Franchise comparable store sales of 4.3% and a reduction in the number of franchised stores period-over-period.
Adjusted EBITDA for the Domestic Franchise segment increased $2.4 million in the three months ended July 3, 2017 , compared to the three months ended June 27, 2016 , primarily due to a non-recurring adjustment of $9.1 million resulting from the impairment of our online ordering system recorded in the three months ended July 3, 2017.
Adjusted EBITDA for the Domestic Franchise segment increased $2.7 million in the six months ended July 3, 2017 , compared to the six months ended June 27, 2016 , primarily due to advertising fund expenses associated with our first national media program and the aforementioned non-recurring adjustment resulting from the impairment of our online ordering system. Advertising fund expenses exceeded fund contributions by $5.5 million and $0.8 million in the six months ended July 3, 2017 and June 27, 2016 , respectively. We expect the advertising fund deficit to largely reverse over the next 12 to 18 months. Additionally, severance and restructuring costs of $2.3 million were recorded in the six months ended July 3, 2017 .
Domestic Company Stores. Total revenues for the Domestic Company Stores segment decreased $0.8 million in the three months ended July 3, 2017 compared to the three months ended June 27, 2016 , primarily due to a decline in comparable store sales of 6.6% , partially offset by an increase in the number of total weeks all Company-owned stores were open period-over-period. Total revenues for the Domestic Company Stores segment decreased $0.7 million in the six months ended July 3, 2017 compared to the six months ended June 27, 2016 , primarily due to a decline in comparable store sales of 8.4% , partially offset by an increase in the number of total weeks all Company-owned stores were open period-over-period.
Adjusted EBITDA for the Domestic Company Stores segment decreased $0.2 million in the three months ended July 3, 2017 , compared to the three months ended June 27, 2016 , as a result of the aforementioned decline in comparable store sales and increased costs for labor and occupancy. Adjusted EBITDA for the Domestic Company Stores segment decreased $0.8 million in the six months ended July 3, 2017 , compared to the six months ended June 27, 2016 , as a result of the aforementioned decline in comparable store sales and increased costs for labor and occupancy.

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International. Total revenues for the International segment were flat for the three and six months ended July 3, 2017 , compared to the three and six months ended June 27, 2016 .
Adjusted EBITDA for the International segment increased for the three and six months ended July 3, 2017 , compared to the three and six months ended June 27, 2016 , primarily due to reductions in selling, general and administrative costs.
Liquidity and Capital Resources
Our primary sources of liquidity are cash flows from operating activities and proceeds from the incurrence of debt, which together are sufficient to fund our operations, tax payments, capital expenditures, interest, fees, and principal payments on our debt as well as support our growth strategy. If the need arises, we may seek additional funding. Our ability to obtain additional financing will depend on many factors, including prevailing market conditions, our financial condition, and our ability to negotiate favorable terms and conditions. Financing may not be available on terms that are acceptable or favorable to us, if at all.
As of July 3, 2017 , we had Cash and cash equivalents of $1.5 million and $20.0 million of available borrowings under a revolving credit facility, of which $2.4 million was drawn. As of July 3, 2017 , we had $105.5 million of outstanding indebtedness. Principal payments under our Senior Credit Facility are due on the last day of each fiscal quarter through the life of the Senior Credit Facility . We believe that our cash flows from operations, available cash and cash equivalents, and available borrowings under our revolving credit facility will be sufficient to meet our liquidity needs for at least the next 12 months.
As of July 3, 2017 , we were in compliance with all of our covenants and other obligations under our Senior Credit Facility .
Cash Flows
The following table presents a summary of cash flows from operating, investing, and financing activities for the periods presented: