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EX-31.2 - EXHIBIT 31.2 - NPC Restaurant Holdings, LLCexhibit312-2015630.htm
EX-32.1 - EXHIBIT 32.1 - NPC Restaurant Holdings, LLCexhibit321-2015630.htm
EX-31.1 - EXHIBIT 31.1 - NPC Restaurant Holdings, LLCexhibit311-2015630.htm
EX-32.2 - EXHIBIT 32.2 - NPC Restaurant Holdings, LLCexhibit322-2015630.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 ____________________________________________________________
Form 10-Q
 ____________________________________________________________
(Mark one)
ý 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2015
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 333-180524-04
 ____________________________________________________________
NPC RESTAURANT HOLDINGS, LLC
(Exact name of registrant as specified in its charter)
 ____________________________________________________________
 
DELAWARE
 
20-4509045
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. employer
identification number)
 
 
 
7300 W. 129th Street
Overland Park, KS
 
66213
(Address of principal executive offices)
 
(Zip Code)
Telephone: (913) 327-5555
(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  ¨   No  ý
(Note: As a voluntary filer, not subject to the filing requirements, the registrant filed all reports required under Section 13 or 15(d) of the Exchange Act during the preceding 12 months.)
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  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large Accelerated filer
 
¨
 
Accelerated filer
 
¨
Non-accelerated filer
 
ý
 
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
There is no market for the Registrant’s equity. As of August 14, 2015, there were 1,000 units of membership interests outstanding.





INDEX
 

2


PART I
PART 1. FINANCIAL INFORMATION

Item 1.
Consolidated Financial Statements (unaudited)

NPC RESTAURANT HOLDINGS, LLC
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands, except share data)
 
 
June 30,
2015
 
December 30,
2014
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
33,483

 
$
12,063

Accounts and other receivables
6,610

 
10,475

Inventories
10,432

 
10,591

Prepaid expenses and other current assets
5,721

 
7,565

Assets held for sale
5,479

 
5,571

Deferred income taxes
12,870

 
13,039

Income taxes receivable

 
2,606

Total current assets
74,595

 
61,910

Facilities and equipment, less accumulated depreciation of $141,328 and $118,984, respectively
198,404

 
198,122

Franchise rights, less accumulated amortization of $58,975 and $49,650, respectively
629,770

 
639,045

Goodwill
294,626

 
294,626

Other assets, net
39,398

 
42,652

Total assets
$
1,236,793

 
$
1,236,355

Liabilities and member’s equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
36,279

 
$
34,844

Accrued liabilities
45,471

 
43,397

Accrued interest
11,411

 
13,065

Income taxes payable
574

 

Current portion of insurance reserves
12,609

 
11,677

       Current portion of debt
4,158

 
4,158

Total current liabilities
110,502

 
107,141

Long-term debt
588,144

 
591,263

Other deferred items
41,212

 
41,229

Insurance reserves
19,298

 
18,974

Deferred income taxes
205,565

 
210,723

Total long-term liabilities
854,219

 
862,189

Commitments and contingencies


 


Member’s equity:
 
 
 
Membership interests (1,000 units authorized, issued and outstanding as of June 30, 2015 and December 30, 2014)

 

Member’s capital
272,072

 
267,025

Total member’s equity
272,072

 
267,025

Total liabilities and member’s equity
$
1,236,793

 
$
1,236,355

See accompanying notes to the unaudited consolidated financial statements.

3


NPC RESTAURANT HOLDINGS, LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands) 
 
13 Weeks Ended
 
26 Weeks Ended
 
June 30,
2015
 
July 1,
2014
 
June 30,
2015
 
July 1,
2014
Sales:
 
 
 
 
 
 
 
Net product sales
$
292,951

 
$
273,232

 
$
588,522

 
$
555,535

Fees and other income
13,285

 
12,674

 
26,922

 
26,624

Total sales
306,236

 
285,906

 
615,444

 
582,159

Costs and expenses:
 
 
 
 
 
 
 
Cost of sales
84,605

 
86,404

 
170,330

 
174,311

Direct labor
88,363

 
80,957

 
177,008

 
164,426

Other restaurant operating expenses
97,158

 
91,506

 
192,875

 
181,125

General and administrative expenses
17,412

 
15,684

 
34,114

 
31,143

Corporate depreciation and amortization of intangibles
5,262

 
5,097

 
10,509

 
10,194

Net facility impairment and closure costs
3,730

 
487

 
4,677

 
568

Other
355

 
(532
)
 
393

 
(308
)
Total costs and expenses
296,885

 
279,603

 
589,906

 
561,459

Operating income
9,351

 
6,303

 
25,538

 
20,700

Interest expense
10,492

 
10,042

 
20,957

 
20,204

(Loss) income before income taxes
(1,141
)
 
(3,739
)
 
4,581

 
496

Income tax benefit
(1,213
)
 
(2,365
)
 
(466
)
 
(1,086
)
Net income (loss)
$
72

 
$
(1,374
)
 
$
5,047

 
$
1,582

 

See accompanying notes to the unaudited consolidated financial statements.

4


NPC RESTAURANT HOLDINGS, LLC
CONSOLIDATED STATEMENT OF MEMBER’S EQUITY
(Unaudited)
(in thousands)
 
 
Member’s
equity
Balance at December 30, 2014
$
267,025

Net income
5,047

Balance at June 30, 2015
$
272,072

See accompanying notes to the unaudited consolidated financial statements.

5


NPC RESTAURANT HOLDINGS, LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands) 

 
26 weeks ended
 
June 30,
2015
 
July 1,
2014
Operating activities
 
 
 
Net income
$
5,047

 
$
1,582

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Depreciation and amortization
31,079

 
30,935

Amortization of debt issuance costs
1,961

 
1,928

Deferred income taxes
(4,989
)
 
(1,281
)
Net facility impairment and closure costs
4,677

 
568

Other
473

 
(584
)
Changes in assets and liabilities, excluding the effect of acquisitions:
 
 
 
Accounts receivable
3,291

 
1,993

Inventories
159

 
(932
)
Prepaid expenses and other current assets
1,844

 
(1,194
)
Accounts payable
1,435

 
6,219

Income taxes
3,180

 
(1,395
)
Accrued interest
(1,654
)
 
681

Accrued liabilities
1,365

 
2,702

Insurance reserves
1,256

 
1,685

Other deferred items
47

 
(1,366
)
Other assets
(122
)
 
(258
)
Net cash provided by operating activities
49,049

 
41,283

Investing activities
 
 
 
Capital expenditures
(26,466
)
 
(35,105
)
Proceeds from sale-leaseback transactions
1,408

 

Proceeds from sale or disposition of assets
548

 
2,373

Net cash used in investing activities
(24,510
)
 
(32,732
)
Financing activities
 
 
 
Borrowings under revolving credit facility
59,000

 
60,800

Payments under revolving credit facility
(59,000
)
 
(67,800
)
Issuance of debt

 
40,000

Payments on term bank facilities
(3,119
)
 
(1,665
)
Debt issue costs

 
(693
)
Purchase of Company stock

 
(60
)
Payment of accrued purchase price to sellers

 
(10,875
)
Net cash (used in) provided by financing activities
(3,119
)
 
19,707

Net change in cash and cash equivalents
21,420

 
28,258

Beginning cash and cash equivalents
12,063

 
20,035

Ending cash and cash equivalents
$
33,483

 
$
48,293

Supplemental disclosures of cash flow information:
 
 
 
Net cash paid for interest
$
20,571

 
$
17,519

Net cash paid for income taxes
$
1,345

 
$
3,342


See accompanying notes to the unaudited consolidated financial statements.

6


NPC RESTAURANT HOLDINGS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 – Basis of Presentation, Interim Financial Statements and Accounting Policies
NPC Restaurant Holdings, LLC is referred to herein as “Holdings.” Holdings and its subsidiaries are referred to herein as the “Company.” Holdings’ wholly-owned subsidiary, NPC International, Inc., is referred to herein as “NPC.” NPC’s wholly-owned subsidiary, NPC Quality Burgers, Inc., is referred to herein as “NPCQB.” On December 28, 2011, all of the outstanding membership interests of Holdings were acquired by NPC International Holdings, Inc. (“NPC Holdings” or “Parent”), an entity controlled by Olympus Growth Fund V, L.P. and certain of its affiliates (“Olympus” or “Sponsor”).
Certain reclassifications have been made to the Consolidated Statements of Operations (unaudited) to conform to current year reporting.
The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for reporting on Form 10-Q. Accordingly, certain information and disclosures required by accounting principles generally accepted in the United States (“GAAP”) for complete consolidated financial statements are not included herein.
The unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s latest Annual Report on Form 10-K.
The results of operations of any interim period are not necessarily indicative of the results of operations for the full year. The Company believes the accompanying unaudited interim consolidated financial statements include all adjustments (consisting of normal recurring adjustments and accruals) necessary to fairly present the Company’s consolidated results of operations, financial position and cash flows as of the dates and for the periods presented.
The preparation of the unaudited interim consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions about future events relating to the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amount of revenue and expenses during the reporting periods. Estimates are revised when facts and circumstances change. As such, actual results could differ materially from those estimates.
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in GAAP when it becomes effective. In July 2015, the FASB approved a one-year deferral of the effective date of the new revenue recognition standard which will become effective for the Company beginning with the first quarter of fiscal 2018. The standard can be adopted either retrospectively to each prior reporting period presented or as a cumulative effect adjustment as of the date of adoption. Under the proposal, early application would be permitted, but not before the original effective date. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which describes how an entity should assess its ability to meet obligations and sets rules for how this information should be disclosed in the financial statements.  This new standard is effective for the first annual period ending after December 15, 2016, and interim periods thereafter, with early adoption permitted.  The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial statements.
In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30) (“ASU 2015-03”), which simplifies the presentation of debt issuance costs. ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU 2015-03 is effective for financial statements issued for fiscal years beginning after December 15, 2015 (and interim periods within those fiscal years) with early adoption permitted and retrospective application required. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial statements.
Note 2 – Goodwill and Other Intangible Assets
There were no changes in goodwill for the 26 weeks ended June 30, 2015.

7


The carrying value of the Company’s goodwill is included in the Pizza Hut and Wendy’s reporting units. The Company assesses goodwill, which is not subject to amortization, for impairment annually in its second quarter, and also at any other date when events or changes in circumstances indicate that the carrying value of these assets may exceed their fair value. The Company based its goodwill impairment testing for the Wendy’s reporting unit on a qualitative assessment. As a result of negative comparable store sales in the Company’s Pizza Hut operations, the Company performed a quantitative assessment and estimated the fair value of the Pizza Hut reporting unit using the discounted expected future cash flows. As a result of the Company’s annual impairment testing in the second quarter, the Company determined that goodwill was not impaired.
Amortizable other intangible assets consist of franchise rights and leasehold interests. These intangible assets are amortized on a straight-line basis over the lesser of their economic lives or the remaining life of the applicable agreement. Intangible assets subject to amortization are summarized below (in thousands):
 
 
June 30, 2015
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
Amortizable intangible assets:
 
 
 
 
 
Franchise rights
$
688,745

 
$
(58,975
)
 
$
629,770

Favorable leasehold interests
13,850

 
(3,776
)
 
10,074

Unfavorable leasehold interests
(17,105
)
 
7,145

 
(9,960
)
 
$
685,490

 
$
(55,606
)
 
$
629,884


 
December 30, 2014
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Book
Value
Amortizable intangible assets:
 
 
 
 
 
Franchise rights
$
688,695

 
$
(49,650
)
 
$
639,045

Favorable leasehold interests
14,479

 
(3,679
)
 
10,800

Unfavorable leasehold interests
(17,417
)
 
6,447

 
(10,970
)
 
$
685,757

 
$
(46,882
)
 
$
638,875

Amortization expense on intangible assets was $4.6 million and $4.2 million for the 13-week periods ended June 30, 2015 and July 1, 2014, respectively and $9.0 million and $8.4 million for the 26-week periods ended June 30, 2015 and July 1, 2014, respectively.
Note 3 – Debt
The Company’s debt consisted of the following (in thousands):
 
 
June 30,
2015
 
December 30,
2014
Term Loan
$
402,302

 
$
405,421

Senior Notes
190,000

 
190,000

Revolving Facility ($110 million) (1)

 

 
592,302

 
595,421

Less current portion
4,158

 
4,158

 
$
588,144

 
$
591,263

 
(1) 
The Company had $90.9 million of borrowing capacity available under its revolving credit facility (“Revolving Facility”), net of $19.1 million of outstanding letters of credit at June 30, 2015 and at December 30, 2014.

The Company’s debt facilities contain restrictions on additional borrowings, certain asset sales, capital expenditures, dividend payments, certain investments and related-party transactions, as well as requirements to maintain various financial ratios. At June 30, 2015, the Company was in compliance with all of its debt covenants.

Based upon the amount of excess cash flow generated during the fiscal year and the Company’s leverage at fiscal year end, each of which is defined in the credit agreement governing the term loan, the Company may be required to make an excess cash

8


flow mandatory prepayment. The excess cash flow mandatory prepayment is an annual requirement under the credit agreement and is due 95 days after the end of each fiscal year. The Company currently estimates that it may be required to make a payment of $5.0 million to $7.0 million in fiscal 2016. However, because this is a preliminary estimate, it is possible that no excess cash flow mandatory prepayment could ultimately be required.
Note 4 – Fair Value Measurements
The Company classifies and discloses assets and liabilities carried at fair value in one of the following three categories:
Level 1: Unadjusted quoted prices available in active markets for identical assets or liabilities.
Level 2: Pricing inputs, other than Level 1 quoted prices, 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 by observable market data. These inputs are frequently utilized in pricing models, discounted cash flow techniques and other widely accepted valuation methodologies.
Level 3: Unobservable inputs that are not corroborated by market data, which requires the Company to develop its own assumptions.
The following tables summarize the carrying amounts and fair values of certain assets at June 30, 2015 and December 30, 2014, (in thousands):
 
June 30, 2015
 
 
 
Fair Value Estimated Using
 
Carrying Amount
 
 
Level 1 Inputs
 
Level 2 Inputs
 
Level 3 Inputs
Equities(1)
$
9,820

 
 
$
6,198

 
$
3,622

 
$

Fixed income(1)
5,112

 
 
1,201

 
3,911

 

Money market fund(2)
29,095

 
 

 
29,095

 

 
 
 
 
 
 
 
 
 
 
December 30, 2014
 
 
 
Fair Value Estimated Using
 
Carrying Amount
 
 
Level 1 Inputs
 
Level 2 Inputs
 
Level 3 Inputs
Equities(1)
$
10,053

 
 
$
6,678

 
$
3,375

 
$

Fixed income(1)
5,355

 
 
1,542

 
3,813

 

Money market fund(2)
7,602

 
 

 
7,602

 

`
(1) 
These investments relate to the Deferred Compensation Plan and the POWR Plan and are located in the other assets line item on the Consolidated Balance Sheets. The investments categorized as Level 2 in the fair value hierarchy are valued by using available market information which includes quoted market prices for identical or similar assets in non-active markets.
(2) 
At June 30, 2015 and December 30, 2014, $0.3 million and $0.5 million, respectively, of the balances in the money market fund related to the Deferred Compensation and POWR Plans and were located in the other assets line item on the Consolidated Balance Sheets. The remaining balances in the money market fund were short-term in nature and were classified in cash and cash equivalents on the Consolidated Balance Sheets. Money market funds are valued at amortized cost which reflects the market-based fair value.
The estimated fair value of the Company’s outstanding borrowings was as follows (in thousands):
 
 
June 30, 2015
 
December 30, 2014
Term Loan
$
396,268

 
$
391,231

Senior Notes
198,550

 
196,650

Revolving Facility

 

 
$
594,818

 
$
587,881

Carrying value
$
592,302

 
$
595,421

The Company measures the fair value of its debt facilities under a Level 2 observable input which consists of quotes from non-active markets. However, the fair value estimates presented herein are not necessarily indicative of the amount that the Company’s debtholders could realize in a current market exchange. Cash and cash equivalents (excluding the money market fund),

9


accounts and other receivables and accounts payable are carried at cost which approximates fair value because of the short-term nature of these instruments.  
The Company reviews long-lived assets related to each unit semi-annually in the second and fourth quarters for indicators of impairment and at any other date when events or changes in circumstances indicate that the carrying value of these assets may exceed their fair value and the carrying amount of a unit’s leasehold improvements and equipment may not be recoverable. Based on the best information available, impaired leasehold improvements and certain personal property are written down to estimated fair market value, which becomes the new cost basis. Additionally, when a commitment is made to close a unit beyond the quarter, any remaining leasehold improvements and all personal property are reviewed for impairment and depreciable lives are adjusted.
The table below summarizes restaurant-level impairment (Level 3) for the periods presented (in thousands):
 
13 Weeks Ended
 
26 Weeks Ended
 
June 30, 2015
 
July 1, 2014
 
June 30, 2015
 
July 1, 2014
Total asset impairments and closures
$
3,730

 
$
487

 
$
4,677

 
$
568

Note 5 – Income Taxes
For the 26 weeks ended June 30, 2015, the Company recorded an income tax benefit of $0.5 million compared to an income tax benefit of $1.1 million for the same period of the prior year. The tax benefit for the 26 weeks ended June 30, 2015 was primarily due to federal employment-related tax credits in relation to projected pre-tax income. The tax benefit for the 26 weeks ended
June 30, 2015 was determined by applying the estimated annual tax rate to interim financial results.
Accounting Standards Codification 740 (“ASC 740”), requires companies to apply their estimated annual tax rate on a year-to-date basis in each interim period. Under ASC 740, companies should not apply the estimated annual tax rate to interim financial results if the estimated annual tax rate is not reliably predictable. In this situation, the interim tax rate should be based on the actual year-to-date results. For the 26 weeks ended July 1, 2014, a reliable projection of the Company’s annual effective rate was difficult to determine, producing significant variations in the customary relationship between income tax expense and pre-tax book income. As such, the Company recorded an income tax benefit of $2.3 million for the 26 weeks ended July 1, 2014 based on actual year-to-date results. This benefit was primarily related to federal employment-related tax credits and was partially offset by income tax expense of $1.2 million for an adjustment to deferred taxes for a change in the applicable state income tax rate.
The Company files a consolidated US federal tax return with its parent company, NPC Holdings. The Company allocates taxes between it and the Parent utilizing the separate return method.
The liability for uncertain tax positions was $2.7 million and $2.8 million at June 30, 2015 and December 30, 2014, respectively.
Note 6 – Accrued Liabilities
Accrued liabilities consist of the following (in thousands):
 
 
June 30, 2015
 
December 30, 2014
Payroll and vacation
$
17,700

 
$
16,535

Accrued real estate and property taxes
6,045

 
5,528

Sales tax payable
4,683

 
4,978

Other
17,043

 
16,356

 
$
45,471

 
$
43,397

Note 7 – Commitments and Contingencies

From time to time, the Company is involved in litigation, most of which is incidental to its business. In the Company’s opinion, no litigation to which the Company currently is a party is likely to have a material adverse effect on the Company’s consolidated financial condition, results of operations or cash flows.

10


Note 8 – Transactions with Sponsor
Olympus Advisory Agreement. On December 28, 2011, the Company entered into a management advisory agreement with the Sponsor pursuant to which the Sponsor or its affiliates provide financial, investment banking, management advisory and other services on the Company’s behalf for an annual fee of $1.0 million, paid in quarterly installments in arrears on the last day of each calendar quarter. The Company accrues the fee ratably to general and administrative expenses. The Sponsor also receives reimbursement for out-of-pocket expenses incurred in connection with services provided pursuant to the agreement.

Note 9 – Condensed Consolidating Financial Statements
NPC’s obligations under the 10 1/2% Senior Notes due 2020 and Senior Secured Credit Facilities are fully guaranteed by Holdings. As of the date hereof, Holdings’ only material asset is 100% of the stock of NPC. The remaining co-issuers with NPC, NPCQB and NPC Operating Company B, Inc. (“NPC Op Co B”) are 100% owned by NPC. NPC Op Co B does not have any assets, operations or cash flows as of or for the period ended June 30, 2015. Holdings and subsidiary guarantees are joint and several, full and unconditional. The following summarizes the Company’s condensed consolidating information as of June 30, 2015 and December 30, 2014, and for each of the 13-week and 26-week periods ended June 30, 2015 and July 1, 2014, respectively (in thousands):
Condensed Consolidating Statements of Operations
 
 
 
 
 
 
 
 
 
 
 
 
 
13 Weeks Ended June 30, 2015
 
Parent
 
Subsidiary
 
Subsidiary
 
Subsidiary
 
 
 
 
 
Guarantor:
Holdings
 
Issuer:
NPC
 
Co-Issuer:
NPCQB
 
Co-Issuer:
NPC Op
Co B
 
Eliminations
 
Consolidated
Total sales
$

 
$
253,911

 
$
52,325

 
$

 
$

 
$
306,236

Total costs and expenses

 
247,557

 
49,328

 

 

 
296,885

Operating income

 
6,354

 
2,997

 

 

 
9,351

Interest expense

 
10,492

 

 

 

 
10,492

Equity in net income of subsidiary
72

 
3,643

 

 

 
(3,715
)
 

Income (loss) before income taxes
72

 
(495
)
 
2,997

 

 
(3,715
)
 
(1,141
)
Income tax benefit

 
(567
)
 
(646
)
 

 

 
(1,213
)
Net income
$
72

 
$
72

 
$
3,643

 
$

 
$
(3,715
)
 
$
72



 
 
 
 
 
 
 
 
 
 
 
 
 
13 Weeks Ended July 1, 2014
 
Parent
 
Subsidiary
 
Subsidiary
 
Subsidiary
 
 
 
 
 
Guarantor:
Holdings
 
Issuer:
NPC
 
Co-Issuer:
NPCQB
 
Co-Issuer:
NPC Op
Co B
 
Eliminations
 
Consolidated
Total sales
$

 
$
252,847

 
$
33,059

 
$

 
$

 
$
285,906

Total costs and expenses

 
247,780

 
31,823

 

 

 
279,603

Operating income

 
5,067

 
1,236

 

 

 
6,303

Interest expense

 
10,042

 

 

 

 
10,042

Equity (deficit) in net income of subsidiary
(1,374
)
 
797

 

 

 
577

 

(Loss) income before income taxes
(1,374
)
 
(4,178
)
 
1,236

 

 
577

 
(3,739
)
Income tax (benefit) expense

 
(2,804
)
 
439

 

 

 
(2,365
)
Net (loss) income
$
(1,374
)
 
$
(1,374
)
 
$
797

 
$

 
$
577

 
$
(1,374
)


 

11


 
 
 
 
 
 
 
 
 
 
 
 
 
26 Weeks Ended June 30, 2015
 
Parent
 
Subsidiary
 
Subsidiary
 
Subsidiary
 
 
 
 
 
Guarantor:
Holdings
 
Issuer:
NPC
 
Co-Issuer:
NPCQB
 
Co-Issuer:
NPC Op
Co B
 
Eliminations
 
Consolidated
Total sales
$

 
$
514,478

 
$
100,966

 
$

 
$

 
$
615,444

Total costs and expenses

 
493,409

 
96,497

 

 

 
589,906

Operating income

 
21,069

 
4,469

 

 

 
25,538

Interest expense

 
20,957

 

 

 

 
20,957

Equity in net income of subsidiary
5,047

 
4,923

 

 

 
(9,970
)
 

Income before income taxes
5,047

 
5,035

 
4,469

 

 
(9,970
)
 
4,581

Income tax benefit

 
(12
)
 
(454
)
 

 

 
(466
)
Net income
$
5,047

 
$
5,047

 
$
4,923

 
$

 
$
(9,970
)
 
$
5,047

 
 
 
 
 
 
 
 
 
 
 
 
 
26 Weeks Ended July 1, 2014
 
Parent
 
Subsidiary
 
Subsidiary
 
Subsidiary
 
 
 
 
 
Guarantor:
Holdings
 
Issuer:
NPC
 
Co-Issuer:
NPCQB
 
Co-Issuer:
NPC Op
Co B
 
Eliminations
 
Consolidated
Total sales
$

 
$
519,215

 
$
62,944

 
$

 
$

 
$
582,159

Total costs and expenses

 
499,750

 
61,709

 

 

 
561,459

Operating income

 
19,465

 
1,235

 

 

 
20,700

Interest expense

 
20,204

 

 

 

 
20,204

Equity in net income of subsidiary
1,582

 
788

 

 

 
(2,370
)
 

Income before income taxes
1,582

 
49

 
1,235

 

 
(2,370
)
 
496

Income tax (benefit) expense

 
(1,533
)
 
447

 

 

 
(1,086
)
Net income
$
1,582

 
$
1,582

 
$
788

 
$

 
$
(2,370
)
 
$
1,582



12



Condensed Consolidating Balance Sheet
 
 
June 30, 2015
 
Parent
 
Subsidiary
 
Subsidiary
 
Subsidiary
 
 
 
 
 
Guarantor:
Holdings
 
Issuer:
NPC
 
Co-Issuer:
NPCQB
 
Co-Issuer:
NPC Op
Co B
 
Eliminations
 
Consolidated
Assets:
 
 
 
 
 
 
 
 
 
 
 
Current assets
$

 
$
65,310

 
$
9,285

 
$

 
$

 
$
74,595

Facilities and equipment, net

 
160,809

 
37,595

 

 

 
198,404

Franchise rights, net

 
584,885

 
44,885

 

 

 
629,770

Goodwill

 
290,502

 
4,124

 

 

 
294,626

Investment in subsidiary
272,072

 
75,112

 

 

 
(347,184
)
 

Other assets, net

 
37,577

 
1,821

 

 

 
39,398

Total assets
$
272,072

 
$
1,214,195

 
$
97,710

 
$

 
$
(347,184
)
 
$
1,236,793

Liabilities and member’s equity:
 
 
 
 
 
 
 
 
 
 
 
Current liabilities
$

 
$
89,838

 
$
20,664

 
$

 
$

 
$
110,502

Long-term debt

 
588,144

 

 

 

 
588,144

Other liabilities and deferred items

 
54,943

 
5,567

 

 

 
60,510

Deferred income taxes

 
209,198

 
(3,633
)
 

 

 
205,565

Member’s equity
272,072

 
272,072

 
75,112

 

 
(347,184
)
 
272,072

Total liabilities and member’s equity
$
272,072

 
$
1,214,195

 
$
97,710

 
$

 
$
(347,184
)
 
$
1,236,793

 
 
December 30, 2014
 
Parent
 
Subsidiary
 
Subsidiary
 
Subsidiary
 
 
 
 
 
Guarantor:
Holdings
 
Issuer:
NPC
 
Co-Issuer:
NPCQB
 
Co-Issuer:
NPC Op
Co B
 
Eliminations
 
Consolidated
Assets:
 
 
 
 
 
 
 
 
 
 
 
Current assets
$

 
$
51,700

 
$
10,210

 
$

 
$

 
$
61,910

Facilities and equipment, net

 
162,248

 
35,874

 

 

 
198,122

Franchise rights, net

 
592,633

 
46,412

 

 

 
639,045

Goodwill

 
290,502

 
4,124

 

 

 
294,626

Investment in subsidiary
267,025

 
75,902

 

 

 
(342,927
)
 

Other assets, net

 
40,794

 
1,858

 

 

 
42,652

Total assets
$
267,025

 
$
1,213,779

 
$
98,478

 
$

 
$
(342,927
)
 
$
1,236,355

Liabilities and member’s equity:
 
 
 
 
 
 
 
 
 
 
 
Current liabilities
$

 
$
90,701

 
$
16,440

 
$

 
$

 
$
107,141

Long-term debt

 
591,263

 

 

 

 
591,263

Other liabilities and deferred items

 
55,467

 
4,736

 

 

 
60,203

Deferred income taxes

 
209,323

 
1,400

 

 

 
210,723

Member’s equity
267,025

 
267,025

 
75,902

 

 
(342,927
)
 
267,025

Total liabilities and member’s equity
$
267,025

 
$
1,213,779

 
$
98,478

 
$

 
$
(342,927
)
 
$
1,236,355



13



Condensed Consolidating Statements of Cash Flows
 
 
26 Weeks Ended June 30, 2015
 
Parent
 
Subsidiary
 
Subsidiary
 
Subsidiary
 
 
 
 
 
Guarantor:
Holdings
 
Issuer:
NPC
 
Co-Issuer:
NPCQB
 
Co-Issuer:
NPC Op
Co B
 
Eliminations
 
Consolidated
Operating activities:
 
 
 
 
 
 
 
 
 
 
 
Net cash flows provided by operating activities
$

 
$
37,079

 
$
11,970

 
$

 
$

 
$
49,049

Investing activities:
 
 
 
 
 
 
 
 
 
 
 
Capital expenditures

 
(20,214
)
 
(6,252
)
 

 

 
(26,466
)
Return of investment in NPCQB

 
5,713

 

 

 
(5,713
)
 

Proceeds from sale-leaseback transactions

 
1,408

 

 

 

 
1,408

Proceeds from sale or disposition of assets

 
499

 
49

 

 

 
548

Net cash flows used in investing activities

 
(12,594
)
 
(6,203
)
 

 
(5,713
)
 
(24,510
)
Financing activities:
 
 
 
 
 
 
 
 
 
 
 
Net payments on debt

 
(3,119
)
 

 

 

 
(3,119
)
Distribution to parent

 

 
(5,713
)
 

 
5,713

 

Net cash flows used in financing activities

 
(3,119
)
 
(5,713
)
 

 
5,713

 
(3,119
)
Net change in cash and cash equivalents

 
21,366

 
54

 

 

 
21,420

Beginning cash and cash equivalents

 
11,278

 
785

 

 

 
12,063

Ending cash and cash equivalents
$

 
$
32,644

 
$
839

 
$

 
$

 
$
33,483



14


 
26 Weeks Ended July 1, 2014
 
Parent
 
Subsidiary
 
Subsidiary
 
Subsidiary
 
 
 
 
 
Guarantor:
Holdings
 
Issuer:
NPC
 
Co-Issuer:
NPCQB
 
Co-Issuer:
NPC Op
Co B
 
Eliminations
 
Consolidated
Operating activities:
 
 
 
 
 
 
 
 
 
 
 
Net cash flows provided by operating activities
$

 
$
31,824

 
$
9,459

 
$

 
$

 
$
41,283

Investing activities:
 
 
 
 
 
 
 
 
 
 
 
Capital expenditures

 
(32,895
)
 
(2,210
)
 

 

 
(35,105
)
Return of investment in NPCQB

 
7,622

 

 

 
(7,622
)
 

Proceeds from sale or disposition of assets

 
2,351

 
22

 

 

 
2,373

Net cash flows used in investing activities

 
(22,922
)
 
(2,188
)
 

 
(7,622
)
 
(32,732
)
Financing activities:
 
 
 
 
 
 
 
 
 
 
 
Payment of accrued purchase price to sellers

 
(10,875
)
 

 

 

 
(10,875
)
Net payments on debt

 
(8,665
)
 

 

 

 
(8,665
)
Issuance of debt

 
40,000

 

 

 

 
40,000

Distribution to parent

 

 
(7,622
)
 

 
7,622

 

Other

 
(753
)
 

 

 

 
(753
)
Net cash flows provided by (used in) financing activities

 
19,707

 
(7,622
)
 

 
7,622

 
19,707

Net change in cash and cash equivalents

 
28,609

 
(351
)
 

 

 
28,258

Beginning cash and cash equivalents

 
19,170

 
865

 

 

 
20,035

Ending cash and cash equivalents
$

 
$
47,779

 
$
514

 
$

 
$

 
$
48,293



15



Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
As used in this report, NPC Restaurant Holdings, LLC is referred to herein as “Holdings.” Holdings and its subsidiaries are referred to as the “Company,” “we” “us,” and “our.” Holdings’ wholly-owned subsidiary, NPC International, Inc. is referred to as “NPC.” NPC’s wholly-owned subsidiary, NPC Quality Burgers, Inc., is referred to herein as “NPCQB.”
Trademarks and Trade Names
The trade name “Pizza Hut” and all other trade names, trademarks, service marks, symbols, slogans, emblems, logos and designs used in the Pizza Hut system and appearing in this Form 10-Q are owned by Pizza Hut, Inc. (“PHI”) and are licensed to us for use with respect to the operation and promotion of our Pizza Hut restaurants. The “WingStreet” name is a trademark of WingStreet, LLC, an entity controlled by Yum! Brands, Inc. (“Yum!”). The trade name “Wendy’s” and all other trade names, trademarks, service marks, symbols, slogans, emblems, logos and designs used in the Wendy’s system and appearing in this Form 10-Q are owned by The Wendy’s Company and its subsidiaries (“Wendy’s”) and are licensed to us for use with respect to the operation and promotion of our Wendy’s restaurants. All other trademarks or trade names appearing in this Form 10-Q are the property of their respective owners. Solely for convenience, trademarks and trade names referred to in this Form 10-Q may appear without the ® or ™ symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or the right of the applicable licensor to these trademarks and trade names.
Market and Industry Data
In this Form 10-Q, we refer to information regarding the U.S. restaurant industry and the quick service restaurant sector from publicly available market research reports and other publicly available information. Unless otherwise indicated, corporate information regarding PHI in this Form 10-Q has been made publicly available by Yum! and corporate information regarding Wendy's has been made publicly available by Wendy’s International, LLC. We have not independently verified such data and we make no representations as to the accuracy of such information. None of the reports referred to in this Form 10-Q were prepared for use in, or in connection with, this Form 10-Q.
Cautionary Statement Regarding Forward Looking Information
This report includes forward-looking statements regarding, among other things, our plans, strategies, and prospects, both business and financial. All statements contained in this document other than historical information are forward-looking statements. Forward-looking statements include, but are not limited to, statements that represent our beliefs concerning future operations, strategies, financial results or other developments, and may contain words and phrases such as “may,” “expect,” “should,” “anticipate,” “intend,” or similar expressions. Because these forward-looking statements are based on estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our control or are subject to change, actual results could be materially different. Although we believe that our plans, intentions and expectations reflected in or suggested by these forward-looking statements are reasonable, there can be no assurance we will achieve or realize these plans, intentions or expectations. Forward-looking statements are inherently subject to risks, uncertainties and assumptions. Important factors that could cause actual results to differ materially from our forward-looking statements, expectations and historical trends include, but are not limited to, the following:
competitive conditions;
general economic and market conditions;
effectiveness of franchisor advertising programs and the overall success of our franchisors;
increases in commodity, labor, fuel and other costs;
effectiveness of the hedging program for cheese prices directed by Restaurant Supply Chain Solutions, LLC (“RSCS”) for the Pizza Hut system;
significant disruptions in service or supply by any of our suppliers or distributors;
changes in consumer tastes, geographic concentration and demographic patterns;
consumer concerns about health and nutrition;
our ability to manage our growth and successfully implement our business strategy;
the risks associated with the expansion of our business, including risks relating to the integration of the Wendy’s restaurants acquired by us;
the effect of disruptions to our computer and information systems or cyber attacks;
the effect of local conditions, events and natural disasters;
general risks associated with the restaurant industry;
the outcome of pending or yet-to-be instituted legal proceedings;
regulatory factors, including changing laws and regulations related to healthcare coverage, employee matters and menu labeling, which may adversely affect our business and results of operations;

16


the loss of our executive officers and certain key personnel;
our ability to service our substantial indebtedness and to comply with the related financial covenants;
restrictions contained in our debt agreements;
availability, terms and deployment of capital;
our ability to obtain debt or equity financing on reasonable terms or at costs similar to that of our current credit facilities; and
various other factors beyond our control.
Any forward-looking statements made in this report speak only as of the date of this report. Consequently, such forward-looking statements should be regarded solely as our current plans, estimates and beliefs. We do not intend, and do not undertake, any obligation to update any forward-looking statements to reflect future events or circumstances after the date of such statements. For a more detailed discussion of the principal factors that could cause actual results to be materially different, you should read our risk factors in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 30, 2014 (“2014 Form 10-K”) as well as our unaudited consolidated financial statements, related notes, and other financial information appearing elsewhere in this report and our other filings with the Securities and Exchange Commission (“SEC”), which are available on the SEC’s website at www.sec.gov.
Overview
NPC was founded in 1962, is the largest franchisee of any restaurant concept in the United States (U.S.), based on unit count, according to the 2015 “Top 200 Restaurant Franchisees” by the Restaurant Finance Monitor, and is the eighth largest restaurant unit operator, based on unit count, in the U.S.
Our Pizza Hut operations. We are the largest Pizza Hut franchisee and as of June 30, 2015 we operated 1,262 Pizza Hut units in 28 states with significant presence in the Midwest, South and Southeast. As of June 30, 2015, our Pizza Hut operations represented approximately 20% of the domestic Pizza Hut restaurant system and 22% of the domestic Pizza Hut franchised restaurant system as measured by number of units, excluding licensed units which operate with a limited menu and no delivery in certain of our markets.
Our Wendy’s operations. As of June 30, 2015, we operated 143 Wendy’s units in 5 states. We expect to continue to expand our Wendy’s operations from the opportunistic acquisitions of restaurants in additional markets and through organic growth by developing new restaurants that meet our investment objectives. All of the Wendy’s restaurants are owned and operated by NPCQB and are primarily located in and around the Salt Lake City, Greensboro-Winston Salem and Kansas City metropolitan areas.
Our Fiscal Year. We operate on a 52- or 53-week fiscal year ending on the last Tuesday in December. Fiscal years 2015 and 2014 each contain 52 weeks. Each quarterly period in fiscal years 2015 and 2014 has 13 weeks.

Unless otherwise noted, the discussion below references both our Pizza Hut and Wendy’s operations.
Our Sales
Net Product Sales. Net product sales are comprised of sales of food and beverages from our restaurants, net of discounts. For the 26 weeks ended June 30, 2015, pizza sales accounted for approximately 77% of our Pizza Hut net product sales. Hamburger and chicken sandwiches accounted for approximately 50% of our Wendy’s net product sales. Various factors influence sales at a given unit, including customer recognition of the Pizza Hut and Wendy’s brands, our level of service and operational effectiveness, pricing, marketing and promotional efforts and local competition. Several factors affect our sales in any period, including the number of units in operation, comparable store sales and seasonality. “Comparable store sales” refer to period-over-period net product sales comparisons for units under our operation for at least 12 months.
Fees and Other Income. Fees and other income for our Pizza Hut operations are comprised primarily of delivery fees charged to customers, vending receipts and other fee income and are not included in our comparable store sales metric.
Seasonality. Our Pizza Hut business is moderately seasonal in nature with net product sales typically being higher in the first half of the fiscal year. Our Wendy’s business is also moderately seasonal in nature with net product sales typically being higher in the spring and summer months. As a result of these seasonal fluctuations, our operating results may vary between fiscal quarters. Further, results for any quarter are not necessarily indicative of the results that may be achieved for the full fiscal year.

Restaurants and Formats. We operate our Pizza Hut restaurants through three different formats to cater to the needs of our customers in each respective market. Delivery units, or “Delcos,” are typically located in strip centers and provide delivery and carryout, with a greater proportion being located in more densely populated areas. Red Roof units, or “RRs,” are traditional free-standing, dine-in restaurants which offer on-location dining room service as well as carryout service. Restaurant-Based Delivery units, or “RBDs,” conduct delivery, dine-in, and carryout operations from the same free-standing location. At June 30, 2015,

17


approximately 96% of our Pizza Hut units include the WingStreet product line. We converted 74 units to include the WingStreet product line during the 26 weeks ended June 30, 2015 and currently expect to convert 17 additional units to WingStreet during fiscal 2015. The WingStreet menu includes bone-in and bone-out fried chicken wings which are tossed in one of eight sauces and appetizers which are available for dine-in, carryout and delivery.
    
Our Wendy’s restaurants are generally free-standing and include a pick-up window in addition to a dining room with counter service. Each Wendy’s restaurant offers an extensive menu specializing in hamburger sandwiches and featuring chicken breast sandwiches, which are prepared to order with the customer’s choice of condiments. The Wendy’s menu also includes chicken nuggets, chili, french fries, baked potatoes, freshly prepared salads, soft drinks, Frosty® desserts and kids’ meals.
The following table sets forth certain information with respect to each year-to-date fiscal period:
 
 
26 Weeks Ended
 
 
June 30, 2015
 
July 1, 2014
 
Number of restaurants open at the end of the period:
 
 
 
 
  Pizza Hut
 
 
 
 
Delco
602

 
578

 
RR
155

 
165

 
RBD
505

 
522

 
   Total Pizza Hut units
1,262

(1) 
1,265

(1) 
  Wendy’s units
143

 
90

 
   Total units
1,405

 
1,355

 
 
(1) 
Includes 1,217 units and 1,036 units offering the WingStreet product line at June 30, 2015 and July 1, 2014, respectively.
Our Costs
Our operating costs and expenses are comprised of cost of sales, direct labor, other restaurant operating expenses and general and administrative expenses. Our cost structure is highly variable with approximately 70% of operating costs variable to sales and volume of transactions.
Cost of Sales. Cost of sales includes the cost of food and beverage products sold, less rebates from suppliers, as well as paper and packaging, and is primarily influenced by fluctuation in commodity prices. Historically, our Pizza Hut cost of sales has primarily been comprised of the following: cheese: 30-35%; dough: 16-20%; meat: 16-20%; and packaging: 8-10%. These costs can fluctuate from year-to-year given the commodity nature of the cost category, but are constant across regions. We are a member of the RSCS, a cooperative designed to operate as a central procurement service for the operators of Yum! restaurants, and participate in various cheese hedging and procurement programs that are directed by the RSCS for cheese, meat and certain other commodities to help reduce the price volatility of those commodities from period-to-period. Based on information provided by the RSCS, the RSCS typically hedges approximately 30% to 50% of the Pizza Hut system’s anticipated cheese purchases through a combination of derivatives taken under the direction of the RSCS. Additionally, the RSCS has entered into contractual pricing arrangements with the supplier to restaurants in the Pizza Hut system on cheese purchases that may cause the prices paid by us to exceed or be less than the current block cheese price.

Our Wendy’s cost of sales is primarily comprised of the following: beef and chicken: 40-42%; packaging: 11-13%; potatoes: 8-10%; and dairy: 8-10%. These costs can fluctuate from year-to-year given the commodity nature of the cost category, but are constant across regions.Wendy’s and its franchisees have established Quality Supply Chain Co-op, Inc. to manage contracts for the purchase and distribution of food, proprietary paper, operating supplies and equipment under national contracts with pricing based upon total system volume for the Wendy’s system in the United States and Canada.
Direct Labor. Direct labor includes the salary, payroll taxes, fringe benefit costs and workers’ compensation expense associated with restaurant based personnel. Direct labor is highly dependent on federal and state minimum wage rate legislation given that the vast majority of our workers are hourly employees. To control labor costs, we are focused on proper scheduling and adequate training of our store employees, as well as retention of existing employees.

Other Restaurant Operating Expenses. Other restaurant operating expenses (“OROE”) include all other costs directly associated with operating a restaurant facility, which primarily represents royalties, advertising, occupancy costs (rent, utilities,

18


repairs and other facility-related expenses), depreciation (facilities and equipment), delivery expenses (for our Pizza Hut operations), supplies, insurance (excluding workers’ compensation) and other restaurant-related costs.    

Beginning in fiscal 2012, PHI began offering development incentives totaling $80,000 per new unit developed (the “Development Incentive”), subject to certain threshold criteria. These incentives are recorded as a reduction to OROE in the year the qualifying asset is opened. The offering of Development Incentives is renewable annually at PHI’s discretion and was renewed for fiscal 2015, with modified threshold criteria.
Additionally, PHI is offering development incentives totaling $10,000 per unit converted to the WingStreet platform (the “WingStreet Incentive”), for fiscal 2013 through fiscal 2015. WingStreet Incentives earned under the program are recorded as a reduction to OROE upon completion of each unit conversion and will be received within 12 months of unit conversion. We converted 74 units during the 26 weeks ended June 30, 2015 that were eligible for the incentive and we currently expect to convert an additional 17 units during fiscal 2015 which will complete our WingStreet conversion program.
Our blended average Pizza Hut royalty rate (excluding Development Incentives and WingStreet Incentives) as a percentage of total sales was 4.9% for both the 26 week periods ended June 30, 2015 and July 1, 2014. Our blended average Wendy’s royalty rate as a percentage of total sales was 3.9% for both the 26 week periods ended June 30, 2015 and July 1, 2014.
General and Administrative expenses. General and administrative expenses include field supervision and personnel costs and the corporate and administrative functions that support our restaurants, including employee wages and benefits, travel, information systems, recruiting and training costs, credit card transaction fees, professional fees, supplies and insurance.    
Impairment and Closure Costs. Impairment and closure costs include any impairment of long-lived assets, including franchise rights, associated with units where the carrying amount of the asset is not recoverable and may exceed its fair value and the carrying amount of a unit’s leasehold improvements and equipment may not be recoverable. When a commitment is made to close a unit, the associated lease and other costs related to the unit are included in closure costs.
Trends and Uncertainties Affecting Our Business
We believe that as a franchisee of such a large number of Pizza Hut and Wendy’s restaurants, our financial success is driven less by variable factors that affect regional restaurants and their markets, and more by trends affecting the food purchase industry – specifically the Quick Service Restaurants or “QSR” industry. The following discussion describes certain key factors that may affect our future performance.
General Economic Conditions and Consumer Spending
Continued high unemployment rates and legislative uncertainty have caused the consumer to experience a real and perceived reduction in disposable income which has negatively impacted consumer spending in most segments of the restaurant industry over the last several years, including the segment in which we compete. Specifically, we believe pressures on low and lower-middle income customers continue to be significant, and we believe that these customers are particularly interested in receiving value at a reasonable price in the current environment.
Competition
The restaurant business is highly competitive. The QSR industry is a fragmented market, and includes well-established competitors.
Our Pizza Hut restaurants face competition from national and regional chains, as well as independent operators, which affects pricing strategies and margins. Additionally, frozen pizzas and take-and-bake pizzas are competitive alternatives in the pizza segment. In addition to more established competitors, we also face competition from new competitors and concepts such as fast casual pizza concepts. Limited product variability within our segment can make differentiation among competitors difficult. Thus, companies in the pizza segment continuously promote and market new product introductions, price discounts and bundled deals, and rely heavily on effective marketing and advertising to drive sales. The price charged for each menu item may vary from market to market (and within markets) depending on competitive pricing and the local cost structure.

Our Wendy’s restaurants face competition from other food service operations within the same geographical area. Wendy’s restaurants compete with other restaurant companies and food outlets, primarily through the quality, variety, convenience, price, and value perception of food products offered. The location of units, quality and speed of service, attractiveness of facilities, effectiveness of marketing and new product development by Wendy’s and its competitors are also important factors. The price charged for each menu item may vary from market to market (and within markets) depending on competitive pricing and the local cost structure.

19


Commodity Prices
For our Pizza Hut operations, commodity prices of packaging products (liner board) and ingredients such as cheese, dough (wheat), and meat, can vary. The prices of these commodities can fluctuate throughout the year due to changes in supply and demand. Our costs can also fluctuate as a result of changes in ingredients or packaging instituted by PHI. For the second quarter of fiscal 2015, the block cheese price averaged $1.64 per pound, a decrease of $0.46 or 22% versus the average price for the second quarter of fiscal 2014. Additionally, meat prices decreased $0.50 per pound or approximately 24% versus the average price for the second quarter of fiscal 2014.

Based upon current market conditions, we currently expect overall commodity deflation for our Pizza Hut operations of approximately 4% to 6% with commodity inflation remaining flat for our Wendy’s operations for fiscal 2015 as compared to the prior year.
Labor Cost
The restaurant industry is labor intensive and known for having a high level of employee turnover given low hourly wages and the part-time composition of the workforce. To the extent that our Pizza Hut delivery sales mix increases, labor costs for our Pizza Hut operations would be expected to increase due to the more labor intensive nature of the delivery transaction. Direct labor is highly dependent on federal and state minimum wage rate legislation given the vast majority of workers are hourly employees whose compensation is either determined or influenced by the minimum wage rate. Certain states’ minimum wage rates are adjusted annually for inflation. These increases in state minimum wage rates are currently expected to increase direct labor expense by approximately $1.1 million in fiscal 2015. However, there are currently a number of federal and state initiatives and proposals to further increase minimum wage rates, which could be material to our operations.
The federal government and several state governments have proposed or enacted legislation regarding health care, including legislation that in some cases requires employers to either provide health care coverage to their full-time employees, pay a penalty or pay into a fund that would provide coverage for them. We continue to evaluate the effects on our business of the Patient Protection and Affordable Care Act, which was signed into law on March 23, 2010, and the related Health Care and Education Reconciliation Act of 2010, which was signed into law on March 30, 2010 (collectively, the “Federal Health Care Acts”). The provisions of the Federal Health Care Acts having the greatest potential financial impact on us became effective in fiscal 2015 and have resulted in a modest increase in our direct labor expense for the first 26 weeks of fiscal 2015.
Additionally, changes in federal labor laws and regulations and governmental agency determinations relating to union organizing rights and activities could result in portions of our workforce being subjected to greater organized labor influence, thereby potentially increasing our labor costs, and could have a material adverse effect on our business, results of operations and financial condition.
Inflation and Deflation
Inflationary factors, such as increases in food and labor costs, directly affect our operations. Because most of our employees are paid on an hourly basis, changes in rates related to federal and state minimum wage and tip credit laws will affect our labor costs.
Significant increases in average gasoline prices in the regions in which we operate could increase our delivery driver reimbursement costs. We estimate that every $0.25 per gallon change in average gas prices in our markets impacts our annual operating results by approximately $0.7 million. However, as gas prices change, the impact upon our operations is somewhat mitigated for price increases by a transfer of sales from the delivery occasion to the carryout access mode, which is perceived as a higher value by consumers and benefits us with lower labor costs for the carryout transaction.
If the economy experiences deflation, which is a persistent decline in the general price level of goods and services, we may suffer a decline in revenues as a result of the falling prices. In that event, given our fixed costs and minimum wage requirements, it is unlikely that we would be able to reduce our costs at the same pace as any declines in revenues. Consequently, a period of prolonged or significant deflation would likely have a material adverse effect on our business, results of operations and financial condition. Similarly, if we reduce the prices we charge for our products as a result of declines in comparable store sales or competitive pressures, we may suffer decreased revenues, margins, income and cash flow from operations.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our unaudited Consolidated Financial Statements. The preparation of these financial statements requires estimation and judgment that affect the reported amounts of revenues, expenses, assets, and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments

20


about the carrying values of assets and liabilities that are not readily apparent from other sources. If these estimates differ materially from actual results, the impact on the unaudited Consolidated Financial Statements may be material. Our critical accounting policies are available under Item 7 of our 2014 Form 10-K filed on March 27, 2015. There have been no significant changes with respect to these policies during the 26 weeks ended June 30, 2015.
As referenced in Item 7 of our Form 10-K, we perform our annual assessment of goodwill, which is not subject to amortization, for impairment during the second quarter. As a result of continued negative comparable store sales in our Pizza Hut operations, we performed a quantitative assessment and estimated the fair value of the Pizza Hut reporting unit using the discounted expected future cash flows. As a result of this quantitative assessment, it was concluded that this reporting unit was not impaired and the fair value of this reporting unit exceeded its carrying value. There was significant improvement in the fair value of the reporting unit when compared to the quantitative assessment performed in the fourth quarter of fiscal 2014, with the fair value returning to a level similar to the fair value at the second quarter of 2014.
We performed a qualitative assessment for our Wendy’s operations and concluded that it was more-likely-than-not that the fair value of the Wendy’s reporting unit was greater than its carrying value.



21


Results of Operations
The table below presents (i) comparable store sales indices, (ii) selected restaurant operating results as a percentage of net product sales and (iii) sales by occasion for the 13-week and 26-week periods ended June 30, 2015 and July 1, 2014:
 
13 Weeks Ended
 
26 Weeks Ended
Consolidated
June 30, 2015
 
July 1, 2014
 
June 30, 2015
 
July 1, 2014
Net product sales, (in thousands)
$
292,951

 
$
273,232

 
$
588,522

 
$
555,535

Fees and other income, (in thousands)
$
13,285

 
$
12,674

 
$
26,922

 
$
26,624

Net product sales
100
 %
 
100
 %
 
100
 %
 
100
 %
Direct restaurant costs and expenses(2):
 
 
 
 
 
 
 
Cost of sales
28.9
 %
 
31.6
 %
 
28.9
 %
 
31.4
 %
Direct labor
30.2
 %
 
29.6
 %
 
30.1
 %
 
29.6
 %
Other restaurant operating expenses
33.2
 %
 
33.5
 %
 
32.8
 %
 
32.6
 %
 
 
 
 
 
 
 
 
Pizza Hut
 
 
 
 
 
 
 
Comparable store sales
 %
 
(5.6
)%
 
(1.6
)%
 
(5.1
)%
Net product sales, (in thousands)
$
240,626

 
$
240,173

 
$
487,556

 
$
492,591

Fees and other income, (in thousands)
$
13,285

 
$
12,674

 
$
26,922

 
$
26,624

Net product sales
100
 %
 
100
 %
 
100
 %
 
100
 %
Direct restaurant costs and expenses(2):
 
 
 
 
 
 
 
Cost of sales
28.2
 %
 
31.4
 %
 
28.3
 %
 
31.2
 %
Direct labor
30.9
 %
 
29.8
 %
 
30.6
 %
 
29.7
 %
Other restaurant operating expenses
34.1
 %
 
34.2
 %
 
33.4
 %
 
33.1
 %
 
 
 
 
 
 
 
 
Wendy’s
 
 
 
 
 
 
 
Comparable store sales(1)
(0.5
)%
 
N/A

 
 %
 
N/A(1)

Net product sales, (in thousands)
$
52,325

 
$
33,059

 
$
100,966

 
$
62,944

Net product sales
100
 %
 
100
 %
 
100
 %
 
100
 %
Direct restaurant costs and expenses(2):
 
 
 
 
 
 
 
Cost of sales
31.8
 %
 
33.0
 %
 
31.9
 %
 
33.0
 %
Direct labor
26.6
 %
 
28.2
 %
 
27.7
 %
 
28.9
 %
Other restaurant operating expenses
28.9
 %
 
28.1
 %
 
29.5
 %
 
28.9
 %
 
(1)
Comparable store sales are only reported for locations that have been operated by the Company for at least 12 months. Comparable store sales for the 13 and 26 week periods ended June 30, 2015 include the Wendy’s units acquired during fiscal 2013.
(2) 
Stated as a percentage of net product sales.

 
13 Weeks Ended
 
26 Weeks Ended
 
June 30, 2015
 
July 1, 2014
 
June 30, 2015
 
July 1, 2014
Pizza Hut Sales by occasion:
 
 
 
 
 
 
 
Delivery
42
%
 
38
%
 
42
%
 
39
%
Carryout
45
%
 
48
%
 
45
%
 
48
%
Dine-in
13
%
 
14
%
 
13
%
 
13
%
 
 
 
 
 
 
 
 
Wendy’s sales by occasion:
 
 
 
 
 
 
 
Pick-up window
69
%
 
65
%
 
69
%
 
65
%
Counter service
31
%
 
35
%
 
31
%
 
35
%
Activity with respect to unit count is set forth in the table below:

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26 Weeks Ended
 
June 30, 2015
 
July 1, 2014
 
Consolidated
Wendy’s
Pizza Hut
 
Consolidated
Wendy’s
Pizza Hut
Beginning of period
1,420

143

1,277

 
1,354

91

1,263

Acquired



 



Developed(1)
7


7

 
12


12

Closed(1)
(20
)

(20
)
 
(11
)
(1
)
(10
)
Sold
(2
)

(2
)
 



End of period
1,405

143

1,262

 
1,355

90

1,265

Equivalent units(2)
1,409

143

1,266

 
1,350

91

1,259

 
(1) 
For Pizza Hut, five units and three units were relocated or rebuilt and are included in both the developed and closed totals above for the 26 week periods ended June 30, 2015 and July 1, 2014, respectively. The closed units for the 26 weeks ended June 30, 2015 also include two units which are being relocated and will re-open upon completion.
(2) 
Equivalent units represent the number of units open at the beginning of a given period, adjusted for units opened, closed, temporarily closed, acquired or sold during the period on a weighted average basis.

13 Weeks Ended June 30, 2015 Compared to the 13 Weeks Ended July 1, 2014

Our Pizza Hut Operations
Net Product Sales. Our Pizza Hut net product sales for the second quarter of fiscal 2015 compared to the same period of fiscal 2014 were $240.6 million and $240.2 million, respectively, an increase of $0.4 million or 0.2%, resulting largely from a 0.2% increase in equivalent units. Comparable store sales were flat for the second quarter of fiscal 2015, rolling over last year’s comparable store sales decrease of 5.6%.
Fees and Other