Edgar Filing: Papa Murphy's Holdings, Inc.

FRSH 2015 10Q Q2

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

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(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended June 29, 2015

[ ] 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

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Papa Murphy’s Holdings, Inc.

(Exact name of registrant as specified in its charter)

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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 or a smaller reporting company. See the definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer [ ]		Accelerated filer [ ]
Non-accelerated filer [X]		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 [X].

At July 31, 2015, there were 16,922,867 shares of the Registrant’s common stock, $0.01 par value, outstanding.

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TABLE OF CONTENTS




PART I — FINANCIAL INFORMATION

Item 1.	Unaudited Condensed Consolidated Financial Statements	3
	Unaudited Condensed Consolidated Statements of Operations for the three and six months ended June 29, 2015, and June 30, 2014	3
	Unaudited Condensed Consolidated Balance Sheets as of June 29, 2015, and December 29, 2014	4
	Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 29, 2015, and June 30, 2014	5
	Notes to Unaudited Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	36
Item 4.	Controls and Procedures	36

PART II — OTHER INFORMATION

Item 1.	Legal Proceedings	38
Item 1A.	Risk Factors	39
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	59
Item 3.	Defaults Upon Senior Securities	59
Item 4.	Mine Safety Disclosures	59
Item 5.	Other Information	59
Item 6.	Exhibits	60

SIGNATURES		61

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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)	June 29, 2015			June 30, 2014			June 29, 2015			June 30, 2014
Revenues
Franchise royalties	$	9,753		$	9,315		$	20,433		$	19,384
Franchise and development fees	830			862			1,970			2,031
Company-owned store sales	18,156			11,477			35,323			23,495
Lease and other	382			192			564			2,053
Total revenues	29,121			21,846			58,290			46,963

Costs and Expenses
Store operating costs:
Cost of food and packaging	6,443			4,499			12,533			9,089
Compensation and benefits	4,722			2,905			9,076			5,935
Advertising	1,753			1,122			3,422			2,244
Occupancy	1,174			674			2,176			1,334
Other store operating costs	1,856			1,007			3,301			2,076
Selling, general and administrative	8,162			8,824			15,045			17,023
Depreciation and amortization	2,420			1,967			4,739			3,808
Loss on disposal of property and equipment	3			36			62			42
Total costs and expenses	26,533			21,034			50,354			41,551
Operating Income	2,588			812			7,936			5,412

Interest expense	1,149			2,316			2,292			5,428
Interest income	(6		)	(19		)	(19		)	(53		)
Loss on early retirement of debt	—			1,191			—			1,191
Loss on disposal or impairment of investments	4,500			—			4,500			—
Other expense, net	44			43			46			55
(Loss) Income Before Income Taxes	(3,099		)	(2,719		)	1,117			(1,209		)

(Benefit from) provision for income taxes	(1,160		)	(1,112		)	460			(421		)
Net (Loss) Income	(1,939		)	(1,607		)	657			(788		)

Net loss attributable to noncontrolling interests	500			—			500			—
Net (Loss) Income Attributable to Papa Murphy's	$	(1,439	)	$	(1,607	)	$	1,157		$	(788	)

(Loss) earnings per share of common stock
Basic	$	(0.09	)	$	(0.19	)	$	0.07		$	(0.39	)
Diluted	$	(0.09	)	$	(0.19	)	$	0.07		$	(0.39	)
Weighted average common stock outstanding
Basic	16,629,666			11,375,211			16,616,936			7,612,646
Diluted	16,629,666			11,375,211			16,872,504			7,612,646

See accompanying notes.

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Papa Murphy’s Holdings, Inc. and Subsidiaries

Unaudited Condensed Consolidated Balance Sheets



(In thousands, except par value and share data)	June 29, 2015			December 29, 2014
Assets
Current Assets
Cash and cash equivalents	$	1,088		$	5,056
Accounts receivable, net of allowance for doubtful accounts of $81 and $60, respectively	5,029			5,661
Notes receivable	71			62
Inventories	825			640
Prepaid expenses and other current assets	4,344			3,423
Advertising cooperative assets, restricted	214			149
Current deferred tax asset	1,536			1,338
Total current assets	13,107			16,329
Property and equipment, net	15,473			12,120
Notes receivable, net of current portion	184			225
Goodwill	106,633			101,082
Trade name and trademarks	87,002			87,002
Definite-life intangibles, net	44,035			44,515
Other assets	284			4,191
Total assets	$	266,718		$	265,464

Liabilities and Equity
Current Liabilities
Accounts payable	$	5,349		$	3,057
Accrued expenses and other current liabilities	8,416			9,600
Advertising cooperative liabilities	307			253
Current portion of unearned franchise and development fees	2,350			2,848
Current portion of long-term debt	2,800			2,800
Total current liabilities	19,222			18,558
Long-term debt, net of current portion	109,976			110,715
Unearned franchise and development fees, net of current portion	460			640
Deferred tax liability	41,799			42,069
Other long-term liabilities	2,109			1,740
Total liabilities	173,566			173,722
Commitments and contingencies (Note 15)

Equity
Papa Murphy’s Holdings Inc. Shareholders’ 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; 16,919,775 and 16,944,308 shares issued, respectively)	169			169
Additional paid-in capital	118,051			117,354
Stock subscriptions receivable	(100		)	(100		)
Accumulated deficit	(24,968		)	(26,125		)
Total Papa Murphy’s Holdings Inc. shareholders’ equity	93,152			91,298
Noncontrolling interests	—			444
Total equity	93,152			91,742
Total liabilities and equity	$	266,718		$	265,464

See accompanying notes.

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Papa Murphy’s Holdings, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows



	Six Months Ended
(In thousands)	June 29, 2015			June 30, 2014
Operating Activities
Net income (loss)	$	657		$	(788	)
Net loss attributable to noncontrolling interests	500			—
Net income (loss) attributable to Papa Murphy’s	1,157			(788		)
Adjustments to reconcile to cash from operating activities
Depreciation and amortization	4,739			3,808
Loss on disposal of property and equipment	62			42
Loss on early retirement of debt	—			1,191
Bad debt expense	325			9
Non-cash employee equity compensation	656			1,545
Amortization of deferred finance charges	160			365
Loss on impairment of cost-method investment	4,000			—
Change in operating assets and liabilities
Accounts receivable	556			(1,978		)
Prepaid expenses and other current assets	(951		)	132
Unearned franchise and development fees	(678		)	(157		)
Accounts payable	1,296			(1,210		)
Accrued expenses and other current liabilities	(521		)	(1,744		)
Deferred taxes	(468		)	(706		)
Other assets and liabilities	(603		)	19
Cash from operating activities	9,730			528

Investing Activities
Acquisition of property and equipment	(2,834		)	(1,085		)
Acquisition of stores, less cash acquired	(9,343		)	(141		)
Proceeds from sale of stores	—			138
Issuance of notes receivable	(250		)	—
Payments received on notes receivable	32			948
Investment in cost-method investee	(500		)	(1,500		)
Cash from investing activities	(12,895		)	(1,640		)

Financing Activities
Payments on long-term debt	(1,400		)	(54,918		)
Advances on revolver, net	500			—
Issuance of common stock, net of underwriting fees	—			59,675
Repurchases of common stock	(10		)	(1,109		)
Debt issuance and modification costs, including prepayment penalties	—			(6		)
Payments received on subscription receivables	—			1,097
Costs associated with initial public offering	—			(3,490		)
Proceeds from exercise of stock options	51			—
Investment by noncontrolling interest holders	56			167
Cash from financing activities	(803		)	1,416

Net change in cash and cash equivalents	(3,968		)	304
Cash and Cash Equivalents, beginning of year	5,056			3,705
Cash and Cash Equivalents, end of period	$	1,088		$	4,009

Supplemental Disclosures of Cash Flow Information
Cash paid during the period for interest	$	2,164		$	6,882
Cash paid during the period for income taxes	1,422			106
Deferred offering costs paid in 2013 reclassified to equity	—			1,537
Noncash Supplemental Disclosures of Investing and Financing Activities
Acquisition of property and equipment in accounts payable	$	1,074		$	51

See accompanying notes.

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Papa Murphy’s Holdings, Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements



Note 1	Description of Business and Basis of Presentation	7
Note 2	Acquisitions and Disposals	8
Note 3	Prepaid Expenses and Other Current Assets	10
Note 4	Property and Equipment	11
Note 5	Goodwill	11
Note 6	Intangible Assets	11
Note 7	Notes Receivable	11
Note 8	Financing Arrangements	12
Note 9	Fair Value Measurement	12
Note 10	Accrued and Other Liabilities	13
Note 11	Income Taxes	13
Note 12	Shareholders’ Equity	14
Note 13	Share-based Compensation	14
Note 14	Earnings per Share (EPS)	16
Note 15	Commitments and Contingencies	17
Note 16	Related Party Transactions	18
Note 17	Segment Information	19

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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 Take ‘N’ Bake pizza franchises and operates Take ‘N’ Bake pizza stores owned by the Company. As of June 29, 2015, the Company had 1,485 stores consisting of 1,451 domestic stores (1,333 franchised stores and 118 Company-owned stores) across 38 states, plus 34 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.

Public offering and stock split

On May 7, 2014, the Company completed an initial public offering (the “IPO”) of 5,833,333 shares of common stock at a price to the public of $11.00 per share. The Company received net proceeds from the offering of approximately $54.6 million after offering fees and expenses. The net proceeds, along with additional cash on hand, were used to repay $55.5 million of the Company’s loans outstanding under the Company’s then existing senior secured credit facility, after which the Company had $112.1 million outstanding under the facility with the revolver undrawn.

Immediately prior to the IPO, the Company amended and restated its certificate of incorporation to reflect the conversion of all outstanding Series A Preferred Stock and Series B Preferred Stock (together, the “Preferred Shares”) to 3,054,318 shares of common stock. In connection with the IPO, on May 1, 2014, the Company amended its certificate of incorporation to effect a 2.2630 for 1 stock split of its common stock. As a result of the stock split, all previously reported share and option amounts in these interim unaudited condensed consolidated financial statements and accompanying notes have been retrospectively restated to reflect the stock split. After the conversion of the Preferred Shares and the stock split, but before the shares were sold in the IPO, the Company had 11,134,070 common shares outstanding.

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 presentation 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 year ended December 29, 2014.

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 (“VIEs”). The Company reports noncontrolling interests in consolidated entities as a component of equity separate from shareholders’ equity. 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 years 2015 and 2014 are 52-week years. 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 2015 and 2014 are references to fiscal years ending December 28, 2015, and ended December 29, 2014, respectively.

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Recent Accounting Pronouncements

In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”). This update requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying value of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs were not affected by this update. The Company early adopted ASU 2015-03 during the three months ended June 29, 2015. As a result of the retrospective adoption, the Company reclassified unamortized debt issuance costs of $1.3 million as of June 29, 2015, and $1.5 million as of December 29, 2014, from Deferred finance charges, net to Long-term debt, net of current portion on the Condensed Consolidated Balance Sheets. Adoption of this standard did not impact the Company’s results of operations or cash flows in either the current or previous interim and annual reporting periods.

Note 2 — Acquisitions and Disposals

Project Pie Investment and Disposal

The Company, through a non-wholly owned subsidiary, Project Pie Holdings, LLC (“PPH”), made investments in Project Pie, LLC (“Project Pie”) in the form of Series A Convertible Preferred Units (the “Preferred Units”). Project Pie is a fast casual custom-pizza restaurant chain with stores located throughout the United States, the Philippines and Scotland.

In connection with its investment in Project Pie, PPH had committed as of December 29, 2014, to fund, upon demand, up to an additional $0.5 million prior to December 2016 through the purchase of additional Series A Preferred Units of Project Pie. During the six months ended June 29, 2015, PPH invested the additional $0.5 million and satisfied its commitment to Project Pie.

The Company disposed of its ownership interests in PPH on June 29, 2015. Prior to the Company’s disposal of its ownership interests in PPH, it recorded a pre-tax impairment of $4.5 million to its investment in Project Pie during the three months ended June 29, 2015.

During the three months ended March 30, 2015, the Company determined that Project Pie was a VIE as a result of Project Pie having insufficient equity at risk, but that the Company did not have a variable interest in Project Pie and did not have control. The Company did not account for its investment in Project Pie as an equity method investment as the Company’s investment was in preferred units which contained subordination characteristics substantially different from the common units and were determined to not be in-substance common stock. The Company’s investment was classified as a cost method investment in Other assets.

Acquisitions in 2015

M2AD Acquisition

On March 9, 2015, Papa Murphy’s Company Stores, Inc. (“PMCSI”), a wholly-owned subsidiary of the Company, acquired certain assets used in the operation of six Papa Murphy’s stores in the Seattle, Washington area from M2AD Management, Inc., the previous operator of the six Papa Murphy’s stores (the “M2AD Acquisition”). Transaction costs of $12,000 associated with the M2AD Acquisition were recognized as Other store operating costs in the Condensed Consolidated Statements of Operations. The total purchase price was $4.1 million, which included a holdback of $6,000. As of June 29, 2015, PMCSI retained $5,000 of the holdback amount. The M2AD Acquisition was funded through existing cash and was accounted for using the acquisition method of accounting whereby operating results subsequent to the acquisition date are included in the interim unaudited condensed consolidated financial statements.

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The fair values of the assets acquired are summarized below (in thousands):



Cash and cash equivalents	$	5
Inventories	39
Prepaid expenses and other current assets	38
Property and equipment	406
Reacquired franchise rights	1,139
Asset retirement obligation	(75		)
Total identifiable net assets acquired	1,552
Goodwill	2,554
Total consideration	$	4,106

Reacquired franchise rights have weighted average useful lives of 6.6 years. Goodwill represents the excess of the purchase price over the net tangible and intangible assets acquired and is expected to be fully deductible for income tax purposes. This goodwill is primarily attributable to the acquired customer bases and, to a lesser extent, economies of scale expected from combining the operations of the acquired entities with the operations of the Company.

Unaudited pro forma information—The following unaudited pro forma consolidated revenues and net (loss) income of the Company give effect to the M2AD Acquisition as if it had occurred as of the beginning of 2014:



	Three Months Ended						Six Months Ended
(in thousands)	June 29, 2015			June 30, 2014			June 29, 2015		June 30, 2014
Pro forma revenues	$	29,121		$	23,049		$	59,368	$	49,535
Pro forma net (loss) income	$	(1,439	)	$	(1,612	)	$	1,168	$	(733	)

The pro forma information presented in this note includes adjustments for amortization of acquired intangible assets, depreciation of acquired property and equipment and income tax expense. The pro forma information is presented for informational purposes and may not be indicative of the results that would have been obtained had the M2AD Acquisition actually occurred at the beginning of 2014, nor is it intended to be indicative of future operating performance.

Revenues and net income from the acquired stores from the closing date of the M2AD Acquisition included in the Company’s Condensed Consolidated Statements of Operations for the three and six months ended June 29, 2015, are as follows:



	Three Months Ended		Six Months Ended
(in thousands)	June 29, 2015		June 29, 2015
Revenues	$	1,279	$	1,564
Net income	105		120

Other Acquisitions

PMCSI also acquired all of the assets of 15 stores through six individually immaterial acquisitions during the six months ended June 29, 2015: eight stores in Tennessee, three in Washington, one in Idaho, one in Oregon, one in Texas and one in Colorado. The Tennessee stores were acquired on January 26, 2015, the Idaho store on January 12, 2015, the Oregon store on March 2, 2015, the Texas store on March 9, 2015, the Colorado store on May 4, 2015, and the Washington stores on May 11, 2015 (collectively, the “Other Acquisitions”). The Company incurred transaction costs of $30,000 associated with the Other Acquisitions that were recognized as Other store operating costs in the Condensed Consolidated Statements of Operations. The aggregate purchase price for the Other Acquisitions was approximately $5.2 million, which included holdbacks totaling $78,000 in the aggregate. As of June 29, 2015, PMCSI retained $8,000 of the aggregate holdback amount. The Other Acquisitions were funded through existing cash and were accounted for using the acquisition method of accounting whereby operating results subsequent to the acquisition date are included in the interim unaudited condensed consolidated financial statements.

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The fair values of the assets acquired are summarized below (in thousands):



Cash and cash equivalents	$	9
Inventories	77
Prepaid expenses and other current assets	64
Property and equipment	1,200
Reacquired franchise rights	1,041
Asset retirement obligation	(169		)
Total identifiable net assets acquired	2,222
Goodwill	2,997
Total consideration	$	5,219

Reacquired franchise rights have weighted average useful lives of 3.4 years. Goodwill represents the excess of the purchase price over the net tangible and intangible assets acquired and is expected to be fully deductible for income tax purposes. This goodwill is primarily attributable to the acquired customer bases and, to a lesser extent, economies of scale expected from combining the operations of the acquired entities with the operations of the Company.

Unaudited pro forma information—The following unaudited pro forma consolidated revenues and net (loss) income of the Company give effect to the Other Acquisitions as if they had occurred as of the beginning of 2014:



	Three Months Ended						Six Months Ended
(in thousands)	June 29, 2015			June 30, 2014			June 29, 2015		June 30, 2014
Pro forma revenues	$	29,402		$	23,507		$	59,738	$	50,394
Pro forma net (loss) income	$	(1,428	)	$	(1,621	)	$	1,190	$	(803	)

The pro forma information presented in this note includes adjustments for amortization of acquired intangible assets, depreciation of acquired property and equipment and income tax expense. The pro forma information is presented for informational purposes and may not be indicative of the results that would have been obtained had the Other Acquisitions actually occurred at the beginning of 2014, nor is it intended to be indicative of future operating performance.

Revenues and net loss from the acquired stores from the closing date of the Other Acquisitions included in the Company’s Condensed Consolidated Statements of Operations for the three and six months ended June 29, 2015, are as follows:



	Three Months Ended			Six Months Ended
(in thousands)	June 29, 2015			June 29, 2015
Revenues	$	1,636		$	2,377
Net loss	(74		)	(124		)

Note 3 — Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consist of the following:



(in thousands)	June 29, 2015		December 29, 2014
Prepaid media development costs ⁽¹⁾	$	322	$	593
Prepaid rents and insurance	1,159		620
POS software licenses for resale	1,409		1,800
Other	1,454		410
Total prepaid expenses and other current assets	$	4,344	$	3,423


(1)	Prepaid media development costs represent costs incurred for advertisements that have not aired.

The Company recognizes software license revenue upon the resale of Point of Sale (“POS”) software licenses to franchise owners at cost. The income from the sale is included in Lease and other revenues and the related expense is recorded in

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Selling, general and administrative costs on the Condensed Consolidated Statements of Operations. POS software license revenue during the periods reported was as follows:



	Three Months Ended				Six Months Ended
(in thousands)	June 29, 2015		June 30, 2014		June 29, 2015		June 30, 2014
POS software license revenue	$	115	$	126	$	301	$	1,926

Note 4 — Property and Equipment

Property and equipment are net of accumulated depreciation of $11.3 million and $9.3 million at June 29, 2015, and December 29, 2014, respectively. Depreciation expense during the periods reported was as follows:



	Three Months Ended				Six Months Ended
(in thousands)	June 29, 2015		June 30, 2014		June 29, 2015		June 30, 2014
Depreciation expense	$	1,075	$	722	$	2,079	$	1,331

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 December 29, 2014	$	19,536	$	81,546	$	101,082
Acquisitions	5,551		—		5,551
Balance at June 29, 2015	$	25,087	$	81,546	$	106,633

There is no goodwill associated with the International Segment. During the three months ended June 29, 2015, the Company has determined that there have not been any triggering events that would require an updated impairment review.

Note 6 — Intangible Assets

Intangible assets are net of accumulated amortization of $21.9 million and $19.3 million as of June 29, 2015, and December 29, 2014, respectively. Amortization expense during the periods reported was as follows:



	Three Months Ended				Six Months Ended
(in thousands)	June 29, 2015		June 30, 2014		June 29, 2015		June 30, 2014
Amortization expense	$	1,345	$	1,245	$	2,660	$	2,477

Note 7 — Notes Receivable

Notes receivable consist of the following:



(in thousands)	June 29, 2015			December 29, 2014
Note maturing in 2020 bearing interest at 9.0% and collateralized by store assets.	$	255		$	287
Total notes receivable	255			287
Less current portion	(71		)	(62		)
Notes receivable, net of current portion	$	184		$	225

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Note 8 — Financing Arrangements

Long-term debt consists of the following:



(in thousands)	June 29, 2015			December 29, 2014
2014 Credit Facility
Term loan	$	110,600		$	112,000
Revolving line of credit	500			—
Notes payable	3,000			3,000
Total principal amount of long-term debt	114,100			115,000
Unamortized debt issuance costs	(1,324		)	(1,485		)
Total long-term debt	112,776			113,515
Less current portion	(2,800		)	(2,800		)
Total long-term debt, net of current portion	$	109,976		$	110,715

2014 senior secured credit facility

On August 28, 2014, PMI Holdings, Inc., a wholly-owned subsidiary of the Company, entered into a $132.0 million senior secured credit facility (the “2014 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 June 29, 2015, the 2014 Credit Facility bore interest under the LIBOR rate option at 3.44%.

With a maturity date of over one year from June 29, 2015, balances outstanding under the 2014 Credit Facility are classified as non-current on the Condensed Consolidated Balance Sheets, except for mandatory, minimum term loan amortization payments of $0.7 million due on the last day of each fiscal quarter.

The weighted average interest rate for all borrowings under our 2014 Credit Facility for the second quarter of 2015 was 3.46%.

2013 senior secured credit facility

In August 2014, the borrowings under the 2014 Credit Facility refinanced the $177.0 million senior secured credit facility entered into in October 2013 (the “2013 Credit Facility”), which included a $167.0 million senior secured term loan and a $10.0 million revolving credit facility, including a $2.5 million letter of credit subfacility.

On May 7, 2014, the Company prepaid $55.5 million of its long-term debt under the 2013 Credit Facility in connection with the IPO. A proportionate share of deferred financing costs of $1.2 million were expensed as a Loss on early retirement of debt on the Company’s Condensed Consolidated Statements of Operations at the time of this debt prepayment.

Notes payable

PMCSI has a $3.0 million note payable which bears interest at 5% and matures in December 2018. This note is subordinated to the 2014 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.

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▪	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:



	June 29, 2015				December 29, 2014
(in thousands)	CARRYING VALUE		FAIR VALUE		CARRYING VALUE		FAIR VALUE		FAIR VALUE MEASUREMENTS
Financial assets
Notes receivable ⁽¹⁾	$	255	$	259	$	287	$	302	Level 3
Cost-method investments ⁽²⁾	—		—		4,000		5,055		Level 3
Financial liabilities
Long-term debt, including current portion thereof ⁽³⁾	114,100		114,100		115,000		113,880		Level 3


(1)	The fair value of the notes receivable was estimated primarily using a discounted cash flow method based on a discount rate, reflecting the applicable credit spread.


(2)	The fair value of cost-method investments was estimated primarily using a discounted cash flow method based on a discount rate, reflecting the applicable credit spread.


(3)	The fair value of long-term debt was estimated 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 and accounts payable. The fair value of cash and cash equivalents, accounts receivable and accounts payable approximates carrying value because of the short-term nature of the accounts.

Note 10 — Accrued and Other Liabilities

Accrued and other liabilities consist of the following:



(in thousands)	June 29, 2015		December 29, 2014
Accrued compensation and related costs	4,150		3,670
Gift cards and certificates payable	2,105		2,912
Accrued interest and non-income taxes payable	698		745
Convention fund balance	576		271
Advertising and development fund	—		507
Unearned product rebates	—		791
Other	887		704
	$	8,416	$	9,600

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)	June 29, 2015			June 30, 2014			June 29, 2015			June 30, 2014
(Benefit from) provision for income taxes	$	(1,160	)	$	(1,112	)	$	460		$	(421	)
(Loss) income before income taxes	(3,099		)	(2,719		)	1,117			(1,209		)
Effective income tax rate	37.4		%	40.9		%	41.2		%	34.8		%

The effective income tax rate for the three months ended June 29, 2015, includes the effect of certain permanent differences between tax reporting purposes and financial reporting purposes and the relative impact of those differences on a small quarterly loss. The effective income tax rate for the three months ended June 30, 2014, includes the effect of certain

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permanent differences between tax reporting purposes and financial reporting purposes and the relative impact of those differences on a small quarterly loss.

The effective income tax rate for the first six months of 2015 includes the effect of a discrete adjustment for the cumulative share-based compensation expense adjustment for certain awards previously considered unlikely to vest. The effective tax rate for the first six months ended June 30, 2014, includes the effect of a separate unfavorable discrete adjustment for an accelerated restricted stock vesting event recorded in early 2014.

Note 12 — Shareholders’ Equity

Preferred stock

Prior to the IPO, the Company’s preferred stock consisted of Series A Preferred Shares and Series B Preferred Shares. The Preferred Shares had a cumulative preferred dividend of 6.00% per year based on an original liquidation value of $36.68 per share. Upon liquidation of the Company, the holders of the Preferred Shares were entitled to receive the unpaid liquidation value plus accreted dividends before any distribution could be made to the holders of common stock. In addition, the Preferred Shares participated in 20% of all remaining earnings if distributed to common stockholders. The unpaid liquidation value of the Series A and Series B Preferred Shares was $21.14 and $26.80 per share, respectively, as of the IPO. At the IPO, the Preferred Shares were converted into 3,054,318 shares of common stock.

Noncontrolling interests

The Company received the following additional investments by noncontrolling interest holders in PPH during the periods reported:



	Three Months Ended				Six Months Ended
(in thousands)	June 29, 2015		June 30, 2014		June 29, 2015		June 30, 2014
Additional investment by noncontrolling interest holders in PPH	$	—	$	111	$	56	$	167

Note 13 — 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”). With the adoption of the 2014 Plan, the Company has discontinued selling stock and issuing awards under the 2010 Plan, but stock previously purchased and awards previously granted under the 2010 Plan remain outstanding.

The Incentive Plans reserve 2,116,747 common shares for equity incentive awards which can be awarded as incentive stock options, non-qualified stock options, restricted stock awards, and unrestricted stock awards. Under the Incentive Plans, the Company has awarded 580,925 and 610,084 shares of restricted common stock to eligible employees as of June 29, 2015, and December 29, 2014, respectively. In addition, the Company has issued 1,074,800 and 945,149 stock options under the Incentive Plans to eligible employees as of June 29, 2015, and December 29, 2014, respectively.

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Restricted common shares

Information with respect to restricted stock activity is as follows:



	Number of Shares of Restricted Common Stock
	Time Vesting		Performance Vesting		Weighted Average Sale/Grant Date Fair Value Per Share
Unvested, December 29, 2014	127,650		215,556		$	2.27
Granted	4,785		—		18.81
Vested	(57,326	)	—		0.90
Repurchased	(7,542	)	(26,402	)	0.74
Unvested, June 29, 2015	67,567		189,154		$	3.09

The weighted average fair value of share-based compensation awards granted and the fair values of awards granted and vested during the period were as follows:



	Three Months Ended				Six Months Ended
(in thousands, except per share amounts)	June 29, 2015		June 30, 2014		June 29, 2015		June 30, 2014
Weighted average grant date fair value per share	$	18.81	N/A		$	18.81	N/A
Total fair value of shares granted	90		$	—	90		$	—
Total fair value of shares vested	35		47		52		432

Stock options

Information with respect to stock option activity is as follows:



	Number of Shares Subject to Options
	Time Vesting		Performance Vesting		Weighted Average Exercise Price Per Share		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value (in thousands)
Outstanding, December 29, 2014	722,307		222,842		$	11.16
Granted	192,000		—		13.43
Exercised	(4,626	)	—		11.00
Forfeited	(37,483	)	(20,240	)	11.79
Outstanding, June 29, 2015	872,198		202,602		$	11.54	9.0 years	$	10,215
Exercisable, June 29, 2015	443,363		—		$	11.18	8.8 years	$	4,372
Vested and expected to vest at June 29, 2015	807,873		172,212		$	11.51	9.0 years	$	9,339

Fair value information for options granted and vested and the intrinsic value of options exercised during the periods reported are as follows:



	Three Months Ended				Six Months Ended
(in thousands, except per share amounts)	June 29, 2015		June 30, 2014		June 29, 2015		June 30, 2014
Weighted average grant date fair value per share	N/A		$	4.27	$	5.41	$	4.27
Total fair value of awards granted	$	—	3,367		1,039		4,151
Total fair value of awards vested	314		1,147		324		1,432
Total intrinsic value of options exercised	—		—		32		—

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Compensation cost and valuation

Total compensation costs recognized in connection with the Incentive Plans during the periods reported were as follows:



	Three Months Ended				Six Months Ended
(in thousands)	June 29, 2015		June 30, 2014		June 29, 2015		June 30, 2014
Stock compensation expense	$	500	$	995	$	656	$	1,545
Income tax benefits associated with stock compensation expense	166		393		218		509

As of June 29, 2015, the total unrecognized stock-based compensation expense, net of estimated forfeitures, was $3.0 million with $2.1 million associated with time vesting awards and $0.9 million associated with performance vesting awards. The remaining weighted average contractual life for unrecognized stock-based compensation expense was 3.5 years as of June 29, 2015.

Prior to the IPO, the valuation of the Company’s common stock and Preferred Shares was based on the principles of option-pricing theory. This approach is based on modeling the value of the various components of an entity’s capital structure as a series of call options on the proceeds expected from the sale of the entity or the liquidation of its assets at some future date. Specifically, each of the preferred and common equity is modeled as a call option on the aggregate value of the Company with an exercise price equal to the liquidation preferences of the more senior securities. Both the income and market approaches were considered when estimating the fair value of the Company.

The Company’s valuation was performed under both an IPO and non-IPO scenario with each value weighted based on an estimated probability of occurrence. The key inputs required to calculate the value of the common stock using the option-pricing model included the risk free rate, the volatility of the underlying assets, and the estimated time until a liquidation event. The Company applied a marketability discount to the value of common stock based on facts and circumstances at each valuation date.

During the reported periods prior to the IPO, the Company assumed the following:



	Three Months Ended March 31, 2014 ⁽¹⁾
	IPO Scenario	Non-IPO Scenario
Risk free rate	0.36%	0.36%
Volatility of the underlying assets	45%	45%
Estimated time until a liquidation event	0.58 years	1.75 years
Marketability discount—common stock	10%	25%
Marketability discount—preferred stock	8%	15%
Weight applied to scenario	95%	5%


(1)	The last valuation of the Company was performed as of March 31, 2014.

The fair value of the stock option awards granted during the periods reported was estimated with the following weighted-average assumptions.



	Three Months Ended		Six Months Ended
	June 29, 2015	June 30, 2014	June 29, 2015	June 30, 2014
Risk free rate	N/A	2.1%	1.9%	2.0%
Expected volatility	N/A	34.9%	37.9%	35.0%
Expected term	N/A	6.5 years	6.3 years	6.3 years
Expected dividend yield	N/A	0.0%	0.0%	0.0%

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. Prior to the IPO, the Company’s cumulative preferred stockholders were entitled to participate in 20% of all remaining earnings or dividends if distributed to common stockholders. As such, the

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Company calculated EPS using the two-class method. The two-class method determines EPS for common stock and participating securities according to dividends and dividend equivalents and their respective participation rights in undistributed earnings.

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 potential common shares would have an anti-dilutive effect.

The following table sets forth the computations of basic and dilutive EPS:



	Three Months Ended						Six Months Ended
(in thousands, except per share data)	June 29, 2015			June 30, 2014			June 29, 2015		June 30, 2014
Earnings:
Net (loss) income	$	(1,939	)	$	(1,607	)	$	657	$	(788	)
Less: net loss attributable to noncontrolling interests	500			—			500		—
Net (loss) income attributable to Papa Murphy's	(1,439		)	(1,607		)	1,157		(788		)
Less: cumulative Series A and B Preferred dividends	—			(552		)	—		(2,150		)
Net (loss) income available to common shareholders	$	(1,439	)	$	(2,159	)	$	1,157	$	(2,938	)
Shares:
Weighted average common shares outstanding	16,630			11,375			16,617		7,613
Dilutive effect of potential common stock ⁽¹⁾	—			—			256		—
Diluted weighted average number of shares outstanding	16,630			11,375			16,873		7,613
(Loss) earnings per share:
Basic (loss) earnings per share	$	(0.09	)	$	(0.19	)	$	0.07	$	(0.39	)
Diluted (loss) earnings per share	$	(0.09	)	$	(0.19	)	$	0.07	$	(0.39	)


(1)	The Company’s potential common stock instruments such as stock options and restricted stock were not included in the computation of diluted EPS for the three and six months ended June 30, 2014 and the three months ended June 29, 2015, as the effect of including these shares in the calculation would have been anti-dilutive.

For the three months ended June 29, 2015, and June 30, 2014, an aggregated total of 390,000 shares and 388,000 shares, respectively, have been excluded from the diluted income per share calculation because their effect would have been anti-dilutive. For the six months ended June 29, 2015, and June 30, 2014, an aggregated total of 88,000 shares and 341,000 shares, respectively, have been excluded from the diluted income per share 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 store units 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, and other operating costs.

The Company has entered into operating leases that it has subleased to three 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 October 2015 to May 2020.

Lease guarantees

The Company is the guarantor for operating leases of eight franchised stores that have terms expiring on various dates from July 2015 to September 2018. 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 June 29, 2015, the Company does not believe it is probable it would be required to perform under the outstanding guarantees.

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Legal proceedings

The Company is currently subject to litigation with a group of franchise owners. In January 2014, six franchise owner groups claimed that the Company misrepresented sales volumes, made false representations to them and charged excess advertising fees, among other things. The Company engaged in mediation with these franchise owners, which is required under the terms of their franchise agreements, in order to address and resolve their claims, but was unable to reach a settlement agreement. On April 4, 2014, a total of 12 franchise owner groups, including those franchise owners that previously made the allegations described above, filed a lawsuit against the Company in the Superior Court in Clark County, Washington, making essentially the same allegations for violation of the Washington Franchise Investment Protection Act, fraud, negligent misrepresentation and breach of contract and seeking declaratory and injunctive relief, as well as monetary damages. Based on motions filed by the Company in that lawsuit, the court ruled on July 9, 2014, that certain of the plaintiffs’ claims under the anti-fraud and nondisclosure provisions of the Washington Franchise Investment Protection Act should be dismissed and that certain other claims in the case would need to be more specifically alleged. The court also ruled that the six franchise owner groups who had not mediated with the Company prior to filing the lawsuit must mediate with the Company in good faith, and that their claims shall be stayed until they have completed mediating with the Company in good faith.

On June 18, 2014, an additional 16 franchise owner groups, represented by the same counsel as the plaintiffs described above, filed a lawsuit in the Superior Court in Clark County, Washington making essentially the same allegations as made in the lawsuit described above and seeking declaratory and injunctive relief, as well as monetary damages. The court consolidated the two lawsuits into a single case and ordered that the plaintiffs in the new lawsuit, none of whom had mediated with the Company prior to filing the lawsuit, must do so, and that their claims be stayed until they have done so.

In October 2014, the Company engaged in mediation with the 22 franchise owner groups who had not previously done so. As a result of that mediation and other efforts, the Company has reached resolution with eleven of the franchise owner groups involved in the consolidated lawsuits, and their claims have either been dismissed or dismissal is pending.

In February 2015, the remaining plaintiffs in the consolidated lawsuits filed an amended complaint, removing some claims, amending some claims, adding claims and naming some of the Company’s former and current franchise sales staff as additional individual defendants. The Company has filed an answer denying the material allegations of the amended complaint.

The Company believes the allegations in these consolidated lawsuits lack merit and, for those plaintiffs with whom the Company is unable to reach resolution, the Company will continue to vigorously defend its interests, including by asserting a number of affirmative defenses and, where appropriate, counterclaims. The Company provides no assurance that it will be successful in its defense of these lawsuits; however, it does not currently expect the cost of resolving them to have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

On May 8, 2015, the Company was named as a defendant in a class action lawsuit claiming a violation of the Telephone Consumer Protection Act, which prohibits companies from making telemarketing calls to numbers listed in the Federal Do-Not-Call Registry and imposes other obligations and limitations on making phone calls and sending text messages to consumers. The lawsuit alleges that the Company did not comply with the statutory requirements for obtaining consumers’ consent to receive text messages from the Company, and seeks statutory penalties for those alleged deficiencies. The Company believes the plaintiff’s interpretation of the applicable law is incorrect, and it will vigorously defend itself in the lawsuit, but provides no assurance that it will be successful. An adverse judgment or settlement could have an adverse impact on the Company’s profitability and could cause variability in its results compared to expectations.

In addition to the foregoing, the Company is subject to routine legal proceedings, claims, and litigation in the ordinary course of its business. The Company may also engage in future litigation with franchise owners to enforce the terms of franchise agreements and compliance with brand standards as determined necessary to protect the Company’s brand, the consistency of products and the customer experience. Lawsuits require significant management attention and financial resources and the outcome of any litigation is inherently uncertain. The Company does not, however, currently expect that the costs to resolve these routine matters will have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

Note 16 — Related Party Transactions

Advisory services and monitoring agreement

Prior to the IPO, the Company was a party to an advisory services and monitoring agreement with affiliates of Lee Equity Partners, LLC (“Lee Equity”). In accordance with the terms of the agreement, the Company paid Lee Equity for ongoing

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advisory and monitoring services, such as management consulting, financial analysis, and other related services. As compensation, the Company paid an annual fee of $0.5 million in four equal quarterly installments plus direct expenses incurred which are included in Selling, general and administrative costs. The agreement did not call for a minimum level of services to be furnished and provided that fees paid to Lee Equity could be deferred at the discretion of Lee Equity or to the extent required under the Company’s 2014 Credit Facility.

On May 7, 2014, the Company completed the IPO and paid Lee Equity $1.5 million in accordance with the terms of the agreement. With the completion of the IPO, the advisory services and monitoring agreement between the Company and Lee Equity was terminated.

Employee loans related to share purchases

In connection with share-based compensation, the Company has made several loans to certain officers and non-officer employees of the Company (see Note 13 — Share-based Compensation). Loans made in connection with the issuance of the Company’s equity have been recognized in Stock subscriptions receivable as a reduction of total equity.

In March 2014, the Company entered into agreements with certain executive officers to repurchase an aggregate of 109,779 shares of common stock at a price of $11.85 per share for a total purchase price of $1.3 million. Included among the repurchased shares were 31,707 shares of common stock for which vesting terms were accelerated in connection with the repurchase. The Company received a payment of $1.0 million from the same executive officers to repay their outstanding stock subscription receivables. Concurrent with the share repurchase, the Company entered into agreements with the same executive officers to issue 109,779 stock options to purchase shares at an exercise price of $11.85 per share, including 78,072 fully vested options and 31,707 options subject to time-based or performance-based vesting provisions. In connection with the acceleration of vesting and the issuance of the fully vested options, the Company recorded stock-based compensation expense of $0.5 million for the six months ended June 30, 2014.

All loans made to officers of the Company were repaid prior to the IPO. Some loans made to non-officer employees of the Company were still outstanding at the time of the IPO. As of June 29, 2015, and December 29, 2014, the Company had stock subscription receivables of $0.1 million.

Related party revenue

The Company was party to transactions to sell services to Project Pie during the period Project Pie was a cost-method investee. Revenue from these transactions are recorded as Lease and other revenues on the Condensed Consolidated Statements of Operations. Related party revenue during the periods reported was as follows:



	Three Months Ended				Six Months Ended
(in thousands)	June 29, 2015		June 30, 2014		June 29, 2015		June 30, 2014
Related party revenue	$	—	$	45	$	4	$	84

As of June 29, 2015, and December 29, 2014, the Company had an Accounts receivable balance from Project Pie of $0 and $66,000, respectively.

Notes receivable

On March 13, 2015, the Company loaned Project Pie, a cost-method investee, $250,000, in exchange for a note receivable which bore interest at 13% and matured in June 2015. This note was written off as a bad debt in the three months ended June 29, 2015.

In June 2015, the Company entered into an agreement with Project Pie under which the Company, at its own discretion, may advance funds not to exceed $0.8 million in exchange for a subordinated note receivable. As of June 29, 2015, no funds were outstanding under the agreement.

Note 17 — Segment Information

The Company has the following reportable segments: (i) Domestic Company Stores; (ii) Domestic Franchise; and (iii) International. 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 Domestic Franchise segment includes operations with respect to franchised stores in the United States and derives its revenues

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primarily from franchise and development fees and franchise royalties from franchised stores in the United States. 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 following tables summarize information on profit or loss and assets for each of the Company’s reportable segments:



	Three Months Ended						Six Months Ended
(in thousands)	June 29, 2015			June 30, 2014			June 29, 2015			June 30, 2014
Revenues
Domestic Franchise	$	10,878		$	10,324		$	22,813		$	23,371
Domestic Company Stores	18,156			11,477			35,323			23,495
International	87			45			154			97
Total	$	29,121		$	21,846		$	58,290		$	46,963
Segment Operating Income (Loss)
Domestic Franchise	$	4,208		$	4,234		$	10,135		$	10,228
Domestic Company Stores	552			158			1,688			678
International	54			(121		)	78			(225		)
Corporate and unallocated	(2,226		)	(3,459		)	(3,965		)	(5,269		)
Total	$	2,588		$	812		$	7,936		$	5,412
Depreciation and Amortization
Domestic Franchise	$	1,288		$	1,261		$	2,589		$	2,430
Domestic Company Stores	1,124			698			2,135			1,363
International	8			8			15			15
Total	$	2,420		$	1,967		$	4,739		$	3,808



(in thousands)	June 29, 2015		December 29, 2014
Total Assets
Domestic Franchise	$	132,156	$	137,417
Domestic Company Stores	44,548		34,953
International	392		447
Other ⁽¹⁾	89,622		92,647
Total	$	266,718	$	265,464


(1)	Other assets which are not allocated to the individual segments primarily include trade names and trademarks, unamortized deferred financing charges, and an intercompany note.

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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. 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 years 2015 and 2014 are 52-week periods ending on December 28, 2015, and ended on December 29, 2014, respectively.

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 this Quarterly Report on Form 10-Q. All statements other than statements of historical fact or relating to present 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, business strategies and priorities, resolution of litigation and claims, expectations for reducing operating costs and increasing sales through the use of our POS system terminals, deductibility of goodwill for income tax purposes, potential efficiencies and synergies created by store acquisitions, expansion and growth opportunities, the number and timing of new store openings, exposure to foreign currency and interest rate risk, retention of senior executives, 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 under 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 this Quarterly Report on Form 10-Q. 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.

Overview

Papa Murphy’s is a franchisor and operator of the largest Take ‘N’ Bake pizza chain in the United States and the fifth largest pizza chain overall. We were founded in 1981 and have grown our footprint to a total of 1,485 system-wide stores as of June 29, 2015, of which 92.1% are franchised, located in 38 states plus Canada and the Middle East.

We have been repeatedly rated the #1 pizza chain in the United States by multiple third-party consumer studies. In 2015, Technomic awarded us the 2015 Chain Restaurant Consumers’ Choice award and named us the Quick Serve concept most likely to be recommended by consumers. Nation’s Restaurant News rated us the #1 limited service restaurant in the Pizza/Italian Category for 2015. We were rated #1 in the Pizza Category by Market Force Information in 2015, including the top spot in food quality, healthy food, and friendly service. We were also rated the #1 pizza chain overall by Nation’s Restaurant News in 2014, 2013, 2012 and 2011. When compared to broader restaurant chain competition, we were recognized by

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Technomic in 2015, 2014 and 2013 as the #1 chain overall among all restaurants and all food categories and by Nation’s Restaurant News in 2013 and 2012 as one of the Top 5 Overall limited service restaurant chains across all food categories.

Our financial results are driven largely by system-wide sales at our franchised and Company-owned stores. System-wide sales are driven by comparable store sales growth and store count, which translate into royalty payments from franchise owners, as well as Company-owned store revenues. We strive to consistently increase both comparable store sales and our store counts. Total revenues can also be impacted by acquisitions of franchised stores by our Domestic Company Stores segment or the refranchising of Company-owned stores.

The Take ‘N’ Bake model offers operating advantages that differentiate us from other restaurant concepts. Our domestic stores (i) do not require ovens, freezers or other expensive cooking equipment because our customers bake their customized pizzas at home; (ii) do not offer delivery, thereby reducing operational complexity for franchise owners and their employees; (iii) maintain shorter opening hours (typically 11:00 a.m. to 9:00 p.m.) that are attractive to franchise owners and their employees; (iv) require fewer employees during each shift compared to most other restaurant concepts, resulting in lower labor costs; and (v) do not require dining areas, resulting in lower occupancy and operating costs.

The relatively small initial and ongoing investments required to own and operate a Papa Murphy’s store creates the opportunity for higher margins and attractive returns. We believe these favorable investment requirements coupled with simple operations, a strong brand message supported by high levels of advertising spending and high-quality menu offerings drive attractive store-level economics, which, in turn, drives demand for new stores.

2015 Highlights

Revenue Growth

Total revenues for the three months ended June 29, 2015, compared to the three months ended June 30, 2014, grew 33.3% from $21.8 million to $29.1 million due primarily to the strategic acquisition of franchised stores by our Domestic Company Stores segment, new store openings, and comparable store sales growth. Total revenues for the six months ended June 29, 2015, compared to the six months ended June 30, 2014, grew 24.1% from $47.0 million to $58.3 million due primarily to the strategic acquisition of franchised stores by our Domestic Company Stores segment, new store openings, and comparable store sales growth. Excluding the year-over-year impact of POS licenses resold to franchisees at cost, total revenue increased 33.5% and 28.8% in the three and six months ended June 29, 2015, respectively, over the comparable periods in 2014.

System-wide sales for the three months ended June 29, 2015, compared to the three months ended June 30, 2014, increased 7.5% from $200.7 million to $215.8 million. System-wide sales for the six months ended June 29, 2015, compared to the six months ended June 30, 2014, increased 8.1% from $416.7 million to $450.4 million.

Comparable store sales growth in 2015 compared to 2014 for selected segments was as follows:



	Three Months Ended				Six Months Ended
	June 29, 2015		June 30, 2014		June 29, 2015		June 30, 2014
Domestic Franchise	4.5	%	1.2	%	5.0	%	2.2	%
Domestic Company Stores	4.9	%	5.7	%	5.6	%	6.4	%
Total domestic stores	4.5	%	1.5	%	5.1	%	2.5	%

As of June 29, 2015, we had achieved 18 straight quarters of comparable store sales growth and 41 of the last 46 quarters had positive comparable store sales growth. In the six months ended June 29, 2015, we also had 17 weeks in which we recorded all-time highs for system-wide sales.

Store Development

We and our franchise owners opened 20 stores in the three months ended June 29, 2015, including 16 in the United States. Through the six months ended June 29, 2015, we and our franchise owners opened 42 stores, including 36 in the United States. While we plan to strategically expand our Company-owned store base in select markets, we expect the majority of our expansion will result from new franchised store openings.

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Acquisitions

During the three months ended June 29, 2015, we acquired three stores in the Seattle, Washington market and one in the Colorado Springs, Colorado market. During the six months ended June 29, 2015, we acquired 21 Papa Murphy’s stores from franchise owners in six different markets across the country. Nine stores were acquired in the Seattle, Washington market, eight stores in the Knoxville, Tennessee market, and one store each in the Boise, Idaho; Portland, Oregon; Dallas, Texas; and Colorado Springs, Colorado markets.

Technology Investments

Our POS system is an important technology platform and tool for our future growth. Future precision marketing tools and mobile coupon capabilities necessitate POS system terminals in our stores. We have rolled out POS system terminals to 1,084 stores as of June 29, 2015. We believe that an opportunity remains for many of our franchise owners to reduce their operating costs by using the POS system terminals.

We continue to roll out an integrated online ordering platform coupled with the latest version of our POS system software, which was in 698 stores as of June 29, 2015. An additional 56 stores were still on our original, non-integrated online ordering platform pending conversion as of June 29, 2015.

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. The following table sets forth our Revenues, Operating Income and Depreciation and amortization for each of our segments for the periods presented:



	Three Months Ended						Six Months Ended
(in thousands)	June 29, 2015			June 30, 2014			June 29, 2015			June 30, 2014
Revenues
Domestic Franchise	$	10,878		$	10,324		$	22,813		$	23,371
Domestic Company Stores	18,156			11,477			35,323			23,495
International	87			45			154			97
Total	$	29,121		$	21,846		$	58,290		$	46,963
Operating Income
Domestic Franchise	$	4,208		$	4,234		$	10,135		$	10,228
Domestic Company Stores	552			158			1,688			678
International	54			(121		)	78			(225		)
Other ⁽¹⁾	(2,226		)	(3,459		)	(3,965		)	(5,269		)
Total	$	2,588		$	812		$	7,936		$	5,412
Depreciation and amortization
Domestic Franchise	$	1,288		$	1,261		$	2,589		$	2,430
Domestic Company Stores	1,124			698			2,135			1,363
International	8			8			15			15
Total	$	2,420		$	1,967		$	4,739		$	3,808


(1)	Represents corporate costs and intersegment elimination.

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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
	June 29, 2015			June 30, 2014			June 29, 2015			June 30, 2014
Domestic store average weekly sales (AWS)	$	11,342		$	10,848		$	11,868		$	11,296
Domestic comparable store sales growth	4.5		%	1.5		%	5.1		%	2.5		%
Domestic comparable stores	1,363			1,309			1,363			1,309
System-wide sales (in thousands)	$	215,752		$	200,718		$	450,385		$	416,701
Number of system-wide stores at period end	1,485			1,436			1,485			1,436
Adjusted EBITDA (in thousands)	$	6,432		$	5,687		$	14,447		$	13,220

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 same stores were open in such time period. This measure allows management to assess changes in customer traffic and spending patterns at our domestic system-wide stores.

Comparable Store Sales Growth

Comparable store sales growth represents the change in year-over-year sales for comparable stores. A comparable store is a store that has been open for at least 52 full weeks from the comparable date (the Tuesday following the opening date). This measure highlights the performance of existing stores, while excluding the effect of newly opened or closed stores. Comparable store sales growth 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 acquisitions and divestitures of stores to assess growth in system-wide sales, royalty revenues and Company-owned store sales.

The following table sets forth the changes in the number of stores in our system as well as the rate of new store openings for the six months ended June 29, 2015.



	Domestic Company Stores		Domestic Franchise		Total Domestic		International	Total		Annualized New Store Opening Rate
Store count at December 29, 2014	91		1,342		1,433		28	1,461
Openings	7		29		36		6	42		5.7	%
Closings	(1	)	(17	)	(18	)	—	(18	)
Net transfers	21		(21	)	—		—	—
Store count at June 29, 2015	118		1,333		1,451		34	1,485

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

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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:


▪	all non-cash losses or expenses (including non-cash share-based compensation expenses and the non-cash portion of rent expenses relating to the difference between GAAP and cash rent expenses), excluding any non-cash loss or expense that is an accrual of a reserve for a cash expenditure or payment to be made, or anticipated to be made, in a future period;


▪	non-recurring or unusual cash fees, costs, charges, losses and expenses;


▪	fees, costs and expenses related to acquisitions;


▪	pre-opening costs with respect to new stores;


▪	historical management fees and expenses incurred under our advisory services and monitoring agreement with Lee Equity, which terminated in connection with the IPO; and


▪	fees and expenses incurred in connection with the issuance of debt.

Adjusted EBITDA eliminates 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 non-cash items and about 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, as well as 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:


▪	as a measurement used 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)	June 29, 2015			June 30, 2014			June 29, 2015		June 30, 2014
Net (Loss) Income	$	(1,939	)	$	(1,607	)	$	657	$	(788	)
Net loss attributable to noncontrolling interests	500			—			500		—
Net (Loss) Income Attributable to Papa Murphy's	(1,439		)	(1,607		)	1,157		(788		)
Depreciation and amortization	2,420			1,967			4,739		3,808
Income tax provision (benefit)	(1,160		)	(1,112		)	460		(421		)
Interest expense, net	1,143			2,297			2,273		5,375
EBITDA	964			1,545			8,629		7,974
Loss on disposal of property and equipment ⁽¹⁾	3			36			62		42
Expenses not indicative of future operations:
Secondary offering and IPO preparation costs ⁽²⁾	345			278			345		651
Loss on Project Pie impairment and disposal ⁽³⁾	4,325			—			4,325		—
Management fees and related expenses ⁽⁴⁾	—			1,543			—		1,678
Transaction costs ⁽⁵⁾	29			60			63		62
New store pre-opening expenses ⁽⁶⁾	176			1			246		11
Non-cash expenses and non-income based state taxes ⁽⁷⁾	590			1,033			777		1,611
Loss on early retirement of debt ⁽⁸⁾	—			1,191			—		1,191
Adjusted EBITDA	$	6,432		$	5,687		$	14,447	$	13,220


(1)	Represents non-cash losses resulting from disposal of property and equipment, including divested Company-owned stores.


(2)	For the 2015 periods, represents offering costs related to the secondary offering of the Company’s common stock; For the 2014 periods, represents non-recurring advisory expenses in connection with our IPO and non-recurring recruitment, relocation and other costs related to the recruitment of a new CFO.


(3)	Represents a $4 million loss recognized upon impairment of Project Pie, a cost-method investment, and its subsequent disposal, and the write-off as bad debt receivables totaling $325,000.


(4)	Represents the elimination of management fees and related costs paid to Lee Equity for advisory services provided pursuant to an advisory services and monitoring agreement. More information can be found in Financial Statements in Note 16 — Related Party Transactions of the accompanying Notes to Unaudited Condensed Consolidated Financial Statements


(5)	Represents transaction costs relating to the acquisition of multiple franchised stores and the investments in and divestment of Project Pie.


(6)	Represents expenses directly associated with the opening of new stores and incurred primarily in advance of the store opening, including wages, benefits, and travel for training of opening teams, grand opening marketing costs and other store operating costs.


(7)	Represents (i) non-cash expenses related to equity-based compensation; (ii) non-cash expenses related to the difference between GAAP and cash rent expense; and (iii) state revenue taxes levied in lieu of an income tax.


(8)	Represents losses resulting from refinancing of long-term debt.

Key Financial Definitions

Revenues

Substantially all of our revenues are derived from 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. Franchise and development fees include initial franchise fees charged for opening a new franchised store, successive fees for the renewal of expiring franchise agreements, transfer fees for transferring ownership of a franchise and fee forfeitures. “Lease and other,” as used in this report, includes revenues earned from the sublease of real estate under a master lease agreement with a national retailer and revenues derived from the resale of POS system licenses to franchise owners at cost, plus revenue from POS support agreements. Lease income is recognized in the period earned, which coincides with the period the expense is due to the master leaseholder. See Selling, General and Administrative Costs below for the related offsetting expense to the POS system licenses resold to franchise owners.

Store Operating Costs

Store operating costs relate to our Domestic Company Stores segment and consist of Cost of food and packaging, Compensation and benefits, Advertising, Occupancy costs and Other store operating costs. We expect all of our Store operating costs to vary as our store count changes from building or acquiring new Company-owned stores. Cost of food and <