Wendy’s and Pizza Hut franchisee NPC International filed for bankruptcy Wednesday.
The restaurant operator, which oversees more than 1,200 Pizza Huts and 390 Wendy’s, was considering restructuring prior to the COVID pandemic. Bloomberg reported in February that the company was weighing its options. NPC is saddled with $903 million in debt and negotiated a restructuring agreement with 92 percent of first-lien lenders and 17 percent of second-lien lenders.
According to court documents, the agreement also "provides for certain milestones that contemplate a sales process for the company's Wendy's business as well as a potential sale of the company's Pizza Hut business, while also providing for the flexibility to effectuate a standalone restructuring around the two businesses."
At the end of January, NPC defaulted on about $800 million in loans after it decided to skip payments. Afterward, the company signed a forbearance agreement with lenders to buy time, according to Bloomberg.
NPC’s Pizza Hut and Wendy’s restaurants will remain open during the proceedings.
“As our industry has been in the midst of dynamic changes due to shifting consumer preferences and dining behavior, we also have been facing increased labor and commodities costs and a higher level of financial leverage that presents obstacles to achieving our long-term business objectives,” said Jon Weber, CEO and President of NPC’s Pizza Hut division in a statement. “These challenges have been magnified recently by the impact and uncertainty of COVID-19, and we believe it is necessary to take proactive steps to strengthen our capital structure, so we have the financial flexibility to continue to adapt to current industry trends. We also intend to use this process to continue to evaluate and optimize our restaurant portfolio so that we are best positioned to meet the needs of consumers across the country.”
In the filing, chief restructuring officer Eric Koza said that in recent years, NPC's Pizza Hut franchises have seen a huge drag on profitability because of a lack of sales growth, volatility in the commodities market, and increased labor pressures. He attributed the lack of sales growth to continued loss of market share, ever-expanding optionality of pizza restaurants, pricing pressures, reduced traffic, and certain barriers specific to Pizza Hut. Koza added that Pizza Hut's brand turnaround in the past several years has strained NPC's financial performance.
"This steady decline in Pizza Hut brand performance has resulted in a dramatic increase in the Company’s leverage over the past two years," the filing said. " ... Despite the company’s various initiatives and efforts, the combination of these challenges impacted the company’s liquidity and profitability and thus its ability to sufficiently overcome these challenges."
During the forbearance, NPC worked several months with Pizza Hut to reach either an out-of-court settlement or in-court settlement through a pre-negotiated Chapter 11 bankruptcy plan to maximize value for stakeholders. The two sides were unable to reach a deal prior to the expiration of the forbearance on June 30, but negotiations are expected to continue during bankruptcy.
NPC's discussions with Wendy's has been more limited, but the franchisee still maintains a strong relationship with the fast-food chain. Leading up to the filing, Wendy's and NPC engaged in discussions about the potential sale of all or some of the franchisee's restaurants. Negotiations were delayed because of the COVID pandemic.
The restructuring is moving forward even though both brands have reported improving sales in recent weeks.
Earlier in June, Yum! reported that domestic Pizza Hut units saw same-store sales growth in the low teens from the end of April through May. In early May, U.S. Pizza Hut locations recorded their highest delivery and carryout average sales week in the past eight years.
Wendy’s reported in early June that domestic comps were down 1.9 percent in May, up from a 14 percent decline in April. Quarter to date through May 31, the brand was down 8.6 percent.
Koza wrote in the filing that after an initial sharp drop, NPC's Pizza Hut business saw a significant rise in sales because of value and limited off-premises options. Meanwhile, Wendy's witnessed initial decreases in sales because of a huge drop in foot and drive-thru traffic and a less developed delivery infrastructure.
But he added that given the two businesses' historical performance, the trends will likely be short-lived as economies continue to reopen.
"The recent sales trends of both businesses and more specifically declines in post-COVID-19 sales growth rates for the Pizza Hut business and steady improvement in sales growth rates for the Wendy’s business, evidences as much," the court documents said.
Before COVID, NPC expected negative profitability trends to continue for Pizza Hut in 2020. EBITDA was expected to be $5.6 million, down from $31.9 million in 2019. But due to the positive impact from the COVID pandemic, that projection was revised to $44.1 million. The brand continues to face industry, labor, and brand-wide challenges. However, it was noted that "recent actions and communication from the Pizza Hut Franchisor related to turnaround initiatives is positive."
For Wendy's, EBITDA was expected to be at $55.2 million, or an increase of 14 percent from 2019, thanks in part to the new breakfast menu. But due to the pandemic, that projection was revised to $48.8 million.
“We are very pleased with the support we are receiving from our senior lenders, which demonstrates their confidence in NPC and our potential for long-term success once we get the company in a stronger financial position,” said Carl Hauch, CEO and president of NPC’s Wendy’s division, in a statement. “The Wendy’s business remains strong and resilient and is already recovering from the impact of the pandemic to produce year-over-year growth. We look forward to continuing our discussions with our brand partners, landlords and other creditor groups and are confident that we will be able to work collaboratively to agree on a long-term plan that is in the best interests of all stakeholders.”
In January, Moody’s Investors Service lowered NPC’s credit rating by three notches and said January’s skipped interest payments “were tantamount to default.” The company chose not to make January 31 interest payments on its first and second-lien loans, sources told Bloomberg. It signed forbearance agreements with creditors that suspended interest payments on its first-lien debt and allowed more time for negotiations.
During Yum!’s Q4 earnings call, CFO Chris Turner said a growth in bad debt expense was related “to just a handful of franchisee situations.” The company has mentioned on multiple occasions that some operators in the system are overleveraged. Former CEO Greg Creed, who retired at the end of 2019, said there are some who ““simply aren’t the right operating partner for us to grow this brand.”
“We do have a handful of situations where we are working with the franchisees to get them into a better place,” Turner said during Yum!’s Q4 earnings call in early February. “Obviously, each of those processes take time and do create some choppiness.”
Some franchisees with mounting debt and lack of capital have struggled to relocate or remodel units the way Yum! wants, which includes Pizza Hut moving toward off-premises and further away from dine-in.
NPC, which employs more than 37,000 people, joins a growing list of brands that have filed bankruptcy amid the pandemic, including Chuck E. Cheese, FoodFirst Global Restaurants, Sustainable Restaurant Holdings, Garden Fresh Restaurants, Le Pain Quotidien, TooJay’s Deli, and HopCat owner Barfly Ventures.