Papa Murphys Holdings, Inc.
Papa Murphy's Holdings, Inc. (Form: S-1, Received: 03/11/2014 17:16:20)
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As filed with the Securities and Exchange Commission on March 11, 2014

Registration No. 333-            

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT UNDER THE

SECURITIES ACT OF 1933

 

 

Papa Murphy’s Holdings, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

(State or Other Jurisdiction of

Incorporation or Organization)

 

5812

(Primary Standard Industrial

Classification Code Number)

 

27-2349094

(IRS Employer

Identification No.)

8000 NE Parkway Drive, Suite 350

Vancouver, WA 98662

(360) 260-7272

(Address, including zip code and telephone number, including area code, of registrant’s principal executive offices)

Papa Murphy’s Holdings, Inc.

8000 NE Parkway Drive, Suite 350

Vancouver, WA 98662

(360) 260-7272

(Name, address, including zip code and telephone number, including area code, of agent for service)

 

 

 

  Copies to:  

Alexander D. Lynch, Esq.

Weil, Gotshal & Manges LLP

767 Fifth Avenue

New York, New York 10153

Telephone: (212) 310-8000

Facsimile: (212) 310-8007

 

Victoria T. Blackwell, Esq.

Papa Murphy’s Holdings, Inc.

8000 NE Parkway Drive, Suite 350

Vancouver, WA 98662

Telephone: (360) 260-7272

Facsimile: (360) 397-6665

 

Marc D. Jaffe, Esq.

Ian D. Schuman, Esq.

Latham & Watkins LLP

885 Third Avenue

New York, New York 10022

Telephone: (212) 906-1200

Facsimile: (212) 751-4864

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended, or the Securities Act, check the following box. ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

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

(Do not check if a smaller reporting company)

  Smaller reporting company  ¨

CALCULATION OF REGISTRATION FEE

 

 

TITLE OF EACH CLASS OF SECURITIES
TO BE REGISTERED
  PROPOSED MAXIMUM
AGGREGATE OFFERING
PRICE (1)
  AMOUNT OF
REGISTRATION FEE

Common Stock, par value $0.01 per share

  $70,000,000   $9,016

 

 

 

(1)  

Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(o) promulgated under the Securities Act. Includes shares of common stock that may be issuable upon exercise of an option to purchase additional shares granted to the underwriters.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act or until the Registration Statement shall become effective on such date as the Commission acting pursuant to said Section 8(a), may determine.


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion Dated March 11, 2014

 

PRELIMINARY PROSPECTUS

                 Shares

 

LOGO

Papa Murphy’s Holdings, Inc.

Common Stock

This is an initial public offering of shares of common stock of Papa Murphy’s Holdings, Inc. We are offering              shares of our common stock. The selling stockholders identified in this prospectus are offering an additional              shares. We will not receive any of the proceeds from the sale of the shares being sold by the selling stockholders. This is our initial public offering and no public market currently exists for our common stock. We expect our initial public offering price will be between $         and $         per share. We have applied to list our common stock on The NASDAQ Global Select Market (“NASDAQ”) under the symbol “FRSH”.

We are an “emerging growth company” as defined under the federal securities laws and, as such, will be subject to reduced public company reporting requirements. See “Prospectus Summary—Implication of Being an “Emerging Growth Company”.”

Investing in our common stock involves a high degree of risk. See “ Risk Factors ” beginning on page 20.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

 

     PER SHARE      TOTAL  

Public Offering Price

   $                    $                

Discounts and Commissions (1)

   $         $     

Proceeds, before expenses, to us

   $         $     

Proceeds, before expenses, to the selling stockholders

   $         $     

 

 

 

(1)  

We refer you to “Underwriting” beginning on page 133 of this prospectus for additional information regarding total underwriter compensation.

Delivery of the shares of common stock is expected to be made on or about                     , 2014. The selling stockholders have granted the underwriters an option for a period of 30 days from the date of this prospectus to purchase an additional                  shares of our common stock to cover over-allotments. We will not receive any proceeds from the sale of shares by the selling stockholders.

 

Jefferies    Baird    Wells Fargo Securities

 

William Blair    Raymond James    Stephens Inc.

Prospectus dated                     , 2014

 


Table of Contents

TABLE OF CONTENTS

 

 

 

Prospectus Summary

     1   

Risk Factors

     20   

Forward-Looking Statements

     45   

Use of Proceeds

     46   

Dividend Policy

     47   

Capitalization

     48   

Dilution

     49   

Unaudited Pro Forma Condensed Combined Financial Statements

     51   

Selected Consolidated Financial and Other Data

     55   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     60   

Business

     81   

Management

     100   

Executive and Director Compensation

     105   

Certain Relationships and Related Person Transactions

     113   

Principal and Selling Stockholders

     118   

Description of Material Indebtedness

     120   

Description of Capital Stock

     123   

Shares Eligible for Future Sale

     127   

Material U.S. Federal Income and Estate Tax Considerations for Non-U.S. Holders

     129   

Underwriting

     133   

Legal Matters

     140   

Experts

     140   

Where You Can Find More Information

     140   

Index to Financial Statements

     F-1   

 

 


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You should rely only on the information contained in this prospectus or in any free-writing prospectus we may authorize to be delivered or made available to you. Neither we, the selling stockholders, nor the underwriters (or any of our or their respective affiliates) have authorized anyone to provide any information other than that contained in this prospectus or in any free writing prospectus prepared by or on behalf of us or to which we have referred you. Neither we, the selling stockholders, nor the underwriters (or any of our or their respective affiliates) take any responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. We, the selling stockholders and the underwriters (or any of our or their respective affiliates), are not making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus is only accurate as of the date on the front cover of this prospectus. Our business, financial condition, results of operations and prospects may have changed since that date.

TRADEMARKS AND TRADE NAMES

We own or have the rights to use various trademarks, service marks and trade names referred to in this prospectus, including, among others, Papa Murphy’s, Papa Murphy’s Take ‘N’ Bake Pizza, deLite and their respective logos. Solely for convenience, we refer to trademarks, service marks and trade names in this prospectus without the TM, SM and ® symbols. Such references are not intended to indicate, in any way, that we will not assert, to the fullest extent permitted by law, our rights to our trademarks, service marks and trade names. Other trademarks, trade names or service marks appearing in this prospectus are the property of their respective owners. As indicated in this prospectus, we have included market data and industry forecasts that were obtained from industry publications and other sources.

PRESENTATION OF FINANCIAL AND OTHER INFORMATION

We prepare our consolidated financial statements in U.S. dollars and in conformity with generally accepted accounting principles in the United States (“GAAP”). Certain amounts included in this prospectus and our audited consolidated financial statements as of and for fiscal years ended December 30, 2013, December 31, 2012 and January 2, 2012 have been rounded for ease of presentation. Percentage amounts included in this prospectus have not in all cases been calculated on the basis of such rounded figures but on the basis of such amounts prior to rounding. For this reason, percentage amounts in this prospectus may vary from those obtained by performing the same calculations using the figures in our consolidated financial statements. Certain other amounts that appear in this prospectus may not sum due to rounding.

On May 4, 2010, affiliates of Lee Equity Partners, LLC (“Lee Equity”) acquired a majority of the capital stock of PMI Holdings Inc., our predecessor. The periods on or prior to May 4, 2010 are referred to as “Predecessor.” Papa Murphy’s Holdings, Inc. was incorporated on March 29, 2010 by affiliates of Lee Equity in connection with the acquisition, and all periods including and after such date are referred to as “Successor.” From March 29, 2010 to May 4, 2010, the date of the acquisition, Papa Murphy’s Holdings, Inc. had no activities other than the incurrence of transaction costs related to the acquisition.

MARKET AND INDUSTRY INFORMATION

Market data used throughout this prospectus is based on management’s knowledge of the industry and the good faith estimates of management. We also relied, to the extent available, upon management’s review of independent industry surveys and publications and other publicly available information prepared by a number of sources, including Zagat , Technomic , Nation’s Restaurant News , NPD Crest , Mintel , Empathica , Franchise Business Review and Forbes . All of the market data used in this prospectus involves a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. Although we believe that these sources are reliable, neither we nor the underwriters can guarantee the accuracy or completeness of this information, and neither we nor the underwriters have independently verified this information. While we believe the estimated market position, market opportunity and market size information included in this prospectus is reliable, such information, which in part is derived from management’s estimates and beliefs, is inherently uncertain and imprecise. Projections, assumptions and estimates of our future performance and the future performance of the industry in which we operate are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors” and elsewhere in this prospectus. These and other factors could cause results to differ materially from those expressed in the estimates prepared by independent parties and by us.

 

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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus. This summary does not contain all of the information you should consider before investing in our common stock. You should read this entire prospectus carefully, including the risks of investing in our common stock discussed under “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto included elsewhere in this prospectus, before making an investment decision. Unless the context requires otherwise, references to “Papa Murphy’s,” “our company,” “we,” “us” and “our” refer to Papa Murphy’s Holdings, Inc. and its direct and indirect subsidiaries.

This prospectus contains consolidated financial statements of Papa Murphy’s Holdings, Inc. To match our operating cycle, we use a 52- or 53-week fiscal year, ending on the Monday nearest to December 31. Fiscal years 2013, 2012 and 2011 were 52-week periods ending on December 30, 2013 (“fiscal year 2013”), December 31, 2012 (“fiscal year 2012”) and January 2, 2012 (“fiscal year 2011”), respectively.

Our Company

Create. Take. Bake.

Papa Murphy’s is a high-growth franchisor and operator of the largest Take ‘N’ Bake pizza chain in the United States. Take ‘N’ Bake pizza restaurants sell uncooked pizzas that customers bake at home. We were founded in 1981 and have grown our footprint to a total of 1,418 franchise and company-owned stores (collectively “system-wide stores”) as of December 30, 2013, more than 20 times the stores of our nearest Take ‘N’ Bake pizza restaurant competitor. The Papa Murphy’s experience is different from traditional pizza restaurants. Our customers:

 

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CREATE their fresh, customized pizza with high-quality ingredients in our stores or online;

 

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TAKE their fresh pizza home; and

 

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BAKE their pizza fresh in their ovens, at their convenience, for a home-cooked meal served hot.

We have been repeatedly rated the #1 pizza chain in the United States by multiple third-party consumer studies. In 2013, 2012 and 2011, we were rated the #1 pizza chain overall by Nation’s Restaurant New s , and in 2012, 2011 and 2010, we were rated the #1 pizza chain by Zagat . Compared to broader restaurant chain competition, we were also recognized by Technomic in 2013 as the #1 chain overall among all restaurants and all food categories, by Nation’s Restaurant New s in 2013 and 2012 as one of the Top 5 Overall limited service restaurant chains across all food categories, and by Zagat in 2012 as one of the Top 5 Overall fast food chains across all food categories. For fiscal years 2013 and 2012 we had total revenues of $80.5 million and $66.9 million, respectively, net income (loss) of $(2.6) million and $(2.1) million, respectively, and Adjusted EBITDA of $24.4 million and $22.1 million, respectively. For a reconciliation of Adjusted EBITDA, a non-GAAP measure, to net loss, see “—Summary Historical Consolidated Financial and other Data.”

We believe our leading consumer ratings are due to the broad appeal of our concept. However, we actively target mothers and families looking to solve the “dinnertime dilemma” of providing their family with a high-quality, home-cooked meal, without investing significant time or money. We believe that our target customer values the focus on freshness and quality that differentiates the Papa Murphy’s pizza-making process:

 

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We make our dough fresh in each store, starting with flour, water and yeast;

 

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We grate our cheese daily from blocks of 100% whole-milk mozzarella cheese;

 

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We slice fresh, never-frozen vegetables by hand;

 

 

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We feature specialty, premium ingredients like artichoke hearts, sun-dried tomatoes, feta cheese and fresh spinach;

 

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We use only high-quality meats with no added fillers; and

 

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We use no trans-fats.

Additionally, our guidelines provide that all pizza dough must be used to make pizzas within 72 hours of preparation, and we recommend our customers bake their pizza within 24 hours of preparation, resulting in a fresh pizza for our customers.

Our store model is also different from many other restaurant models. Because our stores do not have pizza ovens, venting hoods, freezers or dining areas and average 1,400 square feet in size, they require a lower capital investment than traditional pizza, limited service or fast casual restaurants. We also have lower operating costs than traditional pizza, limited service or fast casual restaurants because our stores do not require the hiring of delivery drivers or wait staff. Further, the simplicity of our operations and our shorter opening hours (typically 11:00 a.m. to 9:00 p.m.) are attractive to potential and current franchise owners and allow them to focus on making fresh, high-quality food for our customers.

As of December 30, 2013, our store base was 95.1% franchised, offering us strategic and financial benefits. Our franchise business model enables us to focus our company resources on menu innovation, marketing, franchise owner training and operations support and other initiatives to drive the overall success of our brand. Our franchise business model also allows us to grow our store base and brand awareness with limited corporate capital investment. As a result, our business model is designed to provide us with high operating margins, low capital expenditures, negative working capital and high operating cash flows.

As of December 30, 2013, we had 1,418 system-wide stores, consisting of 1,349 franchise and 69 company-owned stores, located in 38 states, Canada and the United Arab Emirates. We have increased our total store count 68.6% from 2004 to 2013. We currently have a strong new store pipeline and our franchise owners opened 98 stores in 2013, which represents a 27.3% increase in franchise store openings over the prior fiscal year. We have also experienced steady increases in our system-wide sales. From 2004 to 2013, our system-wide sales increased from $385.9 million to $785.6 million.

Total Stores at End of Period

 

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System-wide Sales

 

LOGO

We have experienced strong comparable store sales, revenue and Adjusted EBITDA growth. Our stores have generated positive comparable store sales growth in 35 out of the last 40 quarters through the end of fiscal year 2013, averaging approximately 4% throughout the last ten years. From fiscal year 2009 to fiscal year 2013, our total revenues increased from $54.1 million to $80.5 million, and Adjusted EBITDA increased from $16.5 million to $24.4 million. In fiscal year 2009, we had net income of $4.5 million compared to a net loss of $(2.6) million in fiscal year 2013.

Our Industry

Take ‘N’ Bake pizza is a fast-growing segment of the limited-service restaurant (“LSR”) pizza category. We are the market leader in the Take ‘N’ Bake segment with more than 20 times the number of stores of our next closest Take ‘N’ Bake competitor in the United States. In addition, we are the only national Take ‘N’ Bake LSR pizza chain. We are the fifth largest pizza chain in the United States as measured by system-wide sales and total number of stores. Mintel estimates that the pizza restaurant market grew from $32 billion in 2007 to $38 billion in 2012 and will grow to $44 billion in 2017. We believe the pizza restaurant market is an attractive category due to its size and growth, as well as its fragmented competitive landscape. The top five pizza chains accounted for only 40.8% of category sales in 2012, which provides the potential to take share from smaller pizza chains and independent pizza operators.

 

 

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Our Competitive Strengths

Fresh Made. Fresh Baked. Love at 425°.

We believe we benefit from the following competitive strengths:

High-Quality Pizza at an Attractive Value. We were founded on the following core values—Great Quality, Great Value, Great Customer Service—and we strive to deliver on these values every day. We believe the manner in which we deliver these values to our customers provides a strong foundation for growth.

 

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Great Quality. We have continually focused on quality over the past 33 years, and we believe customers can taste the difference in our food. Unlike some of our national pizza chain competitors, we do not use frozen dough or pre-shredded, pre-packaged or frozen cheese. Our dough is made from scratch daily, and our pizzas are made with high-quality ingredients, including: (i) 100% whole-milk block mozzarella cheese grated in-store; (ii) a variety of sauces including traditional red sauce made from California tomatoes; (iii) fresh, never-frozen vegetables that are chopped by hand daily; (iv) high-quality meat with no added fillers; and (v) specialty toppings such as artichoke hearts, feta cheese, Italian salami, zucchini, sun-dried tomatoes and fresh spinach. Our menu offers customers a variety of original, thin crust and stuffed pizzas as well as the ability to create a customized pizza from a broad selection of crust, sauce and topping combinations. We were ranked #1 in Food Quality, Freshness of Food and Taste and Flavor of Food in numerous customer surveys, including Nation’s Restaurant News in 2013, 2012 and 2011 , Technomic in 2013 and NPD CREST in 2012, 2011 and 2010.

 

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Great Value. We offer a high-quality pizza at a value price point. We were ranked #1 in the pizza value category by Nation’s Restaurant News in 2013, 2012 and 2011, and we were ranked the #1 limited service restaurant chain for value by Technomic in 2013. In 2013, our average transaction size was approximately $16, but because our pizzas serve more than one person, our average check per person was $5.39. We believe this is one of the lowest average checks per person among national pizza chains. Additionally, the Take ‘N’ Bake experience eliminates the need for tipping and delivery fees.

 

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Great Customer Service. We offer our customers a consistent and convenient experience where they are able to create their customized pizza. We train our store crews to greet each customer, to promote the latest new product offers or promotions and to assist each customer in choosing the combination of fresh made pizzas or side items that complete their meal. Our pizzas are made fresh, and our customers can follow their pizza as it is made to order right in front of them. While we do offer pizzas with suggested pre-selected toppings, many pizzas sold in our stores are customized. We provide a fast and friendly in-store experience, with an average in-store service time of approximately four minutes. We were ranked #1 among all pizza chains in Fast and Efficient Service, Cleanliness, Likelihood to Return and Overall Customer Experience by numerous customer surveys including Nation’s Restaurant News in 2013, 2012 and 2011 , Technomic in 2013 , NPD CREST in 2012, 2011 and 2010 and Empathica in 2013.

Top-Rated, Award-Winning Pizza Chain. We have consistently been rated consumers’ #1 pizza chain and ranked among the top restaurant chains overall in the United States in third-party consumer studies.

 

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Zagat National Restaurant Chain Survey

 

   

#1 Rated Pizza Chain in 2012, 2011 and 2010

 

   

Top 5 U.S. Fast Food Chain (all fast food categories, less than 5,000 locations) in 2012 (#2 Top Service and Top Food ), 2011 (#3 Top Service and Top Food ) and 2010 (#4 Overall )

 

 

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Technomic 2013 Consumer Restaurant Brand Metrics Study

 

   

#1 Chain Overall , among all restaurants and food categories surveyed

 

   

#1 Pizza/Italian Chain

 

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Nation’s Restaurant News Consumer Picks Survey

 

   

#1 Pizza/Italian Chain in 2013, 2012 and 2011 (including the #1 ranking in 2013 and 2012 in 10 out of 11 categories such as Food Quality, Value, Service, Likely to Recommend and Likely to Return)

 

   

Top Overall Limited Services Restaurant Chain in 2013 (#3), 2012 (#2) and 2011 (#1)

 

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NPD CREST Customer Survey

 

   

#1 Pizza Chain in 2012, 2011 and 2010 in (i) Taste and Flavor of Food; (ii) Quality of Food; (iii) Freshness of Food; (iv) Fast and Efficient Service; (v) Likelihood to Recommend; and (vi) Overall Customer Experience

 

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Empathica 2013 Quick Service Restaurant Benchmark Study

 

   

#1 Pizza/Pasta Chain in (i) Overall Customer Delight; (ii) Overall Customer Satisfaction; (iii) Good Value for What Customers Paid; (iv) Customer Likelihood to Revisit; and (v) Customer Likelihood to Recommend

 

   

Top Carryout Pizza Chain

Loyal Customer Base. We have developed a loyal and diverse customer base that values (i) our ability to create a fresh, customized pizza; (ii) our high-quality ingredients; (iii) our fast and friendly in-store service; (iv) our bake-at-home convenience; and (v) our attractive price points. We believe our leading consumer ratings and success across a national footprint can be attributed to the broad appeal of our Take ‘N’ Bake concept, which resonates with both families and single adults and attracts both female and male customers across all ages, demographics and income levels. While we believe our concept has broad appeal, we actively target mothers and families looking to solve the “dinnertime dilemma” of providing a fresh, home-cooked meal for their family without investing significant time or money. We believe this core target customer is more loyal and seeks higher-quality pizza. As shown in research conducted by Nation’s Restaurant News , our customers are significantly more likely to recommend Papa Murphy’s as well as more likely to return to Papa Murphy’s stores than our competitors.

 

2013 Likely To Recommend   

2013 Likely To Return

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Franchised Business Model Provides Platform for Growth. As of December 30, 2013, our store base was 95.1% franchised, allowing us to focus on brand differentiation and product innovation while our franchise owners are responsible for day-to-day management with operational guidance from us. The growth of our brand requires limited financial investment by us, given that new store development and substantially all of our store advertising costs are funded by franchise owners. Consequently, our business model is designed to generate significant operating cash flows and an attractive return on assets. As a franchised model, we generate a significant portion of our revenues from ongoing royalties based on a percentage of net sales at franchise stores and fees paid to us by franchise owners opening new stores and renewing expiring franchise agreements, which collectively represented 51.2% of our total revenues for 2013. These royalties and fees provide us with consistent and diverse cash flow. Further, our franchise model minimizes our direct exposure to changes in commodity and other operating costs that may impact our company-owned stores, which represented 48.6% of our total revenues in 2013.

We were named a Top Food Franchise by Franchise Business Review in 2013, and we have received high marks in the publication’s annual franchise satisfaction survey. We strive to be the partner of choice for both individual family owner/operators and sophisticated franchise organizations because we understand that our franchise owners ultimately drive the success of our business. Additionally, our concept provides franchise owners access to financing sources, including loans guaranteed by the Small Business Administration (“SBA”).

Efficient Operating Model Generates Attractive Store-Level Economics. We believe our Take ‘N’ Bake model is efficient and offers franchise owners operating advantages that differentiate us from other restaurant concepts. Our 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 on duty during each shift as compared to most other franchise restaurant concepts, thereby resulting in lower labor costs; and (v) do not require dining areas, thereby resulting in lower occupancy and operating costs. We believe our simple, low cost operations create the opportunity for higher margins and attractive returns for franchise owners. In 2011, we were named to Forbes’ list of Top Franchises for the Money, which we believe highlights the attractive investment opportunity we offer franchise owners.

As of December 30, 2013, a majority of our franchise owners owned one store, and approximately 75% owned one or two stores. We believe many of these owners operate and manage their stores themselves. For fiscal year 2012, our domestic franchise stores that had been open for at least one full year generated average weekly sales (“AWS”) of approximately $11,100 and generated a store-level EBITDA margin in excess of 15% after royalties and advertising but before the impact of manager/owner salary. Additionally, our stores have a low breakeven AWS, which we estimate to be less than half the system average. Our operating model requires a low initial capital expenditure on average of approximately $200,000 per store. In the first full fiscal year after a store has been open, we believe that our franchise owners can earn, on average, a cash-on-cash return of approximately 20% after royalties and advertising but before the impact of manager/owner salary. We believe the combination of our efficient operating model, low initial cash investment and attractive store economics has resulted in our ability to generate consistent new store growth from both new and existing franchise owners, as evidenced by over 570 net new store openings since 2004.

Experienced Management Team. Our strategic vision and culture are driven by our executive management team under the leadership of Mr. Ken Calwell, our Chief Executive Officer, Mr. Mark Hutchens, our Chief Financial Officer and Mr. John Barr, our Chairman. Mr. Calwell is an industry veteran with more than 28 years of relevant restaurant and food experience, including roles as the Chief Marketing Officer and Chief Food Innovation Officer at Wendy’s International, Chief Marketing Officer and Executive Vice President of Research Development at Domino’s Pizza and Senior Director of Marketing at Pizza Hut. Mr. Hutchens has nearly 25 years of progressive financial leadership experience, with an extensive history in the restaurant and retail sector, including roles as the Vice President, Chief Financial Officer – International at Bloomin’ Brands Inc., Senior Vice President,

 

 

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Controller and Chief Accounting Officer at Office Depot, Inc. and Assistant Treasurer - Corporate Finance at YUM! Brands, Inc. Our executive management team has over 140 years of combined operational experience at restaurant chains, franchisors and large corporations including Domino’s Pizza, Donatos, McDonald’s, Pizza Hut, Potbelly Sandwich Works, Starbucks, Wendy’s, Penske and Quaker State. Our executive management team has a deep understanding of our concept, averaging approximately seven years with our Company. Mr. Calwell and Mr. Barr have built a team with significant talent in new product development, brand marketing, franchise development and operations, which we believe positions us well for continued long-term growth.

Our Growth Strategies

Our growth strategy has three key components: (i) opening new stores in existing and new markets; (ii) increasing system-wide comparable store sales; and (iii) improving our profitability by leveraging our scale and infrastructure. We believe that the successful implementation of these three components will support our growth and profitability.

Open Stores in Existing and New Markets. As of December 30, 2013, we had 1,396 stores in the United States, and we believe there are significant development opportunities remaining in the United States and select international markets. We estimate our total store potential in the United States is approximately 4,500 stores, including approximately 2,500 new stores in our existing markets.

We believe our significant unit growth potential, attractive store economics and the simplicity of our store operations will continue to attract new franchise owners and encourage existing franchise owners to expand their current footprint. We expect the majority of our expansion will result from new franchise store openings, and we also plan to strategically expand our company-owned store base in select markets. Our franchise owners opened 98 stores in 2013. We expect our franchise owners to open between 105 and 115 stores in 2014. Our new store strategy consists of the following:

 

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Accelerate Growth in Existing Markets. We believe there is a significant near-term growth opportunity in our existing markets. We intend to focus on further developing our core markets in the West and Midwest, while expanding our store density in existing but less-penetrated developing markets in the South and East. Historically, new stores in existing markets tend to generate higher average unit volumes as markets become more penetrated. As a result, we expect to focus the majority of our near-term new store development in existing markets.

 

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Pursue Growth in New Markets. We have historically proven our ability to expand into new markets as evidenced by the success of our stores in numerous markets across the United States. As we expand our footprint into new markets, we will continue to leverage our brand awareness and well-developed store support infrastructure to enhance new store performance and increase store density in these markets. Additionally, we are in the early stages of international expansion, which we believe represents a long-term growth opportunity. We currently have a 10-year master franchise agreement in Canada, with 18 stores open as of December 30, 2013, as well as a recent 20-year master franchise agreement to open up to 100 franchise stores in the Middle East, with four stores open as of December 30, 2013.

Increase System-wide Comparable Store Sales. We intend to increase comparable store sales by attracting new customers, converting first-time customers into repeat and loyal users and increasing average transaction sizes. While the short-term benefit of increasing comparable store sales is an increase in franchise royalties and company store revenues, it also provides the significant long-term benefit of improved franchise owner profitability, which we believe will contribute to future store growth.

 

  n  

Attract New Customers. We will continue to invest in our brand to further grow customer awareness, build customer loyalty and educate the marketplace on the benefits of Take ‘N’ Bake pizza. As our franchise store base continues to grow and we further penetrate our markets, we will be able to use increased marketing funds to expand our brand recognition through a combination of traditional print and television advertising and through social media.

 

 

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New product development is another tool for attracting customers to our stores. The recent roll-out of our Focus 5 menu strategy is designed to broaden our customer appeal by offering a variety of fresh, high-quality products utilizing our high-quality ingredients. Our Focus 5 menu strategy offers price points ranging from our FAVES line, generally marketed for $5 per pizza, to our Stuffed line of pizzas, generally marketed for $15 per pizza. Our FAVES line of pizzas consists of three simple pizza classics at attractive price points. We believe the introduction of this option has helped increase transactions and comparable store sales growth. Our recently tested Fresh Pan Pizza is a new product at a higher price point that features a fresh, thicker, buttery crust that attracts new customers who prefer a thicker pan-style crust. For a premium price, we also offer gourmet toppings not typically available at large pizza chains such as artichoke hearts, sun-dried tomatoes, feta cheese and fresh spinach. We believe this balanced approach to menu innovation attracts a broader base of customers, drives new customer trial and increases brand loyalty.

 

  n  

Increase Customer Frequency. We focus on converting first-time users into repeat customers and providing loyal customers with reasons to use our brand more frequently. We believe the high quality of our ingredients, our customizable menu and the opportunity for families to provide a home-cooked meal keep customers dedicated to our brand.

We believe that providing a fast and friendly in-store experience drives customer frequency. Our Take ‘N’ Bake concept allows our employees to focus on providing personal service to every customer rather than rushing customer interactions or prioritizing incoming phone delivery orders. We also recently introduced online ordering, which will provide an additional convenience to our customers. In tests in approximately 300 stores in 2013, our online channel resulted in increases in customer frequency and average transaction size. We are also in the early stages of testing a store remodel program, which we believe will enhance our customer experience and drive customer frequency.

In addition, in the past we have made media investments to drive repeat visits with a focus on limited time only product offers and promotions. Recent offers and promotions such as our Taco Grande Pizza and Greek Pepperoni Pizza have generated strong customer interest, which we believe resulted in increases in transactions, the average transaction size and customer frequency.

 

  n  

Increase Transaction Size. Over the past year, we have focused our training and support teams on improving up-sell strategies to drive incremental revenue per transaction. Papa Murphy’s features both large, 14” pizzas that serve two to three people and family size, 16” pizzas that serve four to six people. Our store crews are trained to upsell customers from the large to the family size—approximately 30% more pizza for an incremental charge of approximately $2, which we believe is a great value for the customer. We also present in-store messaging of “meal deals” where a customer can purchase a pizza with either a side item and two liter beverage or two side items for a bundle discount.

We are also leveraging our new product innovation capabilities to drive higher revenue per transaction. For example, our recently tested Fresh Pan Pizza is marketed at a price above our regular menu items, demonstrating the potential for increasing our average transaction size. We believe we have other pricing opportunities for gourmet products already found on our menu and plan to thoughtfully test opportunities to re-position these products to better align with customer value perceptions. We are also leveraging our supplier networks to help us expand our line of sides, salads and desserts.

Improve Profitability and Leverage Our Infrastructure. Through opening stores in existing and new markets and increasing system-wide comparable store sales, we believe we will increase our revenues and Adjusted EBITDA. With 1,396 stores across the United States and 548 domestic franchise owners as of December 30, 2013, we believe we have an established infrastructure to support future growth. Our teams located across the country provide support to our franchise owners in operations, store technology, marketing and new store development. Therefore, as we continue to grow our store base and increase sales, we believe our general and administrative expenses will increase at a lower rate than our revenues, and we will be able to realize certain benefits from economies of scale.

 

 

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Recent Developments

Project Pie Investment

In December 2013, we purchased preferred convertible units of Project Pie, LLC (“Project Pie”), a fast casual custom-pizza restaurant chain with one store located in San Diego, California and one located in Las Vegas, Nevada as of December 31, 2013, for an aggregate purchase price of $2.0 million, representing approximately 25.8% of all issued and outstanding Project Pie common units on a fully converted basis. We retained certain rights and obligations in connection with our investment in Project Pie. For additional information, see “Management’s Discuss and Analysis of Financial Condition and Results of Operations—Project Pie” and “Certain Relationships and Related Person Transactions—Project Pie.”

Reorganization Transactions

Prior to the completion of this offering, we intend to effect certain reorganization transactions consisting of (i) the automatic conversion of all of our outstanding Series A Preferred Stock and Series B Preferred Stock (together, the “Preferred Shares”) to              shares of common stock; (ii) a 1 for                     stock split of our common stock; and (iii) the amendment and restatement of our certificate of incorporation. We refer to these transactions collectively as the “Reorganization Transactions.” Unless otherwise indicated, all information in this prospectus assumes the completion of our Reorganization Transactions in preparation of this offering. Except for pro forma data and as otherwise indicated, financial data does not give effect to the automatic conversion of our Preferred Shares for common stock in connection with this offering.

Our Private Equity Sponsor

Lee Equity is a middle-market private equity investment firm managing more than $1 billion of equity capital. Lee Equity invests in a variety of industries including consumer/retail, business services, distribution/logistics, financial services, healthcare services and media. Immediately prior to this offering, Lee Equity and its affiliates owned approximately 65% of our outstanding capital stock. Immediately following the consummation of this offering, Lee Equity will own approximately     % of our outstanding capital stock, or     % if the underwriters’ option to purchase additional shares is fully exercised. Lee Equity may acquire or hold interests in businesses that compete directly with us, or may pursue acquisition opportunities that are complementary to our business, making such acquisitions unavailable to us. In addition, upon completion of this offering, a majority of the directors serving on our board will have been designated by Lee Equity and under the terms of a new stockholder’s agreement, Lee Equity will have the right to designate two directors to our board as long as it owns 20% or more of the issued and outstanding shares of our common stock and the right to designate one director to our board for as long as it owns 10% or more of our issued and outstanding common stock. Our amended and restated certificate of incorporation will contain provisions renouncing any interest or expectancy held by our directors affiliated with Lee Equity in certain corporate opportunities. In addition, so long as Lee Equity owns 25% or more of the outstanding shares of our common stock, under a new stockholder’s agreement (as described herein), certain actions by us, including among others, certain change of control transactions, issuances of equity securities, the incurrence of significant indebtedness, declaration or payment of non-pro rata dividends, significant investments in or acquisitions or dispositions of assets, adoption of any new equity-based incentive plan, any material increase in the salary of our Chief Executive Officer, certain amendments to our organizational documents, any material change to our business, or any change to the number of directors serving on our board will require Lee Equity’s prior written approval. See “Risk Factors – Risks Related to Our Company and Our Ownership Structure – Lee Equity may acquire interests and positions that could present potential conflicts with our and our stockholders’ interests,” “Risk Factors—Risks Related to Our Company and Our Ownership Structure—Lee Equity will continue to have significant influence over us after this offering, which could limit your ability to influence the outcome of key transactions, including change of control,” “Certain Relationships and Related Person Transactions—Agreements Related to the Acquisition by Lee Equity—Existing Stockholders’ Agreement and Registration Rights Provisions” and “Certain Relationships and Related Person Transactions—Agreements Related to the Acquisition by Lee Equity—New Stockholder’s Agreement.”

 

 

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Implication of Being an “Emerging Growth Company”

As a company with less than $1.0 billion in revenues during its last fiscal year, we qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other regulatory requirements for up to five years that are otherwise applicable generally to public companies. These provisions include, among other matters:

 

  n  

a requirement to present only two years of audited financial statements and only two years of related Management’s Discussion and Analysis of Financial Condition and Results of Operations;

 

  n  

exemption from the auditor attestation requirement on the effectiveness of our system of internal control over financial reporting;

 

  n  

exemption from the adoption of new or revised financial accounting standards until they would apply to private companies;

 

  n  

exemption from compliance with any new requirements adopted by the Public Company Accounting Oversight Board requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer;

 

  n  

an exemption from the requirement to seek non-binding advisory votes on executive compensation and golden parachute arrangements; and

 

  n  

reduced disclosure about executive compensation arrangements.

We will remain an emerging growth company for five years unless, prior to that time, we have more than $1.0 billion in annual revenues, have a market value for our common stock held by non-affiliates of more than $700 million as of June 30 of the year a determination is made whether we are deemed to be a “large accelerated filer,” as defined in Rule 12b-2 promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or issue more than $1.0 billion of non-convertible debt over a three-year period. We have availed ourselves of the reduced reporting obligations and executive compensation disclosure in this prospectus, and expect to continue to avail ourselves of the reduced reporting obligations available to emerging growth companies in future filings. In addition, an emerging growth company can delay its adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we are choosing to “opt out” of such extended transition period, and as a result, we plan to comply with any new or revised accounting standards on the relevant dates on which non-emerging growth companies must adopt such standards. Section 107 of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.

As a result of our decision to avail ourselves of certain provisions of the JOBS Act, the information that we provide may be different than what you may receive from other public companies in which you hold an equity interest. In addition, it is possible that some investors will find our common stock less attractive as a result of our elections, which may cause a less active trading market for our common stock and more volatility in our stock price.

Corporate Information

We are a Delaware corporation and were incorporated in March 2010. Our principal executive office is located at 8000 NE Parkway Drive, Suite 350, Vancouver, WA 98662. Our telephone number at our principal executive office is (360) 260-7272. Our corporate website is www.papamurphys.com . The information on our corporate website is not part of, and is not incorporated by reference into, this prospectus.

 

 

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Risks Associated With our Business

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described in “Risk Factors” before making a decision to invest in our common stock. If any of these risks actually occur, our business, financial condition or results of operations would likely be materially adversely affected. In such case, the trading price of our common stock would likely decline, and you may lose all or part of your investment. Below is a summary of some of the principal risks that we face.

 

  n  

the highly competitive nature of the limited service restaurant pizza category and restaurant sector overall;

 

  n  

changes in consumer preferences, consumption habits and perceptions as well as changes in regulations;

 

  n  

our dependence on our relationship with our franchise owners and the success of their existing and new stores;

 

  n  

our ability to increase revenues by opening new domestic and international franchise and company-owned stores on a timely basis;

 

  n  

our ability to identify, recruit and contract with a sufficient number of qualified franchise owners;

 

  n  

our ability to manage the planned rapid increase in the number of our stores;

 

  n  

opening new stores in existing markets may negatively affect sales at existing stores, and new stores may not be profitable;

 

  n  

risks associated with expansion into international markets;

 

  n  

damage to our reputation or the Papa Murphy’s brand;

 

  n  

our dependence on key members of our management team; and

 

  n  

increased costs of being a public company.

 

 

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THE OFFERING

 

Common stock offered by us

            shares (             shares if the underwriters’ option to purchase additional shares is exercised in full).

 

Common stock offered by the selling stockholders

            shares (             shares if the underwriters’ option to purchase additional shares is exercised in full).

 

Common stock to be outstanding after this offering

            shares (             shares if the underwriters’ option to purchase additional shares is exercised in full).

 

Option to purchase additional shares of common stock

The underwriters may also purchase up to a maximum of              additional shares of common stock from the selling stockholders named in this prospectus to cover over-allotments. The underwriters can exercise this option at any time within 30 days from the date of this prospectus.

 

Use of proceeds

We estimate that the net proceeds to us from our sale of             shares of common stock in this offering will be approximately $         million, after deducting estimated underwriting discounts and commissions and estimated expenses payable by us in connection with this offering. This assumes a public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus. We intend to use these net proceeds to repay $         million in aggregate principal amount of indebtedness under our new senior secured credit facilities, to pay a termination fee associated with our advisory services and monitoring agreement with Lee Equity and to use the remainder for general corporate purposes. We will not receive any proceeds from the sale of shares by the selling stockholders, which include entities affiliated with members of our Board of Directors (the “Board”), and certain of our executive officers. See “Use of Proceeds.”

 

Dividend Policy

We do not anticipate paying any dividends on our common stock in the foreseeable future; however, we may change this policy in the future. See “Dividend Policy.”

 

Risk factors

Investing in our common stock involves a high degree of risk. See “Risk Factors” beginning on page 20 of this prospectus for a discussion of factors you should carefully consider before investing in our common stock.

 

Proposed NASDAQ trading symbol

“FRSH”.

Unless otherwise indicated, the number of shares of our common stock to be outstanding after this offering is based on             shares of common stock outstanding as of                     , 2014, and:

 

  n  

excludes             shares of our common stock issuable upon the exercise of stock options at a weighted average exercise price of $         per share;

 

  n  

excludes an aggregate of             shares of common stock that will initially be available for future equity awards under our 2014 Equity Incentive Plan (the “2014 Plan”);

 

 

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  n  

includes             shares of outstanding restricted common stock;

 

  n  

gives effect to the automatic conversion of our Preferred Shares to              shares of common stock and a 1 for                    stock split of our common stock prior to the completion of this offering;

 

  n  

gives effect to our amended and restated certificate of incorporation and our amended and restated bylaws, which will be in effect prior to the consummation of this offering; and

 

  n  

assumes no exercise of the underwriters’ over-allotment option to purchase up to             additional shares from the selling stockholders.

Unless otherwise indicated, this prospectus assumes an initial public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus.

 

 

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SUMMARY HISTORICAL CONSOLIDATED FINANCIAL AND OTHER DATA

The following tables set forth our summary historical consolidated financial and other data for the periods ending on and as of the dates indicated. We derived the consolidated statements of operations data for the fiscal years 2013, 2012 and 2011 and the consolidated balance sheet data as of December 30, 2013 from our audited consolidated financial statements and related notes thereto included elsewhere in this prospectus.

The following tables set forth certain financial data on a pro forma basis reflecting adjustments set forth in the notes below. The pro forma adjustments are based upon currently available information and certain assumptions that are factually supportable and that we believe are reasonable under the circumstances. The pro forma financial information does not purport to present what our actual consolidated results of operations would have been had the transactions occurred on the dates indicated, nor are they necessarily indicative of results that may be expected for any future period.

Our historical results are not necessarily indicative of future results of operations. You should read the information set forth below together with “Selected Consolidated Financial and Other Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Capitalization” and our consolidated financial statements and the related notes thereto included elsewhere in this prospectus.

 

 

 

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    FISCAL YEAR     PRO FORMA  (1)  
    2013     2012     2011     2013  
    (dollars in thousands, except share, per share and
selected operating data, unless otherwise noted)
 

Consolidated statement of operations data:

       

Revenues

       

Franchise royalties

  $ 36,897      $ 35,113      $ 33,687      $ 36,561   

Franchise and development fees

    4,330        2,826        2,398        4,330   

Company-owned store sales

    39,148        28,813        15,619        45,861   

Lease income

    120        164        218        120   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    80,495        66,916        51,922        86,872   

Costs and expenses

       

Store operating costs:

       

Cost of food and packaging

    14,700        10,741        6,088        17,114   

Compensation and benefits

    10,687        8,160        4,710        12,106   

Advertising

    3,820        2,711        1,514        4,316   

Occupancy

    2,365        1,980        1,102        2,765   

Other store operating costs

    3,988        2,961        1,722        4,250   

Selling, general and administrative

    24,180        21,225        20,833        24,446   

Depreciation and amortization

    6,973        6,187        5,798        7,786   

Loss on disposal or impairment of property and equipment

    847        193        263        847   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

    67,560        54,158        42,030        73,630   
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    12,935        12,758        9,892        13,242   
 

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

    10,523        10,462        10,410        12,389   

Interest income

    (94     (94     (183     (94

Loss on early retirement of debt

    4,029        5,138               4,029   

Other expense, net

    44        248        41        44   
 

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

    (1,567     (2,996     (376     (3,126

Provision (benefit) for income taxes

    1,024        (882     230        440   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

    (2,591     (2,114     (606     (3,566

Net loss attributable to noncontrolling interests

    19                      19   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to Papa Murphy’s

  $ (2,572   $ (2,114   $ (606   $ (3,547
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

 

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    FISCAL YEAR     PRO FORMA  (1)  
    2013     2012     2011     2013  
    (dollars in thousands, except share, per share and
selected operating data, unless otherwise noted)
 

Loss per common share:

       

Basic

  $ (5.29   $ (5.28   $ (4.52   $ (5.86

Diluted

    (5.29     (5.28     (4.52     (5.86

Weighted average of common shares outstanding:

       

Basic

    1,700,360        1,623,171        1,591,262        1,700,360   

Diluted

    1,700,360        1,623,171        1,591,262        1,700,360   

Pro forma as adjusted net income per common
share
(2) :

       

Basic

       

Diluted

       

Pro forma as adjusted weighted average common shares outstanding (2) :

       

Basic

       

Diluted

       

Consolidated statement of cash flows:

  

     

Cash flows from operating activities

  $ 9,874      $ 9,356      $ 11,804     

Cash flows from investing activities

    (15,249     (5,904     (16,062  

Cash flows from financing activities

    6,613        (5,864     (2,563  

Other Financial Data:

       

Adjusted EBITDA (3)

  $ 24,421      $ 22,126      $ 19,740      $ 25,541   

Net working capital (4)

    (1,588     (5,003     (1,973  

Capital expenditures (5)

    3,037        1,343        2,193     

Selected Operating Data:

       

Number of stores at end of period

       

Domestic franchise

    1,327        1,270        1,232     

Domestic company-owned

    69        59        51     

International

    22        18        18     
 

 

 

   

 

 

   

 

 

   

Total

    1,418        1,347        1,301     

Number of comparable stores at end of period  (6)

       

Domestic franchise

    1,226        1,194        1,164     

Domestic company-owned

    68        57        50     

International

    17        15        16     
 

 

 

   

 

 

   

 

 

   

Total

    1,311        1,266        1,230     

Average weekly sales per store (whole dollars)  (7)

  $ 11,099      $ 10,923      $ 10,640     

Comparable store sales growth  (8)

    2.8     2.9     5.7  

System-wide sales  (9)

  $ 785,630      $ 739,091      $ 701,770     

System-wide sales growth  (10)

    6.3     5.3     7.4  

 

 

 

 

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     AS OF DECEMBER 30, 2013  
     ACTUAL      PRO FORMA  (2)      PRO FORMA
AS ADJUSTED  (2)
 
     (dollars in thousands)  

Consolidated balance sheet data:

        

Cash and cash equivalents

   $ 3,705       $         $     

Total current assets

     16,377         

Total current liabilities

     17,965         

Total debt (11)

     170,000         

Total assets

     264,502         

Total shareholders’ equity

     33,925         

 

 

(1)  

We present consolidated statements of operations data on a pro forma basis to give pro forma effect to (i) the entry in October 2013 into a new $177.0 million senior secured term loan facility, which includes a $2.5 million letter of credit subfacility (collectively, the “new senior secured credit facilities”), the proceeds of which were used to repay our existing credit facilities, to make a $31.5 million payment to holders of our Preferred Shares and to fund investments (such transactions, the “Recapitalization”) and (ii) two acquisitions of franchise stores, in each case involving four stores, completed in 2013 (the “2013 Store Acquisitions”) as if the transactions had occurred as of January 1, 2013. See “Unaudited Pro Forma Condensed Combined Financial Statements.”

(2)  

We present certain share data on a pro forma as adjusted basis to give pro forma effect to (i) the Reorganization Transactions, including the automatic conversion of our Preferred Shares to              shares of restricted common stock and              shares of unrestricted common stock and the 1 for             stock split of common stock prior to the completion of this offering, (ii)   the repurchase of an aggregate of 48,516 shares of our outstanding common stock from certain of our executive officers in March 2014 (the “Share Repurchase”), (iii) the Recapitalization and (iv) the 2013 Store Acquisitions, as further adjusted to give effect to the sale by us of shares of              common stock in this offering at an initial public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus, less estimated underwriting discounts and commissions and estimated expenses and the application of the net proceeds to be received by us from this offering, including the repayment of certain indebtedness and payment of fees associated with the termination of our advisory services and monitoring agreement with Lee Equity, as more fully described in “Use of Proceeds.”

We present certain balance sheet data (a) on a pro forma basis to give pro forma effect to (i) the Reorganization Transactions, including the automatic conversion of our Preferred Shares to              shares of restricted common stock and              shares of unrestricted common stock and the 1 for             stock split of common stock prior to the completion of this offering, and (ii) the Share Repurchase and (b) on a pro forma as adjusted basis to give effect to the aforementioned transaction and to give further effect to the sale by us of shares of              common stock in this offering at an initial public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus, less estimated underwriting discounts and commissions and estimated expenses and the application of the net proceeds to be received by us from this offering, including the repayment of certain indebtedness and payment of fees associated with the termination of our advisory services and monitoring agreement with Lee Equity, as more fully described in “Use of Proceeds.”

(3)  

Adjusted EBITDA is calculated as net income (loss) before interest expense, income taxes, depreciation and amortization as adjusted for:

 

  n  

all non-cash losses or expenses (including, but not limited to 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;

 

  n  

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

 

  n  

fees, costs and expenses related to acquisitions and debt refinancing costs;

 

  n  

pre-opening costs with respect to a new store;

 

  n  

management fees and expenses incurred under our advisory services and monitoring agreement with Lee Equity;

 

  n  

fees and expenses incurred in connection with the issuance of debt under the new senior secured credit facilities and related transactions; and

 

  n  

non-cash expenses resulting from purchase accounting adjustments made in accordance with GAAP with respect to acquisitions.

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 income (loss), as determined 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 such financial measure, when viewed with our results of operations in accordance with GAAP and our reconciliation of Adjusted EBITDA to net income (loss), 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

 

 

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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:

 

  n  

as a measurement used in comparing our operating performance on a consistent basis;

 

  n  

to calculate incentive compensation for our employees;

 

  n  

for planning purposes, including the preparation of our internal annual operating budget;

 

  n  

to evaluate the performance and effectiveness of our operational strategies; and

 

  n  

to assess compliance with various metrics associated with our new senior secured credit facilities.

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:

 

  n  

Adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;

 

  n  

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

 

  n  

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.

The following table provides a reconciliation of our net income (loss) to Adjusted EBITDA for the periods presented:

 

 

 

    FISCAL YEAR     PRO FORMA  (a)  
    2013     2012     2011     2013  
    (dollars in thousands)  

Net loss

  $ (2,591   $ (2,114   $ (606   $ (3,566

Depreciation and amortization

    6,973        6,187        5,798        7,786   

Income tax provision (benefit)

    1,024        (882     230        440   

Interest expense, net

    10,429        10,368        10,227        12,295   
 

 

 

   

 

 

   

 

 

   

 

 

 

EBITDA

    15,835        13,559        15,649        16,955   

(Gain) loss on settlement of liabilities (b)

    3,943        5,138        (58     3,943   

Loss on disposal or impairment of property and equipment  (c)

    847        193        263        847   

Management transition and restructuring costs  (d)

    587        490        1,783        587   

Expenses not indicative of future operations  (e)

    1,293        967               1,293   

Management fees and related expenses  (f)

    586        537        797        586   

Transaction costs (g)

    402        24        59        402   

New store pre-opening expenses (h)

    19        52        12        19   

Non-cash expenses and non-income based state taxes (i)

    909        1,166        1,235        909   
 

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

  $ 24,421      $ 22,126      $ 19,740      $ 25,541   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

  ( a)  

We present consolidated statements of operations data on a pro forma basis to give pro forma effect to (i) the Recapitalization and (ii) the 2013 Store Acquisitions. See “Unaudited Pro Forma Condensed Combined Financial Statements.”

  (b)  

Represents (gains) losses resulting from refinancing of long-term debt and settlement of asset retirement obligations.

  (c)  

Represents non-cash losses resulting from disposal or impairment of property and equipment, including divested company stores.

  (d)  

Represents non-recurring management transition and restructuring costs, consisting of severance, retention, recruitment, relocation and other costs in connection with restructuring of our corporate development function and transition of certain members of management.

  (e)  

Represents (i) non-recurring losses on guaranteed lease payments for company stores acquired by franchise owners; (ii) non-recurring roll-out costs of new uniform program; (iii) a one-time valuation allowance of an international notes receivable resulting from the sale of company-owned restaurants; and (iv) non-recurring advisory expenses in connection with this offering.

  (f)  

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. See “Certain Relationships and Related Person Transactions—Agreements Related to the Acquisition by Lee Equity—Advisory Services and Monitoring Agreement.”

 

 

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  (g)  

Represents transaction costs relating to acquisitions and divestitures.

  (h)  

Represents expenses directly associated with the opening of new stores and incurred prior to the opening of new stores, including wages, benefits, travel for the training of opening teams and other store operating costs.

  (i)  

Represents (i) non-cash expenses related to equity-based compensation; (ii) non-cash expenses related to the difference between GAAP and cash rent expense; (iii) non-cash expenses related to the fair valuation of certain common stock and Series A Preferred Stock subject to put options; and (iv) non-income based state taxes.

(4)    

Represents current assets less current liabilities.

(5)    

Represents long-lived asset capital expenditures related to the acquisition of property and equipment and excludes expenditures relating to acquisitions of businesses.

(6)    

A comparable store is a store that has been open for at least 52 weeks from the comparable date, which is the Tuesday following the opening date.

(7)    

AWS consists of the average weekly sales of franchise and company-owned stores over a specified period of time. AWS is calculated by dividing the total net sales of our system-wide stores for the relevant time period by the number of weeks these same stores were open in such time period.

(8)    

System-wide comparable store sales growth represents year-over-year sales comparisons for comparable stores.

(9)    

System-wide sales include net sales by all of our system-wide stores.

(10)    

System-wide sales growth represents year-over-year sales comparisons for system-wide sales.

(11)    

Represents total outstanding indebtedness, including current portion.

 

 

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RISK FACTORS

An investment in our common stock involves a high degree of risk. You should consider carefully the following risk factors and the other information in this prospectus, including our consolidated financial statements and related notes to those statements, before you decide to invest in our common stock. If any of the following risks actually occur, our business, financial condition and results of operations could be materially adversely affected. As a result, the trading price of our common stock could decline and you could lose part or all of your investment.

Risks Relating to Our Business and Industry

The limited service restaurant pizza category and restaurant sector overall are highly competitive and such competition could adversely affect our business, financial condition and results of operations.

The restaurant industry in general, and the limited service restaurant pizza category in particular, are highly competitive with respect to price, value, food quality, ambience, convenience, concept, service and location. A substantial number of restaurant operations compete with us for customer traffic. We compete against other major national limited service restaurant pizza chains and regional and local businesses, including other chains offering Take ‘N’ Bake pizza products as well as dine-in, carry-out and delivery services. We also compete on a broader scale with limited service and other international, national, regional and local limited-service restaurants. Many of our competitors have significantly greater financial, marketing, personnel and other resources as well as greater brand recognition than we do and may have lower operating costs, more and better locations and more effective marketing than we do. Many of our competitors are well established in markets in which our franchise owners and we have existing stores or intend to locate new stores. In addition, many of our competitors emphasize lower-cost value options or meal packages or have loyalty programs, which provide discounts on certain menu offerings, and they may continue to do so in the future. For example, in recent years, several national pizza chains have offered significant price discounts for pizza products, and we have developed similarly priced products in response. In addition, we face increasing competition from pizza product offerings available at grocery stores and convenience stores, which offer Take ‘N’ Bake, frozen and carry-out pizzas.

We also compete for employees, suitable real estate sites and qualified franchise owners. If we are unable to compete successfully and maintain or enhance our competitive position, or if customers have a poor experience at a Papa Murphy’s store, whether company-owned or franchised, we could experience downward pressure on customer traffic, prices, lower demand for our products, reduced margins, the inability to take advantage of new business opportunities and the loss of market share, all of which could have a material adverse effect on our business, financial condition and results of operations.

The food service market is affected by consumer preferences and perceptions. Changes in these preferences and perceptions may lessen the demand for our products, which would reduce sales and harm our business.

Food service businesses are affected by changes in consumer tastes, international, national, regional and local economic conditions and demographic trends. For instance, if prevailing health or dietary preferences cause consumers to avoid pizza and other products we offer in favor of foods that are perceived as more healthy, our business, financial condition and results of operations would be materially adversely affected. In addition, if consumers no longer seek pizza that they can bake at home in favor of pizza that is already baked and/or delivered, our business, financial condition and results of operations would be materially adversely affected. Moreover, because we are primarily dependent on a single product, if consumer demand for pizza in general, and Take ‘N’ Bake pizza in particular, should decrease, our business would be adversely affected more than if we had a more diversified menu, as many other food service businesses do.

Our business and results of operations depend significantly upon the success of our and our franchise owners’ existing and new stores.

Our business and results of operations are significantly dependent upon the success of our franchise owners and our company-owned stores. We and our franchise owners may be adversely affected by:

 

  n  

declining economic conditions, including housing market downturns, rising unemployment rates, lower disposable income, credit conditions, fuel prices and consumer confidence and other events or factors that adversely affect consumer spending in the markets that we serve;

 

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  n  

increased competition in the restaurant industry, particularly in the pizza, casual and fast-casual dining segments;

 

  n  

changes in consumer tastes and preferences;

 

  n  

demographic trends;

 

  n  

customers’ budgeting constraints;

 

  n  

customers’ willingness to accept menu price increases that we may make to offset increases in key input and operating costs;

 

  n  

adverse weather conditions;

 

  n  

our reputation and consumer perception of our concepts’ offerings in terms of quality, price, value, ambience and service; and

 

  n  

customers’ experiences in our stores.

Our company-owned stores and our franchise owners are also susceptible to increases in certain key operating expenses that are either wholly or partially beyond our control, including:

 

  n  

food, particularly mozzarella cheese and other raw materials costs, many of which we do not or cannot effectively hedge;

 

  n  

labor costs, including wage, workers’ compensation, minimum wage requirements, health care and other benefits expenses;

 

  n  

rent expenses and construction, remodeling, maintenance and other costs under leases for our new and existing stores;

 

  n  

compliance costs as a result of changes in legal, regulatory or industry standards;

 

  n  

energy, water and other utility costs;

 

  n  

insurance costs;

 

  n  

information technology and other logistical costs; and

 

  n  

litigation expenses.

If we fail to open new domestic and international franchise and company-owned stores on a timely basis, our ability to increase our revenues could be materially adversely affected.

A significant component of our growth strategy includes the opening of new domestic and international franchise stores. Our franchise owners opened 98 stores in 2013. We and our franchise owners face many challenges associated with opening new stores, including:

 

  n  

identification and availability of suitable store locations with the appropriate size, visibility, traffic patterns, local residential neighborhoods, local retail and business attractions and infrastructure that will drive high levels of customer traffic and sales per store;

 

  n  

competition with other restaurants and retail concepts for potential store sites and anticipated commercial, residential and infrastructure development near new or potential stores;

 

  n  

ability to negotiate acceptable lease arrangements;

 

  n  

availability of financing and ability to negotiate acceptable financing terms;

 

  n  

recruiting, hiring and training of qualified personnel;

 

  n  

construction and development cost management;

 

  n  

completing our construction activities on a timely basis;

 

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  n  

obtaining all necessary governmental licenses, permits and approvals and complying with local, state and federal laws and regulations to open, construct or remodel and operate our stores;

 

  n  

unforeseen engineering or environmental problems with the leased premises;

 

  n  

avoiding the impact of adverse weather during the construction period; and

 

  n  

other unanticipated increases in costs, delays or cost overruns.

As a result of these challenges, we and our franchise owners may not be able to open new stores as quickly as planned or at all. We and our franchise owners have experienced, and expect to continue to experience, delays in store openings from time to time and have abandoned plans to open stores in various markets on occasion. Any delays or failures to open new stores by us or our franchise owners could materially and adversely affect our growth strategy and our results of operations.

Our progress in opening new stores from quarter to quarter may occur at an uneven rate. If we do not open new stores in the future according to our current plans, the delay could materially adversely affect our business, financial condition or results of operations.

If we fail to identify, recruit and contract with a sufficient number of qualified franchise owners, our ability to open new franchise stores and increase our revenues could be materially adversely affected.

The opening of additional franchise stores depends, in part, upon the availability of prospective franchise owners who meet our criteria. Because most of our franchise owners open and operate one or two stores, our growth strategy requires us to identify, recruit and contract with a significant number of new franchise owners each year. We may not be able to identify, recruit or contract with suitable franchise owners in our target markets on a timely basis or at all. In addition, our franchise owners may not have access to the financial or management resources that they need to open the stores contemplated by their agreements with us, or they may elect to cease store development for other reasons. If we are unable to recruit suitable franchise owners or if franchise owners are unable or unwilling to open new stores as planned, our growth may be slower than anticipated, which could materially adversely affect our ability to increase our revenues and materially adversely affect our business, financial condition and results of operations.

The planned rapid increase in the number of our stores may make our future results unpredictable and, if we fail to manage such growth effectively, our business, financial condition and results of operations may be materially adversely affected.

Our franchise owners opened 98 stores in 2013. This growth strategy and the investment associated with the development of each new store may cause our results to fluctuate and be unpredictable or materially adversely affect our results of operations. In addition, our franchise owners and our ability to successfully develop new stores in new markets may be adversely affected by a lack of awareness or acceptance of our brand in these new markets. To the extent that we are unable to foster name recognition and affinity for our brand in new markets, our and our franchise owners’ new stores may not perform as expected and our growth may be significantly delayed or impaired. Moreover, as has happened when other store concepts have tried to expand, we may find that our concept has limited appeal in new markets or we may experience a decline in the popularity of our concept in the markets in which we operate. Newly opened stores or our future markets and stores may not be successful or our system-wide average store sales may not increase at historical rates, which could materially adversely affect our business, financial condition or results of operations.

Our existing store management systems, financial and management controls and information systems may be inadequate to support our planned expansion. Managing our growth effectively will require us to continue to enhance these systems, procedures and controls and to hire, train and retain managers and team members. We believe our culture—from the store level up through management—is an important contributor to our success. As we grow, however, we may have difficulty maintaining our culture or adapting it sufficiently to meet the needs of our operations. Among other important factors, our culture depends on our ability to attract, retain and motivate employees who share our enthusiasm and dedication to our concept. We may not respond quickly enough to the changing demands that our expansion will impose on our management, store teams, existing infrastructure and culture, which could materially adversely affect our business, financial condition or results of operations.

 

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New information or attitudes regarding diet and health could result in changes in regulations and consumer consumption habits that could adversely affect our results of operations.

Government regulation and consumer eating habits may impact our business as a result of changes in attitudes regarding diet and health or new information regarding the adverse health effects of consuming certain menu offerings. These changes have resulted in, and may continue to result in, laws and regulations requiring us to disclose the nutritional content of our food offerings, and they have resulted, and may continue to result in, laws and regulations affecting permissible ingredients and menu offerings. For example, a number of states, counties and cities have enacted menu labeling laws requiring multi-unit restaurant operators to disclose to consumers certain nutritional information, or have enacted legislation restricting the use of certain types of ingredients in restaurants. These requirements may be different or inconsistent with requirements under the Patient Protection and Affordable Care Act of 2010 (the “PPACA”), which establishes a uniform, federal requirement for certain restaurants to post nutritional information on their menus. Specifically, the PPACA requires chain restaurants with 20 or more locations operating under the same name and offering substantially the same menus to publish the total number of calories of standard menu items on menus and menu boards, along with a statement that puts this calorie information in the context of a total daily calorie intake. These inconsistencies could be challenging for us to comply with in an efficient manner. The PPACA also requires covered restaurants to provide to consumers, upon request, a written summary of detailed nutritional information for each standard menu item, and to provide a statement on menus and menu boards about the availability of this information upon request. An unfavorable report on, or reaction to, our menu ingredients, the size of our portions or the nutritional content of our menu items could negatively influence the demand for our products and materially adversely affect our business, financial condition and results of operations.

Compliance with current and future laws and regulations regarding the ingredients and nutritional content of our menu items may be costly and time-consuming. Additionally, if consumer health regulations or consumer eating habits change significantly, we may be required to modify or discontinue certain menu items, and we may experience higher costs associated with the implementation of those changes. We cannot predict the impact of the new nutrition labeling requirements under the PPACA until final regulations are promulgated. The risks and costs associated with nutritional disclosures on our menus could also impact our operations, particularly given differences among applicable legal requirements and practices within the restaurant industry with respect to testing and disclosure, ordinary variations in food preparation among our own restaurants, and the need to rely on the accuracy and completeness of nutritional information obtained from third-party suppliers.

Our results of operations and growth strategy depend in significant part on the success of our franchise owners, and we are subject to a variety of additional risks associated with our franchise owners.

A substantial portion of our revenues comes from royalties generated by our franchise stores. We anticipate that franchise royalties will represent a substantial part of our revenues in the future. As of December 30, 2013, we had 548 domestic franchise owners operating 1,327 domestic stores. Our largest franchise owner operated 37 stores and our top 10 franchise owners operated a total of 221 stores as of December 30, 2013. Accordingly, we are reliant on the performance of our franchise owners in successfully opening and operating their stores and paying royalties to us on a timely basis. Our franchise system subjects us to a number of risks, any one of which may impact our ability to collect royalty payments from our franchise owners, may harm the goodwill associated with our brands, and may materially adversely affect our business and results of operations.

Franchise owner independence. Franchise owners are independent operators, and their employees are not our employees. Accordingly, their actions are outside of our control. Although we have developed criteria to evaluate and screen prospective franchise owners, we cannot be certain that our franchise owners will have the business acumen or financial resources necessary to operate successful franchises in their area approved locations and state franchise laws may limit our ability to terminate or modify these franchise agreements. Moreover, despite our training, support and monitoring, franchise owners may not successfully operate stores in a manner consistent with our standards and requirements, or may not hire and adequately train qualified managers and other store personnel. The failure of our franchise owners to operate their franchises successfully and actions taken by their employees could have a material adverse effect on our reputation, our brand and our ability to attract prospective franchise owners, our business, financial condition or results of operations.

Franchise agreement termination or nonrenewal. Each franchise agreement is subject to termination by us as the franchisor in the event of a default, generally after expiration of applicable cure periods, although under certain

 

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circumstances a franchise agreement may be terminated by us upon notice without an opportunity to cure. The default provisions under the franchise agreements are drafted broadly and include, among other things, any failure to meet operating standards and actions that may threaten our licensed intellectual property.

In addition, each franchise agreement has an expiration date. Upon the expiration of the franchise agreement, we or the franchise owner may, or may not, elect to renew the franchise agreements. If the franchise owner agreement is renewed, the franchise owner will receive a successive franchise agreement for an additional term. Such option, however, is contingent on the franchise owner’s execution of the then-current form of franchise agreements (which may include increased royalty payments, advertising fees and other costs), the satisfaction of certain conditions (including modernization of the restaurant and related operations) and the payment of a renewal fee. If a franchise owner is unable or unwilling to satisfy any of the foregoing conditions, we may elect to not renew the expiring franchise agreement, in which event the franchise agreement will terminate upon expiration of the term.

Franchise owner insurance . The franchise agreements require each franchise owner to maintain certain insurance types and levels. Certain extraordinary hazards, however, may not be covered, and insurance may not be available (or may be available only at prohibitively expensive rates) with respect to many other risks. Moreover, any loss incurred could exceed policy limits and policy payments made to franchise owners may not be made on a timely basis. Any such loss or delay in payment could have a material and adverse effect on a franchise owner’s ability to satisfy obligations under the franchise agreement, including the ability to make royalty payments.

Product liability exposure. We require franchise owners to maintain general liability insurance coverage to protect against the risk of product liability and other risks and demand strict franchise owner compliance with health and safety regulations. However, franchise owners may receive or produce defective food or beverage products, which may materially adversely affect our brand’s goodwill and our business. Further, a franchise owner’s failure to comply with health and safety regulations, including requirements relating to food quality or preparation, could subject them, and possibly us, to litigation. Any litigation, including the imposition of fines or damage awards, could adversely affect the ability of a franchise owner to make royalty payments, or could generate negative publicity, or otherwise adversely affect us.

Franchise owners’ participation in our strategy. Our franchise owners are an integral part of our business. We may be unable to successfully implement our growth strategy if our franchise owners do not actively participate in such implementation. For example, the failure of our franchise owners to focus on the fundamentals of restaurant operations, such as quality, service and cleanliness, would have a negative impact on our success. In addition, it may be difficult for us to monitor our international franchise owners’ implementation of our growth strategy due to our lack of personnel in the markets served by such franchise owners.

Franchise owner litigation and conflicts with franchise owners. Franchise owners are subject to a variety of litigation risks, including, but not limited to, customer claims, personal-injury claims, environmental claims, employee allegations of improper termination and discrimination, claims related to violations of the ADA, religious freedom, the Fair Labor Standards Act (“FLSA”), the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), advertising laws and intellectual-property claims. Each of these claims may increase costs and limit the funds available to make royalty payments and reduce the execution of new franchise agreements. We also may be named in lawsuits against our franchise owners. In addition, the nature of the franchisor-franchise owner relationship may give rise to conflict, and we may become subject to litigation with our franchise owners. For example, in January 2014 eight franchise owners claimed that we misrepresented our sales volumes, made false claims and charged excess advertising fees, among other things. We are currently engaged in mediation with these franchise owners in order to resolve these claims. If we do not reach an agreement in connection with this mediation, the franchise owners may file a lawsuit against us, which may be costly and time consuming to defend and may further distract management. We also may engage in litigation with franchise owners to enforce the terms of our franchise agreements and compliance with our brand standards as determined necessary to protect our brand, the consistency of our products and the customer experience. Such litigation may be time consuming and costly. Any negative outcome of these or any other claims could materially adversely affect our results of operations as well as our ability to expand our franchise system.

 

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Americans with Disabilities Act. Restaurants located in the United States must comply with Title III of the Americans with Disabilities Act of 1990, as amended (the “ADA”). Although we believe newer restaurants meet the ADA construction standards and, further, that franchise owners have historically been diligent in the remodeling of older restaurants, a finding of noncompliance with the ADA could result in the imposition of injunctive relief, fines, awards of damages to private litigants or additional capital expenditures to remedy such noncompliance. Any imposition of injunctive relief, fines, damage awards or capital expenditures could adversely affect the ability of a franchise owner to make royalty payments, or could generate negative publicity, or otherwise adversely affect us.

Access to credit. Our franchise owners typically finance new operations and new store openings with loans or other forms of credit. If our franchise owners are unable to access credit or obtain sufficient credit, or if interest rates on loans that our franchise owners use to finance operations of current stores or to open new stores increase, our franchise owners may have difficulty opening new stores, which could materially adversely affect our results of operations as well as our ability to expand our franchise system.

Franchise owner bankruptcy. The bankruptcy of a multi-unit franchise owner could negatively impact our ability to collect payments due under such franchise owner’s franchise agreement. In a franchise owner bankruptcy, the bankruptcy trustee may reject its franchise agreements pursuant to Section 365 under the United States bankruptcy code, in which case there would be no further royalty payments from such franchise owner. There can be no assurance as to the proceeds, if any, that may ultimately be recovered in a bankruptcy proceeding of such franchise owner in connection with a damage claim resulting from such rejection.

Opening new stores in existing markets may negatively affect sales at existing stores.

We intend to continue opening new franchise stores in our existing markets as a core part of our growth strategy. Expansion in existing markets may be affected by local economic and market conditions. Further, the customer target area of our stores varies by location, depending on a number of factors, including population density, other local retail and business attractions, area demographics and geography. As a result, the opening of a new store in or near markets in which stores already exist could adversely affect the sales of these existing stores. We and our franchise owners may selectively open new stores in and around areas of existing stores. Sales cannibalization between stores may become significant in the future as we continue to expand our operations and could affect sales growth, which could, in turn, materially adversely affect our business, financial condition or results of operations.

New stores may not be profitable and the increases in AWS and comparable store sales that we have experienced in the past may not be indicative of future results.

New stores may not be profitable and their sales performance may not follow historical patterns. In addition, our AWS and comparable store sales may not increase at the rates achieved over the past several years.

If new stores do not perform as planned, or if we or our franchise owners are unable to achieve our expected AWS in the new stores, our business, financial condition or results of operations could be materially adversely affected.

Our expansion into international markets exposes us to a number of risks that may differ in each country where we have franchise stores.

We currently have franchise stores in Canada and the United Arab Emirates and plan to continue to grow internationally. Our international operations are in early stages, historically have not been profitable and have achieved lower margins than our domestic stores. We expect this financial performance to continue in the near-term. Expansion in international markets may also be affected by local economic and market conditions. Therefore, as we expand internationally, our franchise owners may not experience the operating margins we expect, and our results of operations and growth may be materially and adversely affected. Our financial condition and results of operations may be adversely affected if global markets in which our franchise stores compete are affected by changes in political, economic or other factors. These factors, over which neither our franchise owners nor we have control, may include:

 

  n  

recessionary or expansive trends in international markets;

 

  n  

changing labor conditions and difficulties in staffing and managing our foreign operations;

 

  n  

increases in the taxes we pay and other changes in applicable tax laws;

 

  n  

legal and regulatory changes, and the burdens and costs of our compliance with a variety of foreign laws;

 

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  n  

changes in inflation rates;

 

  n  

changes in exchange rates and the imposition of restrictions on currency conversion or the transfer of funds;

 

  n  

difficulty in protecting our brand, reputation and intellectual property;

 

  n  

difficulty in collecting our royalties and longer payment cycles;

 

  n  

expropriation of private enterprises;

 

  n  

increases in anti-American sentiment and the identification of the Papa Murphy’s brand as an American brand;

 

  n  

political and economic instability; and

 

  n  

other external factors.

Termination of area development agreements (“ADAs”) or master franchise agreements with certain franchise owners could adversely impact our revenues.

We enter into ADAs with certain domestic franchise owners that plan to open multiple Papa Murphy’s stores in a designated market area (a “DMA”), and we have entered into master franchise agreements with third parties to develop and operate stores in Canada and in the Middle East. These franchise owners are granted certain rights with respect to specified territories, and at their discretion, these franchise owners may open more stores than specified in their agreements. In fiscal years 2013, 2012 and 2011 we derived 25.2%, 14.5% and 15.4%, respectively, of our franchise and development fees from ADAs or master franchise owner arrangements. The termination of ADAs or an arrangement with a master franchise owner or a lack of expansion by these franchise owners could result in the delay of the development of franchised restaurants, discontinuation or an interruption in the operation of one of our brands in a particular market or markets. We may not be able to find another operator to resume development activities in such market or markets. Any such delay, discontinuation or interruption would result in a delay in, or loss of, royalty income to us by way reduced sales and could materially and adversely affect our business, financial condition or results of operations.

We are subject to all of the risks associated with leasing space subject to long-term non-cancelable leases for stores that we operate.

We do not own any of the real property where our company-owned stores operate. Payments under our operating leases account for a portion of our operating expenses, and we expect the new company-owned stores we open in the future similarly will be leased. Our leases generally have an initial term of five years and generally can be extended only in five-year increments (at increased rates). All of our leases require a fixed annual rent, although some require the payment of additional rent if store sales exceed a negotiated amount. Generally, our leases are net leases, which require us to pay all of the cost of insurance, taxes, maintenance and utilities. We generally cannot cancel these leases. Additional sites that we lease are likely to be subject to similar long-term non-cancelable leases. If an existing or future store is not profitable, resulting in its closure, we may nonetheless be committed to perform our obligations under the applicable lease including, among other things, paying the base rent for the balance of the lease term. In addition, we may fail to negotiate renewals as each of our leases expires, either on commercially acceptable terms or at all, which could cause us to pay increased occupancy costs or to close stores in desirable locations. These potential increased occupancy costs and closed stores could materially adversely affect our business, financial condition or results of operations.

The impact of negative economic factors, including the availability of credit, on our and our franchise owners’ landlords could negatively affect our results of operations.

Negative effects on our and our franchise owners’ existing and potential landlords due to the inaccessibility of credit and other unfavorable economic factors may, in turn, adversely affect our business and results of operations. If our or our franchise owners’ landlords are unable to obtain financing or remain in good standing under their existing financing arrangements, they may be unable to provide construction funding to us or satisfy other lease covenants. In addition, if our franchise owners or our landlords are unable to obtain sufficient credit to continue to properly manage their retail sites, we may experience a drop in the level of quality of such retail centers. The development of new stores may also be adversely affected by the negative financial situations of developers and potential landlords.

 

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Landlords may try to delay or cancel recent development projects (as well as renovations of existing projects) due to the instability in the credit markets and recent declines in consumer spending, which could reduce the number of appropriate locations available that we would consider for our new stores. Furthermore, the failure of landlords to obtain licenses or permits for development projects on a timely basis, which is beyond our control, may negatively impact our ability to implement our development plan.

Damage to our reputation and the Papa Murphy’s brand and negative publicity relating to our stores, including our franchise stores, could reduce sales at some or all of our other stores and could negatively impact our business, financial condition and results of operations.

Our success is dependent in part upon our ability to maintain and enhance the value of the Papa Murphy’s brand, consumers’ connection to our brand and positive relationships with our franchise owners. We may, from time to time, be faced with negative publicity relating to food quality, store facilities, customer complaints or litigation alleging illness or injury, health inspection scores, integrity of our or our suppliers’ food processing, employee relationships or other matters, regardless of whether the allegations are valid or whether we are held to be responsible. The risks associated with such negative publicity cannot be completely eliminated or mitigated and may materially adversely affect our business, financial condition and results of operations and result in damage to our brand. For multi-location food service businesses such as ours, the negative impact of adverse publicity relating to one store or a limited number of stores may extend far beyond the stores or franchise owners involved to affect some or all of our other stores. The risk of negative publicity is particularly great with respect to our franchise stores because we are limited in the manner in which we can regulate them, especially on a real-time basis. A similar risk exists with respect to unrelated food service businesses, if consumers associate those businesses with our own operations.

There has been a marked increase in the use of social media platforms and similar devices, including weblogs (blogs), social media websites and other forms of Internet-based communications which allow individuals to access a broad audience of consumers and other interested persons. Consumers value readily available information concerning goods and services that they purchase and may act on such information without further investigation or authentication. The availability of information on social media platforms is virtually immediate as is its impact. Many social media platforms immediately publish the content their subscribers and participants can post, often without filters or checks on accuracy of the content posted. The opportunity for dissemination of information, including inaccurate information, is seemingly limitless and readily available. Information concerning our company may be posted on such platforms at any time. Information posted may be adverse to our interests or may be inaccurate, each of which may harm our performance, prospects or business. The harm may be immediate without affording us an opportunity for redress or correction. Such platforms also could be used for dissemination of trade secret information, compromising valuable company assets. In general, the dissemination of information online could materially adversely affect our business, financial condition and results of operations, regardless of the information’s accuracy.

Our success depends in part upon effective advertising and marketing campaigns, which may not be successful, and franchise owner support of such advertising and marketing campaigns.

We believe the Papa Murphy’s brand is critical to our business. We expend resources in our marketing efforts using a variety of media, including social media. We expect to continue to conduct brand awareness programs and customer initiatives to attract and retain customers. Additionally, some of our competitors have greater financial resources, which enable them to spend significantly more on marketing and advertising than us. Should our competitors increase spending on marketing and advertising, or should our advertising and promotions be less effective than our competitors, our business, financial condition and results of operations could materially adversely affected.

The support of our franchise owners is critical for the success of our advertising and marketing campaigns we seek to undertake, and the successful execution of these campaigns will depend on our ability to maintain alignment with our franchise owners. Our franchise owners are required to spend approximately five percent of net sales directly on local advertising or contribute to a local fund managed by franchise owners in certain market areas to fund the purchase of advertising media. Our franchise owners are also required to contribute two percent of their net sales to a national fund to support the development of new products, brand development and national marketing programs. In addition, we, our franchise owners and other third parties have contributed additional advertising funds in the past. While we maintain control over advertising and marketing materials and can mandate certain strategic initiatives pursuant to our franchise agreements, we need the active support of our franchise owners if the implementation of these initiatives is to be successful. Additional advertising funds are not contractually required,

 

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and we, our franchise owners and other third parties may choose to discontinue contributing additional funds in the future. Any significant decreases in our advertising and marketing funds or financial support for advertising activities could significantly curtail our marketing efforts, which may in turn materially adversely affect our business, financial condition and results of operations.

Our sales and profits could be adversely affected if comparable store sales are less than we expect.

The level of comparable store sales, which represent the change in year-over-year sales for stores open for at least 53 weeks, excluding the week the store opened, will affect our sales growth and will continue to be a critical factor affecting our profits because the profit margin on comparable store sales is generally higher than the profit margin on new store sales. Our franchise owners’ and our ability to increase comparable store sales depends in part on our ability to successfully implement our initiatives to build sales. It is possible such initiatives will not be successful, that we will not achieve our target comparable store sales growth or that the change in comparable store sales could be negative, which may cause a decrease in sales and our profits that would materially adversely affect our business, financial condition or results of operations.

We experience the effects of seasonality.

Seasonal factors and the timing of holidays cause our revenues to fluctuate from quarter to quarter. We typically follow family eating patterns at home, with our strongest sales levels occurring in the months of September through May, and our lowest sales levels occurring in the months of June, July and August. Therefore, our revenues per store are typically higher in the first and fourth quarters and lower in the second and third quarters.

Additionally, our new store openings have historically been concentrated in the fourth and first quarters because new franchise owners may seek to benefit from historically stronger sales levels occurring in these periods. We believe that new store openings will continue to be weighted towards the fourth quarter. As a result of these factors, our quarterly and annual results of operations and comparable store sales may fluctuate significantly. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year and comparable store sales for any particular future period may decrease and materially adversely affect our business, financial condition or results of operations.

Changes in economic conditions, including continuing effects from the recent recession and adverse weather and other unforeseen conditions, could materially adversely affect our business, financial condition and results of operations.

The restaurant industry depends on consumer discretionary spending. The recent recession, coupled with high unemployment rates, reduced home values, increases in home foreclosures, investment losses, personal bankruptcies, rising fuel prices, reduced access to credit and reduced consumer confidence, has impacted consumers’ ability and willingness to spend discretionary dollars. Economic conditions may remain volatile and may continue to depress consumer confidence and discretionary spending for the near term. If the weak economy continues for a prolonged period of time or worsens, customer traffic could be adversely impacted if our customers have less discretionary income or reduce the amount they spend on quick service meals. We believe that if the current negative economic conditions persist for a long period of time or become more pervasive, consumers might make long-lasting changes to their discretionary spending behavior, including dining out less frequently. In addition, given our geographic concentrations in the West and Midwest, economic conditions in these particular areas of the country could have a disproportionate impact on our overall results of operations, and regional occurrences such as local strikes, terrorist attacks, increases in energy prices, adverse weather conditions, tornadoes, earthquakes, hurricanes, floods, droughts, fires or other natural or man-made disasters could materially adversely affect our business, financial condition and results of operations. Adverse weather conditions may also impact customer traffic at our stores, and, in more severe cases, cause temporary store closures, sometimes for prolonged periods. If store sales decrease, our profitability could decline as we spread fixed costs across a lower level of sales. Reductions in staff levels, asset impairment charges and potential store closures could result from prolonged negative store sales. There can be no assurance that the macroeconomic environment or the regional economics in which we operate will improve significantly or that government stimulus efforts will improve consumer confidence, liquidity, credit markets, home values or unemployment, among other things.

Food safety and foodborne illness concerns could have an adverse effect on our business.

We cannot guarantee that our supply chain and food safety controls and training will be fully effective in preventing all food safety issues at our stores, including any occurrences of foodborne illnesses such as salmonella, E. coli and

 

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hepatitis A. In addition, there is no guarantee that our franchise locations will maintain the high levels of internal controls and training we require at our company-owned stores. Furthermore, our franchise owners and we rely on third-party vendors, making it difficult to monitor food safety compliance and increasing the risk that foodborne illness would affect multiple locations rather than a single store. Some foodborne illness incidents could be caused by third-party vendors and transporters outside of our control. New illnesses resistant to our current precautions may develop in the future, or diseases with long incubation periods could arise, that could give rise to claims or allegations on a retroactive basis. One or more instances of foodborne illness in any of our stores or markets or related to food products we sell could negatively affect our store sales nationwide if highly publicized on national media outlets or through social media. This risk exists even if it were later determined that the illness was wrongly attributed to us or one of our stores. A number of other restaurant chains have experienced incidents related to foodborne illnesses that have had a material adverse effect on their operations. The occurrence of a similar incident at one or more of our stores, or negative publicity or public speculation about an incident, could materially adversely affect our business, financial condition or results of operations.

Changes in food availability and costs could adversely affect our results of operations.

Our profitability and operating margins are dependent in part on our ability to anticipate and react to changes in food costs, particularly the costs of mozzarella cheese and flour. We are party to national supply agreements for core ingredients with certain key third party suppliers, including Saputo Cheese Inc. and Davisco Foods for cheese, Pizza Blends, Inc. for flour and dough mix, Neil Jones Foods Company for tomatoes for sauce and several suppliers for meat, pursuant to which we lock in pricing for our franchise owners and company-owned stores. We rely on Sysco Corporation as the primary distributor of food and other products to our franchise owners and company-owned stores. Our pricing arrangements with national suppliers typically have terms from three months to a year after which the pricing may be renegotiated. Each store purchases food supplies directly from these suppliers and purchases produce locally through a produce buying group.

The type, variety, quality, availability and price of produce, meat and cheese are volatile and are subject to factors beyond our control, including weather, governmental regulation, availability and seasonality, each of which may affect our and our franchise owners’ food costs or cause a disruption in our supply. For example, cheese pricing is higher in the summer months due to a drop off in milk production in higher temperatures. Our food distributors and suppliers also may be affected by higher costs to produce and transport commodities used in our stores, higher minimum wage and benefit costs and other expenses that they pass through to their customers, which could result in higher costs for goods and services supplied to us. We may not be able to anticipate and react to changing food costs through our purchasing practices and menu price adjustments in the future. As a result, any increase in the prices charged by suppliers would increase the food costs for our company-owned stores and for our franchise owners and could adversely impact their profitability. In addition, because we provide moderately priced food, we may choose not to, or may be unable to, pass along commodity price increases to consumers, and any price increases that are passed along to consumers may materially adversely affect store sales which would lower revenues generated from company-owned stores and franchise owner royalties. These potential changes in food and supply costs and availability could materially adversely affect our business, financial condition or results of operations.

Our dependence on a sole supplier or a limited number of suppliers for some ingredients could result in disruptions to our business.

Sysco Corporation is the primary distributor of our food and other products to our domestic franchise owners and company-owned stores and any disruption to this distribution due to work stoppages, strikes or other business interruption may materially adversely affect our franchise owners and us. Additionally, we do not have formal long-term arrangements with all of our suppliers, and therefore our suppliers may implement significant price increases or may not meet our requirements in a timely fashion, or at all. Any material interruptions in our supply chain, such as a material interruption of ingredient supply due to the failures of third-party distributors or suppliers, or interruptions in service by common carriers that ship goods within our distribution channels, may result in significant cost increases and reduce store sales. We may not be able to find alternative distributors or suppliers on a timely basis or at all. Our company-owned and franchise stores could also be harmed by any prolonged disruption in the supply of products from or to our key suppliers due to weather, crop disease and other events beyond our control. Insolvency of key suppliers could also negatively impact our business. Our focus on a limited menu would make the consequences of a shortage of a key ingredient, such as cheese or flour, more severe, and affected stores could experience significant reductions in sales during the shortage.

 

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Changes in laws related to electronic benefit transfer (“EBT”) systems, could adversely impact our results in operations.

Because our products are not cooked, we and our franchise owners currently are able to accept EBT payments, or food stamps, at stores in the United States. Changes in state and federal laws governing where EBT cards may be used and what they may be used for may limit our ability to accept such payments and could significantly reduce sales. Reductions in food stamp benefits occurred in November 2013, and further additional reductions in food stamp benefits have been proposed separately by the Senate and Congress. The recent reductions to and the potential future reductions in food stamp benefits may reduce sales, which could materially adversely affect our business, financial condition and results of operations.

Changes in employment laws may adversely affect our business.

Various federal and state labor laws govern the relationship with our employees and employees of our franchise owners, which may impact our and our franchise owners’ operating costs. These laws include employee classification as exempt/non-exempt for overtime and other purposes, minimum wage requirements, unemployment tax rates, mandatory health benefits, workers’ compensation rates, immigration status, tax reporting and other wage and benefit requirements. A substantial number of employees at our company-owned and franchise stores are paid at rates related to the U.S. federal minimum wage, and increases in the U.S. federal minimum wage may increase labor costs. Any such increases in labor costs might result in franchise owners inadequately staffing restaurants. Understaffed restaurants could reduce sales at such restaurants, decrease royalty payments and adversely affect our brands.

In addition, various states are considering or have already adopted new immigration laws or enforcement programs. The U.S. Congress and Department of Homeland Security from time to time consider and may implement changes to federal immigration laws, regulations or enforcement programs as well. Some of these changes may increase obligations for compliance and oversight, which could subject us to additional costs and make the hiring process for us and our franchise owners more cumbersome, or reduce the availability of potential employees. Although we require all of our employees, including at our company-owned stores, to provide us with government-specified documentation evidencing their employment eligibility, some of our employees may, without our knowledge, be unauthorized workers. We currently participate in the “E-Verify” program, an Internet-based, free program run by the United States government to verify employment eligibility, in states in which participation is required, and we plan to introduce its use throughout our stores. However, use of the “E-Verify” program does not guarantee that we will properly identify all applicants who are ineligible for employment. In addition, our franchise owners are responsible for screening any employees they hire. Unauthorized workers are subject to deportation and may subject us or our franchise owners to fines or penalties, and if any of our or our franchise owners’ workers are found to be unauthorized it may become more difficult for us to hire and keep qualified employees. Termination of a significant number of employees who were unauthorized employees may disrupt store operations and cause temporary increases in our or our franchise owners’ labor costs as we train new employees. We could also become subject to fines, penalties and other costs related to claims that we did not fully comply with all recordkeeping obligations of federal and state immigration compliance laws. These factors could materially adversely affect our business, financial condition or results of operations.

If our franchise owners or we face labor shortages or increased labor costs, our growth and operating results could be adversely affected.

Labor is a primary component in the cost of operating our company-owned stores and for franchise owners. If our franchise owners or we face labor shortages or increased labor costs because of increased competition for employees, higher employee turnover rates, increases in the federal, state or local minimum wage or other employee benefits costs (including costs associated with health insurance coverage), our operating expenses could increase and our growth could be adversely affected. In addition, our success depends in part upon our franchise owners’ and our ability to attract, motivate and retain a sufficient number of well-qualified store operators and management personnel, as well as a sufficient number of other qualified employees, to keep pace with our expansion schedule. Qualified individuals needed to fill these positions are in short supply in some geographic areas. In addition, restaurants have traditionally experienced relatively high employee turnover rates. Although we have not yet experienced significant problems in recruiting or retaining employees, our franchise owners’ and our ability to recruit and retain such individuals may delay the planned openings of new stores or result in higher employee turnover in existing stores, which could have a material adverse effect on our business, financial condition or results of operations.

 

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An increase in the cost of labor could adversely affect our business and our growth. Competition for employees could require us or our franchise owners to pay higher wages, which could result in higher labor costs. In addition increases in the minimum wage would increase our labor costs. Additionally, costs associated with workers’ compensation are rising, and these costs may continue to rise in the future. We may be unable to increase our menu prices in order to pass these increased labor costs on to consumers, in which case our margins would be negatively affected, which could materially adversely affect our business, financial condition or results of operations.

We invest in developing new product offerings, some of which may not be successful.

We invest in continually developing new potential product offerings as well as in marketing and advertising our new products. For example, we recently tested Fresh Pan Pizza, which is marketed at a price above our regular menu items. Our new product offerings may not be well-received by consumers and may not be successful, which could materially adversely affect our results of operations.

From time to time we may invest in enhancements to our franchise platform, on which we may not see a return.

We may not see a return on investments we make in our franchise platform. For example, we have invested in a point-of-sale system that we continue to implement across our franchise base in order to better manage our business. As part of this investment, in September 2013 we purchased approximately $4.5 million of point-of-sale software licenses, and we intend to sell these licenses directly to our franchise owners. We may not be able to sell these licenses to our existing franchise owners on a timely basis, or at all. Our failure to capitalize on investments may materially adversely affect our financial condition.

The effect of changes to healthcare laws in the United States may increase the number of employees who choose to participate in our healthcare plans, which may significantly increase our healthcare costs and negatively impact our results of operations and our franchise owners.

In 2010, the PPACA was signed into law in the United States to require health care coverage for many uninsured individuals and expand coverage for those already insured. We currently offer and subsidize comprehensive healthcare coverage, primarily for our salaried employees. The healthcare reform law will require us to offer healthcare benefits to all full-time employees (including full-time hourly employees) that meet certain minimum requirements of coverage and affordability, or face penalties. If we elect to offer such benefits, we may incur substantial additional expense. If we fail to offer such benefits, or the benefits we elect to offer do not meet the applicable requirements, we may incur penalties. The healthcare reform law also requires individuals to obtain coverage or face individual penalties, so employees who are currently eligible but elect not to participate in our healthcare plans may find it more advantageous to do so when such individual mandates take effect. It is also possible that by making changes or failing to make changes in the healthcare plans offered by us, we will become less competitive in the market for our labor. Finally, implementing the requirements of healthcare reform is likely to impose additional administrative costs. The costs and other effects of these new healthcare requirements cannot be determined with certainty, but they may significantly increase our healthcare coverage costs and could materially adversely affect our business, financial condition or results of operations.

Restaurant companies have been the target of class actions and other litigation alleging, among other things, violations of federal and state law. We could be party to litigation that could adversely affect us by distracting management, increasing our expenses or subjecting us to material money damages and other remedies.

We are subject to lawsuits, administrative proceedings and claims that arise in the ordinary course of our business. In recent years, a number of restaurant companies have been subject to claims by customers, employees, franchise owners and others regarding issues such as food safety, personal injury and premises liability, employment-related claims, harassment, discrimination, disability, compliance with advertising laws, including the Telephone Consumer Protection Act, and other operational issues common to the foodservice industry. A number of these lawsuits have resulted in the payment of substantial damages by the defendants. An adverse judgment or settlement that is not insured or is in excess of insurance coverage could have an adverse impact on our profitability and could cause variability in our results compared to expectations. We carry insurance policies for a significant portion of our risks and associated liabilities with respect to workers’ compensation, general liability, employer’s liability, health benefits and other insurable risks. A judgment in excess of our insurance coverage for any claims could materially adversely affect our business, financial condition and results of operations. Regardless of whether any claims that may be brought against us are valid or whether we are ultimately determined to be liable, our business, financial condition and results of operations could also be adversely affected by negative publicity, litigation costs resulting from the defense of these claims, and the diversion of time and resources from our operations.

 

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Although we have experienced no customer lawsuits to date, our customers occasionally allege we caused an illness or injury they suffered at or after a visit to our stores, or that we have problems with food quality or operations. We are also subject to a variety of other claims arising in the ordinary course of our business, including personal injury claims, contract claims and claims alleging violations of federal and state law regarding workplace and employment matters, equal opportunity, discrimination and similar matters. We may also be named as a defendant in any such claims brought against any of our franchise owners. In addition, we could become subject to class action or other lawsuits related to these or different matters in the future. Regardless of whether any claims against us are valid, or whether we are ultimately held liable, claims may be expensive to defend and may divert time and money away from our operations and hurt our performance. A judgment in excess or outside of our insurance coverage for any claims could materially adversely affect our financial condition or results of operations.

In addition, the restaurant industry has been subject to a growing number of claims based on the nutritional content of food products sold and disclosure and advertising practices. We may also be subject to this type of proceeding in the future and, even if we are not, publicity about these matters (particularly directed at the limited service or fast casual segments of the industry) may harm our reputation and could materially adversely affect our business, financial condition or results of operations.

Our business operations and future development could be significantly disrupted if we lose key members of our management team.

The success of our business continues to depend to a significant degree upon the continued contributions of our senior officers and key employees, both individually and as a group. Our future performance will be substantially dependent in particular on our ability to retain and motivate these senior officers and key employees. Although we have employment agreements in place with certain senior officers and key employees, we cannot prevent them from terminating their employment with us. The loss of the services of our Chief Executive Officer, Chief Financial Officer, other senior officers or other key employees could materially adversely affect our business and plans for future development. We have no reason to believe that we will lose the services of any of our current senior officers and key employees in the foreseeable future; however, we currently have no effective replacement for any of these individuals due to their experience, reputation in the industry and special role in our operations. We do not maintain any key man life insurance policies for any of our employees.

Our indebtedness may limit our ability to invest in the ongoing needs of our business and if we are unable to comply with our financial covenants, our liquidity and results of operations could be adversely affected.

As of December 30, 2013, we had $170.0 million of outstanding indebtedness and $10.0 million of availability under a revolving credit facility, and after giving effect to this offering and the use of proceeds therefrom, which will be used primarily to repay debt, we would have had $         million of outstanding indebtedness, including $         million outstanding under our new senior secured credit facilities. We may, from time to time, incur additional indebtedness.

The agreement governing our new senior secured credit facilities places certain conditions on us, including that it:

 

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requires us to utilize a substantial portion of our cash flow from operations to make payments on our indebtedness, reducing the availability of our cash flow to fund working capital, capital expenditures, development activity and other general corporate purposes;

 

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increases our vulnerability to adverse general economic or industry conditions;

 

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limits our flexibility in planning for, or reacting to, changes in our business or the industries in which we operate;

 

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makes us more vulnerable to increases in interest rates, as borrowings under our new senior secured credit facilities are at variable rates;

 

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limits our ability to obtain additional financing in the future for working capital or other purposes; and

 

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places us at a competitive disadvantage compared to our competitors that have less indebtedness.

Our new senior secured credit facilities place certain limitations on our ability to incur additional indebtedness. However, subject to the qualifications and exceptions in our new senior secured credit facilities, we may be

 

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permitted to incur substantial additional indebtedness and may incur obligations that do not constitute indebtedness under the terms of the new senior secured credit facilities. The new senior secured credit facilities also place certain limitations on, among other things, our ability to enter into certain types of transactions, financing arrangements and investments, to make certain changes to our capital structure and to guarantee certain indebtedness. The new senior secured credit facilities also place certain restrictions on the payment of dividends and distributions and certain management fees. These restrictions limit or prohibit, among other things, our ability to:

 

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pay dividends on, redeem or repurchase our stock or make other distributions;

 

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incur or guarantee additional indebtedness;

 

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sell stock in our subsidiaries;

 

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create or incur liens;

 

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make acquisitions or investments;

 

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transfer or sell certain assets or merge or consolidate with or into other companies;

 

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make certain payments or prepayments of indebtedness subordinated to our obligations under our new senior secured credit facilities; and

 

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enter into certain transactions with our affiliates.

Failure to comply with certain covenants or the occurrence of a change of control under our new senior secured credit facilities could result in the acceleration of our obligations under the new senior secured credit facilities, which would have an adverse effect on our liquidity, capital resources and results of operations.

Our new senior secured credit facilities also require us to comply with certain financial covenants regarding our capital expenditures, total leverage ratio and our interest coverage ratio. Changes with respect to these financial covenants may increase our interest rate and failure to comply with these covenants could result in a default and an acceleration of our obligations under the new senior secured credit facilities, which would have an adverse effect on our liquidity, capital resources and results of operations. See “Description of Material Indebtedness.”

We may be unable to generate sufficient cash flow to satisfy our significant debt service obligations, which would adversely affect our financial condition and results of operations.

Our ability to make principal and interest payments on and to refinance our indebtedness will depend on our ability to generate cash in the future and is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. If our business does not generate sufficient cash flow from operations, in the amounts projected or at all, or if future borrowings are not available to us in amounts sufficient to fund our other liquidity needs, our business financial condition and results of operations could be materially adversely affected. If we cannot generate sufficient cash flow from operations to make scheduled principal and interest payments in the future, we may need to refinance all or a portion of our indebtedness on or before maturity, sell assets, delay capital expenditures or seek additional equity. If we are unable to refinance any of our indebtedness on commercially reasonable terms or at all or to effect any other action relating to our indebtedness on satisfactory terms or at all, our business, financial condition and results of operations could be materially adversely affected.

Any acquisitions, partnerships or joint ventures that we make could disrupt our business and harm our financial condition.

From time to time, we may evaluate potential strategic acquisitions of existing stores or complementary businesses as well as partnerships or joint ventures with third parties, including potential franchisors, to facilitate our growth, particularly our international expansion. We may not be successful in identifying acquisition, partnership and joint venture candidates. In addition, we may not be able to continue the operational success of any stores we acquire or successfully finance or integrate any businesses that we acquire or with which we form a partnership or joint venture. We may have potential write-offs of acquired assets and an impairment of any goodwill recorded as a result of acquisitions. Furthermore, the integration of any acquisition may divert management’s time and resources from our core business and disrupt our operations or may result in conflicts with our business. For example, our Chairman,

 

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John Barr, co-invested in Project Pie with us and agreed to serve as the chairman of the Project Pie board of managers and as chairman of Project Pie, which may divert his attention from our business and result in potential conflicts of interest. In addition, Project Pie may require us to invest additional capital in the future and also may compete with our stores in certain markets. For a description of our investment in Project Pie, see “Certain Relationships and Related Person Transactions—Project Pie.”

Any acquisition, partnership or joint venture may not be successful, may reduce our cash reserves, may negatively affect our earnings and financial performance and, to the extent financed with stock or the proceeds of debt, may be dilutive to our stockholders or increase our already high levels of indebtedness. We cannot ensure that any acquisition, partnership or joint venture we make will not have a material adverse effect on our business, financial condition and results of operations.

Security breaches of confidential customer information in connection with our electronic processing of credit and debit card transactions may adversely affect our business.

The majority of our store sales are by credit or debit cards. Other restaurants and retailers have experienced security breaches in which credit and debit card information of their customers has been stolen. We may in the future become subject to lawsuits or other proceedings for purportedly fraudulent transactions arising out of the actual or alleged theft of our customers’ credit or debit card information. In addition, most states have enacted legislation requiring notification of security breaches involving personal information, including credit and debit card information. Any such claim, proceeding, or mandatory notification could cause us to incur significant unplanned expenses, which could have an adverse impact on our financial condition and results of operations. Further, adverse publicity resulting from these allegations could harm our reputation and could materially adversely affect our business, financial condition and results of operations.

We may not be able to adequately protect our intellectual property, which, in turn, could harm the value of our brand and adversely affect our business.

Our ability to implement our business plan successfully depends in part on our ability to build brand recognition in the markets served by our stores using our trademarks and other proprietary intellectual property, including our brand names and logos. We have registered or applied to register a number of our trademarks. We cannot assure you that our trademark applications will be approved. Third parties may also oppose our trademark applications, or otherwise challenge our use of the trademarks. In the event that our trademarks are successfully challenged, we could be forced to rebrand our goods and services, which could result in loss of brand recognition, and could require us to devote resources to advertising and marketing new brands.

We rely on our franchise owners to assist us in identifying issues at the local level. We enforce our rights through a number of methods, including the issuance of cease-and-desist letters. If it became necessary, we would make infringement claims in federal court. If our efforts to register, maintain and protect our trademarks or other intellectual property are inadequate, or if any third party misappropriates, dilutes or infringes on our intellectual property, the value of our brand may be harmed, which could have a material adverse effect on our business and might prevent our brand from achieving or maintaining market acceptance. We may also face the risk of claims that we have infringed third parties’ intellectual property rights. A successful claim of infringement against us could result in our being required to pay significant damages or enter into costly licensing or royalty agreements in order to obtain the right to use a third party’s intellectual property, any of which could have a negative impact on our results of operations and harm our future prospects. If such royalty or licensing agreements are not available to us on acceptable terms or at all, we may be forced to stop the sale of certain products or services. Any claims of intellectual property infringement, even those without merit, could be expensive and time consuming to defend, require us to rebrand our services, if feasible, and divert management’s attention.

We also rely on trade secrets and proprietary know-how to protect our brand. Our methods of safeguarding this information may not be adequate. Moreover, we may face claims of misappropriation or infringement of third parties’ rights that could interfere with our use of this information. Defending these claims may be costly and, if unsuccessful, may prevent us from continuing to use this proprietary information in the future and may require us to pay monetary damages. We do not maintain confidentiality agreements with all of our team members. Even with respect to the confidentiality agreements we have, we cannot assure you that those agreements will not be breached, that they will provide meaningful protection, or that adequate remedies will be available in the event of an

 

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unauthorized use or disclosure of our proprietary information. If competitors independently develop or otherwise obtain access to our trade secrets or proprietary know-how, the appeal of our stores could be reduced and our business could be harmed.

Information technology system failures or breaches of our network security could interrupt our operations and adversely affect our business.

We rely on our computer systems and network infrastructure across our operations, including point-of-sale processing at our stores. Our ability to effectively and efficiently manage our operations depends upon our ability to protect our computer equipment and systems against damage from physical theft, fire, power loss, telecommunications failure or other catastrophic events, as well as from internal and external security breaches, viruses, worms and other disruptive problems. Any damage or failure of our computer systems or network infrastructure that causes an interruption in our operations could materially adversely affect our business, financial condition and results of operations and subject us to litigation or actions by regulatory authorities. Remediation of such problems could also result in significant, unplanned expenditures.

An increasingly significant portion of our retail sales depends on the continuing operation of our information technology and communications systems, including but not limited to, our online ordering platform, point-of-sale system and our credit card processing systems. Our information technology, communication systems and electronic data may be vulnerable to damage or interruption from earthquakes, terrorist attacks, floods, fires, power loss, telecommunications failures, computer viruses, loss of data, unauthorized data breaches or other attempts to harm our systems. Additionally, we rely on data centers that are also subject to break-ins, sabotage and intentional acts of vandalism that could cause disruptions in our ability to serve our customers and protect customer data. Some of our systems are not fully redundant, and our disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster, intentional sabotage or other unanticipated problems could result in lengthy interruptions in our service. Any errors or vulnerabilities in our systems, or damage to or failure of our systems, could result in interruptions in our services and non-compliance with certain regulations, which could materially adversely affect our business, financial condition and results of operations.

We are subject to extensive government regulation and requirements issued by other groups and our failure to comply with existing or increased regulations could adversely affect our business and operating results.

We are subject to numerous federal, state, local and foreign laws and regulations, as well as, requirements issued by other groups, including those relating to:

 

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the preparation, sale and labeling of food;

 

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building and zoning requirements;

 

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environmental laws;

 

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compliance with the FLSA, which govern such matters as minimum wage, overtime and other working conditions, family leave mandates and a variety of other laws enacted by states that govern these and other employment matters;

 

  n  

the impact of immigration and other local and foreign laws and regulations on our business;

 

  n  

compliance with securities laws and NASDAQ listed company rules;

 

  n  

compliance with the Americans with Disabilities Act of 1990, as amended;

 

  n  

working and safety conditions;

 

  n  

menu labeling and other nutritional requirements;

 

  n  

sales taxes or other transaction taxes;

 

  n  

compliance with the Payment Card Industry Data Security Standards (PCI DSS) and similar requirements;

 

  n  

compliance with the PPACA, and subsequent amendments; and

 

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  n  

compliance with the Dodd-Frank Wall Street Reform and Consumer Protection Act and any rules promulgated thereunder.

We may also become subject to legislation or regulation seeking to tax and/or regulate high-fat foods, foods with high sugar and salt content, or foods otherwise deemed to be “unhealthy.” If we fail to comply with existing or future laws and regulations, we may be subject to governmental or judicial fines or sanctions. In addition, our capital expenditures could increase due to remediation measures that may be required if we are found to be noncompliant with any of these laws or regulations.

We are also subject to a Federal Trade Commission rule and to various state and foreign laws that govern the offer and sale of franchises. Additionally, these laws regulate various aspects of the franchise relationship, including terminations and the refusal to renew franchises. The failure to comply with these laws and regulations in any jurisdiction or to obtain required government approvals could result in a ban or temporary suspension on future franchise sales, fines or other penalties or require us to make offers of rescission or restitution, any of which could materially adversely affect our business, financial condition and results of operations.

Some of the jurisdictions where we have company-owned and franchise stores do not assess sales tax on our Take ‘N’ Bake pizzas because they are not ready to eat when purchased. Accordingly, we may benefit from a pricing advantage over some pizza chain competitors in these jurisdictions. If these jurisdictions were to impose sales tax on our products, these stores may experience a decline in sales due to the loss of this pricing advantage. In addition, our stores may be subject to unanticipated sales tax assessments. These sales tax assessments could result in losses to our franchise owners or franchise stores going out of business, which could adversely affect our number of franchise stores and our results of operations. Changes in sales tax assessments of this type at the franchisee level could lead to undercapitalized franchisees going out of business and loss of royalties at the company level. Similarly, such tax assessments could impact the profitability of our company-owned stores. As a result, changes in sales tax assessments could have a material adverse effect on our business, financial condition and results of operations.

Additionally, the failure to obtain and maintain licenses, permits and approvals could adversely affect our business, financial condition and results of operations. Typically, licenses must be renewed annually and may be revoked, suspended or denied renewal for cause at any time if governmental authorities determine that our conduct violates applicable regulations. Difficulties or failure to maintain or obtain the required licenses and approvals could adversely affect our existing stores and delay or result in our decision to cancel the opening of new stores, which would adversely affect our business, financial condition and results of operations.

Conflict or terrorism could negatively affect our business.

We cannot predict the effects of actual or threatened armed conflicts or terrorist attacks, efforts to combat terrorism, military action against any foreign state or group located in a foreign state or heightened security requirements on local, regional, national or international economies or consumer confidence. Such events could negatively affect our business, including by reducing customer traffic or the availability of commodities.

Our current insurance coverage may not be adequate, insurance premiums for such coverage may increase and we may not be able to obtain insurance at acceptable rates, or at all.

We have retention programs for workers’ compensation, general liability and owned and non-owned automobile liabilities. These insurance policies may not be adequate to protect us from liabilities that we incur in our business. In addition, in the future our insurance premiums may increase and we may not be able to obtain similar levels of insurance on reasonable terms, or at all. Any substantial inadequacy of, or inability to obtain insurance coverage could materially adversely affect our business, financial condition and results of operations.

Changes to accounting rules or regulations may adversely affect our results of operations.

Changes to existing accounting rules or regulations may impact our future results of operations or cause the perception that we are more highly leveraged. Other new accounting rules or regulations and varying interpretations of existing accounting rules or regulations have occurred and may occur in the future. For instance, accounting regulatory authorities have indicated that they may begin to require lessees to capitalize operating leases in their financial statements in the next few years. If adopted, such change would require us to record significant lease obligations on our consolidated balance sheet and make other changes to our financial statements. This and other future changes to accounting rules or regulations could materially adversely affect our business, financial condition or results of operations.

 

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Risks Relating to Our Company and Our Ownership Structure

We will incur increased costs and obligations as a result of being a public company.

As a privately held company, we were not required to comply with certain corporate governance and financial reporting practices and policies required of a publicly traded company. As a publicly traded company, we will incur significant legal, accounting and other expenses that we were not required to incur in the recent past, particularly after we are no longer an “emerging growth company” as defined under the JOBS Act. After this offering, we will be required to file with the SEC annual and quarterly information and other reports that are specified in Section 13 of the Exchange Act. We will also be required to ensure that we have the ability to prepare financial statements that are fully compliant with all SEC reporting requirements on a timely basis. We will also become subject to other reporting and corporate governance requirements, including the requirements of NASDAQ, and certain provisions of the Sarbanes-Oxley Act and the regulations promulgated thereunder, which will impose significant compliance obligations upon us. As a public company, we will, among other things:

 

  n  

prepare and distribute periodic public reports and other stockholder communications in compliance with our obligations under the federal securities laws and applicable NASDAQ rules;

 

  n  

create or expand the roles and duties of our board of directors and committees of the board;

 

  n  

institute more comprehensive financial reporting and disclosure compliance functions;

 

  n  

supplement our internal accounting, auditing and reporting function, including hiring additional staff with expertise in accounting and financial reporting for a public company;

 

  n  

enhance and formalize closing procedures at the end of our accounting periods;

 

  n  

enhance our internal audit and tax functions;

 

  n  

enhance our investor relations function;

 

  n  

establish new internal policies, including those relating to disclosure controls and procedures; and

 

  n  

involve and retain to a greater degree outside counsel and accountants in the activities listed above.

These changes will require a significant commitment of additional resources and many of our competitors already comply with these obligations. We may not be successful in implementing these requirements and the significant commitment of resources required for implementing them could adversely affect our business, financial condition and results of operations. In addition, if we fail to implement the requirements with respect to our internal accounting and audit functions, our ability to report our results of operations on a timely and accurate basis could be impaired and we could suffer adverse regulatory consequences or violate NASDAQ listing standards. There could also be a negative reaction in the financial markets due to a loss of investor confidence in us and the reliability of our financial statements.

The changes necessitated by becoming a public company require a significant commitment of resources and management oversight that has increased and may continue to increase our costs and might place a strain on our systems and resources. As a result, our management’s attention might be diverted from other business concerns.

For as long as we remain an “emerging growth company” as defined in the JOBS Act, we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies.” These exceptions provide for, but are not limited to, relief from the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, less extensive disclosure obligations regarding executive compensation in our periodic reports and proxy statements, exemptions from the requirements to hold a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved and an extended transition period for complying with new or revised accounting standards. We may take advantage of these reporting exemptions until we are no longer an “emerging growth company.” We may remain an “emerging growth company” for up to five years. See “Prospectus Summary—Implication of Being an “Emerging Growth Company”.” To the extent we do not use exemptions from various reporting requirements under the JOBS Act, we may be unable to realize our anticipated cost savings from those exemptions.

 

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Our internal control over financial reporting does not currently meet the standards required by Section 404 of the Sarbanes-Oxley Act of 2002. The failure to achieve and maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business and share price.

As a privately held company, we have not been required to evaluate our internal control over financial reporting in a manner that meets the standards of publicly traded companies required by Section 404(a) of the Sarbanes-Oxley Act, or Section 404. We anticipate being required to meet these standards in the course of preparing our consolidated financial statements as of and for the fiscal year ended December 28, 2015, and our management will be required to report on the effectiveness of our internal controls over financial reporting for such year. We do not currently have comprehensive documentation of our internal controls, nor do we document or test our compliance with these controls on a periodic basis in accordance with Section 404. Furthermore, we have not tested our internal controls in accordance with Section 404 and, due to our lack of documentation, such a test would not be possible to perform at this time. If we fail to maintain an effective internal control environment or to comply with the numerous legal and regulatory requirements imposed on public companies, we could make material errors in, and be required to restate, our financial statements. In the past we have restated our private company financial statements. Specifically, we were previously required to restate our private company financial statements for fiscal years 2012 and 2011, related to the treatment of certain share-based compensation. If, as a public company, we are required to restate our financial statements, we may fail to meet our public reporting obligations and we may be the subject of negative publicity focusing on financial statement inaccuracies and resulting restatements. Additionally, once we are no longer an “emerging growth company,” our independent registered public accounting firm will be required to attest to the effectiveness of our internal control over financial reporting on an annual basis. The rules governing the standards that must be met for our management to assess our internal control over financial reporting are complex and require significant documentation, testing and possible remediation.

In preparing our consolidated financial statements for the nine months ended September 30, 2013 and fiscal years 2012 and 2011, a material weakness in our internal control over financial reporting, as defined in the standards established by the U.S. Public Accounting Oversight Board (“PCAOB”), was identified. The PCAOB defines a material weakness as a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis.

The material weakness identified resulted from ineffective controls over financial reporting, mainly due to a lack of segregation of financial and accounting duties related to our inability to adequately staff our financial reporting function with a sufficient number of staff with the appropriate experience. To remedy the material weakness, we implemented several measures to improve our internal control over financial reporting, such as increasing the headcount of qualified financial reporting personnel, including hiring an SEC reporting manager and a director of accounting to improve the capabilities of existing financial reporting personnel through training and education in the reporting requirements and deadlines set under GAAP, SEC rules and regulations and the Sarbanes-Oxley Act of 2002. We also engaged independent consultants to assist in establishing processes and oversight measures designed to comply with the requirements under GAAP, SEC rules and regulations and the Sarbanes-Oxley Act of 2002.

In connection with the preparation of our consolidated financial statements for fiscal year 2013, although we had added appropriate additional accounting expertise and resources and no longer identified a material weakness in our internal control over financial reporting, a significant deficiency in our internal control still existed because we were still in the process of building and integrating our new resources and developing a reporting process commensurate with public company reporting. The PCAOB defines a significant deficiency as a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company’s financial reporting. To remedy the significant deficiency, we continue to integrate our newer personnel and improve our accounting and reporting process. In addition, in January 2014, we hired a new Chief Financial Officer, and we continue to hire additional qualified personnel and improve our information technology controls and systems. We plan to complete the remediation efforts as soon as practicable.

 

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In addition to the remediation efforts noted above, we are in the early stages of addressing our internal control procedures to satisfy the requirements of Section 404, which requires an annual management assessment of the effectiveness of our internal control over financial reporting. We may encounter problems or delays in completing the implementation of any requested improvements and receiving a favorable attestation in connection with the attestation provided by our independent registered public accounting firm. We will be unable to issue securities in the public markets through the use of a shelf registration statement if we are not in compliance with Section 404. If we are unable to maintain adequate internal control over financial reporting, we may be unable to report our financial information on a timely basis, may suffer adverse regulatory consequences or violations of applicable stock exchange listing rules. Any restatement of our financial statements due to a lack of adequate internal controls or otherwise could further result in a loss of public confidence in the reliability of our financial statements and sanctions imposed on us by the SEC. Furthermore, failure to achieve and maintain an effective internal control environment could have a material adverse effect on our business and share price due to a lack of investor confidence.

In addition, we will incur additional costs in order to improve our internal control over financial reporting and comply with Section 404, including increased auditing and legal fees and costs associated with hiring additional accounting and administrative staff.

Pursuant to the JOBS Act, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act for so long as we are an “emerging growth company.”

Section 404 of the Sarbanes-Oxley Act requires annual management assessments of the effectiveness of our internal control over financial reporting, starting with the second annual report that we file with the SEC as a public company, and generally requires in the same report a report by our independent registered public accounting firm on the effectiveness of our internal control over financial reporting. However, under the JOBS Act, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act until we are no longer an “emerging growth company.” We could be an “emerging growth company” for up to five years.

In addition, Section 107 of the JOBS Act also provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. An “emerging growth company” can therefore delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we are choosing to “opt out” of such extended transition period and, as a result, we plan to comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.

Lee Equity may acquire interests and positions that could present potential conflicts with our and our stockholders’ interests.

Lee Equity makes investments in companies and may, from time to time, acquire and hold interests in businesses that compete directly or indirectly with us. Lee Equity may also pursue, for its own accounts, acquisition opportunities that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us. Our amended and restated certificate of incorporation will contain provisions renouncing any interest or expectancy held by our directors affiliated with Lee Equity in certain corporate opportunities. Accordingly, the interests of Lee Equity may supersede ours, causing it or its affiliates to compete against us or to pursue opportunities instead of us, for which we have no recourse. Such actions on the part of Lee Equity and inaction on our part could have a material adverse effect on our business, financial condition and results of operations.

Upon the completion of this offering, representatives of Lee Equity will occupy a majority of the seats on our board of directors. In addition, under the new stockholder’s agreement that we expect to enter into in connection with this offering, for so long as Lee Equity (or one or more of its affiliates, to the extent assigned thereto), individually or in the aggregate owns (i) 20% or more of the voting power of the issued and outstanding shares of our common stock, Lee Equity will be entitled to designate two director designees or (ii) 10% or more of the voting power of the issued and outstanding shares of our common stock, Lee Equity will be entitled to designate one director designee, in each case to serve on the board of directors at any meeting of stockholders at which directors are to be elected to the

 

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extent that Lee Equity does not have a director designee then serving on the board of directors. We will take all necessary actions, including, among other things, calling a special meeting of the stockholders, to ensure that Lee Equity has at least one or two designees, as the case may be. Accordingly, we expect that after the first anniversary of this offering, at least two of the Lee Equity representatives serving on our board will resign. Lee Equity could invest in entities that directly or indirectly compete with us. As a result of these relationships, when conflicts arise between the interests of Lee Equity and the interests of our stockholders, these directors may not be disinterested.

We are an emerging growth company and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.

We are an emerging growth company, as defined in the JOBS Act, and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies including, but not limited to, not being required to obtain an assessment of the effectiveness of our internal controls over financial reporting from our independent registered public accounting firm pursuant to Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In addition, we may elect to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. To the extent we choose to do so, our financial statements may not be comparable to companies that comply with such new or revised accounting standards. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and the market price of our common stock may be more volatile.

Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us more difficult, limit attempts by our stockholders to replace or remove our current management and limit the market price of our common stock.

Provisions in our certificate of incorporation and bylaws, as amended and restated in connection with this offering, may have the effect of delaying or preventing a change of control or changes in our management. Our amended and restated certificate of incorporation and amended and restated bylaws will include provisions that:

 

  n  

authorize our board of directors to issue, without further action by the stockholders, up to              shares of undesignated preferred stock;

 

  n  

require that any action to be taken by our stockholders be effected at a duly called annual or special meeting and not by written consent;

 

  n  

specify that special meetings of our stockholders can be called only upon the request of a majority of our board of directors or, at the request of Lee Equity so long as Lee Equity (or its affiliates) owns at least 10% of the voting power of all outstanding shares of our common stock;

 

  n  

establish an advance notice procedure for stockholder proposals to be brought before an annual meeting, including proposed nominations of persons for election to our board of directors;

 

  n  

establish that our board of directors is divided into three classes, with each class serving three-year staggered terms;

 

  n  

prohibit cumulative voting in the election of directors; and

 

  n  

provide that our directors may be removed only for cause by a majority of the remaining members of our board of directors or the holders of a supermajority of our outstanding shares of capital stock.

These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management, and may discourage, delay or prevent a transaction involving a change in control of our company that is in the best interest of our minority stockholders. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of our common stock if they are viewed as discouraging future takeover attempts. In addition, because we are

 

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incorporated in Delaware, we have opted out of Section 203 of the Delaware General Corporation Law, but our amended and restated certificate of incorporation will provide that engaging in any of a broad range of business combinations with any “interested” stockholder (any stockholder with 15% or more of our capital stock) for a period of three years following the date on which the stockholder became an “interested” stockholder is prohibited. Our amended and restated certificate of incorporation will contain provisions that have the same effect as Section 203 of the Delaware General Corporations Law, except that they will provide that Lee Equity, or any affiliate thereof or any person or entity which acquires from any of the foregoing stockholders beneficial ownership of 5% or more of then outstanding shares of our voting stock in a transaction or any person or entity which acquires from such transferee beneficial ownership of 5% or more of then outstanding shares of our voting stock other than through a registered public offering or through any broker’s transaction executed on any securities exchange or other over-the-counter market, shall not be deemed an “interested stockholder” for purposes of this provision of our amended and restated certificate of incorporation and therefore not subject to the restrictions set forth in this provision.

Lee Equity will continue to have significant influence over us after this offering, which could limit your ability to influence the outcome of key transactions, including a change of control.

Upon completion of this offering, investment funds affiliated with Lee Equity will beneficially own     % of our outstanding common stock (     % if the underwriters exercise in full the option to purchase additional shares from the selling stockholders). Under the terms of our amended and restated certificate of incorporation and bylaws, Lee Equity will have consent rights with respect to certain significant matters so long as Lee Equity owns 25% or more of the outstanding shares of our common stock, including among others, certain change of control transactions, issuances of equity securities, the incurrence of significant indebtedness, declaration or payments of non-pro rata dividends, significant investments in, or acquisitions or dispositions of assets, adoption of any new equity-based incentive plan, any material increase in the salary of our Chief Executive Officer, certain amendments to our organizational documents, any material change to our business, or any change to the number of directors serving on our board. So long as Lee Equity owns 10% or more of our issued and outstanding common stock, Lee Equity will be granted access to our customary non-public information and members of our management team and shall have the ability to share our material non-public information with any potential purchaser of us that executes an acceptable confidentiality agreement with us which will include a prohibition on trading on material non-public information. Lee Equity will have the right to assign any of its governance and registration rights to its affiliates or to a third party in connection with the sale by Lee Equity of 10% or more of the issued and outstanding shares of our common stock. Under the terms of a new stockholder’s agreement, for so long as Lee Equity (or one or more of its affiliates, to the extent assigned thereto), individually or in the aggregate owns (i) 20% or more of the voting power of the issued and outstanding shares of our common stock, Lee Equity will be entitled to designate two director designees or (ii) 10% or more of the voting power of the issued and outstanding shares of our common stock, Lee Equity will be entitled to designate one director designee, in each case to serve on the board of directors at any meeting of stockholders at which directors are to be elected to the extent that Lee Equity does not have a director designee then serving on the board of directors. We will take all necessary actions, including, among other things, calling a special meeting of the stockholders, to ensure that Lee Equity has at least one or two designees, as the case may be. As such, Lee Equity will continue to have substantial influence over us. Such concentration of ownership may also have the effect of delaying or preventing a change in control, which may be to the benefit of this one stockholder but not in the interest of the investors.

Risks Related to this Offering

We expect that our stock price will fluctuate significantly, which could cause the value of your investment in our common stock to decline, and you may not be able to resell your shares at a price at or above the initial public offering price.

Securities markets worldwide have experienced, and are likely to continue to experience, significant price and volume fluctuations. The market volatility, as well as general economic, market or political conditions, could reduce the market price of our common stock regardless of our results of operations. The trading price of our common stock is likely to be volatile and subject to significant price fluctuations in response to many factors, including:

 

  n  

market conditions in the broader stock market;

 

  n  

changing economic conditions;

 

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  n  

actual or anticipated fluctuations in our quarterly or annual earnings or those of other companies in our industry;

 

  n  

legal or regulatory developments;

 

  n  

the public’s reaction to our press releases, public disclosures, our other public announcements and our filings with the SEC;

 

  n  

changes in accounting standards, policies, guidance, interpretations or principles;

 

  n  

additions or departures of our senior management personnel;

 

  n  

sales, or anticipated sales, of our common stock by our existing investors, directors and executive officers;

 

  n  

adverse market reaction to any indebtedness we may incur or securities we may issue in the future;

 

  n  

actions by shareholders;

 

  n  

issuance of new or changed securities or industry analysts’ reports or recommendations;

 

  n  

litigation or governmental investigations;

 

  n  

acquisitions or strategic alliances by us or our competitors; and

 

  n  

short sales, hedging and other derivative transactions in our common stock.

Our quarterly results of operations may fluctuate significantly because of several factors, including:

 

  n  

the timing of new store openings and related expense;

 

  n  

store operating costs for our newly-opened stores, which are often materially greater during the first several months of operation than thereafter;

 

  n  

labor availability and costs for hourly and management personnel;

 

  n  

profitability of our stores, especially in new markets;

 

  n  

changes in interest rates;

 

  n  

increases and decreases in AWS and comparable store sales;

 

  n  

impairment of long-lived assets and any loss on store closures;

 

  n  

macroeconomic conditions, both nationally and locally;

 

  n  

negative publicity relating to the consumption of products we serve;

 

  n  

changes in consumer preferences and competitive conditions locally and nationally;

 

  n  

expansion to new markets;

 

  n  

increases in infrastructure costs;

 

  n  

fluctuations in commodity prices;

 

  n  

the seasonality of our business; and

 

  n  

our new store openings have historically been fourth quarter focused and we believe that new store openings will continue to be weighted towards the fourth quarter.

These and other factors may cause the market price and demand for shares of our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of our common stock and may otherwise negatively affect the liquidity of our common stock. As a result of these factors, our quarterly and annual

 

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results of operations and comparable store sales may fluctuate significantly. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year and comparable store sales for any particular future period may decrease. In the future, our results of operations may fall below the expectations of securities analysts and investors. In that event, the price of our common stock would likely decrease. In the past, when the market price of a stock has been volatile, security holders have often instituted class action litigation against the company that issued the stock. If we become involved in this type of litigation, regardless of the outcome, we could incur substantial legal costs and our management’s attention could be diverted from the operation of our business, which could materially adversely affect our business, financial condition and results of operations.

Future sales of our common stock in the public market could cause the market price of our common stock to decrease significantly.

Sales of substantial amounts of our common stock in the public market following this offering by our existing shareholders, upon the exercise of outstanding stock options or stock options granted in the future or by persons who acquire shares in this offering may cause the market price of our common stock to decrease significantly. The perception that such sales could occur could also depress the market price of our common stock. Any such sales could also create public perception of difficulties or problems with our business and might also make it more difficult for us to raise capital through the sale of equity securities in the future at a time and price that we deem appropriate.

Upon the completion of this offering, we will have outstanding              shares of common stock, of which:

 

  n  

             shares are shares that we are selling in this offering and, unless purchased by affiliates, may be resold in the public market immediately after this offering; and

 

  n  

             shares will be “restricted securities,” as defined under Rule 144 under the Securities Act, and eligible for sale in the public market subject to the requirements of Rule 144, of which              shares are subject to lock-up agreements and will become available for resale in the public market beginning 180 days after the date of this prospectus and of which              will become available for resale in the public market immediately following this offering.

In addition, we have reserved              shares of common stock for issuance under our equity compensation plans. See “Executive and Director Compensation—2014 Equity Incentive Plan.” Upon consummation of this offering, we expect to have              shares of common stock issuable upon exercise of outstanding options (              of which will be fully vested).

With limited exceptions as described under the caption “Underwriting,” the lock-up agreements with the underwriters of this offering prohibit a stockholder from selling, contracting to sell or otherwise disposing of any common stock or securities that are convertible or exchangeable for common stock or entering into any arrangement that transfers the economic consequences of ownership of our common stock for at least 180 days from the date of the prospectus filed in connection with our initial public offering, although the lead underwriters may, in their sole discretion and at any time without notice, release all or any portion of the securities subject to these lock-up agreements. Upon a request to release any shares subject to a lock-up, the lead underwriters would consider the particular circumstances surrounding the request including, but not limited to, the length of time before the lock-up expires, the number of shares requested to be released, reasons for the request, the possible impact on the market for our common stock and whether the holder of our shares requesting the release is an officer, director or other affiliate of ours. As a result of these lock-up agreements, notwithstanding earlier eligibility for sale under the provisions of Rule 144, none of these shares may be sold until at least 180 days after the date of this prospectus. See “Shares Eligible for Future Sale” and “Underwriting.”

We have granted registration rights to Lee Equity and certain of our other stockholders. Should these stockholders exercise their registration rights under our stockholder agreement, the shares registered would no longer be restricted securities and would be freely tradable in the open market. See “Certain Relationships and Related Person Transactions—Agreements Related to the Acquisition by Lee Equity—Existing Stockholders’ Agreement and Registration Rights Provisions.”

 

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As restrictions on resale expire or as shares are registered, our share price could drop significantly if the holders of these restricted or newly registered shares sell them or are perceived by the market as intending to sell them. These sales might also make it more difficult for us to raise capital through the sale of equity securities in the future at a time and at a price that we deem appropriate.

In addition, immediately following this offering, we intend to file a registration statement registering under the Securities Act the shares of common stock reserved for issuance under our 2014 Plan. See the information under the heading “Shares Eligible for Future Sale” for a more detailed description of the shares that will be available for future sales upon completion of this offering.

We do not expect to pay any cash dividends on our common stock for the foreseeable future.

Because we do not expect to pay any cash dividends on our common stock for the foreseeable future, investors may be forced to sell their shares in order to realize a return on their investment, if any. We do not anticipate that we will pay any dividends to holders of our common stock for the foreseeable future. Any payment of cash dividends will be at the discretion of our board of directors and will depend on our financial condition, capital requirements, legal requirements, earnings and other factors. Our ability to pay dividends is restricted by the terms of new senior secured credit facilities and might be restricted by the terms of any indebtedness that we incur in the future. Consequently, you should not rely on dividends in order to receive a return on your investment. See “Dividend Policy.”

There is no existing market for our common stock and we do not know if one will develop to provide you with adequate liquidity.

Prior to this offering, there has not been a public market for our common stock. An active market for our common stock may not develop following the completion of this offering, or if it does develop, may not be maintained. If an active trading market does not develop, you may have difficulty selling any of our common stock that you buy. The initial public offering price for the shares of our common stock will be determined by negotiations between us and the representative of the underwriters and may not be indicative of prices that will prevail in the open market following this offering. Consequently, you may not be able to sell shares of our common stock at prices equal to or greater than the initial public offering price.

If securities analysts or industry analysts downgrade our shares, publish negative research or reports, or do not publish reports about our business, our share price and trading volume could decline.

The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us, our business and our industry. If one or more analysts adversely change their recommendation regarding our shares or our competitors’ stock, our share price would likely decline. If one or more analysts cease coverage of us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our share price or trading volume to decline. As a result, the market price for our common stock may decline below the initial public offering price and you may not resell your shares of our common stock at or above the initial public offering price.

You will suffer immediate and substantial dilution.

The initial public offering price per share is substantially higher than the pro forma net tangible book value per share immediately after this offering. As a result, you will pay a price per share that substantially exceeds the net tangible book value of our assets after subtracting the book value of our liabilities. Based on our pro forma net tangible book value as of December 30, 2013 and assuming an offering price of $         per share, the midpoint of the range set forth on the cover page of this prospectus, you will incur immediate and substantial dilution in the amount of $         per share. See “Dilution.”

 

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FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact or relating to present facts or current conditions included in this prospectus 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. 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 prospectus 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 prospectus, 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 “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” 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 the performance projected in these forward-looking statements.

Any forward-looking statement made by us in this prospectus 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.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from our sale of              shares of common stock in this offering will be approximately $         million, after deducting estimated underwriting discounts and commissions and estimated expenses payable by us in connection with this offering. The underwriters may also purchase up to a maximum of              additional shares of common stock from the selling stockholders named in this prospectus to cover over- allotments. We estimate that the net proceeds to us, if the underwriters exercise their right to purchase the maximum of              additional shares of common stock from the selling stockholders, will be approximately $         million, after deducting estimated underwriting discounts and commissions and estimated expenses payable by us in connection with this offering. This assumes a public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus.

We intend to use net proceeds from this offering to repay $         million in aggregate principal amount of indebtedness under our new senior secured credit facilities, to pay a $1.5 million termination fee associated with our advisory services and monitoring agreement with Lee Equity and to use the remainder for general corporate purposes. Our new senior secured credit facilities bear interest at a variable interest rate of LIBOR plus 5.75%, as calculated pursuant to the agreement governing our new senior secured credit facilities, and mature on October 25, 2018. See “Description of Material Indebtedness—Credit Facility.” We entered into the new senior secured credit facilities in October 2013 and used the proceeds to repay our then existing credit facilities, to make a $31.5 million payment to holders of our Preferred Shares and to fund investments.

We will not receive any proceeds from the sale of shares by the selling stockholders, which include entities affiliated with members of our Board and certain of our executive officers.

Assuming no exercise of the underwriters’ option to purchase additional shares, a $1.00 increase (decrease) in the assumed initial public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) the net proceeds to us from this offering by $         million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated expenses payable by us in connection with this offering.

 

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DIVIDEND POLICY

In October 2013, we entered into the new senior secured credit facilities, the proceeds, in part of which were used to make a $31.5 million payment to holders of our Preferred Shares. In addition, on June 12, 2012, we made a $36.1 million payment to holders of our Preferred Shares. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Our History and Operations.” We have not declared or paid cash dividends on our common stock. We do not intend to pay cash dividends on our common stock in the foreseeable future. See “Risk Factors—Risks Related to this Offering Structure—We do not expect to pay any cash dividends on our common stock for the foreseeable future.” However, in the future, subject to the factors described below and our future liquidity and capitalization, we may change this policy and choose to pay dividends.

We are a holding company that does not conduct any business operations of our own. As a result our ability to pay cash dividends on our common stock is dependent upon cash dividends and distributions and other transfers from our subsidiaries. The ability of our subsidiaries to pay dividends is currently restricted by the terms of the new senior secured credit facilities and may be further restricted by any future indebtedness we or they incur. In addition, under Delaware law, our Board may declare dividends only to the extent of our surplus (which is defined as total assets at fair market value minus total liabilities, minus statutory capital) or, if there is no surplus, out of our net profits for the then current and/or immediately preceding fiscal year.

Any future determination to pay dividends will be at the discretion of our Board and will take into account:

 

  n  

restrictions in our debt instruments, including restrictions in our new senior secured credit facilities on our ability to pay dividends on our equity interests or redeem, repurchase or retire our equity interests;

 

  n  

general economic business conditions;

 

  n  

our net income (loss), financial condition and results of operations;

 

  n  

our capital requirements;

 

  n  

our prospects;

 

  n  

the ability of our operating subsidiaries to pay dividends and make distributions to us;

 

  n  

legal restrictions; and

 

  n  

such other factors as our Board may deem relevant.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and our capitalization, as of December 30, 2013:

 

  n  

on an actual basis;

 

  n  

on a pro forma basis to give effect to (i) the Reorganization Transactions, including the automatic conversion of our Preferred Shares to shares of our common stock and a 1 for                    stock split of our common stock prior to the consummation of this offering and (ii) the Share Repurchase; and

 

  n  

on a pro forma as adjusted basis to give effect to the aforementioned transactions and to give further effect to the sale of                  shares of our common stock in this offering, assuming no exercise of the underwriters’ option to purchase additional shares, at an assumed initial offering price of $          per share, the midpoint of the price range set forth on the cover page of this prospectus, after deducting estimated underwriting discounts and commissions and estimated expenses payable by us, the application of the net proceeds received by us from this offering, including the repayment of certain indebtedness and payment of fees associated with the termination of our advisory services and monitoring agreement with Lee Equity, as described under “Use of Proceeds”.

This table should be read in conjunction with “Use of Proceeds,” “Selected Consolidated Financial and Other Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, “Description of Capital Stock” and our financial statements and notes thereto included elsewhere in this prospectus.

 

 

 

    AS OF DECEMBER 30, 2013  
    ACTUAL     PRO FORMA     PRO FORMA
AS ADJUSTED  (1)
 
    (in thousands)  

Cash and cash equivalents

  $ 3,705      $                   $                
 

 

 

   

 

 

   

 

 

 

Liabilities:

     

Total long-term debt, including current portion (2)

  $ 170,000      $        $     
 

 

 

   

 

 

   

 

 

 

Stockholders’ equity:

     

Papa Murphy’s Holdings Inc. shareholders’ equity

     

Common Stock, $0.01 par value; 3,000,000 shares authorized and 1,921,337 shares issued and outstanding on an actual basis;                  shares authorized and                  shares issued and outstanding on a pro forma basis; and                  shares authorized and                  shares issued and outstanding on a pro forma as adjusted basis

  $ 19       

Series A, 6% cumulative redeemable, 20% participating preferred stock, $0.01 par value; 3,000,000 shares authorized and 2,853,809 issued and outstanding on an actual basis; no shares authorized on a pro forma and pro forma as adjusted basis

    60,156       

Series B, 6% cumulative redeemable, 20% participating preferred stock, $0.01 par value; 1,000,000 shares authorized and 26,551 shares issued and outstanding on an actual basis; no shares authorized on a pro forma and pro forma as adjusted basis

    741       

Preferred Stock, $0.01 par value, no shares authorized on an actual basis; no shares authorized and no shares issued and outstanding on a pro forma and pro forma as adjusted basis

          

Additional paid-in capital

    1,579       

Stock subscription receivable

    (1,197    

Accumulated deficit

    (27,373    

Accumulated other comprehensive income (loss)

          
 

 

 

     

Total Papa Murphy’s Holdings Inc. shareholders’ equity

    33,925       

Noncontrolling interests

    222       
 

 

 

   

 

 

   

 

 

 

Total equity

    34,147      $        $     
 

 

 

   

 

 

   

 

 

 

Total capitalization

  $ 207,852      $        $     
 

 

 

   

 

 

   

 

 

 

 

 

(1)  

Assuming the number of shares sold by us in this offering remains the same, a $1.00 increase or decrease in the assumed initial public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus, would increase or decrease our total capitalization by $         million.

(2)  

Does not include $10.0 million of availability under our revolving credit facility as of December 30, 2013.

 

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DILUTION

If you invest in our common stock, your interest will be diluted to the extent of the difference between the initial public offering price per share of our common stock and the net tangible book value per share of our common stock after the Reorganization Transactions and this offering. Dilution results from the fact that the per share offering price of our common stock is in excess of the net tangible book value per share attributable to new investors.

Our pro forma net tangible book value as of December 30, 2013 was $        , or $         per share of common stock. Pro forma net tangible book value represents the amount of total tangible assets less total liabilities, and net tangible book value per share represents net tangible book value divided by the number of shares of common stock outstanding, in each case, after giving effect to the Reorganization Transactions and the Share Repurchase but not this offering.

After giving effect to (i) the sale of                  shares of common stock in this offering at the assumed initial public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus, and (ii) the application of the net proceeds from this offering, our pro forma as adjusted net tangible book value as of December 30, 2013 would have been $         million, or $         per share. This represents an immediate increase in pro forma net tangible book value of $         per share to our existing investors and an immediate dilution in pro forma net tangible book value of $         per share to new investors.

The following table illustrates this dilution on a per share of common stock basis:

 

 

 

Assumed initial public offering price per share of common stock

      $                        

Pro forma net tangible book value per share as of December 30, 2013 before this offering

     

Increase in net tangible book value per share attributable to new investors

     

Pro forma as adjusted net tangible book value per share after this offering

     
  

 

  

 

 

 

Dilution in net tangible book value per share to new investors

      $     
  

 

  

 

 

 

 

 

Each $1.00 increase (decrease) in the assumed initial public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) our pro forma as adjusted net tangible book value by $         million, the pro forma as adjusted net tangible book value per share after this offering by $         and the dilution per share to new investors by $         assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same.

If the underwriters were to fully exercise their option to purchase additional share of our common stock, the pro forma as adjusted net tangible book value per share after this offering would be $         per share, and the dilution in pro forma in net tangible book value per share to new investors in this offering would be $         per share.

The following table summarizes, on a pro forma basis as of December 30, 2013 after giving effect to the Reorganization Transactions, the Share Repurchase and this offering, the total number of shares of common stock purchased from us, the total cash consideration paid to us, or to be paid, and the average price per share paid, or to be paid, by our existing investors and by new investors purchasing shares in this offering, at an assumed initial public offering price of $         per share, which is the midpoint of the range set forth on the cover page of this prospectus, before deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us:

 

 

 

     SHARES PURCHASED     TOTAL CONSIDERATION     AVERAGE PRICE PER
SHARE
 
       NUMBER    PERCENT     AMOUNT      PERCENT    

Existing stockholders

                   $                                 $                

New investors

            
  

 

  

 

 

   

 

 

    

 

 

   

 

 

 

Total

        100   $           100   $     
     

 

 

      

 

 

   

 

 

 

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If the underwriters were to fully exercise their option to purchase                  additional shares of our common stock, the percentage of shares of our common stock held by existing investors would be     %, and the percentage of shares of our common stock held by new investors would be     %.

The above discussion and tables are based on the number of shares outstanding at December 30, 2013 on a pro forma basis and excludes                  shares of our common stock issued under our 2014 Plan or              reserved for future awards under our equity incentive plans. In addition, we may choose to raise additional capital due to market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operating plans. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities could result in further dilution to our stockholders.

 

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UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION

The following unaudited pro forma condensed combined statement of operations for the fiscal years ended December 30, 2013 is based on the historical audited consolidated financial statements of Papa Murphy’s Holdings, Inc. (the “Company”). The unaudited pro forma condensed combined statement of operations gives effect to transactions as if they had occurred as of January 1, 2013.

The unaudited pro forma condensed combined financial information gives pro forma effect to the following transactions:

 

  n  

The 2013 Store Acquisitions:

 

   

KK Great Pizza acquisition: Acquisition of four franchise stores in Minnesota and Wisconsin from a franchise owner completed on November 4, 2013;

 

   

TBD Business Group acquisition: Acquisition of four stores in Idaho from a franchise owner completed on December 16, 2013;

 

  n  

The Recapitalization: Repayment of the 2012 Credit Facilities in full and payment of $31.5 million to the holders of our Preferred Shares, using proceeds from our new senior secured credit facilities, entered into on October 25, 2013 and described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Recapitalization,” “Description of Material Indebtedness” and in the accompanying notes to the unaudited pro forma condensed combined balance sheet.

As a result of the transactions described above, pro forma adjustments were made to our historical results of operations to reflect:

 

  n  

Changes in depreciation and amortization expense resulting from preliminary estimates of fair value adjustments to net tangible assets and amortizable intangible assets of the acquired businesses;

 

  n  

The changes to our debt and shareholders’ equity resulting from the transactions;

 

  n  

Transaction fees and debt issuance costs incurred as a result of the transactions described above;

 

  n  

The changes in interest expense resulting from the transactions described above; and

 

  n  

The effect of the above adjustments on income tax expense.

The 2013 Store Acquisitions were accounted for as business combinations using the acquisition method of accounting, which established a new basis of accounting for all assets acquired and liabilities assumed at fair value. The unaudited pro forma adjustments are based upon currently available information and certain assumptions that are factually supportable and that we believe are reasonable under the circumstances. For acquisitions that have been reflected in our audited financial statements and for which the measurement period has closed, the adjustments reflect our actual acquisition method accounting. The excess purchase consideration over the fair value of the net assets acquired is recorded as goodwill.

The unaudited pro forma condensed combined financial information is presented for informational purposes only and does not purport to present what our actual consolidated results of operations would have been had the transactions occurred on the dates indicated, nor are they necessarily indicative of future results of operations. Historical results are not necessarily indicative of results that may be expected for any future period. The unaudited pro forma condensed combined financial information should be read in conjunction with “Summary—Summary Historical Consolidated Financial and Other Data,” “Risk Factors,” “Use of Proceeds,” “Capitalization,” “Selected Consolidated Financial and Other Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s audited consolidated financial statements and the related notes included elsewhere in this prospectus.

Assumptions underlying the pro forma adjustments are described in the accompanying notes, which should be read in conjunction with the unaudited pro forma condensed combined financial information.

 

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PAPA MURPHY’S HOLDINGS, INC.

UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS

FOR THE FISCAL YEAR ENDED DECEMBER 30, 2013

(dollars in thousands, except share and per share data)

 

 

 

    HISTORICAL
COMPANY  (1)
    HISTORICAL
KK GREAT
PIZZA  (2)
    HISTORICAL
TBD
BUSINESS
GROUP  (3)
    ACQUISITION
ACCOUNTING
ADJUSTMENTS  (4)
    RECAPITALIZATION  (5)     PRO FORMA  

REVENUES

           

Franchise royalties

  $ 36,897      $      $      $ (336 ) (a)     $      $ 36,561   

Franchise and development fees

    4,330                                    4,330   

Company-owned store sales

    39,148        2,471        4,242                      45,861   

Lease income

    120                                    120   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    80,495        2,471        4,242        (336            86,872   

COSTS AND EXPENSES

           

Store operating costs (exclusive of depreciation and amortization shown separately below):

           

Cost of food and packaging

    14,700        811        1,603                      17,114   

Compensation and benefits

    10,687        582        837                      12,106   

Advertising

    3,820        164        332                      4,316   

Occupancy

    2,365        171        229                      2,765   

Other store operating costs

    3,988        267        331        (336 ) (a)              4,250   

Selling, general, and administrative

    24,180        160        106                      24,446   

Depreciation and amortization

    6,973        32        115        666 (b)              7,786   

Loss on disposal or impairment of property and equipment

    847                                    847   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

    67,560        2,187        3,553        330               73,630   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    12,935        284        689        (666            13,242   

Interest expense

    10,523               14        601 (c)       1,251 (a)       12,389   

Interest income

    (94                                 (94

Loss on early retirement of debt

    4,029                                    4,029   

Other expense, net

    44                                    44   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    (1,567     284        675        (1,267     (1,251     (3,126

Provision (benefit) for income taxes

    1,024                      (115 ) (d)       (469 ) (b)       440   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    (2,591     284        675        (1,152     (782     (3,566

Net loss attributable to noncontrolling interests

    19                                    19   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to Papa Murphy’s

  $ (2,572   $ 284      $ 675      $ (1,152   $ (782   $ (3,547
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss per share of common stock

           

Basic (6)

  $ (5.29           $ (5.86

Diluted (6)

  $ (5.29           $ (5.86

Weighted-average common stock outstanding

           

Basic (6)

    1,700,360                1,700,360   

Diluted (6)

    1,700,360                1,700,360   

 

 

See the accompanying notes to the unaudited pro forma condensed combined statement of operations.

 

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NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS

(1) Historical Company

Represents audited consolidated statement of operations of the Company, which includes historical results of operations of KK Great Pizza and TBD Business Group from the 2013 Store Acquisitions.

(2) Historical KK Great Pizza

Represents historical statements of operations of KK Great Pizza for the period prior to the acquisition on November 4, 2013. This information should be read in conjunction with the historical financial statements of KK Great Pizza, included elsewhere in this prospectus. The KK Great Pizza acquisition was consummated on November 4, 2013 and results of operations subsequent to the acquisition are reflected in the Company’s historical statements of operations.

(3) Historical TBD Business Group

Represents historical carve-out statements of operations of TBD Business Group for the period prior to the acquisition on December 16, 2013. This information should be read in conjunction with the carve-out historical financial statements of TBD Business Group, included elsewhere in this prospectus. The TBD Business Group acquisition was consummated on December 16, 2013 and results of operations subsequent to the acquisition date are reflected in the Company’s historical statements of operations.

(4) Acquisition Accounting Adjustments

The following adjustments relate to the acquisition accounting effects of the 2013 Store Acquisitions:

 

(a) KK Great Pizza and TBD Business Group were franchise owners of the Company prior to the acquisitions. The adjustment reflects the elimination of franchise royalty revenue of the Company and franchise royalty expense of KK Great Pizza and TBD Business Group as follows (in thousands):

 

 

 

     KK GREAT PIZZA    TBD BUSINESS
GROUP
   TOTAL

Franchise royalty revenue (Company)

     $ 124        $ 212        $ 336  

Franchise royalty expense (Acquirees)

     $ 124        $ 212        $ 336  

 

 

 

(b) Reflects additional depreciation of property and equipment and amortization of definite-life intangibles (reacquired franchise rights) resulting from the preliminary acquisition accounting related to KK Great Pizza and TBD Business Group acquisitions as follows (in thousands):

 

 

 

     KK GREAT PIZZA      TBD BUSINESS
GROUP
     TOTAL  

Depreciation

   $ 52       $ 7       $ 59   

Amortization

     216         391         607   
  

 

 

    

 

 

    

 

 

 

Total

   $ 268       $ 398       $ 666   
  

 

 

    

 

 

    

 

 

 

 

 

 

(c) Reflects additional interest expense related to notes issued in principal amount of $3.0 million as part of the purchase consideration of TBD Business Group and borrowings under our new senior secured credit facilities in principal amount of $6.4 million to fund the 2013 Store Acquisitions.

 

(d)

Reflects the estimated tax effects resulting from the pro forma adjustments related to the 2013 Store Acquisitions at the Company’s estimated statutory tax rate of 37.5%. Additionally, this adjustment reflects the

 

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  pre-acquisition period tax effects of the historical results of operations of KK Great Pizza ($107,000) and TBD Business Group ($253,000) at the Company’s estimated statutory tax rate of 37.5%, as these businesses were non-taxable entities prior to their respective acquisitions by the Company.

(5) Recapitalization

The following adjustments relate to the Company’s Recapitalization transaction:

 

(a) Reflects the interest expense under our new term loan facility, fees on the undrawn amount under our new revolving credit facility, and the amortization of deferred financing costs, less historical interest expense in connection with fully repaid 2012 Credit Facilities. In addition, reflects annual administrative agent fees related to our new senior secured credit facilities. Interest expense does not include the amount relating to the portion of borrowings under our new term loan facility incurred to finance the 2013 Store Acquisitions, which is already reflected in the “Acquisition Accounting Adjustments” column.

We currently have a new term loan of $167.0 million outstanding and no borrowings outstanding under our revolving credit facility at the date of the consummation of the 2013 Store Acquisitions and the Recapitalization. Each 0.125% change in interest rates on our new term loan facility above our LIBOR floor would result in approximately $209,000 change in pro forma interest expense for the fiscal years ended December 30, 2013.

 

(b) Reflects the estimated tax effects resulting from the pro forma adjustments related to the Recapitalization at the Company’s estimated statutory tax rate of 37.5%.

(6) Earnings Per Share

The unaudited pro forma condensed combined basic and diluted loss per share calculations are based on historical basic and diluted weighted-average shares of common stock. Pro forma basic and diluted loss per share was calculated by dividing pro forma net loss available to common stockholders by the historical basic and diluted weighted-average shares of common stock.

 

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SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

We derived the selected consolidated statements of operations and cash flows data for fiscal years ended 2013, 2012 and 2011 and the selected consolidated balance sheet data as of December 30, 2013 and December 31, 2012 from our audited consolidated financial statements and related notes thereto included elsewhere in this prospectus. We derived the selected consolidated balance sheet data as of January 2, 2012 from our audited consolidated financial statements and related notes thereto not included in this prospectus. The selected consolidated statements of operations and cash flows data for the period from December 29, 2009 through May 4, 2010 and the period from March 29, 2010 through January 3, 2011 and the selected consolidated balance sheet data as of May 4, 2010 and January 3, 2011 have been derived from our unaudited consolidated financial information, which are not included in this prospectus. The selected consolidated statements of operations and cash flows data for the fiscal year ended December 28, 2009 and the selected consolidated balance sheet data as of December 28, 2009 have been derived from the Predecessor’s audited consolidated financial information, not included in this prospectus. We have prepared the unaudited consolidated financial information set forth below on the same basis as our audited consolidated financial statements and have included all adjustments, consisting of only normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for such periods. The results for any interim period are not necessarily indicative of the results that may be expected for a full year.

On May 4, 2010, affiliates of Lee Equity acquired a majority of the capital stock of PMI Holdings Inc., our predecessor. The periods on or prior to May 4, 2010 are referred to as “Predecessor.” Papa Murphy’s Holdings, Inc. was incorporated on March 29, 2010 by affiliates of Lee Equity in connection with the acquisition, and all periods including and after such date are referred to as “Successor.” From March 29, 2010 to May 4, 2010, the date of the acquisition, Papa Murphy’s Holdings, Inc. had no activities other than the incurrence of transaction costs related to the acquisition. The selected historical consolidated financial statements for all Successor periods may not be comparable to those of the Predecessor period.

Our historical results are not necessarily indicative of future operating results. You should read the information set forth below together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Capitalization” and our financial statements and the related notes thereto included elsewhere in this prospectus.

 

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    SUCCESSOR     PREDECESSOR  
    FISCAL YEAR     MARCH 29,
2010 (DATE
OF
INCEPTION)
THROUGH

JANUARY 3,
2011
    DECEMBER 29,
2009

THROUGH
MAY 4, 2010
    FISCAL YEAR
ENDED

DECEMBER  28,
2009
 
    2013     2012     2011        
    (dollars in thousands, except share and selected operating data, unless otherwise noted)  

Consolidated statement of operations data:

             

Revenues

             

Franchise royalties

  $ 36,897      $ 35,113      $ 33,687      $ 20,482      $ 11,196      $ 30,358   

Franchise and development fees

    4,330        2,826        2,398        2,029        625        2,433   

Company-owned store sales

    39,148        28,813        15,619        9,223        5,044        20,866   

Lease income

    120        164        218        152        128        436   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    80,495        66,916        51,922        31,886        16,993        54,093   

Costs and expenses

             

Store operating costs:

             

Cost of food and packaging

    14,700        10,741        6,088        3,476        1,844        7,455   

Compensation and benefits

    10,687        8,160        4,710        2,972        1,545        6,912   

Advertising

    3,820        2,711        1,514        922        499        2,165   

Occupancy

    2,365        1,980        1,102        863        368        2,425   

Other store operating costs

    3,988        2,961        1,722        1,033        573        1,542   

Selling, general and administrative

    24,180        21,225        20,833        13,929        10,002        19,000   

Depreciation and amortization

    6,973        6,187        5,798        3,590        1,485        4,878   

Loss on disposal or impairment of property and equipment

    847        193        263        119        132        948   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

    67,560        54,158        42,030        26,904        16,448        45,325   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    12,935        12,758        9,892        4,982        545        8,768   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

    10,523        10,462        10,410        7,372        806        1,115   

Interest income

    (94     (94     (183     (180     (79     (127

Loss (gain) on early retirement of debt

    4,029        5,138                      874        (95

Other expense, net

    44        248        41        2        1        (26
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    (1,567     (2,996     (376     (2,212     (1,057     7,901   

Provision (benefit) for income taxes

    1,024        (882     230        (382     169        3,352   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    (2,591     (2,114     (606     (1,830     (1,226     4,549   

Net loss attributable to noncontrolling interests

    19                                    751   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to Papa Murphy’s

  $ (2,572   $ (2,114   $ (606   $ (1,830   $ (1,226   $ 5,300   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

 

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    SUCCESSOR     PREDECESSOR  
    FISCAL YEAR     MARCH 29,
2010 (DATE
OF
INCEPTION)
THROUGH

JANUARY 3,
2011
    DECEMBER 29,
2009

THROUGH
MAY 4, 2010
    FISCAL YEAR
ENDED

DECEMBER  28,
2009
 
    2013     2012     2011        
    (dollars in thousands, except share, per share and selected operating data, unless otherwise noted)  

Loss per common share:

             

Basic

  $ (5.29   $ (5.28   $ (4.52        

Diluted

    (5.29     (5.28     (4.52        

Weighted average of common shares outstanding:

    1,700,360        1,623,171        1,591,262           

Basic

    1,700,360        1,623,171        1,591,262           

Diluted

             

Consolidated statement of cash flows:

             

Cash flows from operating activities

  $ 9,874      $ 9,356      $ 11,804      $ 5,591      $ 3,785      $ 12,051   

Cash flows from investing activities

    (15,249     (5,904     (16,062     (2,029     16        (1,640

Cash flows from financing activities

    6,613        (5,864     (2,563     (8,376     (4,554     (9,789

Other Financial Data:

             

Adjusted EBITDA (1)

  $ 24,421      $ 22,126      $ 19,740      $ 12,836      $ 6,690      $ 16,550   

Net working capital (2)

    (1,588     (5,003     (1,973     (541     (8,919     (8,119

Capital expenditures (3)

    3,037        1,343        2,193        2,396        274        1,587   

Selected Operating Data:

             

Number of stores at end of period

             

Domestic franchise

    1,327        1,270        1,232        1,208        1,149        1,136   

Domestic company-owned

    69        59        51        33        32        35   

International

    22        18        18        16        14        14   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    1,418        1,347        1,301        1,257        1,195        1,185   

Number of comparable stores at end of period (4)

             

Domestic franchise

    1,226        1,194        1,164        1,116        1,073        1,051   

Domestic company-owned

    68        57        50        33        32        35   

International

    17        15        16        14        11        9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    1,311        1,266        1,230        1,163        1,116        1,095   

AWS per store (whole dollars) (5)

  $ 11,099      $ 10,923      $ 10,640      $ 9,912      $ 10,811      $ 10,615   

Comparable store sales growth  (6)

    2.8     2.9     5.7     (3.3 )%      (2.4 )%      2.2

System-wide sales (7)

  $ 785,630      $ 739,091      $ 701,770      $ 422,979      $ 230,277      $ 630,449   

System-wide sales growth  (8)

    6.3     5.3     7.4     4.7     1.8     7.8

 

 

 

 

 

    SUCCESSOR     PREDECESSOR  
    AS OF     AS OF  
    DECEMBER 30,
2013
    DECEMBER 31,
2012
    JANUARY 2,
2012
    JANUARY 3,
2011
    MAY 4,
2010
    DECEMBER 28,
2009
 
    (dollars in thousands)  

Consolidated balance sheet data:

             

Cash and cash equivalents

  $ 3,705      $ 2,428      $ 4,839      $ 4,729      $ 1,644      $ 2,391   

Total current assets

    16,377        7,565        9,498        17,012        5,415        6,301   

Total current liabilities

    17,965        12,568        11,471        17,552        14,334        14,420   

Total debt (9)

    170,000        125,280        90,226        92,598        30,700        35,083   

Total assets

    264,502        246,617        248,386        253,931        64,730        68,143   

Total shareholders’ equity

    33,925        63,930        100,208        103,338        16,618        17,816   

 

 

 

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(1)  

Adjusted EBITDA is calculated as net income (loss) before interest expense, income taxes, depreciation and amortization as adjusted for:

 

  n  

all non-cash losses or expenses (including, but not limited to 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;

 

  n  

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

 

  n  

fees, costs and expenses related to acquisitions and debt refinancing costs;

 

  n  

pre-opening costs with respect to a new store;

 

  n  

management fees and expenses incurred under our advisory services and monitoring agreement with Lee Equity;

 

  n  

fees and expenses incurred in connection with the issuance of debt under the new senior secured credit facilities and related transactions; and

 

  n  

non-cash expenses resulting from purchase accounting adjustments made in accordance with GAAP with respect to acquisitions.

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 income (loss), as determined by U.S. generally accepted accounting principles, or 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 such financial measure, when viewed with our results of operations in accordance with GAAP and our reconciliation of Adjusted EBITDA to net income (loss), 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:

 

  n  

as a measurement used in comparing our operating performance on a consistent basis;

 

  n  

to calculate incentive compensation for our employees;

 

  n  

for planning purposes, including the preparation of our internal annual operating budget;

 

  n  

to evaluate the performance and effectiveness of our operational strategies; and

 

  n  

to assess compliance with various metrics associated with our new senior secured credit facilities.

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:

 

  n  

Adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;

 

  n  

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

 

  n  

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 income (loss) to Adjusted EBITDA for the periods presented:

 

 

 

    SUCCESSOR   PREDECESSOR  
    FISCAL YEAR     MARCH 29,
2010 (DATE
OF INCEPTION
THROUGH)

JANUARY 3,
2011
          DECEMBER 29,
2009

THROUGH
MAY  4, 2010
    FISCAL YEAR
ENDED

DECEMBER 28,
2009
 
    2013     2012     2011          
    (dollars in thousands)  

Net income (loss)

  $ (2,591   $ (2,114   $ (606   $ (1,830       $ (1,226   $ 4,549   

Depreciation and amortization

    6,973        6,187        5,798        3,590            1,485        4,878   

Income tax provision (benefit)

    1,024        (882     230        (382         169        3,352   

Interest expense, net

    10,429        10,368        10,227        7,192            727        988   
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

   

 

 

 

EBITDA

    15,835        13,559        15,649        8,570            1,155        13,767   

(Gain) loss on settlement of liabilities (a)

    3,943        5,138        (58     (33         864        (534

Loss on disposal or impairment of property and equipment (b)

    847        193        263        119            132        948   

Management transition and restructuring costs  (c)

    587        490        1,783                          1,055   

Expense not indicative of future operations  (d)

    1,293        967                                 343   

Management fees and related expenses  (e)

    586        537        797        329            53        129   

Transaction costs (f)

    402        24        59        3,813            4,523          

Loss from non-controlling interests (g)

                                           409   

New store pre-opening expenses (h)

    19        52        12                          45   

Non-cash expenses and non-income based state taxes  (i)

    909        1,166        1,235        38            (37     388   
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

   

 

 

 

Adjusted EBITDA

  $ 24,421      $ 22,126      $ 19,740      $ 12,836          $ 6,690      $ 16,550   
 

 

 

   

 

 

   

 

 

   

 

 

       

 

 

   

 

 

 

 

 

  (a)  

Represents (gains) losses resulting from refinancing of long-term debt and settlement of asset retirement obligations.

  (b)  

Represents non-cash losses resulting from disposal or impairment of property and equipment, including divested company stores.

  (c)  

Represents non-recurring management transition and restructuring costs, consisting of severance, retention, recruitment, relocation and other costs in connection with restructuring of our corporate development function and transition of certain members of management.

  (d)  

Represents (i) non-recurring losses on guaranteed lease payments for company stores acquired by franchise owners; (ii) non-recurring roll-out costs of new uniform program; (iii) a one-time valuation allowance of an international notes receivable resulting from the sale of company-owned stores; and (iv) non-recurring advisory expenses in connection with this offering.

  (e)  

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. See “Certain Relationships and Related Person Transactions—Advisory Services and Monitoring Agreement.”

  (f)  

Represents transaction costs relating to our acquisition by Lee Equity in 2010 and acquisitions and divestitures.

  (g)  

Represents losses attributable to non-controlling interests.

  (h)  

Represents expenses directly associated with the opening of new stores and incurred prior to the opening of new stores, including wages, benefits, travel for the training of opening teams and other store operating costs.

  (i)  

Represents (i) non-cash expenses related to equity-based compensation; (ii) non-cash expenses related to the difference between GAAP and cash rent expense; (iii) non-cash expenses related to the fair valuation of certain common stock and Series A Preferred Stock subject to put options; and (iv) non-income based state taxes.

(2)  

Represents current assets less current liabilities.

(3)  

Represents long-lived asset capital expenditures related to the acquisition of property and equipment and excludes expenditures relating to acquisitions of businesses.

(4)  

A comparable store is a store that has been open for at least 52 weeks from the comparable date, which is the Tuesday following the opening date.

(5)  

AWS consists of the average weekly sales of franchise and company-owned stores over a specified period of time. AWS is calculated by dividing the total net sales of our system-wide stores for the relevant time period by the number of weeks these same stores were open in such time period.

(6)  

System-wide comparable store sales growth represents year-over-year sales comparisons for comparable stores.

(7)  

System-wide sales include net sales by all of our system-wide stores.

(8)  

System-wide sales growth represents year-over-year sales comparisons for system-wide sales.

(9)  

Represents total outstanding indebtedness, including current portion.

 

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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 “Selected Consolidated Financial and Other Data” and our consolidated financial statements and related notes appearing elsewhere in this prospectus. 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 “Forward-Looking Statements,” “Risk Factors” and elsewhere in this prospectus.

To match our operating cycle, we use a 52- or 53-week fiscal year, ending on the Monday nearest to December 31. Fiscal years 2013, 2012 and 2011 were 52-week periods ending on December 30, 2013, December 31, 2012 and January 2, 2012, respectively.

Overview

Papa Murphy’s is a high-growth franchisor and operator of the largest Take ‘N’ Bake pizza chain in the United States. We were founded in 1981 and have grown our footprint to a total of 1,418 system-wide stores as of December 30, 2013, more than 20 times the stores of our nearest Take ‘N’ Bake pizza restaurant competitor. The Papa Murphy’s experience is different from traditional pizza restaurants. Our customers:

 

  n  

CREATE their fresh customized pizza with high-quality ingredients in our stores or online;

 

  n  

TAKE their fresh pizza home; and

 

  n  

BAKE their pizza fresh in their ovens, at their convenience, for a home-cooked meal served hot.

We have been repeatedly rated the #1 pizza chain in the United States by multiple third-party consumer studies. In 2013, 2012 and 2011, we were rated the #1 pizza chain overall by Nation’s Restaurant New s , and in 2012, 2011 and 2010, we were rated the #1 pizza chain by Zagat . Compared to broader restaurant chain competition, we were also recognized by Technomic in 2013 as the #1 chain overall among all restaurants and all food categories, by Nation’s Restaurant News in 2013 and 2012 as one of the Top 5 Overall limited service restaurant chains across all food categories, and by Zagat in 2012 as one of the Top 5 Overall fast food chains across all food categories.

Our History and Operations

Our history dates back over 30 years and has its roots in Papa Aldo’s Pizza, founded in 1981 in Hillsboro, Oregon and Murphy’s Pizza, founded in 1984 in Petaluma, California. Murphy’s Pizza and Papa Aldo’s were merged into a single entity under the Papa Murphy’s brand in 1995. In 2007, the 1,000th Papa Murphy’s system-wide store opened.

In May 2010, affiliates of Lee Equity acquired all of the equity interests of our parent, PMI Holdings, Inc. Papa Murphy’s Holdings, Inc. was established as a holding company for PMI Holdings, Inc. and its subsidiaries. Under the leadership of our current Chief Executive Officer, we implemented several strategic initiatives, including restructuring our new store development, operations, marketing and finance teams. We rolled out our Focus 5 menu strategy that offers price points ranging the value spectrum in order to increase store traffic and sales through high-quality new product offerings and promotions such as our FAVES and Fresh Pan Pizza offerings, and we introduced online ordering in select markets. We are also in the early stages of testing a store remodel program providing for a more contemporary store format.

Following the Lee Equity acquisition, we also expanded and invested in our senior management team and refinanced our then existing credit facility. In June 2011, we hired Ken Calwell, an industry veteran with extensive experience in the limited service restaurants and pizza restaurants businesses, as our President. In December 2011, Mr. Calwell transitioned into the role of Chief Executive Officer with our prior Chief Executive Officer, John Barr, remaining as

 

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Chairman of the Company. In 2013, we began the process of transitioning our Chief Financial Officer and we hired our current Chief Financial Officer, Mark Hutchens, in January 2014.

As of December 30, 2013, we had 1,396 stores in the United States and believe there are significant domestic growth opportunities. We expect the majority of our expansion will result from new franchise store openings, and we also plan to strategically expand our company-owned store base in select markets. Our domestic and international franchise owners opened 98 stores in 2013. Recently, we have also expanded our international presence. We currently have a 10-year master franchise agreement in Canada, with 18 stores open as of December 30, 2013. In addition, in August 2012 we entered into a 20-year master franchise agreement with Saudi Arabia-based MAM FoodCo LLC to open up to 100 franchise stores in the Middle East, specifically in the United Arab Emirates, Oman, Kuwait, Kingdom of Saudi Arabia, Qatar and Bahrain, with four stores open as of December 30, 2013.

From time to time, we also pursue opportunistic acquisitions of stores from franchise owners. We evaluate these acquisition opportunities on a case-by-case basis, taking into account the economic strength of the stores and the potential to further develop the related market. In 2012, we acquired six stores from franchise owners, and in 2013, we acquired 19 stores from franchise owners. In the fourth quarter of 2013 we acquired franchise stores in Colorado, Minnesota and Idaho for an aggregate purchase price of $9.9 million, paid in cash or a combination of cash and promissory notes. The cash portion of the purchase price for each of these acquisitions was funded through available cash and advances on our new senior secured credit facilities (described below), and the acquisitions are accounted for using the acquisition method of accounting. From time to time, we also may sell company-owned stores to franchise owners.

As part of the financing for the Lee Equity acquisition, certain of our subsidiaries entered into a senior secured credit agreement providing for a $73.6 million term loan and a $7.0 million revolving credit agreement and issued an $18.4 million senior subordinated note (collectively, the “2010 Credit Facilities”), a portion of which was used to repay our then existing $30.7 million senior secured term loan. We refinanced the 2010 Credit Facilities in June 2012 with a new $88.0 million senior secured term loan, a $36.2 million senior subordinated term loan and a $10.0 million revolving credit facility (collectively, the “2012 Credit Facilities”). In addition to repaying the borrowings outstanding under the 2010 Credit Facilities, the proceeds of the 2012 Credit Facilities, along with proceeds from the issuance of additional shares of common and preferred stock and cash on hand, were used to pay accreted dividends to preferred stockholders and provide a partial return of initial investment to preferred stockholders (the “2012 Refinancing”).

In October 2013, we entered into a new $177.0 million senior secured credit facility consisting of a $167.0 million senior secured term loan and a $10.0 million revolving credit facility, which includes a $2.5 million letter of credit subfacility (collectively, the “new senior secured credit facilities”), the proceeds of which were used to repay our existing credit facilities, to make a $31.5 million payment to holders of our Preferred Shares and to fund investments. We refer to these transactions as the “Recapitalization.”

In March 2014, we repurchased an aggregate of 48,516 shares of common stock from certain of our executive officers, including an aggregate of 14,014 shares of common stock for which vesting terms were accelerated in connection with the repurchase. We repurchased the shares at a price of $26.80 per share, the then-current fair market value of our common stock, as determined by a third party valuation firm. See “—Critical Accounting Policies—Shared-based Compensation—Valuation of Common Stock and Preferred Shares.”

Recent Developments

Investment in Project Pie

In December 2013, Project Pie Holdings, LLC (“Project Pie Holdings”), a non-wholly owned subsidiary, purchased 387 Series A Convertible Preferred Units (the “Series A Units”) of Project Pie, a fast casual custom-pizza restaurant chain, for an aggregate purchase price of $2.0 million, paid in cash. Each such Series A Unit is convertible at our option into one common unit of Project Pie. On a fully converted basis, our investment represents 25.8% of all issued and outstanding Project Pie common units as of the purchase date. Until December 2016, the board of managers of Project Pie has the right to request further capital funding from us in exchange for additional Series A Units up to an aggregate value of $2.5 million in increments of $500,000. After that, the board of managers of

 

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Project Pie may continue to request capital funding from us up to an aggregate value of $5.0 million in increments of $500,000, in exchange for which we may purchase additional Series A Units at our option. We also have the right to purchase common units from other members following the completion of Project Pie’s fiscal year 2015 audited financial statements in an amount that would increase our ownership of all common units to 51.0% on a fully converted basis. Similarly, following the completion of Project Pie’s fiscal year 2017 audited financial statements, we have the right to purchase all of the common units from other members, subject to certain exceptions. We also have certain preemptive and registration rights with respect to Project Pie’s securities as well as consent and voting rights with respect to certain significant matters, including certain change of control transactions, issuances of new equity securities, certain matters related to operations and the incurrence of significant debt. In addition, we may designate two members of Project Pie’s board of managers, which initially are John Barr, our Chairman, and Yoo Jin Kim, one of our directors and a partner at Lee Equity. Mr. Barr serves as chairman of Project Pie and of the Project Pie board of managers and also owns approximately 11% of the equity interests of Project Pie Holdings, which he acquired at the same time as our investment in Project Pie. See “Certain Relationships and Related Person Transactions—Project Pie.”

Our Segments

We operate in three business segments: Domestic Franchise, Domestic Company Stores and International. Our Domestic Franchise segment consists of our domestic franchise 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 franchise stores. As of December 30, 2013, we had 18 franchise stores in Canada and four franchise stores in the United Arab Emirates. The following table sets forth our revenues, operating income and depreciation and amortization for each of our segments for the periods presented:

 

 

 

     FISCAL YEAR  
     2013     2012     2011  
     (dollars in thousands)  

Revenues

      

Domestic Franchise

   $ 40,450      $ 37,998      $ 36,115   

Domestic Company Stores

     39,148        28,813        15,619   

International

     897        105        188