ITEM 1. Business
Papa Murphy’s Holdings, Inc. is a 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
1,577
system-wide stores as of
January 2, 2017
.
We have defined three reportable segments for the Company: Domestic Company Stores, Domestic Franchise and International. Financial information about segment operations appears in
Selected Financial Data
,
Management’s Discussion and Analysis of Financial Condition and Results of Operations
and
Financial Statements and Supplementary Data
in
Note 20
—
Segment Information
of the accompanying
Notes to Consolidated Financial Statements
.
We are a Delaware corporation that was organized and acquired a majority of the capital stock of PMI Holdings, Inc., our predecessor, in 2010. In May 2014, we completed our initial public offering (the “
IPO
”) and now our common stock trades on the NASDAQ Global Select Market under the “FRSH” ticker symbol. Papa Murphy’s Holdings, Inc. and its subsidiaries are sometimes referred to as the “Company,” “Papa Murphy’s” or in the first person as “we,” “us” and “our” in this report.
We make available, free of charge, the following filings on our corporate website located at
www.papamurphys.com
as soon as reasonably practicable after such filings are electronically filed with, or furnished to, the Securities and Exchange Commission (“
SEC
”): our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, any amendments to such reports, and our annual proxy statement. Information contained on our corporate website located at
www.papamurphys.com
is not part of this annual report on Form 10-K.
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;
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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.
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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. While our concept has broad appeal to all consumers, we believe this core target customer is more loyal, seeks a higher-quality pizza and 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 daily, 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;
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We use only high-quality meats with no added fillers; and
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Our stores feature a food-forward design, with a makeline that facilitates interactive ordering where store crew members create pizzas in front of the customer. Pizzas are made fresh to order and our customers can follow their pizza as it is made right in front of them.
Our menu offers customers a variety of original, thin, pan and stuffed crust pizzas as well as the ability to create a customized pizza from a broad selection of crust, sauce and topping combinations. Our core menu offerings include the following:
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Signature pizzas: classic combinations plus some unique twists;
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Gourmet Delite pizzas: our artisan thin crust with 35% fewer calories and 25% less fat than our Signature pizzas;
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Stuffed pizzas: two-layer, four-pound pizzas with meats and vegetables stuffed in two layers of dough;
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Fresh Pan pizzas: signature recipes with a thick, buttery crust;
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“C.Y.O.” or Create Your Own pizzas: customer selection of crust, sauce and any combination of our cheese, meat and vegetable toppings; and
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FAVES: three simple pizza classics offered at value price points.
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Loyal Customer Base
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.
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Great Quality.
We have continually focused on quality since our founding and we believe customers can taste the difference. Unlike some of our competitors, we do not use pre-shredded, pre-packaged or frozen cheese and our dough is made from scratch daily, never frozen.
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Great Value.
We offer a high-quality pizza at a value price point.
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Great Customer Service.
We train our store crews to greet each customer, to promote the latest new products and to assist each customer in choosing the combination of fresh made pizzas and side items to complete the customer's meal.
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We have developed a loyal and diverse customer base. We attribute our success across a national footprint to the broad appeal of our concept. Our business model resonates with families and single adults and attracts both female and male customers across all ages, demographics and income levels. Finally, we believe our model encourages a stronger emotional connection with our core target of families. The active role of ordering and watching the pizza being built gives customers a feeling of ownership: “a pizza,” becomes “my pizza.”
Efficient Operating Model Generates Attractive Store-Level Economics
Our stores average just 1,400 square feet in size and do not require ovens, venting hoods, freezers or dining areas because our customers bake their pizzas at home, unlike traditional pizza, limited service or fast casual restaurants. Our stores are designed to highlight our high-quality ingredients, to reinforce the key attributes of our brand and to maximize the customer’s interaction with our friendly team members. Our store model offers franchise owners operating advantages that differentiate us from other restaurant concepts. Our domestic stores:
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Focus on creating fresh pizzas for carry out, reducing operational complexity for franchise owners and their employees;
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Maintain shorter operating hours (typically 11:00 a.m. to 9:00 p.m.) that are attractive to franchise owners and their employees;
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Require fewer employees each shift compared to other restaurant concepts, resulting in lower labor costs;
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Accept
electronic benefit transfer (“
EBT
”) payment systems
(food stamps); and
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Receive strong franchisor support through training, operating standards, supply-chain management and development assistance.
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Our simple, low cost operations create the opportunity for higher margins and attractive returns.
Our strategy is focused on three key components: (i) drive the business through increased awareness and innovation; (ii) development through franchising; and (iii) improve the convenience to our customers. We believe that successfully implementing this strategy will enable us to achieve our growth and profitability targets and leverage our infrastructure.
Drive the Business Through Increased Awareness and Innovation
We work to drive the business forward with increasing sales by focusing on the following tactical areas:
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Increased Awareness.
Starting in 2017, we have added national cable advertising on top of our current local broadcast media. This addition will help educate the marketplace about our concept and grow customer awareness and loyalty. Currently, 42% of our stores are in markets with no TV advertising, and of those with some TV advertising, 79% are not at optimal levels year-round. We believe the addition of national cable advertising will
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significantly help brand recognition in newer markets with lower store density and help to expedite store development and sales growth.
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New Product Innovation.
New product innovation is another tool we use to attract new customers and increase frequency with existing customers. New products have historically been effective in growing comparable store sales. After limited new product introductions in 2016, we are planning some exciting new innovations for 2017 and beyond. In addition to new core products, we work to market new add-on product options and meal deal promotions that bundle together multiple items for an increased value to the customer.
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Development Through Franchising
We believe significant development opportunities remain in the United States and select international markets. We currently estimate our total store potential in the United States alone is at least 4,500 stores, including approximately 2,300 new stores in our existing markets. Historically, we see stronger store performance in markets with greater store penetration and higher brand awareness. During the past five years, we have focused our financial resources on accelerating the build-out of select markets. We intend to continue developing in established markets in the West and Midwest, but the majority of our expansion efforts will be focused on existing but less-penetrated markets in the South and East. Going forward, our strategic development plan will focus on: (i) new store openings; (ii) refranchising of Company-owned stores; and (iii) international development.
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New Store Openings.
New stores will be opened primarily from franchised unit development. Given our unit growth potential, attractive store-level economics and simplicity of store operations, we believe existing franchise owners will expand their current footprint and we will continue to attract new franchise owners. We may introduce development incentives from time to time to expedite store development in select markets.
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Refranchising of Company-Owned Stores.
To expedite store development in select under penetrated markets, we have built 53 Company-owned stores over the past two years. We are now entering the next phase of our strategic development plan which will involve refranchising more than 100 of our Company-owned stores to experienced, well-capitalized operators that can acquire the stores and continue building units to achieve full market penetration. We are targeting a Company-owned store base of about 50 stores by 2020.
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International Development.
We are still in the early stages of international expansion, which we believe represents a long-term growth opportunity. All international stores are developed under a master franchisor arrangement. We currently have two master franchise agreements, one for Canada and one for the six Gulf Cooperation Council states in the Middle East (development so far has been exclusively in the United Arab Emirates).
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Improve Convenience To Our Customers
To improve the convenience to our customers we have made substantial foundational investments in our systems and infrastructure. We substantially completed the roll-out of our POS system and online ordering platform in 2016 to all domestic stores which provides a convenient method of ordering to our customers. We also grew our digital marketing capabilities. Going forward we plan to leverage the investments we've made to improve the convenience to our customers by focusing on the following:
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E-commerce / Online Ordering.
In 2016 we were able to grow our online ordering to about 8% of all transactions, with a goal of reaching 50% in the next few years. Our online ordering platform is programmed to consistently offer additional purchase options based on the customer's current and past ordering patterns. Early evidence demonstrates that orders placed through our online ordering channel deliver an increased average check, averaging more than 20% when compared to other ordering channels in 2016. As the percentage of orders placed through our e-commerce platform increases, this higher average check may moderate.
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Increased Digital Marketing.
In 2016 we continued to focus on building our digital marketing and precision marketing capabilities. We began to communicate more offers exclusively through digital marketing. We anticipate that this trend will continue and grow in 2017 now that almost all stores have a POS system and online ordering capabilities.
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Testing of Delivery.
Online ordering addressed only half of the convenience cycle. In 2017 we plan to begin testing of delivery through the use of various third-party delivery options. Our research indicates a strong demand for delivery from our customers, with more than half indicating they would order more often if delivery was available. We have a unique opportunity with delivery in that because our pizzas are not baked, customers receive the same high-quality fresh food when delivered as when the customer picks up their order in-store.
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Leverage Our Infrastructure
With
1,537
stores across the United States and
517
domestic franchise owners as of
January 2, 2017
, 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. As we execute against our strategic plan and continue to grow our store base, we have made investments in our infrastructure. We expect our selling, general and administrative expenses to increase at a lower rate than our revenues by maintaining tight cost management controls.
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Our Industry and Competition
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With system-wide sales of
$899 million
in fiscal year
2016
, we are the fifth largest pizza chain in the United States as measured by system-wide sales and total number of stores. According to
NPD Crest,
the quick service restaurant (“
QSR
”) pizza market, a subset of the overall pizza category, was about $36 billion in 2016. The top five pizza chains accounted for approximately 49.4% of
QSR
pizza restaurant sales in 2016 compared to 47.8% in 2015 and 43.5% in 2012. We believe the pizza restaurant market continues to be an attractive category due to its size and growth, as well as its fragmented competitive landscape.
We generally compete on the basis of product quality, variety, price, location, image and service with regional and local pizza restaurants as well as national chains such as Domino’s Pizza®, Pizza Hut®, Papa John’s® and Little Caesars Pizza®. On a broader scale, we compete with other limited service restaurants (“
LSR
s”), the overall food service industry, grocery and convenience stores and online meal delivery services. The food service industry, particularly
LSR
s, are competitive with respect to product quality, price, location, service and convenience. Many of our competitors have been in existence for longer periods of time and have developed stronger brand awareness in markets where we compete. In these markets, we compete for customers, employees, management personnel, franchisees and real estate sites suitable for our stores.
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Suppliers and Distribution
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We enter into national supply or pricing agreements with certain key third-party suppliers. We negotiate pricing for our franchised and Company-owned stores with national pricing agreements covering a term of three months to one year. We do not realize any profits from the sale of these supplies to franchise owners.
We rely on multiple third-party distributors as our primary distributors of cheese, refrigerated items, meat, canned and dry goods, paper and disposables and janitorial supplies. Pursuant to our distribution service agreements, we have the right to designate the brands and products supplied. Supplies are delivered to each store one to two times each week.
For our beverage products, we rely on Pepsi-Cola Advertising and Marketing, Inc. (“
Pepsi
”) as our primary provider of packaged beverage products. We have maintained a national distribution relationship with
Pepsi
since 2004.
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Intellectual Property and Trademarks
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We regard the Papa Murphy’s brand name and associated trademarks as valuable assets. We have a portfolio of 31 trademarks registered and several pending trademark registrations with the United States Patent and Trademark Office. We have also secured trademark registrations for our brand name in Canada, China, Mexico, New Zealand, Norway, Australia, Saudi Arabia, Turkey and within the Community Trade Mark (CTM) system, which offers a unified system of protection throughout the European Union. We have secured six trademark registrations in several Middle Eastern countries. All of the marks we own cover store-related services and/or food products.
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Management Information/Technology Systems
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Our point-of-sale system (“
POS system
”) has been customized specifically for Papa Murphy's stores, and we use this integrated restaurant-level technology for inventory, labor management and cash handling in our domestic stores. Our
POS
system
allows us to track sales data and evaluate store efficiency. Through our
POS system
we are able to collect, utilize and disseminate data and information collected by each store to generate reports and evaluate sales performance on a daily basis. In addition, we collect monthly store-level profit and loss statements for internal analysis.
During 2015, 2016 and continuing through 2017, we made substantial investments to further develop our e-commerce capabilities and platform, including a new Papa Murphy's website ordering system. This new ordering channel, fully integrated with our in-store
POS system
, enables us to gather more information about customer ordering habits, which will enable us to further develop attractive offers and increase sales with digital marketing.
We substantially completed the roll out of our
POS system
to all domestic stores in 2016. The
POS system
provides the foundation for efficient store-level operations, the gathering of advanced analytics and the online ordering platform.
Our store base was
89.3%
franchised as of
January 2, 2017
, with our franchise owners operating a total of
1,409
Papa Murphy’s stores in
38
states, Canada and the Middle East. Through our franchise support, development infrastructure and screening process, we have successfully built a base of
534
franchise owners with an average store ownership of approximately 2.5 stores per franchise owner. A majority of our franchise owners owned one store, approximately
75%
owned one or two stores, and 21% of all franchised stores were owned by our 10 largest franchise owners. We believe this highly diversified owner base demonstrates the viability of our store concept across numerous types of owners and operators, and provides an attractive base of owners with capacity to grow with our brand. We believe the relationships we have with our franchise system provide a solid platform for growth.
We are dedicated to providing the tools our franchise owners need to succeed before, during and after a store opening, including assistance with site selection and development, training, operations and marketing. We set forth qualification criteria and provide training programs for franchise owners to ensure that every Papa Murphy’s store meets the same quality and customer service standards to preserve the consistency and reliability of the Papa Murphy’s brand.
Our asset-light franchised business model offers us strategic and financial benefits. It enables us to focus Company resources on menu innovation, marketing, franchise owner training and operations support to drive the overall success of our brand. Our franchised business model also allows us to grow our store base and brand awareness with limited corporate capital investment. Further, our predominantly franchised business model reduces our exposure to changes in commodity and other operating costs. As a result, our business model is designed to provide high operating margins and cash flows with low capital expenditures and working capital.
As of March 1, 2017, we had 2,022 employees, including 319 salaried employees and 1,703 hourly employees. None of our employees are unionized or covered by a collective bargaining agreement and we consider our current employee relations to be good.
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 most heavily concentrated in the fourth quarter and we anticipate that new store openings will continue to be weighted towards the third and fourth quarters. 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 and adversely affect our business, financial condition or results of operations.
We, along with our franchise owners, are subject to various federal, state, local and foreign laws affecting the operation of our respective businesses. Each store is subject to licensing and regulation by a number of governmental authorities, which include zoning, health, safety, sanitation, building and fire agencies in the jurisdiction in which the store operates. In order to maintain our stores, we may be required to expend funds to meet certain federal, state, local and foreign regulations, including regulations that require remodeled stores to be accessible to persons with disabilities. Difficulties in obtaining, or the failure to obtain, required licenses or approvals could delay or prevent the opening of a new store. Our domestic store operations are subject to various federal and state laws governing such matters as minimum wage requirements, benefits, working conditions, citizenship requirements and overtime. We are also subject to federal and state environmental regulations.
We are subject to Federal Trade Commission (“
FTC
”) rules and to various state and foreign laws that govern the offer and sale of franchises. The
FTC
requires us to furnish to prospective franchise owners a franchise disclosure document containing prescribed information. Some states and foreign countries also have disclosure requirements and other laws regulating franchising and the franchisor-franchisee relationship. 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 of future franchise sales, fines or other penalties or require us to make offers of rescission or restitution, any of which could materially and adversely affect our business, financial condition and results of operations.
Item 1A. Risk Factors
An investment in our common stock involves a high degree of risk. Before making an investment decision, you should carefully consider the following risk factors, as well as the other information in this Annual Report on Form 10-K, in evaluating our business. If any of these risks, as well as other risks and uncertainties that are not yet identified or that we currently think are immaterial, actually occur, our business, results of operations or financial condition could be materially and adversely affected. In such an event, the trading price of our common stock could decline and you could lose part or all of your investment.
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Risks Relating to Our Business and Industry
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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 pizza products. We also compete on a broader scale with other international, national, regional and local limited-service restaurants. In addition, we face increasing competition from pizza product and other offerings available at grocery stores and convenience stores and from online meal delivery services, which offer pre-made ready-to-bake frozen and carry-out pizzas and other foods that customers may prepare at home. 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 restaurants, better locations and more effective marketing than we do. Many of our competitors are well established in markets in which we and our franchise owners operate 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.
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 franchise-owned, we could experience decreased customer traffic, downward pressure on prices, lower demand for our products, reduced margins, diminished ability to take advantage of new business opportunities and the loss of market share, all of which could have a material and 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 and 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 and adversely affected. Moreover, because we are primarily dependent on a single product, if consumer demand for pizza in general, and take and 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 franchised and Company-owned stores. We and our franchise owners may be adversely affected by:
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declining economic conditions, including downturns in the housing market, increases in unemployment rates, reductions in consumer disposable income, adverse credit market conditions, increases in fuel prices, drops in consumer confidence and other events or factors that adversely affect consumer spending in the markets that we serve;
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increased competition in the restaurant industry, particularly in the pizza, casual and fast-casual dining segments, and from grocery stores, convenience stores and online meal delivery services;
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changes in consumer tastes and preferences;
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customers’ budgeting constraints;
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customers’ willingness to accept menu price increases;
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adverse weather conditions;
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our reputation and consumer perception of our concepts’ offerings in terms of quality, price, value, ambiance and service; and
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customers’ experiences in our stores.
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In addition, the adverse effects of any of the preceding factors may reduce the attractiveness of new franchise stores to prospective franchise owners, which could make it more difficult to recruit the qualified franchise owners needed to implement our growth strategy and refranchising initiative. 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:
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food costs, particularly for mozzarella cheese and other raw materials, many of which we do not or cannot effectively hedge;
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labor costs, including wages, which are affected by minimum wage requirements, workers’ compensation, health care and other benefits expenses;
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rent expenses and construction, remodeling, maintenance and other costs under leases for our new and existing stores;
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compliance costs as a result of changes in legal, regulatory or industry standards;
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energy, water and other utility costs;
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information technology and other logistics costs; and
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If we fail to open new domestic and international franchise stores on a timely basis, our ability to increase our revenues could be materially and adversely affected.
Our growth strategy includes the opening of new domestic and international franchise stores. We and our franchise owners face many challenges associated with opening new stores, including:
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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;
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competition with other restaurants and retail concepts for potential store sites;
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anticipated commercial, residential and infrastructure development near new or potential stores;
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ability to negotiate acceptable lease arrangements;
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availability of financing and ability to negotiate acceptable financing terms;
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recruiting, hiring and training of qualified personnel;
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construction and development cost management;
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completing our construction activities on a timely basis;
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hiring qualified contractors to build, remodel and maintain our stores;
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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;
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unforeseen engineering or environmental problems with the leased premises;
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adverse weather during the construction period of new stores; and
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other unanticipated increases in costs or delays.
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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 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 and adversely affect our business, financial condition or results of operations.
The planned refranchising of a portion of our Company-owned stores could adversely affect our results of operations.
We have announced plans to refranchise more than 100 of our
168
Company-owned stores (total as of March 1, 2017) by selling the stores and entering into franchise agreements with the buyers. We are targeting to own about 50 Company-owned stores by 2020. Company-owned store sales accounted for
65%
of our total revenues in 2016. We expect the proposed refranchising to result in a decrease in our total revenues because once the stores are refranchised we will derive revenue from the collection of a royalty equal to a percentage of net sales rather than from the total net sales of food and beverages to customers. In addition, refranchising Company-owned stores, and particularly Company-owned stores that have historically enjoyed high profit margins, may reduce our operating income.
We face many challenges associated with refranchising Company-owned stores, including identifying, recruiting and contracting with a sufficient number of qualified franchise owners, retaining employees during the transition to franchise owner management, and obtaining necessary consents from landlords and other third-parties. These challenges may delay, limit or prevent our planned refranchising, which could materially and adversely affect our ability to improve operating margins, reduce our exposure to changes in commodity and other operating costs, and generate cash to be used to repay debt. In addition, if we fail to manage our refranchising initiative effectively, the initiative could be time-consuming and distracting for management.
If we fail to identify, recruit and contract with a sufficient number of qualified franchise owners, our ability to open new franchise stores and refranchise Company-owned stores and increase our revenues and cash flow could be materially and adversely affected.
The opening of additional franchise stores and the refranchising of Company-owned stores depends, in part, upon the attractiveness of our franchise stores to prospective franchise owners and 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. Decreases in system-wide average store sales or comparable store sales in select markets may reduce the attractiveness of new franchise stores to prospective franchise owners, making it more difficult for us to recruit qualified franchise owners. 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 or acquire existing Company-owned stores as planned, our growth may be slower than anticipated, which could materially and adversely affect our ability to increase our revenues and materially and adversely affect our business, financial condition and results of operations.
If we fail to manage growth effectively, our business, financial condition and results of operations may be materially and adversely affected.
Our growth strategy and investment associated with the development of each new store may cause our results to fluctuate and be unpredictable or materially and adversely affect our results of operations. 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 and the take and bake concept as well as by a lack of existing marketing efforts and operational execution in these new markets. Stores in new markets may also face challenges related to being new to a market and having less marketing funds than competitors, which may be due in part to lower store density than competitors. To the extent that we are unable to foster name recognition and affinity for our brand and concept in new markets and implement effective advertising and promotional programs, our franchise owners’ and our 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. New stores may also have difficulty securing adequate financing, particularly in new markets, where there may be a lack of adequate sales history and brand familiarity. Newly opened stores, including newly opened stores in new markets, may not be successful and our system-wide average store sales may not increase at historical rates, which could materially and adversely affect our business, financial condition or results of operations. In addition, to the extent we open new Company-owned stores, pre-opening expenses may vary from period to period based on the timing of when we open new Company-owned stores, which could impact our results of operations from period to period.
Our existing store management systems, financial and management controls, information systems and personnel staffing levels 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 us and our franchise owners 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 and adversely affect our business, financial condition or results of operations.
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
January 2, 2017
, we had
$109.7 million
of outstanding indebtedness, including
$105.9 million
outstanding under our senior secured credit facilities, and
$19.2 million
of availability under a revolving credit facility. We may, from time to time, incur additional indebtedness.
The agreement governing our 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 made 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.
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Our senior secured credit facilities place certain limitations on our ability to incur additional indebtedness. However, subject to the qualifications and exceptions in our senior secured credit facilities, we may be 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 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 and pay. 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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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.
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Failure to comply with certain covenants or the occurrence of a change of control under our senior secured credit facilities could result in the acceleration of our obligations under the senior secured credit facilities, which would have an adverse effect on our liquidity, capital resources and results of operations.
Our senior secured credit facilities also require us to comply with certain financial covenants regarding our leverage ratio, our interest coverage ratio, and, commencing with our fiscal quarter ending January 1, 2018, our fixed charge 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.
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 (“
PPACA
”), which establishes a uniform, federal requirement for certain restaurants to post nutritional information on their menus. Specifically, the
PPACA
generally 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 and 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 implemented. 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, including litigation that has been brought against us by certain 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. 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, and our reliance on the performance of our franchise owners increases as we franchise Company-owned stores. 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 and adversely affect our business and results of operations.
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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 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 each have a material and adverse effect on our reputation, brand, ability to attract prospective franchise owners, business, financial condition or results of operations.
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Franchise agreement termination or non-renewal.
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 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.
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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 agreement. If the franchise 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 agreement (which may include new obligations, as well as increased franchise fees, royalty payments, advertising fees and other fees and 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 not to renew the expiring franchise agreement, in which event the franchise agreement will terminate upon expiration of the term.
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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 any 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 and perform indemnity obligations. Further, the franchise owner may fail to obtain or maintain the required insurance types and levels, and we may not be aware of that failure until a loss is incurred.
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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 and 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 and the sourcing of food from vendors, could subject the franchise owner, 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.
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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. From time to time, franchise owners have disagreed with or resisted elements of our strategy, including new product initiatives and investments in their stores such as remodeling and implementing the
POS system
. Franchise owners may also fail to participate in our marketing initiatives, which could materially and adversely affect their sales trends, average weekly sales (“
AWS
”) and results of operations. In addition, 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. It also 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.
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Franchise owner litigation and conflicts with franchise owners.
Franchise owners are subject to a variety of litigation risks, including customer claims, personal-injury claims, environmental claims, employee claims, intellectual property claims and claims related to violations of the Americans with Disabilities Act, religious freedom, the Fair Labor Standards Act (“
FLSA
”), the Employee Retirement Income Security Act of 1974, as amended, and advertising laws. Each of these claims may increase costs and limit the funds available to make royalty payments and reduce entries into new franchise agreements. We also may be named in lawsuits against our franchise owners.
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In addition, the nature of the franchisor-franchise owner relationship may give rise to conflict. For example, franchise owners have expressed a number of concerns and disagreements with our Company, including concern over a lack of franchise owner involvement in strategic decision-making, inadequate assistance in increasing and difficulty maintaining franchise store profitability in a higher cost environment, disagreement with marketing strategy and initiatives and product launches, concern over the implementation of the Company's text-based marketing program, disagreement with the Company's expansion strategy and the availability of development incentives, dissatisfaction with food safety measures implemented by the Company, including required purchases and new protocols, and dissatisfaction with costs associated with, and the functionality of, the Company's online ordering platform. Our senior management team engages with franchise owner leadership to address these concerns and resolve specific issues raised by the franchise owners. Such engagement may not result in a satisfactory resolution of the issues, which, in turn, could materially and adversely affect our ability to grow our franchise system and maintain relationships with our franchise owners, damage our reputation and our brand, and materially and adversely affect our results of operations.
We currently are subject to litigation with a group of our franchise owners as described in Part I, Item 3.
Legal Proceedings
. We also may become subject to additional litigation with franchise owners in the future. Engaging in such litigation may be costly, time-consuming and distracting to management and also may materially and adversely affect our relationships with potential franchise owners and our ability to attract new franchise owners. In addition to these and other claims that may be brought against us by franchise owners, we also may engage in future 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, distracting and costly. Any negative outcome of these or any other claims could materially and adversely affect our results of operations as well as our ability to expand our franchise system and may damage our reputation and our brand.
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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. Although we believe newer restaurants meet the Americans with Disabilities Act construction standards and, further, that most franchise owners have historically been diligent in the remodeling of older restaurants, a finding of noncompliance with the Americans with Disabilities Act could result in the imposition of injunctive relief, fines, awards of damages to private litigants or additional capital expenditures to remedy such noncompliance. In addition, the Americans with Disabilities Act may also require modifications to guest-facing technologies, including our website, to provide service to, or make reasonable accommodations for, disabled persons. 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.
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Pre-Sale Development Program.
In 2015, we began building stores in our Domestic Company Stores segment under our pre-sale development program. Under this program, from time to time we develop a new store and incur the costs of development of the store, which we ultimately expect to recoup through the sale of the store to a franchise owner. If for any reason we fail to sell a store we have developed under this program and we otherwise are unable to recoup the costs of development of the store, our financial position, results of operations and cash flows could be adversely affected.
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Development Billing Agreement.
In connection with development of new stores by our franchise owners, we currently require them to enter into a development billing agreement under which we pay on the franchise owner’s behalf certain third-party vendors for the development of the new store. Under the agreement, the franchise owner is required to place funds in a specified account and authorize us to collect the funds electronically based on an agreed upon schedule. As a result of these agreements, we may expose our credit to risk resulting from franchise owner defaults, acquire excess inventory and experience unintended tax consequences.
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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, if interest rates on loans that our franchise owners use to finance operations of current stores or to open new stores increase or if franchise owners are unable to service their debt, our franchise owners may have difficulty operating their stores or opening new stores, which could materially and adversely affect our results of operations as well as our ability to expand our franchise system.
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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 is 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.
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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. Competition for sales between our stores may become significant in the future as we continue to expand our operations and could affect sales growth, which could, in turn, materially and adversely affect our business, financial condition or results of operations.
New stores may not be profitable and the changes 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 historical rates.
AWS
for new domestic stores can be influenced by a number of factors, including the extent of store penetration and brand awareness in the markets in which new stores open. Other factors that may impact
AWS
, comparable store sales and performance of new stores are the level of media efficiency, pricing structure, the competitive activity in any market, the concentration of our stores in any market, our overall marketing
plans, the timing of new store openings and franchise owner engagement and ability. In addition, our store grand opening plan focuses less on driving opening day sales than it does on delivering a more sustainable sales level and extending sales momentum well into the first full fiscal year of operations. Although this plan may allow for steadier and more sustainable growth, it may also result in lower
AWS
in earlier periods. Profits and sales performance for new stores in newer, less-penetrated markets may further be adversely affected by a lack of awareness or acceptance of our brand and concept as well as by a lack of existing marketing efforts and operational execution in these markets.
If new stores do not perform as planned, or if our franchise owners or we are unable to achieve our expected
AWS
for the new stores, our business, financial condition or results of operations could be materially and 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 and 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:
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recessionary or expansive trends in international markets;
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changing labor conditions and difficulties in staffing and managing our foreign operations;
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increases in the taxes we pay and other changes in applicable tax laws;
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legal and regulatory changes, and the burdens and costs of our compliance with a variety of foreign laws;
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changes in inflation rates;
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changes in exchange rates and the imposition of restrictions on currency conversion or the transfer of funds;
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difficulty in protecting our brand, reputation and intellectual property;
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difficulty in collecting our royalties and longer payment cycles;
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expropriation of private enterprises;
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increases in anti-American sentiment and the identification of the Papa Murphy’s brand as an American brand;
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other external factors.
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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 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. The termination of
ADAs
or other arrangements 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 or discontinuation or an interruption in the operation 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 of 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.
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 to lease the real property where any of the new Company-owned stores we may open in the future will operate. 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. We also sublease or assign some of our leases to our franchisees, and will continue to do so in the future, either before or after we have
developed a store at the leased location. When we assign or sublease our leases to franchisees, we are in most instances required to retain ultimate liability to the landlord. If an existing or future store is not profitable, resulting in its closure (or, in the case of a lease that we have subleased or assigned to a franchisee, the franchisee defaults on the subleased or assigned lease), we could lose some or all of our development investment as well as be committed to perform our obligations under the applicable lease. This could include, among other things, paying the base rent for the balance of the lease term. We may also be subject to a claim by a franchise owner who defaults on a lease that we knew or should have known that the leased location would be unprofitable.
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 and adversely affect our business, financial condition or results of operations.
The impact of negative economic factors, including the availability of credit, on our franchise owners’ and our 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 locations. The development of new stores may also be adversely affected by the negative financial situations of developers and potential landlords. Landlords may try to delay or cancel development projects (as well as renovations of existing projects) if there is instability in the credit markets or 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, food safety, store facilities, customer complaints or litigation alleging illness or injury, health inspection scores, integrity of our or our suppliers’ food processing, employee and franchise owner relationships, franchise owner litigation 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 and 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.
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 has increased markedly. 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' 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 and 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, as well as compliance with the restrictions and obligations imposed by laws regulating certain marketing practices.
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 television advertising, social media, email and opt-in text messaging. 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 than we do, which enables 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 be materially and adversely affected.
The support of our franchise owners is critical for the success of our advertising and the 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 a minimum of 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 fund to support the development of new products, brand development and national marketing programs. Consequently, a decline in net sales at franchise stores may result in reduced spending on advertising and the development of new products, brand development and national marketing programs, or may require us, our franchise owners or other third-parties to contribute additional advertising funds, which we, our franchise owners and other third-parties have done at various times. Although 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, 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 and adversely affect our business, financial condition and results of operations.
We continue to invest in television advertising in order to expand brand awareness and draw attention to our products and value-based promotions. In January 2017, we launched our first national cable television advertising campaign. There is no assurance that our national cable television advertising campaign will resonate with consumers or be as effective as targeted local advertising in select markets. If these advertising investments do not drive increased store sales, the expense associated with this advertising may adversely impact our financial results, and we may not generate the levels of same store sales we expect. In addition, because some of our competitors have greater financial resources than we do, we may be particularly sensitive to increases in television advertising costs, which may reduce the efficiency of our advertising spending.
Further, some of our marketing campaigns involve emails and opt-in text messages. In the United States, the Telephone Consumer Protection Act imposes obligations and limitations on making phone calls and sending text messages to consumers. The Federal Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003 (the “CAN-SPAM Act”) regulates commercial email messages and specifies penalties for the transmission of commercial email messages that do not comply with certain requirements, such as providing an opt-out mechanism for stopping future emails from senders. States and other countries have similar laws related to telemarketing and commercial emails. Additional or modified laws and regulations, or interpretations of existing, modified or new laws, regulations and rules, could prohibit or increase the cost of engaging with consumers and impair our ability to expand the use of our marketing techniques to more customers. Failure to comply with obligations and restrictions related to text message and email marketing could subject us to lawsuits, fines, statutory damages, consent decrees, injunctions, adverse publicity and other losses that could harm our business. We are currently subject to one such lawsuit, which is described in Part I, Item 3,
Legal Proceedings
.
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 52 full weeks from the comparable date (the Tuesday following the opening date), 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 and 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 have typically been 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 and adversely affect our business, financial condition or results of operations.
Changes in economic conditions, including effects from recession, adverse weather and other unforeseen conditions, could materially and adversely affect our business, financial condition and results of operations.
The restaurant industry depends on consumer discretionary spending. Volatile economic conditions now or in the future may depress consumer confidence and discretionary spending. If the economy fails to fully recover for a prolonged period of time or worsens and if our customers have less discretionary income or reduce the amount they spend on quick service meals, customer traffic could be adversely impacted. We believe that if negative economic conditions persist for a long period of time or become pervasive, consumers might make long-lasting changes to their discretionary spending behavior, including dining out less frequently. Declines in food commodity prices may accelerate these changes in consumer spending by inducing consumers to purchase more of their meals from grocery and convenience stores. 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 and 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 is no assurance that the macroeconomic environment or the regional economies 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 hepatitis A. In addition, we do not assure you 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 types of food products we sell, if publicized on national media outlets or through social media, could negatively affect our store sales nationwide. 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 and 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 and 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 used in 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 our approved distributors and produce locally through an approved produce supplier.
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 and 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 and adversely affect our business, financial condition or results of operations.
Decreases in food costs may also affect consumer behavior in ways adverse to us. If our competitors, including grocery stores, are better able to pass along commodity price decreases to customers than we are, then we may experience lower demand for our products and loss of market share.
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 and adversely affect our franchise owners and us. The initial term of our Distribution Service Agreement with Sysco expired in August 2007, and now the agreement automatically renews for one-year terms until terminated by either party with written notice one year before the termination date in such notice. 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 franchise and Company-owned 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, civil unrest 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.
Changes in laws related to electronic benefit transfer (“
EBT
”) systems, could adversely impact our results of 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 are periodically proposed by lawmakers in the U.S. Senate or House of Representatives. The recent reductions and potential future reductions in food stamp benefits may reduce sales, which could materially and 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 our relationships with our employees and the relationships of our franchise owners with their employees, 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 franchise and Company-owned stores are paid at rates related to the U.S. federal minimum wage, and increases in the U.S. federal minimum wage, or higher minimum wage rates imposed by states or municipalities, 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.
The U.S. federal government and various states are considering or have already adopted new immigration laws and enforcement programs. 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 have implemented 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 and adversely affect our business, financial condition or results of operations.
In what may signal a trend and change in employment law, franchisors are increasingly subject to claims that they are joint employers with their franchisees, and there seems to be support for such claims within the National Labor Relations Board (“
NLRB
”), based on recent
NLRB
decisions. This could expose franchisors, including us, to liability for claims by, or based on the acts of, franchisees’ employees. Although 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 claim not covered by that insurance, or a judgment in excess of our insurance coverage, could materially and 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.
If our franchise owners or we face labor shortages, labor disputes 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 we or our franchise owners 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 and adverse effect on our business, financial condition or results of operations.
Additionally, while we do not currently have any unionized employees and are not currently subject to any unionization efforts, there is a potential for union organizers to engage in efforts to organize our employees or those of our franchise owners. The recent NLRB joint employer decisions referred to above may also create some possibility that employees of our franchise owners could have the right to collectively bargain directly with us. Potential union representation and collective bargaining agreements may result in increased labor costs that can have an impact on competitiveness, as well as impact our ability to retain well-qualified employees. Labor disputes, as well, may precipitate strikes and picketing that may have an impact on business, including guest patronage. Further, potential changes in labor laws could increase the likelihood of some or all of our employees being subjected to greater organized labor influence, and could have a material and adverse effect on our business, financial condition or results of operations by imposing requirements that could potentially increase our costs, reduce our flexibility and impact our employee culture.
Any 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, of which several have been mandated by governing bodies in some localities in which we or our franchise owners operate stores, would increase our labor costs. Moreover, 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 and 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 the marketing and advertising of our new products. Our new product offerings may not be well-received by consumers and may not be successful, which could materially and 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
POS system
that we continue to implement across our franchise base in order to better manage our business. Our failure to capitalize on investments may materially and 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 offer and subsidize comprehensive healthcare coverage, primarily for our salaried employees. The healthcare reform law requires 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. We offer hourly employees who qualify as full-time employees under the
PPACA
the option of enrolling in our health care coverage during our annual open enrollment period, but the number of such employees electing to so enroll is low. If the number of full-time hourly employees electing to enroll in our health care coverage increases significantly, we may incur substantial additional expense, or, if the benefits we offer do not meet applicable requirements, we may incur penalties. 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 U.S. Congress may also consider repealing all or a portion of the
PPACA
and it is uncertain what, if any, new laws and regulations would replace the repealed portions of the
PPACA
. The costs and other effects of these new healthcare requirements, and any proposed repeal or modifications of such requirements, are still being determined, but they may significantly increase our healthcare coverage costs and could materially and 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. For example, on May 8, 2015, we were named as a defendant in a putative class action lawsuit claiming a violation of the Telephone Consumer Protection Act, which prohibits companies from making telemarketing calls to numbers listed in the Federal Do-Not-Call Registry and imposes other obligations and limitation on making phone calls and sending text messages to consumers. Specific information regarding the lawsuit is included in Part 1, Item 3,
Legal Proceedings
. An adverse judgment or settlement, related to this or any other litigation claim, 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 and 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.
Although we have historically experienced very few customer lawsuits, 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 and may become subject to class action or other lawsuits related to these or
different matters in the future. We may also be named as a defendant in any such claims brought against any of our franchise owners. 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 and 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 and adversely affect our business, financial condition or results of operations.
If changes in our senior management and the employee reductions made as part of our strategic realignment disrupt our business operations or impede our ability to attract and retain highly skilled personnel, our future development and operating results could be adversely affected.
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.
On December 29, 2016, Ken Calwell tendered his resignation from his position as our President and Chief Executive Officer and as a member of our Board, effective immediately. Jean Birch, the Chair of our Board, has been named our interim President and Chief Executive Officer, while we search for a new President and Chief Executive Officer, but we do not assure you that we will find a qualified replacement in a timely manner. We cannot be certain that this change in management, operating with an interim President and Chief Executive Officer or any additional change that may come as we select a new President and Chief Executive Officer, will not negatively affect our business and operations.
In addition, in February 2017 we announced a strategic realignment resulting in the elimination of eleven positions at the Company, including two senior officers. These reductions and turnover will result in reallocations of duties and may increase employee uncertainty and cause unintended attrition. In addition, these actions may make it more difficult for us to attract and recruit highly skilled employees. Our future performance will be substantially dependent in particular on our ability to retain and motivate our employees, particularly our senior officers and key employees, and replace the capabilities and talent lost in the recent reduction in force. The loss of any additional senior officers and key employees could have negative effects on our business and operations.
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 Financial Officer, other senior officers or key employees
could have negative effects on our business and operations and
could materially and adversely affect our business and plans for future development. We do not 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.
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 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 and 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 and adversely affected.
Interest rate fluctuations may increase our debt service obligations, which would adversely affect our financial condition and results of operations.
We are subject to interest rate risk on our senior secured credit facility. Interest rates on our senior secured credit facility are based on LIBOR, and under specified circumstances we may be required by our lenders to enter into interest rate swap arrangements. A hypothetical 1.0% increase or decrease in the interest rate associated with our senior secured credit facility would have resulted in a
$1.1 million
change to interest expense on an annualized basis.
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.
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 do not ensure that any acquisition, partnership or joint venture we make will not have a material and 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 and adversely affect our business, financial condition and results of operations.
System security risks, data breaches and cyber attacks could disrupt our operations.
We manage and store various proprietary information and sensitive or confidential data relating to our business, including sensitive and personally identifiable information related to our suppliers, customers and franchise owners. Breaches of our security measures through hacking, fraud or other forms of deception, or the accidental loss, inadvertent disclosure or unapproved dissemination of proprietary information or sensitive or confidential data about us, our suppliers, our customers, our employees, or our franchise owners, could expose us, our customers, our suppliers and our franchise owners to a risk of loss or misuse of this information, result in litigation and potential liability for us, damage our brand and reputation or otherwise harm our business. In addition, our current data protection measures might not protect us against increasingly sophisticated and aggressive threats and the cost and operational consequences of implementing further data protection measures could be significant.
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. Because of the differences in foreign laws concerning proprietary rights, our intellectual property rights may not receive the same degree of protection in foreign countries as they would in the United States. We have registered or applied to register a number of our trademarks. We do not 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. If 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 becomes necessary, we may make infringement claims in federal court. However, we do not assure you that we will have adequate resources to enforce our trademarks and other intellectual property rights. If our efforts to register, maintain and protect our trademarks or other intellectual property are inadequate, or if any third-party misappropriates, dilutes, infringes or otherwise violates our intellectual property, the value of our brand may be harmed, which could have a material and 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 cease selling 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 products or 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 a third-party’s 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 do not 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 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
POS system
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 and adversely affect our business, reputation, 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 our online ordering platform,
POS 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 and adversely affect our business, reputation, 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 described elsewhere in this section and 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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compliance with the
FLSA
, which governs 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;
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compliance with securities laws and NASDAQ listed company rules;
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compliance with the Americans with Disabilities Act;
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working and safety conditions;
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sales taxes or other transaction taxes;
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compliance with the Payment Card Industry Data Security Standards and similar requirements; and
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compliance with the Dodd-Frank Wall Street Reform and Consumer Protection Act and any rules promulgated thereunder.
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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 Federal Trade Commission rules 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 and adversely affect our business, financial condition and results of operations.
Some of the jurisdictions where we have franchise and Company-owned stores do not assess sales tax on our pizzas. 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 franchise owner level could lead to undercapitalized franchise owners 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 and 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.
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 and 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 affect 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 will require lessees to capitalize all but short-term leases in their financial statements by 2019. This change, when implemented, will require us to record significant lease obligations and related right of use assets 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 and adversely affect our business, financial condition or results of operations.
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Risks Relating to Our Company and Our Ownership Structure
|
The requirements of being a public company may strain our resources and divert resources and management’s attention.
As a publicly traded company, we incur, and will continue to incur, significant legal, accounting and other expenses that we were not required to incur prior to our initial public offering in May 2014. This will be particularly so after we are no longer an
“emerging growth company” as defined under the Jumpstart our Business Startups Act (“
JOBS Act
”). We are required to file with the
SEC
annual and quarterly information and other reports that are specified in Section 13 of the Securities Exchange Act of 1934, as amended (the “
Exchange Act
”). We are also 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 are also 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 impose significant compliance obligations upon us. As a public company, we, among other things, must prepare and distribute periodic public reports and other stockholder communications in compliance with our obligations under the federal securities laws and applicable NASDAQ rules.
These additional obligations as a public company require a significant commitment of additional resources and many of our competitors already comply with these obligations. 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 comply with 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 demands of being a public company, including engagement and communications with stockholders, 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 following our initial public offering. 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.
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.
We have implemented internal controls over financial reporting and processes to evaluate their design and test their effectiveness so that management can provide the required management assessments under Section 404 of the Sarbanes-Oxley Act (“
Section 404
”).
Section 404
requires annual management assessments of the effectiveness of our internal control over financial reporting.
Section 404
also generally requires 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
until we are no longer an “emerging growth company.” We could be an “emerging growth company” for up to five years following our initial public offering.
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. 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.
We may encounter problems or delays in implementing improvements in connection with receiving a favorable attestation from our independent registered public accounting firm. 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 violate applicable stock exchange listing rules. Any restatement of our financial statements due to a lack of adequate internal controls or otherwise could result in a loss of public confidence in the reliability of our financial statements and sanctions imposed on us by the
SEC
. Failure to maintain effective internal control over financial reporting could have a material adverse effect on our business and share price.
Lee Equity
may acquire interests and positions that could present potential conflicts with our and our stockholders’ interests.
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.
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 following the consummation of our initial public offering,
Lee Equity
and its affiliates owned approximately 41% of our outstanding capital stock, and as of
March 1, 2017
, owns
26%
of our outstanding capital stock.
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 contains 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. Under a stockholder’s agreement that we entered into with
Lee Equity
in connection with our initial public 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 nominees 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 nominee, in each case to serve on the Board of Directors (the “
Board
”) 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
. 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 nominee designees, as the case may be.
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.
Anti-takeover provisions in our organizational documents could make an acquisition of us more difficult, limit attempts by our stockholders to replace or remove our current management and adversely affect the market price of our common stock.
Provisions in our certificate of incorporation and bylaws may have the effect of discouraging or preventing a change of control or changes in our management. Our certificate of incorporation and bylaws include provisions that:
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▪
|
authorize our
Board
to issue, without further action by the stockholders, up to 15,000,000 shares of undesignated preferred stock;
|
|
|
▪
|
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;
|
|
|
▪
|
specify that special meetings of our stockholders can be called only by or at the direction of our
Board
or, at the request of
Lee Equity
or its transferee that has privately acquired from
Lee Equity
at least 10% of our outstanding common stock, so long as
Lee Equity
or its transferee owns at least 10% of our outstanding common stock;
|
|
|
▪
|
establish an advance notice procedure for stockholder proposals to be brought before an annual or special meeting, including proposed nominations of persons for election to our
Board
;
|
|
|
▪
|
establish that our
Board
is divided into three classes, with each class serving three-year staggered terms;
|
|
|
▪
|
prohibit cumulative voting in the election of directors;
|
|
|
▪
|
provide that our directors may be removed only for cause by a majority of the remaining members of our
Board
or the holders of at least 66 2/3% of our outstanding voting stock
|
|
|
▪
|
empower our
Board
to cancel, postpone or reschedule an annual meeting of stockholders, at any time before the holding of the annual meeting and for any reason; and
|
|
|
▪
|
require comprehensive disclosures and affirmations from any individual who has been proposed by a stockholder as a nominee for election to our
Board
.
|
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
, 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, we have opted out of Section 203 of the Delaware General Corporation Law, which
would otherwise prohibit us from engaging in any of a broad range of business combinations with any “interested stockholder” (any stockholder with 15% or more of our outstanding voting stock) for a period of three years following the time that the stockholder became an “interested stockholder”, subject to certain exceptions. Our certificate of incorporation contains provisions that have similar effect as Section 203 of the Delaware General Corporations Law, except that they exclude from the definition of “interested stockholder”
Lee Equity
, and any person that has acquired from
Lee Equity
or any
Lee Equity
transferee 5% or more of our outstanding voting stock.
Lee Equity
and its affiliates will continue to be able to significantly influence our decisions and their interests may conflict with our or yours in the future.
Lee Equity
and its affiliates beneficially own approximately
26%
of our outstanding common stock as of
March 1, 2017
. Under the terms of our amended and restated certificate of incorporation and bylaws,
Lee Equity
has 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
has 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 stockholder’s agreement between us and
Lee Equity
, 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 nominees 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 nominee, in each case to serve on the
Board
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
. 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 nominee 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
Lee Equity
and other stockholders affiliated with
Lee Equity
but not in the interest of the Company or other stockholders not affiliated with
Lee Equity
.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our corporate headquarters, located in Vancouver, Washington, houses substantially all of our executive management and employees who provide our primary corporate support functions: legal, marketing, technology, human resources, finance, and research and development. We lease the property for the corporate headquarters and all of our
168
Company-owned stores.
Our system-wide stores are typically located in neighborhood shopping centers and the average store size is approximately 1,400 square feet. As of
January 2, 2017
, we and our franchise owners operated
1,577
stores with
1,537
of these stores located in
38
states (consisting of
1,369
franchised and
168
Company-owned stores) plus
19
stores in Canada and
21
stores in the Middle East. Our franchised stores are situated on real property owned by franchise owners or leased directly by franchise owners from third-party landlords.
The map and chart below show the locations of our franchised and Company-owned stores in the United States as of
January 2, 2017
.
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|
|
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|
|
|
|
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|
Domestic Franchised
Stores
|
|
Company-
Owned
Stores
|
|
Total
|
Alabama
|
29
|
|
|
—
|
|
|
29
|
|
Alaska
|
12
|
|
|
—
|
|
|
12
|
|
Arizona
|
59
|
|
|
—
|
|
|
59
|
|
Arkansas
|
5
|
|
|
7
|
|
|
12
|
|
California
|
170
|
|
|
—
|
|
|
170
|
|
Colorado
|
62
|
|
|
28
|
|
|
90
|
|
Florida
|
17
|
|
|
16
|
|
|
33
|
|
Georgia
|
6
|
|
|
—
|
|
|
6
|
|
Idaho
|
25
|
|
|
9
|
|
|
34
|
|
Illinois
|
25
|
|
|
—
|
|
|
25
|
|
Indiana
|
39
|
|
|
—
|
|
|
39
|
|
Iowa
|
38
|
|
|
—
|
|
|
38
|
|
Kansas
|
39
|
|
|
—
|
|
|
39
|
|
Kentucky
|
17
|
|
|
—
|
|
|
17
|
|
Louisiana
|
5
|
|
|
—
|
|
|
5
|
|
Maryland
|
2
|
|
|
—
|
|
|
2
|
|
Michigan
|
8
|
|
|
13
|
|
|
21
|
|
Minnesota
|
76
|
|
|
25
|
|
|
101
|
|
Mississippi
|
2
|
|
|
2
|
|
|
4
|
|
Missouri
|
53
|
|
|
4
|
|
|
57
|
|
Montana
|
14
|
|
|
—
|
|
|
14
|
|
Nebraska
|
19
|
|
|
—
|
|
|
19
|
|
Nevada
|
27
|
|
|
—
|
|
|
27
|
|
New Mexico
|
12
|
|
|
6
|
|
|
18
|
|
North Carolina
|
19
|
|
|
—
|
|
|
19
|
|
North Dakota
|
13
|
|
|
—
|
|
|
13
|
|
Ohio
|
3
|
|
|
—
|
|
|
3
|
|
Oklahoma
|
26
|
|
|
—
|
|
|
26
|
|
Oregon
|
98
|
|
|
7
|
|
|
105
|
|
South Carolina
|
2
|
|
|
—
|
|
|
2
|
|
South Dakota
|
15
|
|
|
—
|
|
|
15
|
|
Texas
|
95
|
|
|
8
|
|
|
103
|
|
Tennessee
|
32
|
|
|
24
|
|
|
56
|
|
Utah
|
59
|
|
|
—
|
|
|
59
|
|
Virginia
|
5
|
|
|
—
|
|
|
5
|
|
Washington
|
132
|
|
|
17
|
|
|
149
|
|
Wisconsin
|
99
|
|
|
2
|
|
|
101
|
|
Wyoming
|
10
|
|
|
—
|
|
|
10
|
|
Total
|
1,369
|
|
|
168
|
|
|
1,537
|
|
Lease Arrangements
We lease the property for our corporate headquarters and our Company-owned stores and have no involvement in the leased property of the franchise locations except for three locations that operate under a sublease and a few leases assigned to franchisees wherein we remain secondarily liable. The typical store is located in a neighborhood-oriented shopping center. Lease terms for these stores are generally five years with one or more five-year renewal options and generally require us to pay a proportionate share of real estate taxes, insurance, common area and other operating costs in addition to base or fixed rent.