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EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - NPC INTERNATIONAL INCdex311.htm
EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 - NPC INTERNATIONAL INCdex322.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - NPC INTERNATIONAL INCdex312.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 - NPC INTERNATIONAL INCdex321.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

 

(Mark one)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 29, 2009

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 333-138338

 

 

NPC INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

 

 

KANSAS   48-0817298

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. employer

identification number)

7300 W. 129th Street

Overland Park, KS 66213

(Address of principal executive offices)

Telephone: (913) 327-5555

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act.    Yes  x    No  ¨

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ¨    No  x

(Note: As a voluntary filer, not subject to the filing requirements, the registrant filed all reports under Section 13 or 15(d) of the Exchange Act during the preceding twelve months.)

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

There is no market for the Registrant’s equity. As of March 26, 2010, there were 1,000 shares of common stock outstanding.

 

 

 


Table of Contents

INDEX

 

          Page

Part I.

      2-19

Item 1.

  

Business

   2

Item 1A.

  

Risk Factors

   8

Item 1B.

  

Unresolved Staff Comments

   17

Item 2.

  

Properties

   18

Item 3.

  

Legal Proceedings

   19

Item 4.

  

Reserved

   19

Part II.

      20-59

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   20

Item 6.

  

Selected Financial Data

   20

Item 7.

  

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

   22

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   36

Item 8.

  

Financial Statements and Supplementary Data

   37

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   58

Item 9A.

  

Controls and Procedures

   58

Item 9A (T).

  

Controls and Procedures

   59

Item 9B.

  

Other Information

   59

Part III.

      60-81

Item 10.

  

Directors, Executive Officers and Corporate Governance of the Registrant

   60

Item 11.

  

Executive Compensation

   64

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   79

Item 13.

  

Certain Relationships and Related Transactions and Director Independence

   80

Item 14.

  

Principal Accounting Fees and Services

   81

Part IV.

      82-86

Item 15.

  

Exhibits, Financial Statement Schedules

   82


Table of Contents

PART I

 

Item 1. Business

General

NPC International, Inc. (referred to herein as “NPC” the “Company” or in the first person notations of “we,” “us” and “our”) is the largest Pizza Hut franchisee and the largest franchisee of any restaurant concept in the United States according to the 2009 “Top 200 Restaurant Franchisees” by Franchise Times. We were founded in 1962 and, as of December 29, 2009 we operated 1,149 Pizza Hut units in 28 states with a significant presence in the Midwest, South and Southeast. As of the end of fiscal 2009, our operations represented approximately 19% of the domestic Pizza Hut restaurant system and 21% of the domestic Pizza Hut franchised restaurant system as measured by number of units, excluding licensed units which operate with a limited menu and no delivery in certain of our markets.

We are a Kansas corporation incorporated in 1974 under the name Southeast Pizza Huts, Inc. In 1984, our name was changed to National Pizza Company, and we were subsequently renamed NPC International, Inc. on July 12, 1994.

On May 3, 2006, all of our outstanding stock was acquired by NPC Acquisition Holdings, LLC (“Holdings”), a company controlled by Merrill Lynch Global Private Equity (“MLGPE”) and certain of its affiliates, referred to in this report as the “2006 Transaction.”

Acquisitions and Dispositions

Between October 2006 and February 2009 we acquired 508 Pizza Hut units, including 333 units from Pizza Hut, Inc. (“PHI”) and 175 units from other Pizza Hut franchisees. During this same time period, we also sold 112 units to PHI as part of an asset sale and purchase agreement and nine units to another Pizza Hut franchisee. These acquisitions were funded through our revolving credit facility, the issuance of a $40.0 million term loan, proceeds from the sale of units to PHI and cash on hand.

 

(Dollars in millions)              # Units     
   

Date

   Base
Purchase/
(Sale)
Price(1)
    Fiscal
2006
&
2007
    Fiscal
2008
    Fiscal
2009
    Fee
Properties
  

Location

Acquired from:

               

PHI

  2/17/2009    $ 14.2          50 (4)       MO, IL
  1/20/2009      18.5          55         CO
  12/9/2008      27.1        88        1    FL, IA,
  12/9/2008      25.7        101           MO, KS, GA
  10/2/2006      20.7      39          2    TN

Other franchisees

  9/30/2008      35.4        99 (2)      9    VA, WV, MD
  9/26/2007      5.3      17             FL
  3/13/2007      27.1      59             ID, OR, WA
                                 

Total acquisitions

     $ 174.0      115      288      105        

Sold to:

               

PHI

  1/20/2009      (19.0       (42 )(3)       AR, IN, KY, LA, OK, TX
  12/9/2008      (18.8     (70        MS, FL, WA, GA

Other franchisee

  10/26/2006      (2.0   (9          AR, NV, UT
                                 

Total dispositions

       (39.8   (9   (70   (42     
                                 
     $ 134.2      106      218      63        
                                 

 

(1)

Base purchase price does not include direct acquisition costs and/or working capital reimbursements which are included in the allocation of purchase price for the 2009 and 2008 acquisitions included in Note 2-Business Combinations and Acquisitions to the Consolidated Financial Statements.

(2)

Includes seven units which were closed immediately upon acquisition.

(3)

Units were included in assets held for sale at December 30, 2008 and treated as discontinued operations along with the 70 units sold in 2008.

(4)

Includes the purchase of operations for one unit which is operated under a management agreement and one unit which was closed immediately upon acquisition.

 

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As a result of the sale of units in 2008 and the sale of units in 2009, which were classified as held for sale at December 30, 2008, our consolidated statements of income for all years presented have been adjusted to remove the operations of the 2008 and 2009 sold units which were reclassified as discontinued operations. Also included in discontinued operations for the fiscal year ended December 30, 2008 was the loss on the sale of those units. The amounts presented throughout, except where otherwise indicated, relate to continuing operations only.

Overview

Our restaurants are primarily located in non-metro and mid-sized metro markets with approximately 45% of our restaurants located in “1 to 2 Pizza Hut Towns.” Our size and scale provide significant operating efficiencies and we believe our emphasis on non-metro locations and small cities provides a cost effective basis for operations. Additionally, we are an operationally driven company that is focused on running efficient restaurants while providing high levels of customer service and quality food at attractive values.

Our Pizza Hut restaurants are open seven days a week and serve both lunch and dinner. Pizza Hut restaurants generally provide carry-out and delivery, and are the only national pizza chain to offer full table service. We operate our Pizza Hut restaurants through three different formats to cater to the needs of our customers in each respective market. Delivery units, or “Delcos,” are typically located in strip centers and provide delivery and carry-out, with a greater proportion being located in more densely populated areas. Red Roof units, or “RRs,” are traditional free-standing, dine-in restaurants which offer on-location dining room service as well as carry-out service, and are principally located in “1 to 2 Pizza Hut Towns.” Restaurant-Based Delivery units, or “RBDs,” conduct delivery, dine-in, and carry-out operations from the same free-standing location. For the fiscal year ended December 29, 2009, our sales were derived from the following occasions: 40% carry-out, 40% delivery and 20% dine-in. Approximately 45% of our units include the WingStreet™ product line. The WingStreet™ menu includes bone-in and bone-out fried chicken wings which are tossed in one of eight sauces and are available for dine-in, carry-out and delivery.

The following table sets forth certain information with respect to each fiscal period:

 

     December 29,
2009
    December 30,
2008
    December 25,
2007
 

Average annual revenue per restaurant(1)

   $ 739,995      $ 827,331      $ 790,737   

Number of restaurants open at the end of the period:

      

Delco

     435        372        202   

RR

     185        188        155   

RBD

     529        496        420   
                        
     1,149 (2)      1,056 (2)      777 (2) 

Units held for sale

       42     
            

Total units in operation

       1,098     

 

 

  (1)

In computing these averages, total net product sales for the fiscal periods were divided by “equivalent units” which represents the number of units open at the beginning of a given period, adjusted for units opened, closed, acquired or sold during the period on a weighted average basis. Equivalent units were 1,142, 806 and 752 in 2009, 2008 and 2007, respectively. Fiscal 2009 and 2007 each consisted of 52 weeks; fiscal 2008 consisted of 53 weeks.

  (2)

Includes 513, 385 and 47 units offering the WingStreet™ product line, as of fiscal year end 2009, 2008 and 2007, respectively.

Approximately 16%, or $107.9 million, of our fiscal 2009 delivery and carry-out sales were processed by our customer service representatives in five call centers. As of December 29, 2009, substantially all of the delivery and carry-out sales for 214 restaurants were processed by these call centers. In addition, these call centers process overflow delivery and carry-out orders for approximately 688 units that are set up for busy or no answer call forward to the call center.

Pizza Hut, Inc.

PHI is the world’s largest pizza quick service restaurant, or “QSR,” company. As of December 31, 2009, the Pizza Hut brand had approximately 6,000 restaurants and delivery units in the United States and over 5,600 international units in more than 100 other countries, excluding licensed units. Since the first Pizza Hut restaurant was opened in 1958 in Wichita, Kansas, the Pizza Hut brand has become one of the most recognized brands in the restaurant industry.

 

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PHI is owned and operated by Yum! Brands, Inc., or “Yum!” Yum! is the world’s largest QSR company, based on number of units, and as of December 31, 2009, its brands comprised approximately 35,000 units (excluding licensed units) in more than 100 countries and territories. In addition to Pizza Hut, Yum! also owns the restaurant brands Taco Bell, KFC, Long John Silver’s and A&W All-American Food Restaurants. Yum! has global scale capabilities in marketing, advertising, purchasing and research and development, and invests significant time working with the franchise community on all aspects of the business, ranging from new products to new equipment to new management techniques.

Our Products

Pizza Hut restaurants generally provide full table service, carry-out and delivery and a menu featuring pizza, pasta, baked buffalo wings, salads, soft drinks and, in some restaurants, sandwiches and beer. Pizza sales account for approximately 77% of our net product sales. Sales of alcoholic beverages are less than 1% of our net product sales.

Most dough products are made fresh as often as twice per day and only 100% Real cheese products are used. All product ingredients are of a high quality and are prepared in accordance with proprietary formulas established by PHI. We offer a variety of pizzas in multiple sizes with a variety of crust styles and different toppings. With the exception of on-the-go “Personal Pan Pizza” and food served at the luncheon buffet, food products are prepared at the time of order.

The WingStreet™ menu includes bone-in and bone-out fried chicken wings which are tossed in one of eight sauces and are available for dine-in, carry-out and delivery, and is already the largest dedicated wing brand in the U.S., based on number of units. We have approximately 45% of our units operating with the WingStreet™ format at December 29, 2009. Further expansion of this concept within our units is uncertain at this time and will be dependent upon the concept meeting established return criteria and product mix expectations.

New product innovations are vital to the continued success of any restaurant system and PHI maintains a research and development department which develops new products and recipes, tests new procedures and equipment and approves suppliers for Pizza Hut products. All new products are developed by PHI and franchisees are prohibited from offering any other products in their restaurants unless approved by PHI.

Business Growth Strategy

The primary focus of our business growth strategy is to deliver upon the fundamentals of restaurant operational excellence and customer service in our existing markets in order to grow our share of pizza occasions year over year. We intend to augment this basic strategy with (i) opportunistic acquisitions of Pizza Hut restaurants from franchisees or PHI, (ii) the development of new Delco locations within our existing territories as justified by the number of currently unserved households and other relevant demographics and (iii) rebuilding or relocating existing assets to better serve our customers.

Franchise Agreements

On January 1, 2003, we began operating under new franchise agreements with PHI, pursuant to two types of agreements: territory franchise agreements and location franchise agreements. Territory franchise agreements govern the franchise relationship between PHI and us with respect to a specific geographical territory, while location franchise agreements govern the franchise relationship between PHI and us with respect to specified restaurants.

We operate approximately 52% of our units under territory franchise agreements, with the remaining units operating under location franchise agreements.

Territory franchise agreements. Our territory franchise agreements provide us with the exclusive right to develop and operate Pizza Hut restaurants and delivery units within a defined geographic territory, such as a county. We also have the right to develop additional Pizza Hut restaurants and delivery units within our franchise territory. If we fail to develop a franchise territory or provide adequate delivery service as required under our franchise agreements, PHI would have the right to operate or franchise Pizza Hut restaurants in that area. As of December 29, 2009, we had no commitments for future development under any territory franchise agreement. Pursuant to our territory franchise agreements, we are required to pay a royalty rate of 4.0% of sales, as defined in the franchise agreements. The royalty rate for delivery units increased to 4.5% as of January 1, 2010 and will increase to 4.75% as of January 1, 2020 and 5.0% as of January 1, 2030.

Location franchise agreements. Our location franchise agreements provide us with the right to operate a Pizza Hut restaurant at a specific location. For dine-in restaurants, PHI may not develop or franchise a new dine-in restaurant in a geographical circle centered on the restaurant containing 15,000 households and with a radius of at least one mile and no more than ten miles. For Delcos, as long as we provide adequate delivery service to our delivery area, PHI may not provide or license delivery service to any point

 

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within the delivery area. If PHI identifies an opportunity to open a new restaurant, within a Site Specific Market (no Territorial franchisees and no PHI-owned units), and we operate the closest Pizza Hut restaurant, PHI must first offer the new opening opportunity to us. Under our 2003 location franchise agreements, we are required to pay a royalty rate of 6.5% of sales, as defined in the franchise agreements. Completion of a remodel of a dine-in restaurant results in a 1.5% royalty rate reduction. Rebuilds and relocations qualify for a 2.5% reduction of the royalty rate at that location.

Other terms of franchise agreements. The territory franchise agreements are effective until December 31, 2032 and contain perpetual 20-year renewal terms subject to certain criteria. The location franchise agreements are also effective until December 31, 2032 at which time we may renew them at our option for a 20-year term. Pursuant to our franchise agreements, PHI must approve our opening of any new restaurant and the closing of any of our existing restaurants. In addition, the franchise agreements limit our ability to raise equity capital and require approval to effect a change of control. PHI has a right of first refusal to acquire existing Pizza Hut restaurants which we may seek to acquire. The franchise agreements also govern the operation of their respective franchises with respect to issues such as restaurant upkeep, advertising, purchase of equipment, the use of Pizza Hut trademarks and trade secrets, training and assistance, advertising, the purchase of supplies, books and records and employee relations. If we fail to comply with PHI’s standards of operations, PHI has various rights, including the right to terminate the applicable franchise agreement, redefine the franchise territory or terminate our right to establish additional restaurants in a territory. The franchise agreements may also be terminated upon the occurrence of certain events, such as the insolvency or bankruptcy of the Company. At no time during our history has PHI sought to terminate any of our franchise agreements, redefine our territories or otherwise limit our franchise rights.

Franchise agreement asset upgrade requirements. The 2003 location and territory franchise agreements require us to perform facility upgrades to dine-in restaurants constructed before 1998; however, there is no specific provision under the franchise agreements related to required asset activity with respect to our Delco’s. The required asset upgrade is determined based upon a combination of (i) the 2002 sales volume of the individual location, and (ii) the population within a three mile radius. These factors are measured for each location relative to established benchmarks to determine the required asset action for each location. The required asset actions consist of three activity classes (i) partial re-image, (ii) full re-image, and (iii) rebuild, relocate or remodel. The partial re-image is the least costly of the standards and is generally reserved for low-volume, low population density locations. A full re-image is generally required for restaurants with average volumes and low population densities and a rebuild, relocate or remodel is generally required for high volume assets or average volume restaurants with high population densities. We must achieve satisfactory progress in completing these asset activities, as determined at various checkpoints through-out the term of the agreement to remain in compliance. All partial and full re-images were completed by the deadline of September 30, 2009. All rebuild, remodel and relocation activities must be completed by December 31, 2015. We were in full compliance with the upgrade requirements defined in the agreement as of December 29, 2009.

The 2006 location franchise agreement that we executed in conjunction with our acquisition in October 2006 of 39 units from PHI in and around Nashville, TN requires us to bring all assets, including Delco’s in that market, in compliance with PHI’s minimum asset standards and re-image specifications. We have two remaining dine-in assets that are required to have a major asset action (defined as a rebuild, relocate, or remodel) completed by October 2018. We were in full compliance with the upgrade requirements defined in the agreement as of December 29, 2009.

Between December 2008 and February 2009, the Company acquired 294 units under the 2008 location franchise agreement which was amended effective with the acquisition of the units primarily as follows:

 

   

Kansas City. This agreement for 51 units was amended to be substantially similar (including royalty rates) to the 2003 territory franchise agreement. This agreement expires December 31, 2032 and contains perpetual 20-year renewal terms subject to certain criteria. This agreement, as amended, does not require any future development activity but does require that we complete four major asset actions by December 2019 on certain qualifying dine-in assets in the market.

 

   

Florida, Georgia, Iowa, and St. Louis. These agreements were amended to be substantially similar to the 2006 location franchise agreement executed in the Nashville acquisition for the 138 units acquired in Florida, Georgia, and Iowa as a part of the December 9, 2008 acquisition and for the 50 units acquired in St. Louis as a part of the February 17, 2009 acquisition. These agreements expire December 31, 2032 and contain a 20-year renewal term subject to certain criteria with no opportunity for royalty reduction for major asset actions, except for four assets paying royalties of 6.5% that can realize a royalty reduction of 2.5% for a rebuild or relocation or 1.5% for a major remodel if completed by January 1, 2016. These agreements, as amended, do not require any future development activity but do require that we complete 12 major asset actions by December 2019 and nine by February 2020, on certain qualifying dine-in assets in the market and four re-images on system restaurants.

 

   

Denver. Two agreements for 55 units were executed as part of the January 20, 2009 acquisition, which expire December 31, 2032 and contain perpetual 20-year renewal terms subject to certain criteria. For 25 units in the market, an agreement was amended to be substantially similar to the 2006 location franchise agreement executed in the Nashville acquisition. We are required to pay a royalty rate of 6.0% of sales for all asset types during the original term of the agreement with no opportunity for royalty reduction for major asset actions, except for one asset paying royalties of 6.5%, which can realize a royalty reduction of 2.5% for a rebuild or relocation or 1.5% for a major remodel if completed by January 1, 2016. The agreement for the remaining 30 units was amended to be substantially similar to the 2003 territory franchise agreement, paying a royalty rate between 4.0%-4.6% of sales for all asset types. This agreement, as amended, does not require any future development activity but does require that we complete one major asset action by January 2020 on certain qualifying dine-in assets in the market.

 

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WingStreet™ agreement. Effective December 25, 2007, the Company entered into a new agreement (the “WingStreet™ agreement”) with PHI that terminated its prior WingStreet™ franchise agreement addendum, which the Company had operated under since December 16, 2005. This agreement identifies the WingStreet™ concept as a Pizza Hut product line or menu extension that is to be incorporated under the Company’s existing franchise agreements with PHI. The royalty rate paid on WingStreet™ sales is the same as Pizza Hut product sales. The WingStreet™ agreement allows the addition of the less costly WingStreet™ Lite format, as defined in accordance with PHI specifications, to an existing dine-in asset to constitute an approved full re-image under the existing franchise agreements. Further, any assets adding the WingStreet™ product line that have had a qualifying major asset action or re-image will no longer be required to have additional asset upgrades in order to incorporate the product line into their unit. Finally, the WingStreet™ agreement provides that the maximum royalty fee to be charged to a unit that incorporates the WingStreet™ product line should not exceed 6.25% of sales, as defined in the franchise agreements. This rate is a reduction from the exiting royalty rate of 6.5% that is currently being paid on certain Delco units operating under our location franchise agreements.

Our blended average royalty rate as a percentage of total net sales was 4.8% for fiscal 2009, 4.4% for fiscal 2008 and 4.3% for fiscal 2007. The increase for fiscal 2009 was due to higher royalty rates associated with the fiscal 2008 and fiscal 2009 acquisitions.

In connection with the 2006 Transaction, on March 7, 2006, we entered into an amendment to the franchise agreements, which among other things, includes PHI’s consent to the 2006 Transaction and certain restrictions on us, including the requirement that PHI approve the appointment of certain of our officers.

Promotion and Advertising

We spend on average 6% of net product sales on local and national advertising activities. We are required under our franchise agreements to be a member of the International Pizza Hut Franchise Holder’s Association (“IPHFHA”), an independent association of substantially all Pizza Hut franchisees. IPHFHA requires its members to pay dues, which are spent primarily for national advertising and promotion. Dues are 2.5% of gross sales, as defined in the franchise agreement. AdCom, a joint advertising committee, consisting of representatives from PHI and IPHFHA, directs the national advertising campaign. PHI is not a member of IPHFHA, but has agreed to make contributions with respect to those restaurants it owns on a per-restaurant basis to AdCom at the same rate as its franchisees. National advertising represents approximately 40% on average of our advertising expenditures.

In addition, each Pizza Hut restaurant is required pursuant to franchise agreements to contribute dues of 1.75% of gross sales, as defined in the franchise agreement, to advertising cooperatives. The advertising cooperatives control the advertising within designated market areas. As the major operator in most markets, we control the majority of the advertising cooperatives in which we participate. Approximately 83% of our units are in marketing areas in which we control local cooperative advertising. The advertising cooperatives are required to use their funds to purchase broadcast media advertising within the designated marketing areas. All advertisements must be approved by PHI. Our contributions to advertising cooperatives represented approximately 28% of our advertising expenditures during the fiscal year ended December 29, 2009.

Prior to October 1, 2009, NPC was responsible for paying the combined dues noted above for national and cooperative advertising of 4.25% only on gross sales relating to pizza products. However, in conjunction with the national launch of the WingStreet™ product line during the fourth quarter of 2009, we will now contribute dues of 4.25% on gross sales for both pizza and WingStreet™ products. If this change was in effect for all of fiscal 2009, this would have resulted in approximately $0.7 million of additional advertising expense.

 

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For 2008 through 2010, the advertising cooperatives agreed to transfer amounts equal to 0.75% of member gross sales from local advertising to the AdCom for its national advertising campaign, bringing the total national advertising budget to 3.25%. Cooperative members will re-evaluate this transfer of funds annually.

The remaining 32% of our total advertising expenditures were utilized within our discretion for local print marketing, including coupon distribution as well as telephone directory advertising, point of purchase materials, local store marketing and sponsorships.

Supplies and Distribution

We purchase substantially all equipment, supplies and food products required in the operation of our restaurants from suppliers who have been quality assurance approved and audited by PHI. Purchasing is substantially provided by the Unified Foodservice Purchasing Co-op LLC (“UFPC”), a cooperative set up to act as a central procurement service for the operators of Yum! franchises.

Under our direction, our distributor will purchase all products under terms negotiated by the UFPC or another cooperative designated by us. If the product is not available through a UFPC agreement, then our distributor may purchase from another Yum! approved source. Our restaurants take delivery of food supplies about twice a week; some restaurants take delivery once a week to take advantage of contracted discounts.

Information Technology

Our restaurants have a point-of-sale, or “POS,” cash register system. The POS system provides effective communication between the kitchen and the server, allowing employees to serve customers in a quick and consistent manner while maintaining a high level of control. It includes a back office system that provides support for inventory, payroll, accounts payable, cash management, and management reporting functions. The system also helps dispatch and monitor delivery activities in the store. The POS system is fully integrated with order entry systems in our call centers, as well as Pizza Hut’s online ordering site – www.PizzaHut.com. In over half of our restaurants, it includes a kitchen management system, which automatically displays recipes, preparation and cooking instructions for all food items.

Product sales and most expenses are captured through the back office system and transferred directly to our general ledger system for accurate and timely reporting. Management and support personnel have access to on-line reporting systems which provide extensive time critical management data. All corporate computer systems, including laptops, restaurant computers, call centers, and administrative support systems are connected using a wide-area network. This network supports an internal web site, or Portal, for daily administrative functions, allowing us to eliminate paperwork from many functions and accelerate response time.

Competition

The restaurant business is highly competitive with respect to price, service, location, convenience, food quality and presentation, and is affected by changes in taste and eating habits of the public, local and national economic conditions and population and traffic patterns. We compete with a variety of restaurants offering moderately priced food to the public, including other large, national QSRs. Within the QSR pizza segment, we compete directly with Domino’s Pizza, Papa John’s, Cici’s, Little Caesars and numerous locally owned restaurants which offer similar pizza, pasta and sandwich products. We do not compete with other operators in the Pizza Hut system, except for licensed units. More broadly, we also compete in the food purchase industry against supermarkets and others such as Papa Murphy’s who offer “take and bake” pizza products. Consumers have become more value conscious and have reduced discretionary spending in response to high levels of unemployment and other factors. As a result, the frozen pizza and take and bake alternatives are becoming an increasingly intrusive competitive threat in the pizza segment. We believe that other companies can easily enter our market segment, which could result in the market becoming saturated, thereby adversely affecting our revenues and profits. There is also active competition for competent employees and for the type of real estate sites suitable for our restaurants.

Intellectual Property

The trade name “Pizza Hut®,” and all other trademarks, service marks, symbols, slogans, emblems, logos and design used in the Pizza Hut system are owned by PHI. The “WingStreet™” name is a trademark of WingStreet, LLC. All of the foregoing are of material importance to our business and are licensed to us under our franchise agreements for use with respect to the operation and promotion of our restaurants.

 

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Government Regulation

We are subject to various federal, state and local laws affecting our business. Each of our restaurants must comply with licensing and regulation by a number of governmental authorities, which include health, sanitation, safety and fire agencies in the state or municipality in which the restaurant is located. To date, we have not been significantly affected by any difficulty, delay or failure to obtain required licenses or approvals.

A small portion of our net product sales are attributable to the sale of beer. A license is required for each site that sells alcoholic beverages (in most cases, with renewal on an annual basis) and licenses may be revoked or suspended for cause at any time.

Regulations governing the sale of alcoholic beverages relate to many aspects of restaurant operations, including the minimum age of patrons and employees, hours of operation, advertising, wholesale purchasing, inventory control and handling, and storage and dispensing of alcoholic beverages.

We are subject to federal and state laws governing such matters as employment and pay practices, overtime, tip credits and working conditions. The bulk of our employees are paid on an hourly basis at rates related to the federal and state minimum wages. We are also subject to federal and state child labor laws, which, among other things, prohibit the use of certain hazardous equipment by employees 18 years of age or younger. We have not, to date, been materially adversely affected by such laws.

We are also subject to the Americans with Disabilities Act of 1990, or “ADA.” The ADA is a federal law which prohibits discrimination against people with disabilities in employment, transportation, public accommodation, communications and activities of government. In part, the ADA requires that public accommodations, or entities licensed to do business with the public, such as restaurants, are accessible to those with disabilities. We entered into a settlement agreement with the U.S. Department of Justice (“DOJ”) in March 2006, which is scheduled to expire in 2010, that requires us to take certain corrective actions with respect to restaurant facilities owned or leased by us as of March 2006. We believe that we have completed all of our requirements by the deadline of March 1, 2010, subject to approval from the DOJ that we are in full compliance.

Seasonality

The Company typically experiences lower net product sales and net income in the second and third quarters of the year. As a result of these seasonal fluctuations, our operating results may vary substantially between fiscal quarters. Further, results for any quarter are not necessarily indicative of the results that may be achieved for the full fiscal year.

Working Capital Practices

Our working capital was a deficit of $68.2 million as of December 29, 2009, which includes the impact of $31.3 million for our mandatory term loan pre-payment that we are required to pay no later than 120 days after our 2009 fiscal year-end. Like most restaurant companies, we are a cash business with low levels of inventories and accounts receivable. Because our sales are primarily cash and we receive credit from our suppliers, we operate on a net working capital deficit. Further, receivables are not a significant asset in the restaurant business and inventory turnover is rapid; therefore, historically we have used available liquid assets to reduce borrowings under our revolving line of credit. Although not required, we currently pay the next day for certain of our supply purchases in order to take advantage of a prompt-payment discount from our distributor. If we were to utilize the 30 day term of trade credit, it would increase our liquidity by approximately $20.0 million.

Employees

As of December 29, 2009, we had over 25,000 employees, of which approximately 95% were employed on an hourly basis. We are not a party to any collective bargaining agreements and believe our employee relations are satisfactory.

 

Item 1A. Risk Factors

Our business operations and the implementation of our business strategy are subject to significant risks inherent in our business, including, without limitation, the risks and uncertainties described below. The occurrence of any one or more of the risks or uncertainties described below could have a material adverse effect on our financial condition, results of operations and cash flows.

 

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Because these forward-looking statements are based on estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our control or are subject to change, actual results could be materially different.

Changes in consumer discretionary spending and general economic conditions could have a material adverse effect on our business and results of operations.

Purchases at our stores are discretionary for consumers and, therefore, our results of operations are susceptible to economic slowdowns and recessions. Our results of operations are dependent upon discretionary spending by consumers, particularly by consumers living in the communities in which our restaurants are located. A significant portion of our stores are clustered in certain geographic areas. A significant weakening in the local economies of these geographic areas, or any of the areas in which our stores are located, may cause consumers to curtail discretionary spending, which in turn could reduce our store sales and have an adverse effect on our results of operations.

The future performance of the U.S. economy is uncertain and is directly affected by numerous national and global financial and other factors that are beyond our control. Continued high unemployment, increases in credit card, home mortgage and other borrowing costs and continued declines in housing values could further weaken the U.S. economy leading to a further decrease in consumer spending. It is difficult to predict the severity and the duration of the current economic slowdown. We believe that consumers generally are more willing to make discretionary purchases, including at our stores, during periods in which favorable economic conditions prevail. Further, fluctuations in the retail price of gasoline and the potential for future increases in gasoline and other energy costs may affect consumers’ disposable incomes available for dining. Changes in consumer spending habits as a result of a further economic slowdown or a reduction in consumer confidence would likely reduce our sales performance, which could have a material adverse affect on our business, results of operations or financial condition.

It is likely that many of our suppliers and other vendors have been adversely impacted by the economic downturn. The inability of suppliers and vendors to access financing, or the insolvency of suppliers or vendors, could lead to disruptions in our supplies. If we are forced to find alternative suppliers or vendors, that could be a distraction to us and adversely impact our business. In addition, we may be adversely affected if the landlords for our leased restaurant properties encounter financial difficulties as a result of the current economic slowdown.

In addition, the financial crisis has resulted in diminished liquidity and credit availability. We are highly leveraged and our existing substantial leverage coupled with current market conditions could adversely affect our ability to obtain additional debt financing on reasonable terms. Any inability to access debt financing in the future on reasonable terms could materially impact our ability to make acquisitions, refinance our existing indebtedness or materially expand our business.

There can be no assurance that economic and financial market conditions will improve or that consumer confidence will be restored in the near future.

Counterparties to our revolving credit facility and interest rate swaps may not be able to fulfill their obligations due to disruptions in the global credit markets.

In borrowing amounts under our revolving credit facility, we are dependent upon the ability of participating financial institutions to honor draws on the facility. The disruptions in the global credit markets may impede the ability of financial institutions syndicated under our revolving credit facility to fulfill their commitments. Additionally, we have entered into interest rate swap agreements on certain portions of our floating rate debt. We are exposed to losses in the event of nonperformance by counterparties on these instruments.

We could incur substantial losses if one of the third party depository institutions we use in our operations would happen to fail or if the money market funds in which we hold cash were to incur losses.

As part of our business operations, we maintain cash balances at third party depository institutions and in money market funds. The balances held in the money market funds are not insured or guaranteed by the FDIC or any other governmental agency. The balances held in third party depository institutions, to the extent in interest bearing accounts, may exceed the FDIC insurance limits or, with respect to non-interest-bearing transaction deposit accounts, may be held in banks which have opted out of the FDIC’s Temporary Liquidity Guarantee Program. We could incur substantial losses if the underlying financial institutions fail or are otherwise unable to return our deposits or if the money market funds in which we hold cash were to incur losses.

 

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The U.S. Quick Service Restaurant market is highly competitive, and that competition could affect our operating results.

We compete on a broad scale with Quick Service Restaurants, or “QSRs,” and other international, national, regional and local restaurants. The overall food service market generally and the QSR market, in particular, are intensely competitive with respect to price, service, location, personnel and type and quality of food. Other key competitive factors include the number and location of restaurants, quality and speed of service, attractiveness of facilities, effectiveness of advertising and marketing programs, and new product development by PHI and its competitors. In addition, we compete within the food service market and the QSR sector not only for customers, but also for management and hourly employees and suitable real estate sites. If we are unable to maintain our competitive position, we could experience downward pressure on prices, lower demand for our products, reduced margins, the inability to take advantage of new business opportunities and the loss of market share, which would have an adverse effect on our operating results.

Some of our QSR competitors have from time to time attempted to draw customer traffic through deep discounting. In addition, during the first quarter of 2010, we have engaged in more aggressive discounting through our any size, any toppings, any crust pizza for $10 promotion. Although we have seen increases in traffic and sales from our promotion to date, to the extent that we continue this promotion or adopt a new pricing strategy and it is not successful in the future, we may realize decreased revenues, margins, income and cash flow from operations. Should our competitors increase spending on advertising and promotion, or should our advertising and promotion be less effective than our competitors’, there could be a material adverse effect on our operating results.

We are highly dependent on the Pizza Hut system and our success is tied to the success of PHI’s brand strength, marketing campaigns and product innovation.

We are a franchisee of PHI and are highly dependent on PHI for our operations. Due to the nature of franchising and our agreements with PHI, our success is, to a large extent, directly related to the success of the Pizza Hut restaurant system, including the financial condition, management and marketing success of PHI and the successful operation of Pizza Hut restaurants owned by other franchisees. Further, if Yum! Brands Inc. were to reallocate resources away from the Pizza Hut brand in favor of its other brands, the Pizza Hut brand could be harmed, which would have a material adverse effect on our operating results. These strategic decisions and PHI’s future strategic decisions may not be in our best interests and may conflict with our strategic plans.

Our ability to compete effectively depends upon the success of the management of the Pizza Hut system; for example, we depend on PHI’s introduction of innovative products, promotions and advertising to differentiate us from our competitors, drive sales and maintain the strength of the Pizza Hut brand. If PHI fails to introduce successful innovative products and launch effective marketing campaigns, our sales may suffer. As a result, any failure of the Pizza Hut system to compete effectively would likely have a material adverse effect on our operating results.

Under our franchise agreements with PHI, we are required to comply with operational programs and standards established by PHI. In particular, PHI maintains discretion over the menu items that we can offer in our restaurants. If we fail to comply with PHI’s standards of operations, PHI has various rights, including the right to terminate the applicable franchise agreement, redefine the franchise territory or terminate our right to establish additional restaurants in a territory. The franchise agreements may also be terminated upon the occurrence of certain events, such as the insolvency or bankruptcy of the Company. If any of our franchise agreements were terminated or any of our franchise rights were limited, our business, financial condition and results of operations would be harmed.

PHI must also approve the acquisition or opening of any new restaurant and the closing of any of our existing restaurants. Therefore, PHI could limit our ability to expand our operations through acquisitions and require us to continue operating underperforming units. In addition, the franchise agreements limit our ability to raise equity capital and require approval to effect a change of control.

Adverse media reports on restaurant segment or brand could adversely affect consumer demand and our results.

Adverse media reports on our segment of the restaurant industry, such as pizza, or restaurants operating under a particular brand, can have an almost immediate and significant adverse impact on companies operating in that segment or restaurants using that brand, even though they have personally not engaged in the conduct being publicized. Such sensationalist media topics could include food borne illness, food contamination, unsanitary conditions or discriminatory behavior. If such a situation were to arise in the pizza segment or with respect to the brand we franchise, consumer demand for the food products we sell and our results of operations could be adversely affected, regardless of our lack of ownership of the relevant locations where the incidents may have occurred.

 

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Increases in food, labor and other costs could adversely affect our profitability and operating results.

An increase in our operating costs could adversely affect our profitability. Factors such as inflation, including but not limited to, increased food costs, increased labor and employee benefit cost and increased energy costs may adversely affect our operating costs. Additionally, significant increases in gasoline prices could result in a decrease of customer traffic at our units and increased operating costs. Most of the factors affecting cost are beyond our control and, in many cases, we may not be able to pass along these increased costs to our customers. Most ingredients used in our pizza, particularly cheese, dough and meat, which are the largest components of our food costs, are subject to significant price fluctuations as a result of seasonality, weather, demand and other factors. While we have developed strategies to mitigate or partially offset the impact of higher commodity costs, there can be no assurances such measures will be successful. In addition, no assurances can be given that the magnitude and duration of these cost increases or any future cost increases will not have a larger adverse impact on our profitability and consolidated financial position than currently anticipated.

The estimated increase in our food costs from a hypothetical $0.10 adverse change in the average cheese block price per pound would have been approximately $3.9 million in 2009, without giving effect to the UFPC directed hedging programs. In addition, our participation in the food hedging programs directed by the UPFC may hedge less than half of our cheese prices and therefore may not adequately protect us from price fluctuations.

Wage rates for a substantial number of our employees are at or slightly above the minimum wage. As federal and/or state minimum wage rates increase, we may need to increase not only the wage rates of our minimum wage employees but also the wages paid to the employees at wage rates which are above the minimum wage, which will increase our costs. Legislation was passed to increase certain states’ minimum wage rates. Further, in May 2007, the United States Congress passed a bill, which was signed into law, to increase the federal minimum wage rate per hour as follows: from $5.15 to $5.85 effective July 24, 2007; $6.55 effective July 24, 2008 and $7.25 effective July 24, 2009. The federal tipped wage rate remained unchanged at $2.13 per hour.

Additionally, potential changes in federal labor laws, including the possible enactment of the Employee Free Choice Act (“EFCA”), could result in portions of our workforce being subjected to greater organized labor influence. The EFCA, also referred to as the “card check” bill, if passed in its current form could significantly change the nature of labor relations in the United States, specifically, how union elections and contract negotiations are conducted. Although we do not currently have union employees, the EFCA could impose more requirements and union activity on our business, thereby potentially increasing our costs, and could have a material adverse effect on our business, results of operations and financial condition.

Shortages or interruptions in the supply or delivery of food products could adversely affect our operating results.

We are dependent on frequent deliveries of food products that meet our specifications at competitive prices. Shortages or interruptions in the supply of food products caused by unanticipated demand, problems in production or distribution, disease or food-borne illnesses, inclement weather or other conditions could adversely affect the availability, quality and cost of ingredients, which would adversely affect our business. In particular, if our distributor fails to meet its service requirements for any reason, it could lead to a material disruption of service or supply until a new distributor is engaged, which could have a material adverse effect on our business. Likewise, all of our cheese is purchased from a single supplier, the loss of which could have a material adverse effect on our business.

Our systems may fail, be damaged or be perceived to be insecure. Further, if we do not maintain the security of customer-related information, we could damage our reputation with customers, incur substantial additional costs and become subject to litigation.

Our operations are dependent upon the successful and uninterrupted functioning of our computer and information systems. Our systems could be exposed to damage or interruption from fire, natural disaster, power loss, telecommunications failure, unauthorized entry and computer viruses. System defects, failures and interruptions could result in:

 

   

additional development costs;

 

   

diversion of technical and other resources;

 

   

loss of customers and sales;

 

   

loss of customer data;

 

   

negative publicity;

 

   

harm to our business and reputation; and,

 

   

exposure to litigation claims, fraud losses or other liabilities.

 

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To the extent we rely on the systems of third parties in areas such as credit card processing, telecommunications and wireless networks, any defects, failures and interruptions in such systems could result in similar adverse effects on our business. Sustained or repeated system defects, failures or interruptions could materially impact our operations and operating results. Also, if we are unsuccessful in updating and expanding our systems, our ability to increase same store sales, improve operations, implement cost controls and grow our business may be constrained.

As do most retailers, we receive certain personal information about our customers. In addition, our online operations at www.pizzahut.com depend upon the secure transmission of confidential information over public networks, including information permitting cashless payments. A compromise of our security systems that results in customer personal information being obtained by unauthorized persons could adversely affect our reputation with our customers and others, as well as our operations, results of operations, financial condition and liquidity, and could result in litigation against us or the imposition of penalties. In addition, a security breach could require that we expend significant additional resources related to our information security systems and could result in a disruption of our operations. Any well-publicized compromise of security could deter people from conducting transactions that involve transmitting confidential information to our systems. Therefore, it is critical that our facilities and infrastructure remain secure and are perceived to be secure. Despite the implementation of security measures, our infrastructure may be vulnerable to physical break-ins, computer viruses, programming errors, attacks by third parties or similar disruptive problems.

Changing health or dietary preferences may cause consumers to avoid products offered by us in favor of alternative foods.

A significant portion of our sales is derived from products, including pizza, which can contain high levels of fat, carbohydrates, and sodium and may be considered harmful to the health of consumers. The foodservice industry is affected by consumer preferences and perceptions. If prevailing health or dietary preferences and perceptions cause consumers to avoid pizza and other products we offer in favor of alternative or healthier foods, demand for our products may be reduced and our business would be harmed. If PHI does not continually develop and successfully introduce new menu offerings that appeal to changing consumer preferences or if we do not timely capitalize on new products, our operating results will suffer.

Moreover, because we are primarily dependent on a single product, if consumer demand for pizza should decrease, our business would suffer more than if we had a more diversified menu, as many other food service businesses do.

Events reported in the media, such as incidents involving food-borne illnesses, food tampering or other concerns, whether or not accurate, can cause damage to the Pizza Hut brand and swiftly affect our sales and profitability.

Reports of food-borne illnesses (such as e-coli, mad cow disease, hepatitis A, trichinosis or salmonella) and injuries caused by food tampering have in the past severely injured the reputations of participants in the QSR segment and could in the future affect us as well. Anything that damages the Pizza Hut reputation or brand could immediately and severely hurt system-wide sales and, accordingly, our revenues, even if unrelated to any of our franchises. If our customers become ill from food-borne illnesses, we could also be forced to temporarily close some restaurants. We cannot guarantee that our operational controls and employee training will be effective in preventing food-borne illnesses and other food safety issues that may affect our restaurants. Food-borne illness incidents could be caused by food suppliers and transporters and, therefore, would be outside of our control.

Failure to successfully implement our growth strategy could harm our business.

We may continue to grow our business by opening and selectively acquiring Pizza Hut restaurants. We may not be able to achieve our growth objectives and these new restaurants may not be profitable. The opening and success of restaurants we may open or acquire in the future depends on various factors, including:

 

   

our ability to obtain the necessary approvals from PHI;

 

   

our ability to obtain or self-fund adequate development financing;

 

   

competition from other QSRs in current and future markets;

 

   

our degree of saturation in existing markets;

 

   

the identification and availability of suitable and economically viable locations;

 

   

our ability to successfully integrate acquired locations;

 

   

sales levels at existing restaurants;

 

   

the negotiation of acceptable lease or purchase terms for new locations;

 

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permitting and regulatory compliance;

 

   

the ability to meet construction schedules;

 

   

our ability to hire and train qualified management and other personnel; and

 

   

general economic and business conditions.

In addition, the QSR pizza market is mature with limited opportunity for unit growth. If we are unable to successfully implement our growth strategy, our revenue growth and profitability may be adversely affected.

Some restaurants constructed or acquired in the future may be located in areas where we have little or no meaningful operating experience. Those markets may have different competitive conditions, consumer tastes and discretionary spending patterns than our existing markets, which may cause our new restaurants to be less successful than restaurants in our existing markets or to incur losses. Restaurants opened in new markets may open at lower average weekly sales volumes than restaurants opened in existing markets, and may have higher restaurant-level operating expense ratios than in existing markets. Sales at restaurants opened in new markets may take longer to reach average unit volumes, if at all, thereby adversely affecting our operating results.

Local conditions, events, and natural disasters could adversely affect our business.

Certain of the regions in which our units are located have been, and may in the future be, subject to adverse local conditions, events or natural disasters, such as earthquakes and hurricanes. Depending upon its magnitude, a natural disaster could severely damage our stores or call centers, which could adversely affect our business, financial condition and operations. We currently maintain property and business interruption insurance through our aggregate property policy for each of our stores. However, in the event of a significant natural disaster or other cataclysmic occurrence, our coverage may not be sufficient to offset all property damages and lost sales. In addition, upon the expiration of our current policies, adequate coverage may not be available at economically justifiable rates, if at all.

Changes in geographic concentration and demographic patterns may negatively impact our operations.

The success of any restaurant depends in substantial part on its location. There can be no assurance that our current locations will continue to be attractive as demographic patterns change. Neighborhood or economic conditions where restaurants are located could change in the future, thus resulting in potentially reduced sales in those locations.

A significant number of our restaurants are located in the Midwest, South and Southeast and in non-metro and mid-metro areas. As a result, a severe or prolonged economic recession or changes in demographic mix, employment levels, population density, weather patterns, real estate market conditions or other factors unique to those geographic regions may adversely affect us more than some of our competitors that are located in other regions or in more urban areas.

We are subject to all of the risks associated with owning and leasing real estate.

As of December 29, 2009, we owned the land and/or the building for 21 restaurants and leased the land and/or building for 1,128 restaurants. Accordingly, we are subject to all of the risks generally associated with owning and leasing real estate, including changes in the investment climate for real estate, demographic trends and supply or demand for the use of the restaurants, as well as potential liability for environmental contamination.

The majority of our existing lease terms end within the next two to seven years. We have the ability to exercise lease options to extend the terms at virtually all of these locations. If an existing or future store is not profitable, and we decide to close it, we may nonetheless be committed to perform our obligations under the applicable lease including, among other things, paying the base rent for the balance of the lease term. Our obligation to continue making rental payments in respect of leases for closed restaurants could have a material adverse effect on our business and results of operations. In addition, as each of our leases expires, we may be subject to increased rental costs or may fail to negotiate renewals, either on commercially acceptable terms or at all. If we are unable to renew our restaurant leases, we may be forced to close or relocate a restaurant, which could subject us to construction and other costs and risks, and could have a material adverse effect on our business and results of operations.

We depend on the service of key individuals, the loss of which could materially harm our business.

Our success will depend, in part, on the efforts of our executive officers and other key employees. In addition, the market for qualified personnel is competitive and our future success will depend on our ability to attract and retain these personnel. We do not have employment agreements with any of our executive officers, other than our chief executive officer and our chief financial officer,

 

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and we do not maintain key-person insurance for any of our officers, employees or members of our Board of Directors. We may not be able to negotiate the terms of renewals of any existing employment agreements on terms favorable to us or at all. The loss of the services of any of our key employees or the failure to attract and retain employees could have a material adverse effect on our business, results of operations and financial condition.

Our current insurance policies may not provide adequate levels of coverage against all claims.

We believe that we maintain insurance coverage that is customary for businesses of our size and type. 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. Moreover, there are types of losses we may incur that cannot be insured against or that we believe are not commercially reasonable to insure such as trade name restoration coverage associated with losses like food borne illness and Avian flu. Any such inadequacy of or inability to obtain insurance coverage could have a material adverse effect on our business, financial condition and results of operations.

In addition, we self-insure a significant portion of expected losses under our workers’ compensation, employee medical, general liability, auto and non-owned auto programs. Reserves are recorded based on our estimates of the ultimate costs to resolve or settle incurred claims, both reported and unreported. If our reserves were inadequate to cover costs associated with resolving or settling claims associated with these programs, or if a judgment substantially in excess of our insurance coverage is entered against us, our financial condition and cash flow could be adversely affected.

Our annual and quarterly financial results may fluctuate depending on various factors, including seasonality of the business, many of which are beyond our control.

Our sales and operating results can vary from quarter to quarter and year to year depending on various factors, which include:

 

   

variations in timing and volume of our sales;

 

   

sales promotions by us and our competitors;

 

   

changes in average same store sales and customer visits;

 

   

variations in the price, availability and shipping costs of our supplies;

 

   

timing of holidays or other significant events; and

 

   

changes in competitive and economic conditions generally.

Certain of the foregoing events may directly and immediately decrease demand for our products, and therefore, may result in an adverse affect on our results of operations and cash flow.

In addition, the Company typically experiences lower net sales in the second and third quarters of the year. As a result of these seasonal fluctuations, our operating results may vary substantially between fiscal quarters.

We face risks associated with litigation from customers, franchisees, employees and others in the ordinary course of business.

Claims of illness or injury relating to food quality or food handling are common in the food service industry. In addition, class action lawsuits have been filed, and may continue to be filed, against various QSRs alleging, among other things, that they have failed to disclose the health risks associated with high-fat foods and that their marketing practices have encouraged obesity. In addition to decreasing our sales and profitability and diverting our management resources, adverse publicity or a substantial judgment against us could negatively impact Pizza Hut’s brand reputation, hindering our ability to grow our business.

Further, we may be subject to employee and other claims in the future based on, among other things, discrimination, harassment, wrongful termination and wage, rest break and meal break issues, including those relating to overtime compensation. These types of claims, as well as other types of lawsuits to which we are subject from time to time, can distract our management’s attention from our business operations. We have been subject to these types of claims, and if one or more of these claims were to be successful, or if there is a significant increase in the number of these claims, our business, financial condition and results of operations could be adversely affected.

In addition, since certain of our restaurants serve alcoholic beverages, we are subject to “dram shop” statutes. These statutes generally allow a person injured by an intoxicated person to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated person. Litigation against restaurant chains has resulted in significant judgments and settlements under dram shop statutes. Because such a plaintiff seeks punitive damages, which may not be covered by insurance, such litigation could

 

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have an adverse impact on our financial condition and results of operations. Regardless of whether any claims against us are valid or whether we are liable, claims may be expensive to defend and may divert time and money away from our operations and hurt our performance. A judgment significantly in excess of our insurance coverage could have a material adverse effect on our financial condition or results of operations. Further, adverse publicity resulting from these allegations may materially affect us and our restaurants.

PHI may not be able to adequately protect its intellectual property, which could harm the value of the Pizza Hut brand and branded products and adversely affect our business.

The success of our business depends on our continued ability to use PHI’s existing trademarks, service marks and other components of the Pizza Hut brand in order to increase brand awareness and further develop our branded products. We have no control over the Pizza Hut brand. If PHI does not adequately protect the Pizza Hut brand, our competitive position and operating results could be harmed.

We are not aware of any assertions that the trademarks or menu offerings we license from PHI infringe upon the proprietary rights of third parties, but third parties may claim infringement by us in the future. Any such claim, whether or not it has merit, could be time-consuming, result in costly litigation, cause delays in introducing new menu items in the future or require us to enter into royalty or licensing agreements. As a result, any such claim could have a material adverse effect on our business and operating results.

We are subject to extensive government and industry regulation, and our failure to comply with existing or increased regulations could adversely affect our business and operating results.

We are subject to extensive federal, state and local laws and regulations, including those relating to:

 

   

the preparation and sale of food;

 

   

liquor licenses which allow us to serve alcoholic beverages;

 

   

building and zoning requirements;

 

   

environmental protection;

 

   

minimum wage, overtime and other labor requirements;

 

   

compliance with the Americans with Disabilities Act of 1990;

 

   

industry regulation regarding credit card information;

 

   

reporting of credit card information;

 

   

working and safety conditions; and,

 

   

federal and state regulations governing the operations of franchises, including rules promulgated by the Federal Trade Commission.

In 2006 we reached a settlement with the U.S. Department of Justice regarding alleged violations of the ADA at our restaurants. Additionally, in recent years there has been an increased legislative, regulatory and consumer focus on nutrition and advertising practices in the food industry, particularly among QSRs. As a result, we may become subject to regulatory initiatives in the area of nutrition disclosure or advertising, such as requirements to provide information about the nutritional content of our food, which could increase our expenses. We may become subject to legislation or regulation seeking to tax and/or regulate high-fat foods. If we fail to comply with existing or future 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.

Our results of operations could be adversely affected by increased costs as a result of changes in laws relating to health care.

The federal government and several state governments have proposed or adopted legislation regarding health care, including legislation that in some cases requires employers to either provide health care coverage to their employees or pay into a fund that would provide coverage for them. This type of legislation would likely increase our costs and could have a material adverse effect on our business, results of operations and financial condition. We are currently evaluating the effects on our business of the Patient Protection and Affordable Care Act, which was signed into law on March 23, 2010.

 

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Failure by us to establish, maintain and apply effective internal control over financial reporting in accordance with the rules of the SEC could harm our business and operating results and/or result in a loss of investor confidence in our financial reports, which could have a material adverse effect on our business.

Beginning with the year ended December 25, 2007 and thereafter, we were required to comply with Section 404 of the Sarbanes-Oxley Act, and for fiscal 2010 we will have to obtain an annual attestation from our independent registered public accounting firm regarding our internal control over financial reporting. Failure to comply with Section 404 or the report by us of a material weakness may cause investors to lose confidence in our financial statements. If we fail to remedy any material weakness, our financial statements may be inaccurate and we may face restricted access to the capital markets.

Federal, state and local environmental regulations relating to the use, storage, discharge, emission and disposal of hazardous materials could expose us to liabilities, which could adversely affect our results of operations.

We are subject to a variety of federal, state and local environmental regulation relating to the use, storage, discharge, emission and disposal of hazardous materials. We own and lease numerous parcels of real estate on which our restaurants are located.

Failure to comply with environmental laws could result in the imposition of severe penalties or restrictions on operations by governmental agencies or courts of law that could adversely affect our operations. Also, if contamination is discovered on properties owned or operated by us, including properties we own or operated in the past, we can be held liable for severe penalties and costs of remediation. These penalties could adversely affect our consolidated results of operations.

Our substantial leverage could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our variable rate debt (exclusive of hedging agreements) and prevent us from meeting our debt obligations.

We are highly leveraged. As of December 29, 2009, our total funded indebtedness was $433.7 million. We had an additional $58.9 million available at that date for borrowing under the revolving credit facility of our senior secured credit facility. The following table shows our level of indebtedness and certain other information as of December 29, 2009:

 

     As of
December 29, 2009
 
     (in millions, except
percentages)
 

Floating rate debt(1)

   $ 78.7   

Fixed rate debt

     355.0   
        

Total debt

     433.7   

Shareholders’ equity

     158.6   
        

Total capitalization

   $ 592.3   
        

Ratio of total debt to total capitalization

     73.2

 

(1)        The floating rate debt included in the table above is reduced by $180.0 million, which is the total notional amount of the floating-to-fixed rate interest rate swaps at December 29, 2009, and is included in fixed rate debt. This subsequently amortized to $150.0 million on December 31, 2009 based on the swap’s amortization schedule, thereby increasing floating rate debt by $30.0 million to $108.7 million.

           

Our high degree of leverage could have important consequences, including:

 

   

making it more difficult for us to make payments on our Senior Subordinated Notes (“Notes”);

 

   

increasing our vulnerability to general economic and industry conditions;

 

   

requiring a substantial portion of cash flows from operating activities to be dedicated to the payment of principal and interest on our indebtedness, therefore reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities;

 

   

exposing us to interest rate risk as certain of our borrowings, including borrowings under our senior secured credit facility;

 

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restricting us from making strategic acquisitions or causing us to make non-strategic divestitures;

 

   

limiting our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions and general corporate or other purposes; and

 

   

limiting our ability to adjust to changing market conditions and placing us at a competitive disadvantage compared to our competitors who are less highly leveraged.

We may be able to incur substantial additional indebtedness in the future, subject to the restrictions contained in our senior secured credit facility and the indenture governing the Notes. If new indebtedness is added to our current debt levels, the related risks that we now face could intensify.

In addition, we have substantial obligations under our operating leases relating to a substantial portion of our retail facilities as well as our regional offices. For fiscal 2009, our minimum required operating lease payments were approximately $50.8 million.

Our debt agreements contain restrictions that limit our flexibility in operating our business.

Our senior secured credit facility and the indenture governing the Notes contain various covenants that limit our ability to engage in specified types of transactions. These covenants limit our ability to, among other things:

 

   

incur additional indebtedness or issue certain preferred shares;

 

   

pay dividends on, redeem or repurchase our capital stock or make other restricted payments;

 

   

make investments;

 

   

create certain liens;

 

   

sell certain assets;

 

   

incur obligations that restrict the ability of our subsidiaries to make dividend or other payments to us;

 

   

guarantee indebtedness;

 

   

engage in transactions with affiliates; and

 

   

consolidate, merge or transfer all or substantially all of our assets.

In addition, under our senior secured credit facility, we are required to satisfy and maintain specified amortizing financial ratios and other financial condition tests. Our ability to meet those financial ratios and tests can be affected by events beyond our control, and we may be unable to meet those ratios and tests. A breach of any of these covenants could result in a default under our senior secured credit facility. Upon the occurrence of an event of default under our senior secured credit facility, the lenders could elect to declare all amounts outstanding under our senior secured credit facility to be immediately due and payable and terminate all commitments to extend further credit. If we were unable to repay those amounts, the lenders under our senior secured credit facility could proceed against the collateral granted to them to secure that indebtedness. We have pledged a significant portion of our assets as collateral under our senior secured credit facility.

Future acquisitions, depending on the size, may require borrowings beyond those available on our existing revolving credit facility and therefore may require further utilization of the remaining additional term loan borrowing capacity under our credit facility as well as other sources of debt or additional equity capital. Recent changes in the financial and credit markets may impair our ability to obtain additional debt financing at costs similar to that of our current credit facility, if at all. If the Company were to access additional debt financing beyond our revolving credit facility to sustain our capital resource growth, it is anticipated that any such additional financing may be at higher costs than the Company’s currently outstanding borrowings under its existing credit facility. In addition any utilization of the remaining additional term loan borrowing capacity under our existing credit facility may result in a reset of the interest rate on our existing term loan borrowings, which may increase our borrowing costs based on current market conditions.

 

Item 1B. Unresolved Staff Comments.

None.

 

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Item 2. Properties.

The following table sets forth certain information regarding restaurants operated by the Company as of December 29, 2009.

 

     Units in
Operation

Dec. 29, 2009
    

Alabama

   101   

Arkansas

   59   

Colorado

   55   

Delaware

   10   

Florida

   135   

Georgia

   83   

Idaho

   33   

Illinois

   53   

Indiana

   4   

Iowa

   59   

Kansas

   33   

Kentucky

   23   

Louisiana

   16   

Maryland

   2   

Minnesota

   6   

Mississippi

   70   

Missouri

   80   

North Carolina

   39   

North Dakota

   14   

Oklahoma

   23   

Oregon

   26   

South Carolina

   5   

South Dakota

   21   

Tennessee

   90   

Texas

   16   

Virginia

   88   

Washington

   4   

West Virginia

   1   
       
   1,149   
       

As of December 29, 2009, we leased approximately 98% of our restaurant properties, as indicated below. The majority of our existing lease terms end within the next two to seven years. We have the ability to exercise lease extension options, which exist in a majority of our leases, for a period of generally one to five years. All leased properties are owned by unaffiliated entities. Our 2009 base rent for continuing operations was approximately $49.8 million and contingent rents were approximately $1.0 million.

 

Restaurants in Operation as of December 29, 2009

    
     Own    Lease    Total   

Red Roof

   13    172    185   

RBD

   7    522    529   

Delco and other

   1    434    435   
                 
   21    1,128    1,149   
                 

The Company operated 1,149 restaurants as of December 29, 2009, which were located in buildings either owned or leased by us. The distinctive Pizza Hut red roof is the identifying feature of Pizza Hut restaurants throughout the world. Pizza Hut restaurants historically have been built according to identification specifications established by PHI relating to exterior style and interior décor. Variations from such specifications are permitted only upon request and if required by local regulations or to take advantage of specific opportunities in a market area. Property sites range from 10,000 to 80,000 square feet. Typically, Red Roof and RBD units range from 1,800 to 5,600 square feet, including a kitchen area, and have seating capacity for 70 to 125 persons. Delco units range from 800 to 3,000 square feet.

We own our restaurant service center office in Pittsburg, Kansas, containing approximately 46,000 square feet of commercial office space. We also own our 12,000 square foot principal executive office building in Overland Park, Kansas.

 

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We currently lease from third parties office space for eleven of our regional offices (which includes shared space with one territory office), one of our territory offices and five call centers.

 

Item 3. Legal Proceedings.

On May 12, 2009, a lawsuit against the Company, entitled Jeffrey Wass, et al. v. NPC International, Inc., Case No. 2:09-CV-2254-JWL-KGS, was filed in the United States District Court for the District of Kansas. A First Amended Complaint, entitled Jeffrey Wass and Mark Smith, et al. v. NPC International, Inc., was filed on July 2, 2009. The Complaint was brought by Plaintiffs Wass and Smith individually and on behalf of similarly situated employees who work or previously worked as delivery drivers for NPC. The First Amended Complaint alleged a collective action under the Fair Labor Standards Act (FLSA) to recover unpaid wages and excessive deductions owed to plaintiffs and similarly situated workers employed by NPC in 28 states, and as a class action under Colorado law on behalf of Plaintiff Smith and all other similarly situated workers employed by NPC in Colorado to recover unpaid minimum wages and excess payroll deductions and certain costs relating to uniforms and special apparel. The First Amended Complaint alleged among other things that NPC deprived plaintiffs and other NPC delivery drivers of minimum wages by providing insufficient reimbursements for automobile and other job-related expenses incurred for the purposes of delivering NPC’s pizza and other food items. On March 2, 2010, the Court entered an Order granting NPC’s motions for judgment on the pleadings as to all claims brought by plaintiffs in the First Amended Complaint, with the exception of a claim for the reimbursement of uniform costs under Colorado law. The Order provided that the claims failed to state a claim under the FLSA and Colorado law and, therefore, would be dismissed with prejudice unless plaintiffs filed a Second Amended Complaint that cured the deficiencies in the First Amended Complaint. The Order also operated to moot plaintiffs’ then-pending motion for conditional collective action certification.

Plaintiffs filed a Second Amended Complaint on March 22, 2010, which alleges a collective action under the FLSA on behalf of plaintiffs and similarly situated workers employed by NPC in 28 states, and a class action under Rule 23 of the Federal Rules of Civil Procedure on behalf of Plaintiff Smith and similarly situated workers employed in states in which the state minimum wage is higher than the federal minimum wage. The Second Amended Complaint contends that NPC deprived delivery drivers of minimum wages by providing insufficient reimbursements for automobile expenses incurred for the purposes of delivering NPC’s pizza and other food items. NPC intends to file a motion to dismiss and for judgment on the pleadings as to all claims set forth in the Second Amended Complaint, which motion will be filed on or before April 8, 2010. As a result, at this time the Company is not able to predict the outcome of the lawsuit, any possible loss or possible range of loss associated with the lawsuit or any potential effect on the Company’s business, results of operations or financial condition. However, the Company believes the lawsuit is wholly without merit and will defend itself from these claims vigorously.

 

Item 4. Reserved.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

There is no established public trading market for any class of common equity of the Company. There is one holder of record of the outstanding shares of common stock of the Company. The Company did not pay any dividends on the common stock in fiscal year 2009 or 2008. The Company’s debt facilities include limitations on the Company’s ability to pay cash dividends on the common stock.

The Company did not issue or sell any equity securities during fiscal 2009 that were not registered under the Securities Act of 1933, as amended.

 

Item 6. Selected Financial Data

The selected consolidated financial data set forth below should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited consolidated financial statements and notes to the financial statements of NPC, which can be found in Item 8.

As a result of the 2006 Transaction, purchase accounting adjustments were made to underlying assets and liabilities based on the appraisal associated with the valuation of certain assets and liabilities. The primary impact to the post-2006 Transaction income statement as a result of the application of purchase accounting included an increase in the amortization and depreciation expense associated with the adjustments to franchise rights and facilities and equipment based upon the estimates of fair value and management’s estimate of the remaining useful lives of the subject assets. The 2006 Transaction resulted in higher debt levels and related interest accruals and increased capitalized debt issue costs which resulted in higher interest expense during the post-transaction periods.

Due to the impact of the changes resulting from the purchase accounting adjustments as a result of the 2006 Transaction, the statement of operations data presentation separates our results into two periods: (1) the period ending with May 2, 2006, the day preceding the consummation of the 2006 Transaction (“Predecessor”) and (2) the period beginning on May 3, 2006 utilizing the new basis of accounting (“Successor”). The results are further separated by a heavy black line to indicate the effective date of the new basis of accounting. Similarly, the current and prior period amounts presented under restaurant operating data and consolidated balance sheet data are separated by a heavy black line to indicate the application of a new basis of accounting between the periods presented. All amounts are in thousands, except restaurant operating data, and all periods have been adjusted to reflect the effect of discontinued operations (See Note 3 to the Consolidated Financial Statements).

 

                                  Predecessor  
     52 Weeks
ended

Dec. 29,
2009
    53 Weeks
ended

Dec. 30,
2008(1)
    52 Weeks
ended
Dec. 25,
2007
    34 Weeks
ended
Dec. 26,
2006
         18 Weeks
ended
May 2,
2006
    52 Weeks
ended
Dec. 27,
2005
 

Consolidated Statements of Income (Loss):

               

Sales:

               

Net product sales

   $ 845,074      $ 666,829      $ 594,634      $ 342,160           $ 189,093      $ 527,162   

Fees and other income

     37,391        22,860        16,620        9,651             5,405        13,981   
                                                     

Total sales

     882,465        689,689        611,254        351,811             194,498        541,143   

Costs and expenses:

                 

Cost of sales

     226,676        188,703        160,862        90,339             48,129        141,494   

Direct labor

     262,298        189,002        168,445        97,289             51,968        146,230   

Other restaurant operating expenses

     291,640        216,465        194,017        115,815             58,243        164,805   

General and administrative expenses

     48,883        40,991        37,131        23,528             23,841        31,200   

Corporate depreciation and amortization of intangibles

     11,761        9,753        9,279        6,135             2,007        6,086   

Other

     1,955        773        (16     (395          (107     (2,837
                                                     

Total costs and expenses

     843,213        645,687        569,718        332,711             184,081        486,978   
                                                     

Operating income

     39,252        44,002        41,536        19,100             10,417        54,165   

Other income (expense):

                 

Interest expense

     (31,266     (33,843     (38,015     (25,306          (3,744     (14,630

Loss on early termination of debt

     —          —          —          —               (11,306     —     

 

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Miscellaneous

           (7     3        85             (690     (577
                                                     

Income (loss) before income taxes

     7,986        10,152        3,524        (6,121          (5,323     38,958   

Income tax (benefit)(3) expense

     (2,463     2,628        (360     (2,956          —          —     
                                                     

Income (loss) from continuing operations

     10,449        7,524        3,884        (3,165          (5,323     38,958   

(Loss) income from discontinued operations, net of taxes

     (59     (25,578     3,886        2,042             3,706        8,330   
                                                     

Net income (loss)

   $ 10,390      $ (18,054   $ 7,770      $ (1,123        $ (1,617   $ 47,288   
                                                     
 

Restaurant Operating Data:

                 

Number of restaurants (at period end)

     1,149 (2)      1,056 (2)      777        726             704        702   

Same store net product sales index

     (10.2 )%      2.0     3.5     (4 )           (4 )      3.2 %(5) 

Working capital(5)

   $ (68,238   $ (42,532   $ (40,844   $ (31,464        $ (172,038 )(6)    $ (48,563
 

Consolidated Balance Sheet Data:

                 

Total assets(5)

   $ 829,324      $ 839,515      $ 829,959      $ 805,702           $ 406,420      $ 411,201   

Total debt (including current portion)(5)

   $ 433,710      $ 453,804      $ 430,500      $ 431,700           $ 136,346      $ 130,185   

_____________________

 

(1)

The fiscal year ended December 30, 2008 includes 53 weeks of operations as compared with 52 weeks for all other years presented. We estimate the additional, or 53rd week, added approximately $14.5 million of net product sales in 2008.

(2)

We acquired 288 units during the fourth quarter of 2008 and 105 units during the first quarter of 2009.

(3)

We elected to adopt subchapter S filing status effective January 1, 2003, at which time we became a “flow-through” entity for federal income tax purposes. In connection with the 2006 Transaction, we converted to a C Corporation filing status and have become subject to state and federal income taxes.

(4)

Comparable store sales for the 52 weeks ended December 26, 2006 were 0.0% and were not impacted by the purchase accounting adjustments.

(5)

Amounts were not adjusted for discontinued operations.

(6)

Working capital at May 2, 2006 included $127,346 of current portion of long-term debt due to the 2006 Transaction.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Cautionary Statement Regarding Forward Looking Information

This report includes forward-looking statements regarding, among other things, our plans, strategies, and prospects, both business and financial. All statements contained in this document other than current or historical information are forward-looking statements. Forward-looking statements include, but are not limited to, statements that represent our beliefs concerning future operations, strategies, financial results or other developments, and may contain words and phrases such as “may,” “expect,” “should,” “anticipate,” “intend,” or similar expressions. Because these forward-looking statements are based on estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our control or are subject to change, actual results could be materially different. Although we believe that our plans, intentions and expectations reflected in or suggested by these forward-looking statements are reasonable, we cannot assure you that we will achieve or realize these plans, intentions or expectations. Forward-looking statements are inherently subject to risks, uncertainties and assumptions. Important factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to, the risk factors described in Item 1A, Risk Factors.

Consequently, such forward-looking statements should be regarded solely as our current plans, estimates and beliefs. We do not intend, and do not undertake, any obligation to update any forward looking statements to reflect future events or circumstances after the date of such statements.

Introduction

As you read this section, please refer to our Consolidated Financial Statements and accompanying notes found in Item 8. Our Consolidated Statements of Income (Loss) show our operating results for the fiscal years ended December 29, 2009, December 30, 2008 and December 25, 2007. In this section, we analyze and explain the significant annual changes of specific line items in the Consolidated Statements of Income (Loss). We also suggest you read Item 1A, “Risk Factors” which will help your understanding of our financial condition, liquidity and operations.

Overview

Who We Are. We are the largest Pizza Hut franchisee and the largest franchisee of any restaurant concept in the United States according to the 2009 “Top 200 Restaurant Franchisees” by Franchise Times. We were founded in 1962 and, as of December 29, 2009 we operated 1,149 Pizza Hut units in 28 states with significant presence in the Midwest, South and Southeast. As of the end of fiscal 2009, our operations represented approximately 19% of the domestic Pizza Hut restaurant system and 21% of the domestic Pizza Hut franchised restaurant system as measured by number of units, excluding licensed units which operate with a limited menu and no delivery in certain of our markets.

Our Fiscal Year. We operate on a 52- or 53-week fiscal year ending on the last Tuesday in December. Fiscal years 2009 and 2007 each contained 52 weeks. Fiscal year 2008 contained 53 weeks.

Acquisitions and Dispositions. Between September 2008 and February 2009 we acquired 294 Pizza Hut units from Pizza Hut, Inc. (“PHI”) for approximately $87.9 million and 99 units for $36.2 million from another Pizza Hut franchisee. During this same time period, we also sold 112 units to PHI for approximately $37.8 million as part of an asset sale and purchase agreement. These acquisitions were funded through our revolving credit facility, the issuance of a $40.0 million term loan, proceeds from sale of units to PHI and cash on hand.

As a result of the sale of units in 2008 and the sale of units in 2009, which were classified as held for sale at December 30, 2008, our Consolidated Statements of Income (Loss) for all years presented have been adjusted to remove the operations of the 2008 and 2009 sold units which were reclassified as discontinued operations. Also included in discontinued operations for the fiscal year ended December 30, 2008 was the loss on the sale of those units. The amounts presented throughout, except where otherwise indicated, relate to continuing operations only.

Our Sales

Net Product Sales. Net product sales are comprised of sales of food and beverages from our restaurants, net of discounts. In fiscal 2009, pizza sales accounted for approximately 77% of net product sales. Sales of alcoholic beverages are less than 1% of our net product sales. Various factors influence sales at a given unit, including customer recognition of the Pizza Hut brand, our level of service and operational effectiveness, pricing, marketing and promotional efforts and local competition. Several factors affect our sales in any period, including the number of stores in operation, comparable store sales and seasonality. “Comparable store sales” refer to period-over-period net product sales comparisons for stores under our operation for at least 12 months.

 

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Fees and Other Income. Fees and other income are comprised primarily of delivery fees charged to customers, vending receipts and other fee income and are not included in our comparable store sales metric.

Store Openings and Closures. Store openings, acquisitions, divestitures, relocations and closures affect period-over-period comparisons. In addition to growth through new store openings and acquisitions, stores that do not meet our operating performance or image criteria are either rebuilt, relocated or closed without replacement. The table below shows the number of stores operated during the 52 weeks ended December 29, 2009. At December 29, 2009, 513 stores included the WingStreet™ product line compared to 385 units offering WingStreet™ at December 30, 2008:

 

     52 Weeks Ended
December 29, 2009
 

Beginning of period

   1,098   

Sold(1)

   (42

Developed(2)

   5   

Acquired(3)

   105   

Closed(2) (3)

   (17
      

End of period

   1,149   
      

(1)        Units were included in held for sale at December 30, 2008.

(2)        For the 52 weeks ended December 29, 2009 four units were relocated or rebuilt, and are included in both the developed and closed totals above.

(3)        Includes one unit acquired that was closed immediately upon purchase.

        

         

        

Comparable Store Sales/Sales Growth. The primary driver of sales growth in fiscal 2009 was a 41.7% increase in equivalent units (the number of units open at the beginning of a given period, adjusted for units opened, closed, acquired or sold during the period on a weighted average basis) largely due to a net acquisition of 281 operating units during 2008 and 2009 (units in operation acquired, less units sold) which was partially offset by a decline in comparable store sales of 10.2%.

The following table summarizes the quarterly comparable store sales results in fiscal 2009 and 2008 for stores in continuing operations:

 

2009

   Quarter 1     Quarter 2     Quarter 3     Quarter 4     Fiscal Year  

Comparable store sales decline

   (5.0 )%    (12.6 )%    (12.9 )%    (10.5 )%    (10.2 )% 

 

2008

   Quarter 1     Quarter 2     Quarter 3     Quarter 4     Fiscal Year  

Comparable store sales growth (decline)

   0.4   7.2   4.5   (3.4 )%    2.0

Seasonality. Our business is seasonal in nature with lower net product sales and operating income in the second and third fiscal quarters. Sales are largely driven by product innovation, advertising and promotional activities and can be adversely impacted by holidays and economic times that generally negatively impact consumer discretionary spending, such as the back to school season. As a result of these seasonal fluctuations, our operating results may vary substantially between fiscal quarters. Further, results for any quarter are not necessarily indicative of the results that may be achieved for the full fiscal year.

Our Costs

Our operating costs and expenses are comprised of cost of sales, direct labor, other restaurant expenses and general and administrative expenses. Our cost structure is highly variable with approximately 70% of operating costs variable to sales and volume of transactions.

Cost of sales. Cost of sales includes the cost of food and beverage products sold, less rebates from suppliers, as well as paper and packaging, and is primarily influenced by fluctuation in commodity prices. Historically, our cost of sales has primarily been comprised of the following: cheese: 30-35%; dough: 16-19%; meat: 13-17%; and packaging: 8-10%. These costs can fluctuate from year-to-year given the commodity nature of the cost category, but are constant across regions. We are a member of the UFPC, a cooperative set up to act as a central procurement service for the operators of Yum! Brands, Inc. restaurants, and participate in various

 

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cheese hedging and procurement programs that are directed by the UFPC for cheese, meat and certain other commodities to help reduce the price volatility of those commodities from period-to-period. Based on information provided by the UFPC, the UFPC expects to hedge approximately 30% to 50% of the Pizza Hut system’s anticipated cheese purchases for fiscal year 2010 through a combination of derivatives taken under the direction of the UFPC.

Direct Labor. Direct labor includes the salary, payroll taxes, fringe benefit costs and workers’ compensation expense associated with restaurant based personnel. Direct labor is highly dependent on federal and state minimum wage rate legislation given that the vast majority of our workers are hourly employees. To control labor costs, we are focused on proper scheduling and adequate training and testing of our store employees, as well as retention of existing employees.

Other restaurant operating expenses. Other restaurant operating expenses include all other costs directly associated with operating a restaurant facility, which primarily represents royalties, advertising, rent and depreciation (facilities and equipment), utilities, delivery expenses, supplies, repairs, insurance, and other restaurant related costs.

Included within other restaurant operating expenses are royalties paid to PHI, which will be impacted in the future as follows. For delivery units currently operating under the Company’s existing franchise agreements and currently paying a 4.0% royalty rate, the franchise agreements provide for future increases in the royalty rates to be paid. The first such increase occurred in certain delivery units effective January 1, 2010, when royalty rates increased by 0.5% of sales to 4.5% or approximately $0.6 million of additional royalty expense for fiscal 2010. Effective January 1, 2020, royalty rates for these delivery units are scheduled to increase to 4.75% and, effective January 1, 2030, these rates will increase to 5.0%.

Our blended average royalty rate as a percentage of total net sales was 4.8% for fiscal 2009, 4.4% for fiscal 2008 and 4.3% for fiscal 2007. The increase for fiscal 2009 was due to higher royalty rates associated with the fiscal 2008 and fiscal 2009 acquisitions.

General and administrative expenses. General and administrative expenses include field supervision and personnel costs and the corporate and administrative functions that support our restaurants, including employee wages and benefits, travel, information systems, recruiting and training costs, professional fees, supplies, insurance and bank service and credit card transaction fees.

Trends and Uncertainties Affecting Our Business

We believe that as a franchisee of such a large number of Pizza Hut restaurants, our financial success is driven less by variable factors that affect regional restaurants and their markets, and more by trends affecting the food purchase industry – specifically the QSR industry. The following discussion describes certain key factors that may affect our future performance.

General Economic Conditions and Consumer Spending

Continued high unemployment rates, declining home values and sales, the negative impact of changes in the credit markets, and low consumer confidence as a result of the changes within the economic environment have caused the consumer to experience a real and perceived reduction in disposable income which has negatively impacted consumer spending in most segments of the restaurant industry, including the segment in which we compete. We believe these economic trends and the resulting negative impact on consumer discretionary spending priorities are the primary causes of our lower comparable store sales.

Competition

The restaurant business is highly competitive. The QSR industry is a fragmented market, with competition from national and regional chains, as well as independent operators, which affects pricing strategies and margins. Additionally, the frozen pizza and take-and-bake alternatives are becoming an increasingly intrusive competitive threat in the pizza segment. Limited product variability within our segment can make differentiation among competitors difficult. Thus, companies in the industry continuously promote and market new product introductions, price discounts and bundled deals, and rely heavily on effective marketing and advertising to drive sales.

Commodity Prices

Commodity prices of packaging products (liner board) and ingredients such as cheese, dough (wheat), and meat, can vary. The prices of these commodities can fluctuate throughout the year due to changes in supply and demand. Our costs can also fluctuate as a result of changes in ingredients or packaging instituted by Pizza Hut. Overall, our total commodity costs were lower during fiscal 2009 than the prior year; such decreases more than offset the higher costs associated with Pizza Hut’s ingredient reformulation and packaging redesign in 2009.

 

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The block cheese price for fiscal 2009 averaged $1.29 per pound, a decrease of $0.57 or 31% versus the average price for fiscal year 2008, additionally, average dough costs declined 14% compared to the prior year. Our average costs of packaging and meat increased during fiscal 2009 by 20% and 5%, respectively, as compared to the prior year, primarily due to higher costs associated with packaging design and product ingredient reformulation.

Labor Costs

The restaurant industry is labor intensive and known for having a high level of employee turnover given low hourly wages and the part-time composition of the workforce. Direct labor is highly dependent on federal and state minimum wage rate legislation given the vast majority of workers are hourly employees whose compensation is either determined or influenced by the minimum wage rate. There has been legislation passed to increase certain states’ minimum wage rates. This has resulted in incremental direct labor expense which we have attempted to mitigate through pricing initiatives, productivity improvement in our restaurants, better overall wage management tactics and other auxiliary cost reduction strategies. Further, in May 2007, the United States Congress passed a bill, which was signed into law, to increase the federal minimum wage rate per hour as follows: from $5.15 to $5.85 effective July 24, 2007; $6.55 effective July 24, 2008 and $7.25 effective July 24, 2009. The federal tipped wage rate remained unchanged at $2.13 per hour. The expected impact on our direct labor costs for these changes is described below under “Inflation and Deflation.”

Additionally, potential changes in federal labor laws, including the possible enactment of the Employee Free Choice Act (“EFCA”), could result in portions of our workforce being subjected to greater organized labor influence. The EFCA, also referred to as the “card check” bill, if passed in its current form could significantly change the nature of labor relations in the United States, specifically, how union elections and contract negotiations are conducted. Although we do not currently have union employees, the EFCA could impose more requirements and union activity on our business, thereby potentially increasing our costs, and could have a material adverse effect on our business, results of operations and financial condition.

Inflation and Deflation

Inflationary factors, such as increases in food and labor costs, directly affect our operations. Because most of our employees are paid on an hourly basis, changes in rates related to federal and state minimum wage and tip credit laws will affect our labor costs. In our comparable units (excluding discontinued operations), the aforementioned state minimum wage rates increased our direct labor expense by approximately $0.7 million during fiscal 2009. Some of the states with indexed minimum wage rates, which impacts 9% of our units, have reported that there will be no increase in minimum wage rates for 2010. Further, the impact to our direct labor costs (which affects 93% of our units) of the federal minimum wage increases effective July 24, 2009 and July 24, 2008 were approximately $3.9 million during fiscal 2009. We estimate the rollover impact of the July 24, 2009 increase to be approximately $2.8 million for 2010. We are not always able to offset higher food, labor, fuel and other costs with price increases.

If the economy experiences deflation, which is a persistent decline in the general price level of goods and services, we may suffer a decline in revenues as a result of the falling prices. In that event, given our fixed costs and minimum wage requirements, it is unlikely that we would be able to reduce our costs at the same pace as any declines in revenues. Consequently, a period of prolonged or significant deflation would likely have a material adverse effect on our business, results of operations and financial condition. Similarly, if we reduce the prices we charge for our products as a result of continuing declines in same store sales or competitive pressures, we may suffer decreased revenues, margins, income and cash flow from operations.

Critical Accounting Policies and Estimates

Our reported results are impacted by the application of certain accounting policies that require us to make subjective or complex judgments about matters that are uncertain and may change in subsequent periods, resulting in changes to reported results.

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The following policies could be deemed critical and require us to make judgments and estimates.

 

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Long-lived assets. The Company reviews long-lived assets related to each unit quarterly for impairment or whenever events or changes in circumstances indicate that the carrying amount of a unit’s leasehold improvements may not be recoverable. The Company evaluates these leasehold improvements using a “two year history of cash flow losses” at the unit as the primary indicator of potential impairment. Based on the best information available, impaired leasehold improvements are written down to estimated fair market value, which becomes the new cost basis. Personal property is reviewed for impairment using the closure of the unit as an indicator of impairment. Personal property that is not transferred to another unit is written down to its estimated fair market value. Additionally, when a commitment is made to close a unit beyond the quarter in which the closure commitment is made, any remaining leasehold improvements and all personal property are reviewed for impairment and depreciable lives are adjusted. However, if actual results are not consistent with our estimates and assumptions, we may be exposed to an impairment charge that could be material.

Intangible assets. Franchise rights and other intangible assets with finite lives are amortized over their useful lives using the straight-line method. Each reporting period we evaluate whether events and circumstances warrant a revision to the remaining estimated useful life of each intangible asset. If we were to determine that events and circumstances warrant a change to the estimate of an intangible asset’s remaining useful life, then the remaining carrying amount of the intangible asset would be amortized prospectively over that revised remaining useful life. As of December 29, 2009 we had $414.2 million in intangible assets (see Note 5 of the Notes to Consolidated Financial Statements – Goodwill and Other Intangible Assets) of which $408.7 million were franchise rights.

Additionally, if an indicator of impairment exists, the results of the designated marketing area (DMA) that supports the franchise rights are reviewed to determine whether the carrying amount of the asset is recoverable based on an undiscounted cash flow method. The underlying estimates of cash flows are developed using historical results projected over the remaining term of the agreements. The estimate of fair value is highly subjective and requires significant judgment related to the estimate of the magnitude and timing of future cash flows. A change in events or circumstances, including a decision to hold an asset or group of assets for sale, a change in strategic direction, or a change in the competitive environment could adversely affect the fair value of the business, which could have a material impact on our results of operations and financial condition.

Accounting for Goodwill. The Company has one operating segment and reporting unit for purposes of evaluating goodwill for impairment. Goodwill was $191.7 million and $188.5 million as of December 29, 2009 and December 30, 2008, respectively.

Goodwill primarily originated with the 2006 Transaction. Additional goodwill was recorded in connection with multiple acquisitions by us of Pizza Hut units since 2006.

We evaluate goodwill for impairment annually and at any other date when events or changes in circumstances indicate that potential impairment is more likely than not and that the carrying amount of goodwill may not be recoverable.

The goodwill impairment test involves a two-step process. The first step is a comparison of the reporting unit’s fair value to its carrying value. If the carrying value exceeds fair value, goodwill is considered potentially impaired and we must complete the second step of the goodwill impairment test. Under step two, the implied fair value of the reporting unit’s goodwill is compared with the carrying amount of the reporting unit’s goodwill. If the carrying amount of goodwill is greater than the implied fair value of goodwill, an impairment loss would be recognized in an amount equal to the excess. The implied fair value of goodwill is calculated in the same manner as the amount of goodwill that is recognized in a business combination by allocating fair value to all assets and liabilities (both recognized and unrecognized). The difference between the fair value and the sum of the amounts that are assigned to recognized and unrecognized assets and liabilities is the implied value of goodwill.

Three calculation methodologies are considered when determining fair value of the reporting unit: the asset approach, the market approach and the income approach. The asset approach was not used as we have significant intangible value that is dependent on our cash flow. The market approach was not used due to deficiencies in the quality and quantity of comparable company data. The income approach explicitly recognizes that the current value of an investment or asset is premised upon the expected receipt of future economic benefits. When applied to a business ownership interest, a value indication is developed by discounting expected cash flows to their present value at a rate of return that incorporates the risk-free rate for the use of the funds, the expected rate of inflation, and the risk associated with the particular investment. The discount rate selected is generally based on the rates of return available from alternative investments of similar type and quality as of the valuation date. The discounted cash flow method provides an indication of value by discounting future net cash flows available for distribution to their present worth at a rate that reflects both the current requirement of the market and the risk inherent in the specific investment. The income approach was used to determine our fair value.

 

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Management judgment is a significant factor in determining whether an indicator of impairment has occurred. Management relies on estimates in determining the fair value of each reporting unit, which include the following critical quantitative factors:

Anticipated future cash flows and terminal value for the reporting unit. The income approach to determining fair value relies on the timing and estimates of future cash flows, including an estimate of terminal value. The projections use management’s estimates of economic and market conditions over the projected period including growth rates in sales and estimates of expected changes in operating margins. Our projections of future cash flows are subject to change if actual results are achieved that differ from those anticipated. We do not expect actual results to vary such that there would be a material change to the estimated fair value of our reporting unit.

Selection of an appropriate discount rate. The income approach requires the selection of an appropriate discount rate, which is based on a weighted average cost of capital analysis. The discount rate is subject to changes in short-term interest rates and long-term yield as well as variances in the typical capital structure of marketplace participants in the quick service restaurant industry. The discount rate is determined based on assumptions that would be used by marketplace participants, and for that reason, the capital structure of selected marketplace participants was used in the weighted average cost of capital analysis. Given the current volatile economic conditions, it is possible that the discount rate could change.

We completed our annual impairment testing during the second quarter of 2009 and determined that goodwill was not impaired. A key assumption in our fair value estimate using the income approach is the discount rate. We selected a weighted average cost of capital of 10.6%. We noted that an increase in the weighted average cost of capital greater than 40 basis points would result in a reduction in fair value that may require us to complete step two of the goodwill impairment test.

Business Combinations. We allocate the purchase price of an acquired business to its identifiable assets and liabilities based on estimated fair values. The excess of the purchase price over the amount allocated to the assets and liabilities, if any, is recorded as goodwill.

We use all available information to estimate fair values including the fair value determination of identifiable intangible assets such as franchise rights, and any other significant assets or liabilities. We adjust the preliminary purchase price allocation, as necessary, up to one year after the acquisition closing date when information that is known to be available or obtainable is obtained.

Our purchase price allocation methodology contains uncertainties because it requires management to make assumptions and to apply judgment to estimate the fair value of acquired assets and liabilities. Management estimates the fair value of assets and liabilities based upon quoted market prices, the carrying value of the acquired assets and widely accepted valuation techniques, including discounted cash flows. Unanticipated events or circumstances may occur which could affect the accuracy of our fair value estimates, including assumptions regarding industry economic factors and business strategies. See Note 2 of the Notes to Consolidated Financial Statements for a discussion of the allocation of the purchase price for acquisitions in fiscal years 2009 and 2008.

Self-insurance accruals. We operate with a significant self-insured retention of expected losses under our workers’ compensation, employee medical, general liability, auto, and non-owned auto programs. We purchase third party coverage for losses in excess of the normal expected levels. Accrued liabilities have been recorded based on our estimates of the ultimate costs to settle incurred claims, both reported and unreported, subject to the Company’s retentions. Provisions for losses expected under the workers’ compensation, general liability and auto programs are recorded based upon estimates of the aggregate liability for claims incurred utilizing independent actuarial calculations based on historical results. However, if actual settlements or resolutions under our insurance program are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material.

A 10% change in our self-insured liabilities estimates would have affected net earnings by approximately $2.1 million for the fiscal year ended December 29, 2009.

Accounting for Derivatives. The Company participates in interest rate related derivative instruments to manage its exposure on its debt instruments. The Company records all derivative instruments on the balance sheet as either assets or liabilities measured at fair value. The calculation of the fair value of the interest rate related derivative instruments is based on estimates of future interest rates and consideration of risk of nonperformance, which may change based on economic or other factors. Changes in the fair value of these derivative instruments are recorded either through current earnings or as other comprehensive income, depending on the type of hedge designation. Gains and losses on derivative instruments designated as cash flow hedges are reported in other comprehensive income and reclassified into earnings in the periods in which earnings are impacted by the hedged item.

 

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Recently Issued Accounting Statements and Pronouncements

See Note 1 to the Consolidated Financial Statements for new accounting standards, including the expected dates of adoption and estimated effects on our consolidated financial statements.

Outlook for First Quarter of 2010

As a result of the negative comparable store sales in 2009, we have focused upon giving the consumer a combination of attractive pricing, abundance and choice, primarily through our any size, any toppings, any crust pizza for $10 promotion, in order to improve sales results. Our stores have generally experienced improved sales and traffic through the first quarter of fiscal 2010. Currently, we expect to generate positive comparable store sales of around 10% for the first quarter of 2010 based upon our experience to date. Although we believe that our marketing strategy has been successful to date, there can be no assurance that such success will continue.

Results of Operations-Adjusted for Discontinued Operations

The table below presents selected restaurant operating results as a percentage of net product sales for the 52 weeks ended December 29, 2009, the 53 weeks ended December 30, 2008 and the 52 weeks ended December 25, 2007, respectively:

 

     52 Weeks
Ending
Dec. 29, 2009
    53 Weeks
Ending
Dec. 30, 2008
    52 Weeks
Ended
Dec. 25, 2007
 

Net product sales

   100.0   100.0   100.0

Direct restaurant costs and expenses

      

Cost of sales

   26.8   28.3   27.1

Cost of labor

   31.0   28.3   28.3

Other restaurant operating expenses

   34.5   32.5   32.6

Fiscal 2009 Compared to Fiscal 2008-Adjusted for Discontinued Operations

Net Product Sales. Net product sales for the 52 weeks ended December 29, 2009 compared to the 53 weeks ended December 30, 2008 were $845.1 million and $666.8 million, respectively, an increase of $178.3 million or 26.7% resulting largely from a 41.7% increase in equivalent units due to acquisitions and development which was partially offset by a decrease in comparable store sales of 10.2%, while rolling over last year’s comparable store sales increase of 2.0%. We believe that the decline in comparable store sales was largely due to the impact of the recession and the resulting negative impact on consumer discretionary spending priorities.

Fiscal 2009 included 52 weeks of operations as compared with 53 weeks for fiscal 2008. We estimate that the additional, or 53rd week, added approximately $14.5 million of net product sales in 2008.

Fees and Other Income. Fees and other income were $37.4 million for the 52 weeks ended December 29, 2009, compared to $22.9 million for the 53 weeks ended December 30, 2008, for an increase of 63.6%. The increase was primarily due to higher customer delivery charge income as a result of delivery transactions in our acquisition units.

Cost of Sales. Cost of sales was $226.7 million for the 52 weeks ended December 29, 2009, compared to $188.7 million for the 53 weeks ended December 30, 2008, for an increase of $38.0 million or 20.1%. Cost of sales decreased 150 basis points (“bps”), as a percentage of net product sales, to 26.8%, compared to 28.3% in the prior year. This decrease was primarily due to a 9% decrease in cheese costs (net of UFPC hedging effect) and a 14% decrease in dough costs. These decreases were partially offset by a 20% increase in packaging costs and a 5% increase in meat ingredient costs (primarily due to the 2009 Pizza Hut package design changes and ingredient reformulation) compared to the prior year. A modest shift in product mix accounted for the remainder of the overall reduction in cost of sales as a percentage of net product sales versus the prior year.

Direct Labor. Direct labor costs were $262.3 million for the 52 weeks ended December 29, 2009, compared to $189.0 million for the 53 weeks ended December 30, 2008, an increase of $73.3 million or 38.8%. Direct labor costs as a percentage of net product sales were 31.0% for fiscal 2009, a 270 basis point increase compared to the prior year. Labor costs as a percent of net product sales increased by approximately 220 bps primarily due to the de-leveraging impact on fixed and semi-fixed labor costs as a result of the comparable store sales decline and to a lesser extent federal minimum wage increases (190 bps) and increased health insurance costs due to adverse claims development (30 bps). The remaining 50 bps increase was primarily due to higher acquisition-unit labor costs which were a result of higher delivery sales mix in these units which is more labor intensive than other occasions, higher average wage rates and general labor inefficiencies due to acquisition integration and training.

 

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Other Restaurant Operating Expenses. Other restaurant operating expenses for the 52 weeks ended December 29, 2009 were $291.6 million compared to $216.5 million for the 53 weeks ended December 30, 2008, an increase of $75.1 million or 34.7%. Other restaurant operating expenses increased 200 bps as a percent of net product sales, to 34.5% for fiscal 2009 compared to 32.5% for the prior year. Approximately 120 bps of the increase was due to the economics of the acquisition units, which caused an increase in our royalty expense (40 bps), higher depreciation expense associated with purchase accounting asset values (40 bps), higher delivery driver reimbursement expenses due to a higher delivery mix (30 bps) and outsourced call center expenses for a certain acquisition market (20 bps) which were partially offset by lower rent (10 bps). The remaining net variance of 80 bps was largely due to the de-leveraging impact on fixed and semi-fixed costs due to the comparable store sales decline consisting primarily of occupancy costs (90 bps), depreciation (50 bps) and advertising (20 bps). These increases were partially offset by a decline in delivery driver reimbursement expenses for comparable stores due to lower fuel prices (30 bps), lower store level bonuses (30 bps) and lower delivery driver insurance costs (20 bps).

Depreciation expense for store operations was $39.1 million or 4.6% of net product sales for the year-to-date period of 2009 compared to $24.8 million or 3.7% of net product sales for the prior year.

General and Administrative Expenses. General and administrative expenses for the 52 weeks ended December 29, 2009 were $48.9 million compared to $41.0 million for the prior year, an increase of $7.9 million or 19.3%. As a direct result of the 2009 and 2008 acquisitions, general and administrative expenses increased approximately $10.7 million, consisting of increased field supervisory personnel costs of $6.1 million, increased credit card transaction fees of $4.0 million and acquisition integration training costs of $0.6 million. These increases were partially offset by lower on-going operational training, bonus and profit sharing expenses and one less week of expenses in fiscal 2009 as compared to the prior year.

Corporate Depreciation and Amortization. Corporate depreciation and amortization costs for the 52 weeks ended December 29, 2009 were $11.8 million compared to $9.8 million for the prior year. The increase over the prior year is largely due to increased franchise rights amortization as a result of the 2008 and 2009 acquisitions which was partially offset by decreased pre-opening expenses related to 41 WingStreet™ product line conversions in 2009 as compared to 153 during 2008.

Other. We recorded expense of $2.0 million and $0.8 million for other expenses for the fiscal periods of 2009 and 2008, respectively. Included in this category were facility impairment charges of $1.4 million and direct acquisition costs of $0.6 million which are required to be expensed under accounting guidance for business combinations effective for fiscal year 2009.

Interest Expense. Interest expense was $31.3 million for the 52 weeks ended December 29, 2009 compared to $33.8 million for the prior year, a decrease of $2.5 million. The decrease is largely due to lower interest rates as compared to the prior year, despite higher average debt levels and the extra week in fiscal 2008. Lower interest rates decreased our cash borrowing rate by 0.9% to 6.5% during fiscal 2009 compared to fiscal 2008 and our average outstanding debt balance increased $18.4 million to $445.7 million in 2009 as compared to the prior year. Interest expense included $2.1 million and $1.8 million for amortization of deferred debt issuance costs for fiscal 2009 and fiscal 2008, respectively.

Income Taxes. For the 52 weeks ended December 29, 2009, we recorded an income tax benefit of $2.5 million or (30.8)% compared to tax expense of $2.6 million or 25.9% for the prior year. During 2009, we recorded a net tax benefit of $1.9 million associated with the change in the liability for uncertain tax positions consisting of the release of liabilities due to the lapse of applicable statutes of limitations which was partially offset by additional interest and penalties accrued. Additionally, we recorded $0.6 million of income tax benefit related to state tax rate changes. Excluding the favorable impact of these items our effective tax rate would have been 0.5%. In addition to these items the decline in rate from 2008 is related to the impact of higher jobs related tax credits in 2009 in relation to net income.

Income from Continuing Operations, net of taxes. Income from continuing operations for the 52 weeks ended December 29, 2009 was $10.4 million, compared to $7.5 million for the prior year. The increase was primarily due to the benefit of a 26.7% increase in net product sales, increased customer delivery charge income, lower commodity costs, an income tax benefit and lower interest expense, which were partially offset by increases in restaurant operating expenses, direct labor and general and administrative expenses.

Loss from Discontinued Operations, net of taxes. Loss from discontinued operations was $0.1 million in fiscal 2009 compared to $25.6 million in 2008. In December 2008, we completed the sale of 70 units to PHI for $18.8 million in cash. As a result

 

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of this sale, we recognized a pre-tax loss included in discontinued operations of $27.4 million in 2008. Also, in December 2008, we entered into an agreement to sell 42 units to PHI for $19.0 million in cash. The sale of these units was completed in January 2009. These units were classified as held for sale at December 30, 2008 and we recorded a $17.2 million pre-tax loss to reduce the carrying amount of these units to fair value. The total after-tax loss on the sale of these units was $30.3 million and was included in discontinued operations. Net income related to these units was $4.7 million for fiscal 2008.

Fiscal 2008 Compared to Fiscal 2007-Adjusted for Discontinued Operations

Net Product Sales. Net product sales for the 53 weeks ended December 30, 2008 compared to the 52 weeks ended December 25, 2007 were $666.8 million and $594.6 million, respectively, an increase of $72.2 million or 12.1% resulting largely from a 7.2% increase in equivalent units due to acquisitions and development and an increase in comparable store sales of 2.0%, while rolling over last year’s comparable store sales increase of 3.5%. Fiscal 2008 included 53 weeks of operations as compared with 52 weeks for fiscal 2007. We estimate the additional, or 53rd week, added approximately $14.5 million of net product sales in 2008.

Fees and Other Income. Fees and other income were $22.9 million for the 53 weeks ended December 30, 2008, compared to $16.6 million for the 52 weeks ended December 25, 2007, for an increase of 37.5%. The increase was primarily due to customer delivery charge increases effective July 2008, in conjunction with the federal minimum wage increase, which were preceded by modest increases in most markets during the second quarter of fiscal 2008, and increased equivalent units.

Cost of Sales. Cost of sales was $188.7 million for the 53 weeks ended December 30, 2008, compared to $160.9 million for the 52 weeks ended December 25, 2007, for an increase of $27.8 million or 17.3%. Cost of sales increased 120 bps, as a percentage of net product sales, to 28.3%, compared to 27.1% in the prior year. The increase was primarily due to increases in the following commodity costs: 8% for cheese costs (net of UFPC hedging benefits), 24% for dough, 10% for meat, 7% for packaging and 59% for vegetable oil. The impact of these overall increases was partially offset by pricing initiatives.

Direct Labor. Direct labor costs were $189.0 million for the 53 weeks ended December 30, 2008, compared to $168.4 million for the 52 weeks ended December 25, 2007, an increase of $20.6 million or 12.2%. Direct labor costs as a percentage of net product sales were 28.3% for both fiscal 2008 and fiscal 2007. The positive impact of sales leverage achieved on fixed labor costs and effective labor management strategies offset higher wage rates caused largely by federal and certain state minimum wage increases and higher workers’ compensation expense.

Other Restaurant Operating Expenses. Other restaurant operating expenses for the 53 weeks ended December 30, 2008 were $216.5 million compared to $194.0 million for the 52 weeks ended December 25, 2007, an increase of $22.5 million or 11.6%. Other restaurant operating expenses decreased 10 bps as a percent of net product sales, to 32.5% for fiscal 2008 compared to 32.6% for the prior year. The decrease of expenses as a percentage of net product sales compared to the prior year was primarily due to lower depreciation expense associated with short-lived assets becoming fully depreciated during the second quarter of 2007 without replacement, and lower delivery driver reimbursement expenses related to changes in our delivery driver reimbursement program in the second quarter of 2007. Depreciation expense for store operations was $24.8 million or 3.7% of net product sales for fiscal 2008 compared to $25.4 million or 4.3% of net product sales for fiscal 2007. These decreases were mostly offset by increased utilities and increased delivery driver insurance costs due to adverse claims development and activity.

General and Administrative Expenses. General and administrative expenses for the 53 weeks ended December 30, 2008 were $41.0 million compared to $37.1 million in the prior year. General and administrative expenses increased approximately $3.9 million compared to the prior year primarily due to increased credit card fees attributable to increased transaction volume, increased salaries expense and higher field personnel and recruiting expenses. The extra week in fiscal 2008 also contributed to the year-over-year increase.

Corporate Depreciation and Amortization. Corporate depreciation and amortization costs for the 53 weeks ended December 30, 2008 were $9.8 million compared to $9.3 million for the prior year. The increase over the prior year is largely due to increased pre-opening expenses related to the addition of the WingStreet™ product line at 153 units in 2008.

Net Facility Impairment Charges. We recorded charges of $0.6 million for 16 properties during the 53 weeks ended December 30, 2008 and $0.7 million for 23 properties during the 52 weeks ended December 25, 2007.

Loss (Gain) on Disposition of Assets. Loss on asset dispositions was $0.1 million for the 53 weeks ended December 30, 2008 compared to a gain of $0.7 million for the 52 weeks ended December 25, 2007.

 

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Interest Expense. Interest expense was $33.8 million for the 53 weeks ended December 30, 2008 compared to $38.0 million for the prior year, a decrease of $4.2 million despite the extra week in fiscal 2008, primarily due to lower interest rates and lower average debt levels as compared to the prior year. Lower interest rates decreased our cash borrowing rate by 0.9% to 7.4% during fiscal 2008 compared to fiscal 2007 and our average outstanding debt balance decreased $5.4 million to $427.3 million in 2008 as compared to the prior year. Interest expense included $1.8 million and $2.2 million for amortization of deferred debt issuance costs for fiscal 2008 and fiscal 2007, respectively.

Income Taxes. For the 53 weeks ended December 30, 2008, we recorded income tax expense on continuing operations of $2.6 million which resulted in an effective income tax rate of 25.9% compared to an effective tax rate of (10.2)% or $0.4 million benefit for the 52 weeks ended December 25, 2007. The rate increase as compared to the prior year is primarily attributable to higher income before taxes in relation to the impact of high tax credits.

Income from Continuing Operations, net of taxes. Income from continuing operations for the 53 weeks ended December 30, 2008 was $7.5 million, compared to $3.9 million for the 52 weeks ended December 25, 2007. The increase was primarily due to the benefit of a 12.1% increase in net product sales, increased customer delivery charge income, reduced depreciation and amortization expense and lower interest expense which were partially offset by increases in commodity costs, general and administrative expenses and income tax expense.

(Loss) Income from Discontinued Operations, net of taxes. Loss from discontinued operations was $25.6 million in fiscal 2008 compared to income in fiscal 2007 of $3.9 million. In December 2008, we completed the sale of 70 units to PHI for $18.8 million in cash. As a result of this sale, we recognized a pre-tax loss included in discontinued operations of $27.4 million in 2008. Also, in December 2008, we entered into an agreement to sell 42 units to PHI for $19.0 million in cash. The sale of these units was completed in January 2009. These units were classified as held for sale at December 30, 2008 and we recorded a $17.2 million pre-tax loss to reduce the carrying amount of these units to fair value. The total after-tax loss on the sale of these units was $30.3 million and was included in discontinued operations. Net income related to these units was $4.7 million for fiscal 2008 and $3.9 million for fiscal 2007.

Liquidity and Sources of Capital

Our short-term and long-term liquidity needs will arise primarily from: (1) interest and principal payments related to our existing credit facility and the Notes; (2) capital expenditures, including those for our re-imaging plan and maintenance capital expenditures; (3) opportunistic acquisitions of Pizza Hut restaurants or other acquisition opportunities; and (4) working capital requirements as may be needed to support our business. We intend to fund our operations, interest expense, capital expenditures, acquisitions and working capital requirements principally from cash from operations, cash reserves and borrowings on our revolving credit facility. Future acquisitions, depending on the size, may require borrowings beyond those available on our existing revolving credit facility and therefore may require further utilization of the additional remaining term loan borrowing capacity under our credit facility described below as well as other sources of debt or additional equity capital.

Credit and capital markets have experienced unusual volatility and disruption, and equity and debt financing have become more expensive and difficult to obtain. These recent changes in the financial and credit markets may impair our ability to obtain additional debt financing at costs similar to that of our current credit facility, if at all. In addition utilization of the additional remaining term loan borrowing capacity under our existing credit facility, beyond parameters established in our current agreement, would result in a reset of the interest rate on our existing term loan borrowings, which would increase our borrowing costs based on current market conditions. We will continue to evaluate the impact from these market changes as we assess our acquisition and other growth opportunities.

Our working capital was a deficit of $68.2 million as of December 29, 2009 including the impact of $31.3 million for the mandatory term loan pre-payment due not later than 120 days after our 2009 fiscal year-end, which was partially offset by the benefit of approximately $9.3 million of additional cash reserves as of December 29, 2009 when compared to the prior fiscal year end. Like most restaurant companies, we are a cash business with low levels of inventories and accounts receivable. Because our sales are primarily cash and we receive credit from our suppliers, we operate on a net working capital deficit. Further, receivables are not a significant asset in the restaurant business and inventory turnover is rapid. Therefore, historically we have used available liquid assets to reduce borrowings under our revolving line of credit. Although not required, we currently pay the next day for certain of our supply purchases in order to take advantage of a prompt-payment discount from our distributor. If we were to utilize the 30 day term of trade credit, it would increase our liquidity by approximately $20.0 million.

 

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Cash flows from operating activities, inclusive of discontinued operations

Cash from operations is our primary source of funds. Changes in earnings and working capital levels are the two key factors that generally have the greatest impact on cash from operations. Our operating activities provided net cash inflows of $62.7 million for fiscal year 2009, $72.9 million for fiscal year 2008 and $61.3 million for fiscal 2007. Cash flows from operations during the 52 weeks ended December 29, 2009 were positively impacted by a $3.8 million increase in after tax cash flows from operations (after adding back non-cash items to net income), which was more than offset by negative changes in working capital of $12.8 million related to timing of payments for accrued liabilities as compared to fiscal 2008.

Cash flows from operations during the 53 weeks ended December 30, 2008 were positively impacted by a $7.3 million increase from net changes in working capital as compared to fiscal 2007, due in part to the favorable working capital effect from the 2008 acquisition activity, and a $6.4 million positive impact of after tax cash flows from operations (after adding back non-cash items to net loss) as compared to the prior year. To the extent positive cash and cash equivalent account balances remain with the same institution as book overdraft account balances at period end and the institution has the right of offset, we are required to net those amounts for financial reporting purposes. During the fiscal year ended December 30, 2008, the Company had no invested cash netted against book overdrafts. For the fiscal year ended December 25, 2007 the Company had a $12.1 million positive change due to cash invested in an overnight investment account netted against book overdrafts at fiscal year end 2006. The impact of these changes resulted in a $12.1 million reduction in cash flows from working capital in fiscal 2008 as compared to fiscal 2007 which was more than offset by a $8.5 million positive change in income taxes, primarily due to higher income tax payments during the first half of 2007, a $3.8 million positive change in receivables and a $6.1 million positive change related to the timing of payments for accrued payroll and other liabilities.

Cash flows from investing activities

Cash flows used in investing activities were $37.8 million during the 52 weeks ended December 29, 2009 compared to $112.3 million during the 53 weeks ended December 30, 2008. During 2009, we completed an asset purchase and sale transaction in which we purchased 55 units for $18.7 million and sold 42 units for $19.5 million, and also completed an acquisition of 50 units for $14.1 million. During 2009 we invested $25.5 million in capital expenditures, consisting of approximately $18.0 million in our existing operations (including approximately $1.9 million for WingStreetdevelopment at 41 units) and $5.6 million for acquisition related information technology (“IT”) equipment. During fiscal 2008, we completed an acquisition of 99 units, including nine fee properties, for $36.1 million and an acquisition of 88 units, including one fee property, for $28.2 million. We also completed an asset purchase and sale transaction in which we purchased 101 units for $27.0 million and sold 70 stores for $18.8 million. During fiscal 2008 we invested $33.9 million in capital expenditures, consisting of approximately $32.3 million in our existing operations (including approximately $9.3 million for WingStreetdevelopment at 178 units) and $1.6 million for acquisition related IT equipment. Proceeds from asset sales were $1.0 million for both fiscal 2009 and 2008.

Additionally, during the third quarter 2008 we purchased 13 formerly leased properties for $6.9 million with the intent to sell and leaseback the properties. Eleven of these properties were sold for $7.0 million (and are included in financing activities below) resulting in a deferred gain of approximately $0.9 million and the remaining two properties were included in fixed assets for approximately $0.8 million. These properties were subsequently sold in the first quarter of 2009 for $0.9 million.

In fiscal year 2007, we invested $33.3 million in capital expenditures, consisting of approximately $31.7 million for existing operations (including approximately $2.3 million for WingStreetdevelopment at 34 units) and $1.6 million for IT equipment related to acquisitions totaling 76 units during 2007. Proceeds from asset sales were $2.2 million during fiscal 2007. These expenditures were partially funded by proceeds from sale-leaseback transactions as reported in financing activities.

Our franchise agreements require us to perform asset actions consisting of three activity classes: (i) partial re-image, (ii) full-re-image, and (iii) rebuild, remodel or relocate. The required asset action (rebuild/remodel vs. re-image) for each dine-in asset was determined based on each asset’s historical sales volume and trade area population. A remodel of an existing asset entails a total interior and exterior refurbishment, completely upgrading the asset to the latest PHI standards. The re-image of an asset entails limited exterior refurbishment (paint, parking lot, etc.) and significant restaurant interior upgrades. We signed a WingStreet™ agreement with PHI that was effective on December 25, 2007. This agreement permits the development of the less costly WingStreet™ Lite format, as defined in accordance with PHI specifications, to an existing dine-in asset to constitute an approved re-image under the existing franchise agreements. Under our 2003 franchise agreements, all partial and full re-images were completed by September 30, 2009 and all rebuild, remodel and relocation activities must be completed by the extended deadline of December 31, 2015. We expect to incur capital expenditures of approximately $28 million over the remaining 6 years to meet these requirements in addition to normal recurring maintenance capital expenditures.

 

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Additionally, as part of our 2008 location and territory franchise agreements that were effective with the December 2008 and first quarter 2009 acquisitions of units from PHI, we are required to complete certain major asset actions (as defined as a rebuild, relocate, or remodel) within 11 years of the acquisition date, or by December 2019 through February 2020. We expect to incur approximately $9 million over the next 10 years to meet these requirements.

We are significantly ahead of schedule on our asset re-image, rebuild/remodel requirements and have the option to reduce capital expenditures at management’s discretion to increase free cash flow and remain comfortably in compliance with our franchise agreements.

We currently expect our capital expenditure investment to be approximately $16 million to $17 million in 2010.

Cash flows from financing activities

Net financing cash outflows were $15.5 million for fiscal 2009 compared to inflows of $37.1 million for fiscal 2008 and $0.7 million for fiscal 2007. During fiscal 2009 we paid our mandatory excess cash flow prepayment of $17.1 million on our senior secured credit facility compared to $4.2 million in the prior year and $10.0 million for a voluntary prepayment on term bank facilities in fiscal 2007. Net repayments under the revolving credit facility were $3.0 million for the 52 weeks ended December 29, 2009 despite borrowing approximately $14.2 million to fund our acquisition of 50 units in February 2009 and $15.0 million to partially fund our mandatory excess cash flow prepayment during the second quarter, compared to $12.5 million during fiscal 2008. During fiscal 2007, net borrowings were $8.8 million under the revolving credit facility.

During the first half of 2009 we completed sale-leaseback transactions for six properties acquired in Virginia during the fourth quarter of 2008 for $2.9 million and completed sale-leaseback transactions on two formerly leased properties (purchased in 2008) for $0.9 million. Additionally, during the third quarter of 2009, we completed sale-leaseback transactions for two properties constructed in 2009 for $2.6 million. During the first half of fiscal 2008 we completed six sale-leaseback transactions on assets principally constructed during 2007 for approximately $6.9 million compared to $2.0 million for a sale-leaseback transaction of two properties in the same period of 2007. During the last half of 2008, we completed sale-leaseback transactions on 11 formerly leased properties for approximately $7.0 million.

During fiscal 2008, we borrowed $40.0 million pursuant to an incremental term loan which we entered into under the existing credit facility’s $100.0 million term accordion feature to fund the 99-unit fourth quarter 2008 acquisition and to augment cash reserves. During 2009, we paid debt issue costs of $1.9 million for legal and recording fees for leasehold mortgages as required by our credit agreement.

As part of the 2006 Transaction, our debt structure consists of the following sources of financing:

 

   

Senior Secured Credit Facility. Our senior secured credit facility was entered into May 3, 2006 and consists of a $75.0 million revolving credit facility and $300.0 million in term loan notes. Interest is paid at LIBOR, the money market rate, or the base rate (as defined), plus an applicable margin based upon a leverage ratio as defined in the credit agreement. We had no borrowings outstanding under the revolving credit facility at December 29, 2009. Availability under this facility is reduced by letters of credit, of which $16.1 million were issued at December 29, 2009. Commitment fees are paid based upon the unused balance of the facility and the fees are determined based upon the aforementioned leverage ratio and were 0.5% at December 29, 2009. Commitment fees and letter of credit fees are reflected as interest expense. The facility is secured by substantially all of the Company’s assets and is due May 3, 2012.

Under our $300.0 million term loan notes, interest is paid at LIBOR plus 1.75%, or the base rate (as defined), plus 0.75%. On October 8, 2008, we borrowed $40.0 million pursuant to an incremental term loan which we entered into under the existing credit facility’s $100.0 million term accordion feature, reducing our available term loan accordion capacity to $60.0 million. Under the $40.0 million incremental term loan, interest is paid at LIBOR plus 2.25%, or the base rate (as defined) plus 1.25%. The combined rate was 2.1% at December 29, 2009. These notes contain scheduled principal payments outlined below and may be prepaid at any time without penalty. The facility is secured by substantially all of the Company’s assets and is due May 3, 2013.

 

   

Senior Subordinated Notes. The Notes bear interest at the rate of 9.5% payable semi-annually in arrears on May 1 and November 1 until maturity of the Notes on May 1, 2014. These Notes are unsecured and are subordinated to the $375.0 million senior secured credit facility and other senior indebtedness, as defined. There are no required principal payments until maturity and these Notes are subject to yield maintenance penalties if redeemed prior to May 1, 2010. Until May 1, 2009, the Notes could be redeemed up to 35% at a redemption

 

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price of 109.500%, plus accrued and unpaid interest, with the net cash proceeds of one or more equity offerings. Effective May 1, 2010, these Notes may be redeemed at a redemption price of 104.750% plus accrued and unpaid interest until May 1, 2011, when the redemption price becomes 102.375% and remains such until May 1, 2012, when these Notes can be redeemed at the face amount, plus accrued and unpaid interest. The issuance of these Notes was registered under the Securities Act of 1933.

Our ability to satisfy our financial covenants under our senior secured credit facility, meet our debt service obligations and reduce our debt will be dependent on our future performance, which in turn, will be subject to general economic conditions and to financial, business, and other factors, including factors beyond our control. We believe that our ability to repay amounts outstanding under our senior secured credit facility and the Notes at maturity will likely require additional financing, which may not be available to us on acceptable terms, if at all. As of December 29, 2009, we had $258.7 million in funded floating rate debt outstanding under our senior secured credit facility. Of this amount, we entered into floating-to-fixed interest rate swaps with notional amounts totaling $180.0 million with expirations ranging from December 31, 2010 to November 18, 2011, leaving us with $78.7 million of floating rate debt at December 29, 2009. These swaps subsequently amortized to $150.0 million on December 31, 2009, leaving us with $108.7 million of floating rate debt.

We are required to make an excess cash flow mandatory prepayment on our term loan notes not later than 120 days after our 2009 fiscal year-end. The mandatory prepayment based on 2009 results will be approximately $31.3 million based upon the amount of excess cash flow generated during the fiscal year and our leverage at fiscal year-end, each of which is defined in the credit agreement. We currently expect to pay this amount utilizing cash reserves on March 30, 2010, the last day of our fiscal 2010 first quarter.

During fiscal 2009, we made all scheduled principal and interest payments. As of December 29, 2009, the Company was in compliance with all of the debt financial covenants.

Our ratios under the foregoing financial covenants in our credit agreement as of December 29, 2009 are as follows:

 

    

Actual

  

Covenant Requirement

     

Minimum total leverage ratio

   4.51x    Not more than 5.25x   

Minimum interest coverage ratio

   1.84x    Not less than 1.65x   

The leverage and interest coverage ratio covenant requirements adjust to 4.75x and 1.70x as of December 30, 2009.

The credit agreement defines “Leverage Ratio” as the ratio of Consolidated Debt for Borrowed Money to Consolidated EBITDA; “Consolidated Interest Coverage Ratio” is defined as the ratio of (x) Consolidated EBITDA plus Rent Expense to (y) Consolidated Interest Expense plus Rent Expense. All of the foregoing capitalized terms are defined in the Credit Agreement, which was filed with the Securities and Exchange Commission on October 31, 2006 as Exhibit 10.2 to the Company’s Registration Statement on Form S-4 (File No 333-138338). The credit agreement provides that each of the above defined terms include the pro forma effect of acquisitions and divestitures on a full year basis. This pro forma effect used in connection with the financial debt covenant ratio calculations is not the same calculation we use to determine Non-GAAP Adjusted EBITDA, which we disclose below and to investors in our earnings releases.

Based upon current operations, we believe that our cash flows from operations, together with borrowings that are available under the revolving credit facility portion of our senior secured credit facility, will be adequate to meet our anticipated requirements for working capital, capital expenditures, and scheduled principal and interest payments through the next 12 months. At December 29, 2009, we had $58.9 million of borrowing capacity available under our revolving line of credit net of $16.1 million of outstanding letters of credit. We will consider additional sources of financing to fund our long-term growth if necessary, including the remaining $60.0 million of term loan capacity available under our existing credit facility.

Non-GAAP measures

Non-GAAP adjusted EBITDA is a supplemental measure of our performance that is not required by or presented in accordance with GAAP. We have included Adjusted EBITDA as a supplemental disclosure because we believe that Adjusted EBITDA provides investors a helpful measure for comparing our operating performance with the performance of other companies that have different financing and capital structures or tax rates. We have substantial interest expense relating to the financing of the 2006 Transaction and substantial depreciation and amortization expense relating to the 2006 Transaction and to our acquisitions of units in recent years. We believe that the elimination of these items, as well as taxes, pre-opening and other expenses and facility impairment charges give investors useful information to compare the performance of our core operations over different periods. The following is a reconciliation of net income to Non-GAAP adjusted EBITDA(1).

 

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     52 Weeks Ending
Dec. 29, 2009
    53 Weeks Ending
Dec. 30, 2008

Net income from continuing operations

   $ 10,449      $ 7,524

Adjustments:

    

Interest expense

     31,266        33,843

Income tax (benefit) expense

     (2,463     2,628

Depreciation and amortization

     51,916        35,155

Net facility impairment charges

     1,368        631

Pre-opening expenses and other

     1,957        1,365
              

Adjusted EBITDA from continuing operations

     94,493        81,146

Adjusted EBITDA from discontinued operations

     142        12,906
              

Non-GAAP adjusted EBITDA

   $ 94,635      $ 94,052
              

 

  (1)

The Company defines Non-GAAP Adjusted EBITDA as consolidated net income plus interest, income taxes, depreciation and amortization, facility impairment charges and pre-opening expenses. Non-GAAP Adjusted EBITDA is not a measure of financial performance under generally accepted accounting principles. Non-GAAP Adjusted EBITDA has limitations as an analytical tool, and should not be considered in isolation from, or as a substitute for analysis of, the Company’s financial information reported under generally accepted accounting principles. Non-GAAP Adjusted EBITDA as defined above may not be similar to EBITDA measures of other companies.

Off Balance Sheet Arrangements and Contractual Obligations

The following table discloses aggregate information about our contractual cash obligations as of December 29, 2009 and the periods in which payments are due:

 

     Payments due by period
     Total    Less
than
1 Year
   1-3
Years
   3-5
Years
   More
than 5
Years
   Other
     (in millions)

Long-term debt

   $ 433.7    $ 31.3    $ 3.6    $ 398.8    $ —      $ —  

Operating leases(1)

     296.2      45.3      76.6      59.6      114.7      —  

Interest payments(2)

     94.3      26.1      44.1      24.1      —        —  

Facility upgrades(3)

     36.8      1.1      15.3      10.6      9.8      —  

Unrecognized tax benefits(4)

     9.8      —        —        —        —        9.8

Purchase and other obligations(5)

     6.2      3.1      3.1      —        —        —  
                                         
   $ 877.0    $ 106.9    $ 142.7    $ 493.1    $ 124.5    $ 9.8
                                         

 

  (1)

The majority of our leases contain renewal options for one to five years. The remaining leases may be renewed upon negotiations, which could increase total lease payments. The above table does not include amounts related to unexercised lease renewal option periods. Total minimum lease payments have been reduced by aggregate minimum sublease rentals of $0.7 million under operating leases due in the future under non-cancelable subleases.

  (2)

The Company obtained a four and one half year amortizing floating-to-fixed rate interest rate swap agreement on June 6, 2006 at a fixed rate of 5.39%. The outstanding notional amount was $50.0 million at December 29, 2009 and amortized down to $20.0 million effective December 31, 2009. During 2008, the Company entered into three three-year floating-to-fixed rate interest rate swap agreements for the following fixed rates and notional amounts: 3.16% on January 31 for $50.0 million; 2.79% on April 7 for $50.0 million and 2.81% on November 18 for $30.0 million. Interest payments are calculated on debt outstanding at December 29, 2009 at rates in effect at the end of the year, including the effect of the swaps.

  (3)

Includes capital expenditure requirements under our franchise agreements for remodeling and re-imaging our assets, as well as WingStreet™ conversion and development requirements (see “Business—Franchise Agreements”). Amounts are presented under the timeline as currently planned by us, however, we have the discretion to apportion these expenditures into future years at a slower rate and remain in compliance.

  (4)

The amount and timing of liabilities for unrecognized tax benefits cannot be reasonably estimated and is shown in the “Other” column.

  (5)

Purchase and other obligations primarily include amounts for obligations under service agreements.

In addition, we expect to incur between $10.0 million and $12.0 million annually, based upon our unit count at December 29, 2009, in maintenance capital expenditures to maintain the Company’s assets in accordance with our standards. These amounts are not included in the above table.

 

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Concurrently with the closing of the 2006 Transaction, the Company acquired the 75% membership interest in Hawk-Eye that was not previously owned by the Company from certain members of management, other than a $3.3 million membership interest that management ultimately exchanged for membership interests in Holdings with an equivalent fair market value. Additionally, in September 2006, certain members of our Board of Directors purchased membership interests in Holdings. The total membership interests not owned by MLGPE are $3.3 million as of December 29, 2009. Under the terms of the Amended and Restated Limited Liability Company Agreement of Holdings (“LLC Agreement”), the membership interests are mandatorily redeemable units, which are required to be repurchased by Holdings upon the resignation of the member. However, the value of this liability is subject to a formula as defined within the LLC Agreement based upon the terms of the member’s resignation. The Company does not have a contractual obligation to fund the purchase of the mandatorily redeemable units; however, the Company may be required to provide a distribution to Holdings in the event of a member’s resignation from the Company. The value of this liability is subject to a formula as defined within the LLC Agreement. Based on the financial results for fiscal 2009, we estimate the membership interests to have a combined value of approximately $3.1 million to $3.3 million, of which the value varies based upon the terms of the member’s resignation, as defined within the LLC Agreement.

Letters of Credit. As of December 29, 2009, we had letters of credit, in the amount of $16.1 million, issued under our existing credit facility primarily in support of self-insured risks and franchise agreement obligations. Based on our leverage ratio determined by fiscal 2009 operating results, we may be required to reinstate a $5.0 million letter of credit due to our franchisor, PHI. If this letter of credit is issued, this will reduce our revolving credit facility borrowing capacity by a like amount.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to various market risks. Market risk is the potential loss arising from adverse changes in market prices and rates. We do not enter into derivative or other financial instruments for trading or speculative purposes.

Interest Rate Risk. Our primary market risk exposure is interest rate risk. All of our borrowings under our senior secured credit facility bear interest at a floating rate. As of December 29, 2009, we had $258.7 million in funded floating rate debt outstanding under our senior secured credit facility. We have interest rate swap agreements that provide for fixed rates as compared to LIBOR on the following notional amounts of floating rate debt:

 

Effective Date

   Notional
Amount
(in millions)
   Fixed
Rate
Paid
   

Maturity Date

    

June 6, 2006

   $ 50.0    5.39   Dec. 31, 2010   

Jan. 31, 2008

     50.0    3.16   Jan. 31, 2011   

April 7, 2008

     50.0    2.79   April 7, 2011   

Nov. 18, 2008

     30.0    2.81   Nov. 18, 2011   
              
   $ 180.0        
              

After giving effect to these swaps, which leaves us with $78.7 million of floating rate debt, a 100 basis point increase in this floating rate would increase annual interest expense by approximately $0.8 million.

Commodity Prices. Commodity prices such as cheese can vary. The price of this commodity can change throughout the year due to changes in supply and demand. Cheese has historically represented approximately 30% of our cost of sales. We are a member of the UFPC, and participate in cheese hedging programs that are directed by the UFPC to help reduce the volatility of this commodity from period-to-period. Based on information provided by the UFPC, the UFPC expects to hedge approximately 30% to 50% of the Pizza Hut system’s anticipated cheese purchases for fiscal year 2010 through a combination of derivatives taken under the direction of the UFPC.

The estimated increase in our food costs from a hypothetical 10% adverse change in the average cheese block price per pound (approximately $0.13 for fiscal 2009 and $0.19 per pound for fiscal 2008) would have been approximately $5.1 million and $5.9 million for the 52 weeks ended December 29, 2009 and 53 weeks ended December 30, 2008, respectively, without giving effect to the UFPC directed hedging programs.

 

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Item 8. Financial Statements and Supplementary Data

NPC INTERNATIONAL, INC.

YEARS ENDED DECEMBER 29, 2009, DECEMBER 30, 2008 AND DECEMBER 25, 2007

INDEX TO FINANCIAL STATEMENTS

 

     Page

Report of Independent Registered Public Accounting Firm

   38-39

Consolidated Financial Statements:

  

Consolidated Balance Sheets

   40

Consolidated Statements of Income (Loss)

   41

Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss)

   42

Consolidated Statements of Cash Flows

   43

Notes to Consolidated Financial Statements

   44-58

 

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of NPC International, Inc.:

In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income (loss), stockholders’ equity and comprehensive income (loss) and cash flows present fairly, in all material respects, the financial position of NPC International, Inc. and its subsidiaries (“the Company”) at December 29, 2009, and the results of their operations and their cash flows for the 52 week period then ended in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

/s/ PRICEWATERHOUSECOOPERS LLP

Kansas City, Missouri

March 26, 2010

 

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of

NPC International, Inc.

Overland Park, Kansas

We have audited the accompanying consolidated balance sheet of NPC International, Inc. (the “Company”) as of December 30, 2008, and the related consolidated statements of (loss) income, stockholders’ equity and comprehensive (loss) income, and cash flows for the 53 week period ended December 30, 2008, and the 52 week period ended December 25, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of NPC International, Inc. as of December 30, 2008, and the results of their operations and their cash flows for the 53 week period ended December 30, 2008, and the 52 week period ended December 25, 2007 in conformity with accounting principles generally accepted in the United States of America.

DELOITTE & TOUCHE LLP

Kansas City, Missouri

March 25, 2009

 

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NPC INTERNATIONAL, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

 

     December 29,
2009
    December 30,
2008
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 14,669      $ 5,327   

Accounts receivable

     4,897        4,110   

Inventories

     7,019        7,291   

Prepaid expenses and other current assets

     4,415        4,633   

Assets held for sale

     1,010        20,934   

Deferred income taxes

     2,801        4,531   

Income taxes receivable

     2,703        2,086   
                

Total current assets

     37,514        48,912   
                

Facilities and equipment, less accumulated depreciation of $105,891 and $67,885, respectively

     164,413        169,114   

Franchise rights, less accumulated amortization of $31,509 and $22,008, respectively

     408,714        407,915   

Goodwill

     191,701        188,530   

Other assets, net

     26,982        25,044   
                

Total assets

   $ 829,324      $ 839,515   
                

Liabilities and stockholders’ equity

    

Current liabilities:

    

Accounts payable

   $ 25,936      $ 22,998   

Accrued liabilities

     34,484        36,795   

Accrued interest

     4,936        6,317   

Current portion of insurance reserves

     9,056        8,240   

Current portion of debt

     31,340        17,094   
                

Total current liabilities

     105,752        91,444   
                

Long-term debt

     402,370        436,710   

Other deferred items

     36,841        35,556   

Insurance reserves

     12,313        11,133   

Deferred income taxes

     113,473        117,240   
                

Total long-term liabilities

     564,997        600,639   
                

Commitments and contingencies

    

Stockholders’ equity:

    

Common stock ($0.01 par value, 2,000 shares authorized and 1,000 shares issued and outstanding as of December 29 2009 and December 30, 2008)

     —          —     

Paid-in-capital

     163,325        163,325   

Accumulated other comprehensive loss

     (3,372     (4,125

Retained deficit

     (1,378     (11,768
                

Total stockholders’ equity

     158,575        147,432   
                

Total liabilities and stockholders’ equity

   $ 829,324      $ 839,515   
                

See accompanying notes to the consolidated financial statements.

 

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NPC INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(in thousands)

 

     52 Weeks
Ended
Dec. 29,
2009
    53 Weeks
Ended
Dec. 30,
2008
    52 Weeks
Ended
Dec. 25,
2007
 

Sales:

      

Net product sales

   $ 845,074      $ 666,829      $ 594,634   

Fees and other income

     37,391        22,860        16,620   
                        

Total sales

     882,465        689,689        611,254   

Costs and expenses:

      

Cost of sales

     226,676        188,703        160,862   

Direct labor

     262,298        189,002        168,445   

Other restaurant operating expenses

     291,640        216,465        194,017   

General and administrative expenses

     48,883        40,991        37,131   

Corporate depreciation and amortization of intangibles

     11,761        9,753        9,279   

Other

     1,955        773        (16
                        

Total costs and expenses

     843,213        645,687        569,718   
                        

Operating income

     39,252        44,002        41,536   

Other income (expense):

      

Interest expense

     (31,266     (33,843     (38,015

Miscellaneous

     —          (7     3   
                        

Income before income taxes

     7,986        10,152        3,524   

Income tax (benefit) expense

     (2,463     2,628        (360
                        

Income from continuing operations

     10,449        7,524        3,884   

(Loss) income from discontinued operations, net of taxes

     (59     (25,578     3,886   
                        

Net income (loss)

   $ 10,390      $ (18,054   $ 7,770   
                        

See accompanying notes to the consolidated financial statements.

 

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NPC INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME (LOSS)

(in thousands, except per share data)

 

     Shares
of common
stock
   Common
stock
   Paid-in
capital
   Retained
earnings
(deficit)
    Accumulated
other
comprehensive
income
(loss)
    Treasury
stock,
at cost
   Total
stockholders’
equity
 

Balance at December 26, 2006

   1,000    $ —      $ 163,325    $ (1,123   $ (719   $ —      $ 161,483   
                                                  

Cumulative impact of change in accounting for uncertainty in income taxes

              (361          (361

Comprehensive income:

                  

Net income

   —        —        —        7,770        —          —        7,770   

Net unrealized change in cash flow hedging derivatives

   —        —        —        —          (644     —        (644

Reclassification adjustment into income for derivatives used in cash flow hedges

   —        —        —        —          92        —        92   
                        

Total comprehensive income

                     7,218   
                                                  

Balance at December 25, 2007

   1,000    $ —      $ 163,325    $ 6,286      $ (1,271   $ —      $ 168,340   
                                                  

Comprehensive loss:

                  

Net loss

   —        —        —        (18,054     —          —        (18,054

Net unrealized change in cash flow hedging derivatives

   —        —        —        —          (4,362     —        (4,362

Reclassification adjustment into income for derivatives used in cash flow hedges

   —        —        —        —          1,508        —        1,508   
                        

Total comprehensive loss

                     (20,908
                                                  

Balance at December 30, 2008

   1,000    $ —      $ 163,325    $ (11,768   $ (4,125   $ —      $ 147,432   
                                                  

Comprehensive loss:

                  

Net income

   —        —        —        10,390        —          —        10,390   

Net unrealized change in cash flow hedging derivatives

   —        —        —        —          (4,114     —        (4,114

Reclassification adjustment into income for derivatives used in cash flow hedges

   —        —        —        —          4,867        —        4,867   
                        

Total comprehensive income

                     11,143   
                                                  

Balance at December 29, 2009

   1,000    $ —      $ 163,325    $ (1,378   $ (3,372   $ —      $ 158,575   
                                                  

See accompanying notes to the consolidated financial statements.

 

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NPC INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

     52 Weeks
Ended
December 29,
2009
    53 Weeks
Ended
December 30,
2008
    52 Weeks
Ended
December 25,
2007
 

Operating activities

      

Net income (loss)

   $ 10,390      $ (18,054   $ 7,770   

Adjustments to reconcile net income (loss) to cash provided by operating activities:

      

Depreciation and amortization

     51,926        41,678        42,555   

Amortization of debt issuance costs

     2,098        1,750        2,183   

Net facility impairment charges

     1,368        631        669   

Loss from discontinued operations

     —          44,599        —     

Deferred income taxes

     (2,544     (11,285     523   

Net (gain) loss on disposition of assets

     (3     142        (685

Changes in assets and liabilities, excluding effects from purchase of companies:

      

Accounts receivable

     (758     1,611        (2,202

Inventories

     560        (287     (750

Prepaid expenses and other current assets

     105        (115     1,107   

Accounts payable

     2,938        (274     12,587   

Accrued liabilities

     (2,658     8,755        1,182   

Income taxes

     (617     808        (7,635

Accrued interest

     (1,381     93        (69

Insurance reserves

     1,996        2,439        1,340   

Other deferred items

     3,787        (1,487     2,522   

Other assets

     (4,533     1,902        186   
                        

Net cash provided by operating activities

     62,674        72,906        61,283   
                        

Investing activities

      

Capital expenditures

     (25,457     (33,908     (33,281

Purchase of formerly leased properties for sale-leaseback

     —          (6,907     —     

Purchase of business assets, net of cash acquired

     (32,804     (91,327     (32,649

Net proceeds from sale of units

     19,463        18,841        —     

Proceeds from sale or disposition of assets

     1,009        1,015        2,247   
                        

Net cash used in investing activities

     (37,789     (112,286     (63,683
                        

Financing activities

      

Borrowings under revolving credit facility

     260,882        213,700        217,700   

Payments under revolving credit facility

     (263,882     (226,200     (208,900

Issuance of term loans

     —          40,000        —     

Payment on term loans

     (17,094     (4,196     (10,000

Debt issue costs

     (1,851     (126     (91

Proceeds from sale-leaseback transactions

     5,500        6,896        2,011   

Proceeds from sale-leaseback transactions on formerly leased properties

     902        7,024        —     
                        

Net cash (used in) provided by financing activities

     (15,543     37,098        720   
                        

Net change in cash and cash equivalents

     9,342        (2,282     (1,680

Beginning cash and cash equivalents

     5,327        7,609        9,289   
                        

Ending cash and cash equivalents

   $ 14,669      $ 5,327      $ 7,609   
                        

Supplemental disclosures of cash flow information:

      

Net cash paid for interest

   $ 30,549      $ 32,000      $ 35,901   

Net cash paid (received) for income taxes

   $ 2,607      $ (524   $ 6,348   

Non-cash investing activities:

      

Accrued capital expenditures

   $ 502      $ 744      $ 2,173   

 

See accompanying notes to the consolidated financial statements.

 

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NPC INTERNATIONAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Summary of Significant Accounting Policies

Description of Business. NPC International, Inc., together with its subsidiaries, is referred to herein as “NPC” and “the Company.” NPC Acquisition Holdings, LLC, its ultimate parent company, is referred to herein as “Holdings.” On May 3, 2006, all of NPC’s outstanding stock was acquired by Holdings, a company controlled by Merrill Lynch Global Private Equity (“MLGPE”) and certain of its affiliates, herein referred to as the “2006 Transaction.”

NPC is the largest Pizza Hut franchisee and the largest franchisee of any restaurant concept in the United States. The Company was founded in 1962 and, as of December 29, 2009 operated 1,149 Pizza Hut units in 28 states with significant presence in the Midwest, South and Southeast. As of the end of fiscal 2009, the Company’s operations represented approximately 19% of the domestic Pizza Hut restaurant system and 21% of the domestic Pizza Hut franchised restaurant system as measured by number of units, excluding licensed units which operate with a limited menu and no delivery in certain markets.

Basis of Presentation. The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The Company operates one operating segment. The Company believes this information includes all adjustments, consisting of normal recurring accruals, necessary to fairly present the financial condition, statements of income and cash flows for the periods then ended.

Fiscal Year. The Company operates on a 52- or 53-week fiscal year ending the last Tuesday in December. The fiscal year ended December 29, 2009 and December 25, 2007 each contained 52 weeks. The fiscal year ended December 30, 2008 contained 53 weeks. For convenience, fiscal years ended December 29, 2009, December 30, 2008 and December 25, 2007 are referred to as fiscal 2009, fiscal 2008 and fiscal 2007, respectively.

Reclassifications. Certain reclassifications have been made to the Consolidated Financial Statements to conform to current year reporting.

Use of Estimates. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash Equivalents. Cash and cash equivalents of the Company are composed of demand deposits with banks and short-term cash investments with maturities of three months or less from the date of purchase by the Company. Periodically, the Company has outstanding checks that are written in excess of the cash balances at its bank that create a book overdraft, which the Company records as a liability.

Inventories. Inventories of food and supplies are carried at the lower of cost (first-in, first-out method) or market.

Revenue Recognition. The Company recognizes revenue when products are delivered to the customer or meals are served. The Company presents sales in the Consolidated Statements of Income net of sales taxes.

Facilities and Equipment. Facilities and equipment are recorded at either cost or fair value as a result of the 2006 Transaction. Depreciation is charged on the straight-line basis for buildings, furniture, and equipment. Leasehold improvements are amortized on the straight-line basis over the shorter of the estimated economic life of the improvements or the term of the lease.

The Company reviews long-lived assets related to each restaurant quarterly for impairment or whenever events or changes in circumstances indicate that the carrying amount of a unit’s leasehold improvements may not be recoverable. The Company evaluates these leasehold improvements using a “two year history of cash flow losses” as the primary indicator of potential impairment. Based on the best information available, impaired leasehold improvements are written down to estimated fair market value, which becomes the new cost basis. The impairment evaluation is based on historical cash flows, which management believes is the best indicator of future cash flows, until the expected disposal date plus any expected terminal value. Personal property is reviewed for impairment using the closure of a unit as an indicator of impairment. Personal property not transferred to another unit is written down to its estimated fair market value. Additionally, when a commitment is made to close a unit beyond the quarter in which the closure commitment is made, it is reviewed for impairment and depreciable lives are adjusted. As management judgment is necessary to estimate future cash flows, actual results could vary from management estimates.

 

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Business Combinations. In accordance with accounting guidance for business combinations, the Company allocates the purchase price of an acquired business to its identifiable assets and liabilities based on estimated fair values. The excess of the purchase price over the amount allocated to the assets and liabilities, if any, is recorded as goodwill.

The Company uses all available information to estimate fair values including the fair value determination of identifiable intangible assets such as franchise rights, and any other significant assets or liabilities. The Company adjusts the preliminary purchase price allocation, as necessary, up to one year after the acquisition closing date when information that is known to be available or obtainable is obtained.

The Company’s purchase price allocation methodology contains uncertainties because it requires management to make assumptions and to apply judgment to estimate the fair value of acquired assets and liabilities. Management estimates the fair value of assets and liabilities based upon quoted market prices, the carrying value of the acquired assets and widely accepted valuation techniques, including discounted cash flows. Unanticipated events or circumstances may occur which could affect the accuracy of its fair value estimates, including assumptions regarding industry economic factors and business strategies.

Assets Held for Sale. In December 2008, the Company entered into an agreement with Pizza Hut, Inc. (“PHI”) to sell 42 units in 2009 and presented the results of operations for these units as discontinued operations for the fiscal year ended December 30, 2008 in accordance with the accounting guidance for impairment or disposal of long-lived assets. The Company also recorded a loss of $17.2 million (pre-tax) to write-down the net assets for these 42 units to their estimated fair value less cost to sell at December 30, 2008, which was included in the loss from discontinued operations in the Consolidated Statements of Income (Loss) for fiscal 2008.

The Company also sells units that have been closed due to underperformance and land parcels that it does not intend to develop in the future. The Company classifies an asset as held for sale in the period during which each of the following conditions is met: (a) management has committed to a plan to sell the asset; (b) the asset is available for immediate sale in its present condition; (c) an active search for a buyer has been initiated; (d) completion of the sale of the asset within one year is probable; (e) the asset is being marketed at a reasonable price; and (f) no significant changes to the plan of sale are expected. Assets held for sale were $1.0 million at December 29, 2009 and $20.9 million at December 30, 2008, of which $19.0 million related to the January 2009 sale of 42 units to PHI.

Pizza Hut Franchise Agreements. Effective January 1, 2003, the Company began operating under new franchise agreements with PHI. The franchise agreements have an initial term of 30 years and a 20-year renewal term. Certain of the franchise agreements contain perpetual 20-year renewal terms subject to certain criteria. The amortization of all franchise rights conclude at the end of this initial term plus one renewal term (or December 31, 2053).

Royalty expense was included in other restaurant operating expenses and totaled $41.9 million for fiscal year 2009 (4.8% of total sales), $30.4 million for fiscal year 2008 (4.4% of total sales), and $26.5 million for fiscal year 2007 (4.3% of total sales).

Lease Accounting. Certain of the Company’s lease agreements provide for scheduled rent increases during the lease term, as well as provisions for renewal options. Rent expense is recognized on a straight-line basis over the lease term. Lease terms are determined based upon management’s estimate of the commercial viability of the location. In addition, landlord-provided tenant improvement allowances are recorded in other deferred items and amortized as a credit to rent expense over the term of the lease. Favorable lease amounts are amortized to expense over the remaining life of the lease including options. Unfavorable lease amounts are amortized to expense over the remaining life of the current contractual lease term.

Intangible assets. Franchise rights and other intangible assets with finite lives are amortized over their useful lives using the straight-line method. Each reporting period the Company evaluates whether events and circumstances warrant a revision to the remaining estimated useful life of each intangible asset. If it was determined that events and circumstances warrant a change to the estimate of an intangible asset’s remaining useful life, then the remaining carrying amount of the intangible asset would be amortized prospectively over that revised remaining useful life.

If an indicator of impairment exists, the results of the designated marketing area (DMA) that supports the franchise rights are reviewed to determine whether the carrying amount of the asset is recoverable based on an undiscounted cash flow method.

 

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Accounting for Goodwill. The Company assesses goodwill, which is not subject to amortization, for impairment annually in its second quarter, and also at any other date when events or changes in circumstances indicate that the carrying value of these assets may exceed their fair value. The Company develops an estimate of the fair value using a discounted income approach. In connection with the Company’s annual test in the second quarter, no impairment has been identified.

Fees and Other Income. Fees and other income are comprised primarily of delivery fees charged to customers and vending receipts.

Advertising costs. Advertising costs are expensed as incurred. The total amounts charged to advertising expense were $52.6 million, $40.5 million and $36.9 million, for fiscal 2009, 2008 and 2007, respectively.

Pre-opening expenses. Costs associated with the opening of new units and WingStreet™ unit conversions are expensed as incurred and are included with corporate depreciation and amortization expenses. Pre-opening expenses were $0.5 million, $1.6 million and $0.7 million for fiscal 2009, 2008 and 2007, respectively.

Self-insurance accruals. The Company operates with a significant self-insured retention of expected losses under its workers’ compensation, employee medical, general liability, auto, and non-owned auto programs. The Company purchases third party coverage for losses in excess of the normal expected levels. Accrued liabilities have been recorded based on the Company’s estimates of the ultimate costs to settle incurred claims, both reported and incurred but unreported, subject to the Company’s retentions. Provisions for losses expected under the workers’ compensation, general liability and auto programs are recorded based upon estimates of the aggregate liability for claims incurred, net of expected recoveries from third party carriers for claims in excess of self-insured retention, utilizing independent actuarial calculations based on historical claims experience. In the event the Company’s insurance carriers are unable to pay claims submitted to them, in excess of its self-insured retention, the Company would record a liability for such estimated payments expected to be incurred.

Fair Value Measurements. The Company performs fair value measurements of certain assets and liabilities, including derivatives and investment balances as described in Note 9, Note 12 and Note 13, respectively. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The three-level fair value hierarchy that prioritizes the source of inputs used in measuring fair value is as follows:

 

Level 1 –

  Unadjusted quoted prices available in active markets for identical assets or liabilities.

Level 2 –

  Pricing inputs, other than Level 1 quoted prices, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data. These inputs are frequently utilized in pricing models, discounted cash flow techniques and other widely accepted valuation methodologies.

Level 3 –

  Unobservable inputs in which there is little or no market data, which requires the Company to develop its own assumptions.

Accounting for Derivatives. The Company participates in interest rate related derivative instruments to manage its exposure on its debt instruments. These derivative contracts are entered into with financial institutions. The Company records all derivative instruments on the balance sheet as either assets or liabilities measured at fair value. The calculation of the fair value of the interest rate related derivative instruments is based on estimates of future interest rates and consideration of risk of nonperformance, which may change based on economic or other factors. Changes in the fair value of these derivative instruments are recorded either through current earnings or as other comprehensive income, depending on the type of hedge designation. Gains and losses on derivative instruments designated as cash flow hedges are reported in other comprehensive income and reclassified into earnings in the periods in which earnings are impacted by the hedged item.

Income Taxes. Deferred taxes are provided for items whose financial and tax bases differ. A valuation allowance is provided against deferred tax assets when it is expected that it is more likely than not that the related asset will not be fully realized.

Certain tax authorities periodically audit the Company. Reserve balances have been established for potential exposures when it is probable that a taxing authority may take a sustainable position on a matter contrary to the Company’s filed position. The Company evaluates these issues on a quarterly basis to adjust for events, such as court rulings or audit settlements that may impact its ultimate payment for such exposures.

 

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Debt Issuance Costs. Costs related to the issuance of debt are capitalized and amortized to interest expense using the straight line method over the period the debt is outstanding, which approximates amounts expected to be amortized using the effective interest method.

The Company issued a Senior Secured Credit Facility dated May 3, 2006 for $375.0 million, consisting of term notes and a revolving credit facility, which resulted in debt issuance costs. Similarly, in fiscal 2009, the Company filed certain regulatory documents in accordance with its credit agreement which resulted in $1.9 million of debt issuance costs. These costs are being amortized over the life of the related debt instruments. Amortization of $2.1 million, $1.8 million, and $2.2 million was charged to interest expense during the fiscal years ended 2009, 2008 and 2007, respectively, related to these costs. The Company had unamortized costs of $8.8 million and $9.1 million for the fiscal years ended December 29, 2009 and December 30, 2008, respectively.

Stock Based Compensation. In May 2006, Holdings agreed to establish a new stock incentive plan (“the Plan”), which governs, among other things, (i) the issuance of matching options on purchased membership interests and (ii) the grant of options with respect to the membership interests.

Options may be granted under the Plan with respect to a maximum of 8% of the membership interests of Holdings as of the closing date of the 2006 Transaction calculated on a fully diluted basis (subject to required capital adjustments). Each grant of options under the Plan will specify the applicable option exercise period, option exercise price, vesting schedules and conditions and such other terms and conditions as deemed appropriate. Three types of options may be granted under the plan. First, Holdings may grant “non-time vesting” options, with respect to up to 1.0% of the interests, to selected participants, which will be vested at grant. Second, Holdings may grant “time vesting” options, with respect to up to 2.0% of the interests, which will vest ratably over a five-year period and subject to the option holders’ continued service. Third, Holdings may grant options, as to the remaining interests, which vest only upon the occurrence of a change of control on or prior to the expiration of the option, and also require continued service through the vesting date. All options granted under the Plan will expire ten years from the date of grant, but generally expire earlier upon resignation of the member.

Recent Accounting Pronouncements. In June 2009, the Financial Accounting Standards Board (“FASB”) issued the Accounting Standards Codification (“ASC”) as the authoritative source of generally accepted accounting principles for nongovernmental entities in the United States. Rules and interpretive releases of the SEC under federal securities laws are also sources of authoritative GAAP for SEC registrants. The adoption of the ASC is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Company adopted the ASC during the third quarter 2009, which changes how the Company references accounting standards, but the adoption did not have an impact on the Company’s consolidated financial statements.

In April 2009, the FASB issued the accounting standard that provides guidance in determining whether impairments in debt securities are other than temporary, and modifies the presentation and disclosures surrounding such instruments. This standard is effective for interim periods ending after June 15, 2009, but early adoption is permitted for interim periods ending after March 15, 2009. The Company adopted this standard during the second quarter of 2009 and such adoption did not have a material impact on the Company’s consolidated financial statements.

In April 2009, the FASB issued an amendment to the accounting standard for financial instruments. This amendment requires disclosures about the fair value of financial instruments in interim financial statements as well as in annual financial statements. The adoption of this amendment is effective for interim periods ending after June 15, 2009, but early adoption is permitted for interim periods ending after March 15, 2009. The Company adopted this amendment during the first quarter 2009 and began providing the additional required disclosures. See Note 7 for a discussion of the fair value of the Company’s long-term debt and Note 9 for a discussion of the Company’s derivative instruments and hedging activities.

In December 2007, the principles and requirements for how an acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired were revised. This amendment significantly changes the accounting for business combinations in a number of areas including the treatment of contingent consideration, pre-acquisition contingencies, transaction costs, in-process research and development and restructuring costs. In addition, this amendment provides that changes in an acquired entity’s deferred tax assets and uncertain tax positions after the measurement period will impact income tax expense. Disclosure requirements were also established, which will enable financial statement users to evaluate the nature and financial effects of business combinations. This amendment is effective for fiscal years beginning after December 15, 2008 with early adoption prohibited. The Company adopted the amendment to the accounting for business combinations for fiscal 2009. See Note 2 for a discussion of the Company’s business combination activity.

 

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Note 2 – Business Combinations and Acquisitions

Between September 2008 and February 2009, the Company acquired 393 Pizza Hut units, including 294 units from PHI and 99 units from another franchisee. These acquisitions were funded through the issuance of a $40.0 million term loan under the Company’s Senior Secured Credit Facility, proceeds from the sale of units to PHI, proceeds drawn on the Company’s revolving credit facility and cash on hand. The acquisitions were accounted for using the purchase method of accounting. Accordingly, net assets were recorded at their estimated fair values. As the purchase price exceeded the fair value of the assets, including identified intangible assets, goodwill associated with this transaction was recorded in the Consolidated Balance Sheets. The goodwill recorded reflects the Company’s ability to synergize acquired units with its existing operations. All of the goodwill recognized for these acquisitions will be deductible for income tax purposes.

Identification and allocation of values assigned to the intangible assets are based on fair value, which was estimated by performing the generally accepted valuation income approach. The income approach is predicated upon the value of the discounted future cash flows that an asset will generate over its remaining useful life, which is consistent with how purchase price is typically determined for purchases such as these. The purchase price allocations, net of cash acquired, as adjusted, were as follows:

 

(Dollars in thousands)       
     2009    2008  

Acquired from

     PHI      PHI      Franchisee        PHI      PHI   

Date acquired

     1/20/09      2/17/09      9/30/08        12/9/08      12/9/08   

Number of units

     55      50      99        88      101   

Fee properties

               9        1        
           VA, WV,           MO, KS,   

Market locations

     CO      MO, IL      MD        FL, IA      GA   

Purchase price allocation:

             

Franchise rights

   $ 8,655    $ 1,938    $ 18,950      $ 9,318    $ 12,111   

Goodwill

     1,077      970      2,290        3,043      1,309   

Fixed assets

     8,621      10,753      15,490        14,996      12,850   

(Unfavorable) favorable leases, net

     142      215      (487     104      (221

Other

     182      200      (50     717      924   
                                     

Total purchase price

   $ 18,677    $ 14,076    $ 36,193      $ 28,178    $ 26,973   
                                     

The above purchase price allocations for 2008 were adjusted during fiscal 2009 to reflect an increase of approximately $1.1 million to goodwill with offsetting decreases of $0.7 million to fixed assets, $0.3 million to franchise rights and $0.1 million to other.

The weighted average amortization period assigned to the franchise rights acquired during 2009 was 44 years.

The unaudited pro forma impact on the results of operations was included in the below table for periods prior to the acquisition date in which the acquisitions were not previously consolidated. The pro forma results of operations are not necessarily indicative of the results that would have occurred had these acquisitions been consummated at the beginning of the periods presented, nor are they necessarily indicative of future operating results.

 

     Pro forma Years Ended
(unaudited)

(in thousands)
     December 29,
2009
   December 30,
2008

Total sales

   $ 891,455    $ 1,023,649

Income before income taxes

     7,858      12,139

Income from continuing operations

   $ 10,372    $ 8,716

The Consolidated Statements of Income for the 52 weeks ended December 29, 2009 included $301.5 million of total sales related to the above acquired units. It is impracticable to disclose earnings for these acquired units as earnings of such units are not tracked on an individual basis. For the fiscal 2009 acquisitions, direct acquisition-related costs of $0.6 million were included in other expense for the 52 weeks ended December 29, 2009.

Note 3 – Discontinued Operations

In December 2008, the Company completed the sale of 70 units to PHI for $18.8 million in cash. As a result of this sale, the Company recognized a pre-tax loss included in discontinued operations of $27.4 million in 2008. Also, in December 2008, the

 

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Company entered into an agreement to sell 42 units to PHI for $19.0 million in cash. The sale of these units was completed in January 2009. These units were classified as held for sale at December 30, 2008 and the Company recorded a $17.2 million pre-tax loss to reduce the carrying amount of these units to fair value. This loss was included in discontinued operations.

Summarized financial information for discontinued operations on units sold is shown below (in thousands):

 

     52 Weeks
Ended
Dec. 29, 2009
    53 Weeks
Ended
Dec. 30, 2008
    52 Weeks
Ended
Dec. 25, 2007

Total sales

   $ 2,009      $ 93,001      $ 86,591
                      

(Loss) income before income taxes

     (84     6,245        5,625

Income tax (benefit) expense

     (25     1,544        1,739
                      

(Loss) income from discontinued operations, net of taxes

     (59     4,701        3,886
                      

Loss

     —          (44,599     —  

Income tax benefit

     —          (14,320     —  
                      

Loss, net of taxes

     —          (30,279     —  
                      

(Loss) income from discontinued operations, net of taxes

   $ (59   $ (25,578   $ 3,886
                      

The following table reconciles the sales price to the loss at December 30, 2008:

 

     Units Sold
December 2008
    Units Sold
January 2009
    Combined  

Sale price

   $ 18,841      $ 19,045      $ 37,886   

Asset values prior to sale or held for sale

      

Franchise rights, net

     31,315        25,067        56,382   

Facilities and equipment, net

     9,655        5,490        15,145   

Goodwill

     4,381        4,429        8,810   

Other, net

     871        1,277        2,148   
                        

Loss

   $ (27,381   $ (17,218   $ (44,599
                        

Note 4 – Facilities and Equipment

Net facilities and equipment consists of the following (in thousands):

 

     Estimated
depreciable life
   December 29,
2009
    December 30,
2008
 

Land

      $ 3,915      $ 5,677   

Buildings and leasehold/land improvements

   5-40 years      123,855        113,609   

Furniture and equipment

   3-10 years      140,157        113,543   

Construction in progress

        2,377        4,170   
                   
        270,304        236,999   

Less accumulated depreciation and amortization

        (105,891     (67,885
                   

Net facilities and equipment

      $ 164,413      $ 169,114   
                   

Depreciation expense is included in other restaurant operating expense and corporate depreciation and amortization. Depreciation expense totaled $40.5 million, $26.1 million and $26.6 in fiscal 2009, 2008 and 2007, respectively.

 

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Note 5 – Goodwill and Other Intangible Assets

Changes in goodwill are summarized below (in thousands):

 

Balance December 25, 2007

   $  191,920   

Acquisitions

     5,551   

Allocation related to units sold or held for sale

     (8,810

Other, net

     (131
        

Balance December 30, 2008

     188,530   

Acquisitions

     3,171   
        

Balance December 29, 2009

   $ 191,701   
        

Goodwill increased $3.2 million during 2009, approximately $2.1 million as a result of the acquisition of 105 units in January and February of 2009 and $1.1 million for items related to the 2008 acquisitions. Goodwill increased $5.6 million as a result of the acquisition of 99 units in September 2008 and 189 units in December 2008. Goodwill decreased by $8.8 million related to the sale of 70 units in December 2008 and 42 units in January 2009.

Amortizable other intangible assets consist of franchise rights, leasehold interests, internally developed software and a non-compete agreement. These intangible assets are amortized on a straight-line basis over the lesser of their economic lives or the remaining life of the applicable agreement. The weighted average amortization period for all intangible assets is as follows:

 

     Years

Franchise rights

   46

Favorable leasehold interests

   15

Unfavorable leasehold interests

   13

Internally developed software

   5

Non-compete agreements

   5

 

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Intangible assets subject to amortization are summarized below (in thousands):

 

     December 29, 2009  
     Gross Carrying
Amount
    Accumulated
Amortization
    Net Book
Value
 

Amortizable intangible assets:

      

Franchise rights

   $ 440,223      $ (31,509   $ 408,714   

Favorable leasehold interests

     10,114        (2,241     7,873   

Unfavorable leasehold interests

     (4,425     1,248        (3,177

Internally developed software

     1,069        (784     285   

Non-compete

     1,925        (1,412     513   
                        

Total

   $ 448,906      $ (34,698   $ 414,208   
                        

 

     December 30, 2008  
     Gross Carrying
Amount
    Accumulated
Amortization
    Net Book
Value
 

Amortizable intangible assets:

      

Franchise rights

   $ 429,923      $ (22,008   $ 407,915   

Favorable leasehold interests

     9,597        (1,945     7,652   

Unfavorable leasehold interests

     (3,778     584        (3,194

Internally developed software

     1,069        (570     499   

Non-compete

     1,925        (1,027     898   
                        

Total

   $ 438,736      $ (24,966   $ 413,770   
                        

Annual amortization during the next five fiscal years is expected to be as follows: $10.3 million in fiscal 2010; $10.1 million in fiscal 2011; $9.9 million in fiscal 2012; $9.9 million in fiscal 2013; and $9.8 million in fiscal 2014.

Note 6 – Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

 

     December 29,
2009
   December 30,
2008

Payroll and vacation

   $ 14,354    $ 14,294

Real estate tax

     3,983      3,170

Sales tax

     3,630      5,212

Other

     12,517      14,119
             
   $ 34,484    $ 36,795
             

Note 7 – Senior Secured Credit Facility and Senior Subordinated Debt

The Company’s debt consisted of the following (in thousands):

 

     December 29,
2009
   December 30,
2008

Term Loan Note

   $ 258,710    $ 275,804

Senior Subordinated Notes

     175,000      175,000

Senior Secured Revolving Credit Facility

     —        3,000
             
     433,710      453,804

Less current portion

     31,340      17,094
             
   $ 402,370    $ 436,710
             

The Company’s Senior Secured Credit Facility was dated May 3, 2006 and consisted of a $75.0 million revolving credit facility and a $300.0 million term loan note. There were no borrowings outstanding under the revolving credit facility as of December 29, 2009. Interest is paid at LIBOR, the money market rate, or the base rate (as defined), plus an applicable margin based upon a leverage ratio as defined in the credit agreement. Availability under this facility is reduced by letters of credit, of which $16.1 million were

 

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issued at December 29, 2009. Commitment fees are paid based upon the unused balance of the facility and the fees are determined based upon the aforementioned leverage ratio and were 0.5% at December 29, 2009. Commitment fees and letter of credit fees are reflected as interest expense. The revolving credit facility is secured by substantially all of the Company’s assets and is due May 3, 2012.

Under the Company’s $300.0 million term loan note, interest is paid at LIBOR plus 1.75%, or the base rate (as defined), plus 0.75%. On October 8, 2008 the Company borrowed $40.0 million pursuant to an incremental term loan entered into by the Company under the existing credit facility’s $100.0 million term accordion feature, reducing the Company’s remaining available term loan accordion capacity to $60.0 million. The proceeds were primarily used to pay down borrowings on the Company’s revolving credit facility as a result of the September 2008 99-unit acquisition and to fund a portion of the purchase price paid for the acquisition of 294 units from PHI between December 2008 and February 2009. Under the $40.0 million incremental term loan, interest is paid at LIBOR plus 2.25%, or the base rate (as defined) plus 1.25%. The combined weighted average rate was 2.1% at December 29, 2009, not including the impact of interest rate swap agreements. These notes contain scheduled principal payments outlined below and may be prepaid at any time without penalty. The term loan note is secured by substantially all of the Company’s assets and is due May 3, 2013.

The Senior Subordinated Notes (“Notes”) bear interest at the rate of 9.5% payable semi-annually in arrears on May 1 and November 1 until maturity of the Notes on May 1, 2014. These Notes are unsecured and are subordinated to the Senior Secured Credit Facility and other senior indebtedness, as defined. There are no required payments until maturity and these Notes are subject to yield maintenance penalties if redeemed prior to May 1, 2010. Effective May 1, 2010, these Notes may be redeemed at a redemption price of 104.750% plus accrued and unpaid interest until May 1, 2011, when the redemption price becomes 102.375% and remains such until May 1, 2012, when these Notes can be redeemed at the face amount, plus accrued and unpaid interest. The issuance of these Notes was registered under the Securities Act of 1933.

The Company’s debt facilities contain restrictions on additional borrowing, certain asset sales, capital expenditures, dividend payments, certain investments and related-party transactions, as well as requirements to maintain various financial ratios. At December 29, 2009, the Company was in compliance with all of its debt financial covenants.

Based upon the provisions of the Senior Secured Credit Facility, the Company will be required to make an excess cash flow mandatory prepayment on the term loan notes not later than 120 days after the Company’s fiscal year ended December 29, 2009. This mandatory prepayment will be approximately $31.3 million based upon the amount of excess cash flow generated during fiscal 2009 and the Company’s leverage at fiscal year end, each of which is defined in the credit agreement.

The estimated fair value of the Company’s debt facilities was as follows (in thousands):

 

     December 29,
2009
   December 30,
2008

Term Loan Note

   $ 242,541    $ 208,232

Senior Subordinated Notes

     172,375      131,250

Revolving Credit Facility

     —        3,000
             
   $ 414,916    $ 342,482
             

Carrying value

   $ 433,710    $ 453,804

The Company determined the estimated fair value using available market information. However, the fair value estimates presented herein are not necessarily indicative of the amount that the Company’s debtholders could realize in a current market exchange.

Maturities of long-term debt are as follows (in thousands):

 

Fiscal year ended:

  

2010

   $ 31,340

2011(1)

     1,190

2012(1)

     2,381

2013

     223,799

2014

     175,000

Thereafter

     —  
      
   $ 433,710
      

(1)  Future anticipated excess cash flow mandatory prepayments on the term loan are contingent upon excess cash flow generated and the Company’s leverage at each respective fiscal year end and are not reflected in these amounts. The payments have historically ranged from $4.2 million to $31.3 million.

 

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Note 8 – Income Taxes

The (benefit) provision for income taxes for the fiscal years ended December 29, 2009, December 30, 2008 and December 25, 2007 consisted of the following (in thousands):

 

     December 29,
2009
    December 30,
2008
    December 25,
2007
 

Current:

      

Federal

   $ (193   $ (1,408   $ (756

State

     274        (214     23   

Deferred:

      

Federal

     (1,785     3,125        298   

State

     (759     1,125        75   
                        

Income tax (benefit) expense

   $ (2,463   $ 2,628      $ (360
                        

Items of reconciliation to the statutory rate:

 

Tax computed at U.S. federal statutory rate

   34.0   34.0   34.0

State and local income taxes (net of federal benefit)

   3.4      3.7      4.3   

Permanent book/tax differences

   14.7      5.2      17.7   

Tax credits

   (50.8   (24.8   (80.7

FIN 48 (release) accrual

   (23.6   5.9      15.7   

Change in deferred tax rate

   (7.7   —        —     

Other

   (0.8   1.9      (1.2
                  

Income tax (benefit) expense

   (30.8 )%    25.9   (10.2 )% 
                  

During 2009, the Company generated $4.1 million of jobs related tax credits from continuing operations compared to $2.5 million in 2008. Also during 2009 the Company recorded $0.6 million of income tax benefit related to state tax rate changes.

Significant components of the Company’s deferred tax assets and liabilities are as follows (in thousands):

 

     December 29,
2009
    December 30,
2008
 

Assets:

    

Insurance reserves

   $ 6,961      $ 6,645   

Deferred gains

     1,873        1,682   

Profit sharing and vacation

     4,833        3,897   

FIN 48 tax benefit

     2,964        3,035   

General business credit carryforwards

     3,076        1,844   

Other

     2,358        1,831   

Interest rate swaps

     2,164        2,671   
                

Total deferred tax assets

     24,229        21,605   
                

Liabilities:

    

Depreciation and amortization

     (133,192     (133,221

Other

     (1,709     (1,093
                

Total deferred tax liabilities

     (134,901     (134,314
                

Net deferred tax liability

   $ (110,672   $ (112,709
                

Current asset

   $ 2,801      $ 4,531   

Non-current liability

   $ (113,473   $ (117,240

The liability for uncertain tax positions was $9.8 million as of December 29, 2009, is considered long term and is included in other deferred items in the consolidated balance sheet. The $9.8 million liability includes $5.1 million for interest and penalties, as the Company recognizes accrued interest and penalties related to uncertain tax positions in income tax expense. The Company recorded a deferred tax asset related to total state tax exposures of $3.0 million.

 

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A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

 

     Fiscal years ended  
     December 29,
2009
    December 30,
2008
    December 25,
2007
 

Beginning balance

   $ 11,752      $ 10,847      $ 8,772   

Additions based on tax positions related to the current year

     179        43        1,410   

Additional interest / penalties accrued

     975        999        919   

Lapse of applicable statute of limitations

     (3,107     (137     (254
                        

Ending balance

   $ 9,799      $ 11,752      $ 10,847   
                        

The net impact on the effective tax rate from the release of the unrecognized tax benefits would be $6.8 million including consideration of the indirect tax benefits established with regard to such reserves. The Company has a liability established with regard to uncertain areas of tax law that could be released in the next 12 months, to the extent the statute of limitations with regard to this item expires. The Company estimates the range of potential change to be between $0 and $1.6 million.

The Company files income tax returns in the U.S. and various state jurisdictions. As of December 29, 2009, the Company is subject to examination in the U.S. federal tax jurisdiction for the 2006-2008 tax years. The Company is also subject to examination in various state jurisdictions for the 2002-2008 tax years, none of which was individually material.

At December 29, 2009, the Company had U.S. general business credit carryforwards of $1.9 million which expire in 2028 and $1.2 million which expire in 2029.

Note 9 – Derivative Financial Instruments

The Company participates in interest rate related derivative instruments to manage its exposure on its debt instruments, which the Company designated as cash flow hedges. The Company records all derivative instruments on the balance sheet as either assets or liabilities measured at fair value. Gains and losses on derivative instruments designated as cash flow hedges are reported in other comprehensive income and reclassified into earnings in the periods in which earnings are impacted by the hedged item. The following swap agreements were entered into as a hedge to fix a portion of the term loan notes under the Senior Secured Credit Facility and provide for fixed rates as compared to the three-month LIBOR rate on the following notional amounts of floating rate debt at December 29, 2009:

 

Effective Date

   Notional
Amount
(in thousands)
    Fixed
Rate
Paid
    Maturity Date

June 6, 2006

   $ 50,000 (1)    5.39   December 31, 2010

January 31, 2008

     50,000      3.16   January 31, 2011

April 7, 2008

     50,000      2.79   April 7, 2011

November 18, 2008

     30,000      2.81   November 18, 2011
            
   $ 180,000       
            

 

  (1)

Subsequently amortized to $20.0 million on December 31, 2009 based on swaps amortization schedule.

The following table presents the fair value of the Company’s hedging portfolio as of December 29, 2009 and December 30, 2008 (in thousands):

 

Liability Derivatives

Balance Sheet Location

   Fair Value
     Dec. 29, 2009    Dec. 30, 2008

Other deferred items

   $ 5,536    $ 6,796

The effect of the derivative instruments on the consolidated financial statements was as follows (in thousands):

 

      Gain (Loss)
Recognized in OCI on
Derivative (Effective Portion)
    Gain (Loss)
Reclassified from Accumulated
OCI into Income
(Effective Portion)
 
     52 Weeks
ended
Dec. 29, 2009
    53 Weeks
ended
Dec. 30, 2008
    Location    52 Weeks
ended
Dec. 29, 2009
    53 Weeks
ended
Dec. 30, 2008
 

Interest rate contracts

   $ (4,114   $ (4,362   Interest expense    $ (4,867   $ (1,508

 

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The Company expects that approximately $3.7 million of the change in the fair value of the interest rate swap contracts included in accumulated other comprehensive loss as of December 29, 2009 will be realized in earnings as additional interest expense within the next twelve months, contemporaneously with the net settlement of the underlying quarterly interest payments. However, actual amounts reclassified to earnings may vary based on actual changes within the LIBOR market rates.

The Company measures the fair value of its interest rate swap contracts under a Level 2 observable input. The Company uses a mark-to-market valuation based on observable interest rate yield curves which are adjusted for credit risk. During fiscal 2009 and fiscal 2008, there was virtually no ineffectiveness related to cash flow hedges.

Note 10 – Commitments and Contingencies

The Company leases certain restaurant equipment and buildings under operating leases. The majority of the Company’s leases contain renewal options for one to five years. The remaining leases may be renewed upon negotiation, however the table below does not include amounts related to unexercised lease renewal option periods. Future minimum lease payments, including non-operating assets, at December 29, 2009 consisted of (in thousands):

 

Fiscal year

    

2010

   $ 45,282

2011

     41,267

2012

     35,373

2013

     31,352

2014

     28,255

Thereafter

     114,743
      

Total minimum lease commitments(1)

   $ 296,272
      

 

  

(1) Total minimum lease payments have been reduced by aggregate minimum non-cancelable sublease rentals of $0.7 million.

The Company’s rent expense, including contingent rent based on a percentage of sales when applicable, is comprised of the following (in thousands):

 

     Fiscal years ended
     December 29,
2009
   December 30,
2008
   December 25,
2007

Minimum rents

   $ 49,768    $ 34,501    $ 30,651

Contingent rents

     1,016      1,663      1,760
                    
   $ 50,784    $ 36,164    $ 32,411
                    

Under the Company’s franchise agreements, the Company is required to rebuild or re-image a substantial number of restaurants, depending upon certain criteria as defined in the franchise agreements. Certain of the assets to be rebuilt are currently paying royalties of 6.5% of sales, as defined in the franchise agreements, and will qualify for a reduction in royalty rate of up to 2.5% of sales depending upon the timing and nature of the asset action. The Company expects to incur capital expenditures of approximately $27.6 million over the remaining 6 years to meet this requirement. As part of its 2008 location franchise agreement that was effective with the December 2008 and January and February 2009 acquisitions of Pizza Hut units from PHI, the Company is required to complete certain major asset actions within 11 years of the acquisition date, or December 2019 through February 2020 and expects to incur approximately $8.7 million over the next 10 years to meet these requirements.

Concurrently with the closing of the 2006 Transaction, the Company acquired the 75% membership interest in Hawk-Eye that was not previously owned by the Company from certain members of management, other than a $3.3 million membership interest that management ultimately exchanged for membership interests in Holdings with an equivalent fair market value. Additionally, in September 2006, certain members of its Board of Directors purchased membership interests in Holdings. The total membership interests not owned by MLGPE are $3.3 million as of December 29, 2009. Under the terms of the Amended and Restated Limited Liability Company Agreement of Holdings (“LLC Agreement”), the membership interests are mandatorily redeemable units, which

 

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are required to be repurchased by Holdings upon the resignation of the member. However, the value of this liability is subject to a formula as defined within the LLC Agreement based upon the terms of the member’s resignation. The Company does not have a contractual obligation to fund the purchase of the mandatorily redeemable units; however, the Company may be required to provide a distribution to Holdings in the event of a member’s resignation from the Company. The value of this contingent obligation is subject to a formula as defined within the LLC Agreement. Based on the financial results for fiscal 2009, the Company estimates the membership interests to have a combined value of approximately $3.1 million to $3.3 million, of which the value varies based upon the terms of the member’s resignation, as defined within the LLC Agreement.

On May 12, 2009, a lawsuit against the Company, entitled Jeffrey Wass, et al. v. NPC International, Inc., Case No. 2:09-CV-2254-JWL-KGS, was filed in the United States District Court for the District of Kansas. A First Amended Complaint, entitled Jeffrey Wass and Mark Smith, et al. v. NPC International, Inc., was filed on July 2, 2009. The Complaint was brought by Plaintiffs Wass and Smith individually and on behalf of similarly situated employees who work or previously worked as delivery drivers for NPC. The First Amended Complaint alleged a collective action under the Fair Labor Standards Act (FLSA) to recover unpaid wages and excessive deductions owed to plaintiffs and similarly situated workers employed by NPC in 28 states, and as a class action under Colorado law on behalf of Plaintiff Smith and all other similarly situated workers employed by NPC in Colorado to recover unpaid minimum wages and excess payroll deductions and certain costs relating to uniforms and special apparel. The First Amended Complaint alleged among other things that NPC deprived plaintiffs and other NPC delivery drivers of minimum wages by providing insufficient reimbursements for automobile and other job-related expenses incurred for the purposes of delivering NPC’s pizza and other food items. On March 2, 2010, the Court entered an Order granting NPC’s motions for judgment on the pleadings as to all claims brought by plaintiffs in the First Amended Complaint, with the exception of a claim for the reimbursement of uniform costs under Colorado law. The Order provided that the claims failed to state a claim under the FLSA and Colorado law and, therefore, would be dismissed with prejudice unless plaintiffs filed a Second Amended Complaint that cured the deficiencies in the First Amended Complaint. The Order also operated to moot plaintiffs’ then-pending motion for conditional collective action certification.

Plaintiffs filed a Second Amended Complaint on March 22, 2010, which alleges a collective action under the FLSA on behalf of plaintiffs and similarly situated workers employed by NPC in 28 states, and a class action under Rule 23 of the Federal Rules of Civil Procedure on behalf of Plaintiff Smith and similarly situated workers employed in states in which the state minimum wage is higher than the federal minimum wage. The Second Amended Complaint contends that NPC deprived delivery drivers of minimum wages by providing insufficient reimbursements for automobile expenses incurred for the purposes of delivering NPC’s pizza and other food items. NPC intends to file a motion to dismiss and for judgment on the pleadings as to all claims set forth in the Second Amended Complaint, which motion will be filed on or before April 8, 2010. As a result, at this time the Company is not able to predict the outcome of the lawsuit, any possible loss or possible range of loss associated with the lawsuit or any potential effect on the Company’s business, results of operations or financial condition. However, the Company believes the lawsuit is wholly without merit and will defend itself from these claims vigorously.

Note 11 – Insurance Reserves

The Company operates with a significant self-insured retention of expected losses under its workers’ compensation, employee medical, general liability, auto, and non-owned auto programs up to certain individual and aggregate reinsurance levels. Losses are accrued based upon the Company’s estimates of the ultimate costs to settle incurred claims, both reported and incurred but unreported using certain third-party actuarial projections and the Company’s claims loss experience. The estimated insurance claims losses could vary significantly should the frequency or ultimate cost of the claims significantly differ from historical trends used to estimate the insurance reserves recorded by the Company. In the event the Company’s insurance carriers are unable to pay claims submitted to them, the Company would record a liability for such estimated payments expected to be incurred.

The Company recorded estimated liabilities for claims loss reserves of $21.4 million and $19.4 million at December 29, 2009 and December 30, 2008, respectively. These estimates are recorded net of amounts expected to be recovered from the third party insurance carrier for claims in excess of self-insured retentions of $5.0 million and $2.7 million at December 29, 2009 and December 30, 2008, respectively.

Note 12 – Employee Benefit Plans

The Company has benefit plans that include: a) non-statutory stock option plans for its employees and non-employee directors, b) a qualified retirement plan, c) a non-qualified Deferred Compensation Plan, and d) a non-qualified Profit Sharing Plan (“POWR Plan”).

In May 2006, Holdings agreed to establish a new stock incentive plan (“the Plan”), which governs, among other things, (i) the issuance of matching options on purchased membership interests and (ii) the grant of options with respect to the membership interests.

 

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     Number of
Options

(in thousands)
   Weighted
Average
Exercise Price
   Weighted
Average
Remaining
Contractual
Term

(in years)

Outstanding at December 30, 2008

   13,874    $ 1.66    7.8

Granted

   —        —     

Exercised

   —        —     

Forfeited or expired

   —        —     
              

Outstanding at December 29, 2009

   13,874    $ 1.66    6.8
                

Exercisable at December 29, 2009

   3,298    $ 1.01    6.5

Options may be granted under the Plan with respect to a maximum of 8.0% of the membership interests of Holdings as of the closing date of the 2006 Transaction calculated on a fully diluted basis (subject to required capital adjustments). Each grant of options under the Plan will specify the applicable option exercise period, option exercise price, vesting schedules and conditions and such other terms and conditions as deemed appropriate. Three types of options may be granted under the plan. First, Holdings may grant “non-time vesting” options, with respect to up to 1.0% of the interests, to selected participants, which will be vested at grant. Second, Holdings may grant “time vesting” options, with respect to up to 2.0% of the interests, which will vest ratably over a five-year period and subject to the option holders’ continued service. Third, Holdings may grant options, as to the remaining interests, which vest only upon the occurrence of a change of control on or prior to the expiration of the option, and also require continued service through the vesting date. All options granted under the Plan will expire ten years from the date of grant, but generally expire earlier upon termination of service by the member. At December 29, 2009, there were 0.2 million shares available for future grants under the Plan.

Under their respective employment agreements, the following options have been granted to certain members of management (in thousands):

 

     As of
December 29, 2009
   As of
December 30, 2008

Non-time vesting options

   1,625    1,625

Time vesting options

   3,583    3,583

Change of control options

   8,666    8,666
         

Total options granted

   13,874    13,874
         

Total options exercisable

   3,298    2,581

The exercise price of the non-time vesting and time vesting options for those options issued in conjunction with the 2006 Transaction was established based on the aggregate equity investment in Holdings at the time of closing of the 2006 Transaction divided by the number of outstanding membership interests, or $1.00. Similarly, the exercise price of the change of control options was established as twice the exercise price of the non-time vesting and time vesting options granted, or $2.00. The exercise price of options granted since the 2006 Transaction was determined at the discretion of the Compensation Committee of Holdings. The exercise price for all options granted was equal to or greater than the fair market value of the option on the date of grant.

The Company considers these options to be liability awards. The compensation cost for the portion of awards that are outstanding for which the requisite service has not been rendered, or the performance condition has not been achieved, will be recognized as the requisite service is rendered and/or performance condition achieved. Further, all options granted under the Plan are subject to a mandatory call provision with a defined value, as stated in the LLC Agreement and described as follows: (1) for termination of employment due to death, disability, retirement, termination without cause (as defined) or resignation with good reason (as defined), each common unit covered by such options will be called at a price calculated as the difference between the greater of $1.00 or the fair value price (“FVP”) as of the termination date, less the exercise price; and, (2) for any other call event, each common unit covered by such options will be called at a price calculated as the difference between the lesser of $1.00 or the FVP as of the termination date, less the exercise price. The Company does not have a contractual obligation to fund the mandatory call of these units; however, the Company may be called upon to provide a distribution to Holdings upon such time a triggering event should occur that would require a mandatory call of outstanding units.

As of December 29, 2009, no options had been exercised by management. As no triggering events have been deemed probable as of December 29, 2009, the Company has recorded no compensation expense for options granted in fiscal years 2009, 2008 and 2007.

 

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The Company has adopted the NPC International, Inc. 401(k) and Deferred Compensation Plan, to which the Company provides matching contributions. Contributions by the Company to these plans were $0.7 million, $0.8 million and $0.7 million during fiscal years 2009, 2008 and 2007, respectively. Additionally, the Company has adopted the POWR Plan, to which contributions are based on certain financial targets set by the Company’s Board of Directors each year. Under this plan, the Company had no accrual for 2009 and accrued $0.7 million and $0.6 million in fiscal 2008 and fiscal 2007, respectively. Generally, each of these accruals was paid during the first quarter of the following fiscal year. Annual contributions to these plans are net of employee forfeitures for that respective year. Contributions to these plans by the Company are maintained in a rabbi trust held with a third party administrator. The Company records the plan assets of these funds at the fair market value of the underlying investments at each reporting period. Investments held within the rabbi trust were $8.0 million and $5.9 million as of December 29, 2009 and December 30, 2008, respectively. The fair market value of the underlying investment was based upon independent market data considered to be a Level 2 observable input.

Note 13 – Related-Party Transactions

MLGPE Advisory Agreement. Upon completion of the 2006 Transaction, the Company entered into an advisory agreement with an affiliate of MLGPE pursuant to which such entity or its affiliates will provide advisory services to the Company. Under the agreement MLGPE or its affiliates will continue to provide financial, investment banking, management advisory and other services on the Company’s behalf for an annual fee of $1.0 million. The Company paid $1.0 million to MLGPE for the fee during each of the fiscal years ended 2009, 2008 and 2007.

Merrill Lynch & Company Investments Derivative Transaction. On June 6, 2006, the Company entered into an amortizing floating-to-fixed rate interest rate swap agreement expiring December 31, 2010, the notional amount of this swap was $50.0 million at fiscal year end 2009. Merrill Lynch Capital Services, Inc. (“MLCS”), was the counterparty on $25.0 million of the total notional amount, and JPMorgan Chase Bank, N.A. (“JPMCB”), an unrelated party, was the counterparty on the residual $25.0 million. Under this swap, the Company will pay both counterparties 5.39% and receive the three-month LIBOR rate as determined on the reset dates. These swaps were entered into to provide a hedge against the effects of rising interest rates on a portion of the $300.0 million term loan notes under the Senior Secured Credit Facility. The Company has recognized $1.6 million ($1.0 million after tax) for fiscal 2009 and $3.1 million ($1.9 million after tax) for fiscal 2008 of other comprehensive losses related to the fair market value of these interest rate swaps.

Effective April 7, 2008, the Company entered into a floating-to-fixed rate interest rate swap agreement expiring April 7, 2011, on a notional amount of $50.0 million with MLCS as the counterparty to the transaction. Under this swap, the Company will pay MLCS 2.79% and receive the three-month LIBOR rate as determined on the reset dates. This swap was entered into as a hedge to fix a portion of the $300.0 million term loan notes under the Senior Secured Credit Facility. The Company has recognized $1.5 million ($0.9 million after tax) for fiscal 2009 and $1.2 million ($0.7 million after tax) for fiscal 2008 of other comprehensive losses related to the fair market value of this interest rate swap.

Bank of America Merchant Services. In January 2009, Bank of America Corporation (“BOA”) acquired the parent company of MLGPE, Merrill Lynch & Co., Inc. During fiscal 2009 the Company paid Bank of America Merchant Services, an affiliate of BOA, $0.3 million for credit card processing services.

Bank of America, N.A. In December 2009, the Company opened a money market account with BOA to invest any excess cash balances on hand. As of December 29, 2009, the Company had $9.9 million invested in this account. These investments are trading securities, which are included in cash and cash equivalents, and the fair value of the investment was determined using independent market data considered to be a Level 2 observable input.

Participation in Senior Secured Credit Facility. BOA and Merrill Lynch Capital Corporation (“MLCC”), an affiliate of MLGPE, were active participants in the Company’s Senior Secured Credit Facility. As of December 29, 2009, BOA held $2.2 million, or 1.0%, of the term loan notes outstanding and $12.5 million, or 16.7%, of the revolving credit facility. MLCC held $7.5 million, or 10.0%, of the revolving credit facility. The Company had no amounts outstanding on the revolving credit facility as of December 29, 2009.

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

 

Item 9A. Controls and Procedures.

Not applicable.

 

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Item 9A(T). Controls and Procedures.

Evaluation of Disclosure Controls and Procedures.

As of the end of the period covered by this Form 10-K for fiscal 2009, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rule 15d-15(e) of the Securities Exchange Act of 1934, as amended (“Exchange Act”). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of such date to provide reasonable assurance that the information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Management’s Report on Internal Control over Financial Reporting.

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework and criteria established in Internal Control — Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 29, 2009.

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Our internal control over financial reporting was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

Changes in Internal Control over Financial Reporting.

There has been no change in our internal control over financial reporting that occurred during the quarter ended December 29, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B. Other Information.

None.

 

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PART III

 

Item 10. Directors and Executive Officers and Corporate Governance of the Registrant

The following table sets forth information with respect to the individuals that serve as our executive officers and directors.

 

Name

  

Age

  

Position

Brandon K. Barnholt    51    Director
Charles W. Peffer    62    Director
Christopher J. Birosak    55    Director
Jaideep Hebbar    30    Director
Robert F. End    54    Director
James K. Schwartz    48    Chairman of the Board of Directors, President, Chief Executive Officer and Chief Operating Officer
Troy D. Cook    47    Executive Vice President–Finance and Chief Financial Officer
D. Blayne Vaughn    53    Senior Vice President–Head of Operations
Linda L. Sheedy    41    Vice President of Marketing
Lavonne K. Walbert    46    Vice President of Human Resources
Michael J. Woods    48    Vice President of Information Technology
Susan G. Dechant    39    Vice President of Administration and Chief Accounting Officer
Kirby W. Mynier    52    Territory Vice President–East
Tracy A. Armentrout    49    Territory Vice President–West
Thomas D. White    50    Territory Vice President–South

Directors and Governance

The Company is not required to have and does not have a separate Nominating and Corporate Governance Committee. Accordingly, the nominees for election as directors are nominated by the Company’s Board of Directors (the “Board”). The current directors were nominated to serve as such by the Board because the Board believes they have the requisite business experience, judgment, skills, integrity and independence, as well as a willingness to devote appropriate time and attention to the Company’s affairs, work as a team, and represent the interests of all stockholders. In addition, the Board considered the interplay each of the directors’ experience with that of the other Board members and believes that the directors possess, in the aggregate, the strategic, managerial and financial skills and experience necessary to fulfill the Board’s duties and fulfill its objectives. While the Board does not have a formal diversity policy, the Board believes that its deliberative process benefits from the diversity of backgrounds, experiences and perspectives represented by the current directors.

In nominating the current directors for re-election, the Board also took into consideration the experience, skills and qualifications of the individual directors which are described below in connection with the description of their prior business experience.

The Board has delegated to the Audit Committee the responsibility to oversee the assessment and management of the Company’s risks, including reviewing with management significant risk exposures potentially facing the Company and the policies and steps implemented by management to identify, assess, manage and monitor such exposures. The Company’s Compensation Committee is responsible for overseeing the assessment and management of any risks related to the Company’s compensation plans and arrangements. The Board is regularly informed through committee reports regarding the Company’s risks, and reviews and discusses such risks in overseeing the Company’s business strategy and risks.

The Board believes that having the Chief Executive Officer also serve as the Chairman of the Board is the best leadership structure for the Company. This structure provides unified leadership and direction for the Company and provides a single, clear focus for the execution of the Company’s strategy and business plans. The Board does not believe it is necessary to have a lead independent director in view of the following: the small size of the Board; two of the six directors are outside, independent directors, three of the remaining directors are representatives of Merrill Lynch Global Private Equity Fund LP and related institutional investors which collectively own 96.5% of the Company’s common stock on a fully diluted basis; and the Board’s history of conducting its deliberations and taking actions in an independent manner.

Brandon K. Barnholt became a director upon closing of the 2006 Transaction. Mr. Barnholt is President and CEO of KeHE Distributors one of the largest specialty food distributors in the U.S. Until September 2006, Mr. Barnholt was the President and

 

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CEO of White Hen Pantry, Inc., a convenience store chain. Prior to leading the management/private equity purchase of White Hen Pantry, Mr. Barnholt was the President and CEO of the 1,200 store retail gas and convenience store chain, Clark Retail Enterprises, Inc. On October 15, 2002, Clark Retail Enterprises filed for Chapter 11 bankruptcy protection. During his career, Mr. Barnholt has led numerous acquisitions and dispositions and has a solid depth of experience in the capital markets. Mr. Barnholt earned a B.S. degree in Finance and Economics from the University of Northern Colorado. The Board nominated Mr. Barnholt for re-election to the Board based on his extensive knowledge of the food and retail industry in general and his knowledge of the Company and its business in particular, his expertise and experience in management, finance, capital markets and acquisitions, and the fact that he qualifies as an independent director under the standards of the Nasdaq Global Market.

Charles W. Peffer became a director upon closing of the 2006 Transaction. Mr. Peffer was a partner in KPMG LLP from 1979 until his retirement in 2002. During that period, Mr. Peffer was the audit partner for many public and private companies and served as Managing Partner of KPMG LLP’s Kansas City office from 1993 to 2000. Mr. Peffer has been a Certified Public Accountant and member of the American Institute of Certified Public Accountants and Kansas and Missouri Societies of CPAs. Mr. Peffer is a director of the Commerce Funds, a family of six funds with approximately $1.2 billion in assets, Garmin Ltd, a NASDAQ 100 company in the technology and consumer electronics industries, and Sensata Technologies Holding N.V., a global industrial technology company specializing in sensors and controls. Mr. Peffer earned a B.S. in Business Administration from the University of Kansas and an M.B.A. from Northwestern University. The Board nominated Mr. Peffer for re-election to the Board based on his expertise and experience in financial and accounting matters, his knowledge of the Company’s business and its industry gained while previously serving as lead outside auditor for the Company and while subsequently serving as a director of the Company, the fact that he qualifies as an independent director under the standards of the Nasdaq Global Market, and that he possesses the qualifications and experience needed to constitute an Audit Committee Financial Expert.

Christopher J. Birosak became a director upon closing of the 2006 Transaction. Mr. Birosak is a Managing Director with BAML Capital Partners, the private equity division of Bank of America Corporation. BAML Capital Partners is the successor organization to Merrill Lynch Global Private Equity, which Mr. Birosak joined in 2004. From 1994 to 2004, Mr. Birosak worked in the Leveraged Finance division of Merrill Lynch in various capacities with particular emphasis on leveraged buyouts and merger and acquisition related financings. Mr. Birosak also serves on the Board of HCA, Inc. and Atrium Companies, Inc. Mr. Birosak earned a B.A. degree in Economics from Wayne State University and an M.B.A. in Finance from the University of Detroit. The Board nominated Mr. Birosak for re-election to the Board based on his knowledge of the Company and its business and industry, his expertise and experience in finance, capital markets and acquisitions, and his designation to serve as a representative of Merrill Lynch Global Private Equity Fund, LP and its related institutional investors.

Jaideep Hebbar became a director in 2009. Mr. Hebbar is a Vice President with BAML Capital Partners, the private equity division of Bank of America Corporation. BAML Capital Partners is the successor organization to Merrill Lynch Global Private Equity, which Mr. Hebbar joined in 2003. Prior to this, Mr. Hebbar worked in the Mergers and Acquisitions division of Merrill Lynch, where he assisted clients in strategic planning and corporate mergers. Mr. Hebbar has B.S. degrees in Finance and Systems Engineering from the University of Pennsylvania (Wharton). The Board nominated Mr. Hebbar for re-election to the Board based on his knowledge of the Company and its business and industry, his expertise and experience in finance, capital markets and acquisitions, and his designation to serve as a representative of Merrill Lynch Global Private Equity Fund, LP and its related institutional investors.

Robert F. End became a director upon closing of the 2006 Transaction. Mr. End is currently a Managing Director of Transportation Resource Partners, a private equity firm. Prior to joining Transportation Resource Partners in 2009, Mr. End was a Managing Director of MLGPE where he also served as U.S. Region Head. Prior to rejoining Merrill Lynch in 2004, Mr. End was a founding Partner and Director of Stonington Partners Inc., a private equity firm established in 1994. Prior to leaving Merrill Lynch in 1994, Mr. End was a Managing Director of Merrill Lynch Capital Partners, the firm’s private equity group. Mr. End joined Merrill Lynch in 1986 and worked in the Investment Banking Division before joining the private equity group in 1989. Mr. End serves on the Board of Directors of The Hertz Corporation and several privately held companies. Mr. End earned an A.B. degree in Government from Dartmouth College and an M.B.A. from the Amos Tuck School of Business Administration at Dartmouth College. The Board nominated Mr. End for re-election to the Board based on his knowledge of the Company and its business and industry, his expertise and experience in finance, capital markets and acquisitions, and his designation to serve as a representative of Merrill Lynch Global Private Equity Fund, LP and its related institutional investors.

James K. Schwartz joined us in late 1991 as Vice President of Accounting and Administration. He was promoted to Vice President Finance, Treasurer and Chief Financial Officer in 1993. In January 1995, he was promoted to President and

 

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Chief Operating Officer and then to Chief Executive Officer in December 2004. Upon the 2006 Transaction, he was given the additional responsibility of Chairman of the Board of Directors. Mr. Schwartz is a Director of the Unified Foodservice Purchasing Co-op Board and served as its Chairman since 2004. He is actively involved in the Pizza Hut system and is serving on the Pizza Hut Advertising Committee and was Chairman of the Franchisee Board in 2009. In 2004, Mr. Schwartz was inducted into the Pizza Hut Franchisee Hall of Fame. Mr. Schwartz is a certified public accountant and earned a B.S. in Accounting and Business Administration from the University of Kansas in 1984. The Board nominated Mr. Schwartz for re-election to the Board based on his extensive knowledge of the Company’s business and its industry, his management and financial experience and his proven track record of effective leadership of the Company’s business.

Troy D. Cook joined us in February 1995 as Vice President Finance and Chief Financial Officer. He was promoted to Executive Vice President and Chief Financial Officer in January 2007. Mr. Cook is a member of the UFPC cheese task force. Mr. Cook is a certified public accountant and earned his B.S. in Accounting and Business Administration from the University of Kansas in 1985.

D. Blayne Vaughn joined us in November 1985 as an Area General Manager. He was promoted to Regional Manager in 1990 and then Regional Vice President in 1993. In May 1997 he was promoted to Vice President of Pizza Hut operations for the Western Division and in January 2003, Mr. Vaughn became Vice President Operations for the Northern Territory. In January 2007, he was promoted to Senior Vice President of Operations of the Northern Territory and to his current position of Senior Vice President Head of Operations in March of 2008. Mr. Vaughn serves on the PHI System Restaurant Readiness Team (SRRT) Committee. Mr. Vaughn has over thirty-five years of experience in the food service industry.

Linda L. Sheedy joined us in January 1998 as Vice President Marketing. Mrs. Sheedy serves on various Pizza Hut committees including the Beverage Committee and Marketing Advisory Council. Mrs. Sheedy has twenty years of marketing experience, with seventeen of those years in the food service industry. Mrs. Sheedy earned a Bachelor of Journalism degree from the University of Missouri in 1990.

Lavonne K. Walbert joined us in February 1999 as Vice President Human Resources. Ms. Walbert serves on various PHI system committees. She is Chairman of the People Capability and Training Committee and is a member of the Government and Political Affairs Committee. Ms. Walbert has twenty-three years of human resources experience in the sales and services industry. Ms. Walbert earned her B.S. in Human Resources Management from the University of Kansas in 1986 and an MBA from Rockhurst in 1999. Ms. Walbert is also affiliated with the National Society of Human Resource Management.

Michael J. Woods joined us in April 2003 as Chief Information Officer (CIO). Mr. Woods holds an Associate of Arts Degree from the University of Maryland and served in the United States Army from 1981 through 1985.

Susan G. Dechant joined us in August 1996 as Corporate Controller. In June 2000, she was promoted to Chief Accounting Officer and Director of Restaurant Services. In August 2006, she was promoted to Vice President of Administration and Chief Accounting Officer and Assistant Secretary. Ms. Dechant earned her B.A. in Accounting from Pittsburg State University in 1992.

Kirby W. Mynier joined NPC in 2002 as a Region Manager and then to his current position as Vice President for the Eastern Territory in 2008. Mr. Mynier has 33 years of experience in the food service industry. Mr. Mynier has a B.S. from Conrad Hilton School of Hotel/Restaurant Management, University of Houston and an M.B.A. in Accounting and Finance from the University of Texas. He is a published co-author (with M. Lynn) of “Effect of Server Posture on Restaurant Tipping” in the Journal of Applied Social Psychology.

Tracy A. Armentrout joined us in 2000 as an Area General Manager as a result of an acquisition of units from PHI. He was promoted to Regional Manager in 2004 and then to his current position as Vice President for the Western Territory in 2008. Mr. Armentrout serves on the PHI CHAMPS advisory board. He has over twenty-nine years of experience in the food service industry. Mr. Armentrout earned his B.S. in Criminal Justice and Law Enforcement from Northeast Missouri State in 1983.

Thomas D. White joined us in 2008 as Vice President-Southern Territory. Prior to joining us, he was Regional Vice President of Jack in the Box from 1997 to 2008 with accountability for 179 units where he developed numerous operations improvements in retention and training. Mr. White has over twenty-four years in the food service and retail industry and earned a B.S. in Business Administration from the University of Rhode Island in 1981.

 

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Mr. Barnholt and Mr. Peffer are the sole members of the Audit Committee of our Board of Directors. Mr. Peffer has been designated by the Board of Directors as an audit committee financial expert.

Code of Ethics

We have adopted a Code of Business Conduct and Ethics which applies to all of our employees, including our executive officers and directors. A copy of the Company’s Code of Business Conduct and Ethics will be made available to any person, without charge, by contacting the Executive Vice President – Finance and Chief Financial Officer, Troy D. Cook, at 913-327-5555, or through a written request to 7300 W. 129th Street, Overland Park, Kansas 66213.

 

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Item 11. Executive Compensation

Compensation Discussion and Analysis

Background of Compensation Program

On May 3, 2006, our former stockholders completed the sale of all our outstanding shares of capital stock to NPC Acquisition Holdings, LLC, or “Holdings,” a company controlled by Merrill Lynch Global Private Equity, or “MLGPE,” and its affiliates. In this Annual Report on Form 10-K, we refer to the acquisition of all of our capital stock by Holdings and related financings, as the “2006 Transaction.” The term “Named Executive Officer” used in this discussion refers to James Schwartz, our principal executive officer, Troy Cook, our principal financial officer, and our three other most highly compensated executive officers during 2009. These other Named Executive Officers include Blayne Vaughn, Senior Vice President – Head of Operations, Lavonne K. Walbert, Vice President – Human Resources and Mike Woods, Vice President—Information Technology and Chief Information Officer.

The following discussion of our compensation philosophy and policies reflects the views of our current Compensation Committee, which is composed solely of three independent directors (as defined under NASDAQ Stock Market Rules). Under its Charter, the Compensation Committee determines the amount and elements of compensation of our Chief Executive Officer, subject to ratification by the Board of Directors, and recommends to the Board of Directors, the amount and elements of compensation of our other executive officers.

The definitive stock purchase, or the “Purchase Agreement,” between our former stockholders and Holdings, dated May 3, 2006, included a condition to the 2006 Transaction that we enter into employment agreements with each of Mr. Schwartz, our President, Chief Executive Officer and Chief Operating Officer, and Mr. Cook, our Executive Vice President – Finance and Chief Financial Officer. The terms of these employment agreements were negotiated at arms length, following the negotiation of the terms of the Purchase Agreement but before the closing of the 2006 Transaction, by Mr. Schwartz and Mr. Cook and their counsel, on the one hand, and Holdings and its counsel, on the other hand. These employment agreements were amended on December 29, 2008, effective fiscal 2009 (collectively, the “Amended and Restated Agreements”). The changes made in each of the Amended and Restated Agreements included the following: (i) the term of the respective agreement was extended to three years from the effective date of the Amended and Restated Agreement, (ii) the renewal periods were increased from one year to two years, (iii) changes were made to the computation of bonus compensation to provide for incremental accruals between the threshold, target and maximum bonus amounts, (iv) certain changes were made to employee benefits provided, including the provision of life insurance and changes in use of the Company’s airplane and (v) the severance payments payable upon termination without cause or termination by the executive with good reason were amended to provide for payment of a pro rata bonus. The Compensation Committee approved the changes negotiated with Mr. Schwartz and Mr. Cook based upon the Committee’s satisfaction with the services provided by Mr. Schwartz and Mr. Cook and the Committee’s desire to strengthen the performance and retention incentives provided to Mr. Schwartz and Mr. Cook. The Amended and Restated Agreements were subsequently amended on March 10, 2009 to clarify that the calculation, timing of payment and other matters relating to the bonus compensation for Mr. Schwartz and Mr. Cook for their service to the Company in 2008 would be governed by the Amended and Restated Agreements rather than their original employment agreement which was entered into on May 3, 2006. Based on the terms of the Amended and Restated Agreements, the Compensation Committee has discretion to vary the amount and elements of compensation received by Mr. Schwartz and Mr. Cook only to the extent of increasing the minimum levels of such compensation beyond those specified in their respective employment agreements, which are described below.

Compensation Philosophy and Objectives

The Compensation Committee believes that the most effective executive compensation program is one that is designed to reward the achievement of specific short-term and long-term goals by the Company, and which aligns executives’ interests with those of the stockholders by rewarding performance above established goals, with the ultimate objective of improving stockholder value. The Compensation Committee evaluates both performance and compensation, as well as the amount and structure of the compensation elements constituting our compensation program, in order to ensure that the Company maintains its ability to attract, motivate and retain highly qualified employees in key positions and that compensation provided to key employees remains competitive relative to the compensation paid to similarly situated executives of our peer companies. To that end, the Compensation Committee believes that the compensation packages provided by the Company to its executives, including the Named Executive Officers, should include both cash and stock-based compensation that reward performance, as measured against established goals.

 

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In order to ensure that the compensation program is structured to remain competitive, the Compensation Committee reviews and takes into account competitive compensation data gathered by the Vice President – Human Resources regarding the elements of compensation and the amount of each element paid by comparable competitors for executives in positions that are similar to our executive officer positions. The primary source data for all elements of compensation is the Chain Restaurant Compensation Association (“CRCA”), which is a survey conducted by the Hay Group, and includes a variety of restaurant groups. The 2009 survey included 33% Dinner Houses, 14% Family Dining establishments, 9% Quick Casual, 26% Quick Service and 18% Restaurant Groups. The Company has utilized this survey as a guide to establishing compensation for a number of years; we do not have input or control over the restaurant groups that participate in this survey. However, despite any variance in the participating restaurant groups, the Company utilizes the CRCA data as a guide and also considers relative volume levels, our franchise status, and our capital structure to determine a competitive compensation structure.

In connection with awarding any element of the compensation program, the Compensation Committee reviews comprehensive tally sheets for each of the executive officers, which provide the amount of compensation to be received with respect to each element of compensation during the relevant time period. The Compensation Committee considers the competitiveness of each element of the compensation package, as well as the competitiveness of total cash compensation comparisons and total compensation comparisons. However, for competitive and retention reasons, the Compensation Committee believes it is desirable to retain flexibility and nimbleness and has therefore not adopted any policies regarding allocating between long-term and currently-paid-out compensation, or between cash and non-cash forms of compensation. The Compensation Committee reviews the alignment between executive compensation and performance on an annual basis and designs the compensation elements to ensure a balance of both short-term and long-term interests.

2009 Elements of Compensation

The principal components of compensation for the Named Executive Officers for the 2009 fiscal year are described below.

Annual Base Salary

Executive officers are paid a base salary as compensation for performance of their primary duties and responsibilities. The annual base salaries for Mr. Schwartz and Mr. Cook were initially set by their Amended and Restated Agreements. Merit increases for the 2009 fiscal year were determined and approved by the Compensation Committee. In considering these factors, the Committee determined to provide smaller increases in base salary in 2009 primarily as a result of the general economic slowdown and the performance challenges faced by the Company in 2009. The annual base salary of the Senior Vice President – Head of Operations and Vice President – Human Resources is recommended by the Chief Executive Officer to the Compensation Committee. The salary of the Vice President – Information Technology is recommended by the Chief Financial Officer to the Chief Executive Officer, who, in turn, recommends such compensation to the Compensation Committee. Recommendations for salary include consideration of the following:

 

   

the level of salary needed to remain competitive with executives with similar positions by restaurant companies with comparable dollar volume and numbers of restaurants;

 

   

the nature and responsibility of the position;

 

   

the achievement of objective performance criteria specific to each position; and

 

   

subjective leadership criteria.

Bonus and Performance-Based Cash Incentive Compensation

Annual cash incentive compensation is designed to motivate and reward executive officers for their contributions. This objective is accomplished by making a large portion of cash compensation dependent upon our financial performance and, in the case of Named Executive Officers other than the Chief Executive Officer and Chief Financial Officer, additional specific performance measures related to their particular duties.

We believe that growth in earnings before interest, taxes, depreciation and amortization, or “EBITDA,” is the measure of financial performance that best reflects the increase in stockholder value. EBITDA is also a principal focus of our performance because it improves our debt service coverage and financial covenant compliance; in addition, EBITDA is a performance measure that yields cash to pay down our debt more quickly, which is a primary objective as we are a highly leveraged entity.

The duties and responsibilities of the Chief Executive Officer and the Chief Financial Officer empower them to drive the overall financial performance of the Company. Their annual cash bonus is therefore appropriately linked to the extent to which a specified

 

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percentage of the EBITDA Target is achieved or exceeded. The EBITDA Target is based on the annual budget approved by the Board of Directors, which is subject to review and consent by MLGPE, our controlling stockholder. The performance of the other Named Executive Officers contributes to the production of EBITDA, but, in recognition of their ability to significantly influence only those parts of our business which are under their direct supervision, their annual cash incentive compensation is linked to the performance of their respective parts of our business, as well as to achieving specified financial and other performance measures.

For fiscal 2009, the Amended and Restated Agreements with Mr. Schwartz and Mr. Cook provided them with the opportunity to earn annual cash incentive compensation of up to the following percentages of their annual base salary if the specified percentage of the EBITDA Target was achieved: (i) 25% of base salary if at least 95% of the EBITDA Target was achieved; (ii) 50% of base salary if at least 100% of the EBITDA Target was achieved; and (iii) 75% of base salary if 105% or more of the EBITDA Target was achieved; however, (i) if EBITDA was greater than 95%, but less than 100%, of the EBITDA Target, the incentive compensation paid would equal 50% of base salary minus the Adjustment Amount and (ii) if EBITDA was greater than 100% of the EBITDA Target, the incentive compensation would equal 50% of base salary plus the Adjustment Amount , up to a maximum of 75% of base salary. The term “Adjustment Amount” is defined in their respective Amended and Restated Agreements and generally provides for an incremental adjustment in the amount of bonus between the threshold, target and maximum bonus amounts based on the difference between actual EBITDA and the EBITDA Target. They did not earn any bonuses in fiscal 2009 under this provision of their Amended and Restated Agreements. They also have the opportunity to earn additional cash bonus compensation each year in recognition of outstanding performance as determined by the Board of Directors in its sole discretion. No discretionary bonuses were awarded to them in fiscal 2009.

The Company increased the target cash incentive compensation for each of Mr. Vaughn, Ms. Walbert and Mr. Woods by awarding incentive compensation available to each named executive officer for achievement of the EBITDA Target. This change was effected in fiscal 2009 to provide for higher alignment of each respective named executive officer’s compensation with overall Company performance. Additionally, with consideration of the Company’s acquisition of a substantial number of restaurants throughout 2008 and 2009, the Compensation awarded discretionary bonuses to the following named executive officers for fiscal 2009: Mr. Vaughn, $10,000 and Ms. Walbert, $10,000.

Mr. Vaughn also incurred a change in bonus structure beginning in fiscal 2008, consistent with the increase in his responsibilities in connection with his promotion to Senior Vice President – Head of Operations, with operational oversight of each of our territories. For fiscal 2009, Mr. Vaughn was eligible to earn target cash incentive compensation of $124,800, of which 60% was based upon achievement of the EBITDA Target as follows: (i) 50% of bonus target, or $37,440, if at least 95% of the EBITDA Target was achieved; (ii) 100% of bonus target, or $74,880, if at least 100% of the EBITDA Target was achieved; and (iii) 120% of bonus target, or $89,856, if 105% or more of the EBITDA Target was achieved. Mr. Vaughn was also eligible for incentive compensation targeted to be 20% of his total incentive compensation paid, or $24,960, the specific amount of which is determined primarily based on a pyramidal bonus structure involving each level of restaurant management on a system wide basis that is designed to align his incentives with each territory and ensure that each level of management within each respective territory is working together effectively to accomplish financial and other performance goals of the Company. This restaurant operations bonus is calculated based upon the aggregate cash incentive compensation payable to each Territory Vice President who reports to the Senior Vice President – Head of Operations, which, in turn, is based on the amount of cash incentive compensation payable to all of the regional managers who report to the respective Territory Vice President, which in turn, is based on the amount of cash incentive compensation payable to area general managers who report to the respective regional managers, which, in turn, is based on the amount of the cash incentive compensation payable to restaurant general managers who report to the respective area general managers. Finally, Mr. Vaughn was eligible for incentive compensation for specific leadership goals that are tied to financial performance and are determinable based on specified operational metrics, such as restaurant general manager turnover, comparable store sales, food safety, CHAMPS scores and delivery metrics. The leadership goals bonus was targeted to be 20% of his total incentive compensation paid, or $24,960.

Ms. Walbert is responsible for the training and human resource management of all of our stores in operation. For fiscal 2009, Ms. Walbert was eligible to earn target cash incentive compensation of $68,560, of which 60% was based upon the achievement of the EBITDA Target as follows: (i) 50% of bonus target, or $20,568, if at least 95% of the EBITDA Target is achieved; (ii) 100% of bonus target, or $41,136, if at least 100% of the EBITDA Target is achieved; and (iii) 120% of bonus target, or $49,363, if 105% or more of the EBITDA Target is achieved. Ms. Walbert was also eligible to receive incentive compensation targeted as 20% of her total incentive compensation paid, or $13,712, based upon assimilation measures including acquisition market financial performance and target turnover and staffing goals. Finally, Ms. Walbert was eligible for incentive compensation targeted as 20% of her total incentive compensation paid, or $13,712, based upon the successful completion of certain projects. Both the achievement and payout of the assimilation goals and completion of certain projects is determined at the discretion of the President, Chief Executive Officer and Chief Operating Officer.

 

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As the officer with principal supervisory responsibility over our information systems, Mr. Wood’s role has a significant impact on our operational efficiency and effectiveness. However, the goals in his area are more project and systems oriented and less susceptible to direct and immediate measurement of their effect on financial performance. As a result, his total cash compensation is more heavily weighted to salary so that his opportunity to receive annual incentive compensation in 2009 was targeted as $62,086, or 40% of base salary. Of this total annual incentive compensation opportunity 60% was based upon the achievement of the EBITDA Target as follows: (i) 50% of bonus target, or $18,626, if at least 95% of the EBITDA Target is achieved; (ii) 100% of bonus target, or $37,252, if at least 100% of the EBITDA Target is achieved; and (iii) 120% of bonus target, or $44,702, if 105% or more of the EBITDA Target is achieved. Additionally, Mr. Woods was eligible to receive incentive compensation targeted as $24,834 to be paid based upon the successful completion of specified information technology projects, which are determined at the discretion of the Executive Vice President – Finance and CFO.

The cash incentive compensation targets were established by the Board of Directors, based upon the financial operating plan for the Company for fiscal 2009. The financial operating plan was prepared by management, with board input, and ultimately approved by the Board of Directors. The EBITDA Target used to pay cash incentive compensation and to make contributions to the POWR Plan for fiscal year 2009 was $120.6 million. In light of the Company’s financial performance in 2009, the Compensation Committee has determined not to establish an EBITDA Target for fiscal 2010 to allow the Company the flexibility to evaluate 2010 performance with consideration of prevailing trends in the business, broader economic conditions and expected performance in fiscal 2011 as well as prospective covenant compliance. The aforementioned considerations, among others, will be evaluated at the sole discretion of the Compensation Committee and will affect payments related to all cash incentive compensation based on achievement of the EBITDA Target, merit increases for all employees, contributions to the Deferred Compensation and Retirement Plan and the POWR Plan.

Deferred Compensation and Retirement Plan

The Named Executive Officers are eligible to participate in our Deferred Compensation and Retirement Plan, or the “DCR Plan.” The objective of the DCR Plan is to provide deferred compensation and retirement income to a select group of management or highly compensated employees in years that such executives are not eligible to participate in the NPC International, Inc. Qualified Profit Sharing Plan (401(k) Plan). Most of our peer companies and companies with which we compete for executive-level talent provide similar plans for their executives. The DCR Plan is designed to replicate many of the features available under a tax-qualified retirement plan, including salary deferral features and opportunities to receive employer matching and profit sharing benefits without the tax benefits of a qualified plan. However, due to the non-qualified nature of the plan, any contributions from executive officers or the Company may be subject to the claims of creditors in the event that such claims should be made.

The Compensation Committee determines which executives may participate in the DCR Plan. The DCR Plan affords participants the opportunity to make two types of compensation deferral elections. First, each such executive may elect to defer all or a portion of his or her base salary. Second, the plan allows each such executive the opportunity to separately elect to defer all or a portion of his or her bonus compensation. As an incentive to participate in the DCR Plan, we match executive contributions up to four percent of the sum of the executive’s salary and bonus compensation. We also may provide additional discretionary contributions as a means of rewarding participants for their efforts with us. The amount of any discretionary contribution may vary from year to year based upon our Board’s assessment of those efforts made by DCR Plan participants and our financial needs; however, no such discretionary contributions were awarded during any of the years presented. For fiscal 2010, the Company has elected to withhold its Company contributions for all executives participating in the DCR Plan and payment of any contributions will be made at the sole discretion of the Compensation Committee at the end of the fiscal year. We believe that both the level of employer-matching contribution and the level of discretionary contributions, if any, that we may contribute to the DCR Plan on behalf of our executive officers are comparable with other peer companies, considered to be those companies included in the CRCA Survey cited above, who provide similar plans for retirement benefits for their executives under qualified retirement plan arrangements.

Participants in the plan may elect the time and manner in which they receive benefits under the plan, subject to requirements of Section 409A of the Internal Revenue Code of 1986, as amended.

POWR Plan

Our Named Executive Officers are eligible to participate in the NPC International, Inc. POWR Plan, which is a performance-based incentive plan providing deferred compensation for certain key management or highly compensated employees selected by our Compensation Committee, which is received following termination of employment. Subject to a participant being terminated due to gross misconduct, in which case a participant forfeits all of his or her benefit under the POWR plan, all benefit payments under the Plan are made only following a participant’s termination of employment or disability. However, due to the non-qualified nature of the plan, any contributions from executive officers or the Company may be subject to the claims of creditors in the event that such claims are successfully adjudicated by the creditors.

 

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There are essentially two components to the POWR Plan. The first component provides participants with the opportunity to earn a contribution equal to a specified percentage of the participant’s annual base salary for that year if we meet the EBITDA Target established by our Board of Directors. This percentage is the same for each Named Executive Officer but varies between a 0-13.5% payout depending on the threshold and target EBITDA Targets achieved. For fiscal 2009, EBITDA achievement less than the threshold EBITDA Target, or 95% of the EBITDA Target, would result in a 0% payout; EBITDA achievement greater than the threshold EBITDA Target but less than the EBITDA Target would result in a 9% payout; EBITDA achievement exceeding the EBITDA Target would result in a 13.5% payout. All participants are also eligible to participate in a “Gain Sharing Pool” which represents 5% of our EBITDA that is in excess of a higher EBITDA Target that is set at the discretion of our Board of Directors. The Gain Sharing Pool EBITDA Target for fiscal 2009 was $122.0 million. Each participant’s share of this Gain Sharing Pool is based on the participant’s individual POWR Plan contribution amount, excluding any POWR Plan Plus contribution, compared to the total profit sharing contributions under the POWR Plan. Contributions made under this first component vest at a rate of 25% each year over a four year period beginning with the year for which the contribution is earned. Participants are considered fully vested in all POWR Plan contributions upon the earlier of achievement of 15 years service or age 60 with at least 5 years service.

The second component of the POWR Plan provides an additional contribution, referred to in the plan as the “POWR Plus Contribution” that rewards participants in the plan who have at least ten years of service with us if the EBITDA Target, as defined above, is met. This additional contribution level for all years presented is 5% of annual base salary for each Named Executive Officer. Because POWR Plan Plus Contributions are designed to reward loyal and faithful key employees who provide valuable service to us over an extended period of time, they will vest only upon 20 years of employment with us.

For fiscal 2010, the Compensation Committee has not established an EBITDA Target and intends to withhold its Company contributions for all employees participating in the POWR Plan and payments of any contributions will be made at the sole discretion of the Compensation Committee at the end of the fiscal year.

Stock Options

In connection with the 2006 Transaction, Holdings agreed to establish a new stock option plan which governs, among other things, the issuance of matching options on purchased membership interests in Holdings, and the grant of options with respect to the membership interests in Holdings. The purpose of this plan, which has been established, are to: (i) attract and retain highly qualified employees for the Company; (ii) motivate them to exercise their best efforts on behalf of the Company and Holdings; (iii) allow participants in the plan to participate in equity value creation at Holdings; and (iv) align the incentives between the participants and Holdings as well as the Company.

Options may be granted under the plan with respect to a maximum of 8% of the membership interests of Holdings as of the closing date of the 2006 Transaction calculated on a fully diluted basis (subject to required capital adjustments). Each grant of options under the plan will specify the applicable option exercise period, option exercise price, vesting schedules and conditions and such other terms and conditions as deemed appropriate by the Compensation Committee or the Board of Holdings. Options with respect to 1.0% of the interests are “non-time vesting” options, which were vested at grant as a matching incentive based upon the level of equity investment made by the executive officer in connection with the 2006 Transaction. These options were made available to our Chief Executive Officer and Chief Financial Officer based upon their purchase of 1,950,000 units and 1,300,000 units of membership interests, at $1.00 per membership unit, in the Company on the date of the 2006 Transaction. Options with respect to 2.0% of the interests are to be “time vesting” options, which will vest ratably as to 20% of the interests subject to the option over a five-year period, subject to the option holders’ continued service. The options as to the remaining 5.0% of the interests vest only upon the occurrence of a change of control of Holdings or the Company on or prior to the expiration of the option, and also require continued service through the vesting date. All options granted under the Plan will expire ten years from the date of grant, but generally expire earlier upon or within 90 days after the termination of service by the member.

The exercise price of the non-time vesting and time vesting options for those options issued in conjunction with the 2006 Transaction was established based on the aggregate equity investment in Holdings at the time of closing of the 2006 Transaction divided by the number of outstanding membership interests, or $1.00. Similarly, the exercise price of the change of control options was established as twice the exercise price of the non-time vesting and time vesting options granted, or $2.00. No options were granted in fiscal 2009. The exercise price of options granted since the 2006 Transaction was determined at the discretion of the Compensation Committee of Holdings. The exercise price for all options granted was equal to or greater than the fair market value of the option on the date of grant.

Options grants will be made at the discretion and through approval of the Board of Holdings to ensure that compensation to our Named Executive Officers remains competitive and in-line with our peer companies.

 

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Perquisites and Other Personal Benefits

The Company provides Named Executive Officers with perquisites and other personal benefits that the Company and the Compensation Committee believe are reasonable and consistent with its overall compensation program to better enable the Company to attract and retain highly qualified employees for key positions.

Under the Amended and Restated Agreements effective for fiscal 2009 with Mr. Schwartz and Mr. Cook, they are each entitled to receive: (i) use of the Company airplane for up to 50 hours per year, (ii) matching gifts aggregating $10,000 annually to nontaxable charitable organizations of their choice, (iii) Mr. Schwartz is eligible for supplemental long-term disability coverage, and (iv) Mr. Schwartz and Mr. Cook are entitled to a reimbursement for out-of-pocket premiums paid for life insurance coverage, (v) a complete biannual medical examination and associated travel expenses, (vi) tax, financial planning and legal services, and (vii) a yearly car allowance.

The incremental cost to the Company for personal use of the Company airplane is calculated based on the average variable operating costs to the Company. Variable operating costs include fuel, maintenance, landing/ramp fees, and other miscellaneous variable costs. The total annual variable costs are divided by the annual hours flown by the Company aircraft to derive an average variable cost per hour flown. This average variable cost per hour flown is then multiplied by the hours flown for personal use to derive the incremental cost. The methodology excludes fixed costs that do not change based on usage, such as pilots’ and other employees’ salaries, purchase costs of the aircraft and non-trip related hangar expenses. Incremental cost to the Company reported within the Summary Compensation Table was based on the hours flown for each personal trip taken by Mr. Schwartz and Mr. Cook.

The Compensation Committee has reviewed the design and operation of the Company’s compensation policies and practices for all employees, including executives, as they relate to risk management practices and risk-taking incentives. The Compensation Committee believes that the Company’s compensation policies and practices do not encourage unnecessary or excessive risk taking and that any risks arising from the Company’s compensation policies and practices for its employees are not reasonably likely to have a material adverse effect on the Company.

 

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Summary Compensation Table

The following table summarizes the compensation of the Named Executive Officers for the fiscal years ended December 29, 2009, December 30, 2008 and December 25, 2007. The Named Executive Officers are the Company’s principal executive officer and principal financial officer, and the three other most highly compensated executive officers ranked by their total compensation in the table below:

Name and Principal

Position

   Year    Salary
($)
   Bonus
($)
   Stock
Awards

($)
   Option
Awards
($)
   Non-Equity
Incentive Plan
Compensation
($)
   Change in
Pension Value
and
Nonqualified
Deferred
Compensation
Earnings ($)
   All Other
Compensation
   Total ($)

(a)

   (b)    (c)(1)    (d)(2)    (e)(3)    (h)(4)    (g)(5)    (h)(6)    (i)(7)    (j)

James K. Schwartz
President, Chief Executive Officer and Chief Operating Officer

   2009

2008

2007

   683,670

661,853

632,006

   —  

—  

—  

   —  

—  

—  

   0

0

0

   —  

368,039

247,212

   198,418

—  

5,682

   68,466

55,135

47,325

   950,553

1,085,027

932,225

Troy D. Cook
Executive Vice President – Finance and Chief Financial Officer

   2009

2008

2007

   455,137

443,670

422,871

   —  

—  

—  

   —  

—  

—  

   0

0

0

   —  

246,221

164,808

   123,868

—  

2,378

   73,743

54,696

37,673

   652,748

744,587

627,730

D. Blayne Vaughn
Senior Vice President – Head of Operations

   2009

2008

2007

   247,917

229,750

194,252

   10,000

—  

—  

   —  

—  

—  

   0

0

0

   9,401

107,411

99,740

   152,934

—  

1,441

   12,376

11,860

9,962

   432,628

349,020

305,395

Lavonne K. Walbert
Vice President – Human Resources

   2009

2008

   172,843

158,323

   13,428

3,809

   —  

—  

   0

0

   0

41,712

   48,772

—  

   8,220

6,918

   243,262

210,762

Michael J. Woods
Vice President – Information Technology and Chief Information Officer

   2009

2008

2007

   158,909

155,399

149,908

   1,500

21,913

18,750

   —  

—  

—  

   0

0

0

   0

24,984

24,139

   70,298

—  

—  

   7,391

7,322

7,093

   238,098

209,618

199,890

 

(1)

Amounts shown are the cumulative base salary earned by the Named Executive Officer throughout fiscal years 2009, 2008 and 2007. These amounts are not reduced by any deferral of compensation for those individuals participating in the Deferred Compensation and Retirement Plan. Base salary for each Named Executive Officer in effect for fiscal years 2009, 2008 and 2007, respectively, were as follows: Mr. Schwartz, $685,000, $665,000 and $637,500; Mr. Cook, $460,575, $445,000 and $425,000; Mr. Vaughn, $249,600, $240,000 and $198,000; Mr. Woods, $155,216, $152,173 and $147,027. The annual base salary for Ms. Walbert for fiscal years 2009 and 2008 was $171,400 and $160,000, respectively. No merit increases were granted for fiscal 2010.

(2)

For fiscal 2009, bonuses include discretionary payments related to the 2008 and 2009 acquisition of 294 units from PHI of $10,000 for Mr. Vaughn and Ms. Walbert. Additionally, the remaining amounts for all periods represent a portion of the annual bonus program earned by Ms. Walbert and Mr. Woods that is made on a discretionary basis, which is determined by management and amounts were paid in each respective year. Amounts paid under the Company’s incentive plan are reported in Column (g) as “Non-Equity Incentive Plan Compensation.”

(3)

No stock awards were granted to any employee during fiscal years 2009, 2008 and 2007.

(4)

The Company is required to disclose the amount of the grant date fair value of options issued in the respective year. Per the terms of the NPC Acquisition Holdings, LLC Management Option Plan, these options have certain vesting conditions that trigger a fair value or formula valuation, depending on the performance condition. The Company has determined that none of these performance conditions was to be considered probable as of the grant date and at the end of all years presented; therefore, no value has been attributed to these options. Further, there were no options granted in fiscal 2009. There can be no assurance that value related to these options will ever be realized. Additionally, even if the highest level of performance conditions is achieved, due to the restrictions on the options, the options would have no value on the date of grant.

(5)

Amounts represent incentive compensation earned by the Named Executive Officers based on specific performance criteria, which is described in further detail under ‘2009 Elements of Compensation’ Item 11. Compensation Discussion and Analysis, for fiscal years 2009, 2008 and 2007, respectively, as follows: Mr. Schwartz, $0, $275,975 and $159,375; Mr. Cook, $0, $184,675 and $106,250; Mr. Vaughn, $9,401, $75,394 and $72,623; and Mr. Woods, $0, $11,413 and $11,027. Incentive compensation for Ms. Walbert was $0 and $20,191 for fiscal 2009 and 2008, respectively. In addition, amounts included above were contributions to the Company’s POWR Plan for each executive for fiscal years 2008 and 2007, respectively, as follows: Mr. Schwartz, $92,064 and $87,837; Mr. Cook, $61,546 and $58,558; Mr. Vaughn, $32,017 and $27,117; Mr. Woods, $13,571 and $13,112. The POWR Plan contribution for Ms. Walbert was $21,521 for fiscal 2008. No contributions were made to the POWR Plan for fiscal 2009. Fiscal years 2009, 2008 and 2007 earnings (losses), respectively, on the POWR Plan are as follows: Mr. Schwartz, $163,795, ($143,386) and $35,064; Mr. Cook, $102,587, ($88,957) and $21,554; Mr. Vaughn, $54,791, ($47,698) and $11,768; Mr. Woods, $23,846, ($20,838) and $5,079. POWR Plan earnings (losses) for Ms. Walbert were $33,535 and ($28,774) for fiscal 2009 and 2008, respectively. POWR Plan earnings (losses) are not included in amounts reported in Column (g) as “Non-Equity Incentive Plan Compensation;” however, any above market earnings on balances in the POWR Plan are reported in Column (h) as “Change in Pension Value and Nonqualified Deferred Compensation Earnings.”

(6)

Amounts represent above market earnings on compensation that is deferred outside of tax-qualified plans within the Company’s POWR Plan and the Deferred Compensation and Retirement Plan. Above market earnings for fiscal 2009 on the combined POWR Plan and Nonqualified Deferred Compensation Plan were as follows: Mr. Schwartz, $198,418; Mr. Cook, $123,868;

 

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Mr. Vaughn, $152,934; Ms. Walbert, $48,772; and Mr. Woods $70,298. Amounts reported were calculated as earnings on plan balances with returns exceeding 120% of the annual applicable federal rate, which was equal to 3.16%, 3.43% and 4.97% for fiscal years 2009, 2008 and 2007, respectively.

(7)

This amount represents (i) the Company contribution to the Deferred Compensation and Retirement Plan for all Named Executive Officers listed above for fiscal year 2009 as follows: Mr. Schwartz, $38,601; Mr. Cook, $25,873; Mr. Vaughn, $12,376; Ms. Walbert, $8,220; and Mr. Woods, $7,391; (ii) perquisites and other personal benefits. Under SEC Rules, companies are required to identify by type all perquisites and other benefits for a “named executive officer” if the total value for that individual equals or exceeds $10,000, and to report and quantify each perquisite or personal benefit that exceeds the greater of $25,000 or 10% of the total amount for that individual.

  (a)

The aggregate value of perquisites and other personal benefits for Mr. Schwartz in fiscal 2009 was $29,864. This amount comprised: personal use of the Company aircraft; a matching gift contribution ($10,000); reimbursement for tax, financial planning and legal services ($11,760); and reimbursement for life insurance premiums.

  (b)

The aggregate value of perquisites and other personal benefits for Mr. Cook in fiscal 2009 was $47,870. This amount comprised: personal use of the Company aircraft ($22,856); a matching gift contribution ($10,000), a biannual medical examination; reimbursement for tax, financial planning and legal services; and reimbursement for life insurance premiums.

  (c)

No perquisites and other personal benefits were received by any other named executive officer that equals or exceeds $10,000.

From time to time, members of management may have guests accompany them on business-related trips. Perquisites and other personal benefits are valued basis of the aggregate incremental cost to the Company. As business-related trips are not incremental to the Company, no amounts were reported with respect to these items. Further, executives are taxed on the imputed income attributable to personal use of the Company aircraft and do not receive tax assistance from the Company with respect to these amounts.

 

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Grants of Plan-Based Awards in Last Fiscal Year

The following table provides information on future payouts under the non-equity incentive plan awards and stock options granted in 2009 to each of the Company’s Named Executive Officers:

 

           Estimated Possible Payouts Under
Non-Equity Incentive Plan Awards
    Estimated Possible Payouts Under
Equity Incentive Plan Awards
              

Name

   Grant
Date
   Threshold
($)
    Target
($)
    Maximum
($)
    Threshold
($)
   Target
($)
   Maximum
($)
   All Other
Stock
Awards:
Number
of Shares
of Stock
or Units
(#)
   All Other
Option
Awards:
Number of
Securities
Underlying
(Options
(#)
   Exercise
or Base
Price of
Option
Awards
($/Sh)

(a)

   (b)    (c)     (d)     (e)     (f)    (g)    (h)    (i)    (j)    (k)

James K. Schwartz
President, Chief Executive Officer and Chief Operating Officer

   12/31/08

12/31/08

   171,250

—  

(1) 

(3) 

  342,500

95,900

(1) 

(3) 

  513,750

126,725

(1) 

(3) 

  —  

—  

   —  

—  

   —  

—  

   —  

—  

   —  

—  

   —  

—  

Troy D. Cook
Executive Vice President – Finance and Chief Financial Officer

   12/31/08

12/31/08

   115,144

—  

(1) 

(3) 

  230,288

64,481

(1) 

(3) 

  345,431

85,206

(1) 

(3) 

  —  

—  

   —  

—  

   —  

—  

   —  

—  

   —  

—  

   —  

—  

D. Blayne Vaughn
Senior Vice President – Head of Operations

   12/31/08

12/31/08

   —  

—  

(2) 

(3) 

  124,800

34,944

(2) 

(3) 

  —  

46,176

(2) 

(3) 

  —  

—  

   —  

—  

   —  

—  

   —  

—  

   —  

—  

   —  

—  

Lavonne K. Walbert
Vice President – Human Resources

   12/31/08

12/31/08

   —  

—  

(2) 

(3) 

  41,136

23,996

(2) 

(3) 

  —  

31,709

(2) 

(3) 

  —  

—  

   —  

—  

   —  

—  

   —  

—  

   —  

—  

   —  

—  

Michael J. Woods
Vice President – Information Technology and Chief Information Officer

   12/31/08

12/31/08

   —  

—  

(2) 

(3) 

  37,252

13,969

(2) 

(3) 

  —  

20,954

(2) 

(3) 

  —  

—  

   —  

—  

   —  

—  

   —  

—  

   —  

—  

   —  

—  

 

(1)

Amounts represent incentive compensation, which is defined by the Amended and Restated Agreements, signed by Mr. Schwartz and Mr. Cook, which equals a specified percentage for the threshold, target and maximum payout as 25%, 50% and 75% of base salary with a corresponding achievement of 95%, 100%, or 105% or more of the EBITDA Target, respectively, that is approved by the Board of Directors on an annual basis. This payout is based on performance achieved during fiscal 2009. Based on fiscal 2009 results, Mr. Schwartz and Mr. Cook earned no incentive award.

(2)

Amounts represent the target incentive compensation for each of these Named Executive Officers for fiscal 2009. Actual incentive compensation earned based on fiscal 2009 results was as follows: Mr. Vaughn, $9,401; Ms. Walbert, $0; and Mr. Woods, $0.

(3)

Amounts represent POWR Plan contributions, which equals a specified percentage for the threshold, target, and maximum payout as 0%, 9%, and 13.5% with a specified achievement of the POWR Plan EBITDA Target. An additional contribution of 5% is made on behalf of executives with more than 10 years of tenure if the target or maximum incentive level is met. The above amounts do not include potential “Gain-Sharing Pool” contributions, which are further described in “2009 Elements of Compensation” in the Compensation Discussion and Analysis, due to the ineligibility to receive such contributions based on fiscal 2009 actual EBITDA results. Based on fiscal 2009 results, no contributions to the POWR Plan were made.

 

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Outstanding Equity Awards at Fiscal Year End

The following table shows the number of exercisable and unexercisable options granted and held by the Company’s Named Executive Officers as of December 29, 2009:

 

      Option Awards

Name

   Number of
Securities
Underlying
Unexercised
Options (#)
Exercisable
    Number of
Securities
Underlying
Unexercised

Options (#)
Unexercisable
    Equity Incentive Plan
Awards: Number of
Securities Underlying
Unexercised
Unearned Options (#)
   Option
Exercise

Price ($)
   Option
Expiration
Date

(a)

   (b)     (c)     (d)    (e)    (f)

James K. Schwartz
President, Chief Executive Officer and Chief Operating Officer

   1,613,400

—  

(1) 

  

  425,600

2,659,000

(2) 

(3) 

  —  

—  

   $
$
1.00
2.00
   5/3/2016
5/3/2016

Troy D. Cook
Executive Vice President – Finance and Chief
Financial Officer

   1,075,400

—  

(1) 

  

  283,600

1,773,000

(2) 

(3) 

  —  
—  
   $
$
1.00
2.00
   5/3/2016
5/3/2016

D. Blayne Vaughn
Senior Vice President – Head of Operations

   108,718

—  

10,000

—  

(2) 

  

(2) 

  

  163,076

665,423

40,000

120,000

(2) 

(3) 

(2) 

(3) 

  —  

—  

—  

—  

   $

$

$

$

1.00

2.00

1.24

2.24

   1/24/2017

1/24/2017

4/2/2018

4/2/2018

Lavonne K. Walbert
Vice President – Human Resources

   94,222

—  

(2) 

  

  141,333

576,700

(2) 

(3) 

  —  

—  

   $

$

1.00

2.00

   1/24/2017

1/24/2017

Michael J. Woods
Vice President – Information Technology and
Chief Information Officer

   79,726

—  

(2) 

  

  119,590

487,977

(2) 

(3) 

  —  

—  

   $

$

1.00

2.00

   1/24/2017

1/24/2017

 

(1)

Options granted on May 3, 2006, in connection with the 2006 Transaction, of which 975,000 and 650,000 options for Mr. Schwartz and Mr. Cook, respectively, have a service period that allows for immediate vest. These options were a matching incentive for the purchase of membership interests in the Company at the time of the 2006 Transaction, which is described further in the ‘2009 Elements of Compensation’ of Item 11. Compensation Discussion and Analysis. The remaining vested options for all Named Executive Officers, have a service period that vests ratably over a period of five years, but allow for accelerated vesting in the event of a change in control. Each of these options expires on the date shown in Column (f), which is ten years from the date of grant.

(2)

Options granted that have a service period that vests ratably over a period of five years, but allow for accelerated vesting in the event of a change in control. These options expire on the date shown in Column (f), which is ten years from the date of grant.

(3)

Options granted that vest only upon a change in control of the entity.

In addition to the service period vesting footnoted above, each option has a mandatory call provision, which results in a fair value or formula valuation depending on the performance condition, which is defined in the NPC Holdings, LLC Management Option Plan. These performance conditions have been determined by management not to be probable at the date of grant or at the end of fiscal 2009; therefore, no value has been attributed to these options. There can be no assurance that value related to these options will ever be realized. However, the expense and related reporting of these earnings will be reported in full at such time the value of options granted can be determined.

No options have been exercised by any named officer as of December 29, 2009.

 

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Nonqualified Deferred Compensation in Last Fiscal Year

The following table shows the executive contributions, earnings and account balances for the Deferred Compensation and Retirement Plan and the POWR Plan for all Named Executive Officers as of and for the fiscal year ended December 29, 2009:

 

Name

  Executive
Contributions
in Last Fiscal
Year ($)
    Registrant
Contributions
in Last Fiscal
Year ($)
    Aggregate
Earnings
in Last Fiscal
Year ($)
    Aggregate
Withdrawals/
Distributions ($)
  Aggregate
Balance at Last
Fiscal Year End ($)
 

(a)

  (b)     (c)     (d)     (e)   (f)  

James K. Schwartz
President, Chief Executive Officer and Chief Operating Officer

  38,601

—  

(1) 

  

  38,601

— 

(1) 

(3) 

  64,540

163,795

(2) 

(2) 

  —  
—  
  271,447

913,314

(1) 

(4) 

Troy D. Cook
Executive Vice President – Finance and Chief Financial Officer

  25,873

—  

(1) 

  

  25,873

— 

(1) 

(3) 

  40,348

102,587

(2) 

(2) 

  —  
—  
  183,464

572,022

(1) 

(4) 

D. Blayne Vaughn
Senior Vice President – Head of Operations

  30,940

—  

(1) 

  

  12,376

— 

(1) 

(3) 

  119,213

54,791

(2) 

(2) 

  —  
—  
  506,097

305,513

(1) 

(4) 

Lavonne K. Walbert
Vice President – Human Resources

  12,330

—  

(1) 

  

  8,220

— 

(1) 

(3) 

  22,228

33,535

(2) 

(2) 

  —  
—  
  90,782

186,989

(1) 

(4) 

Michael J. Woods
Vice President – Information Technology and Chief Information Officer

  22,298

—  

(1) 

  

  7,391

— 

(1) 

(3) 

  54,499

23,846

(2) 

(2) 

  —  
—  
  192,543

132,964

(1) 

(4) 

 

(1)

Amounts represent activity for participation in the Deferred Compensation and Retirement Plan. The Company will match up to 4% of base salary, bonus, and cash incentive compensation (excluding contributions to the POWR Plan) contributed by the participant to the plan. Company contributions shown in Column (c) are also included in Column (i) as “All Other Compensation” on the Summary Compensation Table. Of the aggregate balance shown above, registrant contributions included within the Summary Compensation Table for fiscal years 2008 and 2007, respectively were as follows: Mr. Schwartz, $33,057 and $33,624; Mr. Cook, $22,065 and $23,019; Mr. Vaughn, $11,860 and $9,962; and Mr. Woods, $7,322 and $7,093. Registrant contributions included in the Summary Compensation Table for fiscal 2008 were $6,918 for Ms. Walbert. No amounts have been previously reported prior to fiscal 2008 for Ms. Walbert. There are no limits to the amount of contributions individuals are eligible to contribute to the plan.

(2)

Earnings on the Deferred Compensation and Retirement Plan and the POWR Plan that are considered to be above market earnings are included in Column (h) as a “Change in Pension Value and Nonqualified Deferred Compensation Earnings” in the Summary Compensation Table. Earnings on the POWR Plan are included in footnote 5 of the Summary Compensation Table. Interest is considered to be above-market if the rate of interest exceeds 120% of the applicable federal long-term rate, with compounding. The investment gain or loss for each of these plans shall be allocated to a participant’s account in the ratio that the participant’s account balance as of the preceding valuation date, adjusted for all distributions and forfeitures occurring during the calendar year, bears to the total of all account balances as of the preceding valuation date, as adjusted for all distributions and forfeitures occurring during the calendar year. For purposes of this Section, a participant’s account balance as of such preceding valuation date shall include contributions credited as of such date (even if such contributions are actually made after such date).

(3)

No contributions were made to the POWR Plan for fiscal 2009 for each Named Executive Officer. Contributions made by the Company are based on the achievement of established POWR Plan EBITDA Targets, which are approved by the Board of Directors on an annual basis. Amounts contributed to this plan vest over a four-year period, 25% in the year of contribution and ratably thereafter over the next three years; however, participants are considered fully vested in all POWR Plan contributions upon the earlier of achievement of 15 years service or age 60 with at least 5 years service. The following table details current year vesting and aggregate vested balances from prior years for each Named Executive Officer:

 

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      FY 2009 Vested
Contributions
   Aggregate Vested
Balances

James K. Schwartz
President, Chief Executive Officer and Chief Operating Officer

   $ 124,503    $ 649,225

Troy D. Cook
Executive Vice President – Finance and Chief Financial Officer

     139,820      465,966

D. Blayne Vaughn
Senior Vice President – Head of Operations

     54,791      305,513

Lavonne K. Walbert
Vice President – Human Resources

     39,896      165,939

Michael J. Woods
Vice President – Information Technology and Chief Information Officer

     31,966      121,416

 

(4)

Amounts represent the aggregate balance at the end of fiscal 2009 for participation in the Company’s POWR Plan. Company contributions shown in Column (c) are also included in Column (g) as “Non-Equity Incentive Plan Compensation” on the Summary Compensation Table. Of the aggregate balance shown above, registrant contributions included within the Summary Compensation Table for fiscal years 2008 and 2007, respectively were as follows: Mr. Schwartz, $92,064 and $87,837; Mr. Cook, $61,546 and $58,558; Mr. Vaughn, $32,017 and $27,117; and Mr. Woods, $13,571 and $13,112. Registrant contributions included in the Summary Compensation Table for fiscal 2008 were $21,521 for Ms. Walbert. No amounts have been previously reported prior to fiscal 2008 for Ms. Walbert.

Employment Agreements and Potential Post Employment Matters

On May 3, 2006, we entered into employment agreements with Mr. Schwartz to serve as our President, Chief Executive Officer and Chief Operating Officer and Mr. Cook to serve as our Executive Vice President – Finance and Chief Financial Officer, both for a period of two years. These agreements are automatically renewed for successive one year periods, unless either the Company or Mr. Schwartz or Mr. Cook provides at least 90 days written notice of intent not to renew. These employment agreements were subsequently amended effective fiscal 2009. The Amended and Restated Agreements extend the term of previous employment agreement until January 1, 2012, with automatic successive renewals in two year increments, unless Mr. Schwartz or Mr. Cook provides the Company at least 90 days written notice of intent not to renew. These employment agreements are further described within the Compensation Discussion and Analysis and footnote 1 to the Summary Compensation Table. Under the terms of these agreements, Mr. Schwartz and Mr. Cook are entitled to certain post-employment payments, which are determined based on the terms of the termination with the Company, which are detailed as follows:

 

Reason for termination

 

Payment Obligations to the Employee

Termination without cause

    •   

Unpaid compensation at the date of termination

    •   

Two times the sum of the base salary and bonus compensation earned in the year immediately preceding the year of termination

    •   

A Pro Rata Bonus for the fiscal year in which termination occurs

    •   

Unpaid accrued vacation earned and not taken through the date of termination

    •   

Any other benefits to which he is entitled by any other benefit plan and by applicable law

Termination with good reason(1)

    •   

Unpaid compensation at the date of termination

    •   

Two times the sum of the base salary and bonus compensation earned in the year immediately preceding the year of termination

    •   

A Pro Rata Bonus for the fiscal year in which termination occurs

    •   

Unpaid accrued vacation earned and not taken through the date of termination

    •   

Any other benefits to which he is entitled by any other benefit plan and by applicable law

Voluntary termination

    •   

Unpaid base salary through the end of the month in which termination occurs

    •   

Unpaid bonus compensation for any fiscal year ended prior to the year in which termination occurs

    •   

Unpaid accrued vacation earned and not taken through the date of termination

    •   

Any other benefits to which he is entitled by any other benefit plan and by applicable law

Termination with cause

    •   

Unpaid base salary through the date of termination

    •   

Unpaid bonus compensation for any fiscal year ended prior to the year in which termination occurs

    •   

Unpaid accrued vacation earned and not taken through the date of termination

 

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Reason for termination

 

Payment Obligations to the Employee

    •   

Any other benefits to which he is entitled by any other benefit plan and by applicable law

Death

    •   

Unpaid base salary through the month in which death occurs

    •   

Unpaid bonus compensation for any fiscal year which has ended as of the date of death

    •   

The Pro Rata Bonus amount for the fiscal year in which the date of death occurs

    •   

Unpaid accrued vacation earned and not taken through the date of death

Disability

    •   

Unpaid base salary through the month in which such termination occurs

    •   

Unpaid bonus compensation for any fiscal year which has ended as of the date of termination

    •   

The Pro Rata Bonus amount for the fiscal year in which the date of termination occurs

    •   

Unpaid accrued vacation earned and not taken through the date of termination

 

(1)

Termination with good reason is defined in the respective employment agreements for Mr. Schwartz and Mr. Cook as (i) employee duties assigned that are inconsistent with duties held by each of these executive members as of the date of the 2006 Transaction other than the hiring of a Chief Operating Officer, (ii) the relocation of the principal place of employment more than 35 miles from the current principal place of employment, and (iii) a significant reduction in the employee’s annual bonus opportunity. Under the Amended and Restated Agreements, effective fiscal 2009, this definition was amended to also include (i) any reduction in base salary or a 20% or more reduction in the employee’s annual bonus opportunity, other than a systemic reduction that is applicable to the entire management team, (ii) a material breach of a material provision of the respective employment agreement, or (iii) in the case of Mr. Schwartz, a requirement that he report to a Company officer instead of reporting directly to the Board of Directors of the Company. The Company has 30 days to cure any event that would otherwise constitute good reason for termination.

In addition to the above payments, per the terms of the NPC Acquisition Holdings LLC Agreement, the 1,950,000 and 1,300,000 units of membership interests held by Mr. Schwartz and Mr. Cook, respectively have a mandatory call provision that will require repurchase of their outstanding units at the date of termination. The Company does not have a contractual obligation to fund the purchase of the mandatorily redeemable units; however, the Company may be required to provide a distribution to NPC Holdings in the event of a member’s resignation from the Company. The payout of these interests vary based on the terms of the executives’ termination with the Company, and will result in either a fair value or formula valuation, which is defined within the NPC Acquisition Holdings LLC Agreement.

There are no post employment payment obligations to the remaining Named Executive Officers.

The tables below estimate amounts payable upon a separation as if the individuals were separated on December 29, 2009:

James K. Schwartz, our President, Chief Executive Officer and Chief Operating Officer:

 

Executive Benefits and

Payments upon Separation

   Termination
without cause ($)
    Termination with
good reason ($)
    Voluntary
termination ($)
    Termination with
cause ($)
    Death ($)     Disability ($)  

Compensation:

            

Accrued Salary at 12/29/09(1)

   14,185      14,185      14,185      14,185      14,185      14,185   

Stock Options(2)

   —   (a)    —   (a)    —   (b)    —   (b)    —   (a)    —   (a) 

Accrued Incentive Compensation at 12/29/09(3)

   —        —        —        —        —        —     

Benefits and Perquisites:

            

Severance Payments(4)

   1,370,000      1,370,000     —        —        —        —     

Retirement Plans(5)

   965,671      965,671      965,671      965,671      965,671      965,671   

Membership Interests(6)

   1,950,000 (c)    1,950,000 (c)    1,868,760 (d)    1,868,760 (d)    1,950,000 (c)    1,950,000 (c) 

Accrued Vacation at 12/29/09

   52,692      52,692      52,692      52,692      52,692      52,692   
                                    

Total Post-Employment Payments

   4,352,548      4,352,548      2,901,308      2,901,308      2,982,548      2,982,548   

 

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(1)

Amounts are salary earned and unpaid at year end due to the timing of payroll, which is paid on a one-week lag. Amounts were included in Column (c) as “Salary” on the Summary Compensation Table.

(2)

Options were priced using the formula calculation defined within the NPC Acquisition Holdings LLC Management Option Plan further described below, subject to certain adjustments that were within the terms of the agreement and were approved by the Company’s Board of Directors. This pricing assumes a mandatory call of units for all options that were vested as of December 29, 2009. Due to the valuation, all vested options were calculated as out-of-the money options at the end of fiscal 2009; therefore, a zero value is shown in the table above for each of the vested options.

  (a)

Upon the occurrence of these events, all of the options to purchase membership interests in Holdings are repurchased for aggregate consideration equal to the products of the number of units subject to all option being repurchase times the deemed purchase price unit. The deemed purchase price per unit is equal to the higher of $1.00 or a formula purchase price determined as of the date of separation from employment. The formula purchase price is determined in two steps. The first step is to determine the value of all units which is equal to (A) the product of (i) six, times (ii) consolidated EBITDA from continuing operations for the four full calendar quarters ending immediately preceding the date of determination, less (B) funded net debt, plus (C) proceeds from the exercise of options. The second step is to determine the deemed value of a particular unit which is equal to the quotient of the amount determined in the first step divided by the sum of the number of outstanding units and the number of units underlying options granted under the Option Plan.

  (b)

Upon the occurrence of these events, all of the options to purchase membership interests in Holdings are repurchased for aggregate consideration equal to the product of the number of units subject to all options being repurchased times the deemed purchase price per unit. The deemed purchase price per unit is equal to the lower of $1.00 per unit or a formula purchase price determined as of the date of separation from employment. The formula purchase price is determined in the manner described in footnote (2)(a).

(3)

Amounts are incentive compensation earned and unpaid at year-end. Amounts were included in Column (g) as “Non-Equity Incentive Plan Compensation” on the Summary Compensation Table, and were shown as an expected future payout in the Grants of Plan-Based Awards Table.

(4)

Amount is the severance payment, to which Mr. Schwartz would be entitled based on the terms of Mr. Schwartz’s employment agreement, signed on May 3, 2006.

(5)

Amounts represent the vested balances of the Deferred Compensation and Retirement Plan and the Company’s POWR Plan as of December 29, 2009. Amounts were included in the Nonqualified Deferred Compensation Table.

(6)

Membership interests of 1,950,000 units, with an original purchase price of $1.00, held by Mr. Schwartz were priced using the formula calculation defined within the NPC Acquisition Holdings LLC Agreement, subject to certain adjustments that were within the terms of the agreement and were approved by the Company’s Board of Directors.

  (c)

Upon the occurrence of these events, all of the membership interests in Holdings are repurchased at a price per unit equal to the greater of the original purchase price for the applicable unit or a formula purchase price in each case determined as of the date of separation from employment. The formula purchase price is determined in the manner described in footnote (2)(a).

  (d)

Upon the occurrence of these events, all of the membership interests in Holdings are repurchased at a price per unit equal to the lower of the original purchase price for the applicable unit or a formula purchase price determined as of the date of separation from employment. The formula purchase price is determined in the manner described in footnote (2)(a).

Troy D. Cook, our Executive Vice President – Finance and Chief Financial Officer:

 

Executive Benefits and

Payments upon Separation

   Termination
without cause ($)
    Termination with
good reason ($)
    Voluntary
termination ($)
    Termination with
cause ($)
    Death ($)     Disability ($)  

Compensation:

            

Accrued Salary at 12/29/09(1)

   8,846      8,846      8,846      8,846      8,846      8,846   

Stock Options(2)

   —   (a)    —   (a)    —   (b)    —   (b)    —   (a)    —   (a) 

Accrued Incentive Compensation at 12/29/09(3)

   —        —        —        —        —        —     

Benefits and Perquisites:

            

Severance Payments(4)

   921,150      921,150     —        —        —        —     

Retirement Plans(5)

   649,431      649,431      649,431      649,431      649,431      649,431   

Membership Interests(6)

   1,300,000 (c)    1,300,000 (c)    1,245,840 (d)    1,245,840 (d)    1,300,000 (c)    1,300,000 (c) 

Accrued Vacation at 12/29/09

   35,429      35,429      35,429      35,429      35,429      35,429   
                                    

Total Post-Employment Payments

   2,914,856      2,914,856      1,939,546      1,939,546      1,993,706      1,993,706   

 

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(1)

Amounts are salary earned and unpaid at year end due to the timing of payroll, which is paid on a one-week lag. Amounts were included in Column (c) as “Salary” on the Summary Compensation Table.

(2)

Options were priced using the formula calculation defined within the NPC Acquisition Holdings Management Option Plan further described below, subject to certain adjustments that were within the terms of the agreement and were approved by the Company’s Board of Directors. This pricing assumes a mandatory call of units for all options that were vested as of December 29, 2009. Due to the valuation, all vested options were calculated as out-of-the money options at the end of fiscal 2009; therefore, a zero value is shown in the table above for each of the vested options.

  (a)

Upon the occurrence of these events, all of the options to purchase membership interests in Holdings are repurchased for aggregate consideration equal to the products of the number of units subject to all option being repurchase times the deemed purchase price unit. The deemed purchase price per unit is equal to the higher of $1.00 or a formula purchase price determined as of the date of separation from employment. The formula purchase price is determined in two steps. The first step is to determine the value of all units which is equal to (A) the product of (i) six, times (ii) consolidated EBITDA from continuing operations for the four full calendar quarters ending immediately preceding the date of determination, less (B) funded net debt, plus (C) proceeds from the exercise of options. The second step is to determine the deemed value of a particular unit which is equal to the quotient of the amount determined in the first step divided by the sum of the number of outstanding units and the number of units underlying options granted under the Option Plan.

  (b)

Upon the occurrence of these events, all of the options to purchase membership interests in Holdings are repurchased for aggregate consideration equal to the product of the number of units subject to all options being repurchased times the deemed purchase price per unit. The deemed purchase price per unit is equal to the lower of $1.00 per unit or a formula purchase price determined as of the date of separation from employment. The formula purchase price is determined in the manner described in footnote (2)(a).

(3)

Amounts are incentive compensation earned and unpaid at year-end. Amounts were included in Column (g) as “Non-Equity Incentive Plan Compensation” on the Summary Compensation Table, and were shown as an expected future payout in the Grants of Plan-Based Awards Table.

(4)

Amount is the severance payment, to which Mr. Cook would be entitled based on the terms of Mr. Cook’s employment agreement, signed on May 3, 2006.

(5)

Amounts represent the vested balances of the Deferred Compensation and Retirement Plan and the Company’s POWR Plan as of December 29, 2009. Amounts were included in the Nonqualified Deferred Compensation Table.

(6)

Membership interests of 1,300,000 units, with an original purchase price of $1.00, held by Mr. Cook were priced using the formula calculation defined within the NPC Acquisition Holdings LLC Agreement, subject to certain adjustments that were within the terms of the agreement and were approved by the Company’s Board of Directors.

  (c)

Upon the occurrence of these events, all of the membership interests in Holdings are repurchased at a price per unit equal to the greater of the original purchase price for the applicable unit or a formula purchase price in each case determined as of the date of separation from employment. The formula purchase price is determined in the manner described in footnote (2)(a).

  (d)

Upon the occurrence of these events, all of the membership interests in Holdings are repurchased at a price per unit equal to the lower of the original purchase price for the applicable unit or a formula purchase price determined as of the date of separation from employment. The formula purchase price is determined in the manner described in footnote (2)(a).

Director Compensation Table

The following table summarizes the annual cash compensation earned by the Company’s non-employee directors during 2009:

 

Name

   Fees
Earned or
Paid in
Cash ($)(1)
   Stock
Awards
($)
   Option
Awards
($)
   Non-Equity
Incentive Plan
Compensation
($)
   Change in
Pension Value
and
Nonqualified
Deferred
Compensation
Earnings ($)
   All Other
Compensation
($)
   Total ($)

Charles W. Peffer
Audit Committee Chair

   28,500    —      —      —      —      —      28,500

Brandon K. Barnholt

   26,000    —      —      —      —      —      26,000

 

  (1)

The annual retainer paid to external directors is $17,500 with an additional annual retainer of $3,000 paid to the Audit Committee Chairman. Attendance at each Board and Audit Committee meeting was paid as $1,000 for in-person participation or $500 for teleconference participation.

No compensation was paid for service to Mr. Birosak, Mr. End, or Mr. Hebbar, who represent MLGPE on our Board of Directors.

Compensation Committee Report

The Compensation Committee of our Board of Directors has reviewed and discussed with management the Compensation Discussion and Analysis set forth above which is required by Item 402(b) of Regulation S-K. Based on such review and discussion, we recommended to the Board of Directors that the Compensation Discussion and Analysis be included in the Annual Report on Form 10-K.

 

/s/ Christopher J. Birosak

Christopher J. Birosak
Chairman

/s/ Brandon K. Barnholt

Brandon K. Barnholt

/s/ Robert F. End

Robert F. End

 

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Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The following table provides certain information as of December 29, 2009 with respect to beneficial ownership of the outstanding stock of the Company and the outstanding membership interests of Holdings by (i) each holder known by us who beneficially owns 5% or more of the outstanding voting interests of the Company or Holdings, (ii) each of the Company’s named executive officers, and (iii) each of the members of the Company’s Board of Directors. Unless otherwise indicated in a footnote, the business address of each person is our corporate address.

 

Beneficial Owner-NPC Acquisition Holdings, LLC

   Membership
interests
   Percentage of
interests
 

NPC Acquisition Holdings, LLC

   1,000    100.0

 

Beneficial Owner-NPC Acquisition Holdings, LLC

   Membership
interests
   Percentage of
interests
 

ML Global Private Equity Fund, L.P.

   118,040    72.3

Merrill Lynch Ventures, LLC

   40,000    24.5

ML NPC International Co-Invest, L.P.

   1,960    1.2

James K. Schwartz(1)

   3,563    2.2

Troy D. Cook(1)

   2,375    1.5

Charles W. Peffer(1)(2)

   80    —  

Brandon K. Barnholt(1)(2)

   40    —  

All managers and executive officers as a group (4 persons)(1)

   6,059    3.7

 

(1)

The stock incentive plan, described within this document, pursuant to which Holdings, may from time to time issue and/or grant options to certain members of the Senior Management of the Company to acquire membership interests in Holdings up to a total of 8.0% of the fully-diluted equity interests in Holdings. The above table has been prepared including any options that are exercisable within 60 days from the period of presentation; however, there are options outstanding under the option program that have not vested or will not become exercisable within the near term, or 60 days, as of December 29, 2009.

(2)

Percentage of interest for each of these individuals is less than 1.0%.

NPC Acquisition Holdings, LLC (“Holdings”), the sole stockholder of the Company, maintains a stock incentive plan (“the Plan”), which governs, among other things, (i) the issuance of matching options on purchased membership interests and (ii) the grant of options with respect to the membership interests. Options may be granted under the Plan with respect to a maximum of 8.0% of the membership interests of Holdings as of the closing date for the acquisition calculated on a fully diluted basis (subject to required capital adjustments). Each grant of options under the Plan will specify the applicable option exercise period, option exercise price, vesting schedules and conditions and such other terms and conditions as deemed appropriate. Three types of options may be granted under the plan. First, Holdings may grant “non-time vesting” options, with respect to up to 1.0% of the interests, to selected participants, which will be vested at grant. Second, Holdings may grant “time vesting” options, with respect to up to 2.0% of the interests, which will vest ratably over a five-year period and subject to the option holders’ continued service. Third, Holdings may grant options, as to the remaining interests, which vest only upon the occurrence of a change of control on or prior to the expiration of the option, and also require continued employment through the vesting date. All options granted under the Plan will expire ten years from the date of grant, but generally expire earlier upon termination of service. Details of the option grants, as of December 29, 2009, are set forth in the table below (amounts in thousands):

 

     (A) Number of
securities to be issued

upon exercise of
outstanding options,
warrants and rights
   Weighted-average
exercise price of
outstanding options

warrants and rights
   Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding

securities reflected in
column (A))

Equity compensation plans approved by security holders

   13,874    $ 1.66    247

Equity compensation plans not approved by security holders

   —        —      —  
                

Total

   13,874    $ 1.66    247
                

The exercise price of the options is at the discretion of the Compensation Committee of Holdings; however, the exercise price for all options granted was equal to or greater than the fair market value of the option on the date of grant.

 

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Based upon the terms of options granted, the Company considers these options to be liability awards. The compensation costs for the portion of awards that are outstanding for which the requisite service has not been rendered, or the performance condition has not been achieved, will be recognized as the requisite service is rendered and/or performance condition achieved. Further, all options granted under the Plan are subject to a mandatory call provision with a defined value, as stated in the Amended and Restated Limited Liability Company Agreement of Holdings and described as follows: (1) for termination of employment due to death, disability, retirement, termination without cause (as defined) or resignation with good reason (as defined), each common unit covered by such options will be called at a price calculated as the difference between the greater of $1.00 or the fair value price (“FVP”) as of the termination date, less the exercise price; and, (2) for any other call event, each common unit covered by such options will be called at a price calculated as the difference between the lesser of $1.00 or the FVP as of the termination date, less the exercise price. The Company does not have a contractual obligation to fund the mandatory call of these units; however, we may be called upon to provide a distribution to Holdings upon such time a triggering event should occur that would require a mandatory call of outstanding units.

 

Item 13. Certain Relationships and Related Transactions and Director Independence

Upon completion of the 2006 Transaction, the Company entered into an advisory agreement with an affiliate of MLGPE pursuant to which such entity or its affiliates will provide advisory services to the Company. Pursuant to the advisory agreement, MLGPE was paid $3.0 million at the closing for the financial, investment banking, management advisory and other services performed in connection with the 2006 Transaction and reimbursed $0.9 million for certain expenses incurred in rendering those services. Under the agreement MLGPE or its affiliates will continue to provide financial, investment banking, management advisory and other services on the Company’s behalf for an annual fee of $1.0 million. The Company paid $1.0 million to MLGPE for the fee during each of the fiscal years ended 2009 and 2008.

On June 6, 2006, the Company entered into an amortizing floating-to-fixed rate interest rate swap agreement expiring December 31, 2010, the notional amount of this swap was $50.0 million at fiscal year end 2009. Merrill Lynch Capital Services, Inc. (“MLCS”), was the counterparty on $25.0 million of the total notional amount, and JPMorgan Chase Bank, N.A. (“JPMCB”), an unrelated party, was the counterparty on the residual $25.0 million. Under this swap, the Company will pay both counterparties 5.39% and receive the three-month LIBOR rate as determined on the reset dates. These swaps were entered into to provide a hedge against the effects of rising interest rates on a portion of the $300.0 million term loan notes under the Senior Secured Credit Facility. As of December 29, 2009, the Company has recognized $1.6 million ($1.0 million after tax) of other comprehensive losses related to the fair market value of these interest rate swaps.

Effective April 7, 2008, the Company entered into a floating-to-fixed rate interest rate swap agreement expiring April 7, 2011, on a notional amount of $50.0 million with MLCS as the counterparty to the transaction. Under this swap, the Company will pay MLCS 2.79% and receive the three-month LIBOR rate as determined on the reset dates. This swap was entered into as a hedge to fix a portion of the $300.0 million term loan notes under the Senior Secured Credit Facility. As of December 29, 2009, the Company has recognized $1.5 million ($0.9 million after tax) of other comprehensive losses related to the fair market value of this interest rate swap.

In January 2009 Bank of America Corporation (“BOA”) acquired the parent company of MLGPE, Merrill Lynch & Co., Inc. During fiscal 2009 the Company paid Bank of America Merchant Service, an affiliate of BOA, $0.4 million for credit card processing services.

In December 2009, the Company opened a money market account with BOA to invest any excess cash balances on hand. As of December 29, 2009, the Company had $9.9 million invested in this account. These investments are being reported as trading securities, as cash and cash equivalents, and the fair value of the investment was determined using independent market data considered to be a level 2 observable input.

BOA is an active participant in the Company’s Senior Secured Credit Facility. As of December 29, 2009, BOA held $2.2 million, or 1.0%, of the term loan notes and $12.5 million, or 16.7%, of the revolving credit facility. Merrill Lynch Capital Corporation held $7.5 million, or 10.0%, of the revolving credit facility. The Company had no amounts outstanding on the revolving credit facility as of December 29, 2009. The loans were made in the ordinary course of business, were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans with persons not related to the lender, and did not involve more than the normal risk of collectability or present other unfavorable features.

The Charter of the Audit Committee directs the Audit Committee as follows. The Committee shall review with management and the independent auditor any material financial or other arrangements of the Company which are with related parties or any other transactions or courses of dealing with third parties that appear to involve terms or other aspects that differ from those that would

 

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likely be negotiated with independent parties, and which arrangements or transactions are relevant to an understanding of the Company’s financial statements. The Committee shall consult with counsel if, in the opinion of the Committee, any matter under consideration by the Committee has the potential for any conflict between the interests of the Company and any of its subsidiaries in order to ensure that appropriate procedures are established for addressing any such potential conflict and for ensuring compliance with all applicable laws.

All of the Company’s directors, except Mr. Schwartz, and each of the Audit Committee and Compensation Committee members, qualify as independent directors under the listing standards of the Nasdaq Global Market.

 

Item 14. Principal Accounting Fees and Services

PricewaterhouseCoopers LLP, an independent registered public accounting firm, served as our auditors for fiscal year ended December 29, 2009. Deloitte & Touche LLP, an independent registered public accounting firm, served as our auditors for the fiscal year ended December 30, 2008 (amounts in thousands).

 

(in thousands)

Type of Service

   Fiscal Year Ended
2009
   Fiscal Year Ended
2008

Audit fees

   $ 450    $ 550

Audit-related fees

     —        —  

Tax fees

     —        —  

All other fees

     —        —  
             

Total

   $ 450    $ 550
             

Audit Fees

Audit fees relate to the audit of our consolidated financial statements and regulatory filings, and the reviews of quarterly reports on Form 10-Q. It is the Audit Committee’s policy to review and approve in advance the Company’s independent auditor’s annual engagement letter, including the proposed fees contained therein, as well as all audit and permitted non-audit engagements and relationships between the Company and its independent auditors.

Audit-Related Fees

Audit-related fees primarily relate to consultations on accounting related matters.

Tax Fees

Tax fees relate to tax compliance, tax advice and tax planning services.

 

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PART IV

 

Item 15. Exhibits, Financial Statement Schedules

Pursuant to the rules and regulations of the Securities and Exchange Commission, we have filed or incorporated by reference the documents referenced below as exhibits to this Annual Report on Form 10-K. The documents include agreements to which the Company is a party or has a beneficial interest. The agreements have been filed to provide investors with information regarding their respective terms. The agreements are not intended to provide any other factual information about the Company or its business or operations. In particular, the assertions embodied in any representations, warranties and covenants contained in the agreements may be subject to qualifications with respect to knowledge and materiality different from those applicable to investors and may be qualified by information in confidential disclosure schedules not included with the exhibits. These disclosure schedules may contain information that modifies, qualifies and creates exceptions to the representations, warranties and covenants set forth in the agreements. Moreover, certain representations, warranties and covenants in the agreements may have been used for the purpose of allocating risk between the parties, rather than establishing matters as facts. In addition, information concerning the subject matter of the representations, warranties and covenants may have changed after the date of the respective agreement, which subsequent information may or may not be fully reflected in the Company’s public disclosures. Accordingly, investors should not rely on the representations, warranties and covenants in the agreements as characterizations of the actual state of facts about the Company or its business or operations on the date hereof.

The exhibits that are required to be filed or incorporated by reference herein are listed in the Exhibit Index below (following signatures page of this report).

 

Exhibit No.

 

Document Description

  2.1*   Stock Purchase Agreement dated as of March 3, 2006 among NPC Acquisition Holdings, LLC, NPC International, Inc. and the stockholders of NPC International, Inc. named therein
  2.2*   Merger Agreement dated as of May 3, 2006 between Hawk-Eye Pizza, LLC and NPC Management, Inc.
  2.3   Asset Sale Agreement by and between NPC International, Inc. and Pizza Hut of America, Inc. and Pizza Hut, Inc. dated as of November 3, 2008 (incorporated herein by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed December 8, 2008)
  2.4   Asset Purchase and Sale Agreement by and between NPC International, Inc. and Pizza Hut of America, Inc. and Pizza Hut, Inc. dated as of November 3, 2008 (incorporated herein by reference to Exhibit 2.2 to the Company’s Current Report on Form 8-K filed December 8, 2008)
  2.5   Amendment to Asset Sale Agreement dated as of December 8, 2008 (incorporated herein by reference to Exhibit 2.3 to the Company’s Current Report on Form 8-K filed December 8, 2008)
  2.6   Amendment to Asset Purchase and Sale Agreement dated as of December 8, 2008 (incorporated herein by reference to Exhibit 2.4 to the Company’s Current Report on Form 8-K filed December 8, 2008)
  2.7   Asset Purchase and Sale Agreement by and between NPC International, Inc. and Pizza Hut of America, Inc. and Pizza Hut, Inc. dated as of December 15, 2008 (incorporated herein by reference to Exhibit 2.5 to the Company’s Current Report on Form 8-K filed January 20, 2009)
  2.8   Asset Sale Agreement by and between NPC International, Inc. and Pizza Hut of America, Inc. and Pizza Hut, Inc. dated as of January 13, 2009 (incorporated herein by reference to Exhibit 2.6 to the Company’s Current Report on Form 8-K filed February 17, 2009)
  2.9   Amendment to Asset Sale Agreement dated as of February 12, 2009 (incorporated herein by reference to Exhibit 2.7 to the Company’s Current Report on Form 8-K filed February 17, 2009)
  2.10   Second Amendment to Asset Sale Agreement dated as of February 16, 2009 (incorporated herein by reference to Exhibit 2.8 to the Company’s Current Report on Form 8-K filed February 17, 2009)
  3.1*   Amended and Restated Articles of Incorporation of NPC International, Inc.
  3.2*   Bylaws of NPC International, Inc.
  4.1*   Indenture dated as of May 3, 2006 among NPC International, Inc., NPC Management, Inc. and Wells Fargo Bank, National Association, related to the issue of the 91/2% Senior Subordinated Notes due 2014

 

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Exhibit No.

 

Document Description

  4.2*   Form of 9 1/2% Senior Subordinated Note due 2014 (included in Exhibit 4.1)
  4.3*   Registration Rights Agreement dated as of May 3, 2006 among NPC International, Inc., NPC Management, Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and J.P. Morgan Securities Inc.
10.1*   Hawk-Eye Interests Purchase Agreement, dated as of May 3, 2006, among NPC International, Inc., Oread Capital Holdings, LLC and Troy D. Cook
10.2*   Credit agreement dated as of May 3, 2006 among NPC International, Inc., NPC Acquisition Holdings, LLC as a Guarantor, the other Guarantors party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent, Collateral Agent and Issuing Bank, Merrill Lynch, Pierce, Fenner & Smith Incorporated, as Syndication Agent, Bank of America, N.A. and Sun Trust Bank, as Co-Documentation Agents, and the Lenders signatory thereto
10.4*   Advisory Agreement, dated as of May 3, 2006, among NPC International, Inc., NPC Acquisition Holdings, LLC and Merrill Lynch Global Partners, Inc.
10.7*   NPC International, Inc. Deferred Compensation and Retirement Plan(1)
10.8*   NPC International, Inc. POWR Plan for Key Employees(1)
10.9*   Form of Location Franchise Agreement dated as of January 1, 2003 between Pizza Hut, Inc. and NPC Management, Inc.
10.10*   Form of Territory Franchise Agreement dated as of January 1, 2003 between Pizza Hut, Inc. and NPC Management, Inc.
10.11*   Purchase Agreement and Escrow Instructions dated as of August 26, 2006 between Realty Income Corporation and NPC International, Inc.
10.12*   Purchase Agreement dated as of April 25, 2006 among Merrill Lynch & Co. and J.P. Morgan Securities Inc., as representative for the initial purchasers, NPC International, Inc, and NPC Management, Inc.
10.13   Pizza Hut National Purchasing Coop, Inc. Membership Subscription and Commitment Agreement (incorporated herein by reference to the Registrant’s Annual Report on Form 10-K filed with the Commission on May 28, 1999)
10.14*   ISDA Master Agreement dated as of June 6, 2006 between Merrill Lynch Capital Services, Inc. and NPC International, Inc.
10.15   NPC Acquisition Holdings, LLC Management Option Plan (including forms of executive and director option agreements) dated January 24, 2007 (incorporated by reference as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed January 25, 2007)
10.16   Amendment to Franchise Agreement dated as of December 25, 2007 between Pizza Hut, Inc. and NPC International, Inc. (incorporated by reference as Exhibit 10.16 to the Company’s Annual Report on Form 10-K filed March 14, 2008)
10.17   Swap Transaction Confirmation dated March 31, 2008 between Merrill Lynch Capital Services, Inc. and NPC International, Inc. (incorporated herein by reference to Exhibit 10.17 to the Company’s Quarterly Report on Form 10-Q filed with the Commission on May 9, 2008)
10.18   Amended and Restated Employment Agreement, dated as of December 29, 2008 among NPC International, Inc., NPC Acquisition Holdings, LLC and James K. Schwartz(1) (incorporated herein by reference as Exhibit 10.17 to the Company’s Current Report on Form 8-K filed January 5, 2009)
10.19   Amended and Restated Employment Agreement, dated as of December 29, 2008 among NPC International, Inc., NPC Acquisition Holdings, LLC and Troy D. Cook(1) (incorporated herein by reference as Exhibit 10.18 to the Company’s Current Report on Form 8-K filed January 5, 2009)
10.20   Amendment to Amended and Restated Employment Agreement, dated as of March 10, 2009 among NPC International, Inc., NPC Acquisition Holdings, LLC and James K. Schwartz(1) (incorporated herein by reference as Exhibit 10.19 to the Company’s Current Report on Form 8-K filed March 16, 2009)
10.21   Amendment to Amended and Restated Employment Agreement, dated as of March 10, 2009 among NPC International, Inc., NPC Acquisition Holdings, LLC and Troy D. Cook(1) (incorporated herein by reference as Exhibit 10.20 to the Company’s Current Report on Form 8-K filed March 16, 2009)

 

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Exhibit No.

 

Document Description

14.1   Code of Business Conduct and Ethics (incorporated herein by reference to the Registrant’s Annual Report on Form 10-K filed with the Commission on March 23, 2007)
21.1**   List of subsidiaries
31.1***   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the year ended December 29, 2009
31.2***   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the year ended December 29, 2009
32.1***   Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2***   Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

* Filed as an exhibit with corresponding number to the registrant’s registration statement on Form S-4 (File No 333-138338) and incorporated herein by reference
** Filed as an exhibit with the corresponding number to Amendment No. 1 to the registrant’s registration statement on Form S-4 (File No. 333-138338) and incorporated herein by reference
*** Filed herewith
(1)

Management contracts and compensatory plans and arrangements required to be filed as Exhibits pursuant to Item 15(b) of this report.

 

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Supplemental Information to be furnished with reports filed pursuant to Section 15(d) of the Act by registrants which have not registered securities pursuant to Section 12 of the Act.

The registrant has not and will not provide an annual report for its last fiscal year to its security holders, other than this annual report on 10-K and has not and will not send to more than 10 of its security holders any proxy statement, form of proxy or other proxy soliciting material.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on March 26, 2010.

 

NPC INTERNATIONAL, INC.
By:  

/s/ James K. Schwartz

Name:   James K. Schwartz
Title:   President, Chief Executive Officer and Chief Operating Officer

 

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Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on March 26, 2010:

 

/s/ James K. Schwartz

  Chairman of the Board of Directors, President, Chief Executive Officer
James K. Schwartz   and Chief Operating Officer

/s/ Troy D. Cook

  Executive Vice President—Finance, Chief Financial Officer,
Troy D. Cook   Secretary and Treasurer

/s/ Susan G. Dechant

  Vice President—Administration and Chief Accounting Officer
Susan G. Dechant   (Principal Accounting Officer)

/s/ Brandon K. Barnholt

  Director
Brandon K. Barnholt  

/s/ Christopher J. Birosak

  Director
Christopher J. Birosak  

/s/ Jaideep Hebbar

  Director
Jaideep Hebbar  

/s/ Robert F. End

  Director
Robert F. End  

/s/ Charles W. Peffer

  Director
Charles W. Peffer  

 

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