Attached files

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EX-32.2 - EXHIBIT 32.2 - NPC Restaurant Holdings, LLCexhibit322-20151229.htm
EX-31.2 - EXHIBIT 31.2 - NPC Restaurant Holdings, LLCexhibit312-20151229.htm
EX-31.1 - EXHIBIT 31.1 - NPC Restaurant Holdings, LLCexhibit311-20151229.htm
EX-21.01 - EXHIBIT 21.01 - NPC Restaurant Holdings, LLCexhibit2101-20151229.htm
EX-10.33 - EXHIBIT 10.33 - NPC Restaurant Holdings, LLCexhibit1033cookbonusagreem.htm
EX-10.31 - EXHIBIT 10.31 - NPC Restaurant Holdings, LLCexhibit1031npc-amendmentno5.htm
EX-10.34 - EXHIBIT 10.34 - NPC Restaurant Holdings, LLCexhibit1034hedrickbonusagr.htm
EX-10.32 - EXHIBIT 10.32 - NPC Restaurant Holdings, LLCexhibit1032schwartzbonusag.htm
EX-10.35 - EXHIBIT 10.35 - NPC Restaurant Holdings, LLCexhibit1035.htm
EX-32.1 - EXHIBIT 32.1 - NPC Restaurant Holdings, LLCexhibit321-20151229.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 ____________________________________________________________
Form 10-K
 ____________________________________________________________
(Mark one)
ý 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 29, 2015
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 333-180524-04
 ____________________________________________________________
NPC RESTAURANT HOLDINGS, LLC
(Exact name of registrant as specified in its charter)
 ____________________________________________________________
 
DELAWARE
 
20-4509045
(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)
 
(Zip Code)
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  ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ý    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  ý

(Note: As a voluntary filer, not subject to the filing requirements, the registrant filed all reports required under Section 13 or 15(d) of the Exchange Act during the preceding 12 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  ý    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.  ý
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
 
ý
 
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  ý
State the aggregate market value of the voting and non-voting common equity held by non-affiliates: Not applicable
There is no market for the Registrant’s equity. As of March 9, 2016, there were 1,000 units of membership interests outstanding.





INDEX

 
 
Page
 
 
 
Part I.
 
 
 
 
 
Item 1.
Business
Item 1A.
Risk Factors
Item 1B.
Unresolved Staff Comments
Item 2.
Properties
Item 3.
Legal Proceedings
Item 4.
Mine Safety Disclosures
 
 
 
Part II.
 
 
 
 
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6.
Selected Financial Data
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Financial Statements and Supplementary Data
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.
Controls and Procedures
Item 9B.
Other Information
 
 
 
Part III.
 
 
 
 
 
Item 10.
Directors, Executive Officers and Corporate Governance of the Registrant
Item 11.
Executive Compensation
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.
Certain Relationships and Related Transactions and Director Independence
Item 14.
Principal Accounting Fees and Services
 
 
 
Part IV.
 
 
 
 
 
Item 15.
Exhibits, Financial Statement Schedules
 
 
 



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PART I
Trademarks and Trade Names
The trade name “Pizza Hut” and all other trade names, trademarks, service marks, symbols, slogans, emblems, logos and designs used in the Pizza Hut system and appearing in this Form 10-K are owned by Pizza Hut, Inc. (“PHI”) and are licensed to us for use with respect to the operation and promotion of our Pizza Hut restaurants. The “WingStreet” name is a trademark of WingStreet, LLC, an entity controlled by Yum! Brands, Inc. (“Yum!”). The trade name “Wendy’s” and all other trade names, trademarks, service marks, symbols, slogans, emblems, logos and designs used in the Wendy’s system and appearing in this Form 10-K are owned by affiliates of the Wendy’s Company and are licensed to us for use with respect to the operation and promotion of our Wendy’s restaurants. All other trademarks or trade names appearing in this Form 10-K are the property of their respective owners. Solely for convenience, trademarks and trade names referred to in this Form 10-K may appear without the ® or ™ symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or the right of the applicable licensor to these trademarks and trade names.
Market and Industry Data
In this Form 10-K, we refer to information regarding the U.S. restaurant industry and the quick service restaurant sector from publicly available market research reports and other publicly available information. Unless otherwise indicated, corporate information regarding PHI in this Form 10-K has been made publicly available by Yum! and corporate information regarding Wendy's has been made publicly available by the Wendy’s Company. We have not independently verified such data and we make no representations as to the accuracy of such information. None of the market research reports referred to in this Form 10-K were prepared for use in, or in connection with, this Form 10-K.
Item 1.    Business.
General
As used in this report, NPC Restaurant Holdings, LLC is referred to herein as “Holdings.” Holdings and its subsidiaries are referred to as the “Company,” “we,” “us,” and “our.” Holdings’ wholly-owned subsidiary, NPC International, Inc. is referred to as “NPC.” NPC’s wholly-owned subsidiary, NPC Quality Burgers, Inc., is referred to herein as “NPCQB.”
NPC was founded in 1962 and is the largest franchisee of any restaurant concept in the United States (U.S.), based on unit count, according to the 2015 “Top 200 Restaurant Franchisees” by the Restaurant Finance Monitor and is the eighth largest restaurant unit operator, based on unit count, in the U.S. NPC is a Kansas corporation incorporated in 1974 under the name Southeast Pizza Huts, Inc. In 1984, its name was changed to National Pizza Company, and it was subsequently renamed NPC International, Inc. on July 12, 1994.
Our Pizza Hut operations. We are the largest Pizza Hut franchisee and as of December 29, 2015 we operated 1,251 Pizza Hut units in 28 states with significant presence in the Midwest, South and Southeast. As of December 29, 2015, our Pizza Hut operations represented approximately 20% 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.
Our Wendy’s operations. As of December 29, 2015 we operated 144 Wendy’s units in 5 states.We expect to continue to expand our Wendy’s operations through opportunistic acquisitions of restaurants in additional markets and through organic growth with development of new restaurants that meet our investment objectives. All of our Wendy’s restaurants are owned and operated by NPCQB and are primarily located in and around the Kansas City, Salt Lake City and Greensboro-Winston Salem metropolitan areas.
Overview
Our Pizza Hut restaurants are diversely located, ranging from metro to small-town markets with approximately half of our restaurants located in “1 to 2 Pizza Hut Towns.” Our size and scale provides significant operating efficiencies and geographic and market diversity within certain regions of the country. We believe our diversity of locations, including having a substantial number of units located in non-metro locations and small cities provides a cost effective and diversified 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. Red Roof units, or “RRs,” are traditional

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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 location.
Our Wendy’s restaurants are open seven days a week and serve both lunch and dinner with certain locations serving breakfast. Our Wendy’s units are generally free-standing restaurants and include a pick-up window in addition to a dining room with counter service.
The following table sets forth certain information with respect to each fiscal period:
 
December 29, 2015
 
December 30, 2014
 
December 31, 2013(2)
Pizza Hut:
 
 
 
 
 
Average annual revenue per restaurant(1)
$
765,798

 
$
767,094

 
$
819,881

 
 
 
 
 
 
Sales by occasion:
 
 
 
 
 
Carryout
46
%
 
47
%
 
49
%
Delivery
42
%
 
40
%
 
37
%
Dine-in
12
%
 
13
%
 
14
%
 
 
 
 
 
 
Number of restaurants open at the end of the period:
 
 
 
 
 
RBD
503

 
514

 
527

Delco
602

 
601

 
567

RR
146

 
162

 
169

  Total Pizza Hut restaurants
1,251

 
1,277

 
1,263

 
 
 
 
 
 
Wendy’s:
 
 
 
 
 
Average annual revenue per restaurant(3)
$
1,427,193

 
$
1,377,549

 
$
1,350,387

 
 
 
 
 
 
Sales by occasion:
 
 
 
 
 
Pick-up window
67
%
 
65
%
 
65
%
Counter service
33
%
 
35
%
 
35
%
Number of restaurants open at the end of the period
144

 
143

 
91

_____________________ 
(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 1,262 in both fiscal 2015 and fiscal 2014 and 1,240 in fiscal 2013.
(2) 
The fiscal year ended December 31, 2013 includes 53 weeks of operations as compared with 52 weeks for the other years presented.
(3) 
In computing the fiscal 2015 and fiscal 2014 averages, total net product sales for these fiscal periods were divided by 142 and 116 equivalent units, respectively. In computing the 2013 average, pro forma annual net product sales were divided by 88 full-year equivalent units.

Digital ordering is becoming increasingly important to our Pizza Hut customers, with approximately 41% of our Pizza Hut delivery and carry-out sales processed digitally for fiscal 2015 compared to approximately 34% in fiscal 2014 and 25% in fiscal 2013. In the future, we expect to see continued growth in digital ordering.

We operate two call centers that primarily process overflow delivery and carry-out orders for approximately 1,000 of our Pizza Hut units. In addition, these call centers process orders in certain metro markets that are placed via a specific dedicated Pizza Hut phone number that serves select markets. Approximately 10% of our Pizza Hut delivery and carry-out sales in fiscal 2015 were processed by our customer service representatives in these call centers compared to approximately 13% of delivery and carry-out sales in fiscal 2014. This decline in call center volume is primarily related to the above noted shift to digital ordering.

We treat our Pizza Hut operations and Wendy’s operations as separate operating segments, and we aggregate the operating segments into one reportable segment for financial reporting purposes in accordance with applicable accounting guidance.

Pizza Hut, Inc.

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PHI is the world’s largest pizza quick service restaurant, or “QSR,” company. As of December 26, 2015, the Pizza Hut brand had over 6,300 restaurants and delivery units in the United States and over 8,100 international units in more than 90 other countries and territories, 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.
PHI is owned and operated by Yum!. Yum! is the world’s largest QSR company, based on number of units, and as of December 26, 2015, its brands comprised over 40,000 units (excluding licensed units) in more than 130 countries and territories. In addition to Pizza Hut, Yum! also owns the restaurant brands Taco Bell and KFC. 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.
Wendy’s
Wendy’s is the world’s third largest quick-service restaurant company in the hamburger sandwich segment. As of January 3, 2016, the Wendy's system included approximately 6,500 franchise and Company-operated restaurants in the United States and 28 countries and U.S. territories worldwide.
The Wendy’s Company is the parent company of its 100% owned subsidiary holding company Wendy’s Restaurants, LLC. Wendy’s Restaurants, LLC is the parent company of Wendy’s International, LLC. Wendy’s International, LLC is the indirect parent company of Quality Is Our Recipe, LLC (“Wendy’s”), which is the owner and franchisor of the Wendy’s® restaurant system in the United States.
Our Products
Pizza Hut

Pizza Hut restaurants generally provide full table service, carry-out and/or delivery and a menu featuring pizza, pasta, chicken 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.
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 food served at the lunch buffet, food products are prepared at the time of order. We also offer the WingStreet product line that includes bone-in and bone-out fried chicken wings.
New product innovations are vital to the continued success of any restaurant 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.
Wendy’s
Wendy’s restaurants offer an extensive menu specializing in hamburger and chicken sandwiches, which are prepared to order with the customer’s choice of condiments. The Wendy’s menu also includes chicken nuggets, chili, french fries, baked potatoes, freshly prepared salads, soft drinks, Frosty® desserts, kids’ meals and other limited time offered products.
Business Growth Strategy
An important part 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 market share year over year. We intend to augment this basic strategy with (i) the development of new Pizza Hut Delco locations and Wendy’s units within our existing territories as justified by the number of currently unserved households and other relevant demographics, (ii) opportunistic acquisitions of Pizza Hut and Wendy’s restaurants, (iii) rebuilding or relocating existing assets to better serve our customers and (iv) other acquisition opportunities in the restaurant industry.

Franchise Agreements
Pizza Hut
On January 1, 2003, we began operating under new franchise agreements with PHI, pursuant to two types of agreements: territory franchise agreements (“TFA’s”) and location franchise agreements (“LFA’s”). TFA’s govern the franchise relationship

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between PHI and us with respect to a specific geographical territory, while LFA’s govern the franchise relationship between PHI and us with respect to specified restaurants. Additionally, these agreements require us to be a member of the International Pizza Hut Franchise Holder’s Association (“IPHFHA”), an independent association of substantially all Pizza Hut franchisees.
We operate approximately half of our units under LFA’s, with the remaining units operating under TFA’s.
Territory franchise agreements. Our TFA’s 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; however, this has not occurred to date. As of December 29, 2015, we had no commitments for future development under any TFA. Pursuant to our TFA’s, we are required to pay a royalty rate of 4.0% of RBD and RR sales and 4.5% of Delco sales, as defined in the franchise agreements. The royalty rate for the TFA delivery units will increase to 4.75% as of January 1, 2020 and to 5.0% as of January 1, 2030.
Location franchise agreements. Our LFA’s provide us with the right to operate a Pizza Hut restaurant at a specific location. For dine-in restaurants or “Dine-ins,” which are typically free-standing restaurants which offer on-location dining room service and include both RR and RBD units, PHI may not develop or franchise a new Dine-in 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 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.
Other terms of franchise agreements. The TFA’s are effective until December 31, 2032 and contain perpetual 20-year renewal terms subject to certain criteria. The LFA’s 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 contain restrictions on 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. Effective August 1, 2014, PHI approved the Brand Builder Program which eliminated currently required Major Asset Actions (“MAA”), defined as a rebuild, relocation (including relocation to a delco), or remodel on Dine-in units constructed before 1998 as required under the 2003 LFA’s and TFA’s. In return, PHI is requiring that specifically identified assets be brought up to brand standard or “re-imaged”. The re-image of a Dine-in unit entails limited exterior refurbishment (paint, parking lot, etc.) and significant restaurant interior upgrades. The re-image of a Delco unit entails complete renovation of the customer area (foyer) including new flooring, wall finishes, ceiling and lighting.
The 2003 TFA and LFA franchise agreements allow PHI to require a remodel on up to 15% of our assets annually beginning in 2016. In March 2016, PHI and the IPHFHA jointly introduced the Asset Partner Plan (“Asset Partner Plan”). The Asset Partner Plan will govern the future asset upgrade requirements for qualifying franchisees including remodel scope and timing of such actions. The scope of the proposed remodel requirements under the Asset Partner Plan vary based upon (i) the asset type, (ii) the date of the last asset action and (iii) in some cases population density. The Asset Partner Plan requires each qualifying franchisee in the system to remodel or rebuild 10% of its asset base annually through 2025; thereafter executing a minor remodel ten years after completing a major remodel and a major remodel seven years after completing a minor remodel on a continual cycle moving forward. We anticipate relocating most of our Dine-in assets to the more cost efficient Delco format in lieu of the Dine-in remodel option to ensure a more contemporary store base that better meets the needs of consumers in the markets we serve. Additionally, the Delco format requires significantly less annual maintenance costs and generally has higher margins. All assets constructed before 1980 will be required to be sunset no later than 2036. In the event we do not qualify or determine at a later time not to participate in the Asset Partner Plan, PHI could require that we remodel or rebuild up to 15% of our assets annually in accordance with our franchise agreements.

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Going Forward Franchise Agreements. PHI franchise agreements governing acquisitions completed after 2003 are referred to by PHI as Going Forward Franchise Agreements (“GFFA’s”). Any remaining required MAA’s under these agreements were deferred two years. The various agreements are all LFA’s, expire on December 31, 2032 and contain a 20-year renewal term subject to certain criteria.
The 2006 LFA was executed in conjunction with our acquisition in October 2006 of 39 units from PHI in and around Nashville. We are in full compliance with PHI’s minimum asset standards defined in the agreement.
Between December 2008 and February 2009, the Company acquired 294 units under the 2008 LFA 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 TFA.

Florida, Georgia, Iowa, and St. Louis. These agreements were amended to be substantially similar to the 2006 LFA 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 contain no opportunity for royalty reduction for MAA’s.

Denver. Two agreements for 55 units were executed as part of the January 20, 2009 acquisition. For 25 units in the market, an agreement was amended to be substantially similar to the 2006 LFA 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 MAA’s. The agreement for the remaining 30 units was amended to be substantially similar to the 2003 TFA, paying a royalty rate between 4.0%-4.6% of sales for all asset types.
The 2012 LFA was executed in conjunction with our acquisition in February 2012 of 36 units from PHI in and around Jacksonville, Florida and requires us to bring all assets in compliance with PHI’s minimum asset standards within 6 years of acquisition date. 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 MAA’s.
The above GFFA’s require that we complete MAA’s on certain qualifying Dine-ins in the markets. The Brand Builder Program extended the deadline for such MAA’s by two years and our remaining obligations are outlined below:
GFFA
MAA’s Remaining
Deadline
Kansas City
1

December 2023
Florida, Georgia and Iowa
11

December 2021
St. Louis
8

February 2022
Denver
3

January 2021
Jacksonville
1

February 2024
 
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The required MAA’s outlined above will be eliminated if the Company qualifies for theAsset Partner Plan described for the TFA and LFA’s; replacing the above schedule with an annual 10% requirement for all assets operated under GFFA’s. Based on the qualifying terms outlined, we believe that we will meet all qualifications to participate in this program.
Estimated costs to complete the asset upgrade requirements noted above under the Asset Partner Plan are included in Note 10 Commitments and Contingencies, of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” and the Contractual Obligations and Off Balance Sheet Arrangements table included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
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 provides that the maximum royalty fee to be charged to a Delco unit that incorporates the WingStreet product line should not exceed 6.25% of sales, as defined in the

7


franchise agreements. This rate was a reduction from the existing royalty rate of 6.5% that was being paid on certain units operating under our LFA’s.
Development Incentives. Beginning in 2012, PHI began offering development incentives totaling $80,000 per new unit developed (“Development Incentives”), subject to certain threshold criteria. These incentives are recorded as a reduction to other restaurant operating expenses in the year the qualifying asset is opened. This incentive was renewed for fiscal 2013 through fiscal 2015 (with modified thresholds) and is renewable annually at PHI’s discretion.
Additionally, PHI offered development incentives totaling $10,000 per unit converted to the WingStreet platform for fiscal 2013 through fiscal 2015 (“WingStreet Incentives”). WingStreet Incentives earned under the program are recorded as a reduction to other restaurant operating expenses upon completion of each unit conversion and will be received within 12 months of unit conversion.
Our blended average royalty rate for Pizza Hut units (excluding Development Incentives and WingStreet Incentives) as a percentage of total sales was 4.9% for fiscal 2013 through fiscal 2015.

Wendy’s

On July 22, 2013, we began operating under franchise agreements with Wendy’s that are for specific locations. Each franchise agreement begins at the date of the acquisition and continues for the length of the underlying lease or 20 years, whichever is shorter. Each agreement also has one 10 year renewal, subject to certain conditions. The royalty rate we are required to pay is 4.0% of gross sales, as defined in the franchise agreements, subject to certain incentives. Our blended average royalty rate for Wendy’s units as a percentage of total sales was 3.9% for fiscal 2015 and fiscal 2014 and 3.8% for fiscal 2013.
Other Terms of Franchise Agreements. Pursuant to our Wendy’s franchise agreements, Wendy’s must approve our opening of any new restaurant and the closing of any of our existing restaurants. For acquisitions of Wendy’s restaurants owned by other franchisees, Wendy’s has a right of first refusal to acquire the existing units.

The agreements govern the operation of Wendy's respective franchises with respect to such issues as restaurant maintenance, advertising, purchase of supplies, food specifications and standards, inspections and use of Wendy’s proprietary marks and trade secrets as well as timely completion of Image Activation (“IA”) activities, (defined as a reimage or refresh). If we fail to substantially comply with the standards or procedures set forth in the franchise agreement, Wendy’s may terminate the franchise agreement. The franchise agreements may also be terminated upon other events, including our bankruptcy or insolvency. At no time during our history has Wendy’s sought to terminate any of our franchise agreements or otherwise limit our franchise rights.
Franchise agreement asset development and upgrade requirements. Our franchise agreements require us to perform facility upgrades to all of our restaurants. Estimated costs to complete the asset upgrade requirements are included in Note 10 Commitments and Contingencies, of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” and the Contractual Obligations and Off Balance Sheet Arrangements table included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The estimated costs for our Pizza Hut operations are based upon our proposal under the Asset Partner Plan. We were in full compliance with the upgrade requirements defined in the franchise agreements as of December 29, 2015.

The franchise agreement requirements relating to each acquisition of Wendy’s restaurants by NPCQB are as follows:

Kansas City. The agreements for 35 units require us to pay a royalty rate of 4.0% of sales, excluding breakfast sales for locations serving breakfast in this market. In connection with the acquisition, NPCQB agreed to complete 12 IA’s on existing restaurants by December 31, 2018, of which NPCQB has completed four IA’s as of December 29, 2015. NPCQB also entered into a development agreement with Wendy’s whereby NPCQB has the right to develop five units to be opened by December 31, 2018. New units not replacing an existing restaurant are eligible for a 1.0% royalty reduction for the first 24 months following the restaurant opening. NPCQB has the option to close up to four specified restaurants by December 31, 2016, of which one has been closed as of December 29, 2015.

Salt Lake City. NPCQB agreed to complete 15 IA’s by December 31, 2018, of which six have been completed as of December 29, 2015. NPCQB entered into a development agreement with Wendy’s, whereby NPCQB has the right to develop five units to be opened by December 31, 2018, of which three units have been opened as of December 29, 2015. Additionally, in connection with the acquisition, NPCQB has the option to close up to seven specified restaurants by December 31, 2017, of which NPCQB has closed two units as of December 29, 2015.

8



North Carolina. In connection with the acquisition in July 2014, NPCQB has the option to close up to 12 specified restaurants by June 30, 2019 of which one unit has been closed as of December 29, 2015. NPCQB determined that it will continue to operate four of these specified units while the remaining seven units are under evaluation. NPCQB also agreed to complete 21 IA’s by December 31, 2021, of which NPCQB has completed three IA’s as of December 29, 2015.

Promotion and Advertising

Pizza Hut
We spend on average 6% of net product sales from our Pizza Hut units on local and national Pizza Hut advertising activities. 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 agreements from our Pizza Hut units. 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.
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 agreements, to advertising cooperatives (“advertising co-op’s”). The advertising co-op’s control the advertising within designated marketing areas (“DMA’s”). All advertisements must be approved by PHI.
Effective in 2015 and continuing through 2017, the advertising co-ops have agreed to transfer amounts equal to 1.75% of member gross sales from local advertising to AdCom for national advertising, bringing the total national advertising budget to 4.25%. Previously, for 2012 through 2014, the advertising co-ops agreed to transfer amounts equal to 1.50% of member gross sales from local advertising to Adcom for national advertising, bringing the total national advertising budget during this period to 4.00%. Also during this period, each advertising co-op had the option to rebate the remaining contribution of 0.25% of gross sales back to co-op members if not used to fund local media initiatives.
Additionally, effective in 2012 and continuing through 2017, the IPHFHA established a digital marketing fund whereby members remit $0.10 per online order to the IPHFHA.  The contributions are used to develop, purchase and promote digital marketing for the benefit of the Pizza Hut System. The digital marketing fund will be administered by and through the AdCom. 
The remainder of our total advertising expenditures were utilized within our discretion for local print marketing, including coupon distribution as well as telephone directory advertising, digital marketing, point of purchase materials, local store marketing and sponsorships.
Wendy’s
We spend on average 4% of total net sales from our Wendy’s units on local and national Wendy’s advertising activities. We are required under our franchise agreements to contribute to the national advertising fund and for local and regional advertising programs governed by the Wendy’s Unit Franchise Agreement. Beginning in 2014, the rate is 3.50% of total net sales for national advertising and 0.50% for local and regional advertising compared to 3.25% of total net sales for national advertising and 0.75% of gross sales for local and regional advertising for 2013.
Supplies and Distribution

Pizza Hut
We purchase substantially all equipment, supplies and food products required in the operation of our Pizza Hut restaurants from suppliers who have been quality assurance approved and audited by PHI. Purchasing is substantially provided by Restaurant Supply Chain Solutions, LLC (“RSCS”), a cooperative set up to act as a central procurement service for the operators of Yum! franchises.
We rely upon one distributor to provide most of our food and other supplies. Under our direction, our distributor will purchase all products under terms negotiated by RSCS or another cooperative designated by us. If the product is not available through an RSCS agreement, then our distributor may purchase from another Yum! approved source. Our restaurants take delivery of food supplies one to two times a week.
Wendy’s


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Wendy’s entered into a purchasing co-op relationship agreement with its franchisees to establish Quality Supply Chain Co-op, Inc. (“QSCC”). QSCC manages, for the Wendy’s system in the United States and Canada, contracts for the purchase and distribution of food, proprietary paper, operating supplies and equipment under national contracts with pricing based upon total system volume. All QSCC members (including the Wendy’s Company) pay sourcing fees to third party vendors on products which are sourced through the QSCC.

We rely upon two primary distributors to provide most of our food and other supplies for our Wendy’s restaurants. All products must be purchased by a Wendy’s approved source. Our restaurants take delivery of food and supplies two to three times a week.
Information Technology We have developed a proprietary web-based business intelligence software tool that provides critical operating data on a timely basis to our restaurant teams to assist them in operating efficiently while meeting the needs of customers. Product sales and most expenses are captured through our back office system and transferred directly to our enterprise resource planning (“ERP”) system for accurate and timely reporting. Our back office system provides support for inventory, payroll, accounts payable, cash management, and management reporting functions. 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.

Pizza Hut
Our Pizza Hut restaurants utilize a proprietary 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. 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 approximately 1,150 of our units, the POS system includes a kitchen management system, which automatically displays recipes, preparation and cooking instructions for all food items.
Wendy’s
Our Wendy’s restaurants have an Aloha 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. In all units, the POS system includes a kitchen monitor system, which automatically displays customer orders allowing cooks to prepare orders in the order they were received. 
Product sales and inventory are captured through the back office system and transferred to our ERP system for accurate and timely reporting. We converted our NPCQB operations onto our ERP system during the first half of 2014. We implemented Aloha Back Office which replaced the third party software in all stores during fiscal 2015. Management and support personnel have access to our proprietary business intelligence software which provides extensive time critical management data.  
Competition
The restaurant business is highly competitive with respect to price, service, location, convenience, food quality and presentation, and is affected by changes in local and national economic conditions, taste and eating habits of the public and population and traffic patterns. We compete with a variety of restaurants offering moderately priced food to the public, including other large, national QSRs. We also compete with supermarkets and convenience stores and other food outlets as described below. There is also active competition for competent employees and for the type of real estate sites suitable for our restaurants.

Pizza Hut
Within the QSR pizza segment, we compete directly with national chains and numerous regional chains and locally-owned restaurants which offer similar pizza, pasta and sandwich products. We do not compete with other operators in the Pizza Hut system. More broadly, we also compete in the food purchase industry against supermarkets and convenience stores that sell fresh and/or frozen pizzas and others that offer “take-and-bake” pizza products. In addition to more established competitors, we also face competition from new competitors and concepts such as fast casual pizza concepts. 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. Limited product variability within the pizza segment can make differentiation among competitors difficult. Thus, companies in the pizza segment continuously promote and market new product introductions, price discounts and bundled deals, and rely heavily on effective marketing and advertising to drive sales. The price charged for each menu item may vary from market to market (and within markets) depending on competitive pricing and the local cost structure.`

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Wendy’s

Our Wendy’s restaurants face competition from other food service operations within the same geographical area. Wendy’s restaurants compete with other restaurant companies and food outlets, primarily through the quality, variety, convenience, price, and value perception of food products offered. We compete directly with national chains and numerous regional chains and locally-owned restaurants which offer similar hamburger and sandwich products. The location of units, quality and speed of service, attractiveness of facilities, effectiveness of marketing and new product development by Wendy’s and its competitors are also important factors. The price charged for each menu item may vary from market to market (and within markets) depending on competitive pricing and the local cost structure. Additional competitive pressures for prepared food purchases come from operators outside the restaurant industry. A number of major grocery chains offer fresh deli sandwiches and fully prepared food and meals to go as part of their deli sections. Some of these chains also have in-store cafes with service counters and tables where consumers can order and consume a full menu of items prepared especially for that portion of the operation. Additionally, convenience stores and retail outlets at gas stations frequently offer sandwiches and other foods.
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. The trade name “Wendy’s” and all other trade names, trademarks, service marks, symbols, slogans, emblems, logos and designs used in the Wendy’s system are owned by affiliates of Wendy’s. 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.
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 subject to laws relating to information security, privacy and consumer credit, protection and fraud. We are also subject to laws relating to nutritional content, nutritional labeling, product safety and menu labeling. Additionally, we are subject to federal and state environmental regulations.
We are subject to federal and state laws regarding health care, including legislation that in some cases requires employers to either provide health care coverage to their full-time employees, pay a penalty or pay into a fund that would provide coverage for them.
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.
Seasonality
Our Pizza Hut business is moderately seasonal in nature with net product sales typically being higher in the first half of the fiscal year. Our Wendy’s business is also moderately seasonal in nature with net product sales typically being higher in the

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spring and summer months. As a result of these seasonal fluctuations, our operating results may vary 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 $45.1 million as of December 29, 2015. Like many other restaurant companies, we are able to operate and generally do operate with a working capital deficit because (i) restaurant revenues are received primarily in cash or by credit card with a low level of accounts receivable; (ii) rapid turnover results in a limited investment in inventories; and (iii) cash from sales is usually received before related liabilities for food, supplies and payroll become due. Because we are able to operate with a working capital deficit, we have historically utilized excess cash flow from operations and our revolving credit facility for debt reduction, capital expenditures and acquisitions, and to provide liquidity for our working capital needs. 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 primary distributors. If we were to utilize the 30 day term of trade credit for these distributors, it would increase our cash position by approximately $27.0 million; however this would not impact our working capital.

Available Information
We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports available, free of charge, on our website as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission (SEC"). Our website address is www.npcinternational.com. Information contained on that website is not part of this Form 10-K.
Employees
As of December 29, 2015, we had over 31,000 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 consolidated financial condition, results of operations and cash flows. 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. Some of the factors that impact discretionary consumer spending include unemployment, disposable income and consumer confidence.  These and other macroeconomic factors could have an adverse effect on our sales mix, profitability or development plans, which could harm our financial condition and operating results.
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 products, particularly cheese, beef, dough and meats, 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

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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 $4.0 million in fiscal 2015, without giving effect to the RSCS directed hedging programs. In addition, our participation in the food hedging programs directed by RSCS may hedge less than half of our cheese purchases 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. Approximately 41% of our units operate in states where the state minimum wage rate exceeds the federal minimum wage rate. We currently expect that 12% of our total units will incur an increase in state minimum wage rates in 2016, while 33% of total units experienced an increase in 2015. In addition, there are currently a number of federal, state and local initiatives and proposals, to further increase minimum wage rates. Increased labor costs due to competition, increased minimum wage or mandated employee benefits costs, unionization activity or other factors would adversely impact our cost of sales and operating expenses.

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. In addition, our Wendy's units are dependent upon the strength of Wendy’s brand, marketing 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! 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 under-performing units. In addition, the franchise agreements contain restrictions on our ability to raise equity capital and require approval to effect a change of control.
Similar to our franchise relationship with PHI, the success of our Wendy's units is, to a large extent, directly related to the success of the Wendy’s restaurant system, including the financial condition, management, food quality and innovation and marketing success of Wendy’s and the successful operation of Wendy's restaurants owned by other franchisees. Any failure of the Wendy’s restaurant system to compete effectively would likely have a material adverse effect on the operating results of our Wendy's units. We are parties to franchise agreements with Wendy’s which govern the operation of all of our Wendy's restaurants, and may be terminated by Wendy’s upon certain events, including our failure to comply with the standards or procedures set forth in the franchise agreements or our bankruptcy or insolvency. Wendy’s must approve the acquisition or opening of any new restaurant and the closing of any of our existing restaurants. Therefore, Wendy’s could limit our ability to expand our operations through acquisitions and require us to continue operating under-performing units.


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Franchisor mandated asset upgrade and development requirements could require us to make significant capital expenditures and could have a material adverse effect on our business, financial condition and results of operations.
Under our franchise agreements with PHI and Wendy’s, our franchisors have the right to require us to upgrade our assets to brand standards which could include asset remodeling, reimaging or relocation. See Item 1, "Business - Franchise Agreements." These requirements may be material to our business and may require significant capital outlay. Such requirements may require us to obtain additional financing thereby limiting our ability to grow the business through acquisitions. If we do not comply with franchisor mandates, our franchisors have several remedies, including terminating the applicable franchise agreement for a defaulted restaurant or in certain circumstances terminating the franchise agreement for all restaurants governed by the defaulted restaurant’s agreement. 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.
As described in Item 1, "Business - Franchise Agreements,” PHI and the IPHFHA jointly introduced the Asset Partner Plan. The Asset Partner Plan proposes to govern the future assetupgrade requirements including the remodel scope and timing of such actions. The scope of the proposed remodel requirements vary based upon (i) the asset type, (ii) the date of the last asset action and (iii) in some cases population density. Our franchise agreements allow PHI to require a remodel on up to 15% of our assets annually beginning in 2016. The Asset Partner Plan will require significant capital expenditures by us over the plan period. Additionally, we may choose to permanently close or relocate certain units and convert units to the Delco format. As a result of these actions, we will likely experience a reduction in our net sales with respect to certain units due to temporary or permanent closures and relocation risks such as relocation to a less preferred site or less favorable leasing arrangement and the loss of dine-in sales associated with conversion to the Delco format.
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 national, regional and local restaurants, as well as with grocery stores and convenience stores for certain food items. 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 Wendy’s and their 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.
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 comparable store sales and customer visits;
variations in the price, availability and shipping costs of our supplies;
the development and introduction of new menu offerings that appeal to changing consumer preferences;
timing of holidays or other significant events;
seasonality of demand; 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 effect on our results of operations and cash flow.
In addition, our Pizza Hut business is moderately seasonal in nature with net product sales typically being higher in the first half of the year. Our Wendy’s business is also moderately seasonal in nature with net product sales typically being higher in the spring and summer months.
We face risks associated with litigation from customers, 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

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judgment against us could negatively impact the brand reputation of Pizza Hut or Wendy’s, 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 Pizza Hut 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. 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 or involving punitive damages, which may not be covered by insurance, 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.
Incidents involving food-borne illnesses, food tampering or other concerns can cause damage to our franchisors’ brands and swiftly affect our sales and profitability.
If our customers become ill from food-borne illnesses or as a result of food tampering, we could 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. Incidents involving food-borne illness or food tampering could be caused by food suppliers and transporters and, therefore, would be outside of our control.
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 and industry regulations, including those relating to:
the preparation and sale of food;
state and local licensing,
state and local licensing, including 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;
compliance with the Patient Protection and Affordable Care Act and the related Health Care and Education Reconciliation Act of 2010;
industry regulation regarding credit card information;
information security, privacy, and reporting of credit card information;
working and safety conditions; and
Federal and state immigration laws and regulations in the U.S.
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. We may become subject to legislation or regulation seeking to tax and/or regulate high-fat foods. New or changing laws and regulations and governmental agency determinations relating to union organizing rights and activities may impact our operations and increase our cost of labor. 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.
Adverse media reports on our restaurant segment or brand, such as incidents involving food-borne illnesses, food tampering or other concerns, whether or not accurate, could damage our franchisors’ brands and adversely affect consumer demand and our sales and profitability.

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Adverse media reports on our segment of the restaurant industry, such as pizza or hamburgers, 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. 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. In addition, increased use of social media can create or amplify the effects of negative publicity. If such a situation was to arise, 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.
Our systems may fail or be damaged, which could harm our operations and our business.
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, computer viruses, human error or other causes. System defects, failures, interruptions, unauthorized entries or viruses could result in:
additional development costs;
diversion of technical and other resources;
loss of customers and sales;
loss or theft of employee or customer data;
negative publicity;
harm to our business and reputation; and,
exposure to litigation claims, government investigations and enforcement actions, fraud losses or other liabilities.
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 comparable store sales, improve operations, implement cost controls and grow our business may be constrained.
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.

We are subject to cybersecurity risks, and if we suffer a security breach, we could damage our reputation with customers, incur substantial additional costs and become subject to litigation and government investigations and enforcement actions.

Our business is dependent on the secure and reliable operation of our information systems, including those used to operate and manage our business, and to allow our customers to order online and through call centers. Security breaches could expose us to a risk of loss or misuse of our information or that of our customers or employees, damage to our reputation, litigation, government investigations and enforcement actions and potential liability. We may not have the resources or technical sophistication to anticipate or prevent rapidly evolving types of cyber attacks. Attacks may be targeted at us, our customers, or both. If an actual or perceived breach of our security occurs, customer and/or supplier perception of the effectiveness of our security measures could be harmed and we could lose customers, suppliers or both. Actual or anticipated attacks and risks may have a material adverse effect on our financial results and cause us to incur increasing costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third party experts and consultants.
A person who is able to circumvent our security measures could misappropriate our or our customers’ and employees’ confidential information, cause interruption in our operations, damage our computers or those of our vendors, or otherwise damage our reputation and business. Any compromise of our security could result in a violation of applicable privacy and other laws, significant legal and financial exposure, damage to our reputation, and a loss of confidence in our security measures, which could harm our business and revenues. Any well-publicized compromise of either our security or the security of other Pizza Hut or Wendy’s operators 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.
As do most retailers, we receive certain personal information about our customers. In addition, our online operations at www.pizzahut.com and mobile payment options at our Wendy’s restaurants depend upon the secure transmission of confidential information over public networks, including information permitting cashless payments. Many of our customers use credit or debit

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cards to pay for their purchases. We rely on encryption and authentication technology licensed from third parties to provide the security and authentication to effectively secure transmission of confidential information, including customer payment card numbers. Advances in computer capabilities, new discoveries in the field of cryptography or other developments may result in the technology used by us to protect transaction data being breached or compromised. Data breaches can also occur as a result of non-technical issues.
Under payment card rules and our contracts with our card processors, if there is a breach of payment card information that we store, we could be liable to the payment card issuing banks for their cost of issuing new cards and related expenses. In addition, if we fail to follow payment card industry security standards, even if there is no compromise of customer information, we could incur significant fines or lose our ability to give customers the option of using payment cards to pay for their orders. If we were unable to accept payment cards, our business would be seriously damaged.
Our servers are also vulnerable to computer viruses, physical or electronic break-ins, and similar disruptions, including “denial-of-service” type attacks. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches. Security breaches, including any breach by us or by persons with whom we have commercial relationships that result in the unauthorized release of our customers’ or employees’ personal information, could damage our reputation and expose us to a risk of loss or litigation and possible liability.
Our results of operations could be adversely affected by increased costs as a result of changes in laws and other changes relating to health care.
The federal government and several state governments have proposed or enacted legislation regarding health care, including legislation that in some cases requires employers to either provide health care coverage to their full-time employees, pay a penalty or pay into a fund that would provide coverage for them. During fiscal 2015 we implemented the Patient Protection and Affordable Care Act, which was signed into law on March 23, 2010, and the related Health Care and Education Reconciliation Act of 2010, which was signed into law on March 30, 2010 (collectively, the “Federal Health Care Acts”). The provisions of the Federal Health Care Acts having the greatest potential financial impact on us became effective in fiscal 2015 and have resulted in a modest increase in our direct labor expense for the 52 weeks ended December 29, 2015. Any future increases in these costs, as a result of changes in law, changes in the insurance industry or other changes, could have an 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. For our Pizza Hut units, we use one primary distributor to provide most all of our food and other supplies. 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 for our Pizza Hut operations is purchased from a single supplier, Leprino Foods Dairy Products Company (“Leprino”), the loss of which could have a material adverse effect on our business. Leprino is one of the major pizza category suppliers of cheese in the United States. While we have no other sole sources of supply, we do source other key ingredients from a limited number of suppliers. Alternative sources of supply of cheese or other key ingredients may not be available on a timely basis or be available on terms as favorable to us as under our current arrangements.    
The impact of potentially limited credit availability on third-party vendors such as our suppliers cannot be predicted.  The inability of our suppliers to access financing, or the insolvency of suppliers, could lead to disruptions in our supply chain which could adversely impact our sales, cost of sales and financial condition.
Our Wendy’s units are dependent on frequent deliveries of perishable food products that meet brand specifications. Our Wendy's restaurants take delivery of food and supplies two to three times a week. We rely upon QSCC for the purchase of food, proprietary paper, operating supplies and equipment and rely upon two primary distributors to provide most of our food and other supplies for our Wendy's restaurants. If QSCC does not properly estimate the product needs of our Wendy’s units, makes poor purchasing decisions, or decides to cease its operations, or if our distributors fail to meet their service requirements for any reason, our sales and operating costs could be adversely affected and our results of operations and financial condition could be harmed.
Changing health or dietary preferences may cause consumers to avoid products offered by us in favor of alternative foods.

17


A significant portion of our sales is derived from products, including pizza and hamburgers, which can contain high levels of fat, carbohydrates, and sodium. The foodservice industry is affected by consumer preferences and perceptions. If prevailing health or dietary preferences and perceptions cause consumers to avoid pizza, hamburgers and other products we offer in favor of foods perceived to be healthier, demand for our products may be reduced and our business would be harmed. If PHI and Wendy’s do 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 two primary products, if consumer demand for pizza and hamburgers should decrease, our business would suffer more than if we had a more diversified menu, as many other food service businesses do.
Failure to successfully implement our growth strategy could harm our business.
Our growth strategy includes expanding our ownership and operation of Wendy's units through opportunistic acquisitions of restaurants in additional markets and organic growth through development of new restaurants that meet our investment objectives. In addition, we may continue to grow our business by opening and selectively acquiring Pizza Hut or other 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 or Wendy’s;
our ability to negotiate the acquisition of additional units from Wendy’s or other Wendy's franchisees upon acceptable terms in desirable markets;
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 and margin levels at existing restaurants;
the negotiation of acceptable lease or purchase terms for new locations;
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 and hamburger 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, hurricanes and tornadoes. Depending upon its magnitude, a natural disaster could severely damage our stores or call centers, which could adversely affect our business, financial condition and results of 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 insurance coverage may not be sufficient to offset all property damages and lost sales. In addition, upon the expiration of our current insurance policies, adequate coverage may not be available at economically justifiable rates, if at all.

18


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.
Counterparties to our revolving credit facility may not be able to fulfill their obligations due to disruptions in the global credit markets, which could adversely affect our liquidity.
In borrowing amounts under our revolving credit facility, we are dependent upon the ability of participating financial institutions to honor draws on the facility. Although we do not currently have amounts drawn on our revolving credit facility, we have utilized this facility in the past to fund acquisitions or working capital needs. The disruptions in the global credit markets may impede the ability of financial institutions syndicated under our revolving credit facility to fulfill their commitments, which could adversely affect our liquidity.
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. 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.
We are subject to all of the risks associated with owning and leasing real estate, and any adverse developments could harm our results of operations and financial condition.
As of December 29, 2015, we owned the land and/or the building for 28 restaurants and leased the land and/or building for 1,367 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 six years for our Pizza Hut units and the next 15 to 20 years for our Wendy’s units. 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 services 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 most of whom have extensive experience with our company and in our industry. 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, our chief financial officer and our chief operating officer. Additionally, we do not maintain key-person insurance for any of our officers, employees or members of our Board of Directors. 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 results of operations and financial condition could be adversely affected by any claim or loss that is not covered by insurance or that exceeds our insurance coverage or self-insurance reserves.
    

19


We believe that we maintain insurance coverage that is customary for businesses of our size and type, including coverage for losses in excess of the normal expected levels under our self-insurance program. 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. We do not currently have separate cyber-security insurance. Any inadequacy of insurance 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 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 non-owned auto program can experience significant volatility due to the potential for a combination of high severity accidents and our high retention levels, causing a potential negative impact on our results of operations.
Our franchisors may not be able to adequately protect their intellectual property, which could harm the value of the Pizza Hut or Wendy’s brand and branded products and adversely affect our business.
The success of our business depends on our continued ability to use our franchisors’ existing trademarks, service marks and other components of the Pizza Hut and Wendy’s brands in order to increase brand awareness and further develop our branded products. We have no control over the Pizza Hut or Wendy’s brands. If our franchisors do not adequately protect their brands, 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 or Wendy’s 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.
Failure by us to maintain effective disclosure controls and procedures and 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.
We are required to maintain effective disclosure controls and procedures and effective internal control over financial reporting in connection with our filing of periodic reports with the SEC under the Securities Exchange Act of 1934. Failure to maintain effective disclosure controls and procedures and internal control over financial reporting, or the report by us of a material weakness, may cause investors to lose confidence in our consolidated financial statements. If we fail to remedy any material weakness, our consolidated financial statements may be inaccurate and we may face restricted access to the capital markets.

Our substantial leverage and lease obligations could affect 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 and restrict our future activities.
We are a highly leveraged company. Our total outstanding indebtedness on December 29, 2015 was $591.3 million, comprised of our term loan of $401.3 million ("Term Loan") and $190.0 million of 10 1/2% Senior Notes due 2020 (“Senior Notes”). We can also borrow secured debt up to $110.0 million under our revolving credit facility (“Revolving Facility”). Our Term Loan, together with our Revolving Facility, are referred to herein as our "Senior Secured Credit Facilities". We had $29.1 million of letters of credit issued and outstanding, resulting in $80.9 million of borrowing capacity under our Revolving Facility on December 29, 2015. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Sources of Capital.”
We also have, and will continue to have, significant lease obligations. As of December 29, 2015, our minimum annual rental obligations under long-term operating leases for fiscal 2016 and fiscal 2017 were $61.4 million and $54.9 million, respectively.
Our high degree of leverage and significant lease obligations could have important consequences, including:
increasing our vulnerability to general economic and industry conditions;
limiting our ability to obtain additional financing for working capital, capital expenditures, research and development, debt service requirements, acquisitions and general corporate or other purposes;
restricting us from making strategic acquisitions or causing us to make non-strategic divestitures;

20


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;
exposing us to the risk of increased interest rates as the borrowings under our Senior Secured Credit Facilities will be at variable rates of interest;
requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, thereby reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities.
Our Senior Secured Credit Facilities and the indenture governing the Senior Notes contain various covenants that limit our ability to engage in specified types of transactions. In addition, under our Senior Secured Credit Facilities, 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 Facilities. Upon the occurrence of an event of default under our Senior Secured Credit Facilities, the lenders could elect to declare all amounts outstanding under our Senior Secured Credit Facilities 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 Facilities 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 Facilities. Any acceleration of amounts payable under our Senior Secured Credit Facilities would constitute a default under our Senior Notes. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Sources of Capital.”
Future acquisitions or increased capital expenditures, depending on the size, may require borrowings beyond those available on our Revolving Facility and therefore may require utilization of the additional term loan borrowing capacity under our Senior Secured Credit Facilities, which requires additional commitments from lenders, as well as other sources of debt or additional equity capital. Changes in the financial and credit markets may impair our ability to obtain additional debt financing at costs similar to that of our Senior Secured Credit Facilities, if at all. If we were to access additional debt financing beyond our Senior Secured Credit Facilities to sustain our capital resource growth, additional financing could be at higher costs than the Company’s currently outstanding borrowings. In addition any utilization of the remaining additional term loan borrowing capacity under our Senior Secured Credit Facilities could result in a reset of the interest rate on our term loan borrowings, which would increase our borrowing costs from current market conditions.

We are required to satisfy various financial covenants under our Senior Secured Credit Facilities, and if we are unable to do so in the future we may be required to take corrective actions to avoid a default under our Senior Secured Credit Facilities and Senior Notes.

We were in compliance with the financial covenants under our Senior Secured Credit Facilities as of December 29, 2015, having a leverage ratio of 4.75x as compared to the covenant requirement of not more than 5.50x as of December 29, 2015 and an interest coverage ratio of 1.79x as compared to the covenant requirement of not less than 1.35x. The covenant requirement for the maximum leverage ratio increases to not more than 6.00x for our 2016 fiscal year, and thereafter decreases to 5.75x for our 2017 fiscal year and not more than 5.25x thereafter. The covenant requirement for the minimum interest coverage ratio increases to not less than 1.40x after our 2015 fiscal year. We believe that we will be in compliance with these financial covenants for fiscal year 2016 based upon our current operations and our internal financial forecasts. However, our ability to satisfy these financial covenants going forward depends on our future operating performance, which is in part subject to Pizza Hut and Wendy’s brand performance, prevailing economic and competitive conditions, including commodity prices, and various business, regulatory and other factors, some of which are beyond our control. If we are unable to satisfy these financial covenants in the future and are unable to cure any such failure under the terms of our Senior Secured Credit Facilities, we would be in default under our Senior Secured Credit Facilities, with the consequences described above. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Sources of Capital.”

Federal, state and local environmental regulations relating to the use, storage, discharge, emission, release 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 regulations relating to the use, storage, discharge, emission, release 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 penalties or restrictions on operations that could adversely affect our operations. Also, if contamination is discovered on properties owned or operated by us, including properties

21


we owned or operated in the past, we could be held liable for damages and the costs of remediation. Such damages and costs could adversely affect our operations.

Item 1B.
Unresolved Staff Comments.
None.
Item 2.
Properties.

We believe that our properties, taken as a whole, are generally well maintained and are adequate for our current and foreseeable business needs.

The following table sets forth certain information regarding restaurants operated by the Company as of December 29, 2015.

 
Pizza Hut Units
Wendy’s Units
Total
Alabama
109


109

Arkansas
64


64

Colorado
53


53

Delaware
10


10

Florida
175


175

Georgia
90


90

Idaho
39


39

Illinois
55


55

Indiana
4


4

Iowa
57


57

Kansas
32

18

50

Kentucky
21


21

Louisiana
17


17

Maryland
4


4

Minnesota
5


5

Mississippi
70


70

Missouri
84

17

101

North Carolina
48

52

100

North Dakota
13


13

Oklahoma
26


26

Oregon
33


33

South Carolina
6


6

South Dakota
22


22

Tennessee
91


91

Texas
19


19

Utah

54

54

Virginia
97

3

100

Washington
6


6

West Virginia
1


1

 
1,251

144

1,395


22


As of December 29, 2015, we leased approximately 98% of our restaurant properties, as indicated below. The majority of our existing lease terms end within the next two to six years for Pizza Hut units and the next 15 to 20 years for Wendy’s units. 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 Pizza Hut properties are owned by unaffiliated entities. Approximately 60% of our Wendy’s units are leased from the Wendy’s Company with the remainder of our leased Wendy’s properties owned by unaffiliated entities.
Restaurants in Operation as of December 29, 2015
 
Own
 
Lease
 
Total
Pizza Hut units
 
 
 
 
 
Red Roof`
10

 
136

 
146

RBD
8

 
495

 
503

Delco

 
602

 
602

  Total Pizza Hut units
18

 
1,233

 
1,251

Wendy’s units(1)
10

 
134

 
144

 
28

 
1,367

 
1,395


(1) 
Includes three fee-owned Wendy’s restaurants acquired in July 2014 that we plan to sell within the next 12 months which are included in assets held for sale.
The Company operated 1,395 restaurants as of December 29, 2015, located in buildings either leased or owned by us. Pizza Hut property sites average approximately 40,000 square feet. Typically, Red Roof and RBD units average approximately 3,000 square feet, including a kitchen area and customer seating capacity. Delco units average approximately 1,600 square feet. Wendy’s property sites average approximately 37,000 square feet and units average approximately 3,000 square feet and include customer seating capacity.
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. We currently lease from third parties office space for eight of our regional offices (which includes shared space with one territory office), one territory office, one training office and two call centers.
Item 3.
Legal Proceedings.

From time to time, the Company is involved in litigation which is incidental to its business. In the Company’s opinion, no litigation to which the Company is currently a party is likely to have a material adverse effect on the Company’s consolidated financial condition, results of operations, or cash flows.
Item 4.
Mine Safety Disclosures.
Not applicable.

23



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 membership units of the Company. Holdings paid special cash distributions of $0.1 million to its parent company, NPC International Holdings, Inc., in each of fiscal 2015 and fiscal 2014 to fund the repurchase of stock by its parent company related to employment terminations. The distributions were made in accordance with the Company’s debt facilities, which include limitations on the Company's ability to pay cash dividends and distributions.
The Company did not issue or sell any equity securities during fiscal 2015 that were not registered under the Securities Act of 1933, as amended. The Company did not repurchase any membership units during fiscal 2015.

24



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 consolidated financial statements of the Company, which can be found in Item 8.
On December 28, 2011, all of the outstanding membership interests of Holdings were acquired (the “Acquisition”) by NPC International Holdings, Inc. (“NPC Holdings” or “Parent”), an entity controlled by Olympus Growth Fund V, L.P. and certain affiliated entities. In connection with the Acquisition, NPC Holdings repaid all of the outstanding borrowings of NPC under its then-existing senior secured credit facilities and repurchased or redeemed all then-outstanding 9 1/2% Senior Subordinated Notes due 2014. The Company concurrently obtained new debt financing to consummate the Acquisition and make the related debt repayment through a combination of a term loan, a revolving credit facility and the issuance of $190.0 million of Senior Notes (the “Senior Notes”). The Acquisition and new debt financing are collectively referred to as the "Transactions".
As a result of the Transactions, purchase accounting adjustments were made to underlying assets and liabilities based on a third party valuation. The primary changes to the income statement as a result of the application of purchase accounting includes 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 Transactions resulted in higher debt levels and higher interest rates which resulted in higher interest accruals and increased capitalized debt issue costs which resulted in higher interest expense during the post-transaction period.
Due to the impact of the changes resulting from the purchase accounting adjustments described above, the income statement and statement of cash flows presentation separates the operating results of the Company into two accounting periods; (1) the period prior to December 27, 2011, the day preceding consummation of the Transactions (“predecessor”), and (2) the period beginning December 28, 2011 and after 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 (amounts in thousands in the following table, except restaurant operating data).
 
Successor
 
Predecessor
 
52 Weeks
ended
Dec. 29,
2015
52 Weeks
ended
Dec. 30,
2014
53 Weeks
ended
Dec. 31,
2013(1)
52 Weeks
ended
Dec. 25,
2012(2)
52 Weeks
ended
Dec. 27,
2011
Summary of Operations:
 
 
 
 
 
Total sales
$
1,223,299

$
1,179,897

$
1,094,032

$
1,048,923

$
980,973

Operating income
42,728

34,327

79,925

78,225

26,404(3)

Interest expense
41,784

41,101

42,016

46,691

25,201

Net income
$
6,712

$
1,672

$
29,742

$
15,020

$
4,706

Restaurant Operating Data:
 
 
 
 
 
Number of restaurants (at period end)
1,395

1,420(4)

1,354(4)

1,227(4)

1,151

Comparable store sales index:(5)
 
 
 
 
 
  Pizza Hut
(0.3
)%
(3.7
)%
(3.7
)%
1.9
%
0.4
%
  Wendy’s
2.8
 %
N/A

N/A

N/A

N/A

Working capital
$
(45,081
)
$
(45,231
)
$
(47,964
)
$
(20,957
)
$
(2,893
)
Consolidated Balance Sheet Data:
 
 
 
 
 
Total assets(6)
$
1,220,790

$
1,223,316

$
1,205,112

$
1,169,782

$
848,728

Total debt (including current
portion)
$
591,263

$
595,421

$
565,125

$
558,125

$
372,700

_____________________ 

(1) 
The fiscal year ended December 31, 2013 included 53 weeks of operations as compared with 52 weeks for all other years presented. We estimate the additional, or 53rd week, added approximately $19.0 million of net product sales in fiscal 2013.
(2) 
The Company engaged in the Transactions on December 28, 2011 in connection with the acquisition of the Company by NPC Holdings.
(3) 
Includes $26.6 million of transaction costs related to the Acquisition.
(4) 
We acquired 56 Wendy’s units during fiscal 2014, 91 Wendy’s units during fiscal 2013 and 36 Pizza Hut units during the first quarter of fiscal 2012.
(5) 
Comparable store sales refer to period-over-period net product sales comparisons for stores under our operation for at least 12 months. For fiscal 2014, the comparable store sales include Pizza Hut locations only as comparable store sales for Wendy’s would only include the 35 Wendy’s units acquired in

25


July 2013 and are not a meaningful representation of the sales for our Wendy’s units. The fiscal 2013 comparable store sales include Pizza Hut locations only as the Wendy’s units were acquired during fiscal 2013 and were not under our operation for 12 months.
(6) 
In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes (Topic 740) (“ASU 2015-17”). This update requires that entities with a classified balance sheet present all deferred tax assets and liabilities as noncurrent.We early adopted the standard during the fourth quarter of fiscal 2015, utilizing retrospective application as permitted. As such, the fiscal 2014 amounts have been reclassified to conform to the current presentation, resulting in a reclassification of $13.0 million from current deferred income tax assets to reduce deferred income taxes within long-term liabilities. Fiscal 2011 through fiscal 2013 amounts have not been restated to reflect such change.



26


Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
As used in this report, NPC Restaurant Holdings, LLC is referred to herein as “Holdings.” Holdings and its subsidiaries are referred to as the “Company,” “we,” “us,” and “our.” Holdings’ wholly-owned subsidiary, NPC International, Inc. is referred to as “NPC.” NPC’s wholly-owned subsidiary, NPC Quality Burgers, Inc., is referred to herein as “NPCQB.”
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.
Any forward-looking statements made in this report speak only as of the date of this report. 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 show our operating results for the fiscal years ended December 29, 2015, December 30, 2014 and December 31, 2013. In this section, we analyze and explain the significant annual changes of specific line items in the Consolidated Statements of Income and Consolidated Statements of Cash Flows. We also suggest you read Item 1A, “Risk Factors” which will help your understanding of our financial condition, liquidity and operations.
Overview
NPC was founded in 1962 and is the largest franchisee of any restaurant concept in the United States (U.S.), based on unit count, according to the 2015 “Top 200 Restaurant Franchisees” by the Restaurant Finance Monitor and is the eighth largest restaurant unit operator, based on unit count, in the U.S.
Our Pizza Hut operations. We are the largest Pizza Hut franchisee and as of December 29, 2015 we operated 1,251 Pizza Hut units in 28 states with significant presence in the Midwest, South and Southeast. As of December 29, 2015, our Pizza Hut operations represented approximately 20% 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.
Our Wendy’s operations. As of December 29, 2015 we operated 144 Wendy’s units in 5 states. We expect to continue to expand our Wendy’s operations through opportunistic acquisitions of restaurants in additional markets and through organic growth with development of new restaurants that meet our investment objectives. All of our Wendy’s restaurants are owned and operated by NPCQB and are primarily located in and around the Kansas City, Salt Lake City and Greensboro-Winston Salem metropolitan areas.
Our Fiscal Year. We operate on a 52- or 53-week fiscal year ending on the last Tuesday in December. Fiscal 2015 and fiscal 2014 each contained 52 weeks and fiscal 2013 contained 53 weeks. For convenience, fiscal years ended December 29, 2015, December 30, 2014 and December 31, 2013 are referred to as fiscal 2015, fiscal 2014 and fiscal 2013, respectively.
Our Sales
Net Product Sales. Net product sales are comprised of sales of food and beverages from our restaurants, net of discounts. In fiscal 2015, pizza sales accounted for approximately 77% of our Pizza Hut net product sales. Hamburger and chicken sandwiches accounted for approximately 47% of our Wendy’s net product sales. Various factors influence sales at a given unit, including customer recognition of the Pizza Hut and Wendy’s brands, our level of service and operational effectiveness, pricing, marketing

27


and promotional efforts and local competition. Several factors affect our sales in any period, including the number of units in operation, comparable store sales and seasonality. “Comparable store sales” refer to period-over-period net product sales comparisons for units under our operation for at least 12 months.
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.

Seasonality. Our Pizza Hut business is moderately seasonal in nature with net product sales typically being higher in the first half of the fiscal year. Our Wendy’s business is also moderately seasonal in nature with net product sales typically being higher in the spring and summer months. As a result of these seasonal fluctuations, our operating results may vary between fiscal quarters. Further, results for any quarter are not necessarily indicative of the results that may be achieved for the full fiscal year.

Restaurant formats. 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 carryout, 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 carryout service. Restaurant-Based Delivery units, or “RBDs,” conduct delivery, dine-in, and carryout operations from the same free-standing location. At December 29, 2015, 98% of our Pizza Hut units included the WingStreet product line.

Our Wendy’s restaurants are generally free-standing and include a pick-up window in addition to a dining room with counter service.
The following table sets forth certain information with respect to each fiscal period:
 
December 29, 2015
 
December 30, 2014
 
December 31, 2013(2)
Pizza Hut:
 
 
 
 
 
Average annual revenue per restaurant(1)
$
765,798

 
$
767,094

 
$
819,881

 
 
 
 
 
 
Number of restaurants open at the end of the period:
 
 
 
 
 
RBD
503

 
514

 
527

Delco
602

 
601

 
567

RR
146

 
162

 
169

  Total Pizza Hut restaurants(2)
1,251

 
1,277

 
1,263

 
 
 
 
 
 
Wendy’s:
 
 
 
 
 
Average annual revenue per restaurant(3)
$
1,427,193

 
$
1,419,718

 
$
1,350,387

Number of restaurants open at the end of the period
144

 
143

 
91

_____________________ 
(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 1,262 in both fiscal 2015 and fiscal 2014 and 1,240 in fiscal 2013.
(2) 
The fiscal year ended December 31, 2013 includes 53 weeks of operations as compared with 52 weeks for the other years presented.
(3) 
In computing the fiscal 2015 and fiscal 2014 averages, total net product sales for these fiscal periods were divided by 142 and 116 equivalent units, respectively. In computing the 2013 average, pro forma annual net product sales were divided by 88 full-year equivalent units.
Comparable Store Sales. The primary driver of sales growth in fiscal 2015 was the full-year sales for the 56 Wendy’s units acquired in July 2014 and comparable store sales growth of 2.8% for our Wendy’s operations which were partially offset by a comparable store sales decrease of 0.3% for our Pizza Hut operations.

The following table summarizes the quarterly and annual comparable store sales results for fiscal years 2015, 2014 and 2013 for stores that have been operated by the Company for at least 12 months:

28


 
 
Comparable Store Sales (Decline)/Growth
Pizza Hut
 
Quarter 1
 
Quarter 2
 
Quarter 3
 
Quarter 4
 
Fiscal Year
2015
 
(3.0
)%
 
 %
 
(0.9
)%
 
3.2
 %
 
(0.3
)%
2014
 
(4.7
)%
 
(5.6
)%
 
(0.7
)%
 
(3.5
)%
 
(3.7
)%
2013
 
(2.2
)%
 
(3.7
)%
 
(3.6
)%
 
(5.2
)%
 
(3.7
)%
 
 
 
 
 
 
 
 
 
 
 
Wendy’s
 
 
 
 
 
 
 
 
 
 
2015
 
0.8
 %
 
(0.5
)%
 
3.1
 %
 
5.8
 %
 
2.8
 %

Fiscal 2015 is the first year that we began reporting comparable store sales for our Wendy’s operations with approximately 60% of our units qualifying (greater than 12 months in operation with NPCQB) in the first and second quarter of fiscal 2015 and 100% of units qualifying during the third and fourth quarter of fiscal 2015. Prior to fiscal 2015 an insignificant portion of our Wendy’s store base qualified for the index.
Our Costs
Our operating costs and expenses are comprised of cost of sales, direct labor, other restaurant operating 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 for our Pizza Hut units has primarily been comprised of the following: cheese: 30-35%; dough: 16-20%; meat: 16-20%; 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 RSCS, a cooperative designed to operate as a central procurement service for the operators of Yum! Brands, Inc. restaurants, and participate in various cheese hedging and procurement programs that are directed by RSCS 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 RSCS, the RSCS expects to hedge approximately 30% to 50% of the Pizza Hut system’s anticipated cheese purchases for fiscal 2016 through a combination of derivatives taken under the direction of the RSCS. Additionally, the RSCS has entered into contractual pricing arrangements with the supplier to restaurants in the Pizza Hut system on cheese purchases that may cause the prices paid by us to exceed or be less than the current block cheese price.

Our Wendy’s cost of sales is primarily comprised of the following: beef and chicken: 40-42%; packaging: 11-13%; potatoes: 8-10%; and dairy: 8-10%. These costs can fluctuate from year-to-year given the commodity nature of the cost category, but are constant across regions. Wendy’s and its franchisees have established Quality Supply Chain Co-op, Inc. to manage contracts for the purchase and distribution of food, proprietary paper, operating supplies and equipment under national contracts with pricing based upon total system volume for the Wendy’s system in the United States and Canada.
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 (“OROE”) 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 (for our Pizza Hut operations), supplies, repairs, insurance and other restaurant related costs.
Included within other restaurant OROE are royalties paid to Pizza Hut, Inc. (“PHI”). Beginning in 2012, PHI began offering development incentives totaling $80,000 per new unit developed (the “Development Incentive”), subject to certain threshold criteria. These Development Incentives are recorded as a reduction to other restaurant operating expenses in the year the qualifying asset is opened. The offering of Development Incentives is renewable annually at PHI’s discretion and was renewed for fiscal 2015, with modified threshold criteria, however we did not qualify for the Development Incentives during fiscal 2015. We developed or relocated 36 units and 49 units during fiscal 2014 and fiscal 2013, respectively, qualifying us for Development Incentives of $2.9 million and $3.9 million, respectively.

29


Additionally, PHI has offered development incentives totaling $10,000 per unit converted to the WingStreet platform during fiscal 2013 through 2015 (the “WingStreet Incentive”). WingStreet Incentives earned under the program are recorded as a reduction to other restaurant operating expenses upon completion of each unit conversion and the WingStreet Incentives will be received within 12 months of unit conversion. We converted 83 units, 281 units and 188 units during fiscal 2015, fiscal 2014 and fiscal 2013, respectively, that were eligible for the incentive and earned WingStreet Incentives of $0.8 million, $2.8 million and $1.9 million, respectively.
Royalties paid to PHI are impacted by changes in royalty rates under our existing franchise agreements. Our blended average Pizza Hut royalty rate (excluding Development Incentives and WingStreet Incentives) as a percentage of total Pizza Hut sales was 4.9% for fiscal 2013 through fiscal 2015. For delivery units currently operating under the Company’s existing territory franchise agreements, effective January 1, 2020, royalty rates for these delivery units are scheduled to increase from 4.50% to 4.75% and, effective January 1, 2030, these rates will increase to 5.0%.
Our blended average Wendy’s royalty rate as a percentage of total Wendy’s sales was 3.9% for fiscal 2015 and fiscal 2014 and 3.8% for fiscal 2013.
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, bank service and credit card transaction fees, professional fees, travel, information systems, recruiting and training costs, supplies, and insurance.
Facility Impairment and Closure Costs. Facility impairment and closure costs include any impairment of long-lived assets, including franchise rights associated with units or DMA’s, a unit’s leasehold improvements and equipment where the carrying amount of the asset is not recoverable and may exceed its fair value. When a unit is closed, the associated lease and other costs related to the unit are included in closure costs.
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
Changes in general economic conditions can have a significant impact on consumer spending. Wage stagnation, higher healthcare costs and economic uncertainty, as partially mitigated by lower fuel prices and lower unemployment, appear to have negatively impacted consumer spending in some segments of the restaurant industry, including the segment in which we compete. Specifically, we believe pressures on low and lower-middle income customers continue to be significant, and we believe that these customers are particularly interested in receiving value at a reasonable price in the current environment.
Competition
The restaurant business is highly competitive. The QSR industry is a fragmented market, and includes well-established competitors.
Our Pizza Hut restaurants face competition from national and regional chains, as well as independent operators, which affects pricing strategies and margins. Additionally, frozen pizzas and take-and-bake pizzas are competitive alternatives in the pizza segment. In addition to more established competitors, we also face competition from new competitors and concepts such as fast casual pizza concepts. Limited product variability within our segment can make differentiation among competitors difficult. Thus, companies in the pizza segment continuously promote and market new product introductions, price discounts and bundled deals, and rely heavily on effective marketing and advertising to drive sales. The price charged for each menu item may vary from market to market (and within markets) depending on competitive pricing and the local cost structure.

Our Wendy’s restaurants face competition from other food service operations within the same geographical area. Wendy’s restaurants compete with other restaurant companies and food outlets, primarily through the quality, variety, convenience, price, and value perception of food products offered. The location of units, quality and speed of service, attractiveness of facilities, effectiveness of marketing and new product development by Wendy’s and its competitors are also important factors. The price charged for each menu item may vary from market to market (and within markets) depending on competitive pricing and the local cost structure.
Commodity Prices
For our Pizza Hut operations, 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

30


demand. Our costs can also fluctuate as a result of changes in ingredients or packaging instituted by PHI. For fiscal 2015, the block cheese price averaged $1.61 per pound, a decrease of $0.49 or 23% versus the average price for fiscal 2014. Additionally, meat prices decreased $0.42 per pound or approximately 20% versus the average price for fiscal 2014. For our Wendy’s operations, commodity prices of beef and chicken, packaging, potatoes and dairy can fluctuate throughout the year.
    
Based upon current market conditions, we currently expect overall commodity inflation for our Pizza Hut operations of approximately flat to deflation of 1% and commodity deflation for our Wendy’s operations of approximately 2% to 3% for fiscal 2016 as compared to fiscal 2015.
 
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. To the extent that our Pizza Hut delivery sales mix increases due to changes in occasion mix or the acquisition of units, our labor costs would be expected to increase due to the more labor intensive nature of the delivery transaction. 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. Certain states’ minimum wage rates are adjusted annually for inflation. These increases in state minimum wage rates are currently expected to increase direct labor expense by approximately $0.4 million in fiscal 2016. However, there are currently a number of federal, state and local initiatives and proposals to further increase minimum wage rates, which could be material to our operations.
The federal government and several state governments have proposed or enacted legislation regarding health care, including legislation that in some cases requires employers to either provide health care coverage to their full-time employees, pay a penalty or pay into a fund that would provide coverage for them. During fiscal 2015, we implemented the requirements of the Patient Protection and Affordable Care Act (“ACA”), which was signed into law on March 23, 2010, and the related Health Care and Education Reconciliation Act of 2010, which was signed into law on March 30, 2010 (collectively, the “Federal Health Care Acts”). The provisions of the Federal Health Care Acts having the greatest potential financial impact on us became effective in fiscal 2015 and have resulted in a modest increase in our direct labor expense for the 52 weeks ended December 29, 2015.
Additionally, changes in federal labor laws and regulations and governmental agency determinations relating to union organizing rights and activities could result in portions of our workforce being subjected to greater organized labor influence, thereby potentially increasing our labor 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.
Significant changes in average gasoline prices in the regions in which we operate can have a significant impact on our delivery driver reimbursement costs. We estimate that every $0.25 per gallon change in average gas prices in our markets impacts our annual operating results by approximately $0.9 million. However, as gas prices increase, the impact upon our operations can be somewhat mitigated by a transfer of sales from the delivery occasion to the carryout access mode, as consumers seek greater value (avoiding the extra delivery charge) which benefits us with lower labor costs for the carryout transaction.
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 declines in comparable store sales or competitive pressures, we may suffer decreased revenues, margins, income and cash flow from operations.
Critical Accounting Policies and Estimates
Certain accounting policies 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.

31


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. The following policies are deemed critical and could require us to make judgments and estimates.
Long-lived Assets. We review long-lived assets related to each unit semi-annually for indicators of impairment or whenever events or changes in circumstances indicate that the carrying amount of a unit’s leasehold improvements and equipment may not be recoverable. Based on the best information available, impaired leasehold improvements and certain personal property are written down to estimated fair market value, which becomes the new cost basis. Personal property is reviewed for impairment using the decision to close the unit as an indicator of impairment. Additionally, when a commitment is made to close a unit beyond the quarter, any remaining leasehold improvements and all personal property are reviewed for impairment and depreciable lives are adjusted.

Franchise Rights. Franchise rights are amortized over their useful lives using the straight-line method. We review franchise rights for indicators of impairment annually or whenever events or changes in circumstances indicate that the carrying amount of the franchise rights may not be recoverable. If an indicator of impairment exists, the cash flows of the DMA for our Pizza Hut units or store cash flows for our Wendy’s units, 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. If we determine that a revision is necessary, then the remaining carrying amount of franchise rights would be amortized prospectively over that revised remaining useful life. 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 business, results of operations and financial condition. As of December 29, 2015 we had $620.5 million in franchise rights, (see Note 5 of the Notes to Consolidated Financial Statements - Goodwill and Other Intangible Assets).
Goodwill. We have two operating segments (our Pizza Hut and Wendy’s operations) and two reporting units for purposes of evaluating goodwill for impairment. Goodwill was $294.6 million as of December 29, 2015, consisting of $290.5 million for our Pizza Hut segment and $4.1 million for our Wendy’s segment.
Goodwill primarily originated with the December 28, 2011 acquisition of Holdings by NPC Holdings. Additional goodwill was recorded in connection with the acquisition of 147 Wendy’s units in fiscal 2014 and fiscal 2013.
We assess goodwill, which is not subject to amortization, for impairment annually in the second quarter 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. Management judgment is a significant factor in determining whether an indicator of impairment has occurred. We performed our annual test on our Wendy’s reporting unit during the second quarter of fiscal 2015 and we based our goodwill impairment testing for the Wendy’s reporting unit on a qualitative assessment. The qualitative assessment included an in-depth analysis of many factors, including general economic conditions, industry and market conditions, a broad scope of financial factors, changes in management and key personnel, as well as other drivers of a fair value analysis. As part of the qualitative analysis, many estimates and assumptions were made that related to future economic trends, consumer behaviors, and other factors, all of which are beyond the control of management. As a result of the Company’s qualitative assessment performed during the second quarter of fiscal 2015, it was concluded that it was more-likely-than-not that the fair value of the Wendy’s reporting unit was greater than its carrying value. The qualitative assessment is highly subjective and requires significant judgment, and assessments in future periods may result in different conclusions as to the fair value of the Wendy’s reporting unit.
We performed our annual test on our Pizza Hut operations during the second quarter of fiscal 2015 and as a result of continued negative comparable store sales in these operations, we performed a quantitative assessment and estimated the fair value of the Pizza Hut reporting unit using discounted expected future cash flows. As a result of this quantitative assessment, it was concluded that this reporting unit was not impaired and the fair value of this reporting unit exceeded its carrying value. There was significant improvement in the fair value of the reporting unit when compared to the quantitative assessment performed in the fourth quarter of fiscal 2014, with the fair value returning to a level similar to the fair value at the second quarter of 2014. The determination of the estimated fair value of the Pizza Hut reporting unit requires significant estimates and assumptions. These estimates and assumptions primarily include, but are not limited to, discount rate, terminal growth rate, operating income before depreciation and amortization, and capital expenditures. Due to the inherent uncertainty involved in making those estimates, actual results could differ from those estimates and continued negative comparable store sales could result in an impairment charge in fiscal

32


2016 or a future fiscal period. We evaluate the merits of each significant assumption, both individually and in the aggregate, used to determine the fair value of the Pizza Hut reporting unit for reasonableness.

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, during the measurement period 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 3 of the Notes to Consolidated Financial Statements for a discussion of the allocation of the purchase price for acquisitions in fiscal 2014 and fiscal 2013.
Self-insurance Accruals. We operate with a significant self-insured retention of expected losses under our workers’ compensation, employee medical, general liability and non-owned auto programs. We purchase third party coverage for losses in excess of the normal expected levels. Liabilities for insurance reserves 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 and general liability 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. Our non-owned auto program can experience significant volatility due to a combination of the potential for high severity accidents and our high retention levels, causing a potential negative impact on our results of operations.
A 10% change in our self-insured liabilities estimates would have affected net earnings by approximately $3.4 million for the fiscal year ended December 29, 2015. See Note 11 - "Insurance Reserves" of the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data.
Recently Issued Accounting Statements and Pronouncements
See Note 2 – “Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” for new accounting standards, including the expected dates of adoption and estimated effects on our consolidated financial statements.
Results of Operations
The table below presents (i) comparable store sales indices, (ii) selected restaurant operating results as a percentage of net product sales and (iii) sales by occasion for the 52 weeks ended December 29, 2015 and December 30, 2014 and the 53 weeks ended December 31, 2013:


33


 
52 Weeks Ended
 
53 Weeks Ended
Consolidated
December 29, 2015
 
December 30, 2014
 
December 31, 2013
Net product sales, (in thousands)
$
1,170,071

 
$
1,128,215

 
$
1,042,033

Fees and other income, (in thousands)
$
53,228

 
$
51,682

 
$
51,999

Net product sales
100
 %
 
100
 %
 
100
 %
Direct restaurant costs and expenses(2):
 
 
 
 
 
Cost of sales
29.3
 %
 
31.2
 %
 
29.5
 %
Direct labor
29.8
 %
 
29.7
 %
 
28.5
 %
Other restaurant operating expenses
33.3
 %
 
33.2
 %
 
31.7
 %
 
 
 
 
 
 
Pizza Hut
 
 
 
 
 
Comparable store sales(1)
(0.3
)%
 
(3.7
)%
 
(3.7
)%
Net product sales, (in thousands)
$
966,778

 
$
968,419

 
$
1,016,652

Fees and other income, (in thousands)
$
53,228

 
$
51,682

 
$
51,999

Net product sales
100
 %
 
100
 %
 
100
 %
Direct restaurant costs and expenses(2):
 
 
 
 
 
Cost of sales
28.6
 %
 
30.8
 %
 
29.4
 %
Direct labor
30.3
 %
 
29.8
 %
 
28.4
 %
Other restaurant operating expenses
34.0
 %
 
33.9
 %
 
31.8
 %
 
 
 
 
 
 
Wendy’s
 
 
 
 
 
Comparable store sales
2.8
 %
 
N/A(1)

 
N/A(1)

Net product sales, (in thousands)
$
203,293

 
$
159,796

 
$
25,381

Net product sales
100
 %
 
100
 %
 
100
 %
Direct restaurant costs and expenses(2):
 
 
 
 
 
Cost of sales
32.4
 %
 
33.5
 %
 
33.1
 %
Direct labor
27.5
 %
 
28.9
 %
 
30.0
 %
Other restaurant operating expenses
29.7
 %
 
29.1
 %
 
29.3
 %

(1) 
For fiscal 2014, the comparable store sales include Pizza Hut locations only as comparable store sales for our Wendy’s operations would include only the 35 Wendy’s units acquired in July 2013 and are not a meaningful representation of the sales for our Wendy’s units. The fiscal 2013 comparable store sales include Pizza Hut locations only as the Wendy’s units were acquired during 2013 and were not under our operation for 12 months.
(2) 
Stated as a percentage of net product sales.

 
December 29, 2015
 
December 30, 2014
 
December 31, 2013
Pizza Hut Sales by occasion:
 
 
 
 
 
Carryout
46
%
 
47
%
 
49
%
Delivery
42
%
 
40
%
 
37
%
Dine-in
12
%
 
13
%
 
14
%
 
 
 
 
 
 
Wendy’s sales by occasion:
 
 
 
 
 
Pick-up window
67
%
 
65
%
 
65
%
Counter service
33
%
 
35
%
 
35
%


Activity with respect to unit count is set forth in the table below:


34


 
52 Weeks Ended
Consolidated
December 29, 2015
 
December 30, 2014
 
December 31, 2013
Beginning of period
1,420

 
1,354

 
1,227

Acquired

 
56

 
92

Developed(1)
16

 
37

 
49

Closed(1)
(41
)
 
(27
)
 
(14
)
End of period
1,395

 
1,420

 
1,354

 
 
 
 
 
 
Equivalent units(2)
1,404

 
1,378

 
1,259

 
 
 
 
 
 
Pizza Hut
 
 
 
 
 
Beginning of period
1,277

 
1,263

 
1,227

Acquired

 

 
1

Developed(1)
13

 
36

 
49

Closed(1)
(39
)
 
(22
)
 
(14
)
End of period
1,251

 
1,277

 
1,263

 
 
 
 
 
 
Equivalent units(2)
1,262

 
1,262

 
1,240

 
 
 
 
 
 
Wendy’s
 
 
 
 
 
Beginning of period
143

 
91

 

Acquired

 
56

 
91

Developed(1)
3

 
1

 

Closed(1)
(2
)
 
(5
)
 

End of period
144

 
143

 
91

 
 
 
 
 
 
Equivalent units(2)
142

 
116

 
19


(1) 
For the Pizza Hut operations for the 52 weeks ended December 29, 2015 and December 30, 2014 and 53 weeks ended December 31, 2013, nine units, 15 units and seven units, respectively, were relocated or rebuilt and are included in both the developed and closed totals above. For the Wendy’s operations for the 52 weeks ended December 29, 2015 and December 30, 2014, one unit was relocated and is included in both the developed and closed total above for each of these fiscal years.
(2) 
Equivalent units represent the number of units open at the beginning of a given period, adjusted for units opened, closed, temporarily closed, acquired or sold during the period on a weighted average basis.

Fiscal 2015 Compared to Fiscal 2014

Our Pizza Hut Operations
Net Product Sales. Our Pizza Hut net product sales for the 52 weeks ended December 29, 2015 compared to the 52 weeks ended December 30, 2014 were $966.8 million and $968.4 million, respectively, a decrease of $1.6 million or 0.2%, resulting largely from a decline in comparable store sales of 0.3%.
Fees and Other Income. Fees and other income were $53.2 million for fiscal 2015, compared to $51.7 million for the prior year, an increase of $1.5 million or 3.0%. The increase was due to higher customer delivery charge income as a result of increased delivery transactions.
Cost of Sales. Pizza Hut cost of sales was $276.4 million for fiscal 2015, compared to $298.0 million for the prior year for a decrease of $21.6 million or 7.3%. Cost of sales decreased 2.2%, as a percentage of net product sales, to 28.6%, compared to 30.8% in the prior year largely due to lower ingredient costs, primarily cheese and meat.
Direct Labor. Pizza Hut direct labor costs for fiscal 2015 as compared to the prior year were $292.8 million and $288.5 million, respectively, an increase of $4.3 million, or 1.5%. Direct labor costs were 30.3% of net product sales for fiscal 2015, a 0.5% increase compared to the prior year. This increase was primarily due to higher labor costs largely due to increased

35


delivery sales mix, which is more labor intensive, increases in the state minimum wage rates and higher health insurance expense due to the ACA which were partially offset by lower workers’ compensation expense.
Other Restaurant Operating Expenses. OROE for our Pizza Hut units for fiscal 2015 were $328.8 million compared to $328.2 million for the prior year, an increase of $0.6 million or 0.2%. OROE as a percentage of net product sales were 34.0% of net product sales for fiscal 2015 compared to 33.9% for the prior year, an increase of 0.1%.
Significant changes in OROE for our Pizza Hut units as a percentage of net product sales were as follows:

    
OROE as a percentage of net product sales for the 52 weeks ended December 30, 2014
33.9
 %
Development Incentives and WingStreet Incentives
 
0.3

Advertising expense
 
0.2

Depreciation and amortization expense
 
(0.5
)
Other
 
0.1

OROE as a percentage of net product sales for the 52 weeks ended December 29, 2015
34.0
 %
Depreciation and amortization expense included in OROE for our Pizza Hut operations was $35.5 million or 3.7% of net product sales for the 52 weeks ended December 29, 2015 compared to $40.3 million or 4.2% of net product sales for the prior year. This decrease in depreciation and amortization expense was primarily due to short-lived assets becoming fully depreciated during the fourth quarter of fiscal 2014 without replacement.
Our Wendy’s Operations
Net Product Sales. Wendy’s net product sales for the 52 weeks ended December 29, 2015 compared to the 52 weeks ended December 30, 2014 were $203.3 million and $159.8 million, respectively, an increase of $43.5 million or 27.2%, primarily due to the July 2014 acquisition of 56 Wendy’s restaurants and comparable store sales growth of 2.8%.
Cost of Sales. Wendy’s cost of sales for the 52 weeks ended December 29, 2015 as compared to the prior year, was $66.0 million and $53.5 million, respectively, an increase of $12.5 million primarily due to the July 2014 acquisition of 56 Wendy’s restaurants. Cost of sales decreased 1.1% as a percentage of net product sales, to 32.4%, compared to 33.5% in the prior year largely due to favorable product mix and promotional strategies.
Direct Labor. Wendy’s direct labor costs for the 52 weeks ended December 29, 2015 as compared to the prior year, were $56.0 million and $46.1 million, respectively, an increase of $9.9 million primarily due to the July 2014 acquisition of 56 Wendy’s restaurants. Direct labor costs were 27.5% of net product sales for the 52 weeks ended December 29, 2015, a 1.4% decrease compared to the prior year largely due to improved labor efficiency and lower workers’ compensation expense.
Other Restaurant Operating Expenses. Wendy’s OROE for the 52 weeks ended December 29, 2015 were $60.4 million compared to $46.5 million for the prior year, an increase of $13.9 million primarily due to the July 2014 acquisition of 56 Wendy’s restaurants. OROE increased 0.6% as a percentage of net product sales, to 29.7% of net product sales for the 52 weeks ended December 29, 2015, compared to 29.1% for the prior year.
Significant changes in OROE as a percentage of net product sales were as follows:
    
OROE as a percentage of net product sales for the 52 weeks ended December 30, 2014
29.1
 %
Depreciation and amortization expense
 
0.8

Utilities expense
 
(0.2
)
OROE as a percentage of net product sales for the 52 weeks ended December 29, 2015
29.7
 %
Depreciation and amortization included in OROE for our Wendy’s operations was $9.3 million or 4.6% of net product sales for the 52 weeks ended December 29, 2015 compared to $6.0 million or 3.8% of net product sales for the prior year, an increase of 0.8% of net product sales. This increase was largely due to increased capital expenditures.
Consolidated
General and Administrative Expenses. General and administrative (“G&A”) expenses for the 52 weeks ended December 29, 2015 were $71.6 million compared to $63.2 million for the prior year, an increase of $8.4 million or 13.3%. This increase was largely due to higher incentive compensation as a result of improved financial performance, higher field personnel and support costs and higher salaries expense.

36


    
Corporate Depreciation and Amortization. Corporate depreciation and amortization expense for the 52 weeks ended December 29, 2015 was $21.2 million compared to $20.7 million for the prior year, an increase of $0.5 million.

Net Facility Impairment and Closure Costs. During the 52 weeks ended December 29, 2015 we recorded $7.5 million of expense compared to $1.0 million of expense for the same period of fiscal 2014. The 52 weeks ended December 29, 2015 included asset impairment charges of $6.3 million for underperforming units ($5.0 million for our Pizza Hut operations and $1.3 million for our Wendy’s operations) and $1.2 million for closure charges. The prior year included $1.0 million of impairment and closure charges for our Pizza Hut operations.

Interest Expense. Interest expense was $41.8 million for the 52 weeks ended December 29, 2015 compared to $41.1 million for the prior year, an increase of $0.7 million. Our cash borrowing rate was flat at 6.3% for the 52 weeks ended December 29, 2015 as compared to the prior year. Our average outstanding debt balance increased $7.7 million to $594.6 million for the 52 weeks ended December 29, 2015 as compared to the prior year, largely due to additional borrowings on our term loan during fiscal 2014 to fund the acquisition of 56 Wendy’s restaurants in July 2014. Interest expense included $4.0 million and $3.9 million for amortization of deferred debt issuance costs for fiscal 2015 and fiscal 2014, respectively.
Income Taxes. For fiscal 2015, we recorded an income tax benefit of $5.8 million compared to an income tax benefit of $8.4 million for the prior year. The income tax benefit for fiscal 2015 primarily related to federal employment-related tax credits in relation to lower taxable income. The benefit also included adjustments to deferred taxes for a change in the applicable state income tax rate and other adjustments related to the filing of the 2014 federal and state tax returns during the third quarter of 2015.
The tax benefit for fiscal 2014 was primarily attributable to federal employment-related tax credits, a net book loss before taxes of $6.8 million and a favorable adjustment of $0.8 million related to the release of liabilities for uncertain tax positions which were partially offset by $1.1 million of tax expense related to a change in the state rate on deferred taxes.
Net Income. Net income for fiscal 2015 was $6.7 million compared to $1.7 million for the prior year, an increase of $5.0 million. The increase in net income is primarily attributable to improved profitability from our Wendy’s operations and the 56 Wendy’s units acquired in July 2014. Additionally, our Pizza Hut operations generated improved profitability as decreases in ingredient costs more than offset the impact of a $6.5 million increase in asset impairment and closure costs and increased incentive compensation expenses as compared to the prior year.
 
Fiscal 2014 Compared to Fiscal 2013

The 2013 results of operations for our Wendy’s restaurants were not material to the financial statements as they constituted only 2.4% of consolidated net product sales for the 53 weeks ended December 31, 2013 and 4.7% of total assets at December 31, 2013. Therefore, the comparison of results to fiscal 2013 for our Wendy’s operations has been omitted.
See Note 14 - “Condensed Consolidating Financial Statements” in the Notes to the Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” .

Our Pizza Hut Operations
Net Product Sales. Our Pizza Hut net product sales for the 52 weeks ended December 30, 2014 compared to the 53 weeks ended December 31, 2013 were $968.4 million and $1,016.7 million, respectively, a decrease of $48.2 million or 4.7%, resulting largely from a decline in comparable store sales of 3.7% and the additional, or 53rd week in fiscal 2013, which we estimate constituted approximately $19.0 million of net product sales or 1.9% of prior year net product sales. This decline was partially offset by a 1.8% increase in equivalent units for the 52 weeks ended December 30, 2014 as compared to the prior year.
Fees and Other Income. Fees and other income were $51.7 million for fiscal 2014, compared to $52.0 million for the prior year, a decrease of $0.3 million or 0.6%. The decrease was due to lower customer delivery charge income due to the additional, or 53rd week in fiscal 2013 which was partially offset by increased delivery transactions.
Cost of Sales. Pizza Hut cost of sales was $298.0 million for fiscal 2014, compared to $298.5 million for the prior year for a decrease of $0.5 million or 0.2%. Cost of sales increased 1.4%, as a percentage of net product sales, to 30.8%, compared to 29.4% in the prior year due to increased ingredient costs, primarily cheese and meats.
Direct Labor. Pizza Hut direct labor costs for fiscal 2014 as compared to the prior year were $288.5 million and $289.0 million, respectively, a decrease of $0.5 million, or 0.2%. Direct labor costs were 29.8% of net product sales for fiscal 2014, a 1.4% increase compared to the prior year. The increase in direct labor costs as a percentage of net product sales was primarily due to the deleveraging effect of negative comparable store sales on fixed and semi-fixed labor costs, higher workers’ compensation expense and an increase in delivery transaction mix, which is more labor intensive.

37


Other Restaurant Operating Expenses. OROE for our Pizza Hut units for fiscal 2014 were $328.2 million compared to $323.1 million for the prior year, an increase of $5.1 million or 1.6%. OROE as a percentage of net product sales were 33.9% of net product sales for fiscal 2014 compared to 31.8% for the prior year, an increase of 2.1%.
Significant changes in OROE for our Pizza Hut units as a percentage of net product sales were as follows:

OROE as a percentage of net product sales for the 53 weeks ended December 31, 2013
31.8
%
Deleveraging of rent and occupancy costs
 
0.7

Depreciation and amortization expense
 
0.5

Advertising expense
 
0.4

Insurance expense
 
0.4

Other
 
0.1
%
OROE as a percentage of net product sales for the 52 weeks ended December 30, 2014
33.9
%
Depreciation and amortization expense included in OROE for our Pizza Hut operations was $40.3 million or 4.2% of net product sales for the 52 weeks ended December 30, 2014 compared to $37.2 million or 3.7% of net product sales for the prior year.
Our Wendy’s Operations
Net Product Sales. Our Wendy’s net product sales for fiscal 2014 were $159.8 million.
Cost of Sales. Our Wendy’s cost of sales for fiscal 2014 was $53.5 million or 33.5% of net product sales.
Direct Labor. Our Wendy’s direct labor costs for the 52 weeks ended December 30, 2014 were $46.1 million or 28.9% of net product sales.
Other Restaurant Operating Expenses. Our Wendy’s OROE for fiscal 2014 were $46.5 million or 29.1% of net product sales. Depreciation and amortization expense included in OROE for our Wendy’s operations was $6.0 million or 3.8% of net product sales and rent expense was $10.3 million or 6.5% of net product sales for the 52 weeks ended December 30, 2014.
Consolidated
General and Administrative Expenses. G&A expenses for fiscal 2014 were $63.2 million compared to $60.2 million for the prior year, an increase of $3.0 million or 5.0%. This increase was due to field and corporate personnel costs and credit card transaction fees directly attributable to the Wendy’s operations acquired in the last half of 2013 and July 2014. These costs were partially offset by lower incentive compensation and training expenses for the Pizza Hut operations as well as the rollover of the additional week of operations included in the prior year.
Corporate Depreciation and Amortization. Corporate depreciation and amortization costs were $20.7 million and $18.6 million for fiscal 2014 and fiscal 2013, respectively, an increase of $2.1 million largely related to franchise rights amortization for the Wendy’s units.
Other. We recorded $0.8 million of net other expense for fiscal 2014 as compared to $1.2 million for the prior fiscal year. Included in this category was $0.8 million for acquisition costs for the Wendy’s restaurants for fiscal 2014 compared to $0.5 million in the prior year. Also included were facility impairment charges of $1.0 million for our Pizza Hut units for fiscal 2014 compared to $0.7 million for the prior year. Offsetting this expense for fiscal 2014 were gains on disposition of assets of $1.0 million.

Interest Expense. Interest expense was $41.1 million for fiscal 2014 compared to $42.0 million for the prior year, a decrease of $0.9 million largely due to the additional week of operations, or 53rd week in the prior year which we estimate represented interest expense of approximately $0.9 million and the decrease in our cash borrowing rate of 0.4% to 6.3% for the 52 weeks ended December 30, 2014 as compared to the prior year as a result of the refinancing completed on the term loan in the fourth quarter of 2013. Our average outstanding debt balance increased $28.3 million to $586.9 million for fiscal 2014 as compared to the prior year due to the $40.0 million incremental term loan and increased borrowings on our revolving credit facility used to fund the 56-unit Wendy’s acquisition in July 2014 which partially offset the benefit of a lower borrowing rate. Interest expense included $3.9 million and $3.5 million for amortization of deferred debt issuance costs in fiscal 2014 and 2013, respectively.


38


Income Taxes. For fiscal 2014, we recorded an income tax benefit of $8.4 million compared to income tax expense of $8.2 million for the prior year. The tax benefit for fiscal 2014 was primarily attributable to federal employment-related tax credits, a net book loss before taxes of $6.8 million and a favorable adjustment of $0.8 million related to the release of liabilities for uncertain tax positions which were partially offset by $1.1 million of tax expense related to a change in the state rate on deferred taxes. For fiscal 2013, the lower than statutory rate was primarily due to (i) tax credits, (ii) a $1.6 million favorable tax adjustment related to previously unrecognized prior year federal employment-related credits that were recognized upon extension of the credits on January 2, 2013 and (iii) other adjustments related to the filing of federal and state tax returns during the third quarter.

Net Income. Net income for fiscal 2014 was $1.7 million compared to $29.7 million for the prior year, a decrease of $28.0 million. The decrease is primarily attributable to the impact of negative comparable store sales in our Pizza Hut operations and significant increases in ingredient costs, increased insurance expense that more than offset the increase in income tax benefit and contributions from our Wendy’s operations.

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 senior secured credit facilities (“Senior Secured Credit Facilities”) and 10 1/2% Senior Notes due 2020; (2) capital expenditures, including new unit development, asset refurbishment and maintenance capital expenditures; (3) opportunistic acquisitions of Pizza Hut and Wendy’s 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 (“Revolving Facility”). Future acquisitions, depending on the size, or new capital expenditure requirements may require borrowings beyond those available on our existing Revolving 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. Under our franchise agreements with PHI and Wendy’s, our franchisors have the right to institute asset standards which may be material to our business and could require significant capital outlay.
Our working capital was a deficit of $45.1 million at December 29, 2015. Like many other restaurant companies, we are able to operate and generally do operate with a working capital deficit because (i) restaurant revenues are received primarily in cash or by credit card with a low level of accounts receivable; (ii) rapid turnover results in a limited investment in inventories; and (iii) cash from sales is usually received before related liabilities for food, supplies and payroll become due. Because we are able to operate with minimal working capital or a deficit, we have historically utilized excess cash flow from operations and our Revolving Facility for debt reduction, capital expenditures and acquisitions, and to provide liquidity for our working capital needs. At December 29, 2015, we had $80.9 million of borrowing capacity available under our revolving credit facility net of $29.1 million of outstanding letters 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 cash position by approximately $27.0 million but would have no impact on our working capital.
Cash flows from operating activities
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. Cash provided by operating activities for fiscal 2015 of $79.9 million consisted of (i) net income of $6.7 million, (ii) non-cash adjustments to net income of $67.8 million, and (iii) positive changes in assets and liabilities of $5.4 million largely due to increased insurance reserves and reductions in accounts receivable which were partially offset by accrued interest due to timing of interest payments.
Cash provided by operating activities for fiscal 2014 of $70.5 million consisted of (i) net income of $1.7 million, (ii) non-cash adjustments to net income of $63.5 million, and (iii) positive changes in assets and liabilities of $5.3 million largely due to increased accounts payable, accrued interest due to timing of interest payments and insurance reserves which were partially offset by income taxes receivable, a decrease in other deferred items and an increase in inventory.
Cash provided by operating activities for fiscal 2013 of $97.8 million consisted of (i) net income of $29.7 million, (ii) non-cash adjustments to net income of $62.6 million, and (iii) positive changes in assets and liabilities of $5.4 million largely due to increased accounts payable, reductions in accounts receivable and income tax refunds received which were partially offset by a decrease in accrued liabilities, other deferred items and accrued interest due to timing of payments.

39


Cash flows from investing activities
Cash flows used in investing activities were $53.2 million for fiscal 2015 due to $56.2 million of investments in capital expenditures partially offset by $1.4 million of proceeds from sale-leaseback transactions and $1.6 million of proceeds from the disposition of assets.
Cash flows used in investing activities were $97.3 million for fiscal 2014 consisting of investments in capital expenditures of $66.1 million and $56.8 million for the July 2014 acquisition of Wendy’s restaurants. These investments were partially offset by sale-leaseback proceeds of $24.2 million for 13 properties (11 of the fee-owned properties acquired in the July 2014 acquisition of Wendy’s restaurants and two formerly leased properties acquired post acquisition for $1.7 million) and $3.1 million of proceeds from the disposition of assets.
Cash flows used in investing activities were $106.4 million for fiscal 2013 consisting of investments in capital expenditures of $51.0 million and $55.9 million for the acquisition of 91 Wendy’s units, partially offset by $0.5 million of proceeds from the disposition of assets.

Beginning in fiscal 2012, PHI offered Development Incentives totaling $80,000 per new unit developed, subject to certain threshold criteria. We did not qualify for the Development Incentives for fiscal 2015. We earned $2.9 million and $3.9 million of Development Incentives during fiscal 2014 and fiscal 2013, respectively. Beginning in fiscal 2013, Pizza Hut began offering the WingStreet Incentive of $10,000 per unit converted to the WingStreet platform. During fiscal 2015, fiscal 2014 and fiscal 2013 we earned WingStreet Incentives of $0.8 million, $2.8 million and $1.9 million, respectively. The capital expenditure amounts above do not include the effect of these incentives.

We currently expect our capital expenditure investment to be approximately $56.0 million to $62.0 million in fiscal 2016, consisting of approximately $45.0 million in our Pizza Hut operations and approximately $14.0 million in our Wendy’s operations.

Cash flows from financing activities
Net cash flows used in financing activities were $6.0 million for fiscal 2015 due to $4.2 million for principal payments on the term loan and $1.8 million paid for debt issuance costs as part of the December 2015 amendment of the credit facility.
Net cash flows provided by financing activities were $18.9 million for fiscal 2014. During the second quarter of 2014, we borrowed $40.0 million pursuant to an incremental term loan which we entered into under the existing credit facility’s $125.0 million term accordion feature to partially fund the acquisition of 56 Wendy’s units in July 2014. This cash inflow was partially offset by $10.9 million in post-closing payments to the former owners of Holdings relating to the Acquisition, net payments on the revolving credit facility of $7.0 million, $2.7 million of principal payments on the term loan and $0.7 million paid for debt issuance costs.
Net financing cash inflows were $3.2 million for fiscal 2013 due to borrowings under the revolving credit facility of $7.0 million which were reduced by $2.8 million for post-closing payments to the former owners of Holdings relating to the Acquisition and debt issuance costs of $1.0 million.
    
Our debt structure consists of the following sources of financing:

Senior Secured Credit Facilities. Our Senior Secured Credit Facilities were entered into on December 28, 2011 and consist of a $110.0 million Revolving Facility and a $375.0 million Term Loan. As described below, the Company also issued $40.0 million of additional Term Loan debt in the 2014 fiscal year under the Senior Secured Credit Facilities' Term Loan accordion feature.

The principal amount of the Term Loan amortizes in equal quarterly installments of $1,039,541 with the balance payable at maturity. In conjunction with a refinancing in November 2012, we made a $5.0 million voluntary prepayment which eliminated the quarterly principal payments for fiscal 2013 and a portion of the first quarter payment for fiscal 2014. The installments started again in the second quarter of fiscal 2014. The Term Loan is secured by substantially all of our assets and is due December 28, 2018.

Outstanding borrowings under the Revolving Facility bear interest at the London Interbank Offered Rate (“LIBOR”) plus an applicable margin based upon a leverage ratio as defined in the credit agreement for the Senior Secured Credit Facilities. Availability under the Revolving Facility is reduced by letters of credit, of which $29.1 million were issued largely for self-insured risks at December 29, 2015. Commitment fees are paid equal to 0.50% of the unused balance of the Revolving Facility. Commitment fees and letter of credit fees are reflected as interest expense. The Revolving Facility is secured by substantially all of the Company’s assets and is due September 28, 2018.

40



2015 - On December 10, 2015, the Company amended its Senior Secured Credit Facilities, increasing the spread over LIBOR by 0.75% to 3.75% on the Term Loan and 0.50% to 3.75% on the Revolving Facility and extended the maturity date on the Revolving Facility by nine months to September 28, 2018. As of December 29, 2015, the interest rate on the Revolving Facility for any outstanding borrowings would have been the prevailing LIBOR rate plus a spread of 3.75% for a combined interest rate of 4.17% per annum. As of December 29, 2015, the Term Loan had a combined interest rate of 4.75% per annum.

The amendment also increased the maximum leverage ratio to 6.00x for the fiscal year ended December 27, 2016, reducing to 5.75x for the fiscal 2017 year and 5.25x thereafter. The financial covenants in our credit agreement for our Senior Secured Credit Facilities are described below.

2014 - On June 19, 2014, the Company issued $40.0 million of Term Loan debt under the existing credit facility’s $125.0 million Term Loan accordion feature, on the same terms as the Company’s existing Term Loan. This borrowing reduced the Company’s remaining available Term Loan accordion capacity to $85.0 million. The proceeds were used to fund the July 2014 acquisition of 56 Wendy’s units. As of December 30, 2014, the interest rate on the Revolving Facility for any outstanding borrowings would have been a combined interest rate of 3.42% per annum. As of December 30, 2014, the Term Loan had a combined interest rate of 4.00% per annum.

2013 - On December 16, 2013, the Company refinanced its Senior Secured Credit Facilities lowering the spread over LIBOR by 0.25% to 3.00% on the Term Loan and reducing the Term Loan LIBOR floor by 0.25% to 1.00%, which resulted in a combined interest rate of 4.00% per annum at December 31, 2013.

The refinancing also lowered the spread over LIBOR and base rate loans by 0.25% on the Revolving Facility. As of December 31, 2013, the interest rate on the Revolving Facility was the prevailing LIBOR rate plus a spread of 3.00% for a combined interest rate of 3.17% per annum at December 31, 2013. Additionally, the refinancing also increased the capacity on the Revolving Facility by $10.0 million to $110.0 million and eliminated the annual limitation on the capital expenditures covenant, although all other existing covenants remain in place.

Senior Notes. The Senior Notes bear interest at the rate of 10.50% payable semi-annually in arrears on January 15 and July 15 until maturity of the Senior Notes on January 15, 2020. These Senior Notes are unsecured. Effective January 15, 2016, the Senior Notes may be redeemed at a redemption price of 105.250% of the principal amount of the Senior Notes to be redeemed plus accrued and unpaid interest until January 15, 2017, when the redemption price becomes 102.625% plus accrued and unpaid interest and remains such until January 15, 2018, when these Senior Notes can be redeemed at the face amount, plus accrued and unpaid interest. In June 2012 the Company completed an exchange offer which allowed the holders of Senior Notes to exchange the notes for an equal principal amount of Senior Notes that are registered under the Securities Act of 1933.
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 governing the Term Loan, we may be required to make an excess cash flow mandatory prepayment. The excess cash flow mandatory prepayment is an annual requirement under the credit agreement and is due 95 days after the end of each fiscal year. We will be required to make a mandatory pre-payment of approximately $3.3 million in 2016 based on our fiscal 2015 results.

The financial covenants in our credit agreement for our Senior Secured Credit Facilities, and our ratios under the financial covenants as of December 29, 2015 were as follows:
 
 
 
 
 
 
Covenant Requirement
 
 
Actual
 
 
 
2015
2016
2017
2018
Maximum leverage ratio
 
4.75x
 
Not more than 
 
5.50x
6.00x
5.75x
5.25x
Minimum interest coverage ratio
 
1.79x
 
Not less than
 
1.35x
1.40x
1.40x
1.40x

The credit agreement defines “Leverage Ratio” as the ratio of Consolidated Debt for Borrowed Money to Consolidated EBITDA (for the four fiscal quarters); “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 by the Company with the Securities and Exchange Commission (“SEC”) on April 3, 2012 as Exhibit 10.11 to the Company’s Registration Statement on Form S-4 (File No 333-180524). The calculation of Consolidated Debt for Borrowed Money includes a reduction for cash on hand in excess of $3.0 million, with such reduction n

41


ot to exceed $50.0 million. 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 among other pro forma adjustments. This pro forma effect used in connection with the financial debt covenant ratio calculations is not the same calculation we use to determine Adjusted EBITDA, which we disclose to investors in our earnings releases and which is discussed below.

As of December 29, 2015, we were in compliance with the maximum leverage ratio and the minimum interest coverage ratio. Based on our current operations and our internal financial forecasts, we believe we will be in compliance with these financial covenants in fiscal 2016.

Based upon current operations and our internal financial forecasts, we believe that our cash flows from operations, together with borrowings that are available under the Revolving 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, 2015, we had $80.9 million of borrowing capacity available under our Revolving Facility net of $29.1 million of outstanding letters of credit. We will consider additional sources of financing to fund our long-term growth if necessary, including the $85.0 million of incremental term loan capacity available under our Senior Secured Credit Facilities, which require additional commitments from lenders. Changes in the financial and credit markets may impair our ability to obtain additional debt financing at costs similar to that of our Senior Secured Credit Facilities, if at all. Any additional debt incurred, beyond the parameters established in our current credit agreement, or refinancing of any of our existing indebtedness may result in increased borrowing costs that are in excess of our current borrowing costs based on current credit market conditions. In addition, any utilization of the remaining additional term loan borrowing capacity under our Senior Secured Credit Facilities could result in a reset of the interest rate on our term loan borrowings, which would increase our borrowing costs from current market conditions.

Non-GAAP measures
Adjusted EBITDA is a supplemental measure of our performance that is not required by or presented in accordance with generally accepted accounting principles (“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 incurred substantial interest expense and depreciation and amortization related to the Transactions. We believe the elimination of these items, as well as income taxes and certain other items of a non-operational nature as noted in the table below, give investors and management useful information to compare the performance of our core operations over different periods. The following is a reconciliation of net income to Adjusted EBITDA(1) (in thousands).

 
52 Weeks Ended December 29, 2015
 
52 Weeks Ended December 30, 2014
 
53 Weeks Ended
December 31, 2013
Net income
$
6,712

 
$
1,672

 
$
29,742

Adjustments:
 
 
 
 
 
Interest expense
41,784

 
41,101

 
42,016

Income tax (benefit) expense
(5,768
)
 
(8,446
)
 
8,167

Depreciation and amortization
64,168

 
65,407

 
55,560

Pre-opening expenses and other
1,802

 
1,470

 
1,860

Net facility impairment and closure costs
7,469

 
980

 
727

Development and WingStreet Incentives
(835
)
 
(5,710
)
 
(5,800
)
Non-GAAP adjusted EBITDA
$
115,332

 
$
96,474

 
$
132,272


(1) The Company defines Adjusted EBITDA as consolidated net income plus interest, income taxes, depreciation and amortization, facility impairment and closure costs, pre-opening expenses and certain other items of a non-operational nature less Development and WingStreet Incentives. Adjusted EBITDA is not a measure of financial performance under 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 GAAP. Adjusted EBITDA as defined above may not be similar to EBITDA measures of other companies.

42




Contractual Obligations and Off Balance Sheet Arrangements
The following table discloses aggregate information about our contractual cash obligations as of December 29, 2015 and the periods in which payments are due:
 
Payments due by period
 
Total
 
Less
than
1 Year
 

2-3
Years
 

4-5
Years
 
More
than 5
Years
 
Other
 
(in millions)
Long-term debt
$
591.3

 
$
4.2

 
$
8.3

 
$
578.8

 
$

 
$

Operating leases(1)
471.6

 
61.4

 
104.1

 
75.2

 
230.9

 

Interest payments
155.5

 
40.5

 
80.6

 
34.4

 

 

Facility upgrades(2)
209.1

 
24.6

 
53.2

 
44.0

 
87.3

 

Unrecognized tax benefits(3)
2.7

 

 

 

 

 
2.7

Purchase and other obligations(4)
14.2

 
6.8

 
7.1

 
0.3

 

 

 
$
1,444.4

 
$
137.5

 
$
253.3

 
$
732.7

 
$
318.2

 
$
2.7

_____________________ 
(1) 
Total minimum lease payments have been reduced by aggregate minimum sublease rentals of $0.8 million under operating leases due in the future under non-cancelable subleases.
(2) Includes capital expenditure requirements under our franchise agreements for MAA’s, IA’s and facility improvements, as well as development requirements (see Item 1, “Business-Franchise Agreements”). With respect to our Pizza Hut operations, amounts are presented under the timeline as currently proposed by us to Pizza Hut under the Asset Partner Plan agreement for us to remain in compliance with our franchise agreements. Our existing franchise agreements allow PHI to require us to remodel a number of assets per year beginning in 2016 that is greater than the number reflected in the Asset Partner Plan, which could be imposed by PHI if we fail to qualify for the Asset Partner Plan.
(3) 
The amount and timing of liabilities for unrecognized tax benefits cannot be reasonably estimated and is shown in the “Other” column.
(4) 
Purchase and other obligations primarily include amounts for obligations under service agreements.
Based on current unit counts for both Pizza Hut and Wendy’s, we expect to incur approximately $24.0 million in annual capital expenditures to maintain the Company’s assets in accordance with our standards. These amounts are not included in the above table.
Certain members of management purchased common stock of NPC Holdings for $4.2 million. Under the terms of the Stockholders Agreement of NPC Holdings, the common stock is required to be repurchased by NPC Holdings upon the termination of the employment of the employee. However, the amount of this liability is determined based upon the circumstances of the termination of employment. The Company does not have a contractual obligation to fund the purchase of the mandatorily redeemable stock; however, the Company could be required to provide a distribution to NPC Holdings to fund the repurchase in the event of an employee’s termination of employment from the Company. The value of this contingent obligation is subject to a formula defined in the Stockholders Agreement. Based on the financial results for fiscal 2015, the common stock held by management has a combined value of approximately $2.4 million to $4.2 million.
We have not included other long-term liabilities related to self-insurance reserves in the contractual obligations table, as they do not represent cash requirements arising from contractual payment obligations. While self-insurance reserves represent an estimate of our future obligation and not a contractual payment obligation, we have disclosed our self insurance reserves in Note 11 - "Insurance Reserves" of the Notes to Consolidated Financial Statements included in Item 8, "Financial Statements and Supplementary Data."
Letters of Credit. As of December 29, 2015, we had letters of credit, in the amount of $29.1 million, issued under our existing credit facility largely in support of self-insured risks.

43


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 Facilities bear interest at a floating rate. As of December 29, 2015, we had $401.3 million in funded floating rate debt outstanding under our Senior Secured Credit Facilities. A 100 basis point increase in the floating rate would increase annual interest expense by approximately $4.0 million. However, under our Senior Secured Credit Facilities, we have a LIBOR floor of 1.00% as of December 29, 2015 on our LIBOR Term Loan borrowings. Therefore, current market rates would have to exceed 1.00% before we would realize variability on our interest expense. In addition, we entered into an interest rate cap in January 2012, which limits LIBOR to 2.5% on a notional amount of $150.0 million outstanding under our Term Loan borrowings which expired on January 31, 2016.
Commodity Prices. Commodity prices can vary significantly. The price of commodities can change throughout the year due to changes in supply and demand. Cheese has historically represented approximately 30-35% of our cost of sales. We are a member of RSCS, and participate in cheese hedging programs for our Pizza Hut operations that are directed by RSCS to help reduce the volatility of this commodity from period-to-period. Based on information provided by RSCS, RSCS expects to hedge approximately 30% to 50% of the Pizza Hut system’s anticipated cheese purchases through a combination of derivatives taken under the direction of RSCS.
The estimated increase in our consolidated food costs from a hypothetical 10% adverse change in the average cheese block price per pound would have been approximately $6.6 million for the 52 weeks ended December 29, 2015 without giving effect to the RSCS directed hedging programs. 
Proteins, which primarily include beef, chicken and pork, represent approximately 18-22% of our consolidated cost of sales. The estimated increase in our food costs from a hypothetical 10% adverse change in the average price per pound for proteins would have been approximately $6.2 million for the 52 weeks ended December 29, 2015


44


Item 8.
Financial Statements and Supplementary Data.
NPC RESTAURANT HOLDINGS, LLC
YEARS ENDED DECEMBER 29, 2015, DECEMBER 30, 2014 AND DECEMBER 31, 2013
INDEX TO FINANCIAL STATEMENTS

 
Page
Reports of Independent Registered Public Accounting Firms
Consolidated Financial Statements:
 
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements



45



Report of Independent Registered Public Accounting Firm

To the Board of Directors and Members of NPC Restaurant Holdings, LLC

We have audited the accompanying consolidated balance sheets of NPC Restaurant Holdings, LLC and subsidiaries as of December 29, 2015 and December 30, 2014, and the related consolidated statements of income, equity, and cash flows for the years ended December 29, 2015 and December 30, 2014. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NPC Restaurant Holdings, LLC and subsidiaries as of December 29, 2015 and December 30, 2014, and the results of their operations and their cash flows for the years ended December 29, 2015 and December 30, 2014, in conformity with U.S. generally accepted accounting principles.



/s/ KPMG LLP
Kansas City, Missouri
March 9, 2016

46


Report of Independent Registered Public Accounting Firm

To the Board of Directors and Members of NPC Restaurant Holdings, LLC

In our opinion, the consolidated statements of income, equity, and cash flows for the year ended December 31, 2013 present fairly, in all material respects, the results of operations and cash flows of NPC Restaurant Holdings, LLC and its subsidiaries for the year ended December 31, 2013, 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 7, 2014


47



NPC RESTAURANT HOLDINGS, LLC
CONSOLIDATED BALANCE SHEETS
(in thousands)
 
 
 
 
 
 
December 29,
2015
 
December 30,
2014
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
32,717

 
$
12,063

Accounts and other receivables
7,278

 
10,475

Inventories
10,067

 
10,591

Prepaid expenses and other current assets
7,133

 
7,565

Assets held for sale
2,904

 
5,571

Income taxes receivable
3,016

 
2,606

Total current assets
63,115

 
48,871

Facilities and equipment, less accumulated depreciation of $163,993 and $118,984, respectively
203,468

 
198,122

Franchise rights, less accumulated amortization of $68,307 and $49,650, respectively
620,518

 
639,045

Goodwill
294,626

 
294,626

Other assets, net
39,063

 
42,652

Total assets
$
1,220,790

 
$
1,223,316

Liabilities and member’s equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
34,926

 
$
34,844

Accrued liabilities
44,847

 
43,397

Accrued interest
11,436

 
13,065

Current portion of insurance reserves
12,829

 
11,677

Current portion of debt
4,158

 
4,158

Total current liabilities
108,196

 
107,141

Long-term debt
587,105

 
591,263

Other deferred items
40,834

 
41,229

Insurance reserves
21,203

 
18,974

Deferred income taxes
189,763

 
197,684

Total long-term liabilities
838,905

 
849,150

Commitments and contingencies


 


Member’s equity:
 
 
 
Membership interests (1,000 units authorized, issued and outstanding as of December 29, 2015 and December 30, 2014)

 

Member’s capital
273,689

 
267,025

Total member’s equity
273,689

 
267,025

Total liabilities and member’s equity
$
1,220,790

 
$
1,223,316

See accompanying notes to the consolidated financial statements.

48


NPC RESTAURANT HOLDINGS, LLC
CONSOLIDATED STATEMENTS OF INCOME
(in thousands)
 
 
52 Weeks Ended
 
53 Weeks Ended
 
December 29,
2015
 
December 30,
2014
 
December 31,
2013
Sales:
 
 
 
 
 
Net product sales
$
1,170,071

 
$
1,128,215

 
$
1,042,033

Fees and other income
53,228

 
51,682

 
51,999

Total sales
1,223,299

 
1,179,897

 
1,094,032

Costs and expenses:
 
 
 
 
 
Cost of sales
342,345

 
351,504

 
306,909

Direct labor
348,795

 
334,670

 
296,663

Other restaurant operating expenses
389,187

 
374,680

 
330,572

General and administrative expenses
71,629

 
63,213

 
60,224

Corporate depreciation and amortization of intangibles
21,170

 
20,729

 
18,588

Net facility impairment charges
7,469

 
980

 
727

Other
(24
)
 
(206
)
 
424

Total costs and expenses
1,180,571

 
1,145,570

 
1,014,107

Operating income
42,728

 
34,327

 
79,925

Other expense:
 
 
 
 
 
Interest expense
41,784

 
41,101

 
42,016

Income (loss) before income taxes
944

 
(6,774
)
 
37,909

Income tax (benefit) expense
(5,768
)
 
(8,446
)
 
8,167

Net income
$
6,712

 
$
1,672

 
$
29,742

See accompanying notes to the consolidated financial statements.

49


NPC RESTAURANT HOLDINGS, LLC
CONSOLIDATED STATEMENTS OF EQUITY
(in thousands)
 
 
Total member’s
equity
 
Balance at December 25, 2012
$
235,471

Net income
29,742

Balance at December 31, 2013
265,213

Net income
1,672

Issuance of membership interests, net
140

Balance at December 30, 2014
267,025

Net income
6,712

Repurchase of membership interests, net
(48
)
Balance at December 29, 2015
$
273,689

See accompanying notes to the consolidated financial statements.

50


NPC RESTAURANT HOLDINGS, LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) 
 
52 Weeks Ended
 
53 Weeks Ended
 
December 29,
2015
 
December 30,
2014
 
December 31,
2013
Operating activities
 
 
 
 
 
Net income
$
6,712

 
$
1,672

 
$
29,742

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
 
 
Depreciation and amortization
64,168

 
65,407

 
55,560

Amortization of debt issuance costs
3,980

 
3,896

 
3,458

Deferred income taxes
(7,921
)
 
(5,876
)
 
2,715

Net facility impairment and closure costs
7,469

 
980

 
727

Other
69

 
(875
)
 
143

Changes in assets and liabilities, excluding the effect of acquisitions:
 
 
 
 
 
Accounts receivable
2,950

 
227

 
2,180

Inventories
487

 
(1,887
)
 
(330
)
Prepaid expenses and other current assets
432

 
(802
)
 
(1,691
)
Accounts payable
82

 
4,509

 
7,125

Income taxes
(410
)
 
(3,163
)
 
2,972

Accrued interest
(1,629
)
 
3,424

 
(915
)
Accrued liabilities
597

 
1,576

 
(2,743
)
Accrued predecessor transaction costs and interest

 

 
(176
)
Insurance reserves
3,381

 
4,045

 
482

Other deferred items
(158
)
 
(2,360
)
 
(1,463
)
Other assets
(305
)
 
(295
)
 
(22
)
Net cash provided by operating activities
79,904

 
70,478

 
97,764

Investing activities
 
 
 
 
 
Capital expenditures
(56,210
)
 
(66,067
)
 
(51,031
)
Acquisition of Wendy’s business, net of cash acquired

 
(56,841
)
 
(55,922
)
Proceeds from sale-leaseback transactions
1,408

 
24,182

 

Purchase of assets for sale-leaseback

 
(1,736
)
 

Proceeds from disposition of assets
1,590

 
3,144

 
545

Net cash used in investing activities
(53,212
)
 
(97,318
)
 
(106,408
)
Financing activities
 
 
 
 
 
Borrowings under revolving credit facility
59,000

 
184,250

 
7,000

Payments under revolving credit facility
(59,000
)
 
(191,250
)
 

Payments on term bank facilities
(4,158
)
 
(2,704
)
 

Issuance of debt

 
40,000

 

Debt issue costs
(1,832
)
 
(693
)
 
(967
)
Payment of accrued purchase price to sellers

 
(10,875
)
 
(2,847
)
Other
(48
)
 
140

 

Net cash (used in) provided by financing activities
(6,038
)
 
18,868

 
3,186

Net change in cash and cash equivalents
20,654

 
(7,972
)
 
(5,458
)
Beginning cash and cash equivalents
12,063

 
20,035

 
25,493

Ending cash and cash equivalents
$
32,717

 
$
12,063

 
$
20,035


51


Supplemental disclosures of cash flow information:
 
 
 
 
 
Net cash paid for interest
$
39,274

 
$
33,621

 
$
39,315

Net cash paid for income taxes
$
2,673

 
$
3,516

 
$
3,111

 
 
 
 
 
 
Non-cash investing activities:
 
 
 
 
 
Accrued capital expenditures
$
3,350

 
$
2,435

 
$
1,095

See accompanying notes to the consolidated financial statements.


52


NPC RESTAURANT HOLDINGS, LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Description of Business

NPC Restaurant Holdings, LLC is referred to herein as “Holdings.” Holdings and its subsidiaries are referred to herein as the “Company.” Holdings’ wholly-owned subsidiary, NPC International, Inc., is referred to herein as “NPC.” NPC’s wholly-owned subsidiary, NPC Quality Burgers, Inc., is referred to herein as “NPCQB.” On December 28, 2011, all of the outstanding membership interests of Holdings were acquired by NPC International Holdings, Inc. (“NPC Holdings” or “Parent”), an entity controlled by Olympus Growth Fund V, L.P. and certain of its affiliated entities (“Olympus” or “Sponsor”), herein referred to as the “Transactions”.

Pizza Hut operations. 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, 2015 operated 1,251 Pizza Hut units in 28 states with significant presence in the Midwest, South and Southeast. At the end of fiscal 2015, the Company’s operations represented approximately 20% 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.
Wendy’s operations. As of December 29, 2015, the Company operated 144 Wendy’s units in five states. Between July 2013 and December 2013, the Company acquired a total of 91 Wendy’s units in three separate transactions. Effective July 14, 2014 the Company acquired an additional 56 Wendy’s units primarily located in North Carolina. All of the acquired Wendy’s restaurants are owned and operated by NPCQB and are primarily located in and around the Kansas City, Salt Lake City and Greensboro-Winston Salem metropolitan areas.