Freshworks Annual Report 2015

Plain-text annual report

PAPA MURPHY'S HOLDINGS, INC. FORM 10-K (Annual Report) Filed 03/09/16 for the Period Ending 12/28/15 Address Telephone CIK Symbol SIC Code Fiscal Year 8000 NE PARKWAY DRIVE SUITE 350 VANCOUVER, WA 98662 360 260-7272 0001592379 FRSH 5812 - Eating Places 12/31 http://www.edgar-online.com © Copyright 2016, EDGAR Online, Inc. All Rights Reserved. Distribution and use of this document restricted under EDGAR Online, Inc. Terms of Use. Table of ContentsUNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549––––––––––––––––––––––––––––––––––––––––––––––––––––––––FORM 10-K––––––––––––––––––––––––––––––––––––––––––––––––––––––––(Mark One)[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.For the fiscal year ended December 28, 2015OR[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from toCommission file number 001-36432––––––––––––––––––––––––––––––––––––––––––––––––––––––––Papa Murphy’s Holdings, Inc.(Exact name of registrant as specified in its charter)––––––––––––––––––––––––––––––––––––––––––––––––––––––––Delaware 27-2349094(State or Other Jurisdiction of Incorporation or Organization) (IRS Employer Identification No.)8000 NE Parkway Drive, Suite 350, Vancouver, WA 98662(Address of principal executive offices) (Zip Code)(360) 260-7272(Registrant’s telephone number, including area code)Securities registered pursuant to Section 12(b) of the Act:Common Stock, $0.01 par value NASDAQ Global Select Market(Title of Each Class) (Name of Each Exchange on Which Registered)Securities registered pursuant to Section 12(g) of the Act:NONE––––––––––––––––––––––––––––––––––––––––––––––––––––––––Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X]Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]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 12months (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 [X] No [ ]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 andposted 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 [X] 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’sknowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of“accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.Large accelerated filer [ ] Accelerated filer [X]Non-accelerated filer [ ] Smaller reporting company [ ]Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ]. No [X].At June 29, 2015 , the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the shares of voting and non-votingcommon stock of the Registrant held by non-affiliates was $245,836,683 based on the last sales price of the Registrant’s common stock as reported by the NASDAQ Global SelectMarket on that day.At March 1, 2016 , there were 16,942,932 shares of the Registrant’s common stock, $0.01 par value, outstanding.DOCUMENTS INCORPORATED BY REFERENCE:Part III incorporates certain information by reference from the registrant’s definitive proxy statement for the 2016 annual meeting of shareholders, which will be filed no later than 120days after the close of the registrant’s fiscal year ended December 28, 2015 .Table of ContentsTABLE OF CONTENTS PART I Item 1.Business3Item 1A.Risk Factors9Item 1B.Unresolved Staff Comments28Item 2.Properties28Item 3.Legal Proceedings31Item 4.Mine Safety Disclosures31 PART II Item 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities32Item 6.Selected Financial Data34Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations37Item 7A.Quantitative and Qualitative Disclosures about Market Risk56Item 8.Financial Statements and Supplementary Data57Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure95Item 9A.Controls and Procedures95Item 9B.Other Information95 PART III Item 10.Directors, Executive Officers and Corporate Governance96Item 11.Executive Compensation96Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters96Item 13.Certain Relationships and Related Transactions, and Director Independence96Item 14.Principal Accountant Fees and Services96 PART IV Item 15.Exhibits and Financial Statement Schedules97 SIGNATURES1042Table of ContentsPART IITEM 1. BusinessGeneralPapa Murphy’s Holdings, Inc. is a franchisor and operator of the largest Take ‘N’ Bake pizza chain in the United States. We were founded in 1981 andhave grown our footprint to a total of 1,536 system-wide stores as of December 28, 2015 .We have defined three reportable segments for the Company: Domestic Company Stores, Domestic Franchise and International. Financial informationabout segment operations appears in Selected Financial Data , Management’s Discussion and Analysis of Financial Condition and Results of Operationsand Financial Statements and Supplementary Data in Note 20 — Segment Information of the accompanying Notes to Consolidated Financial Statements.We are a Delaware corporation that was organized and acquired a majority of the capital stock of PMI Holdings, Inc., our predecessor, in 2010. In May2014, we completed our initial public offering (the “ IPO ”) and now our common stock trades on the NASDAQ Global Select Market under the “FRSH”ticker symbol. Papa Murphy’s Holdings, Inc. and its subsidiaries are sometimes referred to as the “Company,” “Papa Murphy’s” or in the first person as“we,” “us” and “our” in this report.We make available, free of charge, the following filings on our corporate website located at www.papamurphys.com as soon as reasonably practicableafter such filings are electronically filed with, or furnished to, the Securities and Exchange Commission (“ SEC ”): our annual report on Form 10-K, ourquarterly reports on Form 10-Q, our current reports on Form 8-K, any amendments to such reports, and our annual proxy statement. Informationcontained on our corporate website located at www.papamurphys.com is not part of this annual report on Form 10-K.On March 9, 2015, Papa Murphy’s Company Stores, Inc., a wholly-owned subsidiary of the Company, completed the purchase of certain assets used inthe operation of six Papa Murphy's stores in the Seattle, Washington, area from M2AD Management, Inc., the previous operator of the six Papa Murphy'sstores. The total purchase price was $4.1 million and was funded through existing cash.On June 29, 2015, the Company disposed of its ownership interests in Project Pie Holdings, LLC (“ PPH ”), a non-wholly owned subsidiary.Our ConceptThe Papa Murphy’s experience is different from traditional pizza restaurants. Our customers:•CREATE their fresh, customized pizza with high-quality ingredients;•TAKE their fresh pizza home; and•BAKE their pizza fresh in their ovens, at their convenience, for a home-cooked meal served hot.We actively target mothers and families looking to solve the “dinnertime dilemma” of providing their family with a high-quality, home-cooked meal, withoutinvesting significant time or money. While our concept has broad appeal to all consumers, we believe this core target customer is more loyal, seeks ahigher-quality pizza and values the focus on freshness and quality that differentiates the Papa Murphy’s pizza-making process:•We make our dough fresh in each store daily, starting with flour, water and yeast;•We grate our cheese daily from blocks of 100% whole-milk mozzarella cheese;•We slice fresh, never-frozen vegetables by hand;•We feature specialty, premium ingredients;•We use only high-quality meats with no added fillers; and•We use no trans-fats.Our stores feature a food-forward, easy-to-use makeline that facilitates interactive ordering, where store crew members create pizzas in front of thecustomer. Pizzas are made fresh to order and our customers can follow their pizza as it is made right in front of them.3Table of ContentsOur menu offers customers a variety of original, thin and stuffed crust pizzas as well as the ability to create a customized pizza from a broad selection ofcrust, sauce and topping combinations. Our core menu offerings include the following:▪Signature pizzas: classic combinations plus some unique twists;▪Gourmet Delite pizzas: gourmet offerings with 25% less fat and 35% fewer calories than our Signature pizzas;▪Stuffed pizzas: two-layer, four-pound pizzas with meats and vegetables stuffed in two layers of dough;▪Fresh Pan pizzas: signature recipes with a thick, buttery crust;▪“C.Y.O.” or Create Your Own pizzas: customer selection of crust, sauce and any combination of our cheese, meat and vegetable toppings; and▪FAVES: three simple pizza classics offered at value price points.We were founded on the following core values—Great Quality, Great Value, Great Customer Service—and we strive to deliver on these values everyday.▪Great Quality. We have continually focused on quality since our founding and we believe customers can taste the difference. Unlike some of ourcompetitors, we do not use pre-shredded, pre-packaged or frozen cheese and our dough is made from scratch daily, never frozen.▪Great Value. We offer a high-quality pizza at a value price point with one of the lowest average checks per person among national pizza chains.Additionally, the Take ‘N’ Bake experience eliminates delivery fees and tipping.▪Great Customer Service. We train our store crews to greet each customer, to promote the latest new products and to assist each customer inchoosing the combination of fresh made pizzas and side items to complete their meal.Loyal Customer BaseWe have developed a loyal and diverse customer base. We attribute our leading consumer ratings and success across a national footprint to the broadappeal of our concept. Our business model resonates with families and single adults and attracts both female and male customers across all ages,demographics and income levels. Finally, we believe our model encourages a stronger emotional connection with our core target of families. The activerole of ordering and watching the pizza being built gives customers a feeling of ownership: “a pizza,” becomes “my pizza.”Efficient Operating Model Generates Attractive Store-Level EconomicsOur store model is different from many other restaurant models. Because our stores do not have pizza ovens, venting hoods, freezers or dining areas,and average just 1,400 square feet in size, they require a lower capital investment than traditional pizza, limited service or fast casual restaurants. Wealso have lower operating costs because our stores do not require the hiring of delivery drivers or wait staff. Our stores are designed to highlight our high-quality ingredients, to reinforce the key attributes of our brand and to maximize the customer’s interaction with our friendly team members.Our Take ‘N’ Bake model offers franchise owners operating advantages that differentiate us from other restaurant concepts. Our domestic stores:•Do not require ovens, freezers or expensive cooking equipment because our customers bake their pizzas at home;•Focus on creating fresh pizzas for carry out only, reducing operational complexity for franchise owners and their employees;•Maintain shorter operating hours (typically 11:00 a.m. to 9:00 p.m.) that are attractive to franchise owners and their employees•Require fewer employees on duty during each shift compared to other restaurant concepts, resulting in lower labor costs; and•Do not have dining areas, resulting in lower occupancy and operating costs.Our simple, low cost operations create the opportunity for higher margins and attractive returns for franchise owners.4Table of ContentsOur StrategyOur strategy is focused on three key components: (i) develop new stores; (ii) increase comparable store sales; and (iii) improve profitability by leveragingour infrastructure. We believe that successfully implementing our strategy in these three target areas will support our continued growth and profitability.Develop New StoresWe believe significant development opportunities remain in the United States and select international markets. We currently estimate our total storepotential in the United States alone is at least 4,500 stores, including approximately 2,400 new stores in our existing markets. Historically, stores tend togenerate higher average unit volumes as markets become more penetrated. As a result, we intend to continue developing our core markets in the Westand Midwest while focusing the majority of our near-term expansion efforts in our existing but less-penetrated markets in the South and East. When weexpand our footprint into new markets, we plan to leverage our brand awareness and infrastructure to enhance new store performance while rapidlyincreasing store density.The majority of our expansion comes from new franchised store openings. We believe our unit growth potential, attractive store-level economics andsimplicity of store operations will continue to attract new franchise owners and encourage existing franchise owners to expand their current footprint. Wetarget a Company-owned store base of approximately 10% of total system stores and plan to strategically expand our Company-owned store base inselect markets through both acquisition of franchised stores and new store construction, striving to optimize the efficiency of our overhead costs.Additionally, we are in the early stages of international expansion, which we believe represents a long-term growth opportunity. We currently have masterfranchise agreements in Canada and the six Gulf Cooperation Council states in the Middle East.Increase Comparable Store SalesWe intend to increase comparable store sales by doing the following:▪Attract New Customers. We continue to invest in our brand by educating the marketplace on the benefits of Take ‘N’ Bake pizza, growingcustomer awareness and building customer loyalty. As we further penetrate existing markets, we are able to use increased marketing funds toexpand our brand recognition through a combination of traditional print, broadcast and digital marketing. New product development is anothertool we use to attract new customers.▪Increase Customer Frequency. We strive to convert first-time users into repeat customers and provide loyal customers with reasons topurchase from us more frequently. Our concept allows our employees to focus on providing personal service to every customer rather thanrushing customer interactions or prioritizing delivery orders. We believe that providing a high quality product with a fast and friendly in-storeexperience increases customer frequency. We also utilize limited time offers and holiday and seasonal promotions to increase frequency ofcustomer visits and attract first-time customers.▪Increase Transaction Size. We utilize several strategies to increase transaction sizes, such as training our store crews on upsell strategies,marketing add-on product options and, increasingly, online ordering:•We continue to roll out our online ordering platform, providing an additional convenience to our customers. As of February 10, 2016 , weoffered online ordering in 1,093 of our stores. Online ordering will be rolled out nationally as of June 30, 2016. Early evidencedemonstrates that orders placed through our online ordering channel deliver an increased average guest check of more than 25% whencompared to other ordering channels. As a larger percent of our stores begin to accept more orders online, this higher average guestcheck may moderate.•Our store crews are trained in upsell strategies to drive incremental revenue per transaction. We also present in-store messaging of“meal deals,” where a customer can add side items or a beverage for a bundled discount. In addition, our new online orderingcapabilities are programmed to consistently offer additional purchase options based on the customer's current and past orderingpatterns.5Table of ContentsImprove Profitability by Leveraging Our InfrastructureWith 1,496 stores across the United States and 541 domestic franchise owners as of December 28, 2015 , we have an established infrastructure tosupport future growth. Our teams located across the country provide support to our franchise owners in operations, store technology, marketing and newstore development. Therefore, as we continue to grow our store base and increase sales, we expect our general and administrative expenses to increaseat a lower rate than our revenues. Furthermore, we anticipate investments in our infrastructure, including new technology such as online ordering and E-commerce, enable us to take advantage of tools such as precision marketing to further grow our transactions and average guest check.Our Industry and CompetitionWith system-wide sales of $892 million in fiscal year 2015 , we are the fifth largest pizza chain in the United States as measured by system-wide salesand total number of stores. According to NPD Crest, the quick service restaurant (“ QSR ”) pizza market, a subset of the overall pizza category, wasabout $34 billion in 2015. The top five pizza chains accounted for approximately 45.3% of QSR pizza restaurant sales in 2015 compared to 43.7% in2014 and 39.1% in 2011. We believe the pizza restaurant market continues to be an attractive category due to its size and growth, as well as itsfragmented competitive landscape.We generally compete on the basis of product quality, variety, price, location, image, and service with regional and local pizza restaurants as well asnational chains such as Pizza Hut®, Domino’s Pizza®, Papa John’s®, and Little Caesars Pizza®. On a broader scale, we compete with other limitedservice restaurants (“ LSR s”) and the overall food service industry. The food service industry, particularly LSR s, are competitive with respect to productquality, price, location, service and convenience. Many of our competitors have been in existence for longer periods of time and have developed strongerbrand awareness in markets in which we compete. In these markets, we compete for customers, employees, management personnel, franchisees andreal estate sites suitable for our stores.Suppliers and DistributionWe enter into national supply or pricing agreements with certain key third-party suppliers. We negotiate pricing for our franchised and Company-ownedstores with national pricing agreements covering a term of three months to one year. We do not realize any profits from the sale of these supplies tofranchise owners. We rely on multiple third party distributors as our primary distributors of cheese, refrigerated items, meat, canned and dry goods, paper and disposablesand janitorial supplies. Pursuant to our distribution service agreements, we have the right to designate the brands and products supplied. Supplies aredelivered to each store one to two times each week.For our beverage products, we rely on Pepsi-Cola Advertising and Marketing, Inc. (“ Pepsi ”) as our primary provider of packaged beverage products. Wehave maintained a national distribution relationship with Pepsi since 2004.Intellectual Property and TrademarksWe regard the Papa Murphy’s brand name and associated trademarks as valuable assets. We have a portfolio of 27 trademarks registered and severalpending trademark registrations with the United States Patent and Trademark Office. We have also secured trademark registrations for our brand namein Canada, China, Mexico, New Zealand, Norway, Australia, Saudi Arabia, Turkey and within the Community Trade Mark (CTM) system, which offers aunified system of protection throughout the European Union. We have applied for trademark registrations in several Middle Eastern countries. All of themarks we own cover store-related services and/or food products.6Table of ContentsManagement Information/Technology SystemsOur point-of-sale system (“ POS system ”) has been customized specifically for Papa Murphy's stores, and we use this integrated restaurant-leveltechnology for inventory, labor management and cash handling. Our POS system allows us to track sales data and evaluate the efficiency of our stores.Through our POS system we are able to collect, store, utilize and disseminate data and information collected by each store to generate reports andevaluate sales performance on a daily basis. Sales information from non-POS system stores is collected and analyzed on a weekly basis. In addition, wecollect monthly store-level profit and loss statements for internal analysis.During 2015 we made substantial investments to further develop our E-commerce capabilities and platform, including app-enabled and online orderingthrough new iPhone and Android apps and a new Papa Murphy's website ordering system. As of December 28, 2015 , these capabilities were still indevelopment, with an anticipated launch slated for March 2016. This new ordering channel, fully integrated with our in-store POS system , enables us togather more information about customer ordering habits, which will enable us to further develop attractive offers and increase sales with digital marketing.We continue to roll out the POS system to all stores and expect all stores to implement the POS system by the third quarter of 2016. The POS systemprovides the foundation for efficient store level operations, the gathering of advanced analytics and the online ordering platform. As of February 10, 2016, the online ordering component of the POS system had been enabled for 1,093 stores in anticipation of our system-wide online ordering launch, up from949 stores as of December 28, 2015 .Franchising OverviewOur store base was 91.7% franchised as of December 28, 2015 , with our franchise owners operating a total of 1,409 Papa Murphy’s stores in 38 states,Canada and the Middle East. Through our franchise support, development infrastructure and screening process, we have successfully built a base of 541franchise owners with an average store ownership of approximately 2.5 stores per franchise owner. A majority of our franchise owners owned one store,approximately 75% owned one or two stores, and 20% of all franchised stores were owned by our 10 largest franchise owners. We believe this highlydiversified owner base demonstrates the viability of our store concept across numerous types of owners and operators, and provides an attractive baseof owners with capacity to grow with our brand. We believe the relationships we have with our franchise system provide a solid platform for growth.We are dedicated to providing the tools our franchise owners need to succeed before, during and after a store opening, including assistance with siteselection and development, training, operations and marketing. We set forth qualification criteria and provide training programs for franchise owners toensure that every Papa Murphy’s store meets the same quality and customer service standards to preserve the consistency and reliability of the PapaMurphy’s brand.Our franchised business model also offers us strategic and financial benefits. It enables us to focus Company resources on menu innovation, marketing,franchise owner training and operations support to drive the overall success of our brand. Our franchised business model also allows us to grow our storebase and brand awareness with limited corporate capital investment. Further, our predominantly franchised business model reduces our exposure tochanges in commodity and other operating costs. As a result, our business model is designed to provide high operating margins and cash flows with lowcapital expenditures and working capital.EmployeesAs of March 7, 2016, we had 2,101 employees, including 318 salaried employees and 1,783 hourly employees. None of our employees are unionized orcovered by a collective bargaining agreement and we consider our current employee relations to be good.7Table of ContentsSeasonalitySeasonal factors and the timing of holidays cause our revenues to fluctuate from quarter to quarter. We typically follow family eating patterns at home,with our strongest sales levels occurring in the months of September through May and our lowest sales levels occurring in the months of June, July andAugust. Therefore, our revenues per store are typically higher in the first and fourth quarters and lower in the second and third quarters. Additionally, ournew store openings have historically been most heavily concentrated in the fourth quarter and we anticipate that new store openings will continue to beweighted towards the third and fourth quarters. As a result of these factors, our quarterly and annual results of operations and comparable store salesmay fluctuate significantly. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for anyyear, and comparable store sales for any particular future period may decrease and materially and adversely affect our business, financial condition orresults of operations.Government RegulationWe, along with our franchise owners, are subject to various federal, state, local and foreign laws affecting the operation of our respective businesses.Each store is subject to licensing and regulation by a number of governmental authorities, which include zoning, health, safety, sanitation, building andfire agencies in the jurisdiction in which the store operates. In order to maintain our stores, we may be required to expend funds to meet certain federal,state, local and foreign regulations, including regulations that require remodeled stores to be accessible to persons with disabilities. Difficulties inobtaining, or the failure to obtain, required licenses or approvals could delay or prevent the opening of a new store. Our domestic store operations aresubject to various federal and state laws governing such matters as minimum wage requirements, benefits, working conditions, citizenship requirementsand overtime. We are also subject to federal and state environmental regulations.We are subject to Federal Trade Commission (“ FTC ”) rules and to various state and foreign laws that govern the offer and sale of franchises. The FTCrequires us to furnish to prospective franchise owners a franchise disclosure document containing prescribed information. Some states and foreigncountries also have disclosure requirements and other laws regulating franchising and the franchisor-franchisee relationship. These laws regulate variousaspects of the franchise relationship, including terminations and the refusal to renew franchises. The failure to comply with these laws and regulations inany jurisdiction or to obtain required government approvals could result in a ban or temporary suspension of future franchise sales, fines or otherpenalties or require us to make offers of rescission or restitution, any of which could materially and adversely affect our business, financial condition andresults of operations.8Table of ContentsItem 1A. Risk FactorsAn investment in our common stock involves a high degree of risk. Before making an investment decision, you should carefully consider the following riskfactors, as well as the other information in this Annual Report on Form 10-K, in evaluating our business. If any of these risks, as well as other risks anduncertainties that are not yet identified or that we currently think are immaterial, actually occur, our business, results of operations or financial conditioncould be materially and adversely affected. In such an event, the trading price of our common stock could decline and you could lose part or all of yourinvestment.Risks Relating to Our Business and IndustryThe limited service restaurant pizza category and restaurant sector overall are highly competitive and such competition could adversely affectour business, financial condition and results of operations.The restaurant industry in general, and the limited service restaurant pizza category in particular, are highly competitive with respect to price, value, foodquality, ambience, convenience, concept, service and location. A substantial number of restaurant operations compete with us for customer traffic. Wecompete against other major national limited service restaurant pizza chains and regional and local businesses, including other chains offering pizzaproducts. We also compete on a broader scale with other international, national, regional and local limited-service restaurants. In addition, we faceincreasing competition from pizza product offerings available at grocery stores and convenience stores, which offer pre-made ready-to-bake frozen andcarry-out pizzas. Many of our competitors have significantly greater financial, marketing, personnel and other resources as well as greater brandrecognition than we do and may have lower operating costs, more restaurants, better locations and more effective marketing than we do. Many of ourcompetitors are well established in markets in which we and our franchise owners operate stores or intend to locate new stores. In addition, many of ourcompetitors emphasize lower-cost value options or meal packages or have loyalty programs, which provide discounts on certain menu offerings, and theymay continue to do so in the future.We also compete for employees, suitable real estate sites and qualified franchise owners. If we are unable to compete successfully and maintain orenhance our competitive position, or if customers have a poor experience at a Papa Murphy’s store, whether Company-owned or franchise-owned, wecould experience decreased customer traffic, downward pressure on prices, lower demand for our products, reduced margins, diminished ability to takeadvantage of new business opportunities and the loss of market share, all of which could have a material and adverse effect on our business, financialcondition and results of operations.The food service market is affected by consumer preferences and perceptions. Changes in these preferences and perceptions may lessen thedemand for our products, which would reduce sales and harm our business.Food service businesses are affected by changes in consumer tastes, international, national, regional and local economic conditions and demographictrends. For instance, if prevailing health or dietary preferences cause consumers to avoid pizza and other products we offer in favor of foods that areperceived as more healthy, our business, financial condition and results of operations would be materially and adversely affected. In addition, ifconsumers no longer seek pizza that they can bake at home in favor of pizza that is already baked and/or delivered, our business, financial condition andresults of operations would be materially and adversely affected. Moreover, because we are primarily dependent on a single product, if consumerdemand for pizza in general, and take and bake pizza in particular, should decrease, our business would be adversely affected more than if we had amore diversified menu, as many other food service businesses do.Our business and results of operations depend significantly upon the success of our and our franchise owners’ existing and new stores.Our business and results of operations are significantly dependent upon the success of our franchised and Company-owned stores. We and ourfranchise owners may be adversely affected by:▪declining economic conditions, including downturns in the housing market, increases in unemployment rates, reductions in consumer disposableincome, adverse credit market conditions, increases in fuel prices, drops in consumer confidence and other events or factors that adverselyaffect consumer spending in the markets that we serve;▪increased competition in the restaurant industry, particularly in the pizza, casual and fast-casual dining segments;▪changes in consumer tastes and preferences;▪demographic trends;9Table of Contents▪customers’ budgeting constraints;▪customers’ willingness to accept menu price increases that we may make to offset increases in key input and operating costs;▪adverse weather conditions;▪our reputation and consumer perception of our concepts’ offerings in terms of quality, price, value, ambiance and service; and▪customers’ experiences in our stores.Our Company-owned stores and our franchise owners are also susceptible to increases in certain key operating expenses that are either wholly orpartially beyond our control, including:▪food costs, particularly for mozzarella cheese and other raw materials, many of which we do not or cannot effectively hedge;▪labor costs, including wages, which are affected by minimum wage requirements, workers’ compensation, health care and other benefitsexpenses;▪rent expenses and construction, remodeling, maintenance and other costs under leases for our new and existing stores;▪compliance costs as a result of changes in legal, regulatory or industry standards;▪energy, water and other utility costs;▪insurance costs;▪information technology and other logistics costs; and▪litigation expenses.If we fail to open new domestic and international franchise and Company-owned stores on a timely basis, our ability to increase our revenuescould be materially and adversely affected.A significant component of our growth strategy includes the opening of new domestic and international franchise stores. We and our franchise ownersface many challenges associated with opening new stores, including:▪identification and availability of suitable store locations with the appropriate size, visibility, traffic patterns, local residential neighborhoods, localretail and business attractions and infrastructure that will drive high levels of customer traffic and sales per store;▪competition with other restaurants and retail concepts for potential store sites;▪anticipated commercial, residential and infrastructure development near new or potential stores;▪ability to negotiate acceptable lease arrangements;▪availability of financing and ability to negotiate acceptable financing terms;▪recruiting, hiring and training of qualified personnel;▪construction and development cost management;▪completing our construction activities on a timely basis;▪obtaining all necessary governmental licenses, permits and approvals and complying with local, state and federal laws and regulations to open,construct or remodel and operate our stores;▪unforeseen engineering or environmental problems with the leased premises;▪adverse weather during the construction period of new stores; and▪other unanticipated increases in costs or delays.As a result of these challenges, we and our franchise owners may not be able to open new stores as quickly as planned or at all. We and our franchiseowners have experienced, and expect to continue to experience, delays in store openings from time to time and have abandoned plans to open stores invarious markets on occasion. Any delays or failures to open new stores by us or our franchise owners could materially and adversely affect our growthstrategy and our results of operations.Our progress in opening new stores from quarter to quarter may occur at an uneven rate. If we do not open new stores in the future according to ourcurrent plans, the delay could materially and adversely affect our business, financial condition or results of operations.10Table of ContentsIf we fail to identify, recruit and contract with a sufficient number of qualified franchise owners, our ability to open new franchise stores andincrease our revenues could be materially and adversely affected.The opening of additional franchise stores depends, in part, upon the availability of prospective franchise owners who meet our criteria. Because most ofour franchise owners open and operate one or two stores, our growth strategy requires us to identify, recruit and contract with a significant number ofnew franchise owners each year. We may not be able to identify, recruit or contract with suitable franchise owners in our target markets on a timely basisor at all. In addition, our franchise owners may not have access to the financial or management resources that they need to open the stores contemplatedby their agreements with us, or they may elect to cease store development for other reasons. If we are unable to recruit suitable franchise owners or iffranchise owners are unable or unwilling to open new stores as planned, our growth may be slower than anticipated, which could materially andadversely affect our ability to increase our revenues and materially and adversely affect our business, financial condition and results of operations.The planned rapid increase in the number of our stores may make our future results unpredictable and, if we fail to manage such growtheffectively, our business, financial condition and results of operations may be materially and adversely affected.Our growth strategy and investment associated with the development of each new store may cause our results to fluctuate and be unpredictable ormaterially and adversely affect our results of operations. For example, our pre-opening expenses may vary from period to period based on the timing ofwhen we open new company-owned stores, which could impact our results of operations from period to period. In addition, our franchise owners and ourability to successfully develop new stores in new markets may be adversely affected by a lack of awareness or acceptance of our brand and the take andbake concept as well as by a lack of existing marketing efforts and operational execution in these new markets. Stores in new markets may also facechallenges related to being new to a market and having less marketing funds than competitors, which may be due in part to lower store density thancompetitors. To the extent that we are unable to foster name recognition and affinity for our brand and concept in new markets and implement effectiveadvertising and promotional programs, our and our franchise owners’ new stores may not perform as expected and our growth may be significantlydelayed or impaired. Moreover, as has happened when other store concepts have tried to expand, we may find that our concept has limited appeal innew markets or we may experience a decline in the popularity of our concept in the markets in which we operate. New stores may also have difficultysecuring adequate financing, particularly in new markets, where there may be a lack of adequate sales history and brand familiarity. Newly openedstores, including newly opened stores in new markets, may not be successful and our system-wide average store sales may not increase at historicalrates, which could materially and adversely affect our business, financial condition or results of operations.Our existing store management systems, financial and management controls and information systems may be inadequate to support our plannedexpansion. Managing our growth effectively will require us to continue to enhance these systems, procedures and controls and to hire, train and retainmanagers and team members. We believe our culture—from the store level up through management—is an important contributor to our success. As wegrow, however, we may have difficulty maintaining our culture or adapting it sufficiently to meet the needs of our operations. Among other importantfactors, our culture depends on our ability to attract, retain and motivate employees who share our enthusiasm and dedication to our concept. We maynot respond quickly enough to the changing demands that our expansion will impose on our management, store teams, existing infrastructure andculture, which could materially and adversely affect our business, financial condition or results of operations.New information or attitudes regarding diet and health could result in changes in regulations and consumer consumption habits that couldadversely affect our results of operations.Government regulation and consumer eating habits may impact our business as a result of changes in attitudes regarding diet and health or newinformation regarding the adverse health effects of consuming certain menu offerings. These changes have resulted in, and may continue to result in,laws and regulations requiring us to disclose the nutritional content of our food offerings, and they have resulted, and may continue to result in, laws andregulations affecting permissible ingredients and menu offerings. For example, a number of states, counties and cities have enacted menu labeling lawsrequiring multi-unit restaurant operators to disclose to consumers certain nutritional information, or have enacted legislation restricting the use of certaintypes of ingredients in restaurants. These requirements may be different or inconsistent with requirements under the Patient Protection and AffordableCare Act of 2010 (“ PPACA ”), which establishes a uniform, federal requirement for certain restaurants to post nutritional information on their menus.Specifically, the PPACA generally requires chain restaurants with 20 or more locations operating under the same name and offering substantially thesame menus to publish the total number of calories of standard menu items on menus and menu boards, along with a statement that puts this calorieinformation in the context of a total daily calorie intake. These inconsistencies could be challenging for us to comply with in an efficient manner. ThePPACA also requires covered restaurants to provide to consumers, upon request, a written summary of detailed nutritional information for each standardmenu item, and to provide a statement on menus and11Table of Contentsmenu boards about the availability of this information upon request. An unfavorable report on, or reaction to, our menu ingredients, the size of ourportions or the nutritional content of our menu items could negatively influence the demand for our products and materially and adversely affect ourbusiness, financial condition and results of operations.Compliance with current and future laws and regulations regarding the ingredients and nutritional content of our menu items may be costly and time-consuming. Additionally, if consumer health regulations or consumer eating habits change significantly, we may be required to modify or discontinuecertain menu items, and we may experience higher costs associated with the implementation of those changes. We cannot predict the impact of the newnutrition labeling requirements under the PPACA until final regulations are implemented. The risks and costs associated with nutritional disclosures onour menus could also impact our operations, particularly given differences among applicable legal requirements and practices within the restaurantindustry with respect to testing and disclosure, ordinary variations in food preparation among our own restaurants, and the need to rely on the accuracyand completeness of nutritional information obtained from third-party suppliers.Our results of operations and growth strategy depend in significant part on the success of our franchise owners, and we are subject to avariety of additional risks associated with our franchise owners, including litigation that has been brought against us by certain franchiseowners.A substantial portion of our revenues comes from royalties generated by our franchise stores. We anticipate that franchise royalties will represent asubstantial part of our revenues in the future. Accordingly, we are reliant on the performance of our franchise owners in successfully opening andoperating their stores and paying royalties to us on a timely basis. Our franchise system subjects us to a number of risks, any one of which may impactour ability to collect royalty payments from our franchise owners, may harm the goodwill associated with our brands, and may materially and adverselyaffect our business and results of operations.•Franchise owner independence. Franchise owners are independent operators, and their employees are not our employees. Accordingly, theiractions are outside of our control. Although we have developed criteria to evaluate and screen prospective franchise owners, we cannot becertain that our franchise owners will have the business acumen or financial resources necessary to operate successful franchises in theirlocations and state franchise laws may limit our ability to terminate or modify these franchise agreements. Moreover, despite our training, supportand monitoring, franchise owners may not successfully operate stores in a manner consistent with our standards and requirements, or may nothire and adequately train qualified managers and other store personnel. The failure of our franchise owners to operate their franchisessuccessfully and actions taken by their employees could each have a material and adverse effect on our reputation, brand, ability to attractprospective franchise owners, business, financial condition or results of operations.•Franchise agreement termination or nonrenewal. Each franchise agreement is subject to termination by us as the franchisor in the event of adefault, generally after expiration of applicable cure periods, although under certain circumstances a franchise agreement may be terminated byus upon notice without an opportunity to cure. The default provisions under the franchise agreements are drafted broadly and include, amongother things, any failure to meet operating standards and actions that may threaten our licensed intellectual property.In addition, each franchise agreement has an expiration date. Upon the expiration of the franchise agreement, we or the franchise owner may, ormay not, elect to renew the franchise agreement. If the franchise agreement is renewed, the franchise owner will receive a successive franchiseagreement for an additional term. Such option, however, is contingent on the franchise owner’s execution of the then-current form of franchiseagreement (which may include new obligations, as well as increased franchise fees, royalty payments, advertising fees and other fees andcosts), the satisfaction of certain conditions (including modernization of the restaurant and related operations) and the payment of a renewal fee.If a franchise owner is unable or unwilling to satisfy any of the foregoing conditions, we may elect not to renew the expiring franchise agreement,in which event the franchise agreement will terminate upon expiration of the term.•Franchise owner insurance. The franchise agreements require each franchise owner to maintain certain insurance types and levels. Certainextraordinary hazards, however, may not be covered, and insurance may not be available (or may be available only at prohibitively expensiverates) with respect to many other risks. Moreover, any loss incurred could exceed policy limits and any policy payments made to franchiseowners may not be made on a timely basis. Any such loss or delay in payment could have a material and adverse effect on a franchise owner’sability to satisfy obligations under the franchise agreement, including the ability to make royalty payments. Further, the franchise owner may failto obtain or maintain the required insurance types and levels, and we may not be aware of that failure until a loss is incurred.12Table of Contents•Product liability exposure. We require franchise owners to maintain general liability insurance coverage to protect against the risk of productliability and other risks and demand strict franchise owner compliance with health and safety regulations. However, franchise owners may receiveor produce defective food or beverage products, which may materially and adversely affect our brand’s goodwill and our business. Further, afranchise owner’s failure to comply with health and safety regulations, including requirements relating to food quality or preparation, could subjectthe franchise owner, and possibly us, to litigation. Any litigation, including the imposition of fines or damage awards, could adversely affect theability of a franchise owner to make royalty payments, or could generate negative publicity, or otherwise adversely affect us.•Franchise owners’ participation in our strategy. Our franchise owners are an integral part of our business. We may be unable to successfullyimplement our growth strategy if our franchise owners do not actively participate in such implementation. From time to time, franchise owners,individually or through an independent franchise owner group, have disagreed with or resisted elements of our strategy, including new productinitiatives and investments in their stores such as remodeling and implementing the POS system . Franchise owners may also fail to participatein our marketing initiatives, which could materially and adversely affect their sales trends, average weekly sales (“ AWS ”) and results ofoperations. In addition, the failure of our franchise owners to focus on the fundamentals of restaurant operations, such as quality, service andcleanliness, would have a negative impact on our success. It also may be difficult for us to monitor our international franchise owners’implementation of our growth strategy due to our lack of personnel in the markets served by such franchise owners.•Franchise owner litigation and conflicts with franchise owners. Franchise owners are subject to a variety of litigation risks, includingcustomer claims, personal-injury claims, environmental claims, employee allegations of improper termination and discrimination, intellectualproperty claims and claims related to violations of the ADA , religious freedom, the FLSA , the Employee Retirement Income Security Act of1974, as amended, and advertising laws. Each of these claims may increase costs and limit the funds available to make royalty payments andreduce entries into new franchise agreements. We also may be named in lawsuits against our franchise owners.In addition, the nature of the franchisor-franchise owner relationship may give rise to conflict. For example, an independent franchise ownergroup has expressed a number of concerns and disagreements that the franchise owners it represents has or has had with our Company,including concern over a lack of franchise owner involvement in strategic decision-making, inadequate assistance in increasing and difficultymaintaining franchise store profitability in a higher cost environment, disagreement with marketing initiatives and product launches, anddissatisfaction with costs associated with the new store remodel program and with the implementation of a new POS system . Our seniormanagement team engages with franchise owner leadership to address these concerns and resolve specific issues raised by the franchiseowners. Such engagement may not result in a satisfactory resolution of the issues, which, in turn, could materially and adversely affect our abilityto grow our franchise system and maintain relationships with our franchise owners, damage our reputation and our brand, and materially andadversely affect our results of operations.We currently are subject to litigation with a group of our franchise owners as described in Item 3. Legal Proceedings . We also may becomesubject to additional litigation with franchise owners in the future. Engaging in such litigation may be costly, time-consuming and distracting tomanagement and also may materially and adversely affect our relationships with potential franchise owners and our ability to attract newfranchise owners. In addition to these and other claims that may be brought against us by franchise owners, we also may engage in futurelitigation with franchise owners to enforce the terms of our franchise agreements and compliance with our brand standards as determinednecessary to protect our brand, the consistency of our products and the customer experience. Such litigation may be time consuming, distractingand costly. Any negative outcome of these or any other claims could materially and adversely affect our results of operations as well as ourability to expand our franchise system and may damage our reputation and our brand.•Americans with Disabilities Act. Restaurants located in the United States must comply with Title III of the ADA . Although we believe newerrestaurants meet the ADA construction standards and, further, that most franchise owners have historically been diligent in the remodeling ofolder restaurants, a finding of noncompliance with the ADA could result in the imposition of injunctive relief, fines, awards of damages to privatelitigants or additional capital expenditures to remedy such noncompliance. Any imposition of injunctive relief, fines, damage awards or capitalexpenditures could adversely affect the ability of a franchise owner to make royalty payments, or could generate negative publicity, or otherwiseadversely affect us.•Access to credit. Our franchise owners typically finance new operations and new store openings with loans or other forms of credit. If ourfranchise owners are unable to access credit or obtain sufficient credit, if interest rates on loans that our franchise owners use to financeoperations of current stores or to open new stores increase or if13Table of Contentsfranchise owners are unable to service their debt, our franchise owners may have difficulty operating their stores or opening new stores, whichcould materially and adversely affect our results of operations as well as our ability to expand our franchise system.•Franchise owner bankruptcy. The bankruptcy of a multi-unit franchise owner could negatively impact our ability to collect payments due undersuch franchise owner’s franchise agreement. In a franchise owner bankruptcy, the bankruptcy trustee may reject its franchise agreementspursuant to Section 365 under the United States bankruptcy code, in which case there would be no further royalty payments from such franchiseowner. There is no assurance as to the proceeds, if any, that may ultimately be recovered in a bankruptcy proceeding of such franchise owner inconnection with a damage claim resulting from such rejection.Opening new stores in existing markets may negatively affect sales at existing stores.We intend to continue opening new franchise stores in our existing markets as a core part of our growth strategy. Expansion in existing markets may beaffected by local economic and market conditions. Further, the customer target area of our stores varies by location, depending on a number of factors,including population density, other local retail and business attractions, area demographics and geography. As a result, the opening of a new store in ornear markets in which stores already exist could adversely affect the sales of these existing stores. We and our franchise owners may selectively opennew stores in and around areas of existing stores. Competition for sales between our stores may become significant in the future as we continue toexpand our operations and could affect sales growth, which could, in turn, materially and adversely affect our business, financial condition or results ofoperations.New stores may not be profitable and the increases in AWS and comparable store sales that we have experienced in the past may not beindicative of future results.New stores may not be profitable and their sales performance may not follow historical patterns. In addition, our AWS and comparable store sales maynot increase at the rates achieved over the past several years. AWS for new domestic stores can be influenced by a number of factors, including the mixof new stores opening in core, developing, and new markets or in high- AWS and low- AWS markets. Other factors that may impact AWS , comparablestore sales, and performance of new stores are the level of media efficiency, pricing structure, the competitive activity in any market, our overallmarketing plans, the timing of new store openings, and franchise owner experience and ability. In addition, our store grand opening plan focuses less ondriving opening day sales as it does on delivering a more sustainable sales level and extending sales momentum well into the first full fiscal year ofoperations. Although this plan may allow for steadier and more sustainable growth, it may also result in lower AWS in earlier periods. Profits and salesperformance for new stores in newer, less-penetrated markets may further be adversely affected by a lack of awareness or acceptance of our brand andconcept as well as by a lack of existing marketing efforts and operational execution in these markets.If new stores do not perform as planned, or if we or our franchise owners are unable to achieve our expected AWS for the new stores, our business,financial condition or results of operations could be materially and adversely affected.Our expansion into international markets exposes us to a number of risks that may differ in each country where we have franchise stores.We currently have franchise stores in Canada and the United Arab Emirates and plan to continue to grow internationally. Our international operations arein early stages and historically have not been profitable and have achieved lower margins than our domestic stores. We expect this financial performanceto continue in the near-term. Expansion in international markets may also be affected by local economic and market conditions. Therefore, as we expandinternationally, our franchise owners may not experience the operating margins we expect, and our results of operations and growth may be materiallyand adversely affected. Our financial condition and results of operations may be adversely affected if global markets in which our franchise storescompete are affected by changes in political, economic or other factors. These factors, over which neither our franchise owners nor we have control, mayinclude:▪recessionary or expansive trends in international markets;▪changing labor conditions and difficulties in staffing and managing our foreign operations;▪increases in the taxes we pay and other changes in applicable tax laws;▪legal and regulatory changes, and the burdens and costs of our compliance with a variety of foreign laws;▪changes in inflation rates;▪changes in exchange rates and the imposition of restrictions on currency conversion or the transfer of funds;▪difficulty in protecting our brand, reputation and intellectual property;▪difficulty in collecting our royalties and longer payment cycles;▪expropriation of private enterprises;14Table of Contents▪increases in anti-American sentiment and the identification of the Papa Murphy’s brand as an American brand;▪political and economic instability; and▪other external factors.Termination of area development agreements (“ ADAs ”) or master franchise agreements with certain franchise owners could adverselyimpact our revenues.We enter into ADAs with certain domestic franchise owners that plan to open multiple Papa Murphy’s stores in a designated market area and we haveentered into master franchise agreements with third-parties to develop and operate stores in Canada and in the Middle East. These franchise owners aregranted certain rights with respect to specified territories, and at their discretion, these franchise owners may open more stores than specified in theiragreements. The termination of ADAs or other arrangements with a master franchise owner or a lack of expansion by these franchise owners could resultin the delay of the development of franchised restaurants or discontinuation or an interruption in the operation of our brands in a particular market ormarkets. We may not be able to find another operator to resume development activities in such market or markets. Any such delay, discontinuation orinterruption would result in a delay in, or loss of, royalty income to us by way of reduced sales and could materially and adversely affect our business,financial condition or results of operations.We are subject to all of the risks associated with leasing space subject to long-term non-cancelable leases.We do not own any of the real property where our Company-owned stores operate. Payments under our operating leases account for a portion of ouroperating expenses, and we expect to lease the real property where any of the new Company-owned stores we may open in the future will operate. Ourleases generally have an initial term of five years and generally can be extended only in five-year increments (at increased rates). All of our leasesrequire a fixed annual rent, although some require the payment of additional rent if store sales exceed a negotiated amount. Generally, our leases are netleases, which require us to pay all of the cost of insurance, taxes, maintenance and utilities. We generally cannot cancel these leases. Additional sitesthat we lease are likely to be subject to similar long-term non-cancelable leases. We also sublease or assign some of our leases to our franchisees, andwill continue to do so in the future, either before or after we have developed a store at the leased location. When we assign or sublease our leases tofranchisees, we are in most instances required to retain ultimate liability to the landlord. If an existing or future store is not profitable, resulting in itsclosure (or, in the case of a lease that we have subleased or assigned to a franchisee, the franchisee defaults on the subleased or assigned lease), wecould lose some or all of our development investment as well as be committed to perform our obligations under the applicable lease. This could include,among other things, paying the base rent for the balance of the lease term. We may also be subject to a claim by a franchise owner who defaults on alease that we knew or should have known that the leased location would be unprofitable.In addition, we may fail to negotiate renewals as each of our leases expires, either on commercially acceptable terms or at all, which could cause us topay increased occupancy costs or to close stores in desirable locations. These potential increased occupancy costs and closed stores could materiallyand adversely affect our business, financial condition or results of operations.The impact of negative economic factors, including the availability of credit, on our and our franchise owners’ landlords could negativelyaffect our results of operations.Negative effects on our and our franchise owners’ existing and potential landlords due to the inaccessibility of credit and other unfavorable economicfactors may, in turn, adversely affect our business and results of operations. If our or our franchise owners’ landlords are unable to obtain financing orremain in good standing under their existing financing arrangements, they may be unable to provide construction funding to us or satisfy other leasecovenants. In addition, if our franchise owners or our landlords are unable to obtain sufficient credit to continue to properly manage their retail sites, wemay experience a drop in the level of quality of such retail locations. The development of new stores may also be adversely affected by the negativefinancial situations of developers and potential landlords. Landlords may try to delay or cancel development projects (as well as renovations of existingprojects) if there is instability in the credit markets or declines in consumer spending, which could reduce the number of appropriate locations availablethat we would consider for our new stores. Furthermore, the failure of landlords to obtain licenses or permits for development projects on a timely basis,which is beyond our control, may negatively impact our ability to implement our development plan.Damage to our reputation and the Papa Murphy’s brand and negative publicity relating to our stores, including our franchise stores, couldreduce sales at some or all of our other stores and could negatively impact our business, financial condition and results of operations.Our success is dependent in part upon our ability to maintain and enhance the value of the Papa Murphy’s brand, consumers’ connection to our brandand positive relationships with our franchise owners. We may, from time to time, be faced with negative publicity relating to food quality, food safety, storefacilities, customer complaints or litigation alleging15Table of Contentsillness or injury, health inspection scores, integrity of our or our suppliers’ food processing, employee and franchise owner relationships, franchise ownerlitigation or other matters, regardless of whether the allegations are valid or whether we are held to be responsible. The risks associated with suchnegative publicity cannot be completely eliminated or mitigated and may materially and adversely affect our business, financial condition and results ofoperations and result in damage to our brand. For multi-location food service businesses such as ours, the negative impact of adverse publicity relating toone store or a limited number of stores may extend far beyond the stores or franchise owners involved to affect some or all of our other stores. The risk ofnegative publicity is particularly great with respect to our franchise stores because we are limited in the manner in which we can regulate them, especiallyon a real-time basis. A similar risk exists with respect to unrelated food service businesses, if consumers associate those businesses with our ownoperations.The use of social media platforms and similar devices, including weblogs (blogs), social media websites and other forms of Internet-basedcommunications which allow individuals to access a broad audience of consumers and other interested persons has increased markedly. Consumersvalue readily available information concerning goods and services that they purchase and may act on such information without further investigation orauthentication. The availability of information on social media platforms is virtually immediate, as is its impact. Many social media platforms immediatelypublish the content their subscribers and participants post, often without filters or checks on accuracy of the content posted. The opportunity fordissemination of information, including inaccurate information, is seemingly limitless and readily available. Information concerning our Company may beposted on such platforms at any time. Information posted may be adverse to our interests or may be inaccurate, each of which may harm ourperformance, prospects or business. The harm may be immediate without affording us an opportunity for redress or correction. Such platforms also couldbe used for dissemination of trade secret information, compromising valuable Company assets. In general, the dissemination of information online couldmaterially and adversely affect our business, financial condition and results of operations, regardless of the information’s accuracy.Our success depends in part upon effective advertising and marketing campaigns, which may not be successful, and franchise owner supportof such advertising and marketing campaigns, as well as compliance with the restrictions and obligations imposed by laws regulating certainmarketing practices.We believe the Papa Murphy’s brand is critical to our business. We expend resources in our marketing efforts using a variety of media, including socialmedia, email and opt-in text messaging. We expect to continue to conduct brand awareness programs and customer initiatives to attract and retaincustomers. Additionally, some of our competitors have greater financial resources than we do, which enables them to spend significantly more onmarketing and advertising than us. Should our competitors increase spending on marketing and advertising, or should our advertising and promotions beless effective than our competitors, our business, financial condition and results of operations could be materially and adversely affected.The support of our franchise owners is critical for the success of our advertising and the marketing campaigns we seek to undertake, and the successfulexecution of these campaigns will depend on our ability to maintain alignment with our franchise owners. Our franchise owners are required to spendapproximately five percent of net sales directly on local advertising or contribute to a local fund managed by franchise owners in certain market areas tofund the purchase of advertising media. Our franchise owners are also required to contribute two percent of their net sales to a national fund to supportthe development of new products, brand development and national marketing programs. In addition, we, our franchise owners and other third-parties maycontribute additional advertising funds, and have done so at various times. Although we maintain control over advertising and marketing materials andcan mandate certain strategic initiatives pursuant to our franchise agreements, we need the active support of our franchise owners if the implementationof these initiatives is to be successful. Additional advertising funds are not contractually required, and we, our franchise owners and other third-partiesmay choose to discontinue contributing additional funds in the future. Any significant decreases in our advertising and marketing funds or financialsupport for advertising activities could significantly curtail our marketing efforts, which may in turn materially and adversely affect our business, financialcondition and results of operations.Further, some of our marketing campaigns involve emails and opt-in text messages. In the United States, the Telephone Consumer Protection Actimposes obligations and limitations on making phone calls and sending text messages to consumers. The Federal Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003 (the “ CAN-SPAM Act ”) regulates commercial email messages and specifies penalties for thetransmission of commercial email messages that do not comply with certain requirements, such as providing an opt-out mechanism for stopping futureemails from senders. States and other countries have similar laws related to telemarketing and commercial emails. Additional or modified laws andregulations, or interpretations of existing, modified or new laws, regulations and rules, could prohibit or increase the cost of engaging with consumers andimpair our ability to expand the use of our marketing techniques to more customers. Failure to comply with obligations and restrictions related to textmessage and email marketing could subject us to lawsuits, fines, statutory damages, consent decrees, injunctions, adverse publicity and other lossesthat could harm our business. We are currently subject to one such lawsuit, which is described in Part I, Item 3, Legal Proceedings .16Table of ContentsOur sales and profits could be adversely affected if comparable store sales are less than we expect.The level of comparable store sales, which represent the change in year-over-year sales for stores open for at least 52 full weeks from the comparabledate (the Tuesday following the opening date), will affect our sales growth and will continue to be a critical factor affecting our profits because the profitmargin on comparable store sales is generally higher than the profit margin on new store sales. Our franchise owners’ and our ability to increasecomparable store sales depends in part on our ability to successfully implement our initiatives to build sales. It is possible such initiatives will not besuccessful, that we will not achieve our target comparable store sales growth or that the change in comparable store sales could be negative, which maycause a decrease in sales and our profits that would materially and adversely affect our business, financial condition or results of operations.We experience the effects of seasonality.Seasonal factors and the timing of holidays cause our revenues to fluctuate from quarter to quarter. We typically follow family eating patterns at home,with our strongest sales levels occurring in the months of September through May, and our lowest sales levels occurring in the months of June, July andAugust. Therefore, our revenues per store have typically been higher in the first and fourth quarters and lower in the second and third quarters.Additionally, our new store openings have historically been concentrated in the fourth and first quarters because new franchise owners may seek tobenefit from historically stronger sales levels occurring in these periods. We believe that new store openings will continue to be weighted towards thefourth quarter. As a result of these factors, our quarterly and annual results of operations and comparable store sales may fluctuate significantly.Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year and comparable storesales for any particular future period may decrease and materially and adversely affect our business, financial condition or results of operations.Changes in economic conditions, including effects from recession, adverse weather and other unforeseen conditions, could materially andadversely affect our business, financial condition and results of operations.The restaurant industry depends on consumer discretionary spending. Volatile economic conditions now or in the future may depress consumerconfidence and discretionary spending. If the economy fails to fully recover for a prolonged period of time or worsens and if our customers have lessdiscretionary income or reduce the amount they spend on quick service meals, customer traffic could be adversely impacted. We believe that if negativeeconomic conditions persist for a long period of time or become pervasive, consumers might make long-lasting changes to their discretionary spendingbehavior, including dining out less frequently. In addition, given our geographic concentrations in the West and Midwest, economic conditions in theseparticular areas of the country could have a disproportionate impact on our overall results of operations, and regional occurrences such as local strikes,terrorist attacks, increases in energy prices, adverse weather conditions, tornadoes, earthquakes, hurricanes, floods, droughts, fires or other natural orman-made disasters could materially and adversely affect our business, financial condition and results of operations. Adverse weather conditions mayalso impact customer traffic at our stores, and, in more severe cases, cause temporary store closures, sometimes for prolonged periods. If store salesdecrease, our profitability could decline as we spread fixed costs across a lower level of sales. Reductions in staff levels, asset impairment charges andpotential store closures could result from prolonged negative store sales. There is no assurance that the macroeconomic environment or the regionaleconomies in which we operate will improve significantly or that government stimulus efforts will improve consumer confidence, liquidity, credit markets,home values or unemployment, among other things.Food safety and foodborne illness concerns could have an adverse effect on our business.We cannot guarantee that our supply chain and food safety controls and training will be fully effective in preventing all food safety issues at our stores,including any occurrences of foodborne illnesses such as salmonella, E. coli and hepatitis A. In addition, we do not assure you that our franchiselocations will maintain the high levels of internal controls and training we require at our Company-owned stores. Furthermore, our franchise owners andwe rely on third-party vendors, making it difficult to monitor food safety compliance and increasing the risk that foodborne illness would affect multiplelocations rather than a single store. Some foodborne illness incidents could be caused by third-party vendors and transporters outside of our control. Newillnesses resistant to our current precautions may develop in the future, or diseases with long incubation periods could arise, that could give rise to claimsor allegations on a retroactive basis. One or more instances of foodborne illness in any of our stores or markets or related to types of food products wesell, if publicized on national media outlets or through social media, could negatively affect our store sales nationwide. This risk exists even if it were laterdetermined that the illness was wrongly attributed to us or one of our stores. A number of other restaurant chains have experienced incidents related tofoodborne illnesses that have had a material and adverse effect on their operations. The occurrence of a similar incident at one or more of our stores, ornegative publicity or public speculation about an incident, could materially and adversely affect our business, financial condition or results of operations.17Table of ContentsChanges in food availability and costs could adversely affect our results of operations.Our profitability and operating margins are dependent in part on our ability to anticipate and react to changes in food costs, particularly the costs ofmozzarella cheese and flour. We are party to national supply agreements for core ingredients with certain key third-party suppliers, including SaputoCheese Inc. and Davisco Foods, for cheese; Pizza Blends, Inc., for flour and dough mix; Neil Jones Foods Company, for tomatoes used in sauce; andseveral suppliers for meat, pursuant to which we lock in pricing for our franchise owners and Company-owned stores. We rely on Sysco Corporation asthe primary distributor of food and other products to our franchise owners and Company-owned stores. Our pricing arrangements with national supplierstypically have terms from three months to a year, after which the pricing may be renegotiated. Each store purchases food supplies directly from ourapproved distributors and produce locally through an approved produce supplier.The type, variety, quality, availability and price of produce, meat and cheese are volatile and are subject to factors beyond our control, including weather,governmental regulation, availability and seasonality, each of which may affect our and our franchise owners’ food costs or cause a disruption in oursupply. For example, cheese pricing is higher in the summer months due to a drop off in milk production in higher temperatures. Our food distributors andsuppliers also may be affected by higher costs to produce and transport commodities used in our stores, higher minimum wage and benefit costs andother expenses that they pass through to their customers, which could result in higher costs for goods and services supplied to us. We may not be able toanticipate and react to changing food costs through our purchasing practices and menu price adjustments in the future. As a result, any increase in theprices charged by suppliers would increase the food costs for our Company-owned stores and for our franchise owners and could adversely impact theirprofitability. In addition, because we provide moderately priced food, we may choose not to, or may be unable to, pass along commodity price increasesto consumers, and any price increases that are passed along to consumers may materially and adversely affect store sales which would lower revenuesgenerated from Company-owned stores and franchise owner royalties. These potential changes in food and supply costs and availability could materiallyand adversely affect our business, financial condition or results of operations.Our dependence on a sole supplier or a limited number of suppliers for some ingredients could result in disruptions to our business.Sysco Corporation is the primary distributor of our food and other products to our domestic franchise owners and Company-owned stores and anydisruption to this distribution due to work stoppages, strikes or other business interruption may materially and adversely affect our franchise owners andus. The initial term of our Distribution Service Agreement with Sysco expired in August 2007, and now the agreement automatically renews for one-yearterms until terminated by either party with written notice one year before the termination date in such notice. Additionally, we do not have formal long-termarrangements with all of our suppliers, and therefore our suppliers may implement significant price increases or may not meet our requirements in atimely fashion, or at all. Any material interruptions in our supply chain, such as a material interruption of ingredient supply due to the failures of third-partydistributors or suppliers, or interruptions in service by common carriers that ship goods within our distribution channels, may result in significant costincreases and reduce store sales. We may not be able to find alternative distributors or suppliers on a timely basis or at all. Our Company-owned andfranchise stores could also be harmed by any prolonged disruption in the supply of products from or to our key suppliers due to weather, crop diseaseand other events beyond our control. Insolvency of key suppliers could also negatively impact our business. Our focus on a limited menu would make theconsequences of a shortage of a key ingredient, such as cheese or flour, more severe, and affected stores could experience significant reductions insales during the shortage.Changes in laws related to electronic benefit transfer (“ EBT ”) systems, could adversely impact our results of operations.Because our products are not cooked, we and our franchise owners currently are able to accept EBT payments, or food stamps, at stores in the UnitedStates. Changes in state and federal laws governing where EBT cards may be used and what they may be used for may limit our ability to accept suchpayments and could significantly reduce sales. Reductions in food stamp benefits occurred in November 2013, and further additional reductions in foodstamp benefits are periodically proposed by lawmakers in the U.S. Senate or House of Representatives. The recent reductions and potential futurereductions in food stamp benefits may reduce sales, which could materially and adversely affect our business, financial condition and results ofoperations.Changes in employment laws may adversely affect our business.Various federal and state labor laws govern our relationships with our employees and the relationships of our franchise owners with their employees,which may impact our and our franchise owners’ operating costs. These laws include employee classification as exempt/non-exempt for overtime andother purposes, minimum wage requirements, unemployment tax rates, mandatory health benefits, workers’ compensation rates, immigration status, taxreporting and other wage and benefit requirements. A substantial number of employees at our Company-owned and franchise stores are18Table of Contentspaid at rates related to the U.S. federal minimum wage, and increases in the U.S. federal minimum wage, or higher minimum wage rates imposed bystates or municipalities, may increase labor costs. Any such increases in labor costs might result in franchise owners inadequately staffing restaurants.Understaffed restaurants could reduce sales at such restaurants, decrease royalty payments and adversely affect our brands.Various states are considering or have already adopted new immigration laws or enforcement programs. The U.S. Congress and Department ofHomeland Security from time to time also consider and may implement changes to federal immigration laws, regulations or enforcement programs. Someof these changes may increase obligations for compliance and oversight, which could subject us to additional costs and make the hiring process for usand our franchise owners more cumbersome, or reduce the availability of potential employees. Although we require all of our employees, including at ourCompany-owned stores, to provide us with government-specified documentation evidencing their employment eligibility, some of our employees may,without our knowledge, be unauthorized workers. We currently participate in the “E-Verify” program, an Internet-based, free program run by the UnitedStates government to verify employment eligibility, in states in which participation is required, and we plan to introduce its use throughout our stores.However, use of the “E-Verify” program does not guarantee that we will properly identify all applicants who are ineligible for employment. In addition, ourfranchise owners are responsible for screening any employees they hire. Unauthorized workers are subject to deportation and may subject us or ourfranchise owners to fines or penalties, and if any of our or our franchise owners’ workers are found to be unauthorized it may become more difficult for usto hire and keep qualified employees. Termination of a significant number of employees who were unauthorized employees may disrupt store operationsand cause temporary increases in our or our franchise owners’ labor costs as we train new employees. We could also become subject to fines, penaltiesand other costs related to claims that we did not fully comply with all recordkeeping obligations of federal and state immigration compliance laws. Thesefactors could materially and adversely affect our business, financial condition or results of operations.In what may signal a trend and change in employment law, franchisors are increasingly subject to claims that they are joint employers with theirfranchisees, and there seems to be support for such claims within the National Labor Relations Board (“ NLRB ”), based on recent NLRB decisions. Thiscould expose franchisors, including us, to liability for claims by, or based on the acts of, franchisees’ employees. Although we carry insurance policies fora significant portion of our risks and associated liabilities with respect to workers’ compensation, general liability, employer’s liability, health benefits andother insurable risks, a claim not covered by that insurance, or a judgment in excess of our insurance coverage, could materially and adversely affect ourbusiness, financial condition and results of operations. Regardless of whether any claims that may be brought against us are valid or whether we areultimately determined to be liable, our business, financial condition and results of operations could also be adversely affected by negative publicity,litigation costs resulting from the defense of these claims, and the diversion of time and resources from our operations.If our franchise owners or we face labor shortages, labor disputes or increased labor costs, our growth and operating results could beadversely affected.Labor is a primary component in the cost of operating our Company-owned stores and for franchise owners. If we or our franchise owners face laborshortages or increased labor costs because of increased competition for employees, higher employee turnover rates, increases in the federal, state orlocal minimum wage or other employee benefits costs (including costs associated with health insurance coverage), our operating expenses couldincrease and our growth could be adversely affected. In addition, our success depends in part upon our franchise owners’ and our ability to attract,motivate and retain a sufficient number of well-qualified store operators and management personnel, as well as a sufficient number of other qualifiedemployees, to keep pace with our expansion schedule. Qualified individuals needed to fill these positions are in short supply in some geographic areas.In addition, restaurants have traditionally experienced relatively high employee turnover rates. Although we have not yet experienced significant problemsin recruiting or retaining employees, our franchise owners’ and our ability to recruit and retain such individuals may delay the planned openings of newstores or result in higher employee turnover in existing stores, which could have a material and adverse effect on our business, financial condition orresults of operations.Additionally, while we do not currently have any unionized employees and are not currently subject to any unionization efforts, there is a potential forunion organizers to engage in efforts to organize our employees or those of our franchise owners. The recent NLRB joint employer decisions referred toabove may also create some possibility that employees of our franchise owners could have the right to collectively bargain directly with us. Potentialunion representation and collective bargaining agreements may result in increased labor costs that can have an impact on competitiveness, as well asimpact our ability to retain well-qualified employees. Labor disputes, as well, may precipitate strikes and picketing that may have an impact on business,including guest patronage. Further, potential changes in labor laws could increase the likelihood of some or all of our employees being subjected togreater organized labor influence, and could have a material and adverse effect on our business, financial condition or results of operations by imposingrequirements that could potentially increase our costs, reduce our flexibility and impact our employee culture.19Table of ContentsAny increase in the cost of labor could adversely affect our business and our growth. Competition for employees could require us or our franchise ownersto pay higher wages, which could result in higher labor costs. In addition increases in the minimum wage would increase our labor costs. Moreover, costsassociated with workers’ compensation are rising, and these costs may continue to rise in the future. We may be unable to increase our menu prices inorder to pass these increased labor costs on to consumers, in which case our margins would be negatively affected, which could materially and adverselyaffect our business, financial condition or results of operations.We invest in developing new product offerings, some of which may not be successful.We invest in continually developing new potential product offerings as well as in the marketing and advertising of our new products. For example, werecently tested and rolled out nationally Fresh Pan pizza, which is marketed at a price above our regular menu items. Our new product offerings may notbe well-received by consumers and may not be successful, which could materially and adversely affect our results of operations.From time to time we may invest in enhancements to our franchise platform, on which we may not see a return.We may not see a return on investments we make in our franchise platform. For example, we have invested in a POS system that we continue toimplement across our franchise base in order to better manage our business. As part of this investment, in September 2013 we purchased approximately$4.5 million of POS system software licenses, and we are selling these licenses directly to our franchise owners. We may not be able to sell all theselicenses to our existing franchise owners on a timely basis. Our failure to capitalize on investments may materially and adversely affect our financialcondition.The effect of changes to healthcare laws in the United States may increase the number of employees who choose to participate in ourhealthcare plans, which may significantly increase our healthcare costs and negatively impact our results of operations and our franchiseowners.In 2010, the PPACA was signed into law in the United States to require health care coverage for many uninsured individuals and expand coverage forthose already insured. We offer and subsidize comprehensive healthcare coverage, primarily for our salaried employees. The healthcare reform lawrequires us to offer healthcare benefits to all full-time employees (including full-time hourly employees) that meet certain minimum requirements ofcoverage and affordability, or face penalties. We offer hourly employees who qualify as full-time employees under the PPACA the option of enrolling inour health care coverage during our annual open enrollment period, but the number of such employees electing to so enroll is low. If the number of full-time hourly employees electing to enroll in our health care coverage increases significantly, we may incur substantial additional expense, or, if thebenefits we offer do not meet applicable requirements, we may incur penalties. It is also possible that by making changes or failing to make changes inthe healthcare plans offered by us, we will become less competitive in the market for our labor. Finally, implementing the requirements of healthcarereform is likely to impose additional administrative costs. The costs and other effects of these new healthcare requirements are still being determined, butthey may significantly increase our healthcare coverage costs and could materially and adversely affect our business, financial condition or results ofoperations.Restaurant companies have been the target of class actions and other litigation alleging, among other things, violations of federal and statelaw. We could be party to litigation that could adversely affect us by distracting management, increasing our expenses or subjecting us tomaterial money damages and other remedies.We are subject to lawsuits, administrative proceedings and claims that arise in the ordinary course of our business. In recent years, a number ofrestaurant companies have been subject to claims by customers, employees, franchise owners and others regarding issues such as food safety,personal injury and premises liability, employment-related claims, harassment, discrimination, disability, compliance with advertising laws (including theTelephone Consumer Protection Act) and other operational issues common to the foodservice industry. A number of these lawsuits have resulted in thepayment of substantial damages by the defendants. For example, on May 8, 2015, we were named as a defendant in a putative class action lawsuitclaiming a violation of the Telephone Consumer Protection Act, which prohibits companies from making telemarketing calls to numbers listed in theFederal Do-Not-Call Registry and imposes other obligations and limitation on making phone calls and sending text messages to consumers. Specificinformation regarding the lawsuit is included in Part 1, Item 3, Legal Proceedings . An adverse judgment or settlement, related to this or any otherlitigation claim, that is not insured or is in excess of insurance coverage could have an adverse impact on our profitability and could cause variability inour results compared to expectations. We carry insurance policies for a significant portion of our risks and associated liabilities with respect to workers’compensation, general liability, employer’s liability, health benefits and other insurable risks. A judgment in excess of our insurance coverage for anyclaims could materially and adversely affect our business, financial condition and results of operations. Regardless of whether any claims that may bebrought against us are valid or whether we are ultimately determined to be liable, our business, financial condition and results of operations could also beadversely affected by negative publicity, litigation costs resulting from the defense of these claims, and the diversion of time and resources from ouroperations.20Table of ContentsAlthough we have historically experienced very few customer lawsuits, our customers occasionally allege we caused an illness or injury they suffered ator after a visit to our stores, or that we have problems with food quality or operations. We are also subject to a variety of other claims arising in theordinary course of our business, including personal injury claims, contract claims and claims alleging violations of federal and state law regardingworkplace and employment matters, equal opportunity, discrimination and similar matters and may become subject to class action or other lawsuitsrelated to these or different matters in the future. We may also be named as a defendant in any such claims brought against any of our franchise owners.Regardless of whether any claims against us are valid, or whether we are ultimately held liable, claims may be expensive to defend and may divert timeand money away from our operations and hurt our performance. A judgment in excess or outside of our insurance coverage for any claims couldmaterially and adversely affect our financial condition or results of operations.In addition, the restaurant industry has been subject to a growing number of claims based on the nutritional content of food products sold and disclosureand advertising practices. We may also be subject to this type of proceeding in the future and, even if we are not, publicity about these matters(particularly directed at the limited service or fast casual segments of the industry) may harm our reputation and could materially and adversely affect ourbusiness, financial condition or results of operations.Our business operations and future development could be significantly disrupted if we lose key members of our management team.The success of our business continues to depend, to a significant degree, upon the continued contributions of our senior officers and key employees,both individually and as a group. Our future performance will be substantially dependent in particular on our ability to retain and motivate these seniorofficers and key employees. Although we have employment agreements in place with certain senior officers and key employees, we cannot prevent themfrom terminating their employment with us. The loss of the services of our Chief Executive Officer, Chief Financial Officer, other senior officers or otherkey employees could materially and adversely affect our business and plans for future development. We do not believe that we will lose the services ofany of our current senior officers and key employees in the foreseeable future; however, we currently have no effective replacement for any of theseindividuals due to their experience, reputation in the industry and special role in our operations. We do not maintain any key man life insurance policiesfor any of our employees.Our indebtedness may limit our ability to invest in the ongoing needs of our business and if we are unable to comply with our financialcovenants, our liquidity and results of operations could be adversely affected.As of December 28, 2015 , we had $112.2 million of outstanding indebtedness, including $109.2 million outstanding under our senior secured creditfacilities, and $20.0 million of availability under a revolving credit facility. We may, from time to time, incur additional indebtedness.The agreement governing our senior secured credit facilities places certain conditions on us, including that it:▪requires us to utilize a substantial portion of our cash flow from operations to make payments on our indebtedness, reducing the availability ofour cash flow to fund working capital, capital expenditures, development activity and other general corporate purposes;▪increases our vulnerability to adverse general economic or industry conditions;▪limits our flexibility in planning for, or reacting to, changes in our business or the industries in which we operate;▪makes us more vulnerable to increases in interest rates, as borrowings under our new senior secured credit facilities are made at variable rates;▪limits our ability to obtain additional financing in the future for working capital or other purposes; and▪places us at a competitive disadvantage compared to our competitors that have less indebtedness.Our senior secured credit facilities place certain limitations on our ability to incur additional indebtedness. However, subject to the qualifications andexceptions in our senior secured credit facilities, we may be permitted to incur substantial additional indebtedness and may incur obligations that do notconstitute indebtedness under the terms of the new senior secured credit facilities. The senior secured credit facilities also place certain limitations on,among other things, our ability to enter into certain types of transactions, financing arrangements and investments, to make certain changes to our capitalstructure and to guarantee certain indebtedness and pay. These restrictions limit or prohibit, among other things, our ability to:▪pay dividends on, redeem or repurchase our stock or make other distributions;▪incur or guarantee additional indebtedness;▪sell stock in our subsidiaries;▪create or incur liens;21Table of Contents▪make acquisitions or investments;▪transfer or sell certain assets or merge or consolidate with or into other companies;▪make certain payments or prepayments of indebtedness subordinated to our obligations under our new senior secured credit facilities; and▪enter into certain transactions with our affiliates.Failure to comply with certain covenants or the occurrence of a change of control under our senior secured credit facilities could result in the accelerationof our obligations under the senior secured credit facilities, which would have an adverse effect on our liquidity, capital resources and results ofoperations.Our senior secured credit facilities also require us to comply with certain financial covenants regarding our leverage ratio and our interest coverage ratio.Changes with respect to these financial covenants may increase our interest rate and failure to comply with these covenants could result in a default andan acceleration of our obligations under the new senior secured credit facilities, which would have an adverse effect on our liquidity, capital resources andresults of operations.We may be unable to generate sufficient cash flow to satisfy our significant debt service obligations, which would adversely affect ourfinancial condition and results of operations.Our ability to make principal and interest payments on and refinance our indebtedness will depend on our ability to generate cash in the future and issubject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. If our business does not generatesufficient cash flow from operations, in the amounts projected or at all, or if future borrowings are not available to us in amounts sufficient to fund ourother liquidity needs, our business financial condition and results of operations could be materially and adversely affected. If we cannot generatesufficient cash flow from operations to make scheduled principal and interest payments in the future, we may need to refinance all or a portion of ourindebtedness on or before maturity, sell assets, delay capital expenditures or seek additional equity. If we are unable to refinance any of ourindebtedness on commercially reasonable terms or at all, or to effect any other action relating to our indebtedness on satisfactory terms or at all, ourbusiness, financial condition and results of operations could be materially and adversely affected.Interest rate fluctuations may increase our debt service obligations, which would adversely affect our financial condition and results ofoperations.We are subject to interest rate risk on our senior secured credit facility. Interest rates on our senior secured credit facility are based on LIBOR, and underspecified circumstances we may be required by our lenders to enter into interest rate swap arrangements. A hypothetical 1.0% increase or decrease inthe interest rate associated with our senior secured credit facility would have resulted in a $1.1 million change to interest expense on an annualized basis.Any acquisitions, partnerships or joint ventures that we make could disrupt our business and harm our financial condition.From time to time, we may evaluate potential strategic acquisitions of existing stores or complementary businesses as well as partnerships or jointventures with third-parties, including potential franchisors, to facilitate our growth, particularly our international expansion. We may not be successful inidentifying acquisition, partnership and joint venture candidates. In addition, we may not be able to continue the operational success of any stores weacquire or successfully finance or integrate any businesses that we acquire or with which we form a partnership or joint venture. We may have potentialwrite-offs of acquired assets and an impairment of any goodwill recorded as a result of acquisitions. Furthermore, the integration of any acquisition maydivert management’s time and resources from our core business and disrupt our operations or may result in conflicts with our business.Any acquisition, partnership or joint venture may not be successful, may reduce our cash reserves, may negatively affect our earnings and financialperformance and, to the extent financed with stock or the proceeds of debt, may be dilutive to our stockholders or increase our already high levels ofindebtedness. We do not ensure that any acquisition, partnership or joint venture we make will not have a material and adverse effect on our business,financial condition and results of operations.Security breaches of confidential customer information in connection with our electronic processing of credit and debit card transactions mayadversely affect our business.The majority of our store sales are by credit or debit cards. Other restaurants and retailers have experienced security breaches in which credit and debitcard information of their customers has been stolen. We may in the future become subject to lawsuits or other proceedings for purportedly fraudulenttransactions arising out of the actual or alleged theft of our customers’ credit or debit card information. In addition, most states have enacted legislationrequiring notification of security breaches involving personal information, including credit and debit card information. Any such claim, proceeding, ormandatory notification could cause us to incur significant unplanned expenses, which could have an adverse impact on our22Table of Contentsfinancial condition and results of operations. Further, adverse publicity resulting from these allegations could harm our reputation and could materially andadversely affect our business, financial condition and results of operations.System security risks, data breaches and cyber attacks could disrupt our operations.We manage and store various proprietary information and sensitive or confidential data relating to our business, including sensitive and personallyidentifiable information related to our suppliers, customers and franchise owners. Breaches of our security measures through hacking, fraud or otherforms of deception, or the accidental loss, inadvertent disclosure or unapproved dissemination of proprietary information or sensitive or confidential dataabout us, our suppliers, our customers, our employees, or our franchise owners, could expose us, our customers, our suppliers and our franchise ownersto a risk of loss or misuse of this information, result in litigation and potential liability for us, damage our brand and reputation or otherwise harm ourbusiness. In addition, our current data protection measures might not protect us against increasingly sophisticated and aggressive threats and the costand operational consequences of implementing further data protection measures could be significant.We may not be able to adequately protect our intellectual property, which, in turn, could harm the value of our brand and adversely affect ourbusiness.Our ability to implement our business plan successfully depends in part on our ability to build brand recognition in the markets served by our stores usingour trademarks and other proprietary intellectual property, including our brand names and logos. Because of the differences in foreign laws concerningproprietary rights, our intellectual property rights may not receive the same degree of protection in foreign countries as they would in the United States.We have registered or applied to register a number of our trademarks. We do not assure you that our trademark applications will be approved. Third-parties may also oppose our trademark applications, or otherwise challenge our use of the trademarks. If our trademarks are successfully challenged, wecould be forced to rebrand our goods and services, which could result in loss of brand recognition, and could require us to devote resources toadvertising and marketing new brands.We rely on our franchise owners to assist us in identifying issues at the local level. We enforce our rights through a number of methods, including theissuance of cease-and-desist letters. If it becomes necessary, we may make infringement claims in federal court. However, we do not assure you that wewill have adequate resources to enforce our trademarks and other intellectual property rights. If our efforts to register, maintain and protect ourtrademarks or other intellectual property are inadequate, or if any third-party misappropriates, dilutes, infringes or otherwise violates our intellectualproperty, the value of our brand may be harmed, which could have a material and adverse effect on our business and might prevent our brand fromachieving or maintaining market acceptance. We may also face the risk of claims that we have infringed third-parties’ intellectual property rights. Asuccessful claim of infringement against us could result in our being required to pay significant damages, or enter into costly licensing or royaltyagreements in order to obtain the right to use a third-party’s intellectual property, any of which could have a negative impact on our results of operationsand harm our future prospects. If such royalty or licensing agreements are not available to us on acceptable terms or at all, we may be forced to ceaseselling certain products or services. Any claims of intellectual property infringement, even those without merit, could be expensive and time consuming todefend, require us to rebrand our products or services, if feasible, and divert management’s attention.We also rely on trade secrets and proprietary know-how to protect our brand. Our methods of safeguarding this information may not be adequate.Moreover, we may face claims of misappropriation or infringement of a third-parties’ rights that could interfere with our use of this information. Defendingthese claims may be costly and, if unsuccessful, may prevent us from continuing to use this proprietary information in the future and may require us topay monetary damages. We do not maintain confidentiality agreements with all of our team members. Even with respect to the confidentiality agreementswe have, we do not assure you that those agreements will not be breached, that they will provide meaningful protection, or that adequate remedies willbe available in the event of an unauthorized use or disclosure of our proprietary information. If competitors independently develop or otherwise obtainaccess to our trade secrets or proprietary know-how, the appeal of our stores could be reduced and our business could be harmed.Information technology system failures or breaches of our network security could interrupt our operations and adversely affect our business.We rely on our computer systems and network infrastructure across our operations, including POS system processing at our stores. Our ability toeffectively and efficiently manage our operations depends upon our ability to protect our computer equipment and systems against damage from physicaltheft, fire, power loss, telecommunications failure or other catastrophic events, as well as from internal and external security breaches, viruses, wormsand other disruptive problems. Any damage or failure of our computer systems or network infrastructure that causes an interruption in our operationscould materially and adversely affect our business, reputation, financial condition and results of operations and subject us to23Table of Contentslitigation or actions by regulatory authorities. Remediation of such problems could also result in significant, unplanned expenditures.An increasingly significant portion of our retail sales depends on the continuing operation of our information technology and communications systems,including our online ordering platform, POS system and our credit card processing systems. Our information technology, communication systems andelectronic data may be vulnerable to damage or interruption from earthquakes, terrorist attacks, floods, fires, power loss, telecommunications failures,computer viruses, loss of data, unauthorized data breaches or other attempts to harm our systems. Additionally, we rely on data centers that are alsosubject to break-ins, sabotage and intentional acts of vandalism that could cause disruptions in our ability to serve our customers and protect customerdata. Some of our systems are not fully redundant, and our disaster recovery planning cannot account for all eventualities. The occurrence of a naturaldisaster, intentional sabotage or other unanticipated problems could result in lengthy interruptions in our service. Any errors or vulnerabilities in oursystems, or damage to or failure of our systems, could result in interruptions in our services and non-compliance with certain regulations, which couldmaterially and adversely affect our business, reputation, financial condition and results of operations.We are subject to extensive government regulation and requirements issued by other groups and our failure to comply with existing orincreased regulations could adversely affect our business and operating results.We are subject to numerous federal, state, local and foreign laws and regulations, as well as requirements issued by other groups, including thoserelating to:▪the preparation, sale and labeling of food;▪building and zoning requirements;▪environmental laws;▪compliance with the FLSA , which governs such matters as minimum wage, overtime and other working conditions, family leave mandates and avariety of other laws enacted by states that govern these and other employment matters;▪the impact of immigration and other local and foreign laws and regulations on our business;▪compliance with securities laws and NASDAQ listed company rules;▪compliance with the ADA ;▪working and safety conditions;▪menu labeling and other nutritional requirements;▪sales taxes or other transaction taxes;▪compliance with the PCI DSS and similar requirements;▪compliance with the PPACA , and subsequent amendments; and▪compliance with the Dodd-Frank Wall Street Reform and Consumer Protection Act and any rules promulgated thereunder.We may also become subject to legislation or regulation seeking to tax and/or regulate high-fat foods, foods with high sugar and salt content, or foodsotherwise deemed to be “unhealthy.” If we fail to comply with existing or future laws and regulations, we may be subject to governmental or judicial finesor sanctions. In addition, our capital expenditures could increase due to remediation measures that may be required if we are found to be noncompliantwith any of these laws or regulations.We are also subject to Federal Trade Commission rules and to various state and foreign laws that govern the offer and sale of franchises. Additionally,these laws regulate various aspects of the franchise relationship, including terminations and the refusal to renew franchises. The failure to comply withthese laws and regulations in any jurisdiction or to obtain required government approvals could result in a ban or temporary suspension on futurefranchise sales, fines or other penalties, or require us to make offers of rescission or restitution, any of which could materially and adversely affect ourbusiness, financial condition and results of operations.Some of the jurisdictions where we have Company-owned and franchise stores do not assess sales tax on our pizzas. Accordingly, we may benefit froma pricing advantage over some pizza chain competitors in these jurisdictions. If these jurisdictions were to impose sales tax on our products, these storesmay experience a decline in sales due to the loss of this pricing advantage. In addition, our stores may be subject to unanticipated sales taxassessments. These sales tax assessments could result in losses to our franchise owners or franchise stores going out of business, which couldadversely24Table of Contentsaffect our number of franchise stores and our results of operations. Changes in sales tax assessments of this type at the franchise owner level could leadto undercapitalized franchise owners going out of business and loss of royalties at the Company level. Similarly, such tax assessments could impact theprofitability of our Company-owned stores. As a result, changes in sales tax assessments could have a material and adverse effect on our business,financial condition and results of operations.Additionally, the failure to obtain and maintain licenses, permits and approvals could adversely affect our business, financial condition and results ofoperations. Typically, licenses must be renewed annually and may be revoked, suspended or denied renewal for cause at any time if governmentalauthorities determine that our conduct violates applicable regulations. Difficulties or failure to maintain or obtain the required licenses and approvals couldadversely affect our existing stores and delay or result in our decision to cancel the opening of new stores, which would adversely affect our business,financial condition and results of operations.Our current insurance coverage may not be adequate, insurance premiums for such coverage may increase and we may not be able to obtaininsurance at acceptable rates, or at all.We have retention programs for workers’ compensation, general liability and owned and non-owned automobile liabilities. These insurance policies maynot 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 maynot be able to obtain similar levels of insurance on reasonable terms, or at all. Any substantial inadequacy of, or inability to obtain insurance coveragecould materially and adversely affect our business, financial condition and results of operations.Changes to accounting rules or regulations may adversely affect our results of operations.Changes to existing accounting rules or regulations may affect our future results of operations or cause the perception that we are more highly leveraged.Other new accounting rules or regulations and varying interpretations of existing accounting rules or regulations have occurred and may occur in thefuture. For instance, accounting regulatory authorities have indicated that they will require lessees to capitalize operating leases in their financialstatements in the next few years, and are promulgating rules to effect that change. This change, when implemented, will require us to record significantlease obligations on our consolidated balance sheet and make other changes to our financial statements. This and other future changes to accountingrules or regulations could materially and adversely affect our business, financial condition or results of operations.Risks Relating to Our Company and Our Ownership StructureThe requirements of being a public company may strain our resources and divert resources and management’s attention.As a publicly traded company, we incur, and will continue to incur, significant legal, accounting and other expenses that we were not required to incurprior to our initial public offering in May 2014. This will be particularly so after we are no longer an “emerging growth company” as defined under theJOBS Act. We are required to file with the SEC annual and quarterly information and other reports that are specified in Section 13 of the SecuritiesExchange Act of 1934, as amended (the “ Exchange Act ”). We are also required to ensure that we have the ability to prepare financial statements thatare fully compliant with all SEC reporting requirements on a timely basis. We are also subject to other reporting and corporate governance requirements,including the requirements of NASDAQ, and certain provisions of the Sarbanes-Oxley Act and the regulations promulgated thereunder, which imposesignificant compliance obligations upon us. As a public company, we, among other things, must prepare and distribute periodic public reports and otherstockholder communications in compliance with our obligations under the federal securities laws and applicable NASDAQ rules.These additional obligations as a public company require a significant commitment of additional resources and many of our competitors already complywith these obligations. The significant commitment of resources required for implementing them could adversely affect our business, financial conditionand results of operations. In addition, if we fail to comply with the requirements with respect to our internal accounting and audit functions, our ability toreport our results of operations on a timely and accurate basis could be impaired and we could suffer adverse regulatory consequences or violateNASDAQ listing standards. There could also be a negative reaction in the financial markets due to a loss of investor confidence in us and the reliability ofour financial statements.The obligations of being a public company require a significant commitment of resources and management oversight that has increased and maycontinue to increase our costs and might place a strain on our systems and resources. As a result, our management’s attention might be diverted fromother business concerns.25Table of ContentsFor as long as we remain an “emerging growth company” as defined in the JOBS Act, we may take advantage of certain exemptions from variousreporting requirements that are applicable to other public companies that are not “emerging growth companies.” These exceptions provide for, but are notlimited to, relief from the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, less extensive disclosure obligations regardingexecutive compensation in our periodic reports and proxy statements, exemptions from the requirements to hold a nonbinding advisory vote on executivecompensation and stockholder approval of any golden parachute payments not previously approved and an extended transition period for complying withnew or revised accounting standards. We may take advantage of these reporting exemptions until we are no longer an “emerging growth company.” Wemay remain an “emerging growth company” for up to five years following our initial public offering. To the extent we do not use exemptions from variousreporting requirements under the JOBS Act, we may be unable to realize our anticipated cost savings from those exemptions.Our internal control over financial reporting does not currently meet the standards required by Section 404 of the Sarbanes-Oxley Act of 2002.The failure to achieve and maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Actcould have a material adverse effect on our business and share price.Section 404 of the Sarbanes-Oxley Act (“ Section 404 ”), requires annual management assessments of the effectiveness of our internal control overfinancial reporting. Section 404 also generally requires a report by our independent registered public accounting firm on the effectiveness of our internalcontrol over financial reporting. However, under the JOBS Act, our independent registered public accounting firm will not be required to attest to theeffectiveness of our internal control over financial reporting pursuant to Section 404 until we are no longer an “emerging growth company.” We could bean “emerging growth company” for up to five years following our initial public offering.The rules governing the standards that must be met for our management to assess our internal control over financial reporting are complex and requiresignificant documentation, testing and possible remediation. If we fail to maintain an effective internal control environment or to comply with the numerouslegal and regulatory requirements imposed on public companies, we could make material errors in, and be required to restate, our financial statements.We may encounter problems or delays in implementing improvements in connection with receiving a favorable attestation from our independentregistered public accounting firm. If we are unable to maintain adequate internal control over financial reporting, we may be unable to report our financialinformation on a timely basis, may suffer adverse regulatory consequences or violate applicable stock exchange listing rules. Any restatement of ourfinancial statements due to a lack of adequate internal controls or otherwise could result in a loss of public confidence in the reliability of our financialstatements and sanctions imposed on us by the SEC . Failure to maintain effective internal control over financial reporting could have a material adverseeffect on our business and share price.Lee Equity may acquire interests and positions that could present potential conflicts with our and our stockholders’ interests.On May 4, 2010, affiliates of Lee Equity Partners, LLC (“ Lee Equity ”) acquired a majority of the capital stock of PMI Holdings Inc., our predecessor. LeeEquity is a middle-market private equity investment firm managing more than $1 billion of equity capital. Lee Equity invests in a variety of industriesincluding consumer/retail, business services, distribution/logistics, financial services, healthcare services and media. Immediately following theconsummation of our initial public offering, Lee Equity and its affiliates owned approximately 41% of our outstanding capital stock, and as of March 1,2016 , owns 26% of our outstanding capital stock. Lee Equity makes investments in companies and may, from time to time, acquire and hold interests inbusinesses that compete directly or indirectly with us. Lee Equity may also pursue, for its own accounts, acquisition opportunities that may becomplementary to our business, and as a result, those acquisition opportunities may not be available to us. Our amended and restated certificate ofincorporation contains provisions renouncing any interest or expectancy held by our directors affiliated with Lee Equity in certain corporate opportunities.Accordingly, the interests of Lee Equity may supersede ours, causing it or its affiliates to compete against us or to pursue opportunities instead of us, forwhich we have no recourse. Such actions, on the part of Lee Equity and inaction on our part, could have a material adverse effect on our business,financial condition and results of operations. Under a stockholder’s agreement that we entered into with Lee Equity in connection with our initial publicoffering, for so long as Lee Equity (or one or more of its affiliates, to the extent assigned thereto), individually or in the aggregate owns (i) 20% or more ofthe voting power of the issued and outstanding shares of our common stock, Lee Equity will be entitled to designate two director nominees or (ii) 10% ormore of the voting power of the issued and outstanding shares of our common stock, Lee Equity will be entitled to designate one director nominee, ineach case to serve on the Board of Directors (the “ Board ”) at any meeting of stockholders at which directors are to be elected to the extent that LeeEquity does not have a director designee then serving on the Board . We will take all necessary actions, including, among other things, calling a specialmeeting of the stockholders, to ensure that Lee Equity has at least one or two nominee designees, as the case may be. Lee Equity could invest in entitiesthat directly26Table of Contentsor indirectly compete with us. As a result of these relationships, when conflicts arise between the interests of Lee Equity and the interests of ourstockholders, these directors may not be disinterested.We are an emerging growth company and we cannot be certain if the reduced disclosure requirements applicable to emerging growthcompanies will make our common stock less attractive to investors.We are an “emerging growth company”, as defined in the JOBS Act, and we may take advantage of certain exemptions from various reportingrequirements that are applicable to other public companies that are not emerging growth companies including not being required to obtain an assessmentof the effectiveness of our internal controls over financial reporting from our independent registered public accounting firm pursuant to Section 404 ,reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements ofholding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. Ifsome investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and the market price ofour common stock may be more volatile.Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us more difficult, limit attempts byour stockholders to replace or remove our current management and limit the market price of our common stock.Provisions in our certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management.Our certificate of incorporation and amended and restated bylaws include provisions that:▪authorize our Board to issue, without further action by the stockholders, up to 15,000,000 shares of undesignated preferred stock;▪require that any action to be taken by our stockholders be effected at a duly called annual or special meeting and not by written consent;▪specify that special meetings of our stockholders can be called only upon the request of a majority of our Board or, at the request of Lee Equityso long as Lee Equity (or its affiliates) owns at least 10% of the voting power of all outstanding shares of our common stock;▪establish an advance notice procedure for stockholder proposals to be brought before an annual meeting, including proposed nominations ofpersons for election to our Board ;▪establish that our Board is divided into three classes, with each class serving three-year staggered terms;▪prohibit cumulative voting in the election of directors; and▪provide that our directors may be removed only for cause by a majority of the remaining members of our Board or the holders of a supermajorityof our outstanding shares of capital stock.These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult forstockholders to replace members of our Board , which is responsible for appointing the members of our management, and may discourage, delay orprevent a transaction involving a change in control of our Company that is in the best interest of our minority stockholders. Even in the absence of atakeover attempt, the existence of these provisions may adversely affect the prevailing market price of our common stock if they are viewed asdiscouraging future takeover attempts. In addition, we have opted out of Section 203 of the Delaware General Corporation Law, which would otherwiseprohibit us from engaging in any of a broad range of business combinations with any “interested” stockholder (any stockholder with 15% or more of ourcapital stock) for a period of three years following the date on which the stockholder became an “interested” stockholder is prohibited, subject to certainexceptions. Our amended and restated certificate of incorporation contains provisions that have the same effect as Section 203 of the Delaware GeneralCorporations Law, except that they provide that Lee Equity , or any affiliate thereof or any person or entity that acquires from any of the foregoingstockholders beneficial ownership of 5% or more of the then outstanding shares of our voting stock in a transaction or any person or entity which acquiresfrom such transferee beneficial ownership of 5% or more of the then outstanding shares of our voting stock other than through a registered public offeringor through any broker’s transaction executed on any securities exchange or other over-the-counter market, shall not be deemed an “interested”stockholder for purposes of such provision of our amended and restated certificate of incorporation and therefore not subject to the restrictions set forth insuch provision.Lee Equity and its affiliates will continue to be able to significantly influence our decisions and their interests may conflict with our or yours inthe future.Lee Equity and its affiliates beneficially own approximately 26% of our outstanding common stock as of March 1, 2016 . Under the terms of our amendedand restated certificate of incorporation and bylaws, Lee Equity has consent rights with respect to certain significant matters so long as Lee Equity owns25% or more of the outstanding shares of our common stock, including among others, certain change of control transactions, issuances of equitysecurities, the incurrence of27Table of Contentssignificant indebtedness, declaration or payments of non-pro rata dividends, significant investments in, or acquisitions or dispositions of assets, adoptionof any new equity-based incentive plan, any material increase in the salary of our Chief Executive Officer, certain amendments to our organizationaldocuments, any material change to our business, or any change to the number of directors serving on our Board . So long as Lee Equity owns 10% ormore of our issued and outstanding common stock, Lee Equity will be granted access to our customary non-public information and members of ourmanagement team and shall have the ability to share our material non-public information with any potential purchaser of us that executes an acceptableconfidentiality agreement with us which will include a prohibition on trading on material non-public information. Lee Equity has the right to assign any of itsgovernance and registration rights to its affiliates or to a third-party in connection with the sale by Lee Equity of 10% or more of the issued andoutstanding shares of our common stock. Under the terms of a stockholder’s agreement between us and Lee Equity , for so long as Lee Equity (or one ormore of its affiliates, to the extent assigned thereto), individually or in the aggregate owns (i) 20% or more of the voting power of the issued andoutstanding shares of our common stock, Lee Equity will be entitled to designate two director nominees or (ii) 10% or more of the voting power of theissued and outstanding shares of our common stock, Lee Equity will be entitled to designate one director nominee, in each case to serve on the Board atany meeting of stockholders at which directors are to be elected to the extent that Lee Equity does not have a director designee then serving on theBoard . We will take all necessary actions, including, among other things, calling a special meeting of the stockholders, to ensure that Lee Equity has atleast one or two nominee designees, as the case may be. As such, Lee Equity will continue to have substantial influence over us. Such concentration ofownership may also have the effect of delaying or preventing a change in control, which may be to the benefit of Lee Equity and other stockholdersaffiliated with Lee Equity but not in the interest of the Company or other stockholders not affiliated with Lee Equity .Item 1B. Unresolved Staff CommentsNone.Item 2. PropertiesOur stores are typically located in neighborhood shopping centers and the average store size is approximately 1,400 square feet. As ofDecember 28, 2015 , we and our franchise owners operated 1,536 stores with 1,496 of these stores located in 38 states (consisting of 1,369 franchisedand 127 Company-owned stores) plus 22 stores in Canada and 18 stores in the Middle East. Our principal executive office is located at 8000 NEParkway Drive, Suite 350, Vancouver, WA 98662. We lease the property for this principal executive office and our 127 Company-owned stores. Ourfranchised stores are situated on real property owned by franchise owners or leased directly by franchise owners from third-party landlords.28Table of ContentsThe map and chart below show the locations of our franchised and Company-owned stores in the United States as of December 28, 2015 .29Table of Contents FRANCHISEDSTORES COMPANY-OWNEDSTORES TOTALAlabama22 — 22Alaska12 — 12Arizona57 — 57Arkansas10 1 11California176 — 176Colorado58 24 82Florida16 10 26Georgia6 — 6Idaho26 9 35Illinois24 — 24Indiana42 — 42Iowa35 — 35Kansas40 — 40Kentucky20 1 21Louisiana7 — 7Maryland3 — 3Michigan10 8 18Minnesota71 24 95Mississippi2 1 3Missouri57 — 57Montana14 — 14Nebraska20 — 20Nevada25 — 25New Mexico12 6 18North Carolina20 — 20North Dakota12 — 12Ohio3 — 3Oklahoma26 — 26Oregon94 7 101South Carolina8 — 8South Dakota13 — 13Texas101 6 107Tennessee32 12 44Utah56 — 56Virginia3 — 3Washington131 16 147Wisconsin96 2 98Wyoming9 — 9Total1,369 127 1,496Lease ArrangementsWe lease the property for our Company-owned stores. The typical store is located in a neighborhood-oriented shopping center. Lease terms for thesestores are generally five years with one or more five-year renewal options and generally require us to pay a proportionate share of real estate taxes,insurance, common area and other operating costs in addition to base or fixed rent.30Table of ContentsItem 3. Legal ProceedingsWe currently are subject to litigation with a group of our franchise owners. In January 2014, six franchise owner groups claimed that we misrepresentedour sales volumes, made false representations to them and charged excess advertising fees, among other things. We engaged in mediation with thesefranchise owners, which is required under the terms of their franchise agreements, in order to address and resolve their claims, but we were unable toreach a settlement agreement. On April 4, 2014, a total of 12 franchise owner groups, including those franchise owners that previously made theallegations described above, filed a lawsuit against us in the Superior Court in Clark County, Washington, making essentially the same allegations forviolation of the Washington Franchise Investment Protection Act, fraud, negligent misrepresentation and breach of contract and seeking declaratory andinjunctive relief, as well as monetary damages. Based on motions filed by us in that lawsuit, the court ruled on July 9, 2014, that certain of the plaintiffs’claims under the anti-fraud and nondisclosure provisions of the Washington Franchise Investment Protection Act should be dismissed and that certainother claims in the case would need to be more specifically alleged. The court also ruled that the six franchise owner groups who had not mediated withus prior to filing the lawsuit must mediate with us in good faith, and that their claims shall be stayed until they have done so.On June 18, 2014, an additional 16 franchise owner groups, represented by the same counsel as the plaintiffs described above, filed a lawsuit in theSuperior Court in Clark County, Washington making essentially the same allegations as made in the lawsuit described above and seeking declaratoryand injunctive relief, as well as monetary damages. The court consolidated the two lawsuits into a single case and ordered that the plaintiffs in the newlawsuit, none of whom had mediated with us prior to filing the lawsuit, must do so, and that their claims be stayed until they have completed mediatingwith us in good faith.In October 2014, we engaged in mediation with the 22 franchise owner groups who had not previously done so. As a result of that mediation and otherefforts, we have now reached resolution with twelve of the franchise owner groups involved in the consolidated lawsuits, and their claims have eitherbeen dismissed or dismissal is pending.In February 2015, the remaining plaintiffs in the consolidated lawsuits filed an amended complaint, removing some claims, amending some claims,adding claims and naming some of our former and current franchise sales staff as additional individual defendants. As before, we believe the allegationsin this litigation lack merit and, for those plaintiffs with whom we are unable to reach resolution, we will continue to vigorously defend our interests,including by asserting a number of affirmative defenses and, where appropriate, counterclaims. We provide no assurance that we will be successful inour defense of these lawsuits; however, we do not currently expect the cost of resolving them to have a material adverse effect on our consolidatedfinancial position, results of operations, or cash flows.We are also currently named as a defendant in a putative class action lawsuit filed by plaintiff John Lennartson on May 8, 2015, in the United StatesDistrict Court for the Western District of Washington. The lawsuit alleges we failed to comply with the requirements of the Telephone ConsumerProtection Act (TCPA) when we sent SMS text messages to consumers. The plaintiff in the lawsuit asks that the court certify the putative class and thatstatutory damages under the TCPA be awarded to plaintiff and each class member. We believe the plaintiff’s interpretation of the applicable law isincorrect and we will continue to vigorously defend ourselves in the lawsuit, but provide no assurance that we will be successful. An adverse judgment orsettlement related to this lawsuit could have a material adverse effect on our consolidated financial position, results of operations, or cash flows.In addition to the foregoing, we are subject to routine legal proceedings, claims, and litigation in the ordinary course of our business. We also may engagein future litigation with franchise owners to enforce the terms of our franchise agreements and compliance with our brand standards as determinednecessary to protect our brand, the consistency of our products and the customer experience. Lawsuits require significant management attention andfinancial resources and the outcome of any litigation is inherently uncertain. We do not, however, expect that the costs to resolve these routine matterswill have a material adverse effect on our consolidated financial position, results of operations, or cash flows.Item 4. Mine Safety DisclosuresNot applicable.31Table of ContentsPART IIItem 5. Market for Registrant's Common Equity, Related Stockholder Matters and IssuerPurchases of Equity SecuritiesOur common stock has traded on the NASDAQ Global Select Market under the symbol FRSH since it began trading on May 2, 2014. Our initial publicoffering was priced at $11.00 per share on May 1, 2014. The following table sets forth, for the periods indicated, the highest and lowest intraday salesprices per share of our common stock as reported on the NASDAQ Global Select Market. High LowFiscal Year 2014 Second quarter (May 2, 2014 - June 30, 2014)$12.10 $8.32Third quarter (July 1, 2014 - September 29, 2014)$11.09 $8.08Fourth quarter (September 30, 2014 - December 29, 2014)$11.92 $8.68 Fiscal Year 2015 First quarter (December 30, 2014 - March 30, 2015)$20.00 $10.60Second quarter (March 31, 2015 - June 29, 2015)$22.72 $16.05Third quarter (June 30, 2015 - September 28, 2015)$21.66 $12.53Fourth quarter (September 29, 2015 - December 28, 2015)$15.19 $10.41On March 1, 2016, we had approximately 36 stockholders of record of our common stock. These figures do not include beneficial owners who holdshares in nominee name.During the fourth quarter ended December 28, 2015 , the Company did not repurchase any shares.DividendsNo dividends have been declared or paid on our shares of common stock and we do not intend to pay dividends on our common stock in the foreseeablefuture. We currently expect to retain all available funds and future earnings, if any, for use in the operation, development and expansion of our business.However, in the future, we may change this policy and choose to pay dividends. Any future determination to pay cash dividends will be at the discretion ofour board of directors and will depend on then-existing conditions, including our financial condition, operating results, business prospects, capitalrequirements, results of operations and other factors that our board of directors considers relevant.We are a holding company that does not conduct any business operations of our own. As a result, our ability to pay cash dividends on our common stockis dependent upon cash dividends and distributions and other transfers from our subsidiaries. The ability of our subsidiaries to pay dividends is restrictedby the terms of our senior secured credit facility. For additional information regarding our financial condition, see Management’s Discussion and Analysisof Financial Condition and Results of Operations .32Table of ContentsPerformance GraphThe following graph demonstrates a comparison of cumulative total returns for Papa Murphy’s common stock, the Standard & Poor’s 500 Stock Index,the NASDAQ Composite Index, and the Standard & Poor’s 400 Restaurants Index over the period from May 1, 2014, (using the price of which our sharesof common stock were initially sold to the public) to December 28, 2015 . The comparison assumes $100 was invested in Papa Murphy’s common stockon May 1, 2014, and in each of the aforementioned indices. Cumulative total returns for each of the indices assumes that all dividends were reinvestedon the day of issuance.Historical stock price performance should not be relied on as indicative of future stock price performance.33Table of ContentsItem 6. Selected Financial DataWe derived the selected consolidated statements of operations and cash flows data for fiscal years 2015 , 2014 and 2013 and the selected consolidatedbalance sheet data as of December 28, 2015 , and December 29, 2014 , from our audited consolidated financial statements and related notes theretoincluded in Financial Statements and Supplementary Data . We derived the selected consolidated statements of operations and cash flows data for fiscalyears 2012 and 2011 and the selected consolidated balance sheet data as of December 30, 2013 , December 31, 2012 , and January 2, 2012 , from ouraudited consolidated financial statements and related notes thereto not included in this report.In connection with the IPO , on May 1, 2014, we converted our Series A Preferred Stock and Series B Preferred Stock (together, the “ Preferred Shares ”)into 3,054,318 common shares and amended our certificate of incorporation to effect a 2.2630 for 1 stock split of our common stock. As a result of thestock split, all previously reported share amounts have been retrospectively restated to reflect the stock split.Our historical results are not necessarily indicative of future operating results. You should read the information set forth below together withManagement’s Discussion and Analysis of Financial Condition and Results of Operations and Financial Statements and Supplementary Data and therelated Notes to Consolidated Financial Statements .34Table of Contents FISCAL YEAR(in thousands, except share and per share data)2015 2014 2013 2012 2011Consolidated Statement of Operations Data: Revenues Franchise royalties$40,243 $39,305 $36,897 $35,113 $33,687Franchise and development fees4,222 4,531 4,330 2,826 2,398Company-owned store sales74,300 50,598 39,148 28,813 15,619Lease and other1,444 2,965 120 164 218Total revenues120,209 97,399 80,495 66,916 51,922Costs and Expenses Store operating costs: Cost of food and packaging26,603 19,686 14,700 10,741 6,088Compensation and benefits19,858 12,673 10,687 8,160 4,710Advertising7,888 5,041 3,820 2,711 1,514Occupancy4,750 2,873 2,365 1,980 1,102Other store operating costs7,517 4,434 3,988 2,961 1,722Selling, general and administrative28,207 29,263 24,180 21,225 20,833Depreciation and amortization10,002 8,052 6,973 6,187 5,798(Gain) loss on disposal or impairment of property and equipment(251) 72 847 193 263Total costs and expenses104,574 82,094 67,560 54,158 42,030Operating Income15,635 15,305 12,935 12,758 9,892Interest expense, net4,523 8,025 10,429 10,368 10,227Loss on early retirement of debt— 4,619 4,029 5,138 —Loss on impairment of investments4,500 — — — —Other expense, net133 178 44 248 41Income (Loss) Before Income Taxes6,479 2,483 (1,567) (2,996) (376)Provision for income taxes2,068 1,235 1,024 (882) 230Net Income (Loss)4,411 1,248 (2,591) (2,114) (606)Net loss attributable to noncontrolling interests500 — 19 — —Net Income (Loss) Attributable to Papa Murphy’s$4,911 $1,248 $(2,572) $(2,114) $(606) Earnings (loss) per common share: Basic (1)$0.29 $(0.07) $(2.34) $(2.33) $(2.00)Diluted (1)0.29 (0.07) (2.34) (2.33) (2.00)Weighted average common stock outstanding: Basic16,653,127 12,101,236 3,847,861 3,673,185 3,600,976Diluted16,870,693 12,101,236 3,847,861 3,673,185 3,600,976 Consolidated Statement of Cash Flows: Cash flows from operating activities$23,743 $15,509 $9,874 $9,356 $11,804Cash flows from investing activities(19,554) (9,527) (15,249) (5,904) (16,062)Cash flows from financing activities(2,378) (4,631) 6,613 (5,864) (2,563)35Table of Contents AS OF(in thousands)December 28, 2015 December 29, 2014 December 30, 2013 December 31, 2012 January 2, 2012Consolidated Balance Sheet Data: Cash and cash equivalents$6,867 $5,056 $3,705 $2,428 $4,839Total current assets18,896 14,991 14,521 6,663 8,394Total assets275,471 264,127 258,712 241,277 243,567Total current liabilities24,149 18,558 17,965 12,568 11,471Total debt (2)112,200 115,000 170,000 125,280 90,226Total Papa Murphy's Holdings, Inc. shareholders’ equity97,656 91,298 33,925 63,930 100,208Net working capital (3)(5,253) (3,567) (3,444) (5,905) (3,077)(in thousands, except selected operating data, unless otherwise noted)FISCAL YEAR2015 2014 2013 2012 2011Other Financial Data: Capital expenditures (4)10,430 4,067 3,037 1,343 2,193Selected Operating Data: Number of stores at end of period Domestic franchised1,369 1,342 1,327 1,270 1,232Domestic Company-owned127 91 69 59 51International40 28 22 18 18Total1,536 1,461 1,418 1,347 1,301 Number of comparable stores at end of period (5) Domestic franchised1,279 1,247 1,226 1,194 1,164Domestic Company-owned110 88 68 57 50International28 20 17 15 16Total1,417 1,355 1,311 1,266 1,230AWS per store (whole dollars) (6)$11,651 $11,480 $11,099 $10,923 $10,640Comparable store sales growth (7)1.9% 4.5% 2.8% 2.9% 5.7%System-wide sales (8)$892,249 $849,682 $785,630 $739,091 $701,770System-wide sales growth (9)5.0% 8.2% 6.3% 5.3% 7.4%(1)Basic and Diluted EPS is a loss for 2014 as a result of cumulative dividends to preferred stockholders prior to our IPO. More information can be found in Financial Statementsand Supplementary Data in Note 16 — Earnings per Share (EPS) of the accompanying Notes to Consolidated Financial Statements .(2)Represents total outstanding indebtedness, including current portion and excluding unamortized, deferred financing costs.(3)Represents total current assets less total current liabilities.(4)Represents long-lived asset capital expenditures related to the acquisition of property and equipment and excludes expenditures relating to acquisitions of businesses.(5)A comparable store is a store that has been open for at least 52 weeks from the comparable date, which is the Tuesday following the opening date.(6)AWS consists of the average weekly sales of domestic franchised and Company-owned stores over a specified period of time. AWS is calculated by dividing the total net salesof our system-wide stores for the relevant time period by the number of weeks these same stores were open in such time period.(7)System-wide comparable store sales growth represents year-over-year sales comparisons for comparable domestic stores.(8)System-wide sales include net sales by all of our system-wide stores.(9)System-wide sales growth represents year-over-year sales comparisons for system-wide sales.36Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results ofOperationsThe following discussion and analysis of our financial condition and results of operations should be read in conjunction with Selected Financial Data andFinancial Statements and Supplementary Data and the related Notes to Consolidated Financial Statements . To match our operating cycle, we use a 52-or 53-week fiscal year, ending on the Monday nearest to December 31. Our fiscal quarters each contain 13 operating weeks, with the exception of thefourth quarter of a 53-week fiscal year, which contains 14 operating weeks. Fiscal years 2015 , 2014 and 2013 were 52-week periods ended onDecember 28, 2015 , December 29, 2014 and December 30, 2013 , respectively.Cautionary Note Regarding Forward-Looking StatementsIn addition to historical information, this discussion and analysis contains “forward-looking statements” within the meaning of the U.S. Private SecuritiesLitigation Reform Act of 1995 that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-lookingstatements as a result of certain factors including, but not limited to, those discussed in the section entitled “Risk Factors” in this Annual Report on Form10-K. All statements other than statements of historical fact or relating to present facts or current conditions included in this discussion and analysis areforward-looking statements. Forward-looking statements give our current expectations and projections relating to our financial condition, results ofoperations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly tohistorical or current facts. Examples of forward-looking statements include those regarding our future financial or operating results, cash flows, sufficiencyof liquidity, operating margins, capital expenditures and working capital needs, business strategies and priorities, resolution of litigation and claims,expansion and growth opportunities, economies of scale achieved by growth, accretion to earnings from acquisitions, expected implementation of POSsystem , seasonal fluctuations, exposure to foreign currency and interest rate risk, as well as industry trends and outlooks. These statements may includewords such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “should,” “can have,” “likely” and other words and terms ofsimilar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events .The forward-looking statements contained in this discussion and analysis are based on assumptions that we have made in light of our industryexperience and our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate underthe circumstances. As you read and consider this discussion and analysis, you should understand that these statements are not guarantees ofperformance or results. They involve risks, uncertainties (many of which are beyond our control) and assumptions. Although we believe that theseforward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual operating and financialperformance and cause our performance to differ materially from the performance anticipated in the forward-looking statements. We believe these factorsinclude, but are not limited to, those described under the section entitled “Risk Factors” in this Annual Report on Form 10-K. Should one or more of theserisks or uncertainties materialize, or should any of these assumptions prove incorrect, our actual operating and financial performance may vary inmaterial respects from expectations based on these forward-looking statements.Any forward-looking statement made by us in this discussion and analysis speaks only as of the date on which we make it. Factors or events that couldcause our actual operating and financial performance to differ may emerge from time to time, and it is not possible for us to predict all of them. Weundertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise,except as may be required by law.OverviewPapa Murphy’s is a franchisor and operator of the largest Take ‘N’ Bake pizza chain in the United States and the fifth largest pizza chain overall. Weoperate through a footprint of 1,536 stores, of which 91.7% are franchised, located in 38 states plus Canada and the Middle East.We have been rated the #1 pizza chain in the United States by multiple third-party consumer studies. For example, in 2016 we were rated the #1 Pizzachain and one of the Top 5 brands overall in Technomic's Chain Restaurant Consumers' Choice Awards, including the top spots in Value andConvenience. We were also rated the #1 pizza chain overall by Nation’s Restaurant New s Consumer Picks each year from 2011 to 2015. Whencompared to broader restaurant chain competition, we were also recognized by Technomic in 2015, 2014 and 2013 as the #1 chain overall among allrestaurants and all food categories and by Nation’s Restaurant News in 2013 and 2012 as one of the Top 5 Overall limited service restaurant chainsacross all food categories.37Table of ContentsOur financial results are driven largely by system-wide sales at our franchised and Company-owned stores. System-wide sales are driven by comparablestore sales growth and store counts, which translate into royalty payments from franchise owners, as well as Company-owned store revenues. Weconsistently strive to increase both comparable store sales and our store counts. Total revenues can also be impacted by acquisitions of franchisedstores by our Domestic Company Stores segment or the refranchising of Company-owned stores.The Take ‘N’ Bake model offers operating advantages that differentiate us from other restaurant concepts. Our domestic stores (i) do not require ovens,freezers or other expensive equipment because our customers bake their customized pizzas at home; (ii) do not offer delivery, reducing operationalcomplexity for franchise owners and their employees; (iii) maintain shorter operating hours (typically 11:00 a.m. to 9:00 p.m.) that are attractive tofranchise owners and their employees; (iv) require fewer employees during each shift compared to other restaurant concepts, resulting in lower laborcosts; and (v) do not have dining areas, resulting in lower occupancy and operating costs.The relatively small initial investments and operating costs required to own and operate a Papa Murphy's store creates the opportunity for higher marginsand attractive returns. We believe the low cost structure, simple operations, a strong brand message supported by high levels of advertising spendingand high-quality menu offerings drive attractive store-level economics, which, in turn, drives demand for new stores.2015 HighlightsRevenue GrowthTotal revenues grew 23.4% from $97 million in 2014 to $120 million in 2015 due primarily to the strategic acquisition of some franchised stores and theopening of new Company-owned stores. System-wide sales increased 5.0% from $850 million in 2014 to $892 million in 2015 as a result of 75 net newstores added during the year and comparable store sales growth. Comparable store sales growth in 2015 compared to 2014 and 2013 for selectedsegments was as follows: Fiscal Year 2015 2014 2013Domestic Franchise1.9% 4.3% 2.8%Domestic Company Stores1.8% 8.1% 4.2%Total domestic stores1.9% 4.5% 2.8%Comparable store sales growth primarily resulted from an increased average check due to targeted price increases and the launch of our Gourmet Deliteproduct category in the fourth quarter of 2014. As of the end of 2015 , we had achieved positive comparable store sales growth in 42 of the last 48quarters.Store DevelopmentDuring 2015 , we and our franchise owners opened 111 stores, including 99 in the United States. While we plan to strategically expand our Company-owned store base in select markets, we may also refranchise selected Company-owned stores over time as opportunities arise. We expect the majorityof our new store expansion will continue to result from new franchised store openings.AcquisitionsOn March 9, 2015, we acquired six Papa Murphy’s stores in the Seattle, Washington area for approximately $4.1 million . The six stores acquired werefrom a single franchise owner and increased our Company-owned store count to 12 units in the Seattle market. This transaction was accretive to annualearnings per share by about $0.02 and contributed approximately $630,000 of incremental EBITDA (as defined below) in 2015 , net of foregone royalties.We also acquired 17 additional Papa Murphy’s stores during 2015 in seven different markets. Eight stores were acquired in the Knoxville, Tennessee,market, three additional stores in the Seattle, Washington, market, two stores in the Dallas, Texas, market, and one store each in the Boise, Idaho;Portland, Oregon; Colorado Springs, Colorado; and Santa Fe, New Mexico markets. These transactions are not expected to affect earnings in the near-term.38Table of ContentsTechnology InvestmentsOur POS system is an important technology platform for our future growth. POS system s will enable direct, digital marketing and mobile couponcapabilities. We have rolled out POS system terminals to 1,211 stores as of December 28, 2015 .We continue to roll out an integrated online ordering platform coupled with the latest version of our POS system software, which had been implementedin 949 stores as of December 28, 2015 . An additional 15 stores were still on our original, non-integrated online ordering platform as ofDecember 28, 2015 , pending conversion.39Table of ContentsOur SegmentsWe operate in three business segments: Domestic Franchise, Domestic Company Stores and International. Our Domestic Franchise segment consists ofour domestic franchised stores, which represent the majority of our system-wide stores. Our Domestic Company Stores segment consists of ourCompany-owned stores in the United States. Our International segment consists of our stores outside of the United States, all of which are franchised.The following table presents our Revenues , Operating Income and Depreciation and amortization for each of our segments for the periods presented: Fiscal Year(in thousands)2015 2014 2013Revenues Domestic Franchise$45,579 $46,233 $40,450Domestic Company Stores74,300 50,598 39,148International330 568 897Total$120,209 $97,399 $80,495Segment Operating Income (Loss) Domestic Franchise$20,750 $21,939 $20,540Domestic Company Stores1,359 1,307 (408)International238 20 (24)Corporate and unallocated(6,712) (7,961) (7,173)Total$15,635 $15,305 $12,935Depreciation and amortization Domestic Franchise$5,392 $5,046 $4,753Domestic Company Stores4,579 2,975 2,193International31 31 27Total$10,002 $8,052 $6,973Key Operating MetricsWe evaluate the performance of our business using a variety of operating and performance metrics. Set forth below is a summary and description of ourkey operating metrics. 2015 2014 2013Domestic store average weekly sales (AWS)$11,651 $11,480 $11,099Domestic comparable store sales growth1.9% 4.5% 2.8%Domestic comparable stores1,389 1,335 1,294System-wide sales (in thousands)$892,249 $849,682 $785,630Number of system-wide stores at period end1,536 1,461 1,418Adjusted EBITDA (in thousands)$28,118 $27,678 $24,440 Average Weekly Sales ( AWS )AWS consists of the average weekly sales of domestic franchised and Company-owned stores over a specified period of time. AWS is calculated bydividing the total net sales of our domestic system-wide stores for the relevant time period by the number of weeks these stores were open in such timeperiod. This measure allows management to assess changes in customer traffic and spending patterns in our domestic stores.Comparable Store Sales GrowthComparable store sales growth represents the change in year-over-year sales for comparable stores. A comparable store is a store that has been openfor at least 52 full weeks from the comparable date (the Tuesday following the opening date).40Table of ContentsThis measure highlights the performance of existing stores, while excluding the effect of newly opened or closed stores. Comparable store sales growthreflects changes in the number of transactions and in customer spend per transaction at existing stores. Customer spend per transaction is affected bychanges in menu prices, sales mix and the number of items sold per customer.System-Wide SalesSystem-wide sales include net sales by all of our system-wide stores. This measure allows management to assess the health of our brand, our relativeposition to competitors and assess changes in our royalty revenues.Store Openings, Closures, Acquisitions and DivestituresWe review the number of new stores, the number of closed stores, and the number of acquisitions and divestitures of stores to assess growth in system-wide sales, royalty revenues and Company-owned store sales.The following table presents the changes in the number of stores in our system for the fiscal years 2015 , 2014 and 2013 . DomesticCompany Stores DomesticFranchise Total Domestic International TotalStore count at December 31, 201259 1,270 1,329 18 1,347Openings1 93 94 5 99Closings(1) (26) (27) (1) (28)Net transfers10 (10) — — —Store count at December 30, 201369 1,327 1,396 22 1,418Openings2 85 87 8 95Closings(1) (49) (50) (2) (52)Net transfers21 (21) — — —Store count at December 29, 201491 1,342 1,433 28 1,461Openings18 81 99 12 111Closings(1) (35) (36) — (36)Net transfers19 (19) — — —Store count at December 28, 2015127 1,369 1,496 40 1,536Starting in 2015, openings in the Domestic Company Stores segment included stores built under our pre-sale development program. During 2015, fourCompany-owned stores opened under this program. As of December 28, 2015 , two of these stores had been sold to franchisees and two were classifiedas Assets held for sale .EBITDA and Adjusted EBITDATo supplement our consolidated financial statements presented in accordance with generally accepted accounting principles in the U.S. (“ GAAP ”), weconsider certain financial measures that are not prepared in accordance with GAAP . These non- GAAP financial measures are not based on anystandardized methodology prescribed by GAAP and are not necessarily comparable to similarly-titled measures presented by other companies.“ Adjusted EBITDA ” is calculated as net income (loss) before interest expense, income taxes, depreciation and amortization (“ EBITDA ”) as adjustedfor:▪All non-cash losses or expenses (including non-cash share-based compensation expenses and the non-cash portion of rent expenses relating tothe difference between GAAP and cash rent expenses), excluding any non-cash loss or expense that is an accrual of a reserve for a cashexpenditure or payment to be made, or anticipated to be made, in a future period;▪Non-recurring or unusual cash fees, costs, charges, losses and expenses;▪Fees, costs and expenses related to acquisitions;▪Pre-opening costs with respect to new stores;▪Historical management fees and expenses incurred under our advisory services and monitoring agreement with Lee Equity , which terminated inconnection with the IPO ; and41Table of Contents▪Fees and expenses incurred in connection with the issuance of debt.Adjusted EBITDA eliminates the effects of items that we do not consider indicative of our operating performance. Adjusted EBITDA is a supplementalmeasure of operating performance that does not represent and should not be considered as an alternative to net income (loss) , as determined by GAAP. Our calculation of Adjusted EBITDA may not be comparable to that reported by other companies.Adjusted EBITDA is a non- GAAP financial measure. Management believes that Adjusted EBITDA , when viewed with our results of operations inaccordance with GAAP and our reconciliation of Adjusted EBITDA to net income (loss) , provides additional information to investors about certainmaterial non-cash items and unusual items. We provide this non- GAAP financial measure to enhance investors’ understanding of our business and ourresults of operations, and to assist investors in evaluating how well we are executing strategic initiatives. We believe Adjusted EBITDA is used byinvestors as a supplemental measure to evaluate the overall operating performance of companies in our industry.Management uses Adjusted EBITDA and other similar measures:▪As a measurement used in comparing our operating performance on a consistent basis;▪To calculate incentive compensation for our employees;▪For planning purposes, including the preparation of our internal annual operating budget; and▪To evaluate the performance and effectiveness of our operational strategies.Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reportedunder GAAP . Some of the limitations are:▪Adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments,on our debt;▪Adjusted EBITDA excludes pre-opening costs and non-cash GAAP rent expense with respect to new stores, which we will continue to incur inthe future as we open new stores consistent with our growth strategy;▪Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in thefuture, and Adjusted EBITDA does not reflect the cash requirements for such replacements; and▪Adjusted EBITDA does not reflect our tax expense or the cash requirements to pay our taxes.To address these limitations, we reconcile Adjusted EBITDA to the most directly comparable GAAP measure, net income. Further, we also review GAAPmeasures and evaluate individual measures that are not included in Adjusted EBITDA .42Table of ContentsThe following table provides a reconciliation of our net income (loss) to Adjusted EBITDA for the periods presented: Fiscal Year(in thousands)2015 2014 2013Net Income (Loss)$4,411 $1,248 $(2,591)Net loss attributable to noncontrolling interests500 — 19Net Income (Loss) Attributable to Papa Murphy’s4,911 1,248 (2,572)Depreciation and amortization10,002 8,052 6,973Income tax provision2,068 1,235 1,024Interest expense, net4,523 8,025 10,429EBITDA21,504 18,560 15,854(Gain) loss on disposal or impairment of property and equipment (1)(251) 72 847Expenses not indicative of future operations: Secondary offering and IPO preparation costs (2)345 622 1,880Loss on Project Pie impairment and disposal (3)4,325 — —Management fees and related expenses (4)— 1,678 586Transaction costs (5)65 78 402New store pre-opening expenses (6)696 32 19Non-cash expenses and non-income based state taxes (7)1,434 2,017 909Loss on settlement of liabilities (8)— 4,619 3,943Adjusted EBITDA$28,118 $27,678 $24,440(1)Represents non-cash losses resulting from disposal or impairment of property and equipment, including divested Company stores.(2)Represents costs related to the secondary offering of the Company's common stock, non-recurring advisory expenses in connection with our IPO and non-recurringmanagement transition and restructuring costs, consisting of severance, recruitment, relocation and other costs in connection with recruiting a new chief financial officerand strategic restructuring activities.(3)Represents a $4 million loss recognized upon impairment of Project Pie , a cost-method investment, and its subsequent disposal, and the write-off as bad debt receivablestotaling $325,000.(4)Represents the elimination of management fees and related costs paid to Lee Equity for advisory services provided pursuant to an advisory services and monitoringagreement and the termination fee incurred with the IPO . More information can be found in Financial Statements and Supplementary Data in Note 19 — Related PartyTransactions of the accompanying Notes to Consolidated Financial Statements .(5)Represents transaction costs relating to the acquisition of multiple franchised stores and the investments in and divestment of Project Pie .(6)Represents expenses directly associated with the opening of new stores and incurred primarily in advance of the store opening, including wages, benefits and travel fortraining of opening teams, grand opening marketing costs and other store operating costs.(7)Represents (i) non-cash expenses related to equity-based compensation; (ii) non-cash expenses related to the difference between GAAP and cash rent expense; (iii) non-cash expenses related to the fair valuation of certain common stock and Series A Preferred Stock subject to put options; (iv) non-cash gains from settlement of assetretirement obligations; and (v) state revenue taxes levied in lieu of an income tax.(8)Represents losses resulting from refinancing of long-term debt.Key Financial DefinitionsRevenuesSubstantially all of our revenues are derived from sales of pizza and other food and beverage products to the general public by Company-owned storesand the collection of franchise royalties and fees associated with franchise and development rights. Franchise and development fees include initialfranchise fees charged for opening a new franchised store, successive fees for the renewal of expiring franchise agreements, transfer fees fortransferring ownership of a franchise and deposit forfeiture fees. “ Lease and other ,” as used in this report, includes revenues earned from the subleaseof real estate under a master lease agreement with a national retailer and revenues derived from the resale of POS system licenses to franchise ownersat cost. Lease income is recognized in the period earned, which coincides with the period the expense is due to the master leaseholder. See Selling,General and Administrative Costs below for the related offsetting expense to the POS system licenses resold to franchise owners.43Table of ContentsStore Operating CostsStore operating costs relate to our Domestic Company Stores segment and consist of Cost of food and packaging , Compensation and benefits ,Advertising , Occupancy costs and Other store operating costs . We expect all of our Store operating costs to vary as our store count changes frombuilding or acquiring new Company-owned stores. Cost of food and packaging and Advertising can be expected to fluctuate predominantly with theincreases or decreases in Revenues of our Domestic Company Stores segment.Selling, General and Administrative CostsSelling, general and administrative costs consist of wages, benefits and other compensation, franchise development expenses, travel, marketing,accounting fees, legal fees, the costs of POS system software licenses sold to franchise owners at cost, sponsor management fees and other expensesrelated to the infrastructure required to support our franchised and Company-owned stores. See Revenues above for the related offsetting revenue fromthe POS system software licenses resold to franchise owners. Selling, general and administrative costs also include net advertising expenses of anadvertising fund we manage on behalf of all domestic stores.Depreciation and AmortizationDepreciation and amortization constitute non-cash charges related to the depreciation of fixed assets, including leasehold improvements and equipment,and the amortization of franchise relationships and reacquired franchise rights relating to our acquisition of certain franchised stores.44Table of ContentsResults of OperationsThe following table presents our results of operations in dollars and as a percentage of total revenues for the fiscal years 2015 , 2014 and 2013 . Fiscal Year 2015 2014 2013(in thousands)$ TOTAL% OFREVENUES $ TOTAL % OF REVENUES $ TOTAL % OF REVENUESRevenues Franchise royalties$40,243 33.5 % $39,305 40.4% $36,897 45.8 %Franchise and development fees4,222 3.5 % 4,531 4.7% 4,330 5.4 %Company-owned store sales74,300 61.8 % 50,598 51.9% 39,148 48.6 %Lease and other (1)1,444 1.2 % 2,965 3.0% 120 0.2 %Total revenues (1)120,209 100.0 % 97,399 100.0% 80,495 100.0 %Costs and Expenses Store operating costs: Cost of food and packaging (2)26,603 22.0 % 19,686 20.2% 14,700 18.3 %Compensation and benefits (2)19,858 16.5 % 12,673 13.0% 10,687 13.3 %Advertising (2)7,888 6.6 % 5,041 5.2% 3,820 4.7 %Occupancy (2)4,750 4.0 % 2,873 2.9% 2,365 2.9 %Other store operating costs (2)7,517 6.3 % 4,434 4.6% 3,988 5.0 %Selling, general, and administrative (1)28,207 23.5 % 29,263 30.0% 24,180 30.0 %Depreciation and amortization10,002 8.3 % 8,052 8.3% 6,973 8.7 %(Gain) loss on disposal or impairment of property and equipment(251) (0.2)% 72 0.1% 847 1.0 %Total costs and expenses104,574 87.0 % 82,094 84.3% 67,560 83.9 %Operating Income (1)15,635 13.0 % 15,305 15.7% 12,935 16.1 %Interest expense, net4,523 3.8 % 8,025 8.3% 10,429 13.0 %Loss on early retirement of debt— — % 4,619 4.7% 4,029 5.0 %Loss on impairment of investments4,500 3.7 % — —% — — %Other expense, net133 0.1 % 178 0.2% 44 — %Income (Loss) Before Income Taxes6,479 5.4 % 2,483 2.5% (1,567) (1.9)%Provision for income taxes2,068 1.7 % 1,235 1.3% 1,024 1.3 %Net Income (Loss)$4,411 3.7 % $1,248 1.3% (2,591) (3.2)%Net loss attributable to noncontrolling interests500 0.4 % — 0.0% 19 — %Net Income (Loss) Attributable to Papa Murphy’s$4,911 4.1 % $1,248 1.3% $(2,572) (3.2)%(1)During 2015 , we incurred $1.0 million in expense related to POS system software licenses resold to franchise owners at cost. The revenue and expense from these transactionsare included in Lease and other and Selling, general and administrative expense, respectively. We originally acquired $4.5 million in POS system software licenses in 2013 in alump sum purchase to obtain more favorable pricing and expedite the roll-out of the POS system . Excluding the revenues and expenses related to the resale of the POS systemsoftware licenses at cost, total non- GAAP revenues for 2015 would be $119.3 million and Selling, general and administrative costs would be $27.3 million , or 22.9% of non-GAAP revenues. Excluding these revenues and costs, Operating Income for 2015 would be $15.6 million , or 13.1% of non- GAAP revenues.During 2014 , we incurred $2.7 million in expense related to POS system software licenses resold to franchise owners at cost. Excluding the revenues and expenses related tothe resale of the POS system software licenses at cost and the costs incurred to prepare for the IPO , total non- GAAP revenues for 2014 would be $94.7 million and Selling,general and administrative costs would be $24.6 million , or 26.0% of non- GAAP revenues. Excluding these revenues and costs, Operating Income for 2014 would be $17.2million , or 18.2% of non- GAAP revenues.(2)Please see the table presented in Costs and Expenses below, which presents Company store expenses as a percentage of Company store revenue for 2015 , 2014 and 2013 .RevenuesTotal revenues . The following table presents Total revenues for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013Total revenues$120,209 23.4% $97,399 21.0% $80,49545Table of ContentsTotal revenues grew due to the acquisition of some franchised stores by our Domestic Company Stores segment, store count increases, and domesticcomparable store sales growth of 1.9% and 4.5% in 2015 and 2014 , respectively, offset by a $1.8 million decrease in revenues from the resale of POSsystem licenses sold to franchise owners at cost.Franchise royalties . The following table presents Franchise royalties for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013Franchise royalties$40,243 2.4% $39,305 6.5% $36,897Percentage of total revenues33.5% 40.4% 45.8%Franchise royalties increased in 2015 due primarily to Domestic Franchise store counts increasing from 1,342 on December 29, 2014 to 1,369 onDecember 28, 2015 and Domestic Franchise comparable store sales growth of 1.9% .Franchise royalties increased in 2014 due primarily to Domestic Franchise store counts increasing from 1,327 on December 30, 2013 to 1,342 onDecember 29, 2014 , and Domestic Franchise comparable store sales growth of 4.3% .The decreases in Franchise royalties as a percentage of Total revenues were the result of Company-owned store sales increases of 46.8% and 29.2% in2015 and 2014 , respectively.Franchise and development fees . The following table presents Franchise and development fees for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013Franchise and development fees$4,222 (6.8)% $4,531 4.6% $4,330Percentage of total revenues3.5% 4.7% 5.4%Franchise and development fees decreased in 2015 due to fewer successive fees as 40 fewer franchise agreements came up for renewal in 2015compared to 2014 . For 2014 , Franchise and development fees increased due primarily to additional successive fees, transfer fees and initial feeforfeitures, partially offset by reduced International development fees and the opening of 5 fewer franchised stores than in 2013 .Company-owned store sales . The following table presents Company-owned store sales for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013Company-owned store sales$74,300 46.8% $50,598 29.2% $39,148Percentage of total revenues61.8% 51.9% 48.6%Company-owned store sales increased in 2015 due to the acquisition of 23 stores from franchise owners, the opening of 18 new Company-owned storesand comparable store sales growth of 1.8% in the Domestic Company Stores segment.For 2014 , Company-owned store sales increased due to the acquisition of 22 stores from franchise owners, the opening of two new Company-ownedstores and comparable store sales growth of 8.1% in the Domestic Company Stores segment, which was partially offset by the divestiture of 9 stores inthe fourth quarter of 2013.Lease and other The following table presents Lease and other revenue for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013Lease and other revenue$1,444 (51.3)% $2,965 N/M $120Percentage of total revenues1.2% 3.0% 0.2%N/M = Not MeaningfulLease and other revenue is primarily driven by the resale of POS system software licenses to franchise owners at cost. An equal and offsetting costrelated to the resale of the POS system software licenses is included in Selling, general and administrative expenses as discussed below. Revenue fromPOS system software licenses was $1.0 million and $2.7 million in 2015 and 2014 , respectively.46Table of ContentsCosts and ExpensesTotal costs and expenses . The following table presents Total costs and expenses for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013Total costs and expenses$104,574 27.4% $82,094 21.5% $67,560Percentage of total revenues87.0% 84.3% 83.9%Total costs and expenses increased in both 2015 and 2014 primarily as the result of store acquisitions from franchise owners during each of those years.Additionally, Total costs and expenses increased in 2014 due to $2.7 million in POS system software licenses we sold to franchise owners at cost, whichdecreased to $1.0 million in 2015 . In 2015 , Total costs and expenses also increased due to the advertising fund deficit spending discussed below, while2014 benefited from a recovery of the advertising fund deficit spending from 2013. Finally, Total costs and expenses in 2014 also included feesassociated with the termination of our advisory and monitoring agreement with Lee Equity .Store operating costs . The following table presents Store operating costs for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013Store operating costs$66,616 49.0% $44,707 25.7% $35,560Percentage of total revenues55.4% 45.9% 44.2%Store operating costs increased in both 2015 and 2014 primarily as a result of the acquisition of stores from franchise owners during each of thoseperiods. Increases in the price of cheese and other food costs also increased Store operating costs in 2014 .The following table presents Store operating costs as a percentage of Company-owned store sales for 2015 , 2014 and 2013 : Fiscal Year 2015 2014 2013As a % of Company-owned store sales: Cost of food and packaging35.8% 38.9% 37.5%Compensation and benefits26.7% 25.0% 27.3%Advertising10.6% 10.0% 9.8%Occupancy6.4% 5.7% 6.0%Other store operating costs10.2% 8.8% 10.2%Total store operating costs89.7% 88.4% 90.8%Total store operating costs . Total store operating costs as a percentage of Company-owned store sales increased 130 basis points in 2015 comparedto 2014 due primarily to the effect of store portfolio changes as we increased our company-owned store ownership in less developed markets. For 2014 ,total store operating costs as a percentage of Company-owned store sales decreased 240 basis points compared to 2013 due primarily to lower costs inCompensation and benefits , Occupancy and Other store operating costs as we improved our expense leverage by increasing individual store sales andadding to our total Company-owned store portfolio. These savings were partially offset by increases in Cost of food and packaging , which were driven byincreases in the prices of certain commodities, primarily cheese and meats.▪Effect of store portfolio changes. We acquired 23 stores in 2015 and 22 stores in 2014 . We also refranchised four stores in 2015 (two ofwhich were constructed in 2015 and built for sale as part of our pre-sale development initiative) and refranchised one store in 2014 . All 18 of thenew stores built in 2015 and 13 of the stores acquired in 2015 had average unit volumes lower than the stores we owned in 2014 , resulting in anoverall Furthermore, the increase in our Company-owned store portfolio provides the ability to better leverage Other store operating costs whichtend to be fixed in nature.▪Cost of food and packaging . Fluctuations in cheese prices affected our Cost of food and packaging as a percentage of Company-owned storesales . Our average cheese price in 2015 decreased 18% compared to 2014 and the average cheese price in 2014 increased 16% over 2013 .47Table of Contents▪Advertising . The increase in Advertising as a percentage of Company-owned store sales in 2015 compared to 2014 was driven by the de-leveraging impact of advertising spend in stores with lower sales volume. Advertising as a percentage of Company-owned store sales increasedfor 2014 compared to 2013 primarily due to the costs of marketing kits for the new Gourmet Delite product launch and other special productpromotions.Selling, general and administrative . The following table presents Selling, general and administrative costs for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013Selling, general and administrative$28,207 (3.6)% $29,263 21.0% $24,180Percentage of total revenues23.5% 30.0% 30.0%Selling, general and administrative costs decreased in 2015 compared to 2014 due to the elimination of fees paid to Lee Equity in 2015 under theadvisory services and monitoring agreement terminated at the IPO and lower POS system software licenses resold to franchise owners at cost, offset byincreased marketing costs recognized due to deficit spending in the marketing fund in 2015 compared to a recovery of a deficit in 2014 . Selling, generaland administrative costs increased in 2014 compared to 2013 primarily due to costs incurred in preparation for the IPO and the costs of POS systemsoftware licenses resold to franchise owners at cost offset by the recovery of the marketing fund deficit from 2013.As a percentage of Total revenues , Selling, general and administrative costs decreased 650 basis points in 2015 compared to 2014 as the previouslymentioned costs were offset by efficiencies gained by leveraging our infrastructure to grow costs at a slower rate than revenues.Excluding the costs incurred in preparation for the IPO and the revenues and expenses related to the resale of POS system software licenses at cost,Selling, general and administrative costs as a percent of Total revenues would have been 22.9% in 2015 , 26.0% in 2014 , and 28.6% in 2013 .Depreciation and amortization . The following table presents Depreciation and amortization for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013Depreciation and amortization$10,002 24.2% $8,052 15.5% $6,973Percentage of total revenues8.3% 8.3% 8.7%Depreciation and amortization increased in both 2015 and 2014 primarily due to an increase in the number of Company-owned stores and increasedcapital expenditures on property and equipment for business technology projects. As a percentage of Total revenues , Depreciation and amortizationremained constant in 2015 and declined in 2014 as the growth in Total revenues from the acquisition of franchised stores outpaced the incrementalDepreciation and amortization associated with the acquired stores. A substantial portion of the acquisition price of acquired stores was attributable togoodwill, which is not amortized.(Gain) loss on disposal or impairment of property and equipment . The following table presents the (Gain) loss on disposal or impairment of propertyand equipment for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013(Gain) loss on disposal or impairment of propertyand equipment$(251) N/M $72 (91.5)% $847Percentage of total revenues(0.2)% 0.1% 1.0%N/M = Not MeaningfulThe gain recorded in 2015 primarily resulted from the sale of Company-owned stores. The loss recorded in 2013 primarily resulted from an assetimpairment charge of $0.6 million related to the classification of assets held for sale and performance at certain of our stores in the Domestic CompanyStore segment.Interest expense, net . The following table presents Interest expense, net for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013Interest expense, net$4,523 (43.6)% $8,025 (23.1)% $10,429Percentage of total revenues3.8% 8.3% 13.0%48Table of ContentsInterest expense, net decreased in both 2015 and 2014 as a result of a reduction in outstanding debt through the application of net proceeds from theIPO in May 2014 and interest rate reductions achieved concurrently with the IPO and an August 2014 refinancing. Additional information on the August2014 refinancing can be found under Financial Statements and Supplementary Data in Note 10 — Financing Arrangements of the accompanying Notesto Consolidated Financial Statements .Loss on early retirement of debt . The following table presents the Loss on early retirement of debt for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013Loss on early retirement of debt$— N/M $4,619 14.6% $4,029Percentage of total revenues—% 4.7% 5.0%N/M = Not MeaningfulThe August 2014 refinancing met the definition of a debt extinguishment under GAAP and resulted in a write-off of existing deferred financing costs of$2.3 million and a prepayment penalty of $1.1 million . In addition, the $55.5 million prepayment made in May 2014 using proceeds from the IPO andcash on hand met the definition of a partial debt extinguishment under GAAP and resulted in a write-off of $1.2 million of existing deferred financingcosts.A recapitalization in October 2013 met the definition of a partial debt extinguishment for accounting purposes and resulted in a write-off of $2.9 million ofexisting deferred financing costs, $0.4 million in additional expenses, and a prepayment penalty of $0.7 million . Additional information on this transactioncan be found under Financial Statements and Supplementary Data in Note 10 — Financing Arrangements of the accompanying Notes to ConsolidatedFinancial Statements .Income Taxes. The following table presents income taxes for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013Provision for income taxes$2,068 67.4% $1,235 20.6% $1,024Percentage of total revenues1.7% 1.3% 1.3%Effective tax rate31.9% 49.7% N/MN/M = Not MeaningfulProvision for income taxes increased in 2015 due to a change in Income (Loss) Before Income Taxes offset by a decline in the effective tax rate. Theeffective tax rate for 2015 was lower due to a benefit from the revaluation of our deferred taxes based on a decline in our blended state tax rate. For 2014, our Provision for income taxes increased slightly, primarily due to a change in Income (Loss) Before Income Taxes .Segment ResultsDomestic Franchise. The following table presents Domestic Franchise Total revenues and Operating Income for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013Total revenues45,579 (1.4)% 46,233 14.3% 40,450Percentage of total revenues37.9% 47.5% 50.3%Operating Income20,750 (5.4)% 21,939 6.8% 20,540Total revenues for the Domestic Franchise segment decreased in 2015 due primarily to a reduction in the resale of POS system software licenses from$2.7 million in 2014 to $1.0 million in 2015 , partially offset by the net addition of 27 domestic franchised stores over the comparable period and segmentcomparable store sales growth of 1.9% . Total revenues for the Domestic Franchise segment increased in 2014 due primarily to revenue related to theresale of POS system software licenses of $2.7 million , the net addition of 15 domestic franchised stores over the comparable period and segmentcomparable store sales growth of 4.3% .Operating Income for the Domestic Franchise segment decreased in 2015 due primarily to increased marketing costs as advertising fund expendituresexceeded contributions. For 2014 , Operating Income for the Domestic Franchise segment increased due to an increase in Total revenues partially offsetby an increase in Selling, general and administrative costs.49Table of ContentsDomestic Company Stores. The following table presents Domestic Company Stores Total revenues and Operating Income (Loss) for 2015 , 2014 and2013 :(in thousands)2015 Change 2014 Change 2013Total revenues$74,300 46.8% $50,598 29.2% $39,148Percentage of total revenues61.8% 51.9% 48.6%Operating Income (Loss)1,359 4.0% 1,307 N/M (408)N/M = Not MeaningfulTotal revenues for the Domestic Company Stores segment increased in 2015 as a result of the acquisition of 23 stores from franchise owners, theopening of 18 new Company-owned stores and segment comparable store sales growth of 1.8% , partially offset by the effects of the closure of onestore. For 2014 , Total revenues for the Domestic Company Stores segment increased due primarily to the acquisition of 22 stores from franchiseowners, the opening of two new Company-owned stores and segment comparable store sales growth of 8.1% , partially offset by the effects of thedivestiture of 10 stores in the fourth quarter of 2013.Operating Income (Loss) for the Domestic Company Stores segment increased in 2015 as a result of comparable store sales growth of 1.8% , partiallyoffset by an increase in depreciation and amortization related to Company-owned stores portfolio changes and decreased operating margins. For 2014 ,Operating Income (Loss) for the Domestic Company Stores segment increased due to comparable store sales growth of 8.1% and increased operatingmargins, partially offset by an increase in depreciation and amortization related to Company-owned stores portfolio changes.International. The following table presents International Total revenues and Operating Income (Loss) for 2015 , 2014 and 2013 :(in thousands)2015 Change 2014 Change 2013Total revenues$330 (41.9)% $568 (36.7)% $897Percentage of total revenues0.3% 0.6% 1.1%Operating Income (Loss)238 N/M 20 N/M (24)N/M = Not MeaningfulTotal revenues for the International segment for 2015 decreased compared to 2014 largely as a result of the recognition of $0.2 million less indevelopment fees related to our expansion in the Middle East. Total revenues for the International segment for 2014 decreased compared to 2013 largelyas a result of the recognition of $0.5 million less in development fees related to our expansion in the Middle East.Operating Income (Loss) for the International segment for 2015 increased primarily due to a reduction in Selling, general and administrative costs,partially offset by decreased revenues of $0.2 million. Operating Income (Loss) for the International segment for 2014 increased due to a reduction in baddebt expenses of $0.4 million, partially offset by decreased revenues of $0.3 million.Liquidity and Capital ResourcesOur primary sources of liquidity are cash flows from operating activities and proceeds from the incurrence of debt, which together are sufficient to fundour operations, tax payments, capital expenditures, interest, fees and principal payments on our debt as well as support to our growth strategy. As apublic company, we may also raise additional capital through the sale of equity.As of December 28, 2015 , we had Cash and cash equivalents of $6.9 million and $20.0 million of available borrowings under a revolving credit facility, ofwhich none was drawn. As of December 28, 2015 , we had $112.2 million of outstanding indebtedness. Principal payments of $0.7 million are duequarterly and increase to $1.4 million quarterly beginning on September 26, 2016 . We believe that our cash flows from operations, available cash andcash equivalents and available borrowings under our revolving credit facility will be sufficient to meet our liquidity needs for at least the next 12 months.As of December 28, 2015 , we were in compliance with all of our covenants and other obligations under our senior secured credit facility.50Table of ContentsCash FlowsThe following table presents a summary of cash flows from operating, investing and financing activities for the periods presented: Twelve Months Ended(in thousands)2015 2014 2013Cash flows from operating activities$23,743 $15,509 $9,874Cash flows from investing activities(19,554) (9,527) (15,249)Cash flows from financing activities(2,378) (4,631) 6,613Effect of exchange rate fluctuations on cash— — 39Total cash flows$1,811 $1,351 $1,277Cash Flows from Operating ActivitiesThe $8.2 million increase over 2014 in cash from operating activities was primarily due to a $3.8 million reduction in interest paid and a $4.3 milliondecrease in net operating assets. Net cash from operating activities increase d by $5.6 million in 2014 compared to 2013 primarily due to an increase innet income of $3.8 million and a $1.9 million increase in non-cash expenses.Cash Flows from Investing ActivitiesIn 2015 , net cash from investing activities increase d by $10.0 million primarily due to a $6.4 million increase in capital spending and a $5.1 millionincrease in cash paid for store acquisitions. In 2014 , net cash from investing activities decrease d by $5.7 million over 2013 primarily due to a $5.7 milliondecrease in cash paid for store acquisitions.Cash Flows from Financing ActivitiesNet cash from financing activities increased in 2015 by $ 2.3 million primarily due to a $3.5 million decrease in IPO-related costs, partially offset by long-term debt payments of $2.8 million .Net cash from financing activities increased in 2014 by $11.2 million primarily due to a decrease in proceeds from the issuance of long-term debt of$112.0 million and an increase in long-term debt payments of $167.1 million , partially offset by the issuance of $59.7 million of common stock and $30.7million less paid in preferred dividends and return of invested capital.Contractual ObligationsAs of December 28, 2015 , our contractual obligations and other commitments were as follows: Payments Due by Year(in millions)Total Less than 1year 1-3 years 3-5 years More than 5yearsLong-term debt obligations$112.2 $2.8 $15.6 $93.8 $—Operating lease obligations23.4 4.7 8.2 5.4 5.1Total$135.6 $7.5 $23.8 $99.2 $5.1Off-Balance Sheet ArrangementsWe have guaranteed certain operating lease payments related to certain franchised stores in connection with the divestiture and refranchising ofCompany-owned stores. The maximum aggregate potential liability associated with the guaranteed lease payments is $1.5 million . We believe that noneof these guarantees has or is likely to have a material effect on our results of operations, financial condition or liquidity. Additional information onguaranteed lease payments can be found in the “Lease guarantees” section of Financial Statements and Supplementary Data in Note 17 —Commitments and Contingencies of the accompanying Notes to Consolidated Financial Statements .51Table of ContentsCritical Accounting PoliciesOur discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements , which have beenprepared in accordance with GAAP . The preparation of these consolidated financial statements requires us to make estimates and judgments that affectthe reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our judgments and estimates including thoserelated to revenue recognition, impairment of goodwill and intangible assets, income taxes, advertising costs and share-based compensation. We baseour estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results maydiffer from these estimates under different assumptions or conditions. We believe that our most critical accounting policies and estimates are:Revenue recognitionSales from Company-owned stores are recognized as revenue when the products are provided to customers. We report revenues net of sales taxescollected from customers and remitted to government taxing authorities. Royalty fees are based on a percentage of sales and are recorded as revenuesas the fees are earned and become receivable from the franchise owner. Lease income is recognized in the period earned, which generally coincideswith the period the expense is due to the master leaseholder, if a sublease.Consideration for franchise and development fees that are received in advance of being earned are included as unearned franchise and developmentfees in our Consolidated Balance Sheets. For fees paid on an installment basis that have otherwise been earned, recognition of revenue is deferred untilcollectability is certain.Franchise fees are recognized as revenue when all material services or conditions relating to the store have been substantially performed or satisfied byus, which is typically when a new franchised store begins operations or on the commencement date of the successive franchise agreement. Developmentfees for the right to develop stores in specific geographic areas are recognized as revenue when all material services or conditions relating to the salehave been substantially performed, which is typically when the first franchised store begins operations in the development area. Development feesdetermined based on the number of stores to open in an area are deferred and recognized on a pro rata basis after individual franchise agreements areexecuted for the stores subject to the development agreements and the stores begin operations.Revenue from gift cards is recognized when the gift card is redeemed by a customer in one of our stores. Revenue is not recognized for gift cardsredeemed in franchised stores. When the likelihood of a gift card being redeemed by a customer is determined to be remote, the value of theunredeemed gift card is recognized by us as a contribution (“ gift card breakage ”) to the advertising fund described below. We determine the gift cardbreakage rate based upon Company-specific historical redemption patterns.Accounts and notes receivableAccounts receivable consist primarily of (a) amounts due from franchise owners for continuing fees that are collected weekly, (b) receivables for supplychain vendor rebates, (c) subleased retail rents, and (d) other miscellaneous receivables. Accounts receivable are stated net of an allowance for doubtfulaccounts determined by management through an evaluation of specific accounts, considering historical losses and existing economic conditions whererelevant.Notes receivable consist primarily of amounts due from sales of Company-owned stores. Management reviews the notes receivable on a periodic basisand evaluates the creditworthiness and financial condition of the counterparty to determine the appropriate allowance, if any. In certain cases, we willchoose to modify the terms of a note to help a store owner achieve certain profitability targets or to accommodate a store owner while the store ownerobtains third-party financing. If the store owner does not repay the note, we have the contractual right to take back ownership of the store based on theunderlying franchise agreement, which therefore minimizes the credit risk to us.Goodwill and other intangible assetsGoodwill arises from business combinations and represents the excess of the purchase consideration transferred over the fair value of the net assetsacquired, including identifiable intangible assets and liabilities assumed. The majority of our goodwill was generated in May 2010 when Lee Equityacquired all of the equity interests of PMI Holdings, Inc. (“ Lee Equity Acquisition ”), though we have also recognized goodwill upon the acquisition ofstores from franchise owners. Goodwill is assigned to reporting units for purposes of impairment testing.52Table of ContentsWe consider our trade name and trademarks to be indefinite-lived intangible assets. These assets were initially recognized in May 2010 upon the LeeEquity Acquisition . Our intangible assets that are not indefinite-lived include franchise relationships and reacquired franchise rights.Goodwill and intangible assets determined to have an indefinite life are not amortized, but are tested for impairment annually, or more often if an eventoccurs or circumstances change that indicate an impairment might exist. Management evaluates indefinite-lived assets each reporting period todetermine whether events and circumstances continue to support an indefinite useful life. Intangible assets with finite lives are amortized over theirestimated useful lives on a straight-line basis and tested for impairment together with long-lived assets.In performing our annual goodwill impairment test, we have the option to first assess qualitative factors to determine whether the existence of events orcircumstances leads to a determination that it is not “more likely than not” that the fair value of a reporting unit is less than its carrying amount. If wedetermine that it is more likely than not, we perform the two-step quantitative goodwill impairment test. Under the two-step quantitative goodwillimpairment test, the fair value of the reporting unit is compared to its respective carrying amount, including goodwill. If the fair value exceeds the carryingamount, then no impairment exists. If the carrying amount exceeds the fair value, further analysis is performed to determine the amount of theimpairment. Both the qualitative and quantitative assessments are completed separately with respect to the goodwill of each of our reporting units. Wereview goodwill for impairment annually, as of the first day of our fourth fiscal quarter, or more frequently if indicators of impairment exist. We can bypassthe qualitative assessment and move directly to the quantitative assessment for any reporting unit in any period and can elect to resume performing thequalitative assessment in any subsequent period.Most of our goodwill is attributed to and tested for impairment at the Domestic Franchise segment, which is considered one reporting unit, as the segmentdoes not have any components of a business for which discrete financial information is available and is regularly reviewed by segment management.In performing our annual impairment test for indefinite-lived intangible assets, we have the option to first assess qualitatively whether it is more likely thannot that the indefinite-lived intangible asset is impaired, thus necessitating a quantitative impairment test. We do not calculate the fair value of anindefinite-lived asset and perform the quantitative test unless we determine that it is more likely than not that the asset is impaired. We review indefinite-lived intangible assets for impairment annually, as of the first day of its fourth fiscal quarter, or more frequently if indicators of impairment exist. We canbypass the qualitative assessment and move directly to the quantitative assessment for any indefinite-lived intangible asset in any period and can elect toresume performing the qualitative assessment in any subsequent period.Impairment of long-lived assetsLong-lived assets are evaluated for recoverability of the carrying amount whenever events and circumstances indicate the carrying amount of an assetmay not be fully recoverable. Some of the events or changes in circumstances that would trigger an impairment review include, but are not limited to,significant under-performance relative to expected and/or historical results (such as two years of comparable store sales decrease or two years ofnegative operating cash flows), significant negative industry or economic trends, or knowledge of transactions involving the sale of similar property atamounts below the carrying value.Assets are grouped for recognition and measurement of impairment at the lowest level for which identifiable cash flows are largely independent of thecash flows of other assets. Typically, long-lived assets relating to Company-owned stores are tested for impairment at the level of the retail market areain which they are located and long-lived assets relating to franchised operations are tested for impairment at the segment level. If the carrying amount ofan asset group exceeds the estimated, undiscounted future cash flows expected to be generated by the asset, then an impairment charge is recognizedto the extent the carrying amount exceeds the asset group’s fair value. In determining fair value, management considers current results, trends, futureprospects, and other economic factors.Income taxesWe account for income taxes using the asset and liability approach. This requires the recognition of deferred tax assets and liabilities for the expectedfuture tax consequences of temporary differences between the financial statement and the tax basis of assets and liabilities at the applicable tax rates. Avaluation allowance is recorded against deferred tax assets if, based on available evidence, it is more likely than not that some or all of the deferred taxassets will not be realized.The effect of uncertain tax positions would be recorded in the consolidated financial statements only after determining a more likely than not probabilitythat the uncertain tax positions would withstand an examination by tax authorities based on the technical merits of the position. The tax benefit to berecognized is measured as the largest amount of benefit that is53Table of Contentsgreater than fifty percent likely of being realized upon ultimate settlement. As facts and circumstances change, management reassesses theseprobabilities and would record any changes in the financial statements as appropriate.Advertising and marketing costsWe expense media development costs when the advertisement is first aired. All other advertising costs, including contributions to other local and regionaladvertising programs are expensed when incurred. These costs are included in Store operating costs or Selling, general and administrative expensesbased on the nature of the advertising and marketing costs incurred.Franchised and Company-owned stores in the United States contribute to an advertising fund that we manage on behalf of these stores. In addition,certain supply chain vendors contribute to the advertising fund. The advertising fund also operates a gift card program for the Papa Murphy's system. Anygift card breakage from this program is recognized as a contribution to the advertising fund. Under our franchise agreements and other agreements, thecontributions received must be spent on marketing, creative efforts, media support, or other related purposes specified in the agreements and result in noprofit recognized. The expenditures are primarily amounts paid to third-parties, but may also include personnel expenses and allocated costs. Inaccordance with GAAP , contributions to the advertising fund are netted against the related expense.At each reporting date, to the extent contributions exceed expenditures on a cumulative basis, the excess contributions to the advertising fund areaccounted for as a deferred liability and are recorded in accrued expenses in our Consolidated Balance Sheets . If expenditures exceed contributions ona cumulative basis, the excess is recorded as an expense within Selling, general and administrative expenses. Previously recognized expenses may berecovered if subsequent contributions exceed expenditures.Share-based CompensationUnder our 2010 Amended Management Incentive Plan and our 2014 Management Incentive Plan, we sponsor stock option plans and restricted stockaward plans. Restricted stock and stock options vest with the achievement of a time vesting or a performance vesting condition.Compensation expense relating to restricted stock is recognized as the portion of the grant date fair value that exceeds any purchase price paid for thestock and is ultimately expected to vest. This expense is recognized over the requisite service period, typically the vesting period, utilizing the straight-lineattribution method.The fair value of stock option awards is estimated on the grant date using a Black-Scholes-Merton option-pricing model. Compensation expense relatingto stock option awards is recognized as the portion of the grant date fair value that is ultimately expected to vest. This expense is recognized over therequisite service period, typically the vesting period, utilizing the straight-line attribution method.In addition, prior to the IPO we sold unrestricted common and preferred stock to certain employees and recognized as compensation expense the portionof the fair value that exceeded the purchase price on the issue date.JOBS ActWe qualify as an “emerging growth company” pursuant to the provisions of the JOBS Act. For as long as we are an “emerging growth company,” we maytake advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growthcompanies,” including not being required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, reduceddisclosure obligations regarding executive compensation in our periodic reports and proxy statements, reduced disclosure obligations relating to thepresentation of financial statements in Management’s Discussion and Analysis of Financial Condition and Results of Operations , exemptions from therequirements of holding advisory “say-on-pay” votes on executive compensation and stockholder advisory votes on golden parachute compensation. Wehave availed ourselves of the reduced reporting obligations and executive compensation disclosure in this annual report on Form 10-K, and expect tocontinue to avail ourselves of the reduced reporting obligations available to emerging growth companies in future filings.In addition, an emerging growth company can delay its adoption of certain accounting standards until those standards would otherwise apply to privatecompanies. However, we are choosing to “opt out” of this extended transition period, and as a result, we plan to comply with any new or revisedaccounting standards on the relevant dates on which non-emerging growth companies must adopt the standards. Section 107 of the JOBS Act providesthat our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.54Table of ContentsRecent Accounting PronouncementsFor a description of recent accounting pronouncements, see the “Recent Accounting Pronouncements” section in Financial Statements andSupplementary Data in Note 2 — Summary of Significant Accounting Policies of the accompanying Notes to Consolidated Financial Statements .55Table of ContentsItem 7A. Quantitative and Qualitative Disclosures about Market RiskCommodity Price RiskWe are exposed to market risks from changes in commodity prices. During the normal course of the year, we enter into national pricing commitments forcheese and other food products that are affected by changes in commodity prices and, as a result, our franchised and Company-owned stores aresubject to volatility in food costs. We also maintain relationships with multiple suppliers for certain key products, such as cheese. We do not engage inspeculative transactions nor do we hold or issue financial instruments for trading purposes. In instances when we use fixed pricing agreements with oursuppliers, these agreements cover our physical commodity needs, are not net-settled and are accounted for as normal purchases.Interest Rate RiskWe are subject to interest rate risk on our senior secured credit facility. Interest rates on our senior secured credit facility are based on LIBOR, and underspecified circumstances we may be required by our lenders to enter into interest rate swap arrangements. A hypothetical 1.0% increase or decrease inthe interest rate associated with our senior secured credit facility would have resulted in a $1.1 million change to interest expense on an annualized basis.Foreign Currency Exchange Rate RiskOur international franchise owners use the local currency as their functional currency. Royalty payments from our franchise owners in the Middle East aregenerally remitted to us in U.S. dollars, and royalty payments from our Canadian franchise owners are generally remitted to us in Canadian dollars.Because our international activities do not account for a significant portion of our revenues, we believe our exposure to foreign currency risk is minimal.56Table of ContentsItem 8. Financial Statements and Supplementary DataINDEX TO CONSOLIDATED FINANCIAL STATEMENTS Consolidated Statements of Operations and Comprehensive Income (Loss) for the Fiscal Years ended December 28, 2015,December 29, 2014, and December 30, 201358Consolidated Balance Sheets as of December 28, 2015 and December 29, 201459Consolidated Statements of Shareholders’ Equity for the Fiscal Years ended December 28, 2015, December 29, 2014 andDecember 30, 201360Consolidated Statements of Cash Flows for the Fiscal Years ended December 28, 2015, December 29, 2014 and December 30, 201361Notes to Consolidated Financial Statements62Report of Independent Registered Public Accounting Firm9457Table of ContentsPapa Murphy’s Holdings, Inc. and SubsidiariesConsolidated Statements of Operations and Comprehensive Income (Loss) Fiscal Year Ended(In thousands, except share and per share data)December 28,2015 December 29,2014 December 30,2013Revenues Franchise royalties$40,243 $39,305 $36,897Franchise and development fees4,222 4,531 4,330Company-owned store sales74,300 50,598 39,148Lease and other1,444 2,965 120Total revenues120,209 97,399 80,495 Costs and Expenses Store operating costs: Cost of food and packaging26,603 19,686 14,700Compensation and benefits19,858 12,673 10,687Advertising7,888 5,041 3,820Occupancy4,750 2,873 2,365Other store operating costs7,517 4,434 3,988Selling, general and administrative28,207 29,263 24,180Depreciation and amortization10,002 8,052 6,973(Gain) loss on disposal or impairment of property and equipment(251) 72 847Total costs and expenses104,574 82,094 67,560Operating Income15,635 15,305 12,935 Interest expense, net4,523 8,025 10,429Loss on early retirement of debt— 4,619 4,029Loss on impairment of investments4,500 — —Other expense, net133 178 44Income (Loss) Before Income Taxes6,479 2,483 (1,567) Provision for income taxes2,068 1,235 1,024Net Income (Loss)4,411 1,248 (2,591)Net loss attributable to noncontrolling interests500 — 19Net Income (Loss) Attributable to Papa Murphy’s4,911 1,248 (2,572) Other Comprehensive Loss Foreign currency translation adjustment— — (2)Total Comprehensive Income (Loss)$4,911 $1,248 $(2,574) Earnings (loss) per share of common stock Basic$0.29 $(0.07) $(2.34)Diluted$0.29 $(0.07) $(2.34)Weighted average common stock outstanding Basic16,653,127 12,101,236 3,847,861Diluted16,870,693 12,101,236 3,847,861See accompanying notes.58Table of ContentsPapa Murphy’s Holdings, Inc. and SubsidiariesConsolidated Balance Sheets(In thousands, except par value and share data)December 28,2015 December 29,2014Assets Current Assets Cash and cash equivalents$6,867 $5,056Accounts receivable, net4,944 5,661Current portion of notes receivable78 62Inventories868 640Prepaid expenses and other current assets6,139 3,572Total current assets18,896 14,991Property and equipment, net21,261 12,120Notes receivable, net of current portion143 225Goodwill106,506 101,082Trade name and trademarks87,002 87,002Definite-life intangibles, net41,366 44,515Other assets297 4,192Total assets$275,471 $264,127Liabilities and Equity Current Liabilities Accounts payable$9,798 $3,057Accrued expenses and other current liabilities9,756 9,853Current portion of unearned franchise and development fees1,795 2,848Current portion of long-term debt2,800 2,800Total current liabilities24,149 18,558Long-term debt, net of current portion108,237 110,715Unearned franchise and development fees, net of current portion540 640Deferred tax liability, net42,439 40,732Other liabilities2,450 1,740Total liabilities177,815 172,385Commitments and contingencies (Note 17) Equity Papa Murphy’s Holdings, Inc. Shareholders’ Equity Preferred stock ($0.01 par value; 15,000,000 shares authorized; no shares issued or outstanding)— —Common stock ($0.01 par value; 200,000,000 shares authorized; 16,949,720 and 16,944,308 shares issued andoutstanding, respectively)169 169Additional paid-in capital118,801 117,354Stock subscriptions receivable(100) (100)Accumulated deficit(21,214) (26,125)Total Papa Murphy’s Holdings, Inc. shareholders’ equity97,656 91,298Noncontrolling interests— 444Total equity97,656 91,742Total liabilities and equity$275,471 $264,127See accompanying notes.59Table of ContentsPapa Murphy’s Holdings, Inc. and SubsidiariesConsolidated Statements of Shareholders’ Equity CUMULATIVESERIES APREFERRED STOCK CUMULATIVESERIES BPREFERRED STOCK COMMON STOCK ADDI-TIONALPAID-INCAPITAL STOCKSUBSCRIP-TIONRECEIV-ABLE ACCUMU-LATEDDEFICIT ACCUMULATEDOTHERCOMPRE-HENSIVEINCOME TOTAL PAPAMURPHY’SHOLDINGS, INC.SHAREHOLDERS’EQUITY NON-CON-TROLLINGINTERESTS TOTALEQUITY (In thousands)SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT BALANCE,December 31, 20122,779 $79,856 27 $1,003 4,287 $43 $396 $(888) $(16,482) $2 $63,930 $— $63,930Common stockissuances— — — — 56 — 366 — — — 366 — 366Common stockrepurchases— — — — (88) (1) (11) — (388) — (400) — (400)Preferred stockdividends andreturn of investedcapital— (21,667) — (262) — — (830) — (7,931) — (30,690) — (30,690)Note receivableissued to fund thepurchase of stock— — — — — — — (309) — — (309) — (309)Stock basedcompensationexpense— — — — — — 61 — — — 61 — 61Reclassification ofliability classifiedput options75 1,967 — — 93 1 1,573 — — — 3,541 — 3,541Noncontrollinginteresttransactions— — — — — — — — — — — 241 241Net loss— — — — — — — — (2,572) — (2,572) (19) (2,591)Adjustment forforeign currencytranslation— — — — — — — — — (2) (2) — (2)BALANCE,December 30, 20132,854 $60,156 27 $741 4,348 $43 $1,555 $(1,197) $(27,373) $— $33,925 $222 $34,147Common stockissued, net oftransaction costs— — — — 5,840 58 54,590 — — — 54,648 — 54,648Common stockrepurchases— — — — (156) (1) (1,517) — — — (1,518) — (1,518)Conversion ofpreferred stock tocommon stock(2,854) (60,156) (27) (741) 6,912 69 60,828 — — — — — —Repayment of notereceivable issuedto fund thepurchase of stock— — — — — — — 1,097 — — 1,097 — 1,097Stock basedcompensationexpense— — — — — — 1,898 — — — 1,898 — 1,898Noncontrollinginteresttransactions— — — — — — — — — — — 222 222Net income— — — — — — — — 1,248 — 1,248 — 1,248BALANCE,December 29, 2014— $— — $— 16,944 $169 $117,354 $(100) $(26,125) $— $91,298 $444 $91,742Common stockissued— — — — 42 — 376 — — — 376 — 376Common stockrepurchases— — — — (36) — (10) — — — (10) — (10)Stock basedcompensationexpense— — — — — — 1,081 — — — 1,081 — 1,081Noncontrollinginteresttransactions— — — — — — — — — — — 56 56Net income (loss)— — — — — — — — 4,911 — 4,911 (500) 4,411BALANCE,December 28, 2015— $— — $— 16,950 $169 $118,801 $(100) $(21,214) $— $97,656 $— $97,656See accompanying notes.60Table of ContentsPapa Murphy’s Holdings, Inc. and SubsidiariesConsolidated Statements of Cash Flows Fiscal Year Ended (In thousands)December 28, 2015 December 29, 2014 December 30, 2013Operating Activities Net Income (Loss)$4,411 $1,248 $(2,591)Net loss attributable to noncontrolling interests500 — 19Net Income (Loss) Attributable to Papa Murphy’s4,911 1,248 (2,572)Adjustments to reconcile to cash from operating activities Depreciation and amortization10,002 8,052 6,973(Gain) loss on disposal or impairment of property and equipment(251) 72 847Loss on early retirement of debt— 4,619 4,029Non-cash employee equity compensation1,081 1,898 846Loss on impairment of cost-method investment4,000 — —Other non-cash items646 563 1,217Change in operating assets and liabilities Accounts receivable641 (3,302) (483)Prepaid expenses and other assets(1,988) 2,265 (5,104)Unearned franchise and development fees(1,213) (507) 1Accounts payable3,628 (766) 1,021Accrued expenses and other liabilities579 244 2,155Deferred taxes1,707 1,123 944Net cash from operating activities23,743 15,509 9,874Investing Activities Acquisition of property and equipment(10,430) (4,067) (3,037)Acquisition of stores, less cash acquired(9,691) (4,608) (10,272)Proceeds from sale of stores1,250 179 29Issuance of notes receivable(250) — —Payments received on notes receivable67 969 31Investment in cost-method investee(500) (2,000) (2,000)Net cash from investing activities(19,554) (9,527) (15,249)Financing Activities Proceeds from issuance of long-term debt— 112,000 167,000Payments on long-term debt(2,800) (169,900) (121,280)Payments on revolver, net— — (4,000)Issuance of common stock, net of underwriting fees— 59,675 57Repurchases of common stock(10) (1,518) (400)Payment of preferred dividends and return of invested capital— — (30,690)Proceeds from exercise of stock options376 — —Debt issuance and modification costs, including prepayment penalties— (2,717) (4,315)Payments received on subscription receivables— 1,097 —Costs associated with initial public offering— (3,490) —Investment by noncontrolling interest holders56 222 241Net cash from financing activities(2,378) (4,631) 6,613Effect of exchange rate fluctuations on cash— — 39Net change in cash and cash equivalents1,811 1,351 1,277Cash and Cash Equivalents, beginning of year5,056 3,705 2,428Cash and Cash Equivalents, end of period$6,867 $5,056 $3,705Supplemental Disclosures of Cash Flow Information Cash paid during the period for interest$3,624 $7,385 $9,769Cash paid during the period for income taxes$3,078 $134 $117Deferred offering costs paid in 2013 reclassified to equity$— $1,537 $—Noncash Supplemental Disclosures of Investing and Financing Activities Issuance of note receivable for preferred and common stock$— $— $309Issuance of note payable for acquisition of stores$— $2,900 $3,000Acquisition of property and equipment in accounts payable$3,098 $97 $309See accompanying notes.61Table of ContentsPapa Murphy’s Holdings, Inc. and SubsidiariesNotes to Consolidated Financial StatementsNote 1Description of Business63Note 2Summary of Significant Accounting Policies63Note 3Acquisitions71Note 4Prepaid Expenses and Other Current Assets77Note 5Property and Equipment77Note 6Divestitures78Note 7Goodwill79Note 8Intangible Assets79Note 9Notes Receivable80Note 10Financing Arrangements80Note 11Fair Value Measurement83Note 12Accrued and Other Liabilities83Note 13Income Taxes84Note 14Shareholders’ Equity85Note 15Share-based Compensation85Note 16Earnings per Share (EPS)88Note 17Commitments and Contingencies89Note 18Retirement Plans90Note 19Related Party Transactions91Note 20Segment Information92Note 21Selected Quarterly Financial Data (unaudited)9362Table of ContentsNote 1 — Description of BusinessDescription of businessPapa Murphy’s Holdings, Inc. (“Papa Murphy’s” or the “Company”), together with its subsidiaries, is a franchisor and operator of a Take ‘N’ Bake pizzachain. The Company franchises the right to operate Take ‘N’ Bake pizza franchises and operates Take ‘N’ Bake pizza stores owned by the Company. Asof December 28, 2015 , the Company had 1,536 stores consisting of 1,496 domestic stores ( 1,369 franchised stores and 127 Company-owned stores)across 38 states, plus 40 franchised stores in Canada and the United Arab Emirates.Substantially all revenues are derived from retail sales of pizza and other food and beverage products to the general public by Company-owned storesand the collection of franchise royalties and fees associated with franchise and development rights.Public offering and stock splitOn May 7, 2014 , the Company completed an initial public offering (“ IPO ”) of 5,833,333 shares of common stock at a price to the public of $11.00 pershare. The Company received net proceeds from the offering of $54.6 million after offering fees and expenses. The net proceeds, along with additionalcash on hand, were used to repay $55.5 million of the Company’s loans outstanding under the Company’s senior secured credit facility, after which theCompany had $112.1 million outstanding under the facility with the revolver undrawn.Immediately prior to the IPO , the Company amended and restated its certificate of incorporation to reflect the conversion of all outstanding Series APreferred Stock and Series B Preferred Stock (together, the “ Preferred Shares ”) to 3,054,318 shares of common stock. The total liquidation preferenceon the Preferred Shares at the time of conversion was $64.3 million . As part of the IPO , the Company increased its authorized shares from 3,000,000shares of common stock, $0.01 par value per share, to 200,000,000 shares of common stock, $0.01 par value per share. The Company also authorizedthe issuance of 15,000,000 shares of preferred stock, $0.01 par value per share, with no shares outstanding.In connection with the IPO , on May 1, 2014, the Company amended its certificate of incorporation to effect a 2.2630 for 1 stock split of its common stock.Concurrent with the stock split, the Company adjusted the number of shares subject to, and the exercise price of, its outstanding stock option awardsunder the Company’s 2010 Amended Management Incentive Plan (“ 2010 Plan ”) so that the holders of the options were in the same economic positionboth before and after the stock split. As a result of the stock split, all previously reported share amounts, including options in these consolidated financialstatements and accompanying notes, have been retrospectively restated to reflect the stock split. After the conversion of the Preferred Shares and thestock split, but before the shares were sold in the IPO , the Company had 11,134,070 common shares outstanding.In 2010, affiliates of Lee Equity Partners, LLC (“ Lee Equity ”) acquired all of the equity interests of PMI Holdings, Inc. (“ Lee Equity Acquisition ”). PapaMurphy’s Holdings, Inc. was established as a holding company for PMI Holdings, Inc. and its subsidiaries. This transaction was considered a businesscombination and was accounted for using the acquisition method of accounting. Assets and liabilities of the Company were recorded at their fair valueand the purchase consideration in excess of the fair value of identifiable assets acquired and liabilities assumed was recorded as goodwill.Note 2 — Summary of Significant Accounting PoliciesPrinciples of consolidation and basis of presentationThese consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“ GAAP ”)and include the accounts of Papa Murphy’s Holdings, Inc., its subsidiaries and certain entities which the Company consolidates as variable interestentities (“ VIEs ”). The Company reports noncontrolling interests in consolidated entities as a component of equity separate from shareholders’ equity. Allsignificant intercompany transactions and balances have been eliminated.The Company participates in various advertising cooperatives with its franchise owners established to collect and administer funds contributed for use inadvertising and promotional programs in a specific market designed to increase sales and promote the Papa Murphy’s brand. Contributions to theadvertising cooperatives are required for both Company-owned and franchised stores and are generally based on a percentage of a store’s sales. TheCompany maintains certain variable63Table of Contentsinterests in these cooperatives. As the cooperatives are required to spend all funds collected on advertising and promotional programs, total equity at riskis not sufficient to permit the cooperatives to finance their activities without additional subordinated financial support. Therefore, these cooperatives areVIEs . As a result of the Company's voting rights exercised through Company-owned stores, the Company consolidates certain of these cooperatives forwhich it is the primary beneficiary. Advertising cooperative assets, consisting primarily of cash and receivables can only be used to settle the obligationsof the respective cooperative. Advertising cooperative liabilities represent the corresponding obligation arising from the receipt of the contributions topurchase advertising and promotional programs for which creditors do not have recourse to the general credit of a primary beneficiary. Therefore, theCompany reports all assets and liabilities of the advertising cooperatives that it consolidates as Prepaid expenses and other current assets and Accruedexpenses and other current liabilities , respectively, in the Consolidated Balance Sheets . Because the contributions to these advertising and marketingcooperatives are specifically designated and segregated for advertising, the Company does not reflect franchise owner contributions to thesecooperatives in its Consolidated Statements of Operations and Comprehensive Income (Loss) or Consolidated Statements of Cash Flows .Fiscal yearThe Company uses a 52- or 53-week fiscal year, ending on the Monday nearest to December 31. Fiscal years 2015 , 2014 and 2013 were 52-weekyears. All references to years relate to fiscal periods rather than calendar periods. References to 2015 , 2014 and 2013 are references to fiscal yearsended December 28, 2015 , December 29, 2014 and December 30, 2013 , respectively.Use of estimatesPreparing financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported inthe Company’s consolidated financial statements and accompanying notes. Significant items that are subject to such estimates and assumptions includegoodwill and intangible assets and related impairment analysis, fair value of stock based compensation and deferred tax asset valuation allowance.Although management bases its estimates on historical experience and assumptions that are believed to be reasonable under the circumstances, actualresults may differ from those estimates.Cash and cash equivalentsThe Company considers all highly liquid investments with original maturities of three months or less when purchased to be cash equivalents. TheCompany maintains cash and cash equivalent balances with financial institutions that periodically exceed federally insured limits. The Company alsoholds limited funds, to the extent necessary, on deposit outside the United States. The Company makes such deposits with entities it believes are of highcredit quality and has not incurred any losses related to these balances. Management believes its credit risk to be minimal.Accounts receivableAccounts receivable consist primarily of (a) amounts due from franchise owners for continuing fees that are collected weekly, (b) receivables for vendorrebates, and (c) other miscellaneous receivables. Accounts receivable are stated net of an allowance for doubtful accounts determined by managementthrough an evaluation of specific accounts, considering historical losses and existing economic conditions where relevant. The Company recorded thefollowing allowance for doubtful accounts:(in thousands)2015 2014Allowance for doubtful accounts$31 $60Notes receivableNotes receivable consist primarily of amounts due from sales of Company-owned stores. Management reviews the notes receivable on a periodic basisand evaluates the creditworthiness and financial condition of the counterparty to determine the appropriate allowance, if any. If the store owner does notrepay the note, the Company has the contractual right to take back ownership of the store based on the underlying franchise agreement, which thereforeminimizes the credit risk to the Company.64Table of ContentsStock subscriptions receivablePrior to our IPO , the Company issued common stock to certain employees for stock subscriptions receivable, which are not collateralized by the stock.The Company had the following outstanding Stock subscriptions receivable which have been classified as a reduction of equity:(in thousands)2015 2014Stock subscriptions receivable$100 $100InventoriesInventories consist principally of food products and packaging supplies for use in Company-owned stores. Inventories are valued at the lower of cost,determined under the first-in, first-out method, or net realizable value.Property and equipmentProperty and equipment are recorded at cost. Property and equipment are depreciated using the straight-line method over the estimated useful lives ofthe assets. Leasehold improvements are amortized using the straight-line method over the shorter of the useful lives of the assets or the related leaseterm, including renewal options to the extent renewals are reasonably assured, not to exceed 10 years.The estimated useful lives for property and equipment are: Property and EquipmentEstimated Useful LifeLeasehold improvementsShorter of lease term or estimated useful life, not to exceed 10 yearsRestaurant equipment and fixtures5 to 7 yearsOffice furniture and equipment3 to 7 yearsSoftware3 to 5 yearsVehicles5 yearsDeferred financing costsCosts incurred to obtain long-term financing are accounted for as a deferred charge and amortized to interest expense over the terms of the respectivedebt agreements using the effective interest method. Unamortized deferred charges are recorded as a reduction from the carrying amount of the relateddebt liability in the Company’s Consolidated Balance Sheets .Stock issuance costsCosts of obtaining new capital by issuing common or preferred stock classified as permanent equity are considered a reduction of the related proceeds,which reduces the carrying value of the related equity capital. Until the close of stock issuance, costs are recorded as other current assets in theCompany’s Consolidated Balance Sheets .Goodwill and other intangible assetsGoodwill arises from business combinations and represents the excess of the purchase consideration transferred over the fair value of the net assetsacquired, including identifiable intangible assets and liabilities assumed. The majority of the Company’s goodwill was generated upon the Lee EquityAcquisition in May 2010, though the Company has also recognized goodwill upon the acquisition of stores from franchise owners. Goodwill is assigned toreporting units for purposes of impairment testing.The Company considers its Trade name and trademarks to be indefinite-lived intangible assets. These assets were initially recognized in May 2010 uponthe Lee Equity Acquisition . The Company’s intangible assets that are not indefinite-lived include franchise relationships and reacquired franchise rights.Goodwill and intangible assets determined to have an indefinite life are not amortized, but are tested for impairment annually, or more often if an eventoccurs or circumstances change that indicate an impairment might exist. Management evaluates indefinite-lived assets each reporting period todetermine whether events and circumstances continue to support an indefinite useful life. Intangible assets with finite lives are amortized over theirestimated useful lives on a straight-line basis and tested for impairment together with long-lived assets.65Table of ContentsIn performing its annual goodwill impairment test, the Company first assesses qualitative factors to determine whether the existence of events orcircumstances leads to a determination that it is not “more likely than not” that the fair value of a reporting unit is less than its carrying amount. If theCompany determines that it is more likely than not, it performs the two-step quantitative goodwill impairment test. Under the two-step quantitativegoodwill impairment test, the fair value of the reporting unit is compared to its respective carrying amount, including goodwill. If the fair value exceeds thecarrying amount, then no impairment exists. If the carrying amount exceeds the fair value, further analysis is performed to determine the amount of theimpairment. Both the qualitative and quantitative assessments are completed separately with respect to the goodwill of each of the Company’s reportingunits. The Company reviews goodwill for impairment annually, as of the first day of our fourth fiscal quarter, or more frequently if indicators of impairmentexist. The Company can bypass the qualitative assessment and move directly to the quantitative assessment for any reporting unit in any period and canelect to resume performing the qualitative assessment in any subsequent period.Most of the Company’s goodwill is attributed to and tested for impairment at the Domestic Franchise segment, which is considered one reporting unit, asthe segment does not have any components of a business for which discrete financial information is available and is regularly reviewed by segmentmanagement.In performing its annual impairment test for indefinite-lived intangible assets, the Company first assesses qualitatively whether it is more likely than notthat the indefinite-lived intangible asset is impaired, thus necessitating a quantitative impairment test. The Company does not calculate the fair value ofan indefinite-lived asset and perform the quantitative test unless it determines that it is more likely than not that the asset is impaired. The Companyreviews indefinite-lived intangible assets for impairment annually, as of the first day of its fourth fiscal quarter, or more frequently if indicators ofimpairment exist. The Company can bypass the qualitative assessment and move directly to the quantitative assessment for any indefinite-livedintangible asset in any period and can elect to resume performing the qualitative assessment in any subsequent period.Impairment of long-lived assetsLong-lived assets are evaluated for recoverability of the carrying amount whenever events and circumstances indicate the carrying amount of an assetmay not be fully recoverable. Some of the events or changes in circumstances that would trigger an impairment review include, but are not limited to,significant under-performance relative to expected and/or historical results (such as two years of comparable store sales decrease or two years ofnegative operating cash flows), significant negative industry or economic trends, or knowledge of transactions involving the sale of similar property atamounts below the carrying value.Assets are grouped for recognition and measurement of impairment at the lowest level for which identifiable cash flows are largely independent of thecash flows of other assets. Typically, long-lived assets relating to Company-owned stores are tested for impairment at the level of the retail market inwhich they are located and long-lived assets relating to franchised operations are tested for impairment at each segment level. If the carrying amount ofan asset group exceeds the estimated, undiscounted future cash flows expected to be generated by the asset, then an impairment charge is recognizedto the extent the carrying amount exceeds the asset group’s fair value. In determining fair value, management considers current results, trends, futureprospects, and other economic factors.Assets held for saleAssets are classified as held for sale when management with the appropriate authority commits to a plan to sell the assets, the assets are available forimmediate sale, the assets are actively marketed at a reasonable price, the sale is probable within a year, and certain other criteria are met. Assets heldfor sale consist primarily of newly opened Company-owned stores or unopened stores under construction by the Company. Assets designated as held forsale are held at the lower of the net book value or fair value less costs to sell and reported separately on the Consolidated Balance Sheets . Depreciationis not charged against property and equipment classified as assets held for sale.66Table of ContentsAsset retirement obligations (“ ARO s”)ARO s are primarily associated with leasehold improvements which, at the end of a lease, the Company is obligated to remove in order to comply withcertain lease agreements. At the inception of a lease with such conditions, the Company records an ARO and a corresponding capital asset in an amountequal to the estimated fair value of the obligation. Fair value is estimated based on a number of assumptions requiring management’s judgment, includingstore closing costs, cost inflation rates, and discount rates in effect at the time the lease is signed. Over time, the obligation is accreted to its projectedfuture value and, upon satisfaction of the ARO conditions, any difference between the recorded liability and the actual retirement costs incurred isrecognized as an operating gain or loss in the Consolidated Statements of Operations and Comprehensive Income (Loss) . The Company recorded thefollowing ARO as a component of Other liabilities :(in thousands)2015 2014Asset retirement obligations$1,490 $1,190Derivative instruments and hedging activityInterest rate movements create a degree of risk to the Company’s operations by affecting the amount of its interest payments and the value of its floatingrate debt. On occasion, the Company uses derivative instruments to manage its exposure to interest rate changes. By using these instruments, theCompany can be exposed to credit risk of the counterparty. The Company minimizes the credit risk by entering into transactions with high credit qualitycounterparties. The Company has not applied hedge accounting to its derivative instruments. All derivative instruments are measured at fair value. TheCompany held interest rate cap derivatives that expired in June 2013. Gains or losses resulting from changes in the fair value of the interest rate capderivatives are recognized as a component of Interest expense, net in the Consolidated Statements of Operations and Comprehensive Income (Loss) .The Company does not hold or issue derivative financial instruments for trading or speculative purposes.Revenue recognitionCompany-owned store sales are recognized when products are provided to customers. Franchise royalties are based on a percentage of sales and arerecognized as the fees are earned and become receivable from the franchise owner.Franchise fees are recognized as revenue when all material services or conditions relating to a store have been substantially performed or satisfied bythe Company, which is typically when a new franchised store begins operations or on the commencement date of the successive franchise agreement.Development fees for the right to develop stores in specific geographic areas are recognized as revenue when all material services or conditions relatingto the sale have been substantially performed, which is typically when the first franchised store begins operations in the development area. Developmentfees determined based on the number of stores to open in an area are deferred and recognized on a pro rata basis after individual franchise agreementsare executed for the stores subject to the development agreements and the stores begin operations.Consideration for Franchise and development fees received in advance of being earned are included as unearned franchise and development fees in theCompany’s Consolidated Balance Sheets . For fees paid on an installment basis that have otherwise been earned, recognition of revenue is deferreduntil collectability is certain.Lease and other consists primarily of (a) lease income recognized in the period earned, which generally coincides with the period the expense is due tothe master leaseholder, if a sublease, and (b) software license revenue from the resale of point-of-sale (“ POS ”) software licenses to franchise owners atcost.The Company operates a system-wide gift card program and recognizes revenue from gift cards when a gift card is redeemed in a Company-ownedstore. When the likelihood of a gift card being redeemed by a customer is determined to be remote (“ gift card breakage ”), the value of the unredeemedgift card is recognized by the Company as a contribution to the advertising fund described under Advertising and marketing costs below. The Companydetermines the gift card breakage rate based upon Company-specific historical redemption patterns.Software revenue recognitionThe Company recognizes revenues for the resale of software licenses upon delivery to franchise owners to the extent collectability is probable. In aneffort to obtain more favorable pricing and expedite the roll-out of POS systems, the Company acquired $4.5 million of POS software licenses in a lumpsum purchase in 2013 and resells them to franchise owners at cost.67Table of ContentsAdvertising and marketing costsAdvertising costs, including contributions to local advertising cooperatives which are based on a percentage of sales, are expensed when incurred exceptfor media development costs which are expensed when the advertisement is first aired. These costs are included in Store operating costs or Selling,general and administrative expenses based on the nature of the advertising and marketing costs incurred.Franchised and Company-owned stores in the United States contribute to an advertising fund that the Company manages on behalf of these stores. Inaddition, certain suppliers contribute to the advertising fund. Under our franchise agreements and other agreements, contributions received by theadvertising fund must be spent on marketing, creative efforts, media support, or other related purposes specified in the agreements and result in no profitrecognized. Contributions to the advertising fund are netted against the related expense. Expenditures of the advertising fund are primarily amounts paidto third-parties, but may also include personnel expenses and allocated costs. At each reporting date, to the extent contributions to the advertising fundexceed expenditures on a cumulative basis, the excess contributions are accounted for as a deferred liability and are recorded in accrued expenses inthe Company’s Consolidated Balance Sheets . However, if expenditures exceed contributions on a cumulative basis, the excess is recorded as anexpense within Selling, general and administrative expenses. In subsequent periods, previously recognized expenses may be recovered if subsequentcontributions exceed expenditures. Advertising expense included in Selling, general and administrative , net of contributions was as follows:(in thousands)2015 2014 2013Advertising expense (recovery), net of contributions$1,200 $(1,110) $1,110As of December 28, 2015 , previously recognized expenses of $1.2 million may be recovered in future periods if subsequent advertising fundcontributions exceed expenditures.Store pre-opening costsPre-opening costs, including wages, benefits and travel for the training and opening teams, Cost of food and packaging , and Other store operating costs, are expensed as incurred prior to a store opening for business.Rent expenseRent expense for the Company’s leases, which generally have escalating rental payments over the term of the lease, is recorded on a straight-line basisover the lease term. The lease term includes renewal options that are reasonably expected to be exercised and begins when the Company has controland possession of the leased property, which is typically before rental payments are due under the lease. The difference between the rent expense andrent paid is recorded as deferred rent as a component of accrued expenses. Tenant allowances are recorded in deferred rent and amortized asreductions of rent expense over the lease term. Rent expense is included in Store Occupancy costs or Selling, general and administrative expenses,based on the nature of the leased facility.When a store is closed before the end of its lease, the Company accrues a loss provision for lease termination costs based on the net present value ofthe contractual, minimum rent obligations reduced by sublease rental income that could be reasonably obtained from the property using a credit-adjusted,risk-free interest rate at the time of closure. Certain other related costs are also included in the loss reserve. The initial charge and any subsequentadjustment to the accrual are included in Store Occupancy costs.Lease guaranteesOn occasion, the Company becomes a guarantor for certain operating leases when it sells a Company-owned store or a store under construction by theCompany. The guarantee obligation is initially measured as the fair value of the guarantee, which is recorded as a liability. The Company recognizes itsrelease from risk as a guarantor as the lease obligation is settled over the remaining lease term. In addition, throughout the guarantee period, theCompany records a reserve when any loss becomes probable in connection with such lease guarantee. As of December 28, 2015 andDecember 29, 2014 , the Company’s recorded liability in connection with lease guarantees was as follows:(in thousands)2015 2014Lease guarantees$32 $—68Table of ContentsIncome taxesThe Company accounts for income taxes using the asset and liability approach. This requires the recognition of deferred tax assets and liabilities for theexpected future tax consequences of temporary differences between the financial statement and the tax basis of assets and liabilities at the applicabletax rates. A valuation allowance is recorded against deferred tax assets if, based on available evidence, it is more likely than not that some or all of thedeferred tax assets will not be realized.The effect of uncertain tax positions would be recorded in the consolidated financial statements only after determining a more likely than not probabilitythat the uncertain tax positions would withstand an examination by tax authorities based on the technical merits of the position. The tax benefit to berecognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. As facts andcircumstances change, management reassesses these probabilities and would record any changes in the financial statements as appropriate.As of December 28, 2015 and December 29, 2014 , the Company recognized no uncertain tax positions or any accrued interest and penalties associatedwith uncertain tax positions.Share-based compensationUnder the 2010 Plan and the Company’s 2014 Management Incentive Plan (“ 2014 Plan ”), the Company sponsors stock option plans and restrictedstock award plans. Restricted stock and stock options vest with the achievement of a time vesting or a performance vesting condition. Compensationexpense relating to restricted stock with time vesting conditions is recognized as the portion of the grant date fair value that exceeds any purchase pricepaid for the stock and is ultimately expected to vest. This expense is recognized over the requisite service period, typically the vesting period, utilizing thestraight-line attribution method.The fair value of stock option awards is estimated on the grant date using a Black-Scholes-Merton option-pricing model. The risk-free interest rate isbased on the estimated effective life and is estimated based on U.S. Treasury Yield Curve rates. Since the Company has no relevant option exerciseexperience, the expected term is based on a simplified method calculation and the expected volatility is based on the historical volatility of the share priceof a group of peer companies. Compensation expense relating to stock option awards is recognized as the portion of the grant date fair value that isultimately expected to vest. This expense is recognized over the requisite service period, typically the vesting period, utilizing the straight-line attributionmethod.Business CombinationsThe Company accounts for business combinations under the acquisition method of accounting, recording any assets acquired and liabilities assumedbased upon their respective fair values. Any excess of the fair value of purchase consideration over the fair value of the assets acquired less liabilitiesassumed is recorded as goodwill. The Company uses management estimates based on historically similar transactions to assist in establishing theacquisition date fair values of assets acquired, liabilities assumed, and contingent consideration granted, if any. These estimates and valuations requirethe Company to make significant assumptions, including projections of future events and operating performance.Internal use softwareExpenditures for major software purchases and software developed for internal use are capitalized and amortized over the useful life of the software (three to five years) on a straight-line basis. The Company’s policy provides for the capitalization of external direct costs of materials and servicesassociated with developing or obtaining internal-use computer software. Costs associated with preliminary project stage activities, training, maintenanceand all other post-implementation stage activities are expensed as incurred.ReclassificationAs a result of the retrospective adoption of ASU 2015-03 (see “Recent accounting pronouncements” below), the Company made certain reclassificationsto the prior year's long-term debt to conform to the balance sheet presentation as of December 28, 2015 . These reclassifications had no effect on theCompany's consolidated financial position, shareholders' equity or net cash flows for any of the periods presented.As a result of the retrospective adoption of ASU 2015-17 (see “Recent accounting pronouncements” below), the Company made certain reclassificationsto the prior year's deferred tax assets to conform to the balance sheet presentation as of December 28, 2015 . These reclassifications had no effect onthe Company's consolidated financial position, shareholders' equity or net cash flows for any of the periods presented.69Table of ContentsIn addition, certain amounts in the prior period financial statements have been reclassified to conform to the current period presentation. Thesereclassifications had no effect on the Company's consolidated financial position, shareholders' equity or net cash flows for any of the periods presented.Recent accounting pronouncementsIn May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ ASU 2014-09 ”), a new standard to achieve aconsistent application of revenue recognition within the U.S., resulting in a single revenue model to be applied by reporting companies under GAAP . Theoriginal effective date for ASU 2014-09 would have required adoption by the Company in the first quarter of fiscal 2017 with early adoption prohibited. InAugust 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606) - Deferral of the Effective Date (“ ASU 2015-14 ”),which defers the effective date of ASU 2014-09 for one year and permits early adoption in accordance with the original effective date of ASU 2014-09 .The new revenue standard is required to be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effectof initially applying the standard recognized at the date of initial application. The Company has not yet selected a transition method. The standard will notimpact the Company's recognition of revenue from Company-owned restaurants or its recognition of franchise royalties, which are based on a percentageof franchise sales. The Company is continuing to evaluate the impact the adoption of this standard will have on the recognition of other less significantrevenue transactions such as franchise and development fees as well as refranchising of Company-owned restaurants.In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03 ”). This update requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deductionfrom the carrying value of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs were notaffected by this update. The Company early-adopted ASU 2015-03 during the three months ended June 29, 2015. Applying the adoption retroactively,the Company reclassified unamortized debt issuance costs of $1.3 million as of June 29, 2015, and $1.5 million as of December 29, 2014 , from Deferredfinance charges, net to Long-term debt, net of current portion on the Consolidated Balance Sheets . Adoption of this standard did not affect theCompany’s results of operations or cash flows in either the current or previous annual reporting periods.In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740) (“ ASU 2015-17 ”). This update requires that deferred tax assets andliabilities be classified as noncurrent in the Company's Consolidated Balance Sheets . The Company early-adopted ASU 2015-17 during the threemonths ended December 28, 2015 . Applying the adoption retroactively, the Company reclassified deferred tax assets of $2.0 million as of September 28,2015 and $1.3 million as of December 29, 2014 , from Current deferred tax asset to Deferred tax liability, net on the Consolidated Balance Sheets .Adoption of this standard did not affect the Company’s results of operations or cash flows in either the current or previous annual reporting periods.In February 2016, the FASB issued ASU 2016-02, Leases (“ ASU 2016-02 ”). This update requires that lessees recognize assets and liabilities on thebalance sheet for the rights and obligations created by all leases with terms of more than 12 months. ASU 2016-02 also will require disclosures designedto give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include bothqualitative and quantitative information. The effective date for ASU 2016-02 is for fiscal years, and interim periods within those fiscal years, beginningafter December 15, 2018 with earlier adoption permitted. The Company is still evaluating the impact of ASU 2016-02 on its financial position and resultsof operations.The accounting standards that have been issued by the FASB or other standards-setting bodies that do not require adoption until a future date are notexpected to have a material impact on our consolidated financial statements upon adoption.70Table of ContentsNote 3 — AcquisitionsInvestmentsThe Company, through a non-wholly owned subsidiary, Project Pie Holdings, LLC (“ PPH ”), made investments in Project Pie, LLC (“ Project Pie ”) in theform of Series A Convertible Preferred Units (the “ Preferred Units ”). Project Pie is a fast casual custom-pizza restaurant chain with stores locatedthroughout the United States, the Philippines and Scotland.The Company disposed of its ownership interests in PPH on June 29, 2015. Prior to the Company’s disposal of its ownership interests in PPH , itrecorded a pre-tax impairment of $4.5 million to its investment in Project Pie .Earlier in 2015, the Company determined that Project Pie was a variable interest entity as a result of Project Pie having insufficient equity at risk, but thatthe Company did not have a variable interest in Project Pie and did not have control. The Company did not account for its investment in Project Pie as anequity method investment since the Company’s investment was in preferred units with subordination characteristics substantially different from thecommon units and were determined not to be in-substance common stock. The Company’s investment was classified as a cost method investment inOther assets .Acquisitions in 2015On March 9, 2015, Papa Murphy’s Company Stores, Inc. (“ PMCSI ”), a wholly owned subsidiary of the Company, acquired certain assets used in theoperation of six Papa Murphy’s stores in the Seattle, Washington, area from M2AD Management Inc., the previous operator of the six Papa Murphy’sstores (the “ M2AD Acquisition ”). Transaction costs of $30,000 associated with the M2AD Acquisition were recognized as Other store operating costs inthe Consolidated Statements of Operations and Comprehensive Income (Loss) . The total purchase price of $4.1 million was funded through existingcash.The fair value of the net assets acquired are summarized below (in thousands):Cash and cash equivalents$5Inventories39Prepaid expenses and other current assets38Property and equipment406Reacquired franchise rights1,139Asset retirement obligations(75)Total identifiable net assets acquired1,552Goodwill2,554Total consideration$4,106Reacquired franchise rights have weighted average useful lives of 6.6 years . Goodwill represents the excess of the purchase price over the net tangibleand intangible assets acquired and is expected to be fully deductible for income tax purposes. This goodwill is primarily attributable to the acquiredcustomer bases and, to a lesser extent, economies of scale expected from combining the operations of the acquired entities with that of the Company.Unaudited pro forma information —The unaudited pro forma consolidated revenues and net income of the Company as though the acquisition datehad been as of the beginning of 2014 are as follows:(in thousands)2015 2014Pro forma revenues$121,287 $102,592Pro forma net income4,958 1,331 The pro forma information presented in this note includes adjustments for amortization of acquired intangible assets, depreciation of acquired propertyand equipment, interest expense on borrowings used to fund the consideration paid and income tax expense. The pro forma information is presented forinformational purposes and may not be indicative of the results that would have been obtained had the acquisitions actually occurred at the beginning of2014 , nor is it intended to be indicative of future operating performance.71Table of ContentsRevenues and net income from the acquired stores from the closing date of the acquisition included in the Company’s Consolidated Statements ofOperations and Comprehensive Income (Loss) for 2015 are as follows (in thousands):Revenues$4,220Net income307PMCSI also acquired all of the assets of 17 stores through eight individually immaterial acquisitions during 2015 : eight stores in Tennessee, three inWashington, two in Texas, one in Idaho, one in Oregon, one in Colorado, and one in New Mexico. The Tennessee stores were acquired on January 26,2015, the Washington stores on May 11, 2015, the Texas stores on March 9, 2015 and July 27, 2015, respectively, the Idaho store on January 12, 2015,the Oregon store on March 2, 2015, the Colorado store on May 4, 2015, and the New Mexico store on November 2, 2015. The Company incurredtransaction costs of $33,000 associated with the acquisitions that were recognized as Other store operating costs in the Consolidated Statements ofOperations and Comprehensive Income (Loss) . The total purchase price for the acquired stores of $5.5 million was funded through existing cash.The fair value of the net assets acquired are summarized below (in thousands):Cash and cash equivalents$10Inventories85Prepaid expenses and other current assets69Property and equipment1,360Reacquired franchise rights1,041Asset retirement obligations(185)Total identifiable net assets acquired2,380Goodwill3,134Total consideration$5,514Reacquired franchise rights have weighted average useful lives of 3.4 years . Goodwill represents the excess of the purchase price over the net tangibleand intangible assets acquired and is expected to be fully deductible for income tax purposes. This goodwill is primarily attributable to the acquiredcustomer bases and, to a lesser extent, economies of scale expected from combining the operations of the acquired entities with that of the Company.Unaudited pro forma information —The unaudited pro forma consolidated revenues and net income of the Company as though the acquisition dateshad been as of the beginning of 2014 are as follows:(in thousands)2015 2014Pro forma revenues$122,183 $105,222Pro forma net income4,932 1,244 The pro forma information presented in this note includes adjustments for amortization of acquired intangible assets, depreciation of acquired propertyand equipment, interest expense on borrowings used to fund the consideration paid and income tax expense. The pro forma information is presented forinformational purposes and may not be indicative of the results that would have been obtained had the acquisitions actually occurred at the beginning of2014 , nor is it intended to be indicative of future operating performance.Revenues and net loss from the acquired stores from the closing dates of the acquisitions that are included in the Company’s Consolidated Statements ofOperations and Comprehensive Income (Loss) for 2015 are as follows (in thousands):Revenues$6,594Net loss(322) 72Table of ContentsAcquisitions in 2014On August 18, 2014, Papa Murphy’s Company Stores, Inc. (“ PMCSI ”), a wholly owned subsidiary of the Company, acquired certain assets used in theoperation of nine Papa Murphy’s stores in the Minneapolis, Minnesota area from Drake Enterprises, the previous operator of the nine Papa Murphy’sstores. Transaction costs of $59,000 associated with the acquisition were recognized as Other store operating costs in the Consolidated Statements ofOperations and Comprehensive Income (Loss) . The total purchase price of $3.5 million was funded through cash and the issuance of a $2.9 million notepayable to the seller (see Note 10 — Financing Arrangements ).The fair value of the net assets acquired are summarized below (in thousands):Cash and cash equivalents$4Inventories46Prepaid expenses and other current assets33Property and equipment546Reacquired franchise rights516Asset retirement obligations(61)Total identifiable net assets acquired1,084Goodwill2,369Total consideration$3,453Reacquired franchise rights have weighted average useful lives of 3.3 years . Goodwill represents the excess of the purchase price over the net tangibleand intangible assets acquired and is expected to be fully deductible for income tax purposes. This goodwill is primarily attributable to the acquiredcustomer bases and, to a lesser extent, economies of scale expected from combining the operations of the acquired entities with that of the Company.Unaudited pro forma information —The unaudited pro forma consolidated revenues and net income (loss) of the Company as though the acquisitiondate had been as of the beginning of 2013 are as follows:(in thousands)2014 2013Pro forma revenues$100,307 $85,215Pro forma net income (loss)1,208 (2,605) The pro forma information presented in this note includes adjustments for amortization of acquired intangible assets, depreciation of acquired propertyand equipment, interest expense on borrowings used to fund the consideration paid and income tax expense. The pro forma information is presented forinformational purposes and may not be indicative of the results that would have been obtained had the acquisitions actually occurred at the beginning of2013 , nor is it intended to be indicative of future operating performance.Revenues and net loss from the acquired stores from the closing date of the acquisition included in the Company’s Consolidated Statements ofOperations and Comprehensive Income (Loss) for 2014 are as follows (in thousands):Revenues$2,039Net loss(56)PMCSI also acquired all of the assets of thirteen stores through six individually immaterial acquisitions during 2014 : five stores in Florida, four in Texas,three in Oregon, and one in Washington. The Florida stores were acquired on December 1, 2014, the Texas stores were acquired on December 4, 2014,the Oregon stores were acquired on December 8, 2014, and the Washington store was acquired on November 25, 2014. The Company incurredtransaction costs of $6,000 associated with the acquisitions that were recognized as Other store operating costs in the Consolidated Statements ofOperations and Comprehensive Income (Loss) . The total purchase price for the acquired stores of $4.1 million was funded through cash.73Table of ContentsThe fair value of the net assets acquired are summarized below (in thousands):Cash and cash equivalents$5Inventories67Prepaid expenses and other current assets58Property and equipment1,191Reacquired franchise rights292Asset retirement obligations(111)Total identifiable net assets acquired1,502Goodwill2,633Total consideration$4,135Reacquired franchise rights have weighted average useful lives of 2.7 years . Goodwill represents the excess of the purchase price over the net tangibleand intangible assets acquired and is expected to be fully deductible for income tax purposes. This goodwill is primarily attributable to the acquiredcustomer bases and, to a lesser extent, economies of scale expected from combining the operations of the acquired entities with that of the Company.Unaudited pro forma information —The unaudited pro forma consolidated revenues and net income (loss) of the Company as though the acquisitiondates had been as of the beginning of 2013 are as follows:(in thousands)2014 2013Pro forma revenues$102,975 $86,497Pro forma net income (loss)1,087 (2,780) The pro forma information presented in this note includes adjustments for amortization of acquired intangible assets, depreciation of acquired propertyand equipment, interest expense on borrowings used to fund the consideration paid and income tax expense. The pro forma information is presented forinformational purposes and may not be indicative of the results that would have been obtained had the acquisitions actually occurred at the beginning of2013 , nor is it intended to be indicative of future operating performance.Revenues and net loss from the acquired stores from the closing dates of the acquisitions that are included in the Company’s Consolidated Statements ofOperations and Comprehensive Income (Loss) for 2014 are as follows (in thousands):Revenues$538Net loss(16) Acquisitions in 2013On December 16, 2013, PMCSI acquired all of the assets of four stores in Idaho from TBD Business Group and incurred transaction costs of $103,000associated with the acquisition which were recognized as other store operating costs in the consolidated statement of operations and comprehensiveloss. The total purchase price for the acquired stores of $7.0 million was funded through cash, advances on the Company’s senior secured revolvingcredit facility, and a note payable to the seller for $3.0 million (see Note 10 — Financing Arrangements ).74Table of ContentsThe fair value of the net assets acquired are summarized below (in thousands): Cash and cash equivalents$3Inventories31Prepaid expenses and other current assets13Property and equipment266Reacquired franchise rights3,625Asset retirement obligations(26)Total identifiable net assets acquired3,912Goodwill3,135Total consideration$7,047Reacquired franchise rights have weighted average useful lives of 7.9 years . Goodwill represents the excess of the purchase price over the net tangibleand intangible assets acquired and is expected to be fully deductible for income tax purposes. This goodwill is primarily attributable to the acquiredcustomer bases and to a lesser extent economies of scale expected from combining the operations of the acquired entities with that of the Company.Unaudited pro forma information —The unaudited pro forma consolidated revenues and net loss of the Company as though the acquisition date hadbeen as of the beginning of 2012 are as follows:(in thousands)2013 2012Pro forma revenues$84,523 $71,129Pro forma net loss(2,669) (2,133)The pro forma information presented in this note includes adjustments for amortization of acquired intangible assets, depreciation of acquired propertyand equipment, interest expense on borrowings used to fund the consideration paid and income tax expense. The pro forma information is presented forinformational purposes and may not be indicative of the results that would have been obtained had the acquisitions actually occurred at the beginning of2012 , nor is it intended to be indicative of future operating performance.Revenues and net loss from the acquired stores from the closing date of the acquisition that are included in the Company’s Consolidated Statements ofOperations and Comprehensive Income (Loss) for 2013 are as follows (in thousands):Revenues$168Net loss(3) On November 4, 2013, PMCSI acquired all the assets of four stores, three in Minnesota and one in Wisconsin, from KK Great Pizza, LLC and incurredtransaction costs of $56,000 associated with the acquisition which were recognized as other store operating costs in the consolidated statement ofoperations and comprehensive loss. The total purchase price for the acquired stores of $2.5 million was funded through cash and advances on theCompany’s senior secured revolving credit facility.The fair value of the net assets acquired are summarized below (in thousands):Cash and cash equivalents$3Inventories23Prepaid expenses and other current assets20Property and equipment276Reacquired franchise rights547Asset retirement obligations(23)Total identifiable net assets acquired846Goodwill1,604Total consideration$2,45075Table of ContentsReacquired franchise rights have weighted average useful lives of 2.5 years . Goodwill represents the excess of the purchase price over the net tangibleand intangible assets acquired and is expected to be fully deductible for income tax purposes. This goodwill is primarily attributable to the acquiredcustomer bases and to a lesser extent economies of scale expected from combining the operations of the acquired entities with that of the Company.Unaudited pro forma information —The unaudited pro forma consolidated revenues and net loss of the Company as though the acquisition date hadbeen as of the beginning of 2012 are as follows:(in thousands)2013 2012Pro forma revenues$82,843 $69,697Pro forma net loss(2,626) (2,173)The pro forma information presented in this note includes adjustments for amortization of acquired intangible assets, depreciation of acquired propertyand equipment, interest expense on borrowings used to fund the consideration paid and income tax expense. The pro forma information is presented forinformational purposes and may not be indicative of the results that would have been obtained had the acquisitions actually occurred at the beginning of2012 , nor is it intended to be indicative of future operating performance.Revenues and net loss from the acquired stores from the closing date of the acquisition that are included in the Company’s Consolidated Statements ofOperations and Comprehensive Income (Loss) for 2013 are as follows (in thousands):Revenues$473Net loss(21) PMCSI also acquired all of the assets of eleven stores through five individually immaterial acquisitions during 2013 : four stores in Washington, four inMinnesota, two in Colorado, and one in Oregon. The Washington stores were acquired on January 9, 2013, the Minnesota stores were acquired onJune 4, 2013, the Colorado stores were acquired on July 9, 2013 and October 14, 2013, and the Oregon store was acquired on March 26, 2013. TheCompany incurred transaction costs of $22,000 associated with the acquisitions that were recognized as Other store operating costs in the ConsolidatedStatements of Operations and Comprehensive Income (Loss) . The total purchase price for the acquired stores of $3.9 million was funded through cashand advances on the Company’s senior secured revolving credit facility.The fair value of the net assets acquired are summarized below (in thousands):Cash and cash equivalents$6Inventories67Prepaid expenses and other current assets44Property and equipment804Reacquired franchise rights759Asset retirement obligations(6)Total identifiable net assets acquired1,674Goodwill2,259Total consideration$3,933Reacquired franchise rights have weighted average useful lives of 2.7 years . Goodwill represents the excess of the purchase price over the net tangibleand intangible assets acquired and is expected to be fully deductible for income tax purposes. This goodwill is primarily attributable to the acquiredcustomer bases and to a lesser extent economies of scale expected from combining the operations of the acquired entities with that of the Company.Unaudited pro forma information —The unaudited pro forma consolidated revenues and net loss of the Company as though the acquisition dates hadbeen as of the beginning of 2012 are as follows:(in thousands)2013 2012Pro forma revenues$82,499 $72,962Pro forma net loss(2,510) (2,170)76Table of ContentsThe pro forma information presented in this note includes adjustments for amortization of acquired intangible assets, depreciation of acquired propertyand equipment, interest expense on borrowings used to fund the consideration paid and income tax expense. The pro forma information is presented forinformational purposes and may not be indicative of the results that would have been obtained had the acquisitions actually occurred at the beginning of2012 , nor is it intended to be indicative of future operating performance.Revenues and net loss from the acquired stores from the closing dates of the acquisitions that are included in the Company’s Consolidated Statements ofOperations and Comprehensive Income (Loss) for 2013 are as follows (in thousands):Revenues$4,671Net loss(186) Note 4 — Prepaid Expenses and Other Current AssetsPrepaid expenses and other current assets consist of the following:(in thousands)2015 2014Prepaid media development costs$352 $593Prepaid rents and insurance1,079 620Taxes receivable2,872 154POS software licenses for resale660 1,800Assets held for sale605 —Advertising cooperative assets, restricted26 149Other545 256Total prepaid expenses and other current assets$6,139 $3,572Prepaid media development costs represent costs incurred for advertisements that have not aired. Assets held for sale includes stores underconstruction or opened in the past twelve months that the Company is actively marketing to new or existing franchisees.During 2015 , the Company recognized $1.0 million in software license revenue upon the resale of POS software licenses to franchise owners at cost.The income from the sale is included in Lease and other revenues and the related expense is recorded in Selling, general and administrative costs on theConsolidated Statements of Operations and Comprehensive Income (Loss) .Note 5 — Property and EquipmentProperty and equipment, net , consists of the following:(in thousands)2015 2014Leasehold improvements$7,099 $4,527Restaurant equipment and fixtures10,803 6,950Office furniture and equipment5,575 5,312Software5,291 3,374Vehicles92 92Construction in progress6,193 1,153 35,053 21,408Accumulated depreciation and amortization(13,792) (9,288)Property and equipment, net$21,261 $12,12077Table of ContentsDepreciation expense during the periods reported was as follows:(in thousands)2015 2014 2013Depreciation expense$4,680 $3,015 $2,405The Company recognized an impairment loss of $0.6 million in 2013 related to certain underperforming Company-owned stores. No impairment loss wasrecognized during 2015 or 2014.Note 6 — DivestituresIn November 2015 , the Company decided to sell four Company-owned stores located in the Denver, Colorado area. On December 28, 2015 , theCompany completed the sale and refranchise of the four Company-owned stores for $1.3 million in cash, and recognized a pre-tax gain of $0.4 million .In connection with the sale, the acquirer paid $60,000 in franchise fees. This disposition did not meet the criteria for accounting as a discontinuedoperation.The following is a summary of the assets sold as of December 28, 2015 (in thousands).Leasehold improvements$341Restaurant equipment and fixtures367Property and equipment708Prepaid expenses and other current assets22Intangible assets8Goodwill263Total assets sold$1,001In September 2013 , the Company decided to sell nine Company-owned stores located in Wichita, Kansas. On November 11, 2013 , the Companycompleted the sale and refranchise of the nine Company-owned stores for $0.8 million , and recognized a gain of $3,000 . In connection with the sale, theacquirer paid $0.1 million in franchise fees. The Company received $0.1 million in cash and a one -year note receivable for $0.8 million in connection withthis transaction. This disposition did not meet the criteria for accounting as a discontinued operation.Current assets and liabilities of these stores were not material. The following is a summary of the assets sold as of November 11, 2013 (in thousands).Leasehold improvements$338Restaurant equipment and fixtures184Property and equipment522Goodwill240Total assets sold$76278Table of ContentsNote 7 — GoodwillThe following summarizes changes to the Company’s Goodwill , by reportable segment:(in thousands)Domestic CompanyStores Domestic Franchise TotalBalance at December 30, 2013$14,543 $81,546 $96,089Acquisitions5,002 — 5,002Disposition(9) — (9)Balance at December 29, 201419,536 81,546 101,082Acquisitions5,687 — 5,687Disposition(263) — (263)Balance at December 28, 2015$24,960 $81,546 $106,506There is no Goodwill associated with the International segment. The Company did not recognize any impairment of goodwill during 2015 , 2014 or 2013as management has concluded that none of its reporting units with a material amount of goodwill are at risk for failing step one of the quantitativeassessment. The Company recorded Goodwill disposals in 2015 , 2014 and 2013 from the sale of Company-owned stores to franchise owners.Note 8 — Intangible AssetsIntangible assets consist of the following: 2015 (in thousands)Gross CarryingAmount AccumulatedAmortization Net Weighted AverageAmortizationPeriodIntangible assets subject to amortization: Franchise relationships$56,000 $(19,788) $36,212 16.0Reacquired franchise rights8,366 (3,212) 5,154 6.0Net intangible assets subject to amortization$64,366 $(23,000) $41,366 14.5Intangible assets not subject to amortization Trade name and trademarks $87,002 2014 (in thousands)Gross CarryingAmount AccumulatedAmortization Net Weighted AverageAmortizationPeriodIntangible assets subject to amortization: Franchise relationships$56,000 $(16,289) $39,711 16.0Reacquired franchise rights7,789 (2,985) 4,804 5.3Net intangible assets subject to amortization$63,789 $(19,274) $44,515 14.7Intangible assets not subject to amortization Trade name and trademarks $87,002 Reacquired franchise rights were recorded as part of the Company’s acquisitions of franchised stores as discussed in Note 3 — Acquisitions . Tradename and trademarks are intangible assets determined to have indefinite lives and are not subject to amortization. Management has concluded that noneof its reporting units with a material amount of intangible assets not subject to amortization are at risk for failing step one of the quantitative assessment.79Table of ContentsAmortization expense during the periods reported was as follows:(in thousands)2015 2014 2013Amortization expense$5,322 $5,037 $4,568The estimated future amortization expense of amortizable intangible assets as of December 28, 2015 is as follows (in thousands):Fiscal years2016$4,976 20174,656 20184,331 20194,068 20203,945 Thereafter19,390 $41,366Note 9 — Notes ReceivableNotes receivable consist of the following:(in thousands)2015 2014Note maturing in 2020 bearing interest at 9.0% and collateralized by store assets$221 $287Total notes receivable221 287Less current portion(78) (62)Notes receivable, net of current portion$143 $225Note 10 — Financing ArrangementsLong-term debt consists of the following:(in thousands)2015 2014Term loan under 2014 credit facility$109,200 $112,000Notes payable3,000 3,000Total principal amount of long-term debt112,200 115,000Less unamortized debt issuance costs(1,163) (1,485)Total long-term debt111,037 113,515Less current portion(2,800) (2,800)Total long-term debt, net of current portion$108,237 $110,715Maturities on long-term debt consist of the following:(in thousands)Senior Secured TermLoan Notes Payable TotalFiscal Years2016$2,800 $— $2,800 20177,000 — 7,000 20185,600 3,000 8,600 201993,800 — 93,800 $109,200 $3,000 $112,20080Table of ContentsThe weighted average interest rate across all senior secured credit facilities for 2015 , 2014 and 2013 was 4.60% , 5.45% and 6.22% , respectively.2014 senior secured credit facilityOn August 28, 2014, PMI Holdings, Inc., a wholly-owned subsidiary of the Company, entered into a $132.0 million senior secured credit facility (the “2014 Credit Facility ”) consisting of a $112.0 million term loan and a $20.0 million revolving credit facility, which includes a $2.5 million letter of credit sub-facility and a $1.0 million swing-line loan sub-facility. Closing and structuring fees of $1.6 million were incurred as a result of this transaction which will beamortized over the duration of the loan. The term loan and any loans made under the revolving credit facility mature in August 2019 .Borrowings under the 2014 Credit Facility bear interest at a rate per annum equal to an applicable margin based on the Company’s consolidated leverageratio, plus, at the Company’s option, either (a) a base rate determined by reference to the highest of (i) the “Prime Rate” publicly quoted by The WallStreet Journal, (ii) the federal funds rate plus 50 basis points, or (iii) the LIBOR rate with a one-month interest period plus 100 basis points, or (b) aLIBOR rate determined for the specified interest period. The applicable margin for borrowings under the 2014 Credit Facility ranges from 150 to 225 basispoints for base rate borrowings and 250 to 325 basis points for LIBOR rate borrowings. The 2014 Credit Facility includes customary fees for loan facilitiesof this type, including a commitment fee on the revolving credit facility. As of December 28, 2015 , the 2014 Credit Facility bore interest under the LIBORrate option at 3.48% .The obligations under the 2014 Credit Facility are guaranteed by certain domestic subsidiaries of the Company (the “ subsidiary guarantors ”) and aresecured by substantially all assets of the Company and the subsidiary guarantors . The 2014 Credit Facility also contains customary affirmative andnegative covenants that are typical for loan facilities of this type, including covenants that, among other things, restrict our ability and the ability of oursubsidiaries to incur indebtedness, issue certain types of equity, incur liens, enter into fundamental changes, including mergers and consolidations, sellassets, make dividends, distributions and investments, and prepay subordinated indebtedness, subject to customary exceptions. The 2014 Credit Facilityalso includes certain financial covenants with respect to a maximum consolidated leverage ratio and a minimum interest coverage ratio.With a maturity date of over one year from December 28, 2015 , balances outstanding under the 2014 Credit Facility are classified as non-current on theConsolidated Balance Sheets , except for mandatory, minimum term loan amortization payments of $0.7 million due on the last day of each fiscal quarter,increasing to $1.4 million on September 26, 2016 .2013 senior secured credit facilityIn August 2014, the borrowings under the 2014 Credit Facility refinanced the $177.0 million senior secured credit facility entered into in October 2013 (the“ 2013 Credit Facility ”), which included a $167.0 million senior secured term loan and a $10.0 million revolving credit facility, including a $2.5 million letterof credit sub-facility. The terms of the 2013 Credit Facility were substantially similar to those of the 2014 Credit Facility , except that the applicable marginfor borrowings ranged from 300 basis points to 475 basis points for base rate borrowings and 450 to 575 basis points for LIBOR borrowings.On May 7, 2014 , the Company prepaid $55.5 million of its long-term debt under the 2013 Credit Facility in connection with the IPO . A proportionateshare of deferred financing costs of $1.2 million were expensed as a Loss on early retirement of debt on the Company’s Consolidated Statements ofOperations and Comprehensive Income (Loss) at the time of this debt prepayment.2013 recapitalizationOn October 25, 2013, the Company refinanced its existing long-term debt, consisting of a senior secured term loan and a revolving credit facility(collectively, the “ 2012 Credit Facility ”). The Company used a portion of the proceeds from its new credit facility and cash on hand to pay accreteddividends and provide a partial return of investment capital to its preferred stockholders. The refinancing also lowered the Company’s cost of capitalthrough lower interest rates on its debt. This transaction is referred to as the “ 2013 Recapitalization .”81Table of ContentsThe following is a summary of the sources and uses of the 2013 Recapitalization (in thousands): New senior secured term loan$167,000 Repayment of existing debt, accrued interest and fees$122,483Existing debt prepayment penalty724Transaction costs incurred on new debt3,389Payment of accreted dividends on preferred stock subject to put options813Payment of preferred dividend and return of invested capital30,691Cash available for acquisitions8,900Total uses$167,000Notes payablePMCSI has a note payable for $3.0 million which bears interest at 5% and matures in December 2018 . This note is subordinated to the senior securedcredit facility.As part of the Drake Enterprises store acquisition, PMCSI issued a note payable for $2.9 million to Drake Enterprises in August 2014. The note boreinterest at 7% and was scheduled to mature in April 2019 with an acceleration clause in the event of a refinancing of the 2013 Credit Facility . The notewas paid in full during September 2014 .Deferred financing costs and prepayment penaltiesIn conjunction with the 2014 Credit Facility , the Company evaluated the refinancing of the 2013 Credit Facility and determined that the borrowing wasextinguished and not modified. Accordingly, unamortized deferred financing costs of $2.3 million from the 2013 Credit Facility and a prepayment penaltyof $1.1 million were expensed as a Loss on early retirement of debt . The Company incurred $1.6 million in financing costs which was capitalized and isbeing amortized using an effective interest rate method.In conjunction with the 2013 Recapitalization , the Company evaluated the refinancing of the 2012 Credit Facility and determined that $33.6 million wasmodified and $87.0 million was extinguished. Accordingly, a prepayment penalty of $0.7 million and unamortized deferred financing costs of $2.9 millionassociated with the 2012 Credit Facility were expensed as a Loss on early retirement of debt . The Company incurred $3.3 million in financing costs ofwhich $0.4 million was expensed as incurred and $2.9 million was capitalized and amortized using an effective interest rate method.Deferred financing costs amortized to interest expense in the Consolidated Statements of Operations and Comprehensive Income (Loss) during theperiods reported were as follows (in thousands):(in thousands)2015 2014 2013Deferred financing costs amortized to interest expense$321 $563 $790Amortization of deferred financing costs in the future is expected to be as follows (in thousands):Fiscal Years2016$330 2017319 2018313 2019201 $1,16382Table of ContentsNote 11 — Fair Value MeasurementThe Company determines the fair value of assets and liabilities based on the price that would be received to sell the asset or paid to transfer the liabilityto a market participant. GAAP defines a fair value hierarchy that prioritizes the assumptions used to measure fair value. The three levels of the fair valuehierarchy are defined as follows:▪Level 1 — Quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.▪Level 2 — Observable inputs other than prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets;quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or canbe corroborated with observable market data▪Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets andliabilities. This includes certain pricing models, discounted cash flow methodologies, and similar techniques that use significantunobservable inputs.The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis: 2015 2014 (in thousands)CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE FAIR VALUEMEASUREMENTSFinancial assets Notes receivable (1)$221 $224 $287 $288 Level 3Cost-method investments (2)— — 4,000 5,055 Level 3(1)The fair value of notes receivable was estimated primarily using a discounted cash flow method based on a discount rate, reflecting the applicable credit spread.(2)The fair value of cost-method investments was estimated primarily using a discounted cash flow method based on a discount rate, reflecting the applicable credit spread.Financial instruments not included in the table above consist of cash and cash equivalents, accounts receivable, accounts payable and long-term debt.The fair value of cash and cash equivalents, accounts receivable and accounts payable approximates carrying value because of the short-term nature ofthe accounts. The fair value of long-term debt approximates carrying value because the borrowings are made with variable market rates and negotiatedterms and conditions that are consistent with current market rates.Note 12 — Accrued and Other LiabilitiesAccrued expenses and other current liabilities consist of the following:(in thousands)2015 2014Accrued compensation and related costs$3,699 $3,670Gift cards and certificates payable2,902 2,912Accrued interest and non-income taxes payable855 745Convention fund balance626 271Advertising and development fund— 507Unearned product rebates922 791Advertising cooperative liabilities137 253Other615 704 $9,756 $9,85383Table of ContentsNote 13 — Income TaxesThe components of the provision for income taxes are as follows:(in thousands)2015 2014 2013Current tax provision Federal$83 $9 $9State278 103 71 361 112 80Deferred tax provision (benefit) Federal2,211 958 299State(504) 165 645 1,707 1,123 944Total provision for income taxes$2,068 $1,235 $1,024The components of the non-current deferred tax liability are as follows:(in thousands)2015 2014Net current deferred income tax asset Assets Unearned franchise and development fees$858 $683Convention and Advertising funds balance232 101Compensation accruals422 3Gift card accruals414 465Other619 519Total current deferred tax assets2,545 1,771Liabilities Other(162) (434)Net current deferred income tax asset$2,383 $1,337 Net noncurrent deferred income tax liability Assets Asset retirement obligation$172 $160Deferred rent206 177Share-based compensation901 588Net operating loss— 1,874Liabilities Fixed asset, goodwill, and intangible asset basis differences(44,491) (44,386)Other(1,610) (482)Net non-current deferred income tax liability$(44,822) $(42,069)As of December 28, 2015 , the Company had no federal or state net operating loss carry forwards. As of December 29, 2014 , the Company had federaland state net operating loss carry forwards of $5.0 million and $3.9 million , respectively. The Company had no federal or state credit carryovers as ofDecember 28, 2015 .At December 28, 2015 , the Company had no unrecognized tax benefits that, if recognized, would affect the effective tax rate. The Company did not haveany tax positions for which it is reasonably possible that the total amount of unrecognized tax benefits will significantly increase or decrease within thenext 12 months. As of December 28, 2015 , the Company had no accrued interest or penalties related to uncertain tax positions. The tax years thatremain subject to examination by federal and major states’ taxing jurisdictions are those for fiscal years 2012 through 2015 .84Table of ContentsTax benefits for federal and state net operating loss carry forwards are recorded as an asset to the extent that management assesses the utilization ofsuch assets to be “more likely than not”; otherwise, a valuation allowance is required to be recorded. The Company has looked to future reversals ofexisting taxable temporary differences in determining that its federal and state net operating loss carry forwards are more likely than not to be utilizedprior to their expiration dates. Consequently, no valuation allowance has been recorded for the deferred tax assets. The Company will continue toevaluate the need for a valuation allowance in the future. Changes in estimated future taxable income and other underlying factors may lead toadjustments to the valuation allowance in the future.A reconciliation of income tax at the United States federal statutory tax rate (using a statutory tax rate of 34% ) to income tax expense for the periodsreported is as follows:(in thousands)2015 2014 2013Federal income tax provision based on statutory rate$2,203 $844 $(534)State and local income tax effect314 177 65Effect of change in blended state rate(464) — 408Non-deductible expenses133 254 90Tax shortfall created by put option cancellation— — 995Tax credits and other(118) (40) —Provision for income taxes$2,068 $1,235 $1,024Note 14 — Shareholders’ EquityPreferred stockPrior to the IPO , the Company’s Preferred Shares had a cumulative preferred dividend of 6.00% per year based on an original liquidation value of$36.68 per share. Upon liquidation of the Company, the holders of the Preferred Shares were entitled to receive the unpaid liquidation value plusaccreted dividends before any distribution could be made to the holders of common stock. In addition, the Preferred Shares participated in 20% of allremaining earnings if distributed to common stockholders. The unpaid liquidation value of the Series A and Series B Preferred Shares was $21.14 and$26.80 per share, respectively, as of the IPO . At the IPO , the Preferred Shares were converted into 3,054,318 shares of common stock.Noncontrolling interestsDuring 2015 , 2014 and 2013 , the Company received investments by noncontrolling interest holders in PPH . Investment amounts for the reportedperiods were as follows:(in thousands)2015 2014 2013Additional investment by noncontrolling interest holders in PPH$56 $222 $241Note 15 — Share-based CompensationIn May 2010, the Company’s Board of Directors approved the 2010 Plan . In May 2014, the Company’s Board of Directors adopted the 2014 Plan(together with the 2010 Plan , the “ Incentive Plans ”). The Incentive Plans reserve 2,116,747 common shares for equity incentive awards consisting ofincentive stock options, non-qualified stock options, restricted stock awards, and unrestricted stock awards. Equity incentive awards may be issued fromeither the 2010 Plan or the 2014 Plan .Restricted common sharesUnder the Incentive Plans , the Company has issued 584,017 and 610,084 shares of restricted common stock to eligible employees as ofDecember 28, 2015 and December 29, 2014 , respectively. The restricted common stock is subject to either time or performance vesting conditions.Time vesting shares issued under the 2010 Plan have generally vested 20% on each of the five anniversaries of the sale date. Time vesting sharespreviously granted under the 2014 Plan have generally vested 100% on the one -year anniversary of the grant date. Performance vesting shares vestwhen the volume-weighted average closing price per share of Papa Murphy’s common stock equals or exceeds $22.00 per share for 90 consecutive85Table of Contentstrading days. To the extent the fair value on the date of the sale or award exceeds the sale price, if any, the excess is recognized as compensationexpense as a component of Selling, general and administrative expenses. Compensation expense for time vesting shares is recognized over therequisite service period on a straight line basis. During 2015, it was deemed probable that the performance vesting condition would be met andcompensation expense has been recorded on a straight line basis from the date of issuance over the initial estimated service period.The Company has a right to repurchase shares sold to employees under the 2010 Plan in the case of a qualifying sale, bankruptcy event, or atermination event of the employee who purchased shares. Unvested shares as of the date of these events, including a grantee’s resignation, arerepurchased at the original sale price. Since the IPO , the Company generally does not repurchase vested shares from terminated employees.Information with respect to restricted stock is as follows: NUMBER OF SHARES OFRESTRICTED COMMON STOCK TIME VESTING PERFORMANCEVESTING WEIGHTED AVERAGESALE/GRANT DATEFAIR VALUE PER SHAREUnvested, 2014127,650 215,556 $2.27Granted7,877 — 19.05Vested(78,472) — 2.18Forfeited/Repurchased(7,542) (29,041) 0.70Unvested, 201549,513 186,515 $3.11Fair value information for restricted stock during the periods reported is as follows:(in thousands, except per share amounts)2015 2014 2013Weighted average sale/grant date fair value per share$19.05 $8.80 $8.67Total fair value of shares issued$150 $60 $490Total fair value of shares vested$171 $509 $105Stock optionsUnder the Incentive Plans , the Company has issued 1,076,555 and 945,149 stock options to eligible employees as of December 28, 2015 andDecember 29, 2014 , respectively. The stock options are subject to either time or performance vesting conditions. Time vesting options awardedgenerally vest 25% on each of the four anniversaries of the grant date. Performance vesting options vest when the volume-weighted average closingprice per share of Papa Murphy’s common stock equals or exceeds $22.00 per share for 90 consecutive trading days. The grant date fair value isrecognized as compensation expense as a component of Selling, general and administrative expenses. The compensation expense is recognized overthe requisite service period, typically the vesting period, on a straight line basis. During 2015, it was deemed probable that the performance vestingcondition would be met and compensation expense has been recorded on a straight line basis from the date of issuance over the initial estimated serviceperiod.Information with respect to stock option activity is as follows: NUMBER OF SHARESSUBJECT TO OPTIONS TIME VESTING PERFORMANCE VESTING WEIGHTED AVERAGE EXERCISE PRICE PER SHARE WEIGHTED AVERAGE REMAINING CONTRACTUAL TERM AGGREGATE INTRINSIC VALUE (in thousands)Outstanding, 2014722,307 222,842 $11.16 Granted192,000 — 13.43 Exercised(34,118) — 11.00 Forfeited(38,233) (22,361) 11.75 Outstanding, 2015841,956 200,481 $11.55 8.5 years $371Exercisable, 2015437,758 — $11.19 8.3 years $182Vested and expected to vest, 2015781,326 170,409 $11.53 8.3 years $34386Table of ContentsFair value information for options granted and vested and the intrinsic value of options exercised during the periods reported are as follows:(in thousands, except per share amounts)2015 2014Weighted average grant date fair value per share$5.41 $4.27Total fair value of awards granted$1,039 $4,151Total fair value of awards vested$431 $1,635Total intrinsic value of options exercised$189 $—There were no options granted during 2013.Compensation cost and valuationTotal compensation costs recognized in connection with the Incentive Plans for 2015 , 2014 and 2013 were as follows:(in thousands)2015 2014 2013Stock compensation expense$1,081 $1,898 $61Income tax benefits associated with stock compensation expense350 626 23 As of December 28, 2015 , the total unrecognized stock-based compensation expense, net of estimated forfeitures, was $2.6 million , with $1.8 millionassociated with time vesting awards and $0.8 million associated with performance vesting awards. The remaining weighted average contractual life forunrecognized stock-based compensation expense was 3.3 years as of December 28, 2015 .The fair value of the stock option awards granted during the periods reported was estimated with the following weighted-average assumptions. 2015 2014Risk free rate1.94% 2.05%Expected volatility37.9% 35.0%Expected term6.3 years 6.3 yearsExpected dividend yield0.0% 0.0% There were no options granted during 2013.Prior to the IPO , the valuation of the Company’s common stock and Preferred Shares was based on the principles of option-pricing theory. Thisapproach is based on modeling the value of the various components of an entity’s capital structure as a series of call options on the proceeds expectedfrom the sale of the entity or the liquidation of its assets at some future date. Specifically, each of the preferred and common equity is modeled as a calloption on the aggregate value of the Company with an exercise price equal to the liquidation preferences of the more senior securities. In estimating thefair value of the aggregate value of the Company, the Company considered both the income approach and the market approach.The key inputs required to calculate the value of the common stock using the option-pricing model prior to the IPO included the risk free rate, the volatilityof the underlying assets, and the estimated time until a liquidation event. The Company applied a marketability discount to the value of common stockbased on facts and circumstances at each valuation date.During the reported periods prior to the IPO , the Company assumed the following: 2014 (1) 2013Risk free rate0.36% 0.10~0.50%Volatility of the underlying assets45% 35~45%Estimated time until a liquidation event(2) (3)Marketability discount—common stock(2) (3)Marketability discount—preferred stock(2) (3)(1)The last valuation of the Company was performed as of March 31, 2014.(2)On July 1, 2013, the Company began to apply a probability weighted expected return method, where equity values were calculated using an option pricing model underIPO and non- IPO scenarios and each value was weighted based on estimated probability of occurrence. During the period, 0.58 ~ 1.75 years were used as estimated timeuntil a liquidation event and 10 ~ 25% and 8 ~ 15% of marketability discount were87Table of Contentsused for common and preferred stock, respectively, depending on IPO or non- IPO scenarios. As of March 31, 2014, the date of the last valuation performed by theCompany, a 95% weight was given to the IPO scenario.(3)During the period, 0.25 ~ 2.50 years were used as estimated time until a liquidation event and 13 ~ 30% and 8 - 15% of marketability discount were used for common andpreferred stock, respectively, depending on IPO or non- IPO scenarios, respectively. As of December 29, 2014 , a 80% weight was given to the IPO scenario.Preferred and common stock subject to put optionsIn July 2011, the Company entered into a share repurchase and put option agreement with an executive officer, pursuant to which the executive officerhad the right and option to have the Company repurchase 74,491 shares of unrestricted preferred stock and 92,951 shares ( 41,075 pre-stock split) ofunrestricted common stock (“ Put Option ”).The change in the fair value of the Put Option during 2013 resulted in additional compensation expense of $0.8 million . In December 2013, the sharerepurchase and put option agreement was canceled.Note 16 — Earnings per Share (EPS)The number of shares and earnings per share (“ EPS ”) data for all periods presented are based on the historical weighted-average shares of commonstock outstanding. Prior to the IPO , the Company’s cumulative preferred stockholders were entitled to participate in 20% of all remaining earnings ordividends if distributed to common stockholders. As such, the Company has calculated EPS using the two-class method. The two-class methoddetermines EPS for common stock and participating securities according to dividends and dividend equivalents and their respective participation rights inundistributed earnings.Basic EPS is calculated by dividing income available to common stockholders by the weighted-average number of shares of common stock outstandingduring each period. Diluted EPS is calculated using income available to common stockholders divided by diluted weighted-average shares of commonstock outstanding during each period, which includes unvested restricted common stock and outstanding stock options. Diluted EPS considers the effectof potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common shares would have an anti-dilutiveeffect.The following table sets forth the computations of basic and diluted EPS :(in thousands, except per share data)2015 2014 2013Earnings: Net income (loss)$4,411 $1,248 $(2,591)Less: Net loss from noncontrolling interests500 — 19Net income (loss) attributable to Papa Murphy’s4,911 1,248 (2,572)Less: cumulative Series A and B Preferred dividends not subject to put options— (2,150) (6,419)Net loss available to common stockholders$4,911 $(902) $(8,991)Shares: Basic weighted average common shares outstanding16,653 12,101 3,848Dilutive effect of restricted equity awards (1)218 — —Diluted weighted average number of shares outstanding16,871 12,101 3,848Loss per share: Basic loss per share$0.29 $(0.07) $(2.34)Diluted loss per share$0.29 $(0.07) $(2.34)(1)The Company’s potential common stock instruments such as stock options and restricted stock were not included in the computation of diluted EPS for 2014 and 2013 asthe effect of including these shares in the calculation would have been anti-dilutive. An aggregated total of 78,000 , 344,000 and 269,000 potential common shares havebeen excluded from the diluted EPS calculation for 2015 , 2014 and 2013 , respectively, because their effect would have been anti-dilutive.88Table of ContentsNote 17 — Commitments and ContingenciesOperating lease commitmentsThe Company leases facilities and various office equipment under non-cancelable operating leases which expire through December 2025 . Lease termsfor its store units are generally for five years with renewal options and generally require the Company to pay a proportionate share of real estate taxes,insurance, common area, and other operating costs.The Company has entered into operating leases that it has subleased to three franchised stores. These operating leases have minimum base rent termsand contingent rent terms if individual franchised store sales exceed certain levels and have terms expiring on various dates from May 2020 to October2020 .As of December 28, 2015 , future minimum payments under the non-cancelable operating leases, excluding contingent rent obligations, are as follows:(in thousands)Total leaseminimumpayments Sublease income Net lease minimumpaymentsFiscal years2016$4,692 $72 $4,620 20174,304 72 4,232 20183,905 72 3,833 20193,188 72 3,116 20202,213 45 2,168 Thereafter5,135 — 5,135 $23,437 $333 $23,104Rent expense for 2015 , 2014 and 2013 was $5.6 million , $3.6 million and $3.1 million , respectively.Lease guaranteesThe Company is the guarantor for operating leases of 17 franchised stores that have terms expiring on various dates from August 2016 to December2020 . The obligations from these leases will generally continue to decrease over time as the leases expire. As of December 28, 2015 , the Companydoes not believe it is probable it would be required to perform under the outstanding guarantees. The applicable franchise owners continue to haveprimary liability for these operating leases.As of December 28, 2015 , future commitments under these leases are as follows (in thousands):Fiscal Years2016$427 2017383 2018302 2019258 2020151 $1,521Legal proceedingsThe Company is currently subject to litigation with a group of franchise owners. In January 2014, six franchise owner groups claimed that the Companymisrepresented sales volumes, made false representations to them and charged excess advertising fees, among other things. The Company engaged inmediation with these franchise owners, which is required under the terms of their franchise agreements, in order to address and resolve their claims, butwas unable to reach a settlement agreement. On April 4, 2014, a total of twelve franchise owner groups, including those franchise owners that previouslymade the allegations described above, filed a lawsuit against the Company in the Superior Court in Clark County, Washington, making essentially thesame allegations for violation of the Washington Franchise Investment Protection Act, fraud, negligent misrepresentation and breach of contract andseeking declaratory and injunctive relief, as well as monetary damages. Based on motions filed by the Company in that lawsuit, the court ruled on July 9,2014 that certain of the plaintiffs’ claims under the anti-fraud and nondisclosure provisions of the Washington Franchise Investment Protection Act shouldbe dismissed and that certain other claims in the case would need to be more specifically alleged. The court also ruled that the89Table of Contentssix franchise owner groups who had not mediated with the Company prior to filing the lawsuit must mediate with the Company in good faith, and that theirclaims shall be stayed until they have completed mediating with the Company in good faith.On June 18, 2014, an additional 16 franchise owner groups, represented by the same counsel as the plaintiffs described above, filed a lawsuit in theSuperior Court in Clark County, Washington making essentially the same allegations as made in the lawsuit described above and seeking declaratoryand injunctive relief, as well as monetary damages. The court consolidated the two lawsuits into a single case and ordered that the plaintiffs in the newlawsuit, none of whom had mediated with the Company prior to filing the lawsuit, must do so, and that their claims be stayed until they have done so.In October 2014, the Company engaged in mediation with the 22 franchise owner groups who had not previously done so. As a result of that mediationand other efforts, the Company has now reached resolution with twelve of the franchise owner groups involved in the consolidated lawsuits, and theirclaims have either been dismissed or dismissal is pending. In addition, some of the claims have been dismissed without prejudice and, as a result, thoseplaintiffs could refile their claims if various contingencies are not met and the Company therefore provides no assurance that those dismissals will actuallyoccur or remain in effect.In February 2015, the remaining plaintiffs in the consolidated lawsuits filed an amended complaint, removing some claims, amending some claims,adding claims and naming some of the Company’s former and current franchise sales staff as additional individual defendants. As before, the Companybelieves the allegations in this litigation lack merit and, for those plaintiffs with whom the Company is unable to reach resolution, the Company willcontinue to vigorously defend its interests, including by asserting a number of affirmative defenses and, where appropriate, counterclaims. The Companyprovides no assurance that it will be successful in its defense of these lawsuits; however, it does not currently expect the cost of resolving them to have amaterial adverse effect on its consolidated financial position, results of operations, or cash flows.The Company is also currently named as a defendant in a putative class action lawsuit filed by plaintiff John Lennartson on May 8, 2015, in the UnitedStates District Court for the Western District of Washington. The lawsuit alleges the Company failed to comply with the requirements of the TelephoneConsumer Protection Act (TCPA) when it sent SMS text messages to consumers. The plaintiff in the lawsuit asks that the court certify the putative classand that statutory damages under the TCPA be awarded to plaintiff and each class member. The Company believes the plaintiff’s interpretation of theapplicable law is incorrect and it will continue to vigorously defend itself in the lawsuit, but provide no assurance that it will be successful. An adversejudgment or settlement related to this lawsuit could have a material adverse effect on the Company's consolidated financial position, results of operations,or cash flows.In addition to the foregoing, the Company is subject to routine legal proceedings, claims, and litigation in the ordinary course of its business. TheCompany may also engage in future litigation with franchise owners to enforce the terms of franchise agreements and compliance with brand standardsas determined necessary to protect the Company’s brand, the consistency of products and the customer experience. Lawsuits require significantmanagement attention and financial resources and the outcome of any litigation is inherently uncertain. The Company does not, however, currentlyexpect that the costs to resolve these routine matters will have a material adverse effect on its consolidated financial position, results of operations, orcash flows.Note 18 — Retirement PlansThe Company has a defined contribution benefit plan, qualified under Section 401(k) of the Internal Revenue Code (the “ 401(k) Plan ”), covering alleligible employees. 401(k) Plan participants may receive up to a 3.00% matching contribution up to the limits established by the plan and by the InternalRevenue Service and are vested immediately. The following table shows the Company’s contributions to the plan for the reported periods:(in thousands)2015 2014 2013Retirement plan contributions$362 $276 $25790Table of ContentsNote 19 — Related Party TransactionsAdvisory services and monitoring agreementPrior to the IPO , the Company was a party to an advisory services and monitoring agreement with affiliates of Lee Equity . In accordance with the termsof the agreement, the Company paid Lee Equity for ongoing advisory and monitoring services, such as management consulting, financial analysis, andother related services. As compensation, the Company paid an annual fee of $0.5 million in four equal quarterly installments, plus direct expensesincurred which are included in Selling, general and administrative costs. The agreement did not call for a minimum level of services to be furnished andprovided that fees paid to Lee Equity could be deferred at the discretion of Lee Equity or by the Company’s senior secured credit facility, if required.On May 7, 2014, the Company completed the IPO and paid Lee Equity $1.5 million in accordance with the terms of the agreement. With the completionof the IPO , the advisory services and monitoring agreement between the Company and Lee Equity was terminated.Employee loans related to share purchasesIn connection with share-based compensation, the Company has made several loans to certain officers and non-officer employees of the Company (seeNote 15 — Share-based Compensation ). Loans made in connection with the issuance of the Company’s equity have been recognized in Stocksubscriptions receivable as a reduction of total equity.In March 2014, the Company entered into agreements with certain executive officers to repurchase an aggregate of 109,779 shares of common stock (48,516 shares pre-stock split) at a price of $11.85 per share ( $26.80 per share pre-stock split), for a total purchase price of $1.3 million . Included amongthe repurchased shares were 31,707 shares of common stock ( 14,014 shares pre-stock split), for which vesting terms were accelerated in connectionwith the repurchase. The Company received a payment of $1.0 million from the same executive officers to repay their outstanding stock subscriptionreceivables. Concurrent with the share repurchase, the Company entered into agreements with the same executive officers to issue 109,779 stockoptions ( 48,516 stock options pre-stock split) to purchase shares at an exercise price of $11.85 per share ( $26.80 per share pre-stock split), including78,072 fully vested options ( 34,502 options pre-stock split) and 31,707 options ( 14,014 options pre-stock split) subject to time-based or marketcondition-based vesting provisions. In connection with the acceleration of vesting and the issuance of the fully vested options, the Company recordedstock-based compensation expense of $0.5 million in 2014.All loans made to officers of the Company were repaid prior to the IPO . Some loans made to non-officer employees of the Company were stilloutstanding at the time of the IPO . As of December 28, 2015 and December 29, 2014 , the Company had Stock subscriptions receivable of $0.1 million .Notes receivableOn August 18, 2009, the Company obtained a note receivable from a third-party in connection with the sale and refranchising of Company-owned stores(see Note 9 — Notes Receivable ). Subsequently, in March 2011 a member of the third-party became an employee of the Company. As of June 30,2014, the member of the third-party ceased to be an employee of the Company. During the second quarter of 2014, the notes receivable outstandingbalance of $0.3 million was reclassified from related party notes receivable to third-party notes receivable. The outstanding balance of the note receivableas of December 28, 2015 was $0.2 million .Related party revenueThe Company was party to transactions to sell services to Project Pie during the period Project Pie was a cost-method investee. The Company recordedrevenues of $4,000 in 2015 and $109,000 in 2014, which are recorded as Lease and other revenues on the Consolidated Statements of Operations andComprehensive Income (Loss) . As of December 28, 2015 and December 29, 2014 , the Company had an Accounts receivable balance from Project Pieof $0 and $66,000 , respectively.91Table of ContentsNote 20 — Segment InformationThe Company has the following reportable segments: (i) Domestic Company Stores; (ii) Domestic Franchise; and (iii) International. The DomesticCompany Stores segment includes operations with respect to Company-owned stores in the United States and derives its revenues from retail sales ofpizza and side items to the general public. The Domestic Franchise segment includes operations with respect to franchised stores in the United Statesand derives its revenues from franchise and development fees and the collection of franchise royalties from the Company’s franchise owners located inthe United States. The International segment includes operations related to the Company’s operations outside the United States and derives its revenuesfrom franchise and development fees and the collection of franchise royalties from franchises located outside the United States.The following tables summarize information on profit or loss and assets for each of the Company’s reportable segments:(in thousands)2015 2014 2013Revenues Domestic Franchise$45,579 $46,233 $40,450Domestic Company Stores74,300 50,598 39,148International330 568 897Total$120,209 $97,399 $80,495Segment Operating Income (Loss) Domestic Franchise$20,750 $21,939 $20,540Domestic Company Stores1,359 1,307 (408)International238 20 (24)Corporate and unallocated(6,712) (7,961) (7,173)Total$15,635 $15,305 $12,935Depreciation and amortization Domestic Franchise$5,392 $5,046 $4,753Domestic Company Stores4,579 2,975 2,193International31 31 27Total$10,002 $8,052 $6,973Interest expense (income), net Domestic Franchise$— $(2) $(9)Domestic Company Stores2,301 2,547 1,505International(3) (27) (35)Other2,225 5,507 8,968Total$4,523 $8,025 $10,429Provision for income taxes Domestic Franchise$— $— $—Domestic Company Stores— — —International9 9 9Other2,059 1,226 1,015Total$2,068 $1,235 $1,02492Table of Contents 2015 2014 2013Total Assets Domestic Franchise$139,705 $137,417 $137,870Domestic Company Stores45,217 34,953 29,458International438 447 515Other (1)90,111 91,310 90,869Total$275,471 $264,127 $258,712(1) Other assets which are not allocated to the individual segments primarily include trade names & trademarks.All long-lived assets are held within the United States. The following table summarizes revenues by geographic area:(in thousands)2015 2014 2013Revenues United States$119,879 $96,831 $79,598International330 568 897Total$120,209 $97,399 $80,495Note 21 — Selected Quarterly Financial Data (unaudited)The following table presents selected unaudited quarterly financial data for the periods indicated:(in thousands, except per share data)Q1 Q2 Q3 Q42015 Revenue$29,168 $29,121 $28,132 $33,788Operating Income5,348 2,588 3,045 4,654Net Income (Loss)2,596 (1,939) 1,122 2,632Basic earnings (loss) per share$0.16 $(0.09) $0.07 $0.16Diluted earnings (loss) per share$0.15 $(0.09) $0.07 $0.16 2014 Revenue$25,117 $21,846 $22,169 $28,267Operating Income4,600 812 3,525 6,368Net Income (Loss)819 (1,607) (788) 2,824Basic (loss) earnings per share$(0.20) $(0.19) $(0.05) $0.17Diluted (loss) earnings per share$(0.20) $(0.19) $(0.05) $0.17The sum of the quarterly earnings per share does not always equal the annual earnings per share as a result of the computation of quarterly versusannual average shares outstanding.93Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Board of Directors and StockholdersPapa Murphy’s Holdings, Inc.We have audited the accompanying consolidated balance sheets of Papa Murphy’s Holdings, Inc. and subsidiaries (the “Company”) as ofDecember 28, 2015 and December 29, 2014 , the related consolidated statements of operations and comprehensive income (loss) , shareholders’equity, and cash flows for each of the three years in the period ended December 28, 2015 . Our audits of the consolidated financial statements includedthe accompanying financial statement schedules listed in the index appearing under Item 15(a). These consolidated financial statements and financialstatement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financialstatements and financial statement schedules based on our audits.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our auditsincluded consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financialstatements , assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidatedfinancial 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 consolidated financial position of PapaMurphy’s Holdings, Inc. and subsidiaries as of December 28, 2015 and December 29, 2014 , and the consolidated results of their operations and theircash flows for each of the three years in the period ended December 28, 2015 , in conformity with accounting principles generally accepted in the UnitedStates of America. In addition, in our opinion, the financial statement schedules, when read in conjunction with the related consolidated financialstatements taken as a whole, present fairly, in all material respects, the information set forth therein.As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for the balance sheetclassification of deferred taxes due to the adoption of Accounting Standards Update 2015-17, Balance Sheet Classification of Deferred Taxes, and debtissuance costs due to the adoption of Accounting Standards Update 2015-03, Simplifying the Presentation of Debt Issuance Costs./s/ Moss Adams LLPPortland, OregonMarch 9, 201694Table of ContentsItem 9. Changes in and Disagreements With Accountants on Accounting and FinancialDisclosureNone.Item 9A. Controls and ProceduresEvaluation of Disclosure Controls and ProceduresOur management, with the participation of our Chief Executive Officer and Chief Financial Officer has evaluated the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by this report, pursuant to Rules 13a-15 and 15d-15 under the Exchange Act . Based on thatevaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosurecontrols and procedures are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit underthe Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that such informationis accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure.Management's Annual Report on Internal Control over Financial ReportingOur management is responsible for establishing and maintaining adequate internal control over financial reporting. With the participation of our ChiefExecutive Officer and Chief Financial Officer, our management evaluated the effectiveness of our disclosure controls and procedures as of the end of theperiod covered by this report, pursuant to Rule 13a-15 under the Exchange Act . In designing and evaluating the disclosure controls and procedures,management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resourceconstraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.Management's evaluation of the effectiveness of our internal control over financial reporting was based on the framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (“ COSO ”) in Internal Control—Integrated Framework (2013) .Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, ourdisclosure controls and procedures are effective to provide reasonable assurance that information we are required to disclose in reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that suchinformation is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, toallow timely decisions regarding required disclosure.We have not engaged an independent registered accounting firm to perform an audit of our internal control over financial reporting as of any balancesheet date or for any period reported in our financial statements. Our independent public registered accounting firm will first be required to attest to theeffectiveness of our internal control over financial reporting for our Annual Report on Form 10-K for the first year we are no longer an “emerging growthcompany.”Changes in Internal Control over Financial ReportingThere have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act ) that occurred during ourlast fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.Item 9B. Other InformationNone.95Table of ContentsPART IIIItem 10. Directors, Executive Officers and Corporate GovernanceThe information required by this item is incorporated by reference to our Definitive Proxy Statement for our 2016 Annual Meeting of Stockholders. TheDefinitive Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of our 2015 fiscal year.Item 11. Executive CompensationThe information required by this item is incorporated by reference to our Definitive Proxy Statement for our 2016 Annual Meeting of Stockholders. TheDefinitive Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of our 2015 fiscal year.Item 12. Security Ownership of Certain Beneficial Owners and Management and RelatedStockholder MattersThe information required by this item is incorporated by reference to our Definitive Proxy Statement for our 2016 Annual Meeting of Stockholders. TheDefinitive Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of our 2015 fiscal year.Item 13. Certain Relationships and Related Transactions, and Director IndependenceThe information required by this item is incorporated by reference to our Definitive Proxy Statement for our 2016 Annual Meeting of Stockholders. TheDefinitive Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of our 2015 fiscal year.Item 14. Principal Accountant Fees and ServicesThe information required by this item is incorporated by reference to our Definitive Proxy Statement for our 2016 Annual Meeting of Stockholders. TheDefinitive Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of our 2015 fiscal year.96Table of ContentsPART IVItem 15. Exhibits and Financial Statement Schedules(a)The following documents are filed as part of this report: Form 10-K PageNo.1.Financial Statements: Consolidated Statements of Operations and Comprehensive Income (Loss) for the Fiscal Years ended December 28, 2015,December 29, 2014, and December 30, 201358 Consolidated Balance Sheets as of December 28, 2015 and December 29, 201459 Consolidated Statements of Shareholders’ Equity for the Fiscal Years ended December 28, 2015, December 29, 2014 andDecember 30, 201360 Consolidated Statements of Cash Flows for the Fiscal Years ended December 28, 2015, December 29, 2014 andDecember 30, 201361 Notes to Consolidated Financial Statements62 Report of Independent Registered Public Accounting Firm942.Financial Statement Schedule: Schedule I - Condensed Financial Information of the Registrant99 Schedule II - Valuation and Qualifying Accounts103 All other schedules are omitted because they are not applicable, not required or the required information is shown in thefinancial statements or the notes thereto. 3.Exhibits: INCORPORATED BY REFERENCEEXHIBIT FILE FILINGNUMBERDESCRIPTION OF EXHIBITSFORMNUMBEREXHIBITDATE3.1Fifth Amended and Restated Certificate of Incorporation of Papa Murphy’s Holdings, Inc.8-K001-364323.1May 13, 20143.2Amended and Restated Bylaws of Papa Murphy’s Holdings, Inc.8-K001-364323.2May 13, 20144.1Form of Common Stock Certificate.S-1/A333-1944884.1April 28, 20144.2Second Amended and Restated Stockholders’ Agreement.8-K001-364324.1May 13, 201410.1‡Amended 2010 Management Incentive Plan.S-1/A333-19448810.1April 4, 201410.2Stockholder’s Agreement8-K001-3643210.1May 13, 201410.3Credit agreement, dated as of August 28, 2014 among PMI Holdings, Inc., General ElectricCapital Corporation and the other financial institutions party thereto.10-Q001-3643210.1November 13,201410.4‡Form of 2014 Equity Incentive Plan.S-1/A333-19448810.5April 28, 201410.5Form of Franchise Agreement.S-1/A333-19448810.6April 4, 201410.6Form of Area Development Agreement.S-1/A333-19448810.7April 4, 201410.7Form of Multiple Store Commitment Letter and Amendment to Franchise Agreement.S-1/A333-19448810.8April 4, 201410.8‡Amended and Restated Executive Employment and Non-Competition Agreement dated as ofJuly 24, 2011 among PMI Holdings, Inc. and John Barr.S-1/A333-19448810.10April 4, 201410.9‡First Amendment to Amended and Restated Executive Employment and Non-CompetitionAgreement dated as of December 30, 2013 among PMI Holdings, Inc. and John Barr.S-1/A333-19448810.11April 4, 201410.10‡Executive Employment and Non-Competition Agreement dated as of May 25, 2011 amongPMI Holdings, Inc. and Ken C. Calwell.S-1/A333-19448810.12April 4, 201410.11‡Executive Employment and Non-Competition Agreement dated as of May 4, 2010 among PMIHoldings, Inc. and Victoria T. Blackwell.S-1/A333-19448810.14April 4, 201497Table of Contents10.12‡Executive Employment and Non-Competition Agreement dated as of January 7, 2013 amongPMI Holdings, Inc. and Jayson Tipp.S-1/A333-19448810.15April 4, 201410.13‡Executive Employment and Non-Competition Agreement dated as of March 21, 2014 amongPMI Holdings, Inc. and Mark Hutchens.S-1/A333-19448810.18April 4, 201410.14‡First Amendment to Executive Employment and Non-Competition Agreement dated as ofMarch 21, 2014 among PMI Holdings, Inc. and Ken Calwell.S-1/A333-19448810.19April 4, 201410.15‡Form of Stock Option Agreement subject to time-vesting under the Amended 2010Management Incentive Plan.S-1/A333-19448810.20April 21, 201410.16‡Form of Stock Option Agreement subject to performance-vesting under the Amended 2010Management Incentive Plan.S-1/A333-19448810.21April 21, 201410.17‡Form of Restricted Stock Agreement subject to time-vesting under the Amended 2010Management Incentive Plan.S-1/A333-19448810.22April 21, 201410.18‡Form of Restricted Stock Agreement subject to performance-vesting under the Amended2010 Management Incentive Plan.S-1/A333-19448810.23April 21, 201410.19‡Form of Amendment to the Restricted Stock Agreement subject to performance-vesting underthe Amended 2010 Management Incentive Plan.S-1/A333-19448810.24April 21, 201410.20‡Form of Stock Option Agreement subject to time-vesting under the Form of 2014 EquityIncentive Plan.S-1/A333-19448810.25April 21, 201410.21‡Form of Restricted Stock Agreement subject to time-vesting under the Form of 2014 EquityIncentive Plan.S-1/A333-19448810.26April 21, 201410.22Form of Indemnification Agreement between Papa Murphy’s Holdings, Inc. and each of itsdirectors and executive officers.S-1/A333-19448810.27April 21, 201410.23Form of Indemnification Agreement between Papa Murphy’s Holdings, Inc. and each of itssponsor-affiliated directors.S-1/A333-19448810.28April 21, 201410.24‡Form of Stock Option Agreement subject to performance-vesting under the Form of 2014Equity Incentive Plan.S-1/A333-19448810.29April 28, 201410.25‡Executive Employment and Non-Competition Agreement between PMI Holdings, Inc. andDan Harmon.S-1/A333-19448810.30April 28, 201421.1*List of Subsidiaries of the Registrant. 23.1*Consent of Moss Adams LLP 31.1*Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d-14(a) of theSecurities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of theSarbanes-Oxley Act of 2002. 31.2*Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a) of theSecurities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of theSarbanes-Oxley Act of 2002. 32.1*Certificate of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as AdoptedPursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2*Certificate of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as AdoptedPursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 101.INS*XBRL Instance Document 101.SCH*XBRL Taxonomy Extension Schema Document 101.CAL*XBRL Taxonomy Extension Calculation Linkbase Document 101.DEF*XBRL Taxonomy Extension Definition Linkbase Document 101.LAB*XBRL Taxonomy Extension Label Linkbase Document 101.PRE*XBRL Taxonomy Extension Presentation Linkbase Document * Filed herewith‡ A management contract or compensatory plan or arrangement98Table of ContentsSCHEDULE I—CONDENSED FINANCIAL INFORMATION OF REGISTRANTPapa Murphy’s Holdings, Inc.Parent Company InformationCondensed Statements of Operations and Comprehensive Income (Loss) Fiscal Year(in thousands)2015 2014 2013Equity in earnings (losses) of subsidiaries$9,486 $4,046 $(1,159)Selling, general and administrative expense2,380 1,392 343Operating Income (Loss)7,106 2,654 (1,502) Other expense, net136 180 56Income (Loss) Before Income Taxes6,970 2,474 (1,558) Provision for income taxes2,059 1,226 1,014Net Income (Loss)4,911 1,248 (2,572) Other Comprehensive Loss Foreign currency translation adjustment— — (2)Total Comprehensive Income (Loss)$4,911 $1,248 $(2,574)See accompanying notes.99Table of ContentsSCHEDULE I—CONDENSED FINANCIAL INFORMATION OF REGISTRANTPapa Murphy’s Holdings, Inc.Parent Company InformationCondensed Balance Sheets (in thousands, except par value and share data)December 28, 2015 December 29, 2014Assets Current Assets Prepaid expenses and other current assets$3,109 $304Total current assets3,109 304Investment in affiliates138,444 135,853Total assets$141,553 $136,157Liabilities and Equity Current Liabilities Other current liabilities$70 $153Due to consolidated affiliates1,388 3,994Total current liabilities1,458 4,147Deferred tax liability42,439 40,731Total liabilities$43,897 $44,878Commitments and contingencies Shareholders’ Equity Preferred stock ($0.01 par value; 15,000,000 shares authorized; no shares issued or outstanding)— —Common stock ($0.01 par value; 200,000,000 shares authorized; 16,949,720 and 16,944,308 shares issued andoutstanding, respectively)169 169Additional paid-in capital118,801 117,354Stock subscription receivable(100) (100)Accumulated deficit(21,214) (26,144)Total shareholders’ equity97,656 91,279Total liabilities and shareholders’ equity$141,553 $136,157See accompanying notes.100Table of ContentsSCHEDULE I—CONDENSED FINANCIAL INFORMATION OF REGISTRANTPapa Murphy’s Holdings, Inc.Parent Company InformationCondensed Statements of Cash Flows Fiscal Year(in thousands)2015 2014 2013Net cash from operating activities$(7,278) $6,106 $(56) Investing Activities Investment in subsidiary— (59,675) (57)(Deemed) dividend from subsidiary6,912 (1,098) 31,148Net cash from investing activities6,912 (60,773) 31,091 Financing Activities Issuance of common stock, net of underwriting fees— 59,675 57Repurchases of common stock(10) (1,518) (400)Payment of preferred dividends and return of invested capital— — (30,690)Proceeds from exercise of stock options376 — —Costs associated with initial public offering— (3,490) —Net cash from financing activities366 54,667 (31,033) Effect of exchange rate fluctuations on cash— — (2)Net change in cash and cash equivalents— — — Cash and Cash Equivalents, beginning of year— — —Cash and Cash Equivalents, end of period$— $— $—See accompanying notes.101Table of ContentsSCHEDULE I—CONDENSED FINANCIAL INFORMATION OF REGISTRANTPapa Murphy’s Holdings, Inc.Parent Company InformationNotes to Condensed Financial InformationNote 1—Basis of PresentationPapa Murphy’s Holdings, Inc. (the “ Parent Company ”) is a holding company with no material operations of its own that conducts substantially all of itsactivities through its subsidiaries.These consolidated financial statements have been presented on a “parent-only” basis. Under a parent-only presentation, the Parent Company ’sinvestments in subsidiaries are presented under the equity method of accounting. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with GAAP have been condensed or omitted. As such, these parent-only statements should be read inconjunction with the Notes to Consolidated Financial Statements of Papa Murphy’s Holdings, Inc. and subsidiaries included in Financial Statements andSupplementary Data .Note 2—DividendsThe following cash dividends were declared and paid to the preferred stockholders of the Parent Company during 2015 , 2014 and 2013 , respectively:(in thousands)2015 2014 2013Series A Preferred holders$— $— $30,346Series B Preferred holders— — 344In order to fund the dividends, dividends were paid to the Parent Company from its subsidiaries. See Note 10 — Financing Arrangements of theCompany’s consolidated financial statements for a discussion of the dividend restriction under the debt covenants.102Table of ContentsSchedule II—Valuation and Qualifying AccountsPapa Murphy’s Holdings, Inc. and Subsidiaries Balance atBeginning ofPeriod Provision (Benefit) (Write-offs), Net ofRecoveries CurrencyTranslationAdjustments Balance at End of PeriodFiscal year 2015 Allowance for trade and other receivables$60 $(30) $1 $— $31Fiscal year 2014 Allowance for trade and other receivables$37 $26 $(3) $— $60Allowance for notes receivable825 — (763) (62) —Total$862 $26 $(766) $(62) $60Fiscal year 2013 Allowance for trade and other receivables$61 $— $(24) $— $37Allowance for notes receivable434 427 — (36) 825Total$495 $427 $(24) $(36) $862103Table of ContentsSIGNATURESPursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by theundersigned, hereunto duly authorized, on March 9, 2016PAPA MURPHY’S HOLDINGS, INC. By: /s/ Mark Hutchens Name:Mark Hutchens Title:Chief Financial OfficerPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of theregistrant in the capacities and on the dates indicated. SIGNATURETITLEDATE /s/ Ken CalwellPresident and Chief Executive OfficerMarch 9, 2016 Ken Calwell(Principal Executive Officer) and Director /s/ Mark HutchensChief Financial OfficerMarch 9, 2016 Mark Hutchens(Principal Financial Officer and Principal Accounting Officer) *Chairman of the Board, DirectorMarch 9, 2016 John Barr *DirectorMarch 9, 2016 Jean M. Birch *DirectorMarch 9, 2016 Benjamin Hochberg *DirectorMarch 9, 2016 Yoo Jin Kim *DirectorMarch 9, 2016 L. David Mounts *DirectorMarch 9, 2016 John Shafer *DirectorMarch 9, 2016 Rob Weisberg *DirectorMarch 9, 2016 Jeffrey B. Welch *By:/s/ Mark Hutchens Mark Hutchens Attorney-in-fact 104Exhibit 21.1SUBSIDIARIES OFPAPA MURPHY'S HOLDINGS, INC.Subsidiary Jurisdiction ofOrganizationMurphy’s Marketing Services, Inc. FloridaPapa Murphy’s Company Stores, Inc. WashingtonPapa Murphy’s Intermediate, Inc. DelawarePapa Murphy’s International LLC DelawarePapa Murphy’s Worldwide LLC DelawarePMI Canada ULC CanadaPMI Holdings, Inc. DelawareExhibit 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe consent to the incorporation by reference in the Registration Statements (Form S-3 No. 333-203907 and Form S-8 No. 333-195634) of PapaMurphy's Holdings, Inc. of our report dated March 9, 2016 , relating to the consolidated financial statements and schedules of Papa Murphy's Holdings,Inc., (which included an explanatory paragraph regarding the Company's adoption of the Accounting Standards Update 2015-17, Balance SheetClassification of Deferred Taxes , and the Accounting Standards Update 2015-03, Simplifying the Presentation of Debt Issuance Costs ), appearing inthis Annual Report (Form 10-K) for the year ended December 28, 2015 ./s/ Moss Adams LLPPortland, OregonMarch 9, 2016Exhibit 31.1CERTIFICATION PURSUANT TO EXCHANGE ACT RULE 13a-14(a)/15d-14(a) AS ADOPTEDPURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, Ken Calwell, certify that:1.I have reviewed this annual report on Form 10-K of Papa Murphy's Holdings, Inc.;2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by thisreport;3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4.The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:a.Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which this report is being prepared;b.Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements forexternal purposes in accordance with generally accepted accounting principals;c.Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; andd.Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of the annual report) that has materially affected, or is reasonably likely tomaterially affect, the registrant’s internal control over financial reporting; and5.The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):a.All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; andb.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internalcontrol over financial reporting.Date: March 9, 2016 /s/ Ken Calwell Ken Calwell President and Chief Executive Officer (Principal Executive Officer)Exhibit 31.2CERTIFICATION PURSUANT TO EXCHANGE ACT RULE 13a-14(a)/15d-14(a) AS ADOPTEDPURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, Mark Hutchens, certify that:1.I have reviewed this annual report on Form 10-K of Papa Murphy's Holdings, Inc.;2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by thisreport;3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4.The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:a.Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under oursupervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which this report is being prepared;b.Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements forexternal purposes in accordance with generally accepted accounting principals;c.Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; andd.Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of the annual report) that has materially affected, or is reasonably likely tomaterially affect, the registrant’s internal control over financial reporting; and5.The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):a.All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which arereasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; andb.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internalcontrol over financial reporting.Date: March 9, 2016 /s/ Mark Hutchens Mark Hutchens Chief Financial Officer (Principal Financial Officer)Exhibit 32.1CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report of Papa Murphy's Holdings, Inc. (the “Company”) on Form 10-K for the period ended December 28, 2015 , as filedwith the Securities and Exchange Commission on the date hereof (the “Report”), I, Ken Calwell, Chief Executive Officer of the Company, certify, pursuantto 18 U.S.C. § 1350, adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that:(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.Date: March 9, 2016 /s/ Ken Calwell Ken Calwell Chief Executive OfficerExhibit 32.2CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report of Papa Murphy's Holdings, Inc. (the “Company”) on Form 10-K for the period ended December 28, 2015 , as filedwith the Securities and Exchange Commission on the date hereof (the “Report”), I, Mark Hutchens, Chief Financial Officer of the Company, certify,pursuant to 18 U.S.C. § 1350, adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that:(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.Date: March 9, 2016 /s/ Mark Hutchens Mark Hutchens Chief Financial Officer

Continue reading text version or see original annual report in PDF format above