SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
For the quarterly period ended September 11, 2005
OR
For the transition period from: to
Commission file numbers:
Domino’s Pizza, Inc.
Domino’s, Inc.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
30 Frank Lloyd Wright Drive
Ann Arbor, Michigan 48106
(Address of principal executive offices)
(734) 930-3030
(Registrant’s telephone number, including area code)
Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act): Yes ¨ No x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.): Yes ¨ No x
As of October 9, 2005, Domino’s Pizza, Inc. had 66,736,814 shares of common stock, par value $0.01 per share, outstanding. As of October 9, 2005, Domino’s, Inc. had 10 shares of common stock, par value $0.01 per share, outstanding. All of the stock of Domino’s, Inc. was held by Domino’s Pizza, Inc.
This Quarterly Report on Form 10-Q is a combined quarterly report being filed separately by two registrants: Domino’s Pizza, Inc. and Domino’s, Inc. Except where the context clearly indicates otherwise, any references in this report to Domino’s Pizza, Inc. includes all subsidiaries of Domino’s Pizza, Inc., including Domino’s, Inc. Domino’s, Inc. makes no representation as to the information contained in this report in relation to Domino’s Pizza, Inc. and its subsidiaries, other than Domino’s, Inc. and its subsidiaries.
TABLE OF CONTENTS
PART I.
Item 1.
Condensed Consolidated Balance Sheets (Unaudited) – September 11, 2005 and January 2, 2005
Condensed Consolidated Statements of Income (Unaudited) – Fiscal quarter and three fiscal quarters ended September 11, 2005 and September 5, 2004
Condensed Consolidated Statements of Cash Flows (Unaudited) – Three fiscal quarters ended September 11, 2005 and September 5, 2004
Notes to Condensed Consolidated Financial Statements (Unaudited)
Item 2.
Item 3.
Item 4.
PART II.
Item 5.
Item 6.
SIGNATURES
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Domino’s Pizza, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(Unaudited)
(In thousands)
January 2, 2005
(Note)
Assets
Current assets:
Cash and cash equivalents
Accounts receivable
Inventories
Notes receivable
Prepaid expenses and other
Advertising fund assets, restricted
Deferred income taxes
Total current assets
Property, plant and equipment:
Land and buildings
Leasehold and other improvements
Equipment
Construction in progress
Accumulated depreciation and amortization
Property, plant and equipment, net
Other assets:
Deferred financing costs
Goodwill
Capitalized software
Other assets
Total other assets
Total assets
Liabilities and stockholders’ deficit
Current liabilities:
Current portion of long-term debt
Accounts payable
Insurance reserves
Advertising fund liabilities
Other accrued liabilities
Total current liabilities
Long-term liabilities:
Long-term debt, less current portion
Total long-term liabilities
Stockholders’ deficit:
Common stock
Additional paid-in capital
Retained deficit
Deferred stock compensation
Accumulated other comprehensive income
Total stockholders’ deficit
Total liabilities and stockholders’ deficit
Note: The balance sheet at January 2, 2005 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.
See accompanying notes.
3
Condensed Consolidated Statements of Income
Revenues:
Domestic Company-owned stores
Domestic franchise
Domestic distribution
International
Total revenues
Cost of sales:
Total cost of sales
Operating margin
General and administrative
Income from operations
Interest income
Interest expense
Other
Income before provision for income taxes
Provision for income taxes
Net income
Earnings per share:
Common stock – basic
Common stock – diluted
Class L common stock – basic and diluted
Dividends declared per share
4
Condensed Consolidated Statements of Cash Flows
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Amortization of deferred financing costs and debt discount
Provision for deferred income taxes
Changes in operating assets and liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Capital expenditures
Net cash used in investing activities
Cash flows from financing activities:
Net proceeds from issuance of common stock
Proceeds from issuance of long-term debt
Repayments of long-term debt and capital lease obligation
Repurchase of common stock
Cash paid for financing fees
Dividends paid
Proceeds from exercise of stock options
Distributions
Net cash used in financing activities
Effect of exchange rate changes on cash and cash equivalents
Decrease in cash and cash equivalents
Cash and cash equivalents, at beginning of period
Cash and cash equivalents, at end of period
5
Notes to Condensed Consolidated Financial Statements
(Unaudited; tabular amounts in thousands, except percentages, share and per share amounts)
September 11, 2005
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto for the fiscal year ended January 2, 2005 included in our annual report on Form 10-K.
In the opinion of management, all adjustments, consisting of normal recurring items, considered necessary for a fair presentation have been included. Operating results for the fiscal quarter and three fiscal quarters ended September 11, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending January 1, 2006.
Domino’s Pizza, Inc. is the parent and holding company of Domino’s, Inc. Accordingly, all 10 outstanding shares of Domino’s, Inc. common stock, par value $0.01 per share, are owned by Domino’s Pizza, Inc. As the holding company of Domino’s, Inc., Domino’s Pizza, Inc. does not conduct ongoing business operations. As a result, the financial information for Domino’s Pizza, Inc. and subsidiaries and Domino’s, Inc. and subsidiaries is substantially similar. As the differences are minor, we have presented Domino’s Pizza, Inc. and subsidiaries information throughout this filing, except for the supplemental guarantor condensed consolidating financial statements of Domino’s, Inc. and subsidiaries included in footnote 9.
2. Comprehensive Income (Loss)
September 11,
2005
Unrealized gains (losses) on derivative instruments, net of tax
Reclassification adjustment for (gains) losses included in net income, net of tax
Currency translation adjustment
Comprehensive income (loss)
3. Segment Information
The following table summarizes revenues, income from operations and earnings before interest, taxes, depreciation, amortization and other, which is the measure by which management allocates resources to its segments and which we refer to as Segment Income, for each of our reportable segments.
Revenues –
2004
Income from operations –
Segment Income –
6
The following table reconciles Total Segment Income to consolidated income before provision for income taxes.
Total Segment Income
Losses on sale/disposal of assets
Non-cash stock compensation expense
Termination of management agreement
4. Earnings Per Share
Net income available to common stockholders – basic and diluted
Allocation of net income to common stockholders:
Class L
Weighted average number of shares:
Earnings per share – basic:
Diluted weighted average number of shares:
Earnings per share – diluted:
The denominator in calculating diluted earnings per share for common stock for the third quarter and first three quarters of 2005 does not include 1,498,500 options to purchase common stock at $25.02 per share as the exercise price exceeded the average market price of the related common stock for those periods. The effect of including these options would have been anti-dilutive. Additionally, the denominator in calculating diluted earnings per share for common stock for the third quarter of 2004 does not include 2,441,176 of dilutive shares resulting from stock options as the Company had a net loss available to common stockholders and, as a result, their inclusion would have been anti-dilutive. Accordingly, diluted and basic earnings per share amounts are identical for that period.
7
5. Stock-Based Compensation
We account for our stock option plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The following table illustrates the effect on net income if we had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” to the stock-based employee compensation.
Net income, as reported
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects
Deduct: Total stock-based employee compensation expense determined under the fair value method for all awards, net of related tax effects
Net income, pro forma
Pro forma earnings per share – basic:
Pro forma earnings per share – diluted:
6. Supplemental Disclosure of Cash Flow Information
During the first three quarters of 2005, we have recorded approximately $17.8 million of reductions in income tax payable as a result of tax benefits related to the exercise of stock options.
The Company recorded a $6.6 million dividend payable during the third quarter. The dividend was subsequently paid on September 30, 2005.
7. Payment of Deferred Compensation
During the third quarter of 2005 as required by the Company’s deferred compensation plan, a significant portion of the outstanding deferred compensation balances were paid to participating employees. The total payments were approximately $4.7 million. At the time of payment, the Company recorded a $4.7 million decrease in both investments in marketable securities and deferred compensation liabilities. As the amounts paid were self-funded by the participating employees, there was no income statement impact resulting from these payments.
8. New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R (revised 2004), “Share-Based Payments” (SFAS 123R). In April 2005, the FASB amended SFAS 123R to delay the effective date of the Statement to the first annual period beginning after June 15, 2005. SFAS 123R requires that the cost of all employee stock options, as well as other equity-based compensation arrangements, be reflected in the financial statements based on the estimated fair value of the awards. We are required to adopt SFAS 123R no later than the beginning of fiscal 2006. We are currently assessing our adoption alternatives. Once our evaluation is complete, we will determine an appropriate method of adoption and the impact the adoption will have on our results of operations.
8
9. Supplemental Guarantor Condensed Consolidating Financial Statements of Domino’s, Inc. and Subsidiaries
The tables below present condensed consolidating financial information for the applicable periods for: (1) Domino’s, Inc.; (2) on a combined basis, the guarantor subsidiaries of Domino’s, Inc.’s senior subordinated notes due 2011, which includes most of the domestic subsidiaries of Domino’s, Inc. and one foreign subsidiary of Domino’s, Inc.; and (3) on a combined basis, the non-guarantor subsidiaries of Domino’s, Inc.’s senior subordinated notes due 2011. The separate financial statements of Domino’s, Inc. and subsidiaries are presented using the equity method of accounting. Accordingly, Domino’s, Inc.’s investment in subsidiaries is included in “Other assets” and the net earnings of the subsidiaries are included in “Equity earnings in subsidiaries”. Except for the minor differences noted in the footnotes to the condensed consolidating financial statements below, the consolidated financial statements of Domino’s, Inc. and subsidiaries are substantially similar to the consolidated financial statements of Domino’s Pizza, Inc. and subsidiaries. Each of the guarantor subsidiaries is jointly, severally, fully and unconditionally liable under the related guarantee.
Domino’s, Inc. and Subsidiaries
Supplemental Guarantor Condensed Consolidating Balance Sheets
Other current assets
Current assets
Other current liabilities
Current liabilities (1)
Long-term debt
Other long-term liabilities
Long-term liabilities
Stockholder’s equity (deficit) (1)
Total liabilities and stockholder’s equity (deficit)
9
Supplemental Guarantor Condensed Consolidating Statements of Income
Revenues
Cost of sales
Equity earnings in subsidiaries
Interest expense, net
Income (loss) before provision (benefit) for income taxes
Provision (benefit) for income taxes
Net income (loss)
10
Income (loss) from operations
Interest income (expense), net (2)
Net income (loss) (2)
11
Supplemental Condensed Consolidating Statements of Cash Flows
Net cash provided by (used in) operating activities (3)
Proceeds from the issuance of long-term debt
Repayments of debt
Distributions to parent, net
Net cash provided by (used in) financing activities (3)
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents, at beginning of period (3)
12
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Unaudited; tabular amounts in millions, except percentages and store data)
The 2005 and 2004 third quarters referenced herein represent the twelve-week periods ended September 11, 2005 and September 5, 2004, respectively. The 2005 and 2004 first three quarters referenced herein represent the thirty-six week periods ended September 11, 2005 and September 5, 2004, respectively.
Overview
During the third quarter and first three quarters of 2005, global retail sales, comprised of retail sales at both our franchise and Company-owned stores worldwide, grew 7.8% and 11.7%, respectively, as compared to the prior year periods. This growth was driven primarily by same store sales growth in both our domestic and international markets as well as an increase in our worldwide store counts. During the same periods, revenues grew 3.9% and 8.9%, respectively, as compared to the prior year periods. Additionally, we reported increases in income from operations of 59.9% and 28.1% as compared to the prior year periods.
Our global retail sales benefited from strong same store sales growth, both domestically and internationally, an increase in our worldwide store counts, and the positive effect of a weaker U.S. Dollar in the key international markets in which we compete. During the third quarter and first three quarters of 2005, domestic same store sales grew 1.1% and 6.3%, respectively, comprised of domestic Company-owned same store sales increases of 4.2% and 8.9%, respectively, and domestic franchise same store sales increases of 0.7% and 5.9%, respectively. These increases in same store sales were driven by positive consumer response to our marketing and promotional activities. Domestic same store sales increased 8.0% and 2.9% in the comparable periods in 2004. We also continued to benefit from strong same store sales in our international markets during the third quarter and first three quarters, which increased 4.5% and 6.9%, respectively, on a constant dollar basis versus the prior year periods. The third quarter marked the 47th consecutive quarter that we have grown our international same store sales when compared to the same quarter in the prior year. Additionally, we grew our worldwide net store counts by 67 and 342 stores during the third quarter and trailing four quarters, respectively. Our net store counts at September 11, 2005 include the closing of 14 domestic franchise stores that occurred as a result of Hurricane Katrina. While these stores suffered significant damage and are not expected to re-open in the near term, our overall operations and financial condition were not significantly impacted by Hurricanes Katrina or Rita.
Income from operations increased $17.0 million, or 59.9%, to $45.4 million in the third quarter, from $28.4 million in the comparable period in 2004, and increased $31.3 million, or 28.1%, to $142.5 million in the first three quarters, from $111.2 million in the comparable period in 2004. These increases were driven by higher royalty revenues from domestic and international franchise stores, higher domestic Company-owned same store sales, higher volumes in our distribution business and lower cheese costs at our Company-owned stores. Additionally, these increases in income from operations were positively impacted by the $10.0 million payment made to an affiliate of our former majority stockholder in connection with our initial public offering to terminate its management agreement, which occurred in the third quarter of 2004. The average published cheese block price per pound decreased $0.12 and $0.14 to $1.48 and $1.51 in the third quarter and first three quarters of 2005, respectively, compared to the prior year period. These increases in income from operations were offset in part by higher variable general and administrative expenses as a result of improved financial performance as compared to the prior year.
Net income increased $19.8 million to $20.8 million in the third quarter, from $1.0 million in the comparable period in 2004, and increased $33.9 million to $69.2 million in the first three quarters, from $35.3 million in the comparable period in 2004. These increases were driven primarily by the aforementioned increases in income from operations as well as a reduction in interest and other expense from the comparable periods in 2004. The reduction in interest expense was a result of lower average debt balances and approximately $3.7 million of deferred financing and bond discount expenses incurred in connection with the redemption of $109.1 million of Domino’s, Inc.’s senior subordinated notes in August of 2004. The reduction in other expense was a result of losses incurred in 2004 in connection with debt retirements, including $9.0 million incurred in connection with the aforementioned redemption of $109.1 million of Domino’s, Inc.’s senior subordinated notes.
13
Critical accounting policies and estimates
The following discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. The preparation of these financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an ongoing basis, our management evaluates its estimates, including those related to revenue recognition, allowance for uncollectible receivables, long-lived and intangible assets, insurance and legal matters and income taxes. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates. Changes in our estimates could materially impact our results of operations and financial condition for any particular period. We believe that our most critical accounting policies are:
Revenue recognition. We earn revenues through our network of domestic Company-owned and franchise stores, dough manufacturing and distribution centers and international operations. Retail sales from Company-owned stores and royalty revenues resulting from the retail sales from franchise stores are recognized as revenues when the items are delivered to or carried out by customers. Sales of food from our distribution centers are recognized as revenues upon delivery of the food to franchisees while sales of equipment and supplies from our distribution centers are generally recognized as revenues upon shipment of the related products to franchisees.
Allowance for uncollectible receivables. We closely monitor our accounts and notes receivable balances and provide allowances for uncollectible amounts as a result of our reviews. These estimates are based on, among other factors, historical collection experience and a review of our receivables by aging category. Additionally, we may also provide allowances for uncollectible receivables based on specific customer collection issues that we have identified. While write-offs of bad debts have historically been within our expectations and the provisions established, management cannot guarantee that future write-offs will not exceed historical rates. Specifically, if the financial condition of our franchisees were to deteriorate resulting in an impairment of their ability to make payments, additional allowances may be required.
Long-lived and intangible assets. We record long-lived assets, including property, plant and equipment and capitalized software, at cost. For acquisitions of franchise operations, we estimate the fair values of the assets and liabilities acquired based on physical inspection of assets, historical experience and other information available to us regarding the acquisition. We depreciate and amortize long-lived assets using useful lives determined by us based on historical experience and other information available to us. We review long-lived assets for impairment when events or circumstances indicate that the related amounts might be impaired. We perform related impairment tests on a market level basis for Company-owned stores. At January 2, 2005, we determined that our long-lived assets were not impaired. However, if our future operating performance were to deteriorate, we may be required to recognize an impairment charge.
We evaluate goodwill for impairment by comparing the fair value of our reporting units to their carrying values. A significant portion of our goodwill relates to acquisitions of domestic franchise stores and is included in our domestic stores segment. At January 2, 2005, the fair value of our business operations with associated goodwill exceeded their recorded carrying value, including the related goodwill. However, if the future performance of our domestic Company-owned stores or other segment operations were to deteriorate, we may be required to recognize a goodwill impairment charge.
At September 11, 2005, we had approximately $5.2 million in net book value of long-lived assets and goodwill associated with our Company-owned operations in The Netherlands. Recently, our Netherlands operations have performed unfavorably as compared to our internal forecasts and expectations. Management has responded to this performance gap by developing plans to improve the operating results of this business. If these plans ultimately prove unsuccessful, we may be required to record an impairment charge associated with these operations.
14
Insurance and legal matters. We are a party to lawsuits and legal proceedings arising in the ordinary course of business. Management closely monitors these legal matters and estimates the probable costs for the resolution of such matters. These estimates are primarily determined by consulting with both internal and external parties handling the matters and are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. If our estimates relating to legal matters proved inaccurate for any reason, we may be required to increase or decrease the related expense in future periods.
For certain periods prior to December 1998 and for periods after December 2001, we maintain insurance coverage for workers’ compensation, general liability and owned and non-owned auto liability under insurance policies requiring payment of a deductible for each occurrence up to between $500,000 and $3.0 million, depending on the policy year and line of coverage. The related insurance reserves are determined using independent actuarial estimates, which are based on historical information along with assumptions about future events. Changes in assumptions for such factors as medical costs and legal actions, as well as changes in actual experience, could cause these estimates to change in the near term which could result in an increase or decrease in the related expense in future periods.
Income taxes. Our net deferred tax assets assume that we will generate sufficient taxable income in specific tax jurisdictions, based on estimates and assumptions. The amounts relating to taxes recorded on the balance sheet, including tax reserves, also consider the ultimate resolution of revenue agent reviews based on estimates and assumptions. If these estimates and assumptions change in the future, we may be required to adjust our valuation allowance or other tax reserves resulting in additional income tax expense or benefit in future periods.
Same Store Sales Growth (versus the comparable periods in 2004)
Third Quarter
of 2005
Domestic franchise stores
Domestic stores
International stores
Store Counts and Net Unit Growth
Domestic
Company-ownedStores
Total
DomesticStores
Store count at June 19, 2005
Openings
Closings
Transfers
Store count at September 11, 2005
Third quarter of 2005 net growth
First three quarters of 2005 net growth
Trailing 4 quarters net growth
Income Statement Data
15
Revenues primarily include retail sales by our 595 domestic and international Company-owned stores, royalties from our 7,350 domestic and international franchise stores, and sales of food, equipment and supplies by our 17 domestic and 8 international distribution centers to certain domestic and international franchise stores. Company-owned store and franchise store revenues may vary significantly from period to period due to changes in store count mix while distribution revenues may vary significantly as a result of fluctuations in commodity prices, primarily cheese and meats.
Consolidated revenues increased $12.6 million, or 3.9%, to $337.6 million in the third quarter of 2005, from $325.0 million in the comparable period in 2004, and increased $86.2 million, or 8.9%, to $1,054.2 million in the first three quarters of 2005, from $968.0 million in the comparable period in 2004. These increases were a result of increases in revenues at each of our reportable segments and are more fully described below.
Domestic Stores Revenues
Domestic stores revenues are comprised of revenues from our domestic Company-owned store operations and domestic franchise operations, as summarized in the following table.
Domestic Stores
of 2004
First Three
Quarters of 2005
Total domestic stores revenues
Domestic stores revenues increased $4.2 million, or 3.5%, to $126.9 million in the third quarter of 2005, from $122.7 million in the comparable period in 2004, and increased $30.2 million, or 8.3%, to $393.3 million in the first three quarters of 2005, from $363.1 million in the comparable period in 2004. These increases in revenues were due primarily to higher domestic Company-owned and franchise same store sales as well as increases in the average number of domestic franchise stores in operation during 2005. Domestic same store sales increased 1.1% and 6.3% in the third quarter and first three quarters of 2005, respectively, compared to the same periods in 2004, driven by positive consumer response to our marketing and promotional activities. These changes in domestic stores revenues are more fully described below.
Domestic Company-Owned Stores Revenues
Revenues from domestic Company-owned store operations increased $3.5 million, or 4.1%, to $91.0 million in the third quarter of 2005, from $87.5 million in the comparable period in 2004, and increased $21.4 million, or 8.3%, to $280.9 million in the first three quarters of 2005, from $259.5 million in the comparable period in 2004. These increases in revenues were due primarily to higher same store sales. Domestic Company-owned same store sales increased 4.2% and 8.9% in the third quarter and first three quarters of 2005, respectively, compared to the same periods in 2004. There were 574 and 578 domestic Company-owned stores in operation as of September 11, 2005 and September 5, 2004, respectively.
Domestic Franchise Revenues
Revenues from domestic franchise operations increased $0.7 million, or 2.0%, to $35.9 million in the third quarter of 2005, from $35.2 million in the comparable period in 2004, and increased $8.8 million, or 8.5%, to $112.4 million in the first three quarters of 2005, from $103.6 million in the comparable period in 2004. These increases in revenues were due primarily to higher same store sales and an increase in the average number of domestic franchise stores open during 2005. Domestic franchise same store sales increased 0.7% and 5.9% in the third quarter and first three quarters of 2005, respectively, compared to the same periods in 2004. There were 4,452 and 4,367 domestic franchise stores in operation as of September 11, 2005 and September 5, 2004, respectively. The domestic franchise store counts at September 11, 2005 include the closing of 14 stores that occurred as result of Hurricane Katrina.
16
Domestic Distribution Revenues
Revenues from domestic distribution operations increased $4.7 million, or 2.6%, to $182.1 million in the third quarter of 2005, from $177.4 million in the comparable period in 2004, and increased $42.9 million, or 8.1%, to $572.1 million in the first three quarters of 2005, from $529.2 million in the comparable period in 2004. These increases in revenues were due primarily to higher volumes related to increases in domestic franchise retail sales, offset in part by decreases in cheese prices. The published cheese block price-per-pound averaged $1.48 and $1.51 in the third quarter and first three quarters of 2005, respectively, down from $1.60 and $1.65 in the comparable periods in 2004. Had the 2005 average cheese prices been in effect during 2004, distribution revenues for the third quarter and first three quarters of 2004 would have been approximately $3.2 million and $9.2 million, respectively, lower than the reported 2004 amounts.
International Revenues
Revenues from international operations increased $3.7 million, or 14.7%, to $28.6 million in the third quarter of 2005, from $24.9 million in the comparable period in 2004, and increased $13.1 million, or 17.3%, to $88.8 million in the first three quarters of 2005, from $75.7 million in the comparable period in 2004. These increases in revenues were due to higher same store sales, an increase in the average number of international stores open during 2005, related increases in revenues from our international distribution operations and the positive effect of a weaker U.S. Dollar in the key international markets in which we compete. On a constant dollar basis, same store sales increased 4.5% and 6.9% in the third quarter and first three quarters of 2005, respectively, versus the comparable period in 2004. There were 2,919 and 2,658 international stores in operation as of September 11, 2005 and September 5, 2004, respectively.
Cost of Sales / Operating Margin
Consolidated cost of sales is comprised primarily of domestic Company-owned store and domestic distribution costs incurred to generate related revenues. Components of consolidated cost of sales primarily include food, labor and occupancy costs.
The consolidated operating margin, which we define as revenues less cost of sales, increased $7.2 million, or 9.1%, to $86.5 million in the third quarter of 2005, from $79.3 million in the comparable period in 2004, and increased $29.9 million, or 12.6%, to $267.9 million in the first three quarters of 2005, from $238.0 million in the comparable period in 2004. These results are summarized in the following table.
Consolidated revenues
Consolidated cost of sales
Consolidated operating margin
The increases in the consolidated operating margin for the third quarter and first three quarters of 2005 were due primarily to higher domestic franchise and international royalty revenues resulting from strong global retail sales growth and higher margins at our Company-owned stores.
As a percentage of revenues, the consolidated operating margin increased 1.2 percentage points to 25.6% in the third quarter of 2005, from 24.4% in the comparable period in 2004, and increased 0.8 percentage points to 25.4% in the first three quarters of 2005, from 24.6% in the comparable period in 2004. The consolidated operating margin as a percentage of revenues was positively impacted by higher same store sales and store counts, which generated increased domestic and international franchise royalty revenues, higher distribution volumes and higher domestic Company-owned store revenues. Additionally, the consolidated operating margin was positively impacted by lower insurance costs and lower cheese costs, which benefited both domestic Company-owned store and distribution operating margins as a percentage of revenues.
17
As mentioned above, the consolidated operating margin as a percentage of revenues was positively impacted by lower cheese costs. Cheese price changes are a “pass-through” in domestic distribution revenues and cost of sales and, as such, have no impact on the related operating margin. However, cheese price changes do impact operating margin as a percentage of revenues. Had the 2005 average cheese prices been in effect during 2004, the total operating margin for the third quarter and first three quarters of 2004 would have been approximately 24.6% and 24.8% of total revenues, respectively, versus the reported 24.4% and 24.6%. This would have resulted in operating margin improvements of 1.0 and 0.6 percentage points in the third quarter and first three quarters of 2005, respectively, versus the reported improvements of 1.2 and 0.8 percentage points.
Domestic Company-Owned Stores Operating Margin
The domestic Company-owned store operating margin increased $3.8 million, or 25.3%, to $19.2 million in the third quarter of 2005, from $15.4 million in the comparable period in 2004, and increased $9.6 million, or 19.9%, to $57.9 million in the first three quarters of 2005, from $48.3 million in the comparable period in 2004. These results are summarized in the following table.
Domestic Company-Owned Stores
Store operating margin
The increases in the domestic Company-owned store operating margin during the third quarter and first three quarters of 2005 were due primarily to increases in same store sales, reductions in cheese prices and lower insurance costs.
As a percentage of store revenues, the store operating margin increased 3.5 percentage points to 21.1% in the third quarter of 2005, from 17.6% in the comparable period in 2004, and increased 2.0 percentage points to 20.6% in the first three quarters of 2005, from 18.6% in the comparable period in 2004.
As a percentage of store revenues, food costs decreased 1.2 percentage points to 27.8% in the third quarter of 2005, from 29.0% in the comparable period in 2004, and increased 0.1 percentage points to 28.4% in the first three quarters of 2005, from 28.3% in the comparable period in 2004. The decrease in food costs as a percentage of store revenues during the third quarter was due primarily to a reduction in cheese prices and a higher average ticket offset by a change in product mix. The increase in food costs as a percentage of store revenues during the first three quarters was due primarily to a change in product mix as a result of certain promotions in 2005, offset in part by a reduction in cheese prices.
As a percentage of store revenues, labor costs decreased 0.4 percentage points to 29.6% in the third quarter of 2005, from 30.0% in the comparable period in 2004, and decreased 0.5 percentage points to 29.5% in the first three quarters of 2005, from 30.0% in the comparable period in 2004. These decreases in labor costs as a percentage of store revenues were due primarily to leveraging labor costs on a higher base of revenues.
As a percentage of store revenues, occupancy costs, which include rent, telephone, utilities and depreciation, decreased 0.4 percentage points to 11.2% in the third quarter of 2005, from 11.6% in the comparable period in 2004, and decreased 0.7 percentage points to 10.7% in the first three quarters of 2005, from 11.4% in the comparable period in 2004. These decreases in occupancy costs as a percentage of store revenues were driven primarily by the positive impact of higher revenues.
As a percentage of store revenues, insurance costs decreased 1.5 percentage points to 3.0% in the third quarter of 2005, from 4.5% in the comparable period in 2004, and decreased 1.0 percentage point to 3.6% in the first three quarters of 2005, from 4.6% in the comparable period in 2004. These decreases in insurance costs as a percentage of store revenues were due primarily to improved experience and the positive impact of higher revenues.
18
Domestic Distribution Operating Margin
The domestic distribution operating margin increased $1.3 million, or 7.5%, to $17.7 million in the third quarter of 2005, from $16.4 million in the comparable period in 2004, and increased $5.9 million, or 11.8%, to $55.4 million in the first three quarters of 2005, from $49.5 million in the comparable period in 2004. These results are summarized in the following table.
Domestic Distribution
Distribution operating margin
The increases in the domestic distribution operating margin during the third quarter and first three quarters of 2005 were due primarily to higher volumes as a result of increases in domestic retail sales and a decrease in insurance costs, offset in part by higher labor and delivery costs.
As a percentage of distribution revenues, the distribution operating margin increased 0.4 percentage points to 9.7% in the third quarter of 2005, from 9.3% in the comparable period in 2004, and increased 0.3 percentage points to 9.7% in the first three quarters of 2005, from 9.4% in the comparable period in 2004. Had the 2005 average cheese prices been in effect during 2004, the distribution operating margin for the third quarter and first three quarters of 2004 would have been approximately 9.4% and 9.5% of distribution revenues, respectively, versus the reported 9.3% and 9.4%. This would have resulted in operating margin improvements of 0.3 and 0.2 percentage points in the third quarter and first three quarters of 2005, respectively, versus the reported increase of 0.4 and 0.3 percentage points.
General and Administrative Expenses
General and administrative expenses decreased $9.8 million, or 19.2%, to $41.1 million in the third quarter of 2005, from $50.9 million in the comparable period in 2004, and decreased $1.3 million, or 1.1%, to $125.5 million in the first three quarters of 2005, from $126.8 million in the comparable period in 2004. These decreases in general and administrative expenses were due primarily to the $10.0 million payment made to an affiliate of our former majority stockholder in connection with our initial public offering to terminate its management agreement with us, which occurred in the third quarter of 2004. The decrease for the first three quarters of 2005 was offset in part by increases in variable general and administrative expenses, including higher administrative labor as a result of higher performance-based bonuses and increases in advertising contributions as a result of higher Company-owned same store sales. As a percentage of total revenues, general and administrative expenses decreased 3.5 percentage points to 12.2% in the third quarter of 2005, from 15.7% in the comparable period in 2004, and decreased 1.2 percentage points to 11.9% in the first three quarters of 2005, from 13.1% in the comparable period in 2004.
Interest Expense
Interest expense decreased $5.6 million, or 32.4%, to $11.7 million in the third quarter of 2005, from $17.3 million in the comparable period in 2004, and decreased $12.3 million, or 27.3%, to $32.9 million in the first three quarters of 2005, from $45.2 million in the comparable period in 2004. These decreases were due primarily to lower average debt balances during 2005 and approximately $3.7 million of deferred financing and bond discount expenses incurred in connection with the redemption of $109.1 million of Domino’s, Inc.’s senior subordinated notes in August 2004.
The average outstanding debt balance, excluding capital lease obligations, decreased $139.8 million to $758.4 million in the third quarter of 2005, from $898.2 million in the comparable period in 2004, and decreased $161.0 million to $760.9 million in the first three quarters of 2005, from $921.9 million in the comparable period in 2004.
19
Our effective borrowing rate increased 0.4 percentage points to 6.0% during the third quarter of 2005, from 5.6% in the comparable period in 2004, and decreased 0.2 percentage points to 5.5% during the first three quarters of 2005, from 5.7% in the comparable period in 2004. The effective borrowing rate for the third quarter of 2005 was negatively impacted by changes in our outstanding interest rate swaps as well as higher market interest rates, offset in part by reduced senior credit facility margin pricing. The effective borrowing rate during the first three quarters of 2005 was positively impacted by the aforementioned reductions in margin pricing, offset in part by higher market interest rates.
At June 30, 2005, two floating-to-fixed interest rate derivatives expired with total notional amounts of $375 million. We paid 1.62% under a $300 million notional amount contract and 3.25% under a $75 million notional amount contract while the counterparty paid a floating interest rate under each contract. Concurrently, a $350 million notional amount floating-to-fixed interest rate derivative started with the Company paying 3.21% under the contract while the counterparty pays a floating interest rate.
The other amount of $9.8 million for the third quarter and first three quarters of 2004 is comprised of losses incurred in connection with debt retirements, including $9.0 million incurred in connection with the redemption of $109.1 million of Domino’s, Inc.’s senior subordinated notes in August 2004.
Provision for Income Taxes
Provision for income taxes increased $12.4 million to $13.0 million in the third quarter of 2005, from $0.6 million in the comparable period in 2004, and increased $19.4 million to $40.8 million in the first three quarters of 2005, from $21.4 million in the comparable period in 2004. The effective tax rate for the third quarter increased 0.6 percentage points to 38.4%, from 37.8% in the comparable period in 2004, and decreased 0.7 percentage points to 37.1% in the first three quarters of 2005, from 37.8% in the comparable period in 2004. The decrease in the effective tax rate for the first three quarters of 2005 was due primarily to the reversal of valuation allowances related to net operating loss deferred tax assets from certain of our foreign operations.
Liquidity and Capital Resources
We had working capital of $2.7 million and cash and cash equivalents of $21.9 million at September 11, 2005. Historically, we have operated with minimal positive or negative working capital, primarily because our receivable collection periods and inventory turn rates are faster than the normal payment terms on our current liabilities. We generally collect our receivables within three weeks from the date of the related sale and we generally experience 40 to 50 inventory turns per year. In addition, our sales are not typically seasonal, which further limits our working capital requirements. These factors, coupled with significant and ongoing cash flows from operations, which are primarily used to repay debt, invest in long-term assets, and pay dividends, reduce our working capital amounts. Our primary sources of liquidity are cash flows from operations and availability of borrowings under our revolving credit facility. We expect to fund planned capital expenditures, debt repayments and dividends from these sources. We did not have any material commitments for capital expenditures as of September 11, 2005.
As of September 11, 2005, we had $755.2 million of debt, of which $2.7 million was classified as a current liability. Letters of credit issued under the revolving credit facility were $28.9 million. These letters of credit are primarily related to our casualty insurance programs and distribution center leases. Borrowings under the revolving credit facility are available to fund our working capital requirements, capital expenditures and other general corporate purposes.
We enter into interest rate swaps, collars or similar instruments with the objective of managing volatility relating to our borrowing costs. As of September 11, 2005, we were party to interest rate derivatives in the total notional amount of $450.0 million. Including the effect of interest rate derivatives, approximately 70% of outstanding borrowings were contractually fixed as of September 11, 2005.
20
Cash provided by operating activities was $108.9 million and $59.1 million in the first three quarters of 2005 and 2004, respectively. The $49.8 million increase was due primarily to a $33.9 million increase in net income and a $26.0 million net change in operating assets and liabilities, offset in part by a $7.0 million decrease in provision for deferred income taxes and a $4.5 decrease in amortization of deferred financing costs and debt discount. The $26.0 million increase in operating cash flow resulting from the net change in operating assets and liabilities was due primarily to the changes in accruals for taxes and interest. In 2005, we reported a year-over-year net source of cash resulting from a reduction in income taxes payable, which is primarily attributable to the $17.8 million reduction as a result of tax benefits related to the exercise of stock options. Additionally, due primarily to lower debt levels in 2005, we reported a $7.9 million year-over-year net source of cash resulting from a reduction in interest payable.
Cash used in investing activities was $18.7 million and $26.7 million in the first three quarters of 2005 and 2004, respectively. The $8.0 million decrease was due primarily to a $7.9 million decrease in capital expenditures. This decrease primarily resulted from the significant capital expenditures in 2004 relating to the renovation of our world headquarters.
Cash used in financing activities was $108.9 million and $54.2 million in the first three quarters of 2005 and 2004, respectively. The $54.7 million increase was due primarily to a $119.6 million decrease in net proceeds from the issuance of common stock, a $75.0 million purchase of common stock in 2005 and $13.5 million of dividend payments in 2005, offset in part by a $90.4 million decrease in repayments of long-term debt, $40.0 million of proceeds resulting from short-term borrowings to partially fund the aforementioned share repurchase and a $16.9 million decrease in distributions to our founder and former majority stockholder and his wife in conjunction with our initial public offering in 2004.
Based upon the current level of operations and anticipated growth, we believe that the cash generated from operations and amounts available under the revolving credit facility will be adequate to meet our anticipated debt service requirements, capital expenditures, dividend payments and working capital needs for the next twelve months. Our ability to continue to fund these items and continue to reduce debt could be adversely affected by the occurrence of any of the events described under “Risk Factors” in our filings with the Securities and Exchange Commission. There can be no assurance, however, that our business will generate sufficient cash flows from operations or that future borrowings will be available under the senior secured credit facility or otherwise to enable us to service our indebtedness, including the senior secured credit facility and the senior subordinated notes, or to make anticipated capital expenditures, or to make anticipated dividend payments. Our future operating performance and our ability to service or refinance the senior subordinated notes and to service, extend or refinance the senior secured credit facility will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control. Additionally, Domino’s, Inc. may be requested to provide funds to its parent company, Domino’s Pizza, Inc. for dividends, distributions and/or other cash needs of Domino’s Pizza, Inc.
Forward-Looking Statements
This filing contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements relating to our anticipated profitability and operating performance reflect management’s expectations based upon currently available information and data. However, actual results are subject to future risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. The risks and uncertainties that can cause actual results to differ materially include: the uncertainties relating to litigation; consumer preferences, spending patterns and demographic trends; the effectiveness of our advertising, operations and promotional initiatives; our ability to retain key personnel; new product and concept developments by Domino’s and other food-industry competitors; the ongoing profitability of our franchisees and the ability of Domino’s and our franchisees to open new restaurants; changes in food prices, particularly cheese, labor, utilities, insurance, employee benefits and other operating costs; the impact that widespread illness or general health concerns may have on our business and the economy of the countries in which we operate; severe weather conditions and natural disasters; changes in our effective tax rate; changes in government legislation and regulations; adequacy of our insurance coverage; costs related to future financings and changes in accounting policies. Further information about factors that could affect Domino’s financial and other results is included in our other filings with the Securities and Exchange Commission. We do not undertake to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
21
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market Risk
We are exposed to market risks from interest rate changes on our variable rate debt. Management actively monitors this exposure. We do not engage in speculative transactions nor do we hold or issue financial instruments for trading purposes.
Interest Rate Derivatives
We enter into interest rate swaps, collars or similar instruments with the objective of managing volatility relating to our borrowing costs.
We are party to an interest rate swap agreement which effectively converts the variable LIBOR component of the effective interest rate on a portion of our debt under our senior secured credit facility to a fixed rate over a specified term. We are also party to two interest rate swap agreements which effectively convert the 8.25% interest rate on our senior subordinated notes to variable rates over the term of the senior subordinated notes.
These agreements are summarized in the following table.
Derivative
Notional Amount
Company
Pays
Counterparty
Interest Rate Swap
Interest Rate Risk
Our variable interest expense is sensitive to changes in the general level of interest rates. At September 11, 2005, the weighted average interest rate on our $223.0 million of variable interest debt was 6.2%.
We had total interest expense of approximately $32.9 million in the first three quarters of 2005. The estimated increase in interest expense for this period from a hypothetical 200 basis point adverse change in applicable variable interest rates would be approximately $2.9 million.
Item 4. Controls and Procedures
Domino’s Pizza, Inc.’s Chairman and Chief Executive Officer, David A. Brandon, and Executive Vice President and Chief Financial Officer, Harry J. Silverman, performed an evaluation of the effectiveness of Domino’s Pizza, Inc.’s and Domino’s, Inc.’s disclosure controls and procedures (as that term is defined in Rule 13a-15(e) under the Securities Exchange of 1934, as amended) as of the end of the period covered by this report. Based on that evaluation, Messrs. Brandon and Silverman concluded that each of Domino’s Pizza, Inc.’s and Domino’s, Inc.’s disclosure controls and procedures were effective.
During the quarterly period ended September 11, 2005 there have been no changes in either Domino’s Pizza, Inc.’s or Domino’s, Inc.’s internal controls over financial reporting that have materially affected or are reasonably likely to materially affect Domino’s Pizza, Inc.’s or Domino’s, Inc.’s internal control over financial reporting.
22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are a party to lawsuits, revenue agent reviews by taxing authorities and administrative proceedings in the ordinary course of business which include workers’ compensation, general liability, automobile and franchisee claims. We are also subject to suits related to employment practices and, specifically in California, wage and hour claims and two class actions pending in Orange County, California Superior Court brought by former employees. On June 10, 2003, a class action complaint was filed alleging that we failed to provide meal and rest breaks to our employees. This case is in the discovery stage and no determination with respect to class certification has been made.
On August 19, 2004, a class action complaint was filed by a former general manager alleging that we misclassified the position of general manager. We classify the general manager of a Domino’s Pizza store as an exempt employee. This case involves the issue of whether employees and former employees in the general manager position who worked in our 60 California stores during specified time periods were misclassified as exempt and deprived of overtime pay. We believe this case is without merit and intend to vigorously defend against the related claims. This case is in the earliest stages of discovery, and the status of the class action certification is yet to be determined. We are presently unable to predict the probable outcome of this matter or the amounts of any potential damages at issue.
We believe that these matters, individually and in the aggregate, will not have a significant adverse effect on our financial condition and that our established reserves adequately provide for the resolution of such claims.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
None.
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits
Description
23
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrants have duly caused this report to be signed on their behalf by the undersigned duly authorized officer.
/s/ Harry J. Silverman
24