SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
For the quarterly period ended September 5, 2004
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
As of October 11, 2004, Domino’s Pizza, Inc. had 68,655,553 shares of common stock, par value $0.01 per share, outstanding. As of October 11, 2004, 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.
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)
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:
Class L common stock
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 December 28, 2003 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 (loss) before provision (benefit) for income taxes
Provision (benefit) for income taxes
Net income (loss)
Net income (loss) available to common stockholders – basic and diluted
Earnings per share:
Class L common stock – basic
Class L common stock – diluted
Common stock – basic
Common stock – diluted
4
Condensed Consolidated Statements of Cash Flows
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Amortization of deferred financing costs
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:
Proceeds from the issuance of long-term debt
Cash paid for financing fees
Repayments of debt
Net proceeds from the issuance of common stock
Purchases of preferred stock
Distributions
Net cash used in financing activities
Effect of exchange rate changes on cash and cash equivalents
Increase (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 share and per share amounts)
September 5, 2004
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 December 28, 2003 included in our other filings with the Securities and Exchange Commission.
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 5, 2004 are not necessarily indicative of the results that may be expected for the fiscal year ending January 2, 2005.
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 7.
2. Comprehensive Income (Loss)
September 5,
2004
Unrealized gains (losses) on derivative instruments, net of tax
Reclassification adjustment for losses included in net income (loss), 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 –
2003
Income from operations –
Segment Income –
6
The following table reconciles Total Segment Income to consolidated income (loss) before provision (benefit) for income taxes.
Total Segment Income
Gains (losses) on sale/disposal of assets
Other non-cash stock compensation expense
Termination of management agreement
2003 recapitalization expenses
4. Earnings Per Share
Accumulated preferred stock dividends
Accretion amounts relating to redemption value of preferred stock
Allocation of net income (loss) to common stockholders:
Class L
Weighted average number of shares:
Earnings per share – basic:
Diluted weighted average number of shares:
Earnings per share – diluted:
7
The denominator in calculating diluted earnings per share for common stock for the third quarter of 2004 does not include 2,441,176 dilutive shares resulting from stock options as their inclusion would be anti-dilutive. Additionally, the denominator in calculating diluted earnings per share for common stock for the third quarter and first three quarters of 2003 does not include 1,992,759 and 2,119,319, respectively, of dilutive shares resulting from stock options as their inclusion would be anti-dilutive.
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 (loss), 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 (loss), pro forma
The pro forma basic and diluted earnings per share amounts for Class L and common stock are the same as reported amounts.
6. Significant Changes in Equity
Prior to the Domino’s Pizza, Inc. initial public offering of common stock (the “IPO”) completed on July 16, 2004, the Company amended its certificate of incorporation and bylaws to, among other changes, convert all of its Class L common stock into shares of its common stock. In the IPO, Domino’s Pizza, Inc. issued and sold 9,375,000 shares of common stock resulting in net proceeds to the Company of approximately $119.6 million. Also in the IPO, existing shareholders sold an aggregate of 14,846,929 shares of common stock. The Company did not receive any proceeds from the sale of shares by the selling shareholders. Immediately following the closing of the IPO, the Company had 68,653,626 shares of common stock outstanding. Additionally, in connection with the IPO, the Company used general funds to pay in full $16.9 million of contingent notes held by our founder and former majority stockholder and his spouse.
7. 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.
8
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)
Cash and cash equivalents (1)
Current liabilities
9
Supplemental Guarantor Condensed Consolidating Statements of Income
Revenues
Cost of sales
Income (loss) from operations
Equity earnings in subsidiaries
Interest income (expense), net (2)
Other expense
Net income (loss) (2)
General and administrative (2)
Interest income (expense), net
Provision (benefit) for income taxes (2)
10
Supplemental Condensed Consolidating Statements of Cash Flows
Net cash provided by (used in) operating activities (3)
Distributions to parent, net
Net cash provided by (used in) financing activities (3)
Cash and cash equivalents, at beginning of period (3)
11
Net cash provided by (used in) operating activities
Proceeds from issuance of long-term debt
Net cash provided by (used in) financing activities
Cash and cash equivalents, at end 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 2004 and 2003 third quarters referenced herein represent the twelve-week periods ended September 5, 2004 and September 7, 2003, respectively. The 2004 and 2003 first three quarters referenced herein represent the thirty-six week periods ended September 5, 2004 and September 7, 2003, respectively.
Overview
During the third quarter and first three quarters of 2004, global retail sales, comprised of retail sales at both our franchise and Company-owned stores worldwide, grew 12.0% and 8.6%, respectively. During these same periods, revenues grew 11.0% and 7.5%, respectively. Excluding costs incurred in connection with our IPO in the third quarter of 2004 and costs incurred in connection with our recapitalization in the third quarter of 2003, we achieved an increase in income from operations, despite an intensely competitive landscape, an environment of rising commodity prices negatively affecting our food costs and an increase in losses on sale/disposal of assets of $3.2 million (comprised of a $ 0.4 million net loss in 2004 and a $2.8 million net gain in 2003).
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 2004, domestic same store sales increased 8.0% and 2.9%, respectively, led by our domestic franchise operations. These positive same store sales results were driven by positive consumer response to the Company’s marketing and promotional activities. We also had continued strong sales from our international operations, which increased 5.9% and 5.8% on a constant dollar basis during the third quarter and first three quarters of 2004. On a historical dollar basis, international same store sales increased 9.9% and 12.0% during the third quarter and first three quarters of 2004. The third quarter marked the 43rd consecutive quarter that we have grown our international same store sales. Additionally, our worldwide store counts increased 271 stores from year-ago levels, led by our international operations.
Income from operations increased $6.0 million to $28.4 million in the third quarter. This increase was driven largely by $15.7 million of costs incurred in connection with our 2003 recapitalization, offset by $10.0 million of costs incurred in connection with our initial public offering. Additionally, income from operations improved despite the negative impact of a $3.2 million increase in losses on sale/disposal of assets and increases in food costs at Company-owned stores, primarily cheese. The average published cheese block price per pound increased $0.22 to $1.60 in the third quarter of 2004 compared to the prior year. Net income increased $19.0 million to nearly $1.0 million in the third quarter.
Same Store Sales Growth
The following is a summary of our same store sales growth for the third quarter and first three quarters of 2004.
Third Quarter
of 2004
First Three
Quarters of 2004
Domestic franchise stores
Domestic stores
International:
Constant dollar
Historical dollar
13
Store Growth Activity
The following is a summary of our store growth activity for the third quarter and first three quarters of 2004.
Domestic
Company-ownedStores
Store count at June 13, 2004
Openings
Closings
Transfers
Store count at September 5, 2004
Store count at December 28, 2003
Income Statement Data
The following is a summary of income statement data for the third quarter and first three quarters of 2004 and 2003.
of 2003
Operating expenses:
Interest expense, net
Income (loss) before provision
(benefit) for income taxes
Revenues include retail sales by Company-owned stores, royalties and fees from domestic and international franchise stores, and sales of food, equipment and supplies by our 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 food prices, primarily cheese prices.
Consolidated revenues increased $32.2 million or 11.0% to $325.0 million in the third quarter of 2004, from $292.8 million in the comparable period in 2003, and increased $67.7 million or 7.5% to $968.0 million in the first three quarters of 2004, from $900.3 million in the comparable period in 2003. These increases were a result of increases in revenues at each of our reportable segments and are more fully described below.
14
Domestic Stores
Domestic stores revenues are comprised of revenues from our domestic Company-owned store operations and domestic franchise operations, as summarized in the following table.
Total domestic stores revenues
Domestic stores revenues increased $8.9 million or 7.8% to $122.7 million in the third quarter of 2004, from $113.8 million in the comparable period in 2003, and increased $6.7 million or 1.9% to $363.1 million in the first three quarters of 2004, from $356.4 million in the comparable period in 2003. These increases in revenues were due primarily to increases in both our domestic Company-owned and domestic franchise same store sales as well as increases in the average number of domestic franchise stores in operation during 2004. Domestic same store sales increased 8.0% and 2.9% in the third quarter and first three quarters of 2004, respectively, compared to the same periods in 2003, driven by positive consumer response to the Company’s marketing and promotional activities. These changes in domestic stores revenues are more fully described below.
Domestic Company-Owned Stores
Revenues from domestic Company-owned store operations increased $5.1 million or 6.1% to $87.5 million in the third quarter of 2004, from $82.4 million in the comparable period in 2003, and increased $1.3 million or 0.5% to $259.5 million in the first three quarters of 2004, from $258.2 million in the comparable period in 2003. These increases in revenues were due primarily to increases in same store sales of 6.8% and 1.1% in the third quarter and first three quarters of 2004, respectively, compared to the same periods in 2003. There were 578 and 579 domestic Company-owned stores in operation as of September 5, 2004 and September 7, 2003, respectively.
Domestic Franchise
Revenues from domestic franchise operations increased $3.8 million or 12.1% to $35.2 million in the third quarter of 2004, from $31.4 million in the comparable period in 2003, and increased $5.4 million or 5.5% to $103.6 million in the first three quarters of 2004, from $98.2 million in the comparable period in 2003. These increases in revenues were due primarily to increases in same store sales of 8.2% and 3.1% in the third quarter and first three quarters of 2004, respectively, compared to the same periods in 2003 and an increase in the average number of domestic franchise stores open during 2004. There were 4,367 and 4,296 domestic franchise stores in operation as of September 5, 2004 and September 7, 2003, respectively.
Domestic Distribution
Revenues from domestic distribution operations increased $19.7 million or 12.5% to $177.4 million in the third quarter of 2004, from $157.7 million in the comparable period in 2003, and increased $49.4 million or 10.3% to $529.2 million in the first three quarters of 2004, from $479.8 million in the comparable period in 2003. The increase in domestic distribution revenues in the third quarter of 2004 was due primarily to increases in volumes related to increases in domestic franchise retail sales and a market increase in overall food prices, primarily higher cheese prices. The increase in domestic distribution revenues in the first three quarters of 2004 was due primarily to a market increase in overall food prices, primarily higher cheese prices. The published cheese block price-per-pound averaged $1.60 and $1.65 in the third quarter and first three quarters of 2004, respectively, up from $1.38 and $1.21 in the comparable periods in 2003. Had the 2004 average cheese prices been in effect during the comparable periods of 2003, distribution revenues for the third quarter and first three quarters of 2003 would have been approximately $6.8 million and $40.9 million higher than the reported 2003 amounts, respectively.
15
Revenues from international operations increased $3.6 million or 16.7% to $24.9 million in the third quarter of 2004, from $21.3 million in the comparable period in 2003, and increased $11.5 million or 17.9% to $75.7 million in the first three quarters of 2004, from $64.2 million in the comparable period in 2003. These increases in revenues were due to increases in same store sales, an increase in the average number of international stores open during 2004, and related increases in revenues from our international distribution operations. On a constant dollar basis, same store sales increased 5.9% and 5.8% in the third quarter and first three quarters of 2004, compared to the same periods in 2003. On a historical dollar basis, same store sales increased 9.9% and 12.0% in the third quarter and first three quarters of 2004, respectively, compared to the same periods in 2003, reflecting a generally weaker U.S. Dollar in those markets in which we compete. There were 2,658 and 2,457 international stores in operation as of September 5, 2004 and September 7, 2003, 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 $7.8 million or 10.9% to $79.3 million in the third quarter of 2004, from $71.5 million in the comparable period in 2003, and increased $9.3 million or 4.0% to $238.0 million in the first three quarters of 2004, from $228.7 million in the comparable period in 2003, as summarized in the following table.
Quarters of 2003
Consolidated revenues
Consolidated cost of sales
Consolidated operating margin
The increases in consolidated operating margin for the third quarter and first three quarters of 2004 were due primarily to increases in domestic franchise and international revenues resulting from strong retail sales growth. As a percentage of revenues, the consolidated operating margin was flat in the third quarter of 2004 compared to the same period in 2003 and decreased 0.8 percentage points to 24.6% in the first three quarters of 2004, from 25.4% in the comparable period in 2003.
Cheese price changes are a “pass-through” in domestic distribution revenues and cost of sales and, as such, have no impact on operating margin or income. However, cheese price changes do impact operating margin as a percentage of revenues. Had the 2004 average cheese prices been in effect during the comparable periods of 2003, the total operating margin for the third quarter and first three quarters of 2003 would have been approximately 23.9% and 24.3% of total revenues, respectively, or an improvement of 0.5 and 0.3 percentage points in the third quarter and first three quarters of 2004, respectively.
The domestic Company-owned store operating margin increased $0.8 million or 5.4% to $15.4 million in the third quarter of 2004, from $14.6 million in the comparable period in 2003, and decreased $1.9 million or 3.8% to $48.3 million in the first three quarters of 2004, from $50.2 million in the comparable period in 2003, as summarized in the following table.
Store operating margin
The increase in the domestic Company-owned store operating margin during the third quarter of 2004 was due primarily to an increase in same store sales, offset in part by an increase in overall food costs, primarily cheese. The decrease in the domestic Company-owned store operating margin during first three quarters of 2004 was due primarily to an increase in overall food costs and an increase insurance costs, offset in part by an increase in same store sales.
16
As a percentage of store revenues, the store operating margin decreased 0.1 percentage points to 17.6% in the third quarter of 2004, from 17.7% in the comparable period in 2003, and decreased 0.8 percentage points to 18.6% in the first three quarters of 2004, from 19.4% in the comparable period in 2003.
As a percentage of store revenues, food costs increased 1.3 percentage points to 29.0% in the third quarter of 2004, from 27.7% in the comparable period in 2003 and increased 1.2 percentage points to 28.3% in the first three quarters of 2004, from 27.1% in the comparable period in 2003. These increases in food costs as a percentage of store revenues were due primarily to an increase in overall food prices, primarily cheese.
As a percentage of store revenues, labor costs decreased 0.6 percentage points to 30.0% in the third quarter of 2004, from 30.6% in the comparable period in 2003 and decreased 0.4 percentage points to 30.0% in the first three quarters of 2004, from 30.4% in the comparable period in 2003.
As a percentage of store revenues, occupancy costs, which include rent, telephone, utilities and depreciation, decreased 0.2 percentage points to 11.6% in the third quarter of 2004, from 11.8% in the comparable period in 2003, and increased 0.1 percentage points to 11.3% in the first three quarters of 2004, from 11.2% in the comparable period in 2003.
The domestic distribution operating margin increased $1.1 million or 7.1% to $16.4 million in the third quarter of 2004, from $15.3 million in the comparable period in 2003, and decreased $1.4 million or 2.8% to $49.5 million in the first three quarters of 2004, from $50.9 million in the comparable period in 2003, as summarized in the following table.
Distribution operating margin
The increase in the domestic distribution operating margin during the third quarter of 2004 was due primarily to increases in volumes as a result of increases in domestic retail sales, offset in part by increases in insurance, occupancy and delivery costs. The decrease in domestic distribution operating margin during the first three quarters of 2004 was due primarily to increases in insurance, occupancy and delivery costs.
As a percentage of distribution revenues, the distribution operating margin decreased 0.4 percentage points to 9.3% in the third quarter of 2004, from 9.7% in the comparable period in 2003, and decreased 1.2 percentage points to 9.4% in the first three quarters of 2004, from 10.6% in the comparable period in 2003. The decreases in the domestic distribution operating margin as a percentage of revenues were due primarily to the negative impact on operating margin due to increases in food prices.
Had the 2004 average cheese prices been in effect during the comparable periods of 2003, the distribution operating margin for the third quarter and first three quarters of 2003 would have been approximately 9.3% and 9.8% of distribution revenues, respectively, or flat for the third quarter of 2004 and a decrease of 0.4 percentage points during the first three quarters of 2004.
General and Administrative Expenses
General and administrative expenses increased $1.8 million or 3.7% to $50.9 million in the third quarter of 2004, from $49.1 million in the comparable period in 2003, and increased $2.6 million or 2.1% to $126.8 million in the first three quarters of 2004, from $124.2 million in the comparable period in 2003. General and administrative expenses during the third quarter were negatively impacted as compared to 2003 by a $10.0 million payment made in connection with our IPO to an affiliate of our former majority stockholder to terminate its management agreement, as well as a $3.2 million year-over-year increase in losses on sale/disposal of assets, including a $2.8 million gain relating to the collection of a note receivable in 2003. Separately, the Company recognized $0.9 million in 2003 relating to the collection of a previously fully reserved note receivable. The Company also experienced increases in administrative labor, rents, advertising and insurance during 2004. Offsetting these increases in general and administrative expenses was approximately $15.7 million of expenses incurred in connection with the Company’s 2003 recapitalization.
17
Interest Expense
Interest expense decreased $13.7 million or 44.2% to $17.3 million in the third quarter of 2004, from $31.0 million in the comparable period in 2003 and decreased $9.1 million or 16.8% to $45.2 million in the first three quarters of 2004, from $54.3 million in the comparable period in 2003. These decreases in interest expense were due primarily to approximately $15.6 million of financing fees that were written-off in connection with the Company’s 2003 recapitalization, offset by approximately $3.7 million of financing fees that were written-off in connection with the retirement of $109.1 million of senior subordinated notes in the third quarter of 2004.
Additionally, interest expense was positively impacted by more favorable interest rates. Our effective borrowing rate decreased 0.8 and 1.3 percentage points to 5.6% and 5.7% during the third quarter and first three quarters of 2004, respectively. Our average outstanding debt balance, excluding capital lease obligations, decreased $52.6 million to $898.3 million in the third quarter of 2004, from $950.9 million in the comparable period in 2003. Our average outstanding debt, excluding capital lease obligations, balance increased $211.7 million to $921.9 million in the first three quarters of 2004, from $710.2 million in the comparable period in 2003.
Other expense decreased $10.6 million or 52.3% to $9.8 million in the third quarter of 2004, from $20.4 million in the comparable period in 2003 and decreased $12.4 million or 56.0% to $9.8 million in the first three quarters of 2004, from $22.2 million in the comparable period in 2003. 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. The other amounts of $20.4 million and $22.2 million for the third quarter and first three quarters of 2003, respectively, are comprised of losses incurred in connection with debt retirements, including $20.4 million of bond tender fees incurred in connection with the recapitalization in the third quarter of 2003.
Provision for Income Taxes
Provision for income taxes increased $11.4 million to $0.6 million in the third quarter of 2004, from a benefit of $10.8 million in the comparable period in 2003, and increased $10.8 million to $21.4 million in the first three quarters of 2004, from $10.6 million in the comparable period in 2003. The effective tax rate for all periods presented has remained relatively flat.
Liquidity and Capital Resources
We had working capital of $16.5 million and cash and cash equivalents of $20.2 million at September 5, 2004. 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 and invest in long-term assets, reduce our working capital amounts. More recently, due to the one percent annual amortization payments required by our senior secured credit facility, as well as voluntary prepayments we have made on the senior secured credit facility principal amount, we do not have a significant current portion of long-term debt. Accordingly, our working capital has been positively impacted. 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 and debt repayments from these sources. We did not have any material commitments for capital expenditures as of September 5, 2004.
As of September 5, 2004, we had $804.3 million of debt, of which $0.3 million was classified as a current liability. There were no borrowings under our $125.0 million revolving credit facility. Letters of credit issued under the revolving credit facility were $26.1 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.
18
We enter into interest rate swaps, collars or similar instruments with the objective of reducing volatility relating to our borrowing costs. As of September 5, 2004, we are party to interest rate derivatives in the total notional amount of $505.0 million.
Cash provided by operating activities was $57.7 million and $52.1 million in the first three quarters of 2004 and 2003, respectively. The $5.6 million increase was due primarily to a $17.6 million increase in net income, offset by a $12.1 million decrease in amortization of deferred financing costs.
Cash used in investing activities was $26.7 million and $9.9 million in the first three quarters of 2004 and 2003, respectively. The $16.8 million increase was due primarily to an $11.1 million increase in capital expenditures, due primarily to renovations of our corporate headquarters, and a $5.2 million decrease in net repayments of notes receivable.
Cash used in financing activities was $54.2 million and $39.6 million in the first three quarters of 2004 and 2003, respectively. The $14.6 million increase was due primarily to net cash used in our initial public offering in 2004 exceeding the net cash used in our recapitalization in 2003. In connection with our initial public offering in 2004, we received net proceeds from the issuance of common stock of approximately $119.6 million. We used these net proceeds and cash from operations to repurchase approximately $109.1 million of senior subordinated notes, and repay approximately $16.9 million of notes payable to our founder and former majority stockholder and his wife. Additionally, during the first three quarters of 2004, we repaid approximately $46.5 million of additional debt obligations. In connection with our recapitalization in 2003, we received proceeds from the issuance of long-term debt of approximately $1.0 billion. We used these proceeds to repay approximately $362.3 million outstanding under our then existing credit facility, repurchase approximately $206.7 million of senior subordinated notes, retire our preferred stock for approximately $200.6 million, distribute $188.3 million to our shareholders and pay approximately $20.0 million of financing fees. Furthermore, during the first three quarters of 2003, we repaid approximately $71.4 million of additional debt obligations.
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 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
Certain statements contained in this filing relating to capital spending levels and the adequacy of our capital resources are forward-looking. Also, statements that contain words such as “believes,” “expects,” “anticipates,” “intends,” “estimates” or similar expressions are forward-looking statements. Forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. Among these risks and uncertainties are competitive factors, increases in our operating costs, ability to retain our key personnel, our substantial leverage, ability to implement our growth and cost-saving strategies, industry trends and general economic conditions, adequacy of insurance coverage and other factors, all of which are described in our 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.
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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 reducing volatility relating to our borrowing costs.
We are party to three interest rate swap agreements which effectively convert the variable LIBOR component of the effective interest rate on a portion of our debt under our senior secured credit facility to various fixed rates over various terms. We are also party to two interest rate swap agreements which effectively convert the fixed component of our debt under our senior subordinated notes to variable LIBOR rates over the term of the senior subordinated notes.
These agreements are summarized in the following table.
Derivative
Total
Notional Amount
Domino’s
Pays
Counterparty
Interest Rate Swap
In 2004, we entered into an additional interest rate swap agreement effectively converting the variable LIBOR component on a portion of our senior secured credit facility term debt to various fixed rates over various terms. The agreement has a notional starting amount of $350.0 million, begins in June 2005, ends in June 2007 and fixes our interest rate at 3.21%. We pay a fixed interest rate under these agreements while the counterparty pays a floating rate.
Interest Rate Risk
Our variable interest expense is sensitive to changes in the general level of interest rates. At September 5, 2004, the weighted average interest rate on our $208.0 million of variable interest debt was 4.2%.
We had total interest expense of approximately $45.2 million in the first three quarters of 2004. 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 $5.6 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 5, 2004 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.
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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 actions alleging that our store managers are misclassified as exempt employees. 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 estimated resolution of such claims.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
Period
(c) Total Number
of Shares
(or Units)
Purchased as
Part of Publicly
AnnouncedPlans orPrograms
(d) Maximum
Number (orApproximateDollar Value)of Shares (orUnits) thatMay Yet BePurchasedUnder thePlans orPrograms
Period #1 (June 14, 2004 to July 11, 2004)
Period #2 (July 12, 2004 to August 8, 2004)
Period #3 (August 9, 2004 to September 5, 2004)
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Description
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b. Reports on Form 8-K.
The following Current Reports on Form 8-K were filed with or furnished to the SEC during the period covered by this report:
Current Report on Form 8-K of Domino’s Pizza, Inc. dated July 27, 2004, which included a press release announcing financial results for the second quarter of 2004 which ended June 13, 2004.
Current Report on Form 8-K of Domino’s Pizza, Inc. and Domino’s, Inc. dated August 24, 2004, which included a press release announcing the Company’s purchase of $109.1 million of Domino’s, Inc.’s 8.25% senior subordinated notes due 2011.
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.
DOMINO’S PIZZA, INC.
DOMINO’S, INC.
(Registrants)
Date: October 19, 2004
/s/ Harry J. Silverman
Harry J. Silverman
Chief Financial Officer
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