SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
For the quarterly period ended June 19, 2005
OR
For the transition period from: to
Commission file numbers:
Domino’s Pizza, Inc. 333-114442
Domino’s, Inc. 333-107774
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 July 17, 2005, Domino’s Pizza, Inc. had 66,182,767 shares of common stock, par value $0.01 per share, outstanding. As of July 17, 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
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
(In thousands, except per share data)
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
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
Class L common stock – 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
Other
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 issuance of long-term debt
Repayments of long-term debt and capital lease obligation
Purchase of common stock
Dividends
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 percentages, share and per share amounts)
June 19, 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 two fiscal quarters ended June 19, 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 10.
2. Comprehensive Income
June 19,
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
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.
June 13,
Total Segment Income
Losses on sale/disposal of assets
Non-cash stock compensation expense
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:
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. Related Party Share Repurchase
During the second quarter, we repurchased and retired 4,409,171 shares of our Common Stock from JP Morgan Capital, L.P. and its affiliates (collectively, JPMP), for $75.0 million, or $17.01 per share. The repurchase price of $17.01 per share in this private transaction was based on a negotiated discount between us and JPMP. We used $35.0 million of available cash on hand and $40.0 million of borrowings from our revolving credit facility to fund the repurchase of shares.
7. Income Taxes
Our effective tax rate was 35.2% for the second quarter, down from 37.8% in the first quarter. This decrease in the effective tax rate for the second quarter was the result of the reversal of approximately $1.1 million of valuation allowances related to net operating loss deferred tax assets from certain of our foreign operations.
8. Supplemental Disclosure of Cash Flow Information
During the first two quarters of 2005, we have recorded approximately $12.7 million in income tax payable reductions as a result of the tax benefit related to the exercise of stock options.
9. 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 at the beginning of fiscal 2006. We are currently assessing valuation model alternatives (i.e. Black-Scholes or binomial models) as well as related assumptions to be used in such models. Additionally, we are evaluating the two adoption alternatives (the modified-prospective method and the modified-retrospective method). Once our evaluation is complete, we will determine an appropriate valuation model, the method of adoption and the impact the adoption will have on our results of operations.
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10. 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
Income (loss) from operations
Equity earnings in subsidiaries
Interest expense, net
Income (loss) before provision (benefit) for income taxes
Provision (benefit) for income taxes
Net income (loss)
10
Interest income (expense), net
11
Supplemental Condensed Consolidating Statements of Cash Flows
Net cash provided by (used in) operating activities (2)
Proceeds from the issuance of long-term debt
Repayments of debt
Net cash provided by (used in) financing activities (2)
Net cash provided by (used in) operating activities
Increase in cash and cash equivalents
Cash and cash equivalents, at beginning of period (2)
Cash and cash equivalents, at end of period (2)
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 second quarters referenced herein represent the twelve-week periods ended June 19, 2005 and June 13, 2004, respectively. The 2005 and 2004 first two quarters referenced herein represent the twenty-four week periods ended June 19, 2005 and June 13, 2004, respectively.
Overview
During the second quarter and first two quarters of 2005, global retail sales, comprised of retail sales at both our franchise and Company-owned stores worldwide, grew 13.5% and 13.7%, respectively, as compared to the prior year periods. This growth was driven primarily by robust 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 7.0% and 11.5%, respectively, as compared to the prior year periods. Additionally, we reported increases in income from operations of 18.5% and 17.3% 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 second quarter and first two quarters of 2005, domestic same store sales grew 6.9% and 9.0%, respectively, comprised of domestic Company-owned same store sales increases of 8.6% and 11.2%, respectively, and domestic franchise same store sales increases of 6.6% and 8.7%, respectively. These positive same store sales results were driven by positive consumer response to the Company’s marketing and promotional activities. We also continued to benefit from strong same store sales in our international markets during the second quarter and first two quarters, which increased 7.8% and 8.2%, respectively, on a constant dollar basis versus the prior year periods. The second quarter marked the 46th consecutive quarter that we have grown our international same store sales. Additionally, we grew our worldwide net store counts by 79 and 348 stores during the second quarter and trailing four quarters, respectively.
Income from operations increased $7.3 million, or 18.5%, to $46.6 million in the second quarter, from $39.3 million in the comparable period in 2004, and increased $14.3 million, or 17.3%, to $97.1 million in the first two quarters, from $82.8 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. The average published cheese block price per pound decreased $0.50 and $0.14 to $1.51 and $1.53 in the second quarter and first two 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 $7.5 million, or 47.3%, to $23.4 million in the second quarter, from $15.9 million in the comparable period in 2004, and increased $14.1 million, or 41.0%, to $48.4 million in the first two quarters, from $34.3 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 expense from the comparable periods in 2004. The reduction in interest expense was a result of lower average debt balances and a reduction in our average borrowing rates. Additionally, net income was positively impacted by lower income taxes resulting from the reversal of valuation allowances related to net operating loss deferred tax assets from certain of our foreign operations.
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 June 19, 2005, we had approximately $5.5 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 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 a partial 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 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)
Second Quarter
of 2005
Domestic franchise stores
Domestic stores
International stores
Store Counts and Net Unit Growth
Domestic
Company-ownedStores
Total
DomesticStores
Store count at March 27, 2005
Openings
Closings
Transfers
Store count at June 19, 2005
Second quarter net growth
First two quarters net growth
Trailing 4 quarters net growth
Income Statement Data
15
Revenues primarily include retail sales by Company-owned stores, royalties 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 commodity prices, primarily cheese and meats.
Consolidated revenues increased $22.8 million, or 7.0%, to $347.0 million in the second quarter of 2005, from $324.2 million in the comparable period in 2004, and increased $73.6 million, or 11.5%, to $716.6 million in the first two quarters of 2005, from $643.0 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
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 $11.1 million, or 9.4%, to $128.9 million in the second quarter of 2005, from $117.8 million in the comparable period in 2004, and increased $26.0 million, or 10.8%, to $266.4 million in the first two quarters of 2005, from $240.4 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 6.9% and 9.0% in the second quarter and first two quarters of 2005, respectively, compared to the same periods in 2004, 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 $7.6 million, or 9.1%, to $91.7 million in the second quarter of 2005, from $84.1 million in the comparable period in 2004, and increased $17.9 million, or 10.4%, to $189.9 million in the first two quarters of 2005, from $172.0 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 8.6% and 11.2% in the second quarter and first two quarters of 2005, respectively, compared to the same periods in 2004. There were 569 and 577 domestic Company-owned stores in operation as of June 19, 2005 and June 13, 2004, respectively.
Domestic Franchise
Revenues from domestic franchise operations increased $3.4 million, or 10.3%, to $37.2 million in the second quarter of 2005, from $33.8 million in the comparable period in 2004, and increased $8.1 million, or 11.8%, to $76.5 million in the first two quarters of 2005, from $68.4 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 6.6% and 8.7% in the second quarter and first two quarters of 2005, respectively, compared to the same periods in 2004. There were 4,460 and 4,348 domestic franchise stores in operation as of June 19, 2005 and June 13, 2004, respectively. The average royalty rate earned on domestic franchise retail sales was 5.4% in the second quarter of 2005.
16
Domestic Distribution
Revenues from domestic distribution operations increased $7.3 million, or 4.0%, to $188.2 million in the second quarter of 2005, from $180.9 million in the comparable period in 2004, and increased $38.2 million, or 10.9%, to $390.0 million in the first two quarters of 2005, from $351.8 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 a decrease in cheese prices. The published cheese block price-per-pound averaged $1.51 and $1.53 in the second quarter and first two quarters of 2005, respectively, down from $2.01 and $1.67 in the comparable periods in 2004. Had the 2005 average cheese prices been in effect during 2004, distribution revenues for the second quarter and first two quarters of 2004 would have been approximately $12.9 million and $6.1 million, respectively, lower than the reported 2004 reported amounts.
Revenues from international operations increased $4.3 million, or 17.0%, to $29.8 million in the second quarter of 2005, from $25.5 million in the comparable period in 2004, and increased $9.4 million, or 18.6%, to $60.2 million in the first two quarters of 2005, from $50.8 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 7.8% and 8.2% in the second quarter and first two quarters of 2005, respectively, versus the comparable period in 2004. There were 2,849 and 2,605 international stores in operation as of June 19, 2005 and June 13, 2004, respectively. The average royalty rate earned on international franchise retail sales was 3.2% in the second quarter of 2005.
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 $10.8 million, or 13.9%, to $88.4 million in the second quarter of 2005, from $77.6 million in the comparable period in 2004 and increased $22.7 million, or 14.3%, to $181.4 million in the first two quarters of 2005, from $158.7 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 consolidated operating margin for the second quarter and first two quarters of 2005 were due primarily to higher domestic franchise and international royalty revenues resulting from strong global retail sales growth.
As a percentage of revenues, the consolidated operating margin increased 1.6 percentage points to 25.5% in the second quarter of 2005, from 23.9% in the comparable period in 2004, and increased 0.6 percentage points to 25.3% in the first two quarters of 2005, from 24.7% 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 as a result of lower cheese costs, which benefited 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 second quarter and first two quarters of 2004 would have each been approximately 24.9% of total revenues, versus the reported 23.9% and 24.7%, respectively. This would have resulted in operating margin improvements of 0.6 and 0.4 percentage points in the second quarter and first two quarters of 2005, respectively, versus the reported improvements of 1.6 and 0.6 percentage points.
The domestic Company-owned store operating margin increased $3.5 million, or 23.1%, to $18.6 million in the second quarter of 2005, from $15.1 million in the comparable period in 2004, and increased $5.7 million, or 17.3%, to $38.7 million in the first two quarters of 2005, from $33.0 million in the comparable period in 2004. These results are summarized in the following table.
Store operating margin
The increases in the domestic Company-owned store operating margin during the second quarter and first two quarters of 2005 were due primarily to increases in same store sales and reductions in cheese prices.
As a percentage of store revenues, the store operating margin increased 2.3 percentage points, to 20.3%, in the second quarter of 2005, from 18.0% in the comparable period in 2004, and increased 1.2 percentage points, to 20.4% in the first two quarters of 2005, from 19.2% in the comparable period in 2004.
As a percentage of store revenues, food costs decreased 1.3 percentage points to 28.3% in the second quarter of 2005, from 29.6% in the comparable period in 2004, and increased 0.8 percentage points to 28.7% in the first two quarters of 2005, from 27.9% in the comparable period in 2004. The decrease in food costs as a percentage of store revenues during the second quarter was due primarily to a reduction in cheese prices. The increase in food costs as a percentage of store revenues during the first two 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 increased 0.3 percentage points to 29.6% in the second quarter of 2005, from 29.3% in the comparable period in 2004, and decreased 0.6 percentage points to 29.4% in the first two quarters of 2005, from 30.0% in the comparable period in 2004.
As a percentage of store revenues, occupancy costs, which include rent, telephone, utilities and depreciation, decreased 0.5 percentage points to 10.8% in the second quarter of 2005, from 11.3% in the comparable period in 2004, and decreased 0.7 percentage points to 10.5% in the first two quarters of 2005, from 11.2% in the comparable period in 2004. These decreases in occupancy costs as a percentage of revenues were driven primarily by higher same store sales.
The domestic distribution operating margin increased $1.6 million, or 9.5%, to $18.0 million in the second quarter of 2005, from $16.4 million in the comparable period in 2004, and increased $4.6 million, or 14.0%, to $37.7 million in the first two quarters of 2005, from $33.1 million in the comparable period in 2004. These results are summarized in the following table.
Distribution operating margin
18
The increases in the domestic distribution operating margin during the second quarter and first two quarters of 2005 were due primarily to higher volumes as a result of increases in domestic retail sales, offset in part by higher labor, delivery and occupancy costs.
As a percentage of distribution revenues, the distribution operating margin increased 0.5 percentage points, to 9.6%, in the second quarter of 2005, from 9.1% in the comparable period in 2004, and increased 0.3 percentage points, to 9.7% in the first two 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 second quarter and first two quarters of 2004 would have been approximately 9.8% and 9.6% of distribution revenues, respectively, versus the reported 9.1% and 9.4%. This would have resulted in an operating margin decrease of 0.2 percentage points during the second quarter of 2005, versus the reported increase of 0.5 percentage points, and an operating margin improvement of 0.1 percentage points in the first two quarters of 2005, versus the reported improvements of 0.3 percentage points.
General and Administrative Expenses
General and administrative expenses increased $3.5 million, or 9.2%, to $41.8 million in the second quarter of 2005, from $38.3 million in the comparable period in 2004, and increased $8.4 million, or 11.1%, to $84.3 million in the first two quarters of 2005, from $75.9 million in the comparable period in 2004. These increases in general and administrative expenses were due primarily to 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 increased 0.3 percentage points to 12.1% in the second quarter of 2005, from 11.8% in the comparable period in 2004, and remained flat at 11.8% in the first two quarters of 2005 compared to the comparable period in 2004.
Interest Expense
Interest expense decreased $3.3 million, or 24.0%, to $10.6 million in the second quarter of 2005, from $13.9 million in the comparable period in 2004, and decreased $6.7 million, or 24.1%, to $21.2 million in the first two quarters of 2005, from $27.9 million in the comparable period in 2004. These decreases in interest expense were due primarily to lower average debt balances and a reduction in our average borrowing rates. Our average outstanding debt balance, excluding capital lease obligations, decreased $159.4 million to $771.4 million in the second quarter of 2005, from $930.8 million in the comparable period in 2004, and decreased $171.5 million to $762.2 million in the first two quarters of 2005, from $933.7 million in the comparable period in 2004. Our effective borrowing rate decreased 0.5 percentage points to 5.3% during both the second quarter and first two quarters in 2005, respectively, from 5.8% in the prior year periods. These reductions in average borrowing rates were due to senior credit facility margin pricing reductions and prepayments of senior subordinated notes in 2004, offset in part by higher market interest rates.
Provision for Income Taxes
Provision for income taxes increased $3.1 million to $12.7 million in the second quarter of 2005, from $9.6 million in the comparable period in 2004, and increased $7.0 million to $27.8 million in the first two quarters of 2005, from $20.8 million in the comparable period in 2004. The effective tax rate for the second quarter decreased 2.6 percentage points to 35.2% in the second quarter of 2005, from 37.8% in the comparable period in 2004, and decreased 1.3 percentage points to 36.5% in the first two quarters of 2005, from 37.8% in the comparable period in 2004. These decreases in the effective tax rate were due primarily to the reversal of valuation allowances related to net operating loss deferred tax assets from certain of our foreign operations.
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Liquidity and Capital Resources
We had negative working capital of $21.2 million and cash and cash equivalents of $10.5 million at June 19, 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 June 19, 2005.
As of June 19, 2005, we had $770.7 million of debt, of which $16.5 million was classified as a current liability, including $15.0 million of borrowings under our $125.0 million revolving credit facility. Letters of credit issued under the revolving credit facility were $27.3 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 reducing volatility relating to our borrowing costs. As of June 19, 2005, we were party to interest rate derivatives in the total notional amount of $475.0 million. Subsequent to the second quarter, a $300.0 million interest rate swap expired and a $350.0 million interest rate swap took effect. Approximately 72% of outstanding borrowings were contractually fixed as of June 19, 2005.
Cash provided by operating activities was $71.6 million and $52.9 million in the first two quarters of 2005 and 2004, respectively. The $18.7 million increase was due primarily to a $14.1 million increase in net income and a $5.7 million net change in operating assets and liabilities.
Cash used in investing activities was $12.7 million and $17.3 million in the first two quarters of 2005 and 2004, respectively. The $4.6 million decrease was due primarily to a $2.4 million decrease in capital expenditures and a $1.9 million increase in proceeds from the sale of property, plant and equipment resulting from the sale of nine Company-owned stores in the first quarter of 2005.
Cash used in financing activities was $88.6 million and $27.3 million in the first two quarters of 2005 and 2004, respectively. The $61.3 million increase was due primarily to a $75.0 million purchase of common stock, a $23.7 million increase in repayments of long-term debt and a $6.9 million dividend payment, offset in part by $40.0 million of proceeds resulting from short-term borrowings to partially fund the aforementioned share repurchase.
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.
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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.
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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 two 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 8.25% interest rate on our debt under 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
Term
Company
Pays
Counterparty
Interest Rate Swap
LIBOR plus
319 basis points
324 basis points
In 2004, we entered into an additional interest rate swap agreement effectively converting the variable LIBOR component of the effective interest rate on a portion of our debt under our senior secured credit facility term debt to a fixed rate. The agreement has a notional starting amount of $350.0 million, began June 30, 2005, ends in June 2007 and fixes the variable LIBOR component at 3.21%. We pay a fixed interest rate under this agreement while the counterparty pays a floating rate. Additionally, the $300.0 million interest rate swap included in the table above expired on June 30, 2005.
Interest Rate Risk
Our variable interest expense is sensitive to changes in the general level of interest rates. At June 19, 2005, the weighted average interest rate on our $213.0 million of variable interest debt was 5.9%.
We had total interest expense of approximately $21.2 million in the first two 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 $2.0 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 June 19, 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.
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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 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
Period
Period #1 (March 28, 2005 to April 24, 2005)
Period #2 (April 25, 2005 to May 22, 2005)
Period #3 (May 23, 2005 to June 19, 2005)
Item 3. Defaults Upon Senior Securities
None.
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Item 4. Submission of Matters to a Vote of Security Holders
(a) We held our 2005 Annual Meeting of Shareholders on May 5, 2005.
(b) The following matters were voted upon at the 2005 Annual Meeting of Shareholders:
Votes For
Votes Withheld
Andrew B. Balson
Vernon “Bud” O. Hamilton
Votes Against
Votes Abstaining
55,295,930
The proposal passed with 99.9% of the voted shares being voted “FOR” the proposal.
Item 5. Other Information
Item 6. Exhibits
Description
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SIGNATURES
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
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