Business Context and Reporting Period
Domino’s Pizza, Inc. filed this unaudited Form 10-Q for the twelve-week fiscal quarter ended March 24, 2019, compared with the quarter ended March 25, 2018. Domino’s operates a global franchised pizza system, U.S. company-owned stores, and supply chain operations. At quarter-end, the system had 16,114 stores in more than 85 markets, including 5,903 U.S. stores and 10,211 international stores.
Financial Results and Key Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total revenue | $836.0 million | $785.4 million | +6.4% |
| Operating margin | $322.3 million; 38.6% | $299.9 million; 38.2% | +$22.4 million; +0.4 pts |
| Income from operations | $143.5 million; 17.2% | $133.5 million; 17.0% | +7.5% |
| Income before taxes | $109.1 million | $103.7 million | +5.3% |
| Net income | $92.7 million; 11.1% | $88.8 million; 11.3% | +4.3% |
| Diluted EPS | $2.20 | $2.00 | +10.0% |
| Operating cash flow | $97.0 million | $83.7 million | +$13.3 million |
| Capital expenditures | $12.2 million | $13.6 million | Lower |
- Revenue growth was led by supply chain revenue of $472.1 million, U.S. franchise royalties and fees of $96.7 million, and U.S. company-owned store revenue of $123.5 million.
- Global retail sales increased 4.6%. U.S. same-store sales increased 3.9%, consisting of 2.1% growth at company-owned stores and 4.1% at franchise stores. International same-store sales increased 1.8%, excluding foreign currency effects.
- The company opened 200 net new stores during the quarter: 173 internationally and 27 in the U.S.
- Supply chain operating margin improved to 11.4% from 10.8%, while U.S. company-owned store operating margin declined to 22.6% from 23.2%, primarily because of higher labor costs.
- General and administrative expense increased 6.5% to $89.7 million, reflecting continued investments in technology and other strategic initiatives.
- Net interest expense increased 15.3% to approximately $34.4 million, primarily because of higher average borrowings and borrowing rates following the 2018 recapitalization.
- The effective tax rate increased to 15.1% from 14.3%.
Liquidity, Debt and Capital Allocation
- Unrestricted cash and cash equivalents were $83.1 million at March 24, 2019. Restricted cash and cash equivalents were $150.1 million, including amounts supporting the asset-backed securitization structure and interest reserves.
- Working capital was $23.4 million, excluding restricted cash, advertising fund assets and related liabilities.
- Long-term debt totaled approximately $3.48 billion, including $35.9 million classified as current. The company also had $25.0 million outstanding under variable funding notes and $101.9 million available for borrowing, net of letters of credit.
- Cash used in financing activities was $55.1 million, including $49.0 million of debt repayments and $8.1 million of share repurchases.
- Domino’s repurchased and retired 33,549 shares for approximately $8.1 million during the quarter. Approximately $150.6 million remained available under the repurchase authorization.
- The board declared a quarterly dividend of $0.65 per share, compared with $0.55 per share for the comparable 2018 quarter. Approximately $27.2 million was accrued for dividends at quarter-end.
- Management stated that operating cash flow, unrestricted cash and available variable funding capacity were expected to be adequate for anticipated debt service, capital expenditures and working capital needs for at least the next twelve months, while cautioning that future cash flows and borrowing availability are not assured.
Material Changes, Outlook and Unusual Items
- Growth in operations was partly offset by decelerating same-store sales compared with the prior-year quarter, when U.S. and international same-store sales growth was materially higher.
- Foreign currency movements reduced international franchise revenue by approximately $3.7 million and international supply chain revenue by approximately $2.2 million. Management estimated that a hypothetical 10% adverse currency movement would reduce quarterly royalty revenue by approximately $4.8 million.
- The company adopted ASC 842 lease accounting using the modified retrospective method. This added approximately $222.0 million of operating lease right-of-use assets and $230.3 million of operating lease liabilities at March 24, 2019, with no material effect on reported income or cash flow.
- Additional future lease commitments not included in the recognized lease liability tables were approximately $43.0 million for operating leases and $28.7 million for a finance lease, expected to commence in 2019.
- Subsequent to quarter-end, Domino’s entered into agreements to sell 59 U.S. company-owned stores to existing franchisees.
- Subsequent to quarter-end, the board declared another $0.65 per share quarterly dividend, payable June 28, 2019.
- The company disclosed substantial leverage, refinancing and interest-rate exposure, including LIBOR transition risk, commodity cost volatility, foreign currency risk, labor cost pressures, competitive pressures, technology and cybersecurity risks, franchisee performance risk, adverse weather or health events, and potential legal or regulatory matters.
- A previously disclosed traffic-accident lawsuit was remanded for a new trial after an appellate court reversed the prior judgment. The company continues to deny liability and stated that existing legal matters were not expected to materially affect its financial position, results or cash flows.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting. No material changes were reported to the risk factors in the 2018 Form 10-K.
Facts Investors Should Verify
- Whether positive same-store sales and continued store growth can offset the recent slowdown in comparable sales trends.
- The company’s ability to service and refinance approximately $3.48 billion of debt, particularly large scheduled maturities in 2022, 2025 and 2027.
- Interest-rate exposure from floating-rate borrowings and the effect of the LIBOR transition on borrowing costs.
- Whether labor, food, fuel, insurance and other operating costs will pressure company-owned store margins.
- The financial and strategic effects of selling 59 company-owned stores to franchisees.
- The treatment and use restrictions associated with restricted cash and advertising fund assets.
- Potential exposure from the remanded personal-injury lawsuit and other ordinary-course legal proceedings.