Business Context and Reporting Period
Domino’s Pizza, Inc. filed this Form 10-K for the 52-week fiscal year ended December 30, 2012. The company operates through domestic stores, domestic supply chain, and international segments. Its network included 10,255 stores, comprising 388 company-owned stores and 9,867 franchise stores in all 50 states and more than 70 international markets.
Domino’s reported that it was the leading U.S. pizza delivery company, with a 22.5% U.S. pizza-delivery market share based on reported consumer spending. Its franchise-oriented model generates royalties, supply-chain sales, and company-owned store revenue.
Key Financial Metrics
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Revenue | $1,678.4 million | $1,652.2 million | +1.6% |
| Income from operations | $282.3 million | $259.1 million | +8.9% |
| Operating margin | 16.8% | 15.7% | +1.1 percentage points |
| Net income | $112.4 million | $105.4 million | +6.7% |
| Diluted EPS | $1.91 | $1.71 | +11.7% |
| Cash flow from operations | $176.3 million | $153.1 million | +$23.2 million |
| Capital expenditures | $29.3 million | $24.3 million | +$4.9 million |
| Cash and cash equivalents | $54.8 million | $50.3 million | +$4.5 million |
| Restricted cash | $60.0 million | $92.6 million | -$32.6 million |
| Total debt | $1,560.8 million | $1,451.3 million | +$109.5 million |
Revenue by segment was $518.7 million for domestic stores, $942.2 million for domestic supply chain, and $217.6 million for international. Segment income from operations was $169.9 million, $73.8 million, and $105.3 million, respectively, before $66.7 million of unallocated corporate and other expenses.
Consolidated operating margin increased to 29.9% from 28.5%, principally because of a higher mix of franchise revenue, improved company-owned store margins, and lower commodity costs. Domestic company-owned store margin increased to 23.6% from 20.6%; domestic supply chain margin increased modestly to 10.5% from 10.4%.
Domestic same-store sales increased 3.1%, including 1.3% for company-owned stores and 3.2% for franchise stores. International same-store sales increased 5.2% on a constant-dollar basis. Global retail sales increased 6.5%.
Material Changes Versus the Prior Comparable Period
- Revenue growth was modest because higher franchise, supply-chain, and international revenue was partly offset by lower company-owned store revenue following the sale of company-owned stores.
- Operating income and margins improved despite higher general and administrative expenses, which increased 3.6% to $219.0 million.
- Interest expense increased $9.8 million to $101.4 million, primarily because of costs associated with the 2012 recapitalization.
- International stores increased by 492 net locations to 5,327, surpassing the domestic store count. Total stores increased from 9,742 to 10,255.
- Domestic company-owned stores declined from 394 to 388, while domestic franchise stores increased from 4,513 to 4,540.
- The company completed a recapitalization that issued $1.575 billion of 5.216% fixed-rate notes, replaced the prior debt facilities, and established a $100.0 million variable funding facility.
- The recapitalization included a $3.00-per-share special dividend totaling $171.1 million, related anti-dilution payments, and approximately $10.5 million of net pretax recapitalization-related expenses.
- The company repurchased $88.2 million of common stock during 2012 and had approximately $152.4 million remaining under its $200.0 million authorization at year-end.
Liquidity, Debt, Outlook, and Risks
Management stated that operating cash flow, unrestricted cash, and available borrowings were expected to be sufficient for foreseeable operating, capital, working-capital, and debt-service needs. The company had $56.5 million of borrowing capacity under the variable funding notes after $43.5 million of letters of credit.
The fixed-rate notes had an expected repayment date of January 2019 and scheduled principal payments of $23.6 million in each of 2013 and 2014, followed by larger scheduled payments through 2019. The debt is subject to financial and non-financial covenants, including debt-service coverage and global-retail-sales requirements. Failure to satisfy covenants could accelerate repayment and restrict cash flows.
Management expected annual capital expenditures of approximately $25 million to $35 million, primarily for company-owned stores, supply-chain facilities, point-of-sale systems, digital ordering, and other technology. The company planned continued domestic and international store growth, brand investment, menu innovation, digital ordering expansion, and share repurchases subject to debt-agreement restrictions.
Beginning in 2013, domestic franchisees increased their national advertising contribution from 5.5% to 6.0% of retail sales. The company also initiated a quarterly dividend of $0.20 per share payable in March 2013 and estimated approximately $5 million of additional 2013 general and administrative expense from equity grants and longer vesting periods.
- Principal risks include substantial leverage, refinancing and covenant risk, dependence on franchisees, intense competition, commodity and labor-cost inflation, supply-chain disruption, foreign-currency volatility, international economic conditions, food safety, litigation, regulatory changes, cybersecurity, and loss of key personnel.
- A hypothetical 10% adverse foreign-currency movement in the top ten international markets would have reduced 2012 revenue by approximately $8.7 million.
- A $0.25 adverse change in the average cheese block price per pound was estimated to increase company-owned store food costs by approximately $2.0 million.
- Legal and insurance accruals were recorded for ordinary-course claims; management stated that ultimate losses could exceed recorded legal accruals by $5.0 million, although it did not expect a material adverse effect.
Investor Verification Checklist
- Verify the reconciliation of reported revenue growth with store transfers, commodity-price effects, and foreign-currency impacts.
- Review the 2012 recapitalization documents, fixed-rate note covenants, scheduled amortization, and January 2019 expected repayment requirement.
- Assess cash flow after capital expenditures, dividends, share repurchases, and required debt service rather than relying solely on operating cash flow.
- Monitor international same-store sales, net store openings, currency movements, and concentration among major master franchisees.
- Evaluate exposure to cheese, meat, labor, fuel, healthcare, and other operating-cost increases.
- Review legal, insurance, tax, franchise, food-safety, privacy, and cybersecurity contingencies, including the disclosed potential excess legal losses.
- Confirm the impact of the 2013 advertising contribution increase, new quarterly dividend, equity grants, and expected additional compensation expense.