Domino’s Pizza, Inc. — FY2018 Form 10-K Summary
Business context and reporting period
Domino’s operates a global pizza delivery and carryout system through three reportable segments: U.S. Stores, Supply Chain, and International Franchise. The company had 15,914 stores in more than 85 markets at December 30, 2018, including 5,876 U.S. stores and 10,038 international stores. Fiscal 2018 ended December 30, 2018, comprised 52 weeks; the fourth quarter comprised 16 weeks and ended December 30, 2018.
Revenue is generated from company-owned stores, franchise royalties and fees, U.S. franchise advertising contributions, and sales of food, equipment, and supplies to franchisees. More than half of global retail sales came through digital channels during 2018.
Key financial metrics
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Total revenues | $3,432.9 million | $2,788.0 million | +23.1% |
| Income from operations | $571.7 million | $521.2 million | +9.7% |
| Operating margin | 16.7% | 18.7% | Down 2.0 percentage points |
| Net income | $362.0 million | $277.9 million | +30.3% |
| Diluted EPS | $8.35 | $5.83 | +43.2% |
| Net cash from operating activities | $394.2 million | $341.3 million | +$52.9 million |
| Capital expenditures | $119.9 million | $90.0 million | Higher investment |
| Total debt, net of issuance costs | $3,531.6 million | $3,153.8 million | Higher by $377.8 million |
Reported net margin was approximately 10.5%, compared with 10.0% in 2017. The effective tax rate declined to 15.6% from 30.6%, primarily because of the lower U.S. federal tax rate under the 2017 Tax Cuts and Jobs Act and tax benefits from equity compensation.
- U.S. Stores revenue was $1.265 billion, including $514.8 million from company-owned stores, $391.5 million from U.S. franchise royalties and fees, and $358.5 million of U.S. franchise advertising revenue.
- Supply Chain revenue was $1.943 billion, representing nearly 57% of consolidated revenue. Supply chain operating margin was 10.9%, down from 11.2%.
- International franchise revenue was $224.7 million, or approximately 6.5% of consolidated revenue. International same-store sales increased 3.5% on a constant-dollar basis.
- U.S. same-store sales increased 6.6%, comprising 4.8% growth at company-owned stores and 6.8% at franchised stores.
- Global retail sales increased 10.6%, and the company opened 1,058 net new stores.
- Year-end unrestricted cash was $25.4 million. Restricted cash and cash equivalents totaled $167.0 million, including amounts reserved for debt service and interest requirements. Working capital was $14.6 million, excluding restricted and advertising-fund balances.
- Dividends paid totaled $92.2 million, or $2.20 per share. The company repurchased $591.2 million of common stock and had $158.8 million remaining under its $750.0 million authorization at year-end.
Fourth-quarter results
| Metric | Q4 FY2018 | Q4 FY2017 |
|---|---|---|
| Total revenues | $1,082.1 million | $891.5 million |
| Income before taxes | $134.6 million | $136.6 million |
| Net income | $111.6 million | $93.3 million |
| Diluted EPS | $2.62 | $2.09 |
Fourth-quarter revenue benefited materially from the adoption of ASC 606, which required gross presentation of U.S. franchise advertising contributions and related expenses. The filing does not provide a separate Q4 same-store sales figure in the supplied text.
Material changes versus the prior comparable period
- ASC 606 was adopted using the modified retrospective method. The change added $358.5 million of U.S. franchise advertising revenue and an equal advertising expense in 2018; management stated that the effect on operating income and net income was not expected to be material.
- Reported operating margin increased before considering the gross advertising presentation, but consolidated operating margin as a percentage of reported revenue declined to 16.7% because the newly reported advertising revenue carries no cost of sales and is offset by a corresponding expense below operating margin.
- The 2018 Recapitalization issued $825.0 million of fixed-rate notes, repaid approximately $490.1 million of 2015 notes, funded debt-service reserves and transaction costs, and supported share repurchases. Total debt increased despite the refinancing activity.
- Interest expense increased to $146.3 million from $122.5 million because of higher average borrowings and recapitalization-related costs, partially offset by a lower weighted-average borrowing rate of 4.0% versus 4.2%.
- U.S. company-owned store margin declined to 22.7% from 23.1%, primarily because of higher food and labor costs. Food costs were 27.4% of store revenue and labor costs were 30.1%.
- The company sold 14 company-owned stores during 2018 and recorded a total pretax gain of approximately $5.9 million, net of goodwill reductions.
- New management leadership took effect during 2018: Richard E. Allison, Jr. became chief executive officer and Russell J. Weiner became chief operating officer and president of the Americas.
Guidance, outlook, risks, contingencies, and unusual items
The filing does not provide formal quantitative revenue, earnings, or same-store-sales guidance. Management expects positive operating cash flow to continue, plans further U.S. and international store expansion, and intends to continue investing in digital ordering, technology, supply chain capacity, and the Domino’s brand. Management also expects the 6% U.S. franchise advertising contribution rate to remain in place for the foreseeable future and expects lower effective tax rates to continue in future periods.
- Leverage and refinancing: Debt service depends on sustained cash generation. Scheduled principal payments include approximately $953.0 million in 2022 and $1.14 billion in 2025 under the contractual-obligation presentation. Debt agreements contain leverage and debt-service coverage covenants, and refinancing may be required around anticipated repayment dates.
- Interest-rate exposure: Variable-rate borrowings are tied to LIBOR. A hypothetical 1% adverse LIBOR change would have increased 2018 interest expense by approximately $3.0 million. The filing notes uncertainty regarding LIBOR’s continuation after 2021.
- Commodity and labor costs: Cheese, food, fuel, labor, minimum-wage changes, insurance, and occupancy costs may pressure margins. Cheese represented approximately 20% to 25% of the market basket purchased by company-owned stores.
- Supply concentration: U.S. pizza cheese was purchased from a single supplier under a seven-year pricing and supply agreement, and most U.S. meat toppings came from a single supplier under a contract expiring in June 2022.
- Franchise and competitive risks: Results depend substantially on franchisee profitability, royalty payments, store development, brand standards, and competition from pizza chains, restaurants, supermarkets, meal kits, delivery aggregators, and other food-delivery services.
- International and currency risks: Approximately 6.5% of 2018 revenue came from the international franchise segment. A hypothetical 10% adverse currency movement would have reduced international royalty revenue by approximately $20.0 million.
- Legal contingency: A prior $10.1 million jury judgment in a delivery-vehicle accident case was reversed and remanded for a new trial in May 2018. The company denies liability and states that existing legal matters are not expected to materially affect its financial position, results, or cash flows.
- Other commitments: Letters of credit totaled $48.1 million, franchise lease guarantees had a maximum potential payment of $2.4 million, and additional leases expected to commence in 2019 were not included in the disclosed lease-commitment table.
- Accounting change ahead: The company expected adoption of the new lease standard at the beginning of fiscal 2019 to add approximately $230 million of right-of-use assets and lease liabilities, with no material initial income-statement or cash-flow effect expected.
Most important facts for an investor to verify
- Separate the underlying operating growth from the $358.5 million ASC 606 gross-up in reported 2018 revenue and expenses.
- Review debt maturities, covenant calculations, variable-rate exposure, and the company’s ability to refinance anticipated 2022, 2025, and 2027 repayment obligations.
- Monitor U.S. same-store sales, international constant-currency sales, net store openings, franchisee health, and digital-ordering trends.
- Assess whether food, labor, insurance, and delivery costs continue to compress company-owned and supply-chain margins.
- Reconcile cash available for dividends and repurchases with unrestricted cash, restricted cash, debt-service reserves, capital expenditures, and variable-funding-note capacity.
- Evaluate the impact of the 2019 lease-accounting adoption on reported assets, liabilities, leverage, and operating metrics.
- Review the status and potential exposure of the Wiederhold litigation and other employment, franchise, insurance, tax, privacy, cybersecurity, and regulatory matters.