DOMINOS PIZZA INC annual report, FY2015

Business Context and Reporting Period

Domino’s Pizza, Inc. filed this Form 10-K for the fiscal year ended January 3, 2016. Fiscal 2015 included 53 weeks, including a 17-week fourth quarter, compared with 52 weeks and a 16-week fourth quarter in fiscal 2014. Domino’s operates through three segments: Domestic Stores, Supply Chain, and International Franchise.

The company had 12,530 stores at year-end, including 5,200 domestic stores and 7,330 international stores. It opened 901 net new stores during 2015, with 768 net openings internationally. Approximately 50% of U.S. sales came through digital channels.

Financial and Operating Metrics

Metric	Fiscal 2015	Fiscal 2014	Change
Revenue	$2,216.5 million	$1,993.8 million	+11.2%
Operating income	$405.4 million	$345.4 million	+17.4%
Operating margin	18.3%	17.3%	+1.0 percentage point
Net income	$192.8 million	$162.6 million	+18.6%
Diluted EPS	$3.47	$2.86	+21.3%
Cash flow from operations	$291.8 million	$192.3 million	+51.7%
Capital expenditures	$63.3 million	$70.1 million	Down

• Domestic same-store sales increased 12.0%, comprising 12.2% for Company-owned stores and 11.9% for franchised stores.
• International same-store sales increased 7.8% excluding foreign currency effects, but declined 4.4% after currency translation.
• Segment revenue was $669.7 million for Domestic Stores, $1.383 billion for Supply Chain, and $163.6 million for International Franchise.
• Consolidated operating margin increased to 30.8% from 29.8%, primarily because of higher franchise revenue, supply-chain margins, favorable commodity costs, and the additional fiscal week.
• Year-end unrestricted cash was $133.4 million, restricted cash was $180.9 million, and working capital was $45.7 million.
• Total debt, net of issuance costs, was $2.241 billion, compared with $1.501 billion at the end of fiscal 2014. Stockholders’ deficit increased to $1.800 billion.
• The company had $78.8 million of available borrowing capacity under its $125 million variable funding facility and $46.2 million of outstanding letters of credit.

Material Changes Versus the Prior Comparable Period

• Revenue growth was driven by higher store-level sales, store growth, increased supply-chain volumes, equipment sales related to the store reimaging program, and the 53rd week. The additional week contributed an estimated $49.7 million of revenue.
• Lower cheese prices reduced domestic Supply Chain revenue by approximately $45.3 million but improved Company-owned store food costs. Average cheese block prices declined to $1.62 per pound from $2.13.
• Company-owned store operating margin increased to 24.6% from 23.3%. Food and occupancy costs declined as percentages of revenue, while labor and insurance costs increased.
• General and administrative expense increased 11.3% to $277.7 million, reflecting technology, e-commerce, international operations, performance compensation, and the additional fiscal week.
• Interest expense increased to $99.5 million from $86.9 million, including approximately $7.3 million of fourth-quarter costs related to the 2015 Recapitalization.
• The company completed a $1.3 billion debt issuance in October 2015, repaid approximately $551 million of prior notes, and established new fixed-rate notes at 3.484% and 4.474%.
• Domino’s repurchased $738.6 million of common stock in 2015, including a $600 million accelerated share repurchase, and ended the year with approximately $200 million remaining under its $800 million authorization.
• Dividends declared increased to $1.24 per share from $1.00 per share. The board subsequently declared a quarterly dividend of $0.38 per share payable in March 2016.

Guidance, Outlook, Commentary, Risks and Unusual Items

Management stated that operating cash flow, unrestricted cash, restricted cash available as collateral, and variable-funding capacity were expected to be adequate for anticipated debt service, capital expenditures, dividends, repurchases, and working-capital needs for the foreseeable future. The company did not provide specific quantitative revenue or earnings guidance in the filing.

• Management intends to continue international store expansion, digital ordering and marketing investments, technology development, store reimaging, dividends, and share repurchases.
• The company expects substantially all stores to adopt the Pizza Theater design by the end of 2017.
• Debt service and refinancing are significant risks. Scheduled principal payments include $878.5 million in 2019, $488.0 million in 2020, and $728.0 million in 2025. Failure to meet leverage or debt-service covenants could accelerate repayment and restrict cash flows.
• International results are exposed to currency movements; management estimated that a hypothetical 10% adverse currency change would have reduced 2015 international royalty revenue by approximately $15.6 million.
• Key operating risks include competition, consumer preferences, food and labor inflation, minimum-wage increases, cheese and other commodity prices, supply interruptions, reliance on certain suppliers, franchisee performance, food safety, data security, litigation, insurance costs, and regulatory changes.
• Unusual 2015 items included approximately $8.1 million of net Recapitalization-related expenses, a $4.3 million incremental insurance expense from updated actuarial estimates, and a $0.7 million gain on the sale of four Company-owned stores.
• Two employment-practice cases and two casualty cases were outstanding in the ordinary course. Recorded accruals were considered adequate, but ultimate losses could exceed recorded amounts by approximately $2.0 million. A previously reported $32 million Texas jury judgment was reversed on appeal; a further review petition remained pending.
• The company early adopted accounting changes affecting the presentation of debt issuance costs and deferred taxes. The debt-cost change primarily reclassified amounts on the balance sheet and did not materially affect earnings or cash flow.

Important Facts for Investors to Verify

• Reconcile reported growth with the effect of the 53rd week and assess comparable growth excluding that benefit.
• Review the debt maturity schedule, leverage calculations, covenant thresholds, required catch-up payments, and refinancing exposure in 2019–2020.
• Assess whether cash generation can sustainably support dividends and substantial share repurchases while reducing or refinancing debt.
• Evaluate the effect of foreign currency changes on international royalties and the company’s continued international expansion.
• Monitor cheese, labor, fuel, insurance, and other commodity costs, including the company’s ability to pass increases through to stores or customers.
• Review the final settlement of the $600 million accelerated share repurchase agreement, expected by the end of the first quarter of 2016.
• Confirm the status and potential exposure of pending litigation, employment claims, casualty matters, and insurance reserves.