Domino’s Pizza, Inc. 2017 Second-Quarter Form 10-Q Summary
Business Context and Reporting Period
Domino’s Pizza, Inc. operates a global pizza restaurant system with more than 14,200 locations in over 85 markets. Its primary revenue sources are royalties and fees from franchisees, sales from company-owned stores, and sales of food, equipment and supplies through its supply chain operations. This unaudited Form 10-Q covers the 12-week fiscal quarter and 24-week year-to-date period ended June 18, 2017, compared with the periods ended June 19, 2016.
Financial Performance and Key Metrics
| Metric | Q2 2017 | Q2 2016 | YTD 2017 | YTD 2016 |
|---|---|---|---|---|
| Total revenues | $628.6 million | $547.3 million | $1,252.8 million | $1,086.5 million |
| Income from operations | $112.9 million | $103.7 million | $228.9 million | $202.4 million |
| Net income | $65.7 million | $49.3 million | $128.2 million | $94.7 million |
| Diluted EPS | $1.32 | $0.98 | $2.58 | $1.86 |
| Operating margin | 18.0% | 19.0% | 18.3% | 18.6% |
| Net margin | 10.5% | 9.0% | 10.2% | 8.7% |
| Operating cash flow | Not separately provided | Not separately provided | $115.1 million | $69.5 million |
- Global retail sales increased 11.8% in Q2 and 12.5% year to date.
- Domestic same-store sales increased 9.5% in Q2 and 9.8% year to date; international same-store sales, excluding foreign currency effects, increased 2.6% and 3.4%, respectively.
- The company opened 217 net new stores in Q2, including 178 internationally and 39 domestically. Total stores increased to 14,217 from 12,936 a year earlier.
- Q2 revenues increased 14.8% and year-to-date revenues increased 15.3%. Q2 net income increased 33.5%, while year-to-date net income increased 35.4%.
- Q2 cost of sales rose to 69.3% of revenue from 68.6%; the consolidated operating margin declined 0.7 percentage points to 30.7% before general and administrative expenses.
- General and administrative expense increased 17.4% in Q2 and 15.5% year to date, primarily due to technology, e-commerce, information technology, strategic investments and performance-related costs.
- The effective tax rate declined to 25.7% in Q2 from 37.4% and to 28.4% year to date from 37.5%, primarily due to the adoption of ASU 2016-09. The adoption reduced income tax expense by $10.4 million in Q2 and $16.9 million year to date.
Liquidity, Debt and Cash Flow
- At June 18, 2017, unrestricted cash and cash equivalents were $52.2 million and restricted cash was $161.7 million. Working capital was $47.7 million, excluding restricted cash.
- Total debt was approximately $2.18 billion, including $2.18 billion of long-term debt and $0.3 million classified as current debt. The weighted-average borrowing rate was 4.6%.
- Year-to-date operating cash flow was $115.1 million, compared with $69.5 million in 2016. Capital expenditures were $25.2 million, compared with $25.0 million.
- Cash used in financing activities was $45.8 million, including $22.3 million of dividends, $12.7 million of share repurchases, $9.8 million of debt repayments and $4.9 million of taxes on vested restricted stock.
- The company had $79.3 million of available capacity under its $125.0 million variable funding note facility after $45.7 million of outstanding letters of credit. No borrowings were outstanding under the facility at June 18, 2017.
- The company declared a quarterly dividend of $0.46 per share in Q2 and declared another $0.46 per share dividend on July 19, 2017. Approximately $22.6 million was accrued for dividends at June 18, 2017.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven by higher domestic and international same-store sales, additional stores and increased supply chain volumes.
- Income from operations grew more slowly than revenue because of higher general and administrative spending, insurance expense, labor and food costs, transaction-related expenses and foreign currency effects.
- Domestic company-owned store margin declined to 20.8% in Q2 from 24.6%, primarily because of higher insurance, labor, food and transaction-related costs.
- International franchise same-store sales growth slowed to 2.6% in Q2 from 7.1%, excluding foreign currency effects. Foreign exchange reduced international franchise revenue by approximately $1.6 million in Q2 and $3.1 million year to date.
- Cash flow improved substantially from the prior year, while investing cash flow changed from a $50.3 million source to a $59.9 million use, mainly because restricted cash increased by $35.2 million in 2017.
- Share repurchases were substantially lower: $12.7 million year to date in 2017 versus $224.1 million in the comparable 2016 period. Approximately $136.4 million remained authorized for future repurchases.
Outlook, Commentary, Risks and Unusual Items
- Management expects cash from operations, unrestricted cash and available borrowing capacity to fund working capital, capital expenditures, debt service, dividends and share repurchases for at least the next twelve months, subject to business and financial conditions.
- On July 24, 2017, after quarter-end, subsidiaries issued $1.9 billion of new asset-backed notes: $300 million floating-rate notes, $600 million of five-year fixed-rate notes and $1.0 billion of ten-year fixed-rate notes. The floating-rate notes bear interest at LIBOR plus 125 basis points.
- Proceeds from the recapitalization were intended to repay approximately $910.5 million of remaining 2012 Notes, fund transaction costs and pre-fund debt service, with remaining proceeds available for general corporate purposes. A new $175 million variable funding facility was undrawn at closing.
- The company continues to appeal an approximately $8.9 million final judgment related to a delivery-vehicle accident lawsuit and denies liability. Management stated that existing legal matters are not expected to materially affect financial position, results or cash flows, although litigation remains a contingency.
- Key risks include substantial leverage and refinancing needs, franchisee performance, consumer demand, food and labor cost inflation, insurance costs, commodity prices, foreign currency movements, technology and competitive developments, severe weather, regulatory changes, litigation and the availability of variable funding and letters of credit.
- The company expects the future adoption of lease accounting guidance to materially increase reported assets and liabilities. The company was evaluating the impact of the revenue recognition standard, with adoption expected January 1, 2018.
- Management reported that disclosure controls and procedures were effective and that there were no material changes to internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Reconcile reported net income and EPS growth with the $10.4 million Q2 and $16.9 million year-to-date tax benefit from equity-based compensation accounting.
- Review the post-quarter-end recapitalization, including interest rates, scheduled principal payments, refinancing requirements and the use of proceeds.
- Assess whether domestic same-store sales and store expansion can offset slower international same-store sales and foreign currency pressure.
- Monitor domestic company-owned store margins, particularly insurance, labor, food and transaction-related costs.
- Evaluate liquidity using unrestricted cash rather than total cash, because $161.7 million of cash was restricted and $45.7 million of letters of credit were outstanding.
- Review the status and potential exposure of the delivery-accident appeal and other litigation.
- Confirm the effects of forthcoming lease and revenue recognition accounting changes on reported assets, liabilities and revenue presentation.