Business Context and Reporting Period
Domino’s Pizza, Inc. reported its unaudited first fiscal quarter ended March 25, 2012, a 12-week period, compared with the quarter ended March 27, 2011. The company operates a primarily franchised global pizza network, domestic company-owned stores, and domestic and international supply-chain operations.
- Global retail sales increased 6.1%.
- Same-store sales increased 2.0% domestically and 4.7% internationally on a constant-dollar basis.
- System stores increased to 9,810 from 9,379, with international stores exceeding domestic stores for the first time.
Financial Performance and Key Metrics
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Total revenue | $384.6 million | $389.2 million | Down 1.2% |
| Operating margin | $114.6 million; 29.8% | $111.6 million; 28.7% | Up $3.0 million; margin up 1.1 points |
| Income from operations | $66.9 million; 17.4% of revenue | $65.1 million; 16.7% | Up 2.7% |
| Income before taxes | $34.8 million | $43.7 million | Down 20.4% |
| Net income | $20.7 million | $27.1 million | Down 23.5% |
| Diluted EPS | $0.35 | $0.43 | Down $0.08 |
| Cash flow from operations | $20.2 million | $27.8 million | Down $7.6 million |
| Capital expenditures | $3.6 million | $3.9 million | Down $0.2 million |
Domestic company-owned store revenue declined 6.2% to $77.6 million because 58 stores were sold to franchisees during 2011, partly offset by 1.6% same-store sales growth. Domestic franchise revenue rose 2.6% to $45.2 million. Domestic supply-chain revenue declined 1.1% to $214.1 million, while international revenue increased 3.9% to $47.6 million.
Consolidated cost of sales declined to 70.2% of revenue from 71.3%, benefiting from revenue mix, lower cheese prices, and improved company-owned store margins. The domestic company-owned store margin increased to 23.6% from 20.7%, while the domestic supply-chain margin decreased to 10.6% from 11.2%.
Liquidity, Debt, and Capital Structure
- Cash and cash equivalents were $214.7 million at March 25, 2012, compared with $50.3 million at January 1, 2012.
- Restricted cash and cash equivalents totaled $47.3 million, including reserves for debt service, interest, and letters of credit.
- Working capital was $11.5 million, excluding restricted cash.
- Total debt was approximately $1.58 billion, including $24.5 million classified as current.
- The company completed a recapitalization involving $1.575 billion of 5.216% fixed-rate senior secured notes and $100 million of variable funding notes. The variable facility was undrawn at closing, with approximately $60.3 million available at quarter-end after letters of credit.
- Operating, investing, and financing activities generated net cash of $20.2 million, $42.5 million, and $102.6 million, respectively. Financing cash flow reflected $1.575 billion of new debt issuance, $1.447 billion of debt repayments, and $31.2 million of financing costs.
Management stated that unrestricted cash, expected operating cash flow, and available variable-funding capacity should be sufficient for foreseeable operating, capital expenditure, working-capital, and debt-service needs. No material capital expenditure commitments were reported.
Material Changes Versus the Prior Comparable Period
- Operating income improved despite lower revenue, reflecting higher franchise royalties, better company-owned store margins, and favorable revenue mix.
- Net income declined primarily because interest expense increased by $10.8 million to $32.3 million.
- The quarter included approximately $10.5 million of recapitalization-related pretax expenses, including debt-fee and discount write-offs, overlapping interest on old and new facilities, and other transaction costs.
- The effective tax rate increased to 40.4% from 38.0%, partly because of a $0.9 million valuation allowance on a deferred tax asset.
- Cash flow from operations decreased due primarily to timing-related changes in operating assets and liabilities.
- No open-market share repurchases were made during the quarter, compared with approximately $5.8 million of repurchases in Q1 2011. Approximately $82.3 million remained under the authorized repurchase program.
Outlook, Commentary, Risks, and Unusual Items
Management emphasized continued positive domestic same-store sales, international store growth, effective promotions, operational execution, advertising, and technology initiatives, including the Android mobile application. No specific quantitative earnings or sales guidance was provided.
On March 16, 2012, the board declared a $3.00 per share special cash dividend totaling $171.1 million. It was paid on April 2, 2012, after the quarter-end, together with related option anti-dilution payments. The company recorded $187.0 million of related current liabilities at quarter-end and expects approximately $2.4 million of future payments as certain restricted stock vests.
The new debt is secured by substantially all revenue-generating assets and is subject to leverage, debt-service, global retail sales, and other covenants. The company was in compliance with all covenants at March 25, 2012. Failure to meet certain covenants could accelerate repayment obligations.
Key risks include refinancing and servicing substantial debt, availability of variable-funding borrowings, commodity prices, labor and operating costs, consumer spending, franchisee profitability and expansion, foreign currency, litigation, taxes, insurance, severe weather, regulation, and competition. Accrued litigation matters could ultimately exceed recorded amounts by up to $4.0 million, although management does not expect a significant adverse financial effect.
Management reported effective disclosure controls and no material changes in internal control over financial reporting. The filing states that no material changes occurred in previously disclosed risk factors.
Important Facts for Investors to Verify
- Reconcile the recurring earnings impact of the recapitalization with the approximately $10.5 million of Q1 transaction-related pretax expenses.
- Evaluate debt-service capacity, the 4.5x leverage condition, scheduled principal payments, and the terms governing potential acceleration of the secured notes.
- Assess the effect of the $171.1 million special dividend and related option payments on future liquidity and leverage.
- Monitor whether domestic and international same-store sales and international store growth offset declining company-owned store counts and supply-chain volume.
- Track commodity costs, particularly cheese, meats, fuel, labor, and other operating expenses, which materially affect margins.
- Review the $0.9 million deferred-tax-asset valuation allowance and future effective tax-rate developments.
- Consider the reported potential exposure of up to $4.0 million above accrued litigation losses and the company’s ability to refinance or extend future debt maturities.