DPZ 10-Q Quarter ended June 18, 2017

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 18, 2017

OR

For the transition period from to

Commission file number: 001-32242

Domino’s Pizza, Inc.

(Exact Name of Registrant as Specified in Its Charter)

(734) 930-3030

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of July 18, 2017, Domino’s Pizza, Inc. had 48,255,380 shares of common stock, par value $0.01 per share, outstanding.

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Domino’s Pizza, Inc.

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Domino’s Pizza, Inc. and Subsidiaries

(Unaudited)

Note: The balance sheet at January 1, 2017 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

See accompanying notes.

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Domino’s Pizza, Inc. and Subsidiaries

(Unaudited)

See accompanying notes.

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Domino’s Pizza, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

See accompanying notes.

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Domino’s Pizza, Inc. and Subsidiaries

(Unaudited)

See accompanying notes.

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Domino’s Pizza, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited; tabular amounts in thousands, except percentages, share and per share amounts)

June 18, 2017

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the consolidated financial statements and footnotes for the fiscal year ended January 1, 2017 included in the Company’s 2016 Annual Report on Form 10-K, filed with the Securities and Exchange Commission on February 28, 2017 (the “2016 Form 10-K”).

In the opinion of management, all adjustments, consisting of normal recurring items, considered necessary for a fair statement have been included. Operating results for the fiscal quarter ended June 18, 2017 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2017.

2. Segment Information

The following table summarizes revenues, income from operations and earnings before interest, taxes, depreciation, amortization and other, which is the measure by which the Company allocates resources to its segments and which we refer to as Segment Income, for each of our reportable segments.

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The following table reconciles Total Segment Income to consolidated income before provision for income taxes.

3. Earnings Per Share

The denominators used in calculating diluted earnings per share for common stock for the second quarter of 2017 and two fiscal quarters of 2017 do not include 69,010 options to purchase common stock, as the effect of including these options would have been anti-dilutive. The denominator used in calculating diluted earnings per share for the two fiscal quarters of 2017 does not include 13,050 restricted performance shares, as the effect of including these shares would have been anti-dilutive. The denominators used in calculating diluted earnings per share for common stock for the second quarter of 2016 and two fiscal quarters of 2016 do not include 216,690 options to purchase common stock, as the effect of including these options would have been anti-dilutive. The denominators used in calculating diluted earnings per share for the second quarter of 2016 and two fiscal quarters of 2016 do not include 17,870 and 23,560 restricted performance shares, respectively, as the effect of including these shares would have been anti-dilutive.

4. Stockholders’ Deficit

The following table summarizes changes in Stockholders’ Deficit for the two fiscal quarters of 2017.

5. Dividends

During the second quarter of 2017, on April 25, 2017, the Company’s Board of Directors declared a $0.46 per share quarterly dividend on its outstanding common stock for shareholders of record as of June 15, 2017 which was paid on June 30, 2017. The Company had approximately $22.6 million accrued for common stock dividends at June 18, 2017.

Subsequent to the second quarter, on July 19, 2017, the Company’s Board of Directors declared a $0.46 per share quarterly dividend on its outstanding common stock for shareholders of record as of September 15, 2017 to be paid on September 30, 2017.

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6. Accumulated Other Comprehensive Loss

The approximately $2.8 million of accumulated other comprehensive loss at June 18, 2017 and the approximately $3.1 million of accumulated other comprehensive loss at January 1, 2017 represent currency translation adjustments, net of tax. There were no reclassifications out of accumulated other comprehensive loss to net income in the two fiscal quarters of 2017 or the two fiscal quarters of 2016.

7. Open Market Share Repurchase Program

The Company did not repurchase any shares of its common stock under its Board of Directors approved open market share repurchase program in the second quarter of 2017. During the two fiscal quarters of 2017, the Company repurchased and retired 80,360 shares of its common stock under its Board of Directors-approved open market share repurchase program for a total of approximately $12.7 million. As of June 18, 2017, the end of the second quarter, the Company had a total remaining authorized amount for share repurchases of approximately $136.4 million.

During the first quarter of 2016, the Company received and retired 456,936 shares of its common stock in connection with the final settlement of its previously announced $600.0 million accelerated share repurchase program. During the second quarter of 2016, the Company repurchased and retired 1,845,126 shares of its common stock under its Board of Directors approved open market share repurchase program for a total of approximately $224.1 million.

8. Fair Value Measurements

Fair value measurements enable the reader of the financial statements to assess the inputs used to develop those measurements by establishing a hierarchy for ranking the quality and reliability of the information used to determine fair values. The Company classifies and discloses assets and liabilities carried at fair value in one of the following three categories:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market data.

The fair values of the Company’s cash equivalents and investments in marketable securities are based on quoted prices in active markets for identical assets. The following tables summarize the carrying amounts and fair values of certain assets at June 18, 2017 and January 1, 2017:

Management estimated the approximate fair values of the 2012 fixed rate notes and the 2015 fixed rate notes as follows (in thousands):

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The fixed rate notes are classified as a Level 2 measurement, as the Company estimates the fair value amount by using available market information. The Company obtained quotes from two separate brokerage firms that are knowledgeable about the Company’s fixed rate notes and, at times, trade these notes. The Company also performed its own internal analysis based on the information gathered from public markets, including information on notes that are similar to those of the Company. However, considerable judgment is required to interpret market data to estimate fair value. Accordingly, the fair value estimates presented are not necessarily indicative of the amount that the Company or the debtholders could realize in a current market exchange. The use of different assumptions and/or estimation methodologies may have a material effect on the estimated fair values stated above.

9. Legal Matters

On February 14, 2011, Domino’s Pizza LLC was named as a defendant in a lawsuit along with Fischler Enterprises of C.F., Inc., a franchisee, and Jeffrey S. Kidd, the franchisee’s delivery driver, filed by Yvonne Wiederhold, the plaintiff, as Personal Representative of the Estate of Richard E. Wiederhold, deceased. The case involved a traffic accident in which the franchisee’s delivery driver is alleged to have caused an accident involving a vehicle driven by Richard Wiederhold. Mr. Wiederhold sustained spinal injuries resulting in quadriplegia and passed away several months after the accident. The jury returned a $10.1 million judgment for the plaintiff where the Company and Mr. Kidd were found to be 90% liable (after certain offsets and other deductions the final verdict was $8.9 million). In the second quarter of 2016, the trial court ruled on all post-judgment motions and entered the judgment. The Company denies liability and in the third quarter of 2016 filed an appeal of the verdict on a variety of grounds. The Company continues to deny liability in this matter.

10. Supplemental Disclosures of Cash Flow Information

The Company had non-cash investing activities related to accruals for capital expenditures of $2.8 million at June 18, 2017 and $0.7 million at June 19, 2016.

11. Recapitalization

On July 24, 2017, the Company completed a recapitalization (the “2017 Recapitalization”) in which certain of the Company’s subsidiaries issued new notes pursuant to an asset-backed securitization. The new notes consist of $300.0 million Series 2017-1 Floating Rate Senior Secured Notes, Class A-2-I with an anticipated term of five years (the “Floating Rate Notes”), $600.0 million Series 2017-1 3.082% Fixed Rate Senior Secured Notes, Class A-2-II with an anticipated term of five years (the “Five-year Fixed Rate Notes”), and $1.0 billion Series 2017-1 4.118% Fixed Rate Senior Secured Notes, Class A-2-III with an anticipated term of 10 years (the “Ten-year Fixed Rate Notes” and, collectively with the Floating Rate Notes and the Five-year Fixed Rate Notes, the “2017 Notes”) in an offering exempt from registration under the Securities Act of 1933, as amended. The interest rate on the Floating Rate Notes will be payable at a rate equal to LIBOR plus 125 basis points. The 2017 Notes have scheduled principal payments of $4.8 million in 2017, $19.0 million in each of 2018 through 2021, $871.8 million in 2022, $10.0 million in each of 2023 through 2026, and $907.5 million in 2027.

Concurrently, the Company also issued a new variable funding note facility which allows for advances of up to $175.0 million of Series 2017-1 Variable Funding Senior Secured Notes, Class A-1 Notes and certain other credit instruments, including letters of credit (the “Variable Funding Notes”). The Variable Funding Notes were undrawn on the closing date. The Company’s previous variable funding note facility was canceled. Gross proceeds from the issuance of the 2017 Notes was $1.9 billion.

12. New Accounting Pronouncements

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 requires a lessee to recognize assets and liabilities on the balance sheet for leases with lease terms greater than 12 months. ASU 2016-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. Based on a preliminary assessment, the Company expects the adoption of this guidance to have a material impact on its assets and liabilities due to the recognition of right-of-use assets and lease liabilities on its consolidated balance sheets at the beginning of the earliest period presented. The Company is continuing its assessment, which may identify additional impacts this guidance will have on its consolidated financial statements and disclosures.

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) . In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing . In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients and ASU 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting . In December 2016, the FASB

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issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers . These amendments provide additional clarification and implementation guidance on the previously issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) .

The amendments in ASU 2016-08 clarify how an entity should identify the specified good or service for the principal versus agent evaluation and how it should apply the control principle to certain types of arrangements. ASU 2016-10 clarifies the following two aspects of ASU 2014-09: identifying performance obligations and licensing implementation guidance. ASU 2016-11 rescinds several SEC Staff Announcements that are codified in Topic 605, including, among other items, guidance relating to accounting for consideration given by a vendor to a customer, as well as accounting for shipping and handling fees and freight services. ASU 2016-12 provides clarification to Topic 606 on how to assess collectability, present sales tax, treat noncash consideration, and account for completed and modified contracts at the time of transition. ASU 2016-12 clarifies that an entity retrospectively applying the guidance in Topic 606 is not required to disclose the effect of the accounting change in the period of adoption. Additionally, ASU 2016-20 clarifies certain narrow aspects within Topic 606 including its scope, contract cost accounting, and disclosures. The new guidance requires enhanced disclosures, including revenue recognition policies to identify performance obligations to customers and significant judgments in measurement and recognition. The effective date and transition requirements for these amendments are the same as the effective date and transition requirements of ASU 2014-09, which is effective for fiscal years, and for interim periods within those years, beginning after December 15, 2017. The Company is currently evaluating the overall impact that ASU 2014-09 and its related amendments will have on the Company’s consolidated financial statements, as well as the expected timing and method of adoption effective January 1, 2018. Based on a preliminary assessment, the adoption of this guidance is not expected to have a material impact on our recognition of sales from Company-owned stores, ongoing royalty fees which are based on a percentage of franchise sales, or revenues from our supply chain centers. The Company is continuing to evaluate the impact of the adoption of this guidance on the recognition of less significant revenues such as development fees, franchise fees, and technology fees.

The Company is currently evaluating whether the standards will require a different accounting treatment for contributions received by and disbursements made by Domino’s National Advertising Fund Inc. (“DNAF”), our consolidated not for profit subsidiary. DNAF exists solely for the purpose of promoting the Domino’s Pizza brand in the U.S. The Company currently presents the restricted assets and liabilities of the DNAF in its Condensed Consolidated Balance Sheets and, under existing accounting guidance, has determined that it acts as an agent in regard to franchise store contributions and disbursements. Accordingly, these franchisee contributions and disbursements are presented net in the Condensed Consolidated Statements of Income. See Note 1 to the consolidated financial statements in the 2016 Form 10-K for additional details.

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). ASU 2016-09 is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. The new standard was effective for the Company beginning January 2, 2017.

As a result, excess tax benefits or deficiencies from equity-based compensation activity are reflected in the consolidated statements of income as a component of the provision for income taxes, whereas they previously were recognized in the consolidated statement of stockholders’ deficit. The Company also elected to account for forfeitures as they occur, rather than to use an estimate of expected forfeitures for financial statement reporting purposes. The adoption of ASU 2016-09 resulted in a decrease in our provision for income taxes of $10.4 million in the second quarter of 2017 and $16.9 million in the two fiscal quarters of 2017. This represents a decrease in the Company’s effective tax rate of 11.8 percentage points for the second quarter of 2017 and 9.4 percentage points for the two fiscal quarters of 2017, primarily due to the recognition of excess tax benefits for options exercised and the vesting of equity awards. The Company’s election to account for forfeitures as they occur had an immaterial impact on its equity-based compensation expense.

The Company adopted the cash flow presentation prospectively, and accordingly, excess tax benefits from equity-based compensation of $16.9 million in the two fiscal quarters of 2017 are presented as an operating activity, while $34.9 million of excess tax benefits from equity-based compensation in the two fiscal quarters of 2016 is presented as a financing activity. The presentation requirements for cash flows related to taxes paid for restricted stock upon vesting had no impact on our consolidated statements of cash flows for any of the periods presented because such cash flows have historically been presented as a financing activity.

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(Unaudited; tabular amounts in millions, except percentages and store data)

The 2017 and 2016 second quarters referenced herein represent the twelve-week periods ended June 18, 2017 and June 19, 2016. The 2017 and 2016 two fiscal quarters referenced herein represent the twenty-four-week periods ended June 18, 2017 and June 19, 2016.

Overview

Domino’s is the second largest pizza restaurant chain in the world, with more than 14,200 locations in over 85 markets. Founded in 1960, our roots are in convenient pizza delivery, while a significant amount of our sales also come from carryout customers. Domino’s generates revenues and earnings by charging royalties to our independent franchisees. The Company also generates revenues and earnings by selling food, equipment and supplies to franchisees primarily in the U.S. and Canada, and by operating a number of our own stores. Franchisees profit by selling pizza and other complementary items to their local customers. In our international markets, we generally grant geographical rights to the Domino’s Pizza ^® brand to master franchisees. These master franchisees are charged with developing their geographical area, and they profit by sub-franchising and selling ingredients and equipment to those sub-franchisees, as well as by running pizza stores. Everyone in the system can benefit, including the end consumer, who can feed their family Domino’s menu items conveniently and economically.

Our financial results are driven largely by retail sales at our franchise and Company-owned stores. Changes in retail sales are driven by changes in same store sales and store counts. We monitor both of these metrics very closely, as they directly impact our revenues and profits, and strive to consistently increase both metrics. Retail sales drive royalty payments from franchisees, as well as Company-owned store and supply chain revenues. Retail sales are primarily impacted by the strength of the Domino’s Pizza ^® brand, the results of our extensive advertising through various media channels, the impact of technological innovation and digital ordering, our ability to execute our strong and proven business model and the overall global economic environment.

During the second quarter and two fiscal quarters of 2017, we sustained our strong domestic same store sales performance and also continued our growth in international same store sales. Our Domino’s Piece of the Pie Rewards ^TM loyalty program contributed significantly to our domestic same store sales performance. Additionally, we remained focused on growing online ordering and improving the digital customer experience through our technology platforms.

We also continued our global expansion with the opening of 217 net new stores in the second quarter of 2017, bringing our year-to-date total to 406 stores. We opened 178 net new stores internationally and 39 net new stores domestically during the second quarter of 2017. Overall, we believe this global store growth, along with our strong sales, emphasis on technology, operations, and marketing initiatives have combined to strengthen our brand.

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Global retail sales, which are total retail sales at franchise and Company-owned stores worldwide, increased 11.8% in the second quarter of 2017 and 12.5% in the two fiscal quarters of 2017. These increases were driven primarily by domestic and international same store sales growth, as well as an increase in our worldwide store counts during the trailing four quarters. The impact of foreign currency exchange rates partially offset these increases, resulting from a generally stronger U.S. dollar when compared to the currencies in the international markets in which we compete. Domestic same store sales growth reflected the sustained positive sales trends and the continued success of our products, marketing and technology platforms. International same store sales also continued to grow.

Total revenues increased $81.3 million, or 14.8%, in the second quarter of 2017, and $166.3 million, or 15.3% in the two fiscal quarters of 2017. These increases were due primarily to higher supply chain volumes resulting from order and store count growth, as well as higher Company-owned store, domestic franchise and international franchise revenues resulting from same store sales and store count growth. These changes in revenues are described in more detail below.

Income from operations increased $9.2 million, or 8.8%, in the second quarter of 2017, and $26.5 million, or 13.1%, in the two fiscal quarters of 2017. These increases were driven by higher royalty revenues from domestic and international franchise stores, as well as increased supply chain volumes. The negative impact of changes in foreign currency exchange rates on international franchise royalties as well as higher general and administrative expenses partially offset these increases.

Net income increased $16.4 million, or 33.5%, in the second quarter of 2017, and $33.5 million, or 35.4%, in the two fiscal quarters of 2017. These increases were driven by higher income from operations, as noted above. The adoption of the new equity-based compensation standard also positively impacted net income through a reduction in the provision for income taxes.

Revenues

Revenues primarily consist of retail sales from our Company-owned stores, royalties and fees from our domestic and international franchised stores and sales of food, equipment and supplies from our supply chain centers to substantially all of our domestic franchised stores and certain international franchised stores. Company-owned store and franchised store revenues may vary from period to period due to changes in store count mix. Supply chain revenues may vary significantly from period to period as a result of fluctuations in commodity prices as well as the mix of products we sell.

Domestic Stores Revenues

Domestic stores revenues increased $27.3 million, or 16.3%, in the second quarter of 2017, and $56.2 million, or 16.9%, in the two fiscal quarters of 2017. These increases were driven by higher domestic Company-owned same store sales, royalty revenues earned on higher franchise same store sales, and an increase in the average number of stores open during each period. These changes in domestic stores revenues are more fully described below.

Domestic Company-Owned Stores

Revenues from domestic Company-owned store operations increased $14.6 million, or 14.9%, in the second quarter of 2017, and $31.7 million, or 16.3%, in the two fiscal quarters of 2017. These increases were due primarily to higher same store sales during the second quarter and two fiscal quarters of 2017. Domestic Company-owned same store sales increased 11.2% in the second quarter of 2017, and 12.6% in the two fiscal quarters of 2017. This compared to an increase of 9.1% in the second quarter of 2016 and 6.5% in the two fiscal quarters of 2016. An increase in the average number of Company-owned stores open during the second quarter and two fiscal quarters of 2017 also contributed to the increases in revenues.

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Domestic Franchise

Revenues from domestic franchise operations increased $12.7 million, or 18.3%, in the second quarter of 2017, and $24.5 million, or 17.8%, in the two fiscal quarters of 2017. These increases were driven by growth of 9.3% in same store sales in the second quarter of 2017 and a 9.6% increase in the two fiscal quarters of 2017. This compared to an increase of 9.8% in the second quarter of 2016, and 8.2% in the two fiscal quarters of 2016. An increase in the average number of domestic franchised stores open during the second quarter and two fiscal quarters of 2017 also contributed to the increase in revenues. Revenues further benefited from fees paid by franchisees for our digital ordering platform.

Supply Chain Revenues

Domestic Supply Chain

Domestic supply chain revenues increased $46.6 million, or 15.1%, in the second quarter of 2017, and $92.6 million, or 15.0%, in the two fiscal quarters of 2017. These increases were primarily attributable to higher volumes from increased order counts at the store level as well as store count growth. The cheese block price per pound averaged $1.54 in the second quarter of 2017 as compared to $1.40 in the second quarter of 2016. The cheese block price per pound averaged $1.59 in the two fiscal quarters of 2017 as compared to $1.43 in the two fiscal quarters of 2016. Our market basket pricing increased slightly during the second quarter and two fiscal quarters of 2017. We estimate that the higher market basket pricing resulted in an increase in domestic supply chain revenues of approximately $1.5 million in the second quarter of 2017 and $5.8 million during the two fiscal quarters of 2017.

International Supply Chain

Revenues from international supply chain operations increased $4.2 million, or 14.2%, in the second quarter of 2017, and $11.1 million, or 19.1%, in the two fiscal quarters of 2017. The increases resulted primarily from higher volumes from increased order counts at the store level. The increase for the second quarter of 2017 was partially offset by an approximate $1.4 million negative impact of foreign currency exchange rates. The impact of foreign currency exchange rates was flat for the two fiscal quarters of 2017.

International Franchise Revenues

Revenues from international franchise operations increased $3.1 million, or 7.6%, in the second quarter of 2017, and $6.4 million, or 8.1%, in the two fiscal quarters of 2017. These increases were due to higher same store sales and an increase in the average number of international stores open during each period. These increases were offset in part by the negative impact of changes in foreign currency exchange rates of approximately $1.6 million in the second quarter of 2017, and $3.1 million in the two fiscal quarters of 2017. Excluding the impact of foreign currency exchange rates, same store sales increased 2.6% in the second quarter of 2017, and 3.4% in the two fiscal quarters of 2017. This compared to an increase of 7.1% in the second quarter of 2016, and 7.5% in the two fiscal quarters of 2016.

Cost of Sales / Operating Margin

Cost of sales consists primarily of Company-owned store and supply chain costs incurred to generate related revenues. Components of consolidated cost of sales primarily include food, labor and occupancy costs.

Consolidated operating margin (which we define as revenues less cost of sales) increased $21.0 million, or 12.2%, in the second quarter of 2017, and $47.6 million, or 14.0%, in the two fiscal quarters of 2017. Higher domestic and international franchise revenues as well as higher supply chain volumes contributed to the increased operating margin in the second quarter of 2017 and the two fiscal quarters of 2017. Franchise revenues do not have a cost of sales component, so changes in franchise revenues have a disproportionate effect on the operating margin.

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