10-K 1 d866504d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 28, 2014

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 001-32242

 

 

Domino’s Pizza, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

DELAWARE   38-2511577

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

30 Frank Lloyd Wright Drive

Ann Arbor, Michigan

  48105
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code (734) 930-3030

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class:

 

Name of each exchange on which registered:

Domino’s Pizza, Inc.   New York Stock Exchange
Common Stock, $0.01 par value  

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act:    Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act:    Yes  ¨    No  x

Indicate by check mark whether the 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  x    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  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K:  x

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.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act):    Yes  ¨    No  x

The aggregate market value of the voting and non-voting common stock held by non-affiliates of Domino’s Pizza, Inc. as of June 15, 2014 computed by reference to the closing price of Domino’s Pizza, Inc.’s common stock on the New York Stock Exchange on such date was $3,969,974,918.

As of February 17, 2015, Domino’s Pizza, Inc. had 55,630,531 shares of common stock, par value $0.01 per share, outstanding.

Documents incorporated by reference:

Portions of the definitive proxy statement to be furnished to shareholders of Domino’s Pizza, Inc. in connection with the annual meeting of shareholders to be held on April 21, 2015 are incorporated by reference into Part III.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

         Page No.  
Part I   

Item 1.

 

Business.

     2   

Item 1A.

 

Risk Factors.

     11   

Item 1B.

 

Unresolved Staff Comments.

     19   

Item 2.

 

Properties.

     19   

Item 3.

 

Legal Proceedings.

     19   

Item 4.

 

Mine Safety Disclosures.

     19   
Part II   

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

     20   

Item 6.

 

Selected Financial Data.

     22   

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

     24   

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk.

     38   

Item 8.

 

Financial Statements and Supplementary Data.

     39   

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

     69   

Item 9A.

 

Controls and Procedures.

     69   

Item 9B.

 

Other Information.

     69   
Part III   

Item 10.

 

Directors, Executive Officers and Corporate Governance.

     70   

Item 11.

 

Executive Compensation.

     72   

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

     72   

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence.

     72   

Item 14.

 

Principal Accountant Fees and Services.

     72   
Part IV   

Item 15.

 

Exhibits, Financial Statement Schedules.

     73   
SIGNATURES      82   

Throughout this document, Domino’s Pizza, Inc. (NYSE: DPZ) is referred to as the “Company,” “Domino’s”, “Domino’s Pizza” or in the first person notations of “we,” “us” and “our.”

In this document, we rely on and refer to information regarding the U.S. quick service restaurant, or QSR, sector and the U.S. QSR pizza category from the CREST® report prepared by The NPD Group, as well as market research reports, analyst reports and other publicly-available information. Although we believe this information to be reliable, we have not independently verified it. Domestic sales information relating to the U.S. QSR sector and the U.S. QSR pizza category represent reported consumer spending obtained by The NPD Group’s CREST® report from consumer surveys. This information relates to both our Company-owned and franchised stores.

 

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Part I

Item 1. Business.

Overview

Domino’s is the second largest pizza restaurant chain in the world, with more than 11,600 locations in over 75 markets. Founded in 1960, our roots are in convenient pizza delivery, while a significant amount of our sales also come from carryout customers. Although we are a highly-recognized global brand, we focus on serving the local neighborhoods in which we live and do business through our large network of franchise owners and Company-owned stores. On average, we sell more than 1.5 million pizzas each day throughout our global system.

Our business model is straightforward: we handcraft and serve quality food at a competitive price, with easy ordering access and efficient service, which are enhanced by our technology innovations. Our dough is generally made fresh and distributed to stores around the world by us and our franchisees.

Domino’s generates revenues and earnings by charging royalties to its franchisees. Royalties are ongoing percent-of-sales fees for use of the Domino’s brand marks. 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 business model can yield strong returns for our franchise owners and Company-owned stores. It can also yield significant cash flow to us, through a consistent franchise royalty payment and supply chain revenue stream, with moderate capital expenditures. We have historically returned cash to shareholders through dividend payments and share buybacks since becoming a publicly-traded company.

Our History

We pioneered the pizza delivery business and built Domino’s Pizza® into one of the most widely-recognized consumer brands in the world. We have been delivering quality, affordable food to our customers since 1960, when brothers Thomas and James Monaghan borrowed $900 to purchase a small pizza store in Ypsilanti, Michigan. Thomas purchased his brother’s share of the business shortly thereafter. Concentrating first on building stores near college campuses and military bases in the 1960s and 1970s, the brand grew quickly in the 1980s in urban markets and near residential communities. We became “Domino’s Pizza” in 1965 and opened our first franchised store in 1967. The first international stores opened in 1983, in Canada and Australia.

Monaghan sold 93% of his economic stake in the Company in 1998 through a leveraged buy-out transaction with Bain Capital, LLC. He sold and transferred his remaining stake in the Company in 2004, when we completed our initial public offering. In connection with the initial public offering, on May 11, 2004, we reincorporated in Delaware.

Since 1998, the Company has been structured with a leveraged balance sheet and has completed a number of recapitalization events. The Company’s most recent recapitalization transaction in 2012 (the “2012 Recapitalization”) primarily consisted of:

 

   

the issuance of $1.575 billion of borrowings of fixed rate notes

 

   

the repurchase and retirement of all previously outstanding fixed rate notes

 

   

the replacement of its existing variable funding note facility with a new $100.0 million variable funding note facility, and

 

   

the payment of a special cash dividend to shareholders and related anti-dilution payments and adjustments to certain stock option holders.

We re-launched our brand in the U.S. in late 2009 by introducing a new recipe for our core pizza product. Since 2008, the majority of our menu has changed, either through the improvement of existing products or the introduction of new products, such as our Handmade Pan Pizza and Specialty Chicken. Globally, we opened our 10,000th store in 2012 and our 11,000th store in 2014. In 2013, we announced a plan requiring all stores to adopt our new “Pizza Theater” store design, which is more inviting to customers and allows them to see their orders being made fresh in front of them. Our goal is to be substantially complete with these remodels by the end of 2017.

 

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Our Industry

The U.S. QSR pizza category is large and fragmented. From 2004 through 2014, the U.S. QSR pizza category has grown from $31.1 billion to $32.9 billion. It is the third-largest category within the $261.9 billion U.S. QSR sector. The U.S. QSR pizza category is primarily comprised of delivery, dine-in and carryout.

We compete primarily in the delivery and carryout segments of the pizza industry. We are the market share leader in the delivery segment and we have the second largest share in the carryout segment. 2014 delivery segment sales of $10.0 billion (down from $11.2 billion in 2004) account for approximately 31% of total U.S. QSR pizza. While the delivery segment declined during the period from 2004 to 2012, sales increased slightly during the past two years, from $9.6 billion in 2012 to $10.0 billion in 2014. The three industry leaders, including Domino’s, account for approximately 55% of U.S. pizza delivery, based on reported consumer spending, with the remaining sales going to regional chains and independent establishments. From 2004 to 2014, the carryout segment grew from $12.2 billion to $14.8 billion. The four industry leaders, including Domino’s, account for approximately 41% of the carryout segment.

In contrast to the United States, international pizza delivery is relatively underdeveloped, with only Domino’s and three other competitors having a significant global presence. We believe that demand for pizza and pizza delivery is large and growing throughout the world, driven by international consumers’ increasing emphasis on convenience, and the proven success of our 30 years of conducting business abroad.

Our Competition

The global pizza delivery and carryout segments are highly competitive. In the U.S., we compete against regional and local companies as well as national chains Pizza Hut®, Papa John’s® and Little Caesars Pizza®. Internationally, we compete primarily with Pizza Hut®, Papa John’s® and country-specific national and local pizzerias. We generally compete on the basis of product quality, location, image, service and price. We and our competitors can be affected by changes in consumer tastes, economic conditions, demographic trends and consumers’ disposable income. We compete not only for customers, but also for employees, suitable real estate sites and qualified franchisees.

Our Customers

The Company’s business is not dependent upon a single retail customer or small group of customers, including franchisees. No customer accounted for more than 10% of total consolidated revenues in 2014, 2013 or 2012. Our largest franchisee based on store count, Domino’s Pizza Enterprises (ASX: DMP), operates 1,411 stores in six international markets, and accounts for 12% of our total store count. Royalty revenues from this franchisee accounted for 1.6% of our consolidated revenues in 2014. Our international business unit only requires a minimal amount of general and administrative expenses to operate its markets, and does not have costs of sales. Therefore, the vast majority of these royalty revenues result in profits to us.

Our Menu

We offer a menu designed to present an attractive, quality offering to customers, while keeping it simple enough to minimize order errors and expedite order-taking and food preparation. Our basic menu features pizza products with varying sizes and crust types. Our typical store also offers oven-baked sandwiches, pasta, boneless chicken and wings, bread side items, desserts and Coca-Cola® soft drink products. International markets vary toppings by country and culture, such as squid toppings in Japan or spicy cheese in India, and often feature regional specialty items, such as a banana and cinnamon dessert pizza in Brazil.

Store Image and Operations

We have been focused primarily on pizza delivery for over 50 years, and also on carryout as a significant component of our business. In 2012, we introduced our carryout-friendly Pizza Theater store design; we expect that substantially all of our stores will convert to this design by the end of 2017. Many stores will offer casual seating and will enable customers to watch the preparation of their orders, but will not offer a full-service dine-in experience. As a result, our stores generally do not require expensive restaurant facilities and staffing.

Research and Development

We conduct research and product development at our World Resource Center in Ann Arbor, Michigan. Company-sponsored research and development activities, which include testing new products for possible menu additions, are an important activity for us and our franchisees. We do not consider the amounts spent on research and development to be material.

 

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Our Business Segments

Historically, we have operated in, and reported, three business segments: domestic stores, international and domestic supply chain. In the fourth quarter of 2014 several organizational changes were made within the Company’s management structure, with one of the changes impacting the management of our supply chain operations. As a result, management determined that our previous domestic supply chain segment and the international supply chain operations division of our previous international segment should be combined into a new global supply chain segment. As a result, we now report the following three business segments: domestic stores, international franchise and supply chain. While the consolidated results of the Company have not been impacted by this change in our reportable segments, we have restated our historical segment information in order to provide readers of our financial statements with a consistent presentation.

Domestic Stores

Our domestic stores segment consists primarily of our franchise operations, through which we oversee a network of 4,690 franchised stores located in the contiguous United States. We also operate a network of 377 domestic Company-owned stores located in the contiguous United States.

During 2014, our domestic stores segment accounted for $578.7 million, or 29% of our consolidated revenues. We use our Company-owned stores as test sites for new products and promotions as well as operational improvements. We also use them for training new store managers and operations team members, as well as developing prospective franchisees. While we are primarily a franchised business, we evaluate our mix of domestic Company-owned and franchise stores in an effort to optimize our long-term profitability.

We maintain a productive relationship with our independent franchise owners through regional franchise teams, distributing materials that help franchise stores comply with our standards and using franchise advisory groups that facilitate communications between us and our franchisees.

Domestic Franchise Profile

As of December 28, 2014, our 4,690 domestic franchise stores were owned and operated by 899 domestic franchisees. Our franchise formula enables franchisees to benefit from our brand name with a relatively low initial capital investment. As of December 28, 2014, the average domestic franchisee owned and operated five stores and had been in our franchise system for over 16 years. At the same time, 12 of our domestic franchisees operated more than 50 stores, including our largest domestic franchisee who operated 140 stores, and 340 of our domestic franchisees each operated one store.

We apply rigorous standards to prospective domestic franchisees. We generally require them to manage a store for at least one year before being granted a franchise. This enables us to observe the operational and financial performance of a potential franchisee prior to entering into a long-term contract. In the U.S. today, approximately 90% of our 899 independent franchise owners started their careers with us as delivery drivers or in other in-store positions. We generally restrict the ability of domestic franchisees to be involved in other businesses, which focuses our franchisees’ attention on operating their stores. As a result, the majority of our domestic franchisees have historically come from within the Domino’s Pizza system. We believe these standards are largely unique to the franchise industry and result in qualified and focused franchisees operating their stores.

Domestic Franchise Agreements

We enter into franchise agreements with domestic franchisees under which the franchisee is granted the right to operate a store in a particular location for a term of 10 years, with an ability to renew for an additional term of 10 years. We have a franchise contract renewal rate of approximately 99%. Under the current standard franchise agreement, we assign an exclusive area of primary responsibility to each franchised store. Each franchisee is generally required to pay a 5.5% royalty fee on sales. Occasionally, we will collect lower rates based on area development agreements, sales initiatives and new store incentives.

Our domestic stores currently contribute 6% of their retail sales to fund national marketing and advertising campaigns (subject, in limited instances, to lower rates based on certain incentives and waivers). These funds are administered by Domino’s National Advertising Fund Inc., or DNAF, our not-for-profit advertising subsidiary. The funds are primarily used to purchase media for advertising, but also support market research, field communications, public relations, commercial production, talent payments and other activities to promote the brand. In addition to the national and market-level advertising contributions, domestic stores spend additional funds on local store marketing activities.

 

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We have the contractual right, subject to state law, to terminate a franchise agreement for a variety of reasons, including, but not limited to, a franchisee’s failure to adhere to the Company’s franchise agreement, failure to make required payments, or failure to adhere to specified Company policies and standards.

International Franchise

Our international franchise segment is comprised of a network of franchised stores in more than 75 international markets. At December 28, 2014, we had 6,562 international franchise stores. During 2014, this segment accounted for $152.6 million, or 8% of our consolidated revenues. The principal sources of revenues from those operations are royalty payments generated by retail sales from franchised stores.

Our international franchisees employ our basic standard operating model, and adapt it to satisfy the local eating habits and consumer preferences of various regions outside the United States. Currently, the vast majority of our international stores operate under master franchise agreements.

We believe Domino’s appeals to potential international franchisees because of our recognized brand name and technological leadership, the moderate capital expenditures required to open and operate our stores and our system’s favorable store economics. In our top 10 markets, four master franchise companies are publicly traded on stock exchanges: in Australia (ASX: DMP), India (JUBLFOOD: NS), Mexico (ALSEA: MX) and the United Kingdom (DOM: L). The following table shows our store count as of December 28, 2014 in our top 10 international markets, which account for approximately 73% of our international stores.

 

Market

   Number
of stores
 

India

     830   

United Kingdom

     811   

Mexico

     604   

Australia

     547   

Turkey

     425   

South Korea

     405   

Canada

     386   

Japan

     354   

France

     239   

Netherlands

     158   

International Franchisee Profile

The vast majority of our markets outside of the contiguous United States are operated by master franchisees with franchise and distribution rights for entire regions or countries. In a few select markets, we franchise directly to individual store operators. Prospective master franchisees are required to possess local market knowledge to establish and develop Domino’s Pizza stores, with the ability to identify and access targeted real estate sites, as well as expertise in local laws, customs, culture and consumer behavior. We also seek candidates that have access to sufficient capital to meet growth and development plans.

Master Franchise Agreements

Our master franchise agreements generally grant the franchisee exclusive rights to develop or sub-franchise stores and the right to operate supply chain centers in particular geographic areas. Agreements are generally for a term of 10 to 20 years, with options to renew for additional terms. The agreements typically contain growth clauses requiring franchisees to open a minimum number of stores within a specified period. The master franchisee is generally required to pay an initial, one-time franchise fee as well as an additional franchise fee upon the opening of each new store. The master franchisee is also required to pay a continuing royalty fee as a percentage of retail sales, which varies among international markets, and averaged approximately 3.1% in 2014.

Supply Chain

Our supply chain segment operates 16 regional dough manufacturing and food supply chain centers in the contiguous U.S., one thin crust manufacturing center, one vegetable processing center and one center providing equipment and supplies to certain of our domestic and international stores. We also operate seven dough manufacturing and food supply chain centers in Canada, Alaska and Hawaii. Our supply chain segment leases a fleet of more than 500 tractors and trailers. During 2014, our supply chain segment accounted for $1.26 billion, or 63% of our consolidated revenues.

 

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Our centers manufacture fresh dough and purchase, receive, store and deliver quality food and other complementary items to over 99% of our U.S. and Canadian franchised stores and all of our Company-owned stores. We regularly supply nearly 5,500 stores with various food and supplies. Our supply chain segment made approximately 571,000 full-service deliveries in 2014 or approximately two deliveries per store per week, and we produced over 340 million pounds of dough during 2014.

We believe our franchisees voluntarily choose to obtain food, supplies and equipment from us because we offer the most efficient, convenient and cost-effective alternative, while also offering both quality and consistency. Our supply chain segment offers profit-sharing arrangements to franchisees who purchase all of their food for their stores from our centers. These profit-sharing arrangements generally offer participating franchisees and Company-owned stores with 50% (or a higher percentage in the case of Company-owned stores and certain franchisees who operate a larger number of stores) of their regional supply chain center’s pre-tax profits. We believe these arrangements strengthen our ties and provide aligned benefits with franchisees.

Third-Party Suppliers

Over half of our annual food spend is with suppliers where we have maintained a partnership of at least 20 years. Our supply partners are required to meet strict quality standards to ensure food safety. We review and evaluate these partners’ quality assurance programs through (among other actions) on-site visits, third party audits and product evaluations to ensure compliance with our standards. We believe the length and quality of our relationships with third-party suppliers provides us with priority service and quality products at competitive prices.

Cheese is our largest food cost. The price we charge to our domestic franchisees for cheese is based on the Chicago Mercantile Exchange cheddar block price, plus a supply chain markup. As cheese prices fluctuate, our revenues and margin percentages in our supply chain segment also fluctuate; however, actual supply chain dollar margins remain unchanged. We currently purchase our domestic pizza cheese from a single supplier. Under the September 2012 agreement, our domestic supplier agreed to provide an uninterrupted supply of cheese and the Company agreed to a five-year pricing schedule to purchase all of its domestic pizza cheese from this supplier. While we expect to meet the terms of this agreement, if we do not, we will be required to repay the cost savings as outlined in the agreement. The majority of our meat toppings in the U.S. come from a single supplier under a contract that began in May 2014 and expires in November 2015. We have the right to terminate these arrangements for quality failures and for uncured breaches.

We are party to a multi-year agreement with Coca-Cola for the contiguous United States. This contract, renegotiated in December 2013, provides for Coca-Cola to continue to be our exclusive beverage supplier and expires on December 31, 2018 or at such time as a minimum number of cases of Coca-Cola products are purchased by us, whichever occurs last.

We believe alternative third-party suppliers are available for all of these referenced products. While we may incur additional costs if we are required to replace any of our supply partners, we do not believe such additional costs would have a material adverse effect on our business. We continually evaluate each supply category to determine the optimal sourcing strategy.

We have not experienced any significant shortages of supplies or delays in receiving our inventories or products. Prices charged to us by our supply partners are subject to fluctuation, and we have historically been able to pass increased costs and savings on to our stores. We periodically enter into supplier contracts to manage the risk from changes in commodity prices. We do not engage in speculative transactions, nor do we hold or issue financial instruments for trading purposes.

Our Strengths

Strong Brand Equity

We are the second largest pizza company in the world. We believe our Domino’s Pizza® brand is one of the most widely-recognized consumer brands in the world. We are the recognized world leader in pizza delivery and have a significant business in carryout. We believe consumers associate our brand with the timely delivery of quality, affordable food.

Over the past five years, our U.S. franchise and Company-owned stores have invested an estimated $1.4 billion in national, co-operative and local advertising. Our international franchisees also invest significant amounts in advertising efforts in their markets. We continue to reinforce our brand with extensive advertising through various media channels. We have also enhanced the strength of our brand through marketing affiliations with brands such as Coca-Cola.

 

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We are the number one pizza delivery company in the United States with a 24.7% share of pizza delivery based on reported consumer spending. With 5,067 stores located in the contiguous United States, our store delivery areas cover a majority of U.S. households. Our share position and scale allow us to leverage our purchasing power, supply chain strength and marketing investments. We believe our scale and market coverage allow us to effectively serve our customers’ demands for convenience and timely delivery. Outside the U.S., we have significant market share positions in many of the markets in which we compete.

Strong and Proven Business Model

Our business model is comprised of domestic and international franchise royalties, revenues from supply chain and revenue from retail sales at Company-owned stores. We have developed this model over our many years of operation and it is anchored by strong store-level economics, which provide an entrepreneurial incentive for our franchisees and historically has generated demand for new stores. Our franchise system, in turn, has produced strong and consistent earnings for us through royalty fees and through supply chain revenues, with moderate associated capital expenditures by us.

We developed a cost-efficient store model, characterized by a delivery- and carryout-oriented store design, with moderate capital requirements and a menu of quality, affordable items. At the store level, we believe the simplicity and efficiency of our operations give us significant advantages over our competitors, who, in many cases, also focus on dine-in or have broader menu offerings. At the supply chain level, we believe we provide quality and consistency for our franchise customers while also driving profits for us, which we share with our franchisees.

Our menu simplifies and streamlines production and delivery processes and maximizes economies of scale on purchases of our principal food items. In addition, our stores are small (averaging approximately 1,500 square feet) and less expensive to build, furnish and maintain as compared to many other restaurant concepts. The combination of this efficient store model and strong sales volume has resulted in strong store-level financial returns and, we believe, makes Domino’s Pizza an attractive business opportunity for existing and prospective franchisees around the world.

We believe our store economics have led to a strong, well-diversified franchise system. This established franchise system has produced strong cash flow and earnings for us, enabling us to invest in the Domino’s Pizza® brand, stores, technology and supply chain centers, pay significant dividends, repurchase and retire shares of our common stock and repurchase and retire outstanding principal on our fixed rate notes.

Technological Innovation

Technological innovation is vital to our brand and our long-term success. Digital ordering is critical to competing in the global pizza industry. In 2014, nearly 45% of our U.S. sales came via digital platforms. That metric is higher in some of our international markets. We believe we are among the largest e-commerce retailers in terms of annual transactions. After launching digital ordering domestically in 2008, we made the strategic decision in 2010 to develop our own online ordering platform and to manage this important and growing area of our business internally. Over the next four years, we launched mobile applications that cover 95% of the smartphones and tablets on the U.S. market. In 2013, we launched an enhanced online ordering profiles platform, allowing customers the ability to reorder their favorite order in as few as five clicks or 30 seconds. In 2014, we introduced “Dom,” a voice ordering application, which we believe is the first in the restaurant industry, and we also made the Domino’s Tracker® available on the Pebble smartwatch platform.

All of this improved functionality has been developed to work seamlessly with our Domino’s PULSE™ point-of-sale system. Our Domino’s PULSE system is designed to improve operating efficiencies for our franchisees and our corporate management and assist franchisees in independently managing their business. We have installed Domino’s PULSE in every Company-owned store in the U.S., in more than 99% of our domestic franchised stores and in nearly 60% of our international stores.

We believe utilizing Domino’s PULSE with our integrated mobile applications throughout our system, provides us with competitive advantages over other concepts. We intend to continue to enhance and grow our online ordering, digital marketing and technological capabilities.

 

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Product Innovation

In late 2009, we reintroduced our core pizza with a new recipe, which we believe has been key to our continued growth in customer reorder rate, consumer traffic and increased sales. This recipe is now in use in the vast majority of markets around the world. Our more than 50 years of innovation have resulted in numerous new product developments, including our recent innovations of Handmade Pan Pizza, Specialty Chicken, Parmesan Bread Bites and Stuffed Cheesy Bread, among others. Product innovation is also present in our global markets, where our master franchisees have the ability to recommend products to suit their local market tastes. Products include the Mayo Jaga in Japan (bacon, potatoes and sweet mayonnaise) and the Saumoneta in France (light cream, potatoes, onions, smoked salmon and dill).

Internal Dough Manufacturing and Supply Chain System

In addition to generating significant revenues and earnings in the United States and Canada, we believe our vertically integrated dough manufacturing and supply chain system enhances the quality and consistency of our products, enhances our relationships with franchisees and leverages economies of scale to offer lower costs to our stores. It also allows store managers to better focus on store operations and customer service by relieving them of the responsibility of mixing dough in the stores and sourcing other ingredients. Many of our international master franchisees also profit from running supply chain businesses.

Our Ideals

We believe in: opportunity, hard work, inspired solutions, winning together, embracing community, and uncommon honesty.

Opportunity abounds at Domino’s. You can start in an entry-level position and become a store owner – in fact, 90% of our independent franchise owners in the U.S. started their careers with us as delivery drivers or in other in-store positions. Thousands of other team members – supervisors, trainers, quality auditors, international business consultants, marketers and executives – also began their careers in the stores. Internal growth and providing opportunities for anyone willing to work hard is the foundation of our core beliefs.

The ideals of inspired solutions, uncommon honesty and winning together were driving forces behind the relaunch of our brand. We were inspired by our harshest critics when it came to the perceived taste of our pizza. Our solution was not simply more advertising; the solution was to create a new recipe and a broader menu of great-tasting products. Our marketing campaign was shockingly honest in its approach: telling consumers (and showing them via television ads) that we heard their negative feedback and were listening. And, without the buy-in from our franchise owners, we couldn’t have done it. We believe that we can’t focus solely on the Company’s success; we must focus on making our stores and our franchisees successful. That’s winning together.

Community Involvement

We believe in supporting the communities we serve through donating our time, money and pizza. You can find more information about our community giving at biz.dominos.com. Here are two organizations worthy of note:

Our national philanthropic partner is St. Jude Children’s Research Hospital®. St. Jude is internationally-recognized for its pioneering work in finding cures and saving children with cancer and other catastrophic diseases. Through a variety of internal and consumer-based activities, including a national fundraising campaign called St. Jude Thanks and Giving®, the Domino’s Pizza system has contributed more than $25.0 million to St. Jude since our partnership began in 2004, including $5.2 million in 2014. In addition to raising funds, we have supported St. Jude through in-kind donations, including hosting hospital-wide pizza parties for patients and their families. Our system also helps St. Jude build awareness through the inclusion of the St. Jude logo on millions of our pizza boxes and through a link on our consumer website.

We also support the Domino’s Pizza Partners Foundation. Founded in 1986, the mission of the Partners Foundation is “Team Members Helping Team Members.” Primarily funded by team member and franchise contributions, the foundation is a separate, not-for-profit organization that has disbursed nearly $15.0 million since its inception, to meet the needs of Domino’s team members facing crisis situations, such as fire, accidents, illness or other personal tragedies.

 

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Additional Disclosures

Employees

As of December 28, 2014, we had approximately 11,000 employees in our Company-owned stores, supply chain centers, World Resource Center (our corporate headquarters) and regional offices. None of our employees are represented by a labor union or covered by a collective bargaining agreement. As franchisees are independent business owners, they and their employees are not included in our employee count. We consider our relationship with our employees and franchisees to be good. We estimate the total number of people who work in the Domino’s Pizza system, including our employees, franchisees and the employees of franchisees, was over 240,000 as of December 28, 2014.

Working Capital

Information about the Company’s working capital is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7., pages 33 through 35.

Government Regulation

We, along with our franchisees, are subject to various federal, state and local laws affecting the operation of our business. Each store is subject to licensing and regulation by a number of governmental authorities, which include zoning, health, safety, sanitation, building and fire agencies in the jurisdiction in which the store is located. In connection with maintaining our stores, we may be required to expend funds to meet certain federal, state and local regulations, including regulations requiring that remodeled or altered stores be accessible to persons with disabilities. Difficulties in obtaining, or the failure to obtain, required licenses or approvals could delay or prevent the opening of a new store in a particular area or cause an existing store to cease operations. Our supply chain facilities are also licensed and subject to similar regulations by federal, state and local health and fire codes.

We are also subject to the Fair Labor Standards Act and various other federal and state laws governing such matters as minimum wage requirements, overtime and other working conditions and citizenship requirements. A significant number of our and our franchisees’ food service personnel are paid at rates related to the applicable minimum wage, and past increases in the minimum wage have increased labor costs, as would future increases.

We are subject to the rules and regulations of the Federal Trade Commission and various state laws regulating the offer and sale of franchises. The Federal Trade Commission and various state laws require that we furnish a franchise disclosure document containing certain information to prospective franchisees, and a number of states require registration of the franchise disclosure document with state authorities. We are operating under exemptions from registration in several states based on the net worth of our operating subsidiary, Domino’s Pizza LLC, and experience. We believe our franchise disclosure document, together with any applicable state versions or supplements, and franchising procedures comply in all material respects with both the Federal Trade Commission guidelines and all applicable state laws regulating franchising in those states in which we have offered franchises.

Internationally, our franchise stores are subject to national and local laws and regulations that are often similar to those affecting our domestic stores, including laws and regulations concerning franchises, labor, health, sanitation and safety. Our international stores are also often subject to tariffs and regulations on imported commodities and equipment, and laws regulating foreign investment. We believe our international disclosure statements, franchise offering documents and franchising procedures comply in all material respects with the laws of the foreign countries in which we have offered franchises.

Privacy and Data Protection

We are subject to a number of privacy and data protection laws and regulations globally. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increase in attention given to privacy and data protection issues with the potential to directly affect our business. This includes recently-enacted laws and regulations in the United States and internationally requiring notification to individuals and government authorities of security breaches involving certain categories of personal information. We have a privacy policy posted on our website at www.dominos.com and believe that we are in material compliance therewith.

Trademarks

We have many registered trademarks and service marks and believe that the Domino’s® mark and Domino’s Pizza® names and logos, in particular, have significant value and are important to our business. Our policy is to pursue registration of our trademarks and to vigorously oppose the infringement of any of our trademarks. We license the use of our registered marks to franchisees through franchise agreements.

 

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Environmental Matters

We are not aware of any federal, state or local environmental laws or regulations that will materially affect our earnings or competitive position, or result in material capital expenditures. However, we cannot predict the effect of possible future environmental legislation or regulations. During 2014, there were no material capital expenditures for environmental control facilities, and no such material expenditures are anticipated in 2015.

Seasonal Operations

The Company’s business is not typically seasonal.

Backlog Orders

The Company has no backlog orders as of December 28, 2014.

Government Contracts

No material portion of the Company’s business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the United States government.

Financial Information about Business Segments and Geographic Areas

Financial information about international and United States markets and business segments is incorporated herein by reference to Selected Financial Data, Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and related footnotes in Part II, Item 6., pages 22 through 23, Item 7. and 7A., pages 24 through 38 and Item 8., pages 39 through 68, respectively, of this Form 10-K.

Available Information

The Company makes available, free of charge, through its internet website biz.dominos.com, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and amendments to those reports filed or furnished pursuant to Section 13(a), 15(d), or 16 of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after electronically filing such material with the Securities and Exchange Commission. You may read and copy any materials filed with the Securities and Exchange Commission at the Securities and Exchange Commission’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the Securities and Exchange Commission at 1-800-SEC-0330. This information is also available at www.sec.gov. The reference to these website addresses does not constitute incorporation by reference of the information contained on the websites and should not be considered part of this document.

 

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Item 1A. Risk Factors.

The quick service restaurant pizza category is highly competitive and such competition could adversely affect our operating results.

In the U.S., we compete against regional and local companies as well as national chains Pizza Hut®, Papa John’s® and Little Caesars Pizza®. Internationally, we compete primarily with Pizza Hut®, Papa John’s® and country-specific national and local pizzerias. We could experience increased competition from existing or new companies in the pizza category which could create increasing pressures to grow our business in order to maintain our market share. If we are unable to maintain our competitive position, we could experience downward pressure on prices, lower demand for our products, reduced margins, the inability to take advantage of new business opportunities and the loss of market share, all of which would have an adverse effect on our operating results and could cause our stock price to decline.

We also compete on a broader scale with quick service and other international, national, regional and local restaurants. The overall food service market and the quick service restaurant sector are intensely competitive with respect to food quality, price, service, image, convenience and concept, and are often affected by changes in:

 

 

consumer tastes;

 

 

international, national, regional or local economic conditions;

 

 

disposable purchasing power;

 

 

demographic trends; and

 

 

currency fluctuations related to international operations.

We compete within the food service market and the quick service restaurant sector not only for customers, but also for management and hourly employees, suitable real estate sites and qualified franchisees. Our supply chain segment is also subject to competition from outside suppliers. While over 99% of domestic franchisees purchased food, equipment and supplies from us in 2014, domestic franchisees are not required to purchase food, equipment or supplies from us and they may choose to purchase from outside suppliers. If other suppliers who meet our qualification standards were to offer lower prices or better service to our franchisees for their ingredients and supplies and, as a result, our franchisees chose not to purchase from our domestic supply chain centers, our financial condition, business and results of operations would be adversely affected.

If we fail to successfully implement our growth strategy, which includes opening new domestic and international stores, our ability to increase our revenues and operating profits could be adversely affected.

A significant component of our growth strategy includes the opening of new domestic and international stores. We and our franchisees face many challenges in opening new stores, including, among others:

 

 

availability of financing with acceptable terms;

 

 

selection and availability of suitable store locations;

 

 

negotiation of acceptable lease or financing terms;

 

 

securing required domestic or foreign governmental permits and approvals;

 

 

employment and training of qualified personnel; and

 

 

general economic and business conditions.

The opening of additional franchise stores also depends, in part, upon the availability of prospective franchisees who meet our criteria. Our failure to add a significant number of new stores would adversely affect our ability to increase revenues and operating income.

We and our franchisees are currently planning to expand our international operations in many of the markets where we currently operate and in selected new markets. This may require considerable management time as well as start-up expenses for market development before any significant revenues and earnings are generated. Operations in new foreign markets may achieve low margins or may be unprofitable, and expansion in existing markets may be affected by local economic and market conditions. Therefore, as we expand internationally, we or our franchisees may not experience the operating margins we expect, our results of operations may be negatively impacted and our common stock price may decline.

We may also pursue strategic acquisitions as part of our business. If we are able to identify acquisition candidates, such acquisitions may be financed, to the extent permitted under our debt agreements, with substantial debt or with potentially dilutive issuances of equity securities.

 

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The food service market is affected by consumer preferences and perceptions. Changes in these preferences and perceptions may lessen the demand for our products, which would reduce sales and harm our business.

Food service businesses are affected by changes in consumer tastes, international, national, regional and local economic conditions, and demographic trends. For instance, if prevailing health or dietary preferences cause consumers to avoid pizza and other products we offer in favor of foods that are perceived as more healthy, our business and operating results would be harmed. Moreover, because we are primarily dependent on a single product, if consumer demand for pizza should decrease, our business would suffer more than if we had a more diversified menu, as many other food service businesses do.

Reports of food-borne illness or food tampering could reduce sales and harm our business.

Reports, whether true or not, of food-borne illnesses (such as E. Coli, avian flu, bovine spongiform encephalopathy, hepatitis A, trichinosis or salmonella) and injuries caused by food tampering have in the past severely injured the reputations of participants in the QSR sector and could in the future as well. The potential for acts of terrorism on our global food supply also exists and, if such an event occurs, it could have a negative impact on us and could severely hurt sales and profits. In addition, our reputation is an important asset; as a result, anything that damages our reputation could immediately and severely affect our sales and profits. Media reports of illnesses and injuries, whether accurate or not, could force some stores to close or otherwise reduce sales at such stores. In addition, reports of food-borne illnesses or food tampering, even those occurring solely at the restaurants of competitors, could, by resulting in negative publicity about the restaurant industry, adversely affect us on a local, regional, national or international basis.

Increases in food, labor and other costs could adversely affect our profitability and operating results.

An increase in our operating costs could adversely affect our profitability. Factors such as inflation, increased food costs, increased labor and employee health and benefit costs, increased rent costs and increased energy costs may adversely affect our operating costs. Most of the factors affecting costs are beyond our control and, in many cases, we may not be able to pass along these increased costs to our customers or franchisees. Most ingredients used in our pizza, particularly cheese, are subject to significant price fluctuations as a result of seasonality, weather, demand and other factors. The cheese block price per pound averaged $2.13 in 2014, and the estimated increase in Company-owned store food costs from a hypothetical $0.25 adverse change in the average cheese block price per pound would have been approximately $2.2 million in 2014. Labor costs are largely a function of the minimum wage for a majority of our store personnel and certain supply chain center personnel and, generally, are also a function of the availability of labor. Food, including cheese costs and labor represent approximately 50% to 60% of a typical Company-owned store’s sales.

We do not have long-term contracts with certain of our suppliers, and as a result they could seek to significantly increase prices or fail to deliver.

We do not have long-term contracts or arrangements with certain of our suppliers. Although in the past we have not experienced significant problems with our suppliers, our suppliers may implement significant price increases or may not meet our requirements in a timely fashion, or at all. The occurrence of any of the foregoing could have a material adverse effect on our results of operations.

Shortages or interruptions in the supply or delivery of fresh food products could adversely affect our operating results.

We and our franchisees are dependent on frequent deliveries of fresh food products that meet our specifications. Shortages or interruptions in the supply of fresh food products caused by unanticipated demand, problems in production or distribution, financial or other difficulties of suppliers, inclement weather or other conditions could adversely affect the availability, quality and cost of ingredients, which would adversely affect our operating results.

Any prolonged disruption in the operations of any of our dough manufacturing and supply chain centers could harm our business.

We operate 16 regional dough manufacturing and supply chain centers, one thin crust manufacturing center and one vegetable processing center in the contiguous United States and a total of seven dough manufacturing and supply chain centers in Alaska, Hawaii and Canada. Our domestic dough manufacturing and supply chain centers service all of our Company-owned stores and over 99% of our domestic franchise stores. As a result, any prolonged disruption in the operations of any of these facilities, whether due to technical or labor difficulties, destruction or damage to the facility, real estate issues or other reasons, could adversely affect our business and operating results.

 

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Our success depends in part upon effective advertising, and lower advertising funds may reduce our ability to adequately market the Domino’s Pizza® brand.

We have been routinely named a MegaBrand by Advertising Age. Each Domino’s store located in the contiguous United States is obligated to pay a percentage of its sales in advertising fees. In fiscal 2014, each store in the contiguous United States generally was required to contribute 6% of their sales to DNAF (subject, in limited instances, to lower rates based on certain incentives and waivers), which uses such fees for national advertising in addition to contributions for local market-level advertising. We currently anticipate that this 6% contribution rate will remain in place for the foreseeable future. While additional funds for advertising in the past have been provided by us, our franchisees and other third parties, none of these additional funds are legally required. The lack of continued financial support for advertising activities could significantly curtail our marketing efforts, which may in turn materially and adversely affect our business and our operating results.

We face risks of litigation and negative publicity from customers, franchisees, suppliers, employees and others in the ordinary course of business, which can or could divert our financial and management resources. Any adverse litigation or publicity may negatively impact our financial condition and results of operations.

Claims of illness or injury relating to food quality or food handling are common in the food service industry, and vehicular accidents and injuries occur in the food delivery business. Claims within our industry of improper supplier actions have also recently arisen that, if made against one of our suppliers, could potentially damage our brand image. In addition, class action lawsuits have been filed, and may continue to be filed, against various quick service restaurants alleging, among other things, that quick service restaurants have failed to disclose the health risks associated with high-fat foods and that quick service restaurant marketing practices have encouraged obesity. In addition to decreasing our sales and profitability and diverting our management resources, adverse publicity or a substantial judgment against us could negatively impact our financial condition, results of operations and brand reputation, thereby hindering our ability to attract and retain franchisees and grow our business.

Further, we may be subject to employee, franchisee and other claims in the future based on, among other things, discrimination, harassment, wrongful termination and wage, rest break and meal break issues, and those claims relating to overtime compensation. We are currently subject to these types of claims and have been subject to these types of claims in the past. If one or more of these claims were to be successful or if there is a significant increase in the number of these claims or if we receive significant negative publicity, our business, financial condition and operating results could be harmed.

Loss of key employees or our inability to attract and retain new qualified employees could hurt our business and inhibit our ability to operate and grow successfully.

Our success in the highly competitive pizza delivery and carry-out business will continue to depend to a significant extent on our leadership team and other key management personnel. Other than with our President and Chief Executive Officer, J. Patrick Doyle, we do not have long-term employment agreements with any of our executive officers. As a result, we may not be able to retain our executive officers and key personnel or attract additional qualified management. While we do not have long-term employment agreements with our executive officers, for all of our executive officers we have non-compete and non-solicitation agreements that extend for 24 months following the termination of such executive officer’s employment. Our success also will continue to depend on our ability to attract and retain qualified personnel to operate our stores, dough manufacturing and supply chain centers and international operations. The loss of these employees or our inability to recruit and retain qualified personnel could have a material adverse effect on our operating results.

Adverse global economic conditions subject us to additional risk.

Our financial condition and results of operations are impacted by global markets and economic conditions over which neither we nor our franchisees have control. An economic downturn, including further deterioration in the economic conditions in European countries, may result in a reduction in the demand for our products, longer payment cycles, slower adoption of new technologies and increased price competition. Poor economic conditions may adversely affect the ability of our franchisees to pay royalties or amounts owed, and could have a material adverse impact on our ability to pursue our growth strategy, which would reduce cash collections and in turn, may materially and adversely affect our ability to service our debt obligations.

Our international operations subject us to additional risk. Such risks and costs may differ in each country in which we and our franchisees do business and may cause our profitability to decline due to increased costs.

We conduct a significant and growing portion of our business outside the United States. Our financial condition and results of operations may be adversely affected if global markets in which our franchise stores compete are affected by changes in political, economic or other factors. These factors, over which neither we nor our franchisees have control, may include:

 

 

recessionary or expansive trends in international markets;

 

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changing labor conditions and difficulties in staffing and managing our foreign operations;

 

 

increases in the taxes we pay and other changes in applicable tax laws;

 

 

legal and regulatory changes, and the burdens and costs of our compliance with a variety of foreign laws;

 

 

changes in inflation rates;

 

 

changes in exchange rates and the imposition of restrictions on currency conversion or the transfer of funds;

 

 

difficulty in collecting our royalties and longer payment cycles;

 

 

expropriation of private enterprises;

 

 

increases in anti-American sentiment and the identification of the Domino’s Pizza® brand as an American brand;

 

 

political and economic instability; and

 

 

other external factors.

Fluctuations in the value of the U.S. dollar in relation to other currencies may lead to lower revenues and earnings.

Exchange rate fluctuations could have an adverse effect on our results of operations. Approximately 7.7% of our total revenues in 2014, 7.4% of our total revenues in 2013 and 7.1% of our total revenues in 2012 were derived from our international franchise segment, a majority of which were denominated in foreign currencies. We also operate dough manufacturing and distribution facilities in Canada, which generate revenues denominated in Canadian dollars. Sales made by franchise stores outside the United States are denominated in the currency of the country in which the store is located, and this currency could become less valuable in U.S. dollars as a result of exchange rate fluctuations. Unfavorable currency fluctuations could lead to increased prices to customers outside the United States or lower profitability to our franchisees outside the United States, or could result in lower revenues for us, on a U.S. dollar basis, from such customers and franchisees. A hypothetical 10% adverse change in the foreign currency rates in our international markets would have resulted in a negative impact on international royalty revenues of approximately $14.7 million in 2014.

We may not be able to adequately protect our intellectual property, which could harm the value of our brand and branded products and adversely affect our business.

We depend in large part on our brand and branded products and believe that they are very important to our business. We rely on a combination of trademarks, copyrights, service marks, trade secrets and similar intellectual property rights to protect our brand and branded products. The success of our business depends on our continued ability to use our existing trademarks and service marks in order to increase brand awareness and further develop our branded products in both domestic and international markets. We have registered certain trademarks and have other trademark registrations pending in the United States and foreign jurisdictions. Not all of the trademarks that we currently use have been registered in all of the countries in which we do business, and they may never be registered in all of these countries. We may not be able to adequately protect our trademarks and our use of these trademarks may result in liability for trademark infringement, trademark dilution or unfair competition. All of the steps we have taken to protect our intellectual property in the United States and in foreign countries may not be adequate. In addition, the laws of some foreign countries do not protect intellectual property rights to the same extent as the laws of the United States. Further, through acquisitions of third parties, we may acquire brands and related trademarks that are subject to the same risks as the brands and trademarks we currently own.

We may from time to time be required to institute litigation to enforce our trademarks or other intellectual property rights, or to protect our trade secrets. Such litigation could result in substantial costs and diversion of resources and could negatively affect our sales, profitability and prospects regardless of whether we are able to successfully enforce our rights.

Our earnings and business growth strategy depends on the success of our franchisees, and we may be harmed by actions taken by our franchisees, or employees of our franchisees, that are outside of our control.

A significant portion of our earnings comes from royalties generated by our franchise stores. Franchisees are independent operators, and their employees are not our employees. We provide tools for franchisees to use in training their employees, but the quality of franchise store operations may be diminished by any number of factors beyond our control. Consequently, franchisees may not successfully operate stores in a manner consistent with our standards and requirements. If they do not, our image and reputation may suffer, and as a result our revenues and stock price could decline. While we try to ensure that our franchisees maintain the quality of our brand and branded products, our franchisees may take actions that adversely affect the value of our intellectual property or reputation. As of December 28, 2014, we had 899 domestic franchisees operating 4,690 domestic stores. 12 of these franchisees each operate over 50 domestic stores, including our largest domestic franchisee who operates 140 stores, and the average franchisee owns and operates five stores.

 

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In addition, our international master franchisees are generally responsible for the development of significantly more stores than our domestic franchisees. As a result, our international operations are more closely tied to the success of a smaller number of franchisees than our domestic operations. Our largest international master franchisee operates 1,411 stores in six markets, which accounts for approximately 22% of our total international store count. Our domestic and international franchisees may not operate their franchises successfully. If one or more of our key franchisees were to become insolvent or otherwise were unable or unwilling to pay us our royalties or other amounts owed, our business and results of operations would be adversely affected.

Interruption, failure or compromise of our information technology, communications systems and electronic data could hurt our ability to effectively serve our customers and protect customer data, which could damage our reputation and adversely affect our business and operating results.

A significant portion of our retail sales depends on the continuing operation of our information technology and communications systems, including but not limited to, Domino’s PULSE™, our online ordering platforms and our credit card processing systems. Our information technology, communication systems and electronic data may be vulnerable to damage or interruption from earthquakes, terrorist attacks, floods, fires, power loss, telecommunications failures, computer viruses, loss of data, unauthorized data breaches or other attempts to harm our systems. Additionally, we operate data centers that are also subject to break-ins, sabotage and intentional acts of vandalism that could cause disruptions in our ability to serve our customers and protect customer data. Some of our systems are not fully redundant, and our disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster, intentional sabotage or other unanticipated problems could result in lengthy interruptions in our service. Any errors or vulnerabilities in our systems, or damage to or failure of our systems, could result in interruptions in our services and non-compliance with certain regulations, which could reduce our revenues and profits, and damage our business and brand.

We rely on proprietary and commercially available systems, software, tools and monitoring to provide security for processing, transmission and storage of confidential customer information, such as payment card and personal information and any unauthorized data breaches could damage our reputation and adversely affect our business.

Unauthorized intrusion into the portions of our computer systems or those of our franchisees that process and store information related to customer transactions may result in the theft of customer data. Furthermore, the systems currently used for transmission and approval of payment card transactions, and the technology utilized in payment cards themselves, all of which can put payment card data at risk, are determined and mandated by payment card industry standards, not by us. In addition to improper activities by third parties, bugs in newly-deployed or early stage advances in hardware and software capabilities, encryption technology, and other events or developments may facilitate or result in a compromise or breach of our computer systems. Any such compromises or breaches could cause interruptions in operations and damage to the reputation of the Domino’s Pizza® brand, subject us to costs and liabilities and hurt sales, revenues and profits.

We are subject to extensive government regulation and requirements issued by other groups and our failure to comply with existing or increased regulations could adversely affect our business and operating results.

We are subject to numerous federal, state, local and foreign laws and regulations, as well as, requirements issued by other groups, including those relating to:

 

 

the preparation, sale and labeling of food;

 

 

building and zoning requirements;

 

 

environmental protection;

 

 

minimum wage, overtime and other labor requirements;

 

 

compliance with securities laws and New York Stock Exchange listed company rules;

 

 

compliance with the Americans with Disabilities Act of 1990, as amended;

 

 

working and safety conditions;

 

 

menu labeling and other nutritional requirements;

 

 

compliance with the Payment Card Industry Data Security Standards (PCI DSS) and similar requirements;

 

 

compliance with the Patient Protection and Affordable Care Act, and subsequent amendments; and

 

 

compliance with the Dodd-Frank Wall Street Reform and Consumer Protection Act and any rules promulgated thereunder.

The Patient Protection and Affordable Care Act and subsequent amendments require employers such as us to provide health insurance for all qualifying employees or pay penalties for not providing coverage. We anticipate that the majority of the increases in these costs will begin in 2015 and will escalate in subsequent years. While we do not expect the incremental costs of this program to be material to us, these costs will likely have an adverse effect on our results of operations and financial position, as well as an adverse effect on some of our larger franchisees.

 

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We may also become subject to legislation or regulation seeking to tax and/or regulate high-fat foods, foods with high sugar and salt content, or foods otherwise deemed to be “unhealthy.” If we fail to comply with existing or future laws and regulations, we may be subject to governmental or judicial fines or sanctions. In addition, our capital expenditures could increase due to remediation measures that may be required if we are found to be noncompliant with any of these laws or regulations.

We are also subject to a Federal Trade Commission rule and to various state and foreign laws that govern the offer and sale of franchises. Additionally, these laws regulate various aspects of the franchise relationship, including terminations and the refusal to renew franchises. The failure to comply with these laws and regulations in any jurisdiction or to obtain required government approvals could result in a ban or temporary suspension on future franchise sales, fines or other penalties or require us to make offers of rescission or restitution, any of which could adversely affect our business and operating results.

Our current insurance coverage may not be adequate, insurance premiums for such coverage may increase and we may not be able to obtain insurance at acceptable rates, or at all.

We have retention programs for workers’ compensation, general liability and owned and non-owned automobile liabilities. We are generally responsible for up to $1.0 million per occurrence under these retention programs for workers’ compensation and general liability. We are also generally responsible for between $500,000 and $3.0 million per occurrence under these retention programs for owned and non-owned automobile liabilities. Total insurance limits under these retention programs vary depending upon the period covered and range up to $110.0 million per occurrence for general liability and owned and non-owned automobile liabilities and up to the applicable statutory limits for workers’ compensation. These insurance policies may not be adequate to protect us from liabilities that we incur in our business. In addition, in the future our insurance premiums may increase and we may not be able to obtain similar levels of insurance on reasonable terms, or at all. Any such inadequacy of, or inability to obtain insurance coverage could have a material adverse effect on our business, financial condition and results of operations.

Our annual and quarterly financial results are subject to significant fluctuations depending on various factors, many of which are beyond our control, and if we fail to meet the expectations of securities analysts or investors, our share price may decline significantly.

Our sales and operating results can vary significantly from quarter-to-quarter and year-to-year depending on various factors, many of which are beyond our control. These factors include, among other things:

 

 

variations in the timing and volume of our sales and our franchisees’ sales;

 

 

the timing of expenditures in anticipation of future sales;

 

 

sales promotions by us and our competitors;

 

 

changes in competitive and economic conditions generally;

 

 

changes in the cost or availability of our ingredients or labor; and

 

 

foreign currency exposure.

As a result, our operational performance may decline quickly and significantly in response to changes in order patterns or rapid decreases in demand for our products. We anticipate that fluctuations in operating results will continue in the future.

Our common stock price could be subject to significant fluctuations and/or may decline.

The market price of our common stock could be subject to significant fluctuations. Among the factors that could affect our stock price are:

 

 

changes planned or actual to our capital or debt structure;

 

 

variations in our operating results;

 

 

changes in revenues or earnings estimates or publication of research reports by analysts;

 

 

speculation in the press or investment community;

 

 

strategic actions by us or our competitors, such as sales promotions, acquisitions or restructurings;

 

 

actions by institutional and other stockholders;

 

 

changes in our dividend policy;

 

 

changes in the market values of public companies that operate in our business segments;

 

 

general market conditions; and

 

 

domestic and international economic factors unrelated to our performance.

The stock markets in general have experienced volatility that has sometimes been unrelated to the operating performance of particular companies. These broad market fluctuations may cause the trading price of our common stock to decline.

 

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Our substantial indebtedness could adversely affect our business and limit our ability to plan for or respond to changes in our business.

We have a substantial amount of indebtedness. As of December 28, 2014, our consolidated long-term indebtedness was approximately $1.52 billion. We may also incur additional debt, which would not be prohibited under the terms of our current securitized debt agreements. Our substantial indebtedness could have important consequences to our business and our shareholders. For example, it could:

 

 

make it more difficult for us to satisfy our obligations with respect to our debt agreements;

 

 

increase our vulnerability to general adverse economic and industry conditions;

 

 

require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow for other purposes; and

 

 

limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate, thereby placing us at a competitive disadvantage compared to our peers that may have less debt.

In addition, the financial and other covenants we agreed to with our lenders may limit our ability to incur additional indebtedness, make investments, pay dividends and engage in other transactions, and the leverage may cause potential lenders to be less willing to loan funds to us in the future. Our failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in the acceleration of repayment of all of our indebtedness.

We may be unable to generate sufficient cash flow to satisfy our significant debt service obligations, which would adversely affect our financial condition and results of operations.

Our ability to make principal and interest payments on and to refinance our indebtedness will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. If our business does not generate sufficient cash flow from operations, in the amounts projected or at all, or if future borrowings are not available to us under our variable funding notes in amounts sufficient to fund our other liquidity needs, our financial condition and results of operations may be adversely affected. If we cannot generate sufficient cash flow from operations to make scheduled principal amortization and interest payments on our debt obligations in the future, we may need to refinance all or a portion of our indebtedness on or before maturity, sell assets, delay capital expenditures or seek additional equity. If we are unable to refinance any of our indebtedness on commercially reasonable terms or at all or to effect any other action relating to our indebtedness on satisfactory terms or at all, our business may be harmed.

The terms of our securitized debt financing of certain of our wholly-owned subsidiaries have restrictive terms and our failure to comply with any of these terms could put us in default, which would have an adverse effect on our business and prospects.

Unless and until we repay all outstanding borrowings under our securitized debt, we will remain subject to the restrictive terms of these borrowings. The securitized debt, under which certain of our wholly-owned subsidiaries issued and guaranteed fixed rate notes and variable funding senior revolving notes, contain a number of covenants, with the most significant financial covenant being a debt service coverage calculation. These covenants limit the ability of certain of our subsidiaries to, among other things:

 

 

sell assets;

 

 

alter the business we conduct;

 

 

engage in mergers, acquisitions and other business combinations;

 

 

declare dividends or redeem or repurchase capital stock;

 

 

incur, assume or permit to exist additional indebtedness or guarantees;

 

 

make loans and investments;

 

 

incur liens; and

 

 

enter into transactions with affiliates.

The securitized debt also requires us to maintain specified financial ratios at the end of each fiscal quarter. These restrictions could affect our ability to pay dividends or repurchase shares of our common stock. Our ability to meet these financial ratios can be affected by events beyond our control, and we may not satisfy such a test. A breach of this covenant could result in a rapid amortization event or default under the securitized debt. If amounts owed under the securitized debt are accelerated because of a default under the securitized debt and we are unable to pay such amounts, the investors may have the right to assume control of substantially all of the securitized assets.

 

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During the seven-year term following issuance, the outstanding senior notes will accrue interest at a fixed rate of 5.216% per year. Additionally, the senior notes have original scheduled principal amortization payments of $29.5 million in 2015, $37.4 million in 2016, $39.4 million in each of 2017 and 2018, and $9.8 million in 2019. In accordance with our debt agreements, once we meet certain conditions, including maximum leverage ratios as defined of less than or equal to 4.5x total debt to EBITDA, we cease to make the scheduled principal amortization payments. If one of the defined leverage ratios subsequently exceeds 4.5x, we must make-up the payments we had previously not made. During the second quarter of 2014, we met the maximum leverage ratios of less than 4.5x, and, in accordance with our debt agreements, ceased debt amortization payments in the third quarter of 2014. We continued to meet the maximum leverage ratios of less than 4.5x in the third and fourth quarters of 2014 and currently do not plan to make previously scheduled debt amortization payments as permitted in our debt agreements.

If we are unable to refinance or repay amounts under the securitized debt prior to the expiration of the seven-year term, our cash flow would be directed to the repayment of the securitized debt and, other than a weekly management fee sufficient to cover minimal selling, general and administrative expenses, would not be available for operating our business.

No assurance can be given that any refinancing or additional financing will be possible when needed or that we will be able to negotiate acceptable terms. In addition, our access to capital is affected by prevailing conditions in the financial and capital markets and other factors beyond our control. There can be no assurance that market conditions will be favorable at the times that we require new or additional financing.

The indenture governing the securitized debt will restrict the cash flow from the entities subject to the securitization to any of our other entities and upon the occurrence of certain events, cash flow would be further restricted.

In the event that a rapid amortization event occurs under the indenture (including, without limitation, upon an event of default under the indenture or the failure to repay the securitized debt at the end of the seven-year term), the funds available to us would be reduced or eliminated, which would in turn reduce our ability to operate or grow our business.

 

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Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

We lease approximately 223,000 square feet for our World Resource Center located in Ann Arbor, Michigan under an operating lease with Domino’s Farms Office Park, L.L.C., an unrelated company. The lease, as amended, expires in December 2022 and has two five-year renewal options.

We own one domestic Company-owned store building and five supply chain center buildings. We also own two store buildings that we lease to domestic franchisees. All other domestic Company-owned stores are leased by us, typically under five-year leases with one or two five-year renewal options. All other domestic and international supply chain centers are leased by us, typically under leases ranging between five and 15 years with one or two five-year renewal options. All other franchise stores are leased or owned directly by the respective franchisees. We believe that our existing headquarters and other leased and owned facilities are adequate to meet our current requirements.

Item 3. Legal Proceedings.

We are a party to lawsuits, revenue agent reviews by taxing authorities and administrative proceedings in the ordinary course of business which include, without limitation, workers’ compensation, general liability, automobile and franchisee claims. We are also subject to suits related to employment practices.

Litigation is subject to many uncertainties, and the outcome of individual litigated matters is not predictable with assurance. Included in the matters referenced above, we are party to three employment practice cases, six casualty cases and one patent case. We have established legal and insurance accruals for losses relating to these cases which we believe are reasonable based upon our assessment of the current facts and circumstances. However, it is reasonably possible that our ultimate losses could exceed the amounts recorded by $4.0 million. The remaining cases referenced above could be decided unfavorably to us and could require us to pay damages or make other expenditures in amounts or a range of amounts that cannot be estimated with accuracy. In management’s opinion, these matters, individually and in the aggregate, should not have a significant adverse effect on the financial condition of the Company, and the established accruals adequately provide for the estimated resolution of such claims.

We were also named as a defendant in a lawsuit along with a large franchisee and the franchisee’s delivery driver. During the third quarter of 2013, the jury delivered a $32.0 million judgment for the plaintiff where we were found to be 60% liable. We deny liability and filed an appeal of the verdict on a variety of grounds. This case is covered under our casualty insurance program, subject to a $3.0 million deductible. We also have indemnity provisions in our franchise agreements.

While we may occasionally be party to large claims, including class action suits, we do not believe that these matters, individually or in the aggregate, will materially affect our financial position, results of operations or cash flows.

Item 4. Mine Safety Disclosures.

Not applicable.

 

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Part II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

As of February 17, 2015, Domino’s Pizza, Inc. had 170,000,000 authorized shares of common stock, par value $0.01 per share, of which 55,630,531 were issued and outstanding. Domino’s Pizza, Inc.’s common stock is traded on the New York Stock Exchange (“NYSE”) under the ticker symbol “DPZ.”

The following table presents the high and low closing prices by quarter for Domino’s Pizza, Inc.’s common stock, as reported by the NYSE, and dividends declared per common share.

 

2013:

   High      Low      Dividends
Declared
Per Share
 

First quarter (December 31, 2012 – March 24, 2013)

   $ 51.19       $ 43.55       $ 0.20   

Second quarter (March 25, 2013 – June 16, 2013)

     60.72         49.65         0.20   

Third quarter (June 17, 2013 – September 8, 2013)

     64.00         57.01         0.20   

Fourth quarter (September 9, 2013 – December 29, 2013)

     70.68         63.04         0.20   

2014:

                    

First quarter (December 30, 2013 – March 23, 2014)

   $ 80.02       $ 67.17       $ 0.25   

Second quarter (March 24, 2014 – June 15, 2014)

     78.62         71.13         0.25   

Third quarter (June 16, 2014 – September 7, 2014)

     76.43         70.17         0.25   

Fourth quarter (September 8, 2014 – December 28, 2014)

     95.93         75.54         0.25   

Our Board of Directors declared a quarterly dividend of $0.31 per common share on February 11, 2015 payable on March 30, 2015 to shareholders of record at the close of business on March 13, 2015.

We currently anticipate continuing the payment of quarterly cash dividends. The actual amount of such dividends will depend upon future earnings, results of operations, capital requirements, our financial condition and certain other factors. There can be no assurance as to the amount of free cash flow that we will generate in future years and, accordingly, dividends will be considered after reviewing returns to shareholders, profitability expectations and financing needs and will be declared at the discretion of our Board of Directors.

As of February 17, 2015, there were 1,019 registered holders of record of Domino’s Pizza, Inc.’s common stock.

We have a Board of Directors-approved open market share repurchase program for up to $200.0 million of our common stock, of which approximately $132.7 million remained available at December 28, 2014 for future purchases of our common stock. Any future purchases of our common stock would be funded by current cash amounts, available borrowings or future excess cash flow.

The following table summarizes our repurchase activity during the fourth quarter ended December 28, 2014:

 

Period

   Total Number
of Shares
Purchased (1)
     Average Price Paid
per Share
     Total Number of Shares
Purchased as Part of
Publicly  Announced
Program
     Maximum Approximate
Dollar Value of Shares
that May Yet Be
Purchased Under the
Program
 

Period #1 (September 8, 2014 to October 5, 2014)

     1,555       $ 76.63         —         $ 132,726,701   

Period #2 (October 6, 2014 to November 2, 2014)

     1,915         89.54         —           132,726,701   

Period #3 (November 3, 2014 to November 30, 2014)

     1,209         94.71         —           132,726,701   

Period #4 (December 1, 2014 to December 28, 2014)

     —           —           —           132,726,701   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     4,679       $ 86.59         —         $ 132,726,701   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 4,679 shares were purchased as part of the Company’s employee stock purchase discount plan. During the fourth quarter, the shares were purchased at an average price of $86.59.

 

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The comparative stock performance line graph below compares the cumulative shareholder return on the common stock of Domino’s Pizza, Inc. for the five-year period between December 31, 2009 through December 31, 2014, with cumulative total return on (i) the Total Return Index for the New York Stock Exchange (the “NYSE Composite Index”), (ii) the Standard & Poor’s 500 Index (the “S&P 500”) and (iii) the peer group, the Standard & Poor’s 400 Restaurant Index (the “S&P 400 Restaurant Index”). Management believes that the companies included in the S&P 400 Restaurant Index appropriately reflect the scope of the Company’s operations and match the competitive market in which the Company operates. The cumulative total return computations set forth in the performance graph assume the investment of $100 in the Company’s common stock, the NYSE Composite Index, the S&P 500 Index and the S&P 400 Restaurant Index on December 31, 2009.

 

LOGO

 

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Item 6. Selected Financial Data.

The selected financial data set forth below should be read in conjunction with, and is qualified by reference to, Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and related notes included in this Form 10-K. The selected financial data below, with the exception of store counts and same store sales growth, have been derived from the audited consolidated financial statements of Domino’s Pizza, Inc. and subsidiaries. This historical data is not necessarily indicative of results to be expected for any future period.

 

     Fiscal year ended (5)  

(dollars in millions, except per share data)

   December 28,
2014
    December 29,
2013
    December 30,
2012 (4)
    January 1,
2012
    January 2,
2011
 

Income statement data:

          

Revenues:

          

Domestic Company-owned stores

   $ 348.5      $ 337.4      $ 323.7      $ 336.3      $ 345.6   

Domestic franchise

     230.2        212.4        195.0        187.0        173.3   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Domestic stores

     578.7        549.8        518.7        523.4        519.0   

Supply chain

     1,262.5        1,118.9        1,039.8        1,021.0        960.7   

International franchise

     152.6        133.6        120.0        107.8        91.2   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     1,993.8        1,802.2        1,678.4        1,652.2        1,570.9   

Cost of sales

     1,399.1        1,253.2        1,177.1        1,181.7        1,132.3   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating margin

     594.8        549.0        501.3        470.5        438.6   

General and administrative expense

     249.4        235.2        219.0        211.4        210.9   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     345.4        313.8        282.3        259.1        227.7   

Interest income

     0.1        0.2        0.3        0.3        0.2   

Interest expense

     (86.9     (88.9     (101.4     (91.6     (96.8

Other (1)

     —          —          —          —          7.8   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before provision for income taxes

     258.6        225.1        181.2        167.8        138.9   

Provision for income taxes

     96.0        82.1        68.8        62.4        51.0   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 162.6      $ 143.0      $ 112.4      $ 105.4      $ 87.9   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

          

Common stock – basic

   $ 2.96      $ 2.58      $ 1.99      $ 1.79      $ 1.50   

Common stock – diluted

     2.86        2.48        1.91        1.71        1.45   

Dividends declared per share

   $ 1.00      $ 0.80      $ 3.00      $ —        $ —     

Balance sheet data (at end of period):

          

Cash and cash equivalents

   $ 30.9      $ 14.4      $ 54.8      $ 50.3      $ 47.9   

Restricted cash and cash equivalents

     121.0        125.5        60.0        92.6        85.5   

Working capital (2)

     41.8        (28.5     16.8        37.1        33.4   

Total assets

     619.3        525.3        478.2        480.5        460.8   

Total long-term debt

     1,523.5        1,512.3        1,536.4        1,450.4        1,451.3   

Total debt

     1,524.1        1,536.4        1,560.8        1,451.3        1,452.2   

Total stockholders’ deficit

     (1,219.5     (1,290.2     (1,335.5     (1,209.7     (1,210.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents
     Fiscal year ended (5)  

(dollars in millions)

   December 28,
2014
    December 29,
2013
    December 30,
2012 (4)
    January 1,
2012
    January 2,
2011
 

Other financial data:

          

Depreciation and amortization

   $ 35.8      $ 25.8      $ 23.2      $ 24.0      $ 24.1   

Capital expenditures

     71.8        40.4        29.3        24.3        25.4   

Same store sales growth (3):

          

Domestic Company-owned stores

     6.2     3.9     1.3     4.1     9.7

Domestic franchise stores

     7.7     5.5     3.2     3.4     10.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Domestic stores

     7.5     5.4     3.1     3.5     9.9

International stores

     6.9     6.2     5.2     6.8     6.9

Store counts (at end of period):

          

Domestic Company-owned stores

     377        390        388        394        454   

Domestic franchise stores

     4,690        4,596        4,540        4,513        4,475   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Domestic stores

     5,067        4,986        4,928        4,907        4,929   

International stores

     6,562        5,900        5,327        4,835        4,422   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total stores

     11,629        10,886        10,255        9,742        9,351   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) The fiscal 2010 Other amount represents the net gain recognized on the repurchase and retirement of principal on the 2007 notes.
(2) The working capital amounts exclude restricted cash amounts of $121.0 million in 2014, $125.5 million in 2013, $60.0 million in 2012, $92.6 million in 2011 and $85.5 million in 2010.
(3) Same store sales growth is calculated including only sales from stores that also had sales in the comparable period of the prior year, but excluding sales from certain seasonal locations such as stadiums and concert arenas. International same store sales growth is calculated similarly to domestic same store sales growth. Changes in international same store sales are reported on a constant dollar basis which reflects changes in international local currency sales.
(4) In connection with our recapitalization in 2012, the Company borrowed $1.575 billion of fixed rate notes and used a portion of the proceeds from the borrowings to repay in full the outstanding principal under the 2007 notes, pay accrued interest on the 2007 notes, pay transaction-related fees and expenses and fund a reserve account for the payment of interest on the 2012 fixed rate notes. In fiscal 2012, the Company recorded $32.5 million of deferred financing costs as an asset in the consolidated balance sheet. This amount, in addition to the $7.4 million recorded on the consolidated balance sheet in fiscal 2011 is being amortized into interest expense over the seven-year expected term of the debt. In connection with the repayment of the 2007 notes, we wrote off $8.1 million, net, of unamortized deferred financing fees and interest rate swap. Additionally, we incurred $2.1 million of interest expense on the 2007 borrowings subsequent to the closing of the 2012 Recapitalization but prior to the repayment of the 2007 notes, resulting in the payment of interest on both the 2007 and 2012 facilities for a short period of time. Further, the Company incurred $0.3 million of other net 2012 Recapitalization-related general and administrative expenses, including stock compensation expenses, payroll taxes related to the payments made to certain stock option holders and legal and professional fees incurred in connection with the 2012 Recapitalization. In connection with the 2012 Recapitalization, the Company also paid a special cash dividend on our outstanding common stock totaling $171.1 million, made a corresponding anti-dilution equivalent payment of $13.5 million on certain stock options and accrued an estimated $2.4 million for payments to be made to certain performance-based restricted stock grants upon vesting. Total cash paid for common stock dividends and related anti-dilution payments totaled $185.5 million in fiscal 2012 and as of December 30, 2012 the total estimated liability recorded for future cash dividend payments on certain performance-based restricted stock was approximately $1.5 million. Of the total amount of $187.0 million recorded for common stock dividends and related anti-dilution payments, $10.2 million was recorded as a reduction of additional paid-in capital and $176.8 million was recorded as an increase in retained deficit.
(5) The 2010, 2011, 2012, 2013 and 2014 fiscal years each include 52 weeks.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

Our fiscal year typically includes 52 weeks, comprised of three twelve-week quarters and one sixteen-week quarter. Every five or six years our fiscal year includes an extra (or 53rd) week in the fourth quarter. Fiscal 2012, fiscal 2013 and fiscal 2014 each consisted of 52 weeks.

Description of the Business

Domino’s is the second largest pizza restaurant chain in the world, with more than 11,600 locations in over 75 markets. Founded in 1960, our roots are in convenient pizza delivery, while a significant amount of our sales also come from carryout customers. Although we are a highly-recognized global brand, we focus on serving the local neighborhoods in which we live and do business through our large network of franchise owners and Company-owned stores. On average, we sell more than 1.5 million pizzas each day throughout our global system.

Our business model is straightforward: we handcraft and serve quality food at a competitive price, with easy ordering access and efficient service, which are enhanced by our technology innovations. Our dough is generally made fresh and distributed to stores around the world by us and our franchisees.

Domino’s generates revenues and earnings by charging royalties to its franchisees. Royalties are ongoing percent-of-sales fees for use of the Domino’s brand marks. 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 business model can yield strong returns for our franchise owners and Company-owned stores. It can also yield significant cash flow to us, through a consistent franchise royalty payment and supply chain revenue stream, with moderate capital expenditures. We have historically returned cash to shareholders through dividend payments and share buybacks since becoming a publicly-traded company.

In the fourth quarter of 2014 several organizational changes were made within the Company’s management structure, with one of the changes impacting the management of our supply chain operations. As a result, management determined that our previous domestic supply chain segment and the international supply chain operations division of our previous international segment should be combined into a new global supply chain segment. As a result, we now report the following three business segments: domestic stores, supply chain and international franchise. While the consolidated results of the Company have not been impacted by this change in our reportable segments, we have restated our historical segment information in order to provide readers of our financial statements with a consistent presentation.

Fiscal 2014 Highlights

 

   

Global retail sales (which are total retail sales at Company-owned and franchised stores worldwide) increased 11.1% as compared to 2013.

 

   

Same store sales increased 7.5% in our domestic stores and, when excluding the impact of foreign currency exchange rates, increased 6.9% in our international stores.

 

   

Our revenues increased 10.6%.

 

   

Our income from operations increased 10.1%.

 

   

Our net income increased 13.7%.

During 2014, we continued our rapid global expansion with the opening of 743 net new stores. Our international segment led the way with a record 662 net new store openings.

We continued our focus on growing online ordering and the digital customer experience as we introduced “Dom,” a voice ordering application, which we believe is the first in the restaurant industry, and we also made the Domino’s Tracker® available on the Pebble smartwatch platform. Our emphasis on technology innovation helped us generate approximately 45% of U.S. sales from digital channels in 2014, as well as reach an estimated $3.6 billion in global digital sales.

Overall, we believe our focus in 2014 on global growth and technology will strengthen our brand in the future.

 

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Table of Contents

Fiscal 2013 Highlights

 

   

Global retail sales increased 8.2% as compared to 2012.

 

   

Same store sales increased 5.4% in our domestic stores and, when excluding the impact of foreign currency exchange rates, increased 6.2% in our international stores.

 

   

Our revenues increased 7.4%.

 

   

Our income from operations increased 11.2%.

 

   

Our net income increased 27.2%.

During 2013, we continued our strong global growth, as evidenced by the 631 net new stores that were opened. Our international segment led the way with 573 net new store openings.

We also remained focused on technology and improving the experience for our customers. We launched our enhanced online ordering profiles platform, allowing customers the ability to reorder their favorite order in as few as five clicks, or about 30 seconds. Our emphasis on technology innovation helped us generate approximately 40% of U.S. sales from digital channels in 2013, as well as reach an estimated $3 billion in global digital sales.

We believe our accomplishments and efforts in each of these areas will improve our brand image and brand positioning in the future.

Critical accounting policies and estimates

The following discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an ongoing basis, our management evaluates its estimates, including those related to revenue recognition, long-lived and intangible assets, insurance and legal matters, share-based payments and income taxes. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates. Changes in our accounting policies and estimates could materially impact our results of operations and financial condition for any particular period. We believe that our most critical accounting policies and estimates are:

Revenue recognition. We earn revenues through our network of domestic Company-owned and franchised stores, dough manufacturing and supply chain centers and international operations. Retail sales from franchise stores are reported to the Company by its franchisees and are not included in Company revenues. Retail sales from Company-owned stores and royalty revenues resulting from the retail sales from franchised stores are recognized as revenues when the items are delivered to or carried out by customers. Retail sales are generally reported and related royalties paid to the Company based on a percentage of retail sales, as specified in the related standard franchise agreement (generally 5.5% of domestic franchise retail sales and, on average, 3.1% of international franchise retail sales). Revenues from Company-owned stores and royalty revenues from franchised stores can fluctuate from time-to-time as a result of store count changes. This can occur when a Company-owned store is sold to a franchisee. If a Company-owned store that generated $500,000 in revenue in fiscal 2013 was sold to a franchisee in fiscal 2014, revenues from Company-owned stores would have declined by $500,000 in fiscal 2014, while franchise royalty revenues would have increased by only $27,500 in fiscal 2014, as we generally collect 5.5% of a domestic franchisee’s retail sales. Sales of food from our supply chain centers are recognized as revenues upon delivery of the food to franchisees, while sales of equipment and supplies are generally recognized as revenues upon shipment of the related products to franchisees.

Long-lived and intangible assets. We record long-lived assets, including property, plant and equipment and capitalized software, at cost. For acquisitions of franchise operations, we estimate the fair values of the assets and liabilities acquired based on physical inspection of assets, historical experience and other information available to us regarding the acquisition. We depreciate and amortize long-lived assets using useful lives determined by us based on historical experience and other information available to us. We evaluate the potential impairment of long-lived assets at least annually or whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Our evaluation is based on various analyses, including the projection of undiscounted cash flows. For Company-owned stores, we perform related impairment tests on an operating market basis, which the Company has determined to be the lowest level for which identifiable cash flows are largely independent of other cash flows. If the carrying amount of a long-lived asset exceeds the amount of the expected future undiscounted cash flows of that asset, the Company estimates the fair value of the asset. If the carrying amount of the asset exceeds the estimated fair value of the asset, an impairment loss is recognized and the asset is written down to its estimated fair value.

 

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We have not made any significant changes in the methodology used to project the future market cash flows of Company-owned stores during the years presented. Same store sales fluctuations and the rates at which operating costs will fluctuate in the future are key factors in evaluating recoverability of the related assets. If our same store sales significantly decline or if operating costs increase and we are unable to recover these costs, the carrying value of our Company-owned stores, by market, may be unrecoverable and we may be required to recognize an impairment charge. As discussed in Note 1 to our consolidated financial statements, the Company incurred an impairment charge related to its corporate airplane in the fourth quarter of 2014. Aside from this impairment charge, the Company did not record an impairment charge during fiscal 2014.

A significant portion of our goodwill relates to acquisitions of domestic franchise stores and is included in our domestic stores segment, specifically, our Company-owned stores division. We evaluate goodwill annually for impairment by comparing the fair value of the reporting unit (which is primarily determined using the present value of historical cash flows) to its carrying value. If the carrying value of the reporting unit exceeds the fair value, goodwill would be impaired. We have not made any significant changes in the methodology used to evaluate goodwill impairment during the years presented. At December 28, 2014, the fair value of our business operations with associated goodwill exceeded their recorded carrying value, including the related goodwill. If cash flows generated by our Company-owned stores were to decline significantly in the future or there were negative revisions to the market multiple assumption, we may be required to recognize a goodwill impairment charge. However, based on the latest impairment analysis, we do not believe it is reasonably likely that there could be changes in assumptions that would trigger impairment.

Insurance and legal matters. We are a party to lawsuits and legal proceedings arising in the ordinary course of business. Management closely monitors these legal matters and estimates the probable costs for the resolution of such matters. These estimates are primarily determined by consulting with both internal and external parties handling the matters and are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. While historically our actual losses have been materially consistent with our reserves, legal judgments can be volatile and difficult to predict. Accordingly, if our estimates relating to legal matters proved inaccurate for any reason, we may be required to increase or decrease the related expense in future periods. We had accruals for legal matters of approximately $4.3 million at December 28, 2014 and $5.0 million at December 29, 2013.

For certain periods prior to December 1998 and for periods after December 2001, we maintain insurance coverage for workers’ compensation, general liability and owned and non-owned auto liability under insurance policies requiring payment of a deductible for each occurrence up to between $500,000 and $3.0 million, depending on the policy year and line of coverage. The related insurance reserves are based on undiscounted independent actuarial estimates, which are based on historical information along with assumptions about future events. Specifically, various methods, including analyses of historical trends and actuarial valuation methods, are utilized to estimate the cost to settle reported claims, and claims incurred but not yet reported. The actuarial valuation methods develop estimates of the future ultimate claim costs based on the claims incurred as of the balance sheet date. When estimating these liabilities, several factors are considered, including the severity, duration and frequency of claims, legal cost associated with claims, healthcare trends and projected inflation.

Our methodology for determining our exposure has remained consistent throughout the years presented. Management believes that the various assumptions developed and actuarial methods used to determine our self-insurance reserves are reasonable and provide meaningful data that management uses to make its best estimate of our exposure to these risks. While historically our actual losses have been materially consistent with our reserves, changes in assumptions for such factors as medical costs and legal actions, as well as changes in actual experience, could cause our estimates to change in the near term which could result in an increase or decrease in the related expense in future periods. A 10% change in our self-insurance liability at December 28, 2014 would have affected our income before provision for income taxes by approximately $4.1 million for fiscal 2014. We had accruals for insurance matters of approximately $41.4 million at December 28, 2014 and $38.8 million at December 29, 2013.

Share-based payments. We recognize compensation expense related to our share-based compensation arrangements over the requisite service period based on the grant date fair value of the awards. The grant date fair value of each restricted stock and performance-based restricted stock award is equal to the market price of our stock on the date of grant. The grant date fair value of each stock option award is estimated using a Black-Scholes option pricing model. The pricing model requires assumptions, including the expected life of the stock option, the risk-free interest rate, the expected dividend yield and expected volatility of our stock over the expected life, which significantly impact the assumed fair value. We are also required to estimate the expected forfeiture rate and only recognize expense for those awards expected to vest. We use historical data to determine these assumptions. Additionally, our stock option, restricted stock and performance-based restricted stock arrangements provide for accelerated vesting and the ability to exercise during the remainder of the ten-year stock option life upon the retirement of individuals holding the awards who have achieved specified service and age requirements.

 

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Management believes that the methods and various assumptions used to determine compensation expense related to these arrangements are reasonable, but if the assumptions change significantly for future grants, share-based compensation expense will fluctuate in future years.

Income taxes. We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax basis of assets and liabilities and reserves for uncertain tax positions. We measure deferred tax assets and liabilities using current enacted tax rates that will apply in the years in which we expect the temporary differences to be recovered or paid. Judgment is required in determining the provision for income taxes, related reserves and deferred tax assets and liabilities. These include establishing a valuation allowance related to the ability to realize certain deferred tax assets, if necessary. On an ongoing basis, management will assess whether it remains more likely than not that the net deferred tax assets will be realized. The Company had valuation allowances recorded for deferred tax assets of approximately $0.5 million as of December 28, 2014 and approximately $0.9 million as of December 29, 2013. Our accounting for deferred tax assets represents our best estimate of future events. Our net deferred tax assets assume that we will generate sufficient taxable income in specific tax jurisdictions, based on our estimates and assumptions. Changes in our current estimates due to unanticipated events could have a material impact on our financial condition and results of operations.

The amounts recorded on the balance sheet relating to uncertain tax positions consider the ultimate resolution of revenue agent reviews based on estimates and assumptions. We believe we have appropriately accounted for our uncertain tax positions; however, tax audits, changes in tax laws and other unforeseen matters may result in us owing additional taxes. We adjust our reserves for uncertain tax positions when facts and circumstances change or due to the passage of time. The completion of a tax audit, the expiration of a statute of limitations, or changes in penalty and interest reserves associated with uncertain tax positions are examples of situations when we may adjust our reserves. Management believes that our tax positions comply with applicable tax law and that we have adequately provided for these matters. However, to the extent the final tax outcome of these matters is different than our recorded amounts, we may be required to adjust our tax reserves resulting in additional income tax expense or benefit in future periods.

Same Store Sales Growth

 

     2014     2013     2012  

Domestic Company-owned stores

     6.2     3.9     1.3

Domestic franchise stores

     7.7     5.5     3.2
  

 

 

   

 

 

   

 

 

 

Domestic stores

     7.5     5.4     3.1

International stores (excluding foreign currency impact)

     6.9     6.2     5.2
  

 

 

   

 

 

   

 

 

 

Store Growth Activity

 

     Domestic
Company-owned
Stores
    Domestic
Franchise
    Total
Domestic
Stores
    International
Stores
    Total  

Store count at January 1, 2012

     394        4,513        4,907        4,835        9,742   

Openings

     2        80        82        559        641   

Closings

     (2     (59     (61     (67     (128

Transfers

     (6     6        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Store count at December 30, 2012

     388        4,540        4,928        5,327        10,255   

Openings

     2        102        104        611        715   

Closings

     —          (46     (46     (38     (84
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Store count at December 29, 2013

     390        4,596        4,986        5,900        10,886   

Openings

     —          115        115        722        837   

Closings

     —          (34     (34     (60     (94

Transfers

     (13     13        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Store count at December 28, 2014

     377        4,690        5,067        6,562        11,629   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Income Statement Data

 

(dollars in millions)

   2014     2013     2012  

Domestic Company-owned stores

   $ 348.5        $ 337.4        $ 323.7     

Domestic franchise

     230.2          212.4          195.0     

Supply chain

     1,262.5          1,118.9          1,039.8     

International franchise

     152.6          133.6          120.0     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     1,993.8        100.0     1,802.2        100.0     1,678.4        100.0

Domestic Company-owned stores

     267.4          256.6          247.4     

Supply chain

     1,131.7          996.7          929.7     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost of sales

     1,399.1        70.2     1,253.2        69.5     1,177.1        70.1

Operating margin

     594.8        29.8     549.0        30.5     501.3        29.9

General and administrative

     249.4        12.5     235.2        13.1     219.0        13.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     345.4        17.3     313.8        17.4     282.3        16.8

Interest expense, net

     (86.7     (4.4 )%      (88.7     (4.9 )%      (101.1     (6.0 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before provision for income taxes

     258.6        13.0     225.1        12.5     181.2        10.8

Provision for income taxes

     96.0        4.8     82.1        4.6     68.8        4.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 162.6        8.2   $ 143.0        7.9   $ 112.4        6.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

2014 compared to 2013

(tabular amounts in millions, except percentages)

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 as a result of fluctuations in commodity prices as well as the mix of products we sell.

Consolidated revenues increased $191.6 million or 10.6% in 2014. The increase was driven by higher supply chain revenues due to higher volumes from increased store order counts, higher commodity prices, and increased sales of equipment to stores in connection with our store reimaging program. Domestic store revenues rose due to an increase in same store sales and store count growth. In addition, higher international franchise same store sales and store count growth also increased consolidated revenues. These increases were offset in part by the negative impact on international revenues of changes in foreign currency exchange rates. These changes in revenues are more fully described below.

Domestic stores. Revenues from domestic stores are primarily comprised of retail sales from domestic Company-owned store operations as well as royalties from retail sales and other fees from domestic franchised stores, as summarized in the following table.

 

     2014     2013  

Domestic Company-owned stores

   $ 348.5         60.2   $ 337.4         61.4

Domestic franchise

     230.2         39.8     212.4         38.6
  

 

 

    

 

 

   

 

 

    

 

 

 

Total domestic stores revenues

   $ 578.7         100.0   $ 549.8         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Higher franchise same store sales, store count growth and higher domestic Company-owned same store sales drove an increase in overall domestic store revenues of $28.9 million or 5.3%. These results are more fully described below.

Domestic Company-owned stores. Revenues from domestic Company-owned store operations increased $11.1 million or 3.3% in 2014. This increase was due to a 6.2% increase in same store sales as compared to 2013, offset in part by a decrease in the average number of domestic Company-owned stores open during 2014.

Domestic franchise. Revenues from domestic franchise operations increased $17.8 million or 8.4% in 2014. The increase was driven by a 7.7% increase in same store sales as compared to 2013 and, to a lesser extent, an increase in the average number of domestic franchised stores open during 2014. Revenues further benefited from fees paid by franchisees related to our insourced online ordering platform and we also incurred an increase in expenses related to these technology initiatives.

 

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Supply chain. Revenues from supply chain operations are primarily comprised of sales of food, equipment and supplies from our supply chain centers to substantially all of our domestic franchised stores and certain international franchised stores, as summarized in the following table.

 

     2014     2013  

Domestic supply chain

   $ 1,141.1         90.4   $ 1,009.9         90.3

International supply chain

     121.4         9.6     109.0         9.7
  

 

 

    

 

 

   

 

 

    

 

 

 

Total supply chain

   $ 1,262.5         100.0   $ 1,118.9         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Domestic supply chain. Domestic supply chain revenues increased $131.2 million or 13.0% in 2014. The increase was primarily attributable to higher volumes from increased order counts at the store level, higher overall commodity prices, and increases in sales of equipment and supplies. Changes in U.S. cheese prices increased revenues by approximately $33.0 million in 2014.

International supply chain. Revenues from international supply chain operations increased $12.4 million or 11.3% in 2014. This increase resulted primarily from higher volumes in 2014, and was offset in part by the negative impact of foreign currency exchange rates of approximately $7.3 million during the year.

International franchise. International franchise revenues primarily consist of royalties from retail sales and other fees from our international franchise stores. Revenues from international franchise operations increased $19.0 million or 14.3% in 2014. This increase was due to higher same store sales and an increase in the average number of international stores open during 2014, and was offset in part by the negative impact of changes in foreign currency exchange rates of approximately $3.4 million in 2014. Excluding the impact of foreign currency exchange rates, same store sales increased 6.9% in 2014 compared to 2013. When the impact of foreign currency exchange rates is included, same store sales increased 4.9% in 2014 compared to 2013. This variance was caused by a generally stronger U.S. dollar when compared to the currencies in the international markets in which we compete.

Cost of sales / Operating margin. Consolidated cost of sales consists primarily of domestic 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. The changes to the consolidated operating margin, which we define as revenues less cost of sales are summarized in the following table.

 

     2014     2013  

Consolidated revenues

   $ 1,993.8         100.0   $ 1,802.2         100.0

Consolidated cost of sales

     1,399.1         70.2     1,253.2         69.5
  

 

 

    

 

 

   

 

 

    

 

 

 

Consolidated operating margin

   $ 594.8         29.8   $ 549.0         30.5
  

 

 

    

 

 

   

 

 

    

 

 

 

The $45.8 million or 8.3% increase in consolidated operating margin was due primarily to higher domestic and international franchise revenues and higher supply chain margins. Franchise revenues do not have a cost of sales component, so changes in franchise revenues have a disproportionate effect on the consolidated operating margin.

As a percentage of total revenues, our consolidated operating margin decreased 0.7 percentage points in 2014, due to lower supply chain and Company-owned stores operating margins as a percentage of their revenues. These changes were primarily a result of higher commodity prices and were offset in part by a higher mix of franchise revenues and are more fully described below.

Domestic Company-owned stores. The changes to domestic Company-owned store operating margin, which do not include other store-level costs such as royalties and advertising, are summarized in the following table.

 

     2014     2013  

Revenues

   $ 348.5         100.0   $ 337.4         100.0

Cost of sales

     267.4         76.7     256.6         76.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Store operating margin

   $ 81.1         23.3   $ 80.8         24.0
  

 

 

    

 

 

   

 

 

    

 

 

 

The $0.3 million or 0.4% increase in the domestic Company-owned store operating margin was due primarily to higher same store sales. This was offset in part by an increase in overall commodity prices and labor and related expenses.

As a percentage of store revenues, the store operating margin decreased 0.7 percentage points in 2014, as discussed in more detail below.

 

   

Food costs increased 0.7 percentage points to 28.3% in 2014, due primarily to higher overall commodity prices. The cheese block price per pound averaged $2.13 in 2014 compared to $1.75 in 2013.

 

   

Occupancy costs, which include rent, telephone, utilities and depreciation, decreased 0.1 percentage points to 9.2% in 2014 due primarily to the positive impact of higher sales per store.

 

   

Labor and related costs remained flat at 28.0% in 2014.

 

   

Insurance costs decreased 0.1 percentage points to 2.7% in 2014, due primarily to the positive impact of higher sales per store.

 

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Supply chain. The changes to the supply chain operating margin are summarized in the following table.

 

     2014     2013  

Revenues

   $ 1,262.5         100.0   $ 1,118.9         100.0

Cost of sales

     1,131.7         89.6     996.7         89.1
  

 

 

    

 

 

   

 

 

    

 

 

 

Supply chain operating margin

   $ 130.8         10.4   $ 122.2         10.9
  

 

 

    

 

 

   

 

 

    

 

 

 

The $8.6 million increase in the supply chain operating margin was due primarily to higher volumes from increased store order counts.

As a percentage of supply chain revenues, the supply chain operating margin decreased 0.5 percentage points in 2014 due to higher commodity prices and higher health insurance costs, offset in part by the positive impact of higher volumes. Increases in certain food prices have a negative effect on the supply chain operating margin percentage due to the fixed dollar margin earned by supply chain on certain food items. Changes in U.S. cheese prices increased both revenues and costs by $33.0 million in 2014. If the 2014 U.S. cheese prices had been in effect during 2013, the supply chain operating margin as a percentage of supply chain revenues would have decreased by 0.3 percentage points. However, the dollar margin would have been unaffected.

General and administrative expenses. General and administrative expenses increased $14.2 million or 6.1% in 2014. These increases were due in part to an impairment charge of $5.8 million in connection with replacing our corporate airplane, as well as continued investments that we made in technology and international initiatives, including the addition of team members in both areas. A decrease in non-cash compensation expense of $4.4 million partially offset these increases.

Interest income. Interest income decreased slightly to $0.1 million in 2014.

Interest expense. Interest expense decreased $2.0 million to $86.9 million in 2014. The decrease was due primarily to lower interest expense resulting from a lower average debt balance during 2014 compared to 2013 and to a lesser extent, lower interest expense from the cash collateralization of our letters of credit.

Our cash borrowing rate remained flat at 5.3% during fiscal 2014. Our average outstanding debt balance, excluding capital lease obligations, was approximately $1.52 billion in 2014 and approximately $1.54 billion in 2013. The decrease in the Company’s average outstanding debt balance resulted from the principal payments made on its fixed rate notes during the first two quarters of 2014.

Provision for income taxes. Provision for income taxes increased $13.9 million to $96.0 million in 2014, due primarily to higher pre-tax income. The Company’s effective income tax rate increased 0.6 percentage points to 37.1% of pre-tax income in 2014. The lower effective tax rate in fiscal 2013 primarily resulted from a tax benefit recorded for prior tax years in connection with the Company revising its calculation for a deduction related to its domestic dough production.

2013 compared to 2012

(tabular amounts in millions, except percentages)

Revenues. Consolidated revenues increased $123.8 million or 7.4% in 2013. The increase was driven by higher supply chain revenues due to a change in the mix of products sold, higher volumes from increased store order counts and higher commodity prices. Higher International same store sales and store count growth also increased consolidated revenues. Domestic franchise and Company-owned store revenues also rose due to an increase in same store sales. These increases were offset in part by the negative impact on international revenues of changes in foreign currency exchange rates. These changes in revenues are more fully described below.

Domestic stores. Domestic stores revenues are summarized in the following table.

 

     2013     2012  

Domestic Company-owned stores

   $ 337.4         61.4   $ 323.7         62.4

Domestic franchise

     212.4         38.6     195.0         37.6
  

 

 

    

 

 

   

 

 

    

 

 

 

Total domestic stores revenues

   $ 549.8         100.0   $ 518.7         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Higher franchise same store sales and higher domestic Company-owned same store sales drove an increase in royalty revenues, which increased overall domestic store revenues by $31.1 million or 6.0%. These results are more fully described below.

Domestic Company-owned stores. Revenues from domestic Company-owned store operations increased $13.8 million or 4.3% in 2013. The increase was primarily due to a 3.9% increase in same store sales as compared to 2012.

 

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Domestic franchise. Revenues from domestic franchise operations increased $17.4 million or 8.9% in 2013. The increase was driven by a 5.5% increase in same store sales as compared to 2012 and to a lesser extent, an increase in the average number of domestic franchised stores open during 2013. Revenues further benefited from fees paid by franchisees related to our insourced online ordering platform and we also incurred an increase in expenses related to these technology initiatives. Additionally, we contracted with a third party to manage our gift card program during 2013. In connection with this change, we refined our assessment of our gift card liability and recorded approximately $3.2 million of domestic franchise revenue and reimbursed approximately $1.5 million to our national advertising fund, as discussed further in general and administrative expenses.

Supply chain. Supply chain revenues are summarized in the following table.

 

     2013     2012  

Domestic supply chain

   $ 1,009.9         90.3   $ 942.2         90.6

International supply chain

     109.0         9.7     97.6         9.4
  

 

 

    

 

 

   

 

 

    

 

 

 

Total supply chain

   $ 1,118.9         100.0   $ 1,039.8         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Domestic supply chain. Domestic supply chain revenues increased $67.7 million or 7.2% in 2013. The increase was primarily attributable to higher volumes from increased order counts at the store level, higher overall commodity prices, a change in the mix of products sold and increases in sales of equipment and supplies. Changes in U.S. cheese prices increased revenues by approximately $8.6 million in 2013.

International supply chain. Revenues from international supply chain operations increased $11.4 million or 11.7% in 2013. The increase resulted primarily from higher volumes during the year, and was offset in part by the negative impact of foreign currency exchange rates of $2.9 million in 2013.

International franchise. International franchise revenues increased $13.6 million or 11.3% in 2013. The increase was primarily driven by higher same store sales and an increase in the average number of international stores open during 2013, offset in part by the negative impact of changes in foreign currency exchange rates of approximately $4.3 million in 2013. Excluding the impact of foreign currency exchange rates, same store sales increased 6.2% in 2013 compared to 2012. When the impact of foreign currency exchange rates is included, same store sales increased 2.8% in 2013 compared to 2012. This variance was caused by a generally stronger U.S. dollar when compared to the currencies in the international markets in which we compete.

Cost of sales / Operating margin. The changes to the consolidated operating margin, which we define as revenues less cost of sales, are summarized in the following table.

 

     2013     2012  

Consolidated revenues

   $ 1,802.2         100.0   $ 1,678.4         100.0

Consolidated cost of sales

     1,253.2         69.5     1,177.1         70.1
  

 

 

    

 

 

   

 

 

    

 

 

 

Consolidated operating margin

   $ 549.0         30.5   $ 501.3         29.9
  

 

 

    

 

 

   

 

 

    

 

 

 

The $47.7 million or 9.5% increase in consolidated operating margin was due primarily to higher domestic and international franchise revenues, higher margins at our Company-owned stores and higher domestic supply chain margins. Franchise revenues do not have a cost of sales component, so changes in franchise revenues have a disproportionate effect on the consolidated operating margin.

As a percentage of total revenues, our consolidated operating margin increased 0.6 percentage points in 2013, due to a higher mix of franchise revenues and higher supply chain and Company-owned stores operating margins, offset in part by higher overall commodity prices.

Domestic Company-owned stores. The changes to domestic Company-owned store operating margin, which do not include other store-level costs such as royalties and advertising, are summarized in the following table.

 

     2013     2012  

Revenues

   $ 337.4         100.0   $ 323.7         100.0

Cost of sales

     256.6         76.0     247.4         76.4
  

 

 

    

 

 

   

 

 

    

 

 

 

Store operating margin

   $ 80.8         24.0   $ 76.3         23.6
  

 

 

    

 

 

   

 

 

    

 

 

 

The $4.5 million or 6.0% increase in the domestic Company-owned store operating margin was the result of higher same store sales, lower labor and related expenses, lower occupancy expenses and lower insurance expenses. This was offset in part by an increase in overall commodity prices.

 

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As a percentage of store revenues, the store operating margin increased 0.4 percentage points in 2013, as discussed in more detail below.

 

   

Food costs increased 0.5 percentage points to 27.6% in 2013, due primarily to higher overall commodity prices. The cheese block price per pound averaged $1.75 in 2013 compared to $1.69 in 2012.

 

   

Occupancy costs, which include rent, telephone, utilities and depreciation, decreased 0.2 percentage points to 9.3% in 2013 due primarily to the positive impact of higher sales per store.

 

   

Labor and related costs decreased 0.4 percentage points to 28.0% in 2013, due primarily to leveraging the higher sales per store.

 

   

Insurance costs decreased 0.3 percentage points to 2.8% in 2013, due primarily to lower health costs per store and the positive impact of higher sales per store.

Supply chain. The changes to the supply chain operating margin are summarized in the following table.

 

     2013     2012  

Revenues

   $ 1,118.9         100.0   $ 1,039.8         100.0

Cost of sales

     996.7         89.1     929.7         89.4
  

 

 

    

 

 

   

 

 

    

 

 

 

Supply chain operating margin

   $ 122.2         10.9   $ 110.1         10.6
  

 

 

    

 

 

   

 

 

    

 

 

 

The supply chain operating margin increased $12.1 million or 11.0% in 2013 due primarily to higher volumes from increased store order counts and a change in the mix of products sold.

As a percentage of supply chain revenues, the supply chain operating margin increased 0.3 percentage points in 2013 due to the positive impact of higher volumes and lower health insurance costs, offset in part by higher commodity costs. Increases in certain food prices have a negative effect on the supply chain operating margin percentage due to the fixed dollar margin earned by supply chain on certain food items. Changes in U.S. cheese prices increased both revenues and costs by $8.6 million in 2013. If the 2013 U.S. cheese prices had been in effect during 2012, the supply chain operating margin as a percentage of supply chain revenues would have decreased by 0.1 percentage points. However, the dollar margin would have been unaffected.

General and administrative expenses. General and administrative expenses increased $16.2 million or 7.4% in 2013. These increases were due in part to an increase in non-cash compensation expense of $4.4 million and higher variable performance-based compensation expenses of approximately $2.0 million. General and administrative expenses also include a reimbursement of approximately $1.5 million during 2013 to our national advertising fund related to their historical costs to support the Company’s gift card program, as discussed above in domestic franchise revenues. Additionally, we continued our investments in technology and international initiatives, including the addition of team members in both areas, which also increased general and administrative expenses during 2013 compared to 2012.

Interest income. Interest income decreased slightly to $0.2 million in 2013.

Interest expense. Interest expense decreased $12.6 million to $88.9 million in 2013. The decrease was driven by approximately $10.2 million of expenses incurred in the first quarter of 2012 related to the 2012 Recapitalization which did not recur in 2013, as well as from lower interest expense resulting from a lower average debt balance during 2013 compared to 2012.

Our cash borrowing rate decreased slightly, by 0.2 percentage points, to 5.3% during fiscal 2013. Our average outstanding debt balance, excluding capital lease obligations, was approximately $1.5 billion in 2013 and approximately $1.6 billion in 2012. The decrease in the Company’s average outstanding debt balance resulted from the principal payments made on its fixed rate notes during 2013.

Provision for income taxes. Provision for income taxes increased $13.3 million in 2013, due primarily to higher pre-tax income. The Company’s 2013 effective income tax rate decreased 1.5 percentage points to 36.5% of pre-tax income. This decrease was partly from a tax benefit of approximately $1.4 million recorded in the third quarter of 2013 related to prior tax years in connection with the Company revising its calculation for a deduction related to its domestic dough production.

 

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Liquidity and capital resources

Historically, we have operated with minimal positive working capital or negative working capital primarily because our receivable collection periods and inventory turn rates are faster than the normal payment terms on our current liabilities. We generally collect our receivables within three weeks from the date of the related sale, and we generally experience 30 to 40 inventory turns per year. In addition, our sales are not typically seasonal, which further limits our working capital requirements. These factors, coupled with the use of our ongoing cash flows from operations to service our debt obligations, invest in our business, pay dividends and repurchase our common stock, reduce our working capital amounts. As of December 28, 2014, we had working capital of $41.8 million, excluding restricted cash and cash equivalents of $121.0 million and including total unrestricted cash and cash equivalents of $30.9 million.

As of December 28, 2014, we had approximately $56.2 million of restricted cash held for future principal and interest payments, $43.9 million of cash held as collateral for outstanding letters of credit, $20.8 million of restricted cash held in a three month interest reserve as required by the related debt agreements and $0.1 million of other restricted cash, for a total of $121.0 million of restricted cash and cash equivalents.

The Company entered into a recapitalization transaction in 2012, in which certain of our subsidiaries replaced the outstanding 2007 fixed rate notes and variable funding notes with new notes (the Notes) issued pursuant to an asset-backed securitization. The Notes consist of $1.575 billion of Series 2012-1 5.216% Fixed Rate Senior Secured Notes, Class A-2 (the Fixed Rate Notes) and $100.0 million of Series 2012-1 Variable Funding Senior Secured Notes, Class A-1 (the Variable Funding Notes). Additional information related to the Recapitalization transaction is included in Note 4 to our consolidated financial statements.

The Fixed Rate Notes original scheduled principal amortization payments are $29.5 million in 2015, $37.4 million in 2016, $39.4 million in each of 2017 and 2018, and $9.8 million in 2019. In accordance with our debt agreements, once we meet certain conditions, including maximum leverage ratios as defined of less than or equal to 4.5x total debt to EBITDA, we cease to make the scheduled principal amortization payments. If one of the defined leverage ratios subsequently exceeds 4.5x, we must make-up the payments we had previously not made. During the second quarter of 2014, we met the maximum leverage ratios of less than 4.5x, and, in accordance with our debt agreements, ceased debt amortization payments in the third quarter of 2014. We continued to meet the maximum leverage ratios of less than 4.5x in the third and fourth quarters of 2014 and currently do not plan to make previously scheduled debt amortization payments as permitted in our debt agreements.

The Notes are subject to certain financial and non-financial covenants, including a debt service coverage calculation, as defined in the related agreements. In the event that certain covenants are not met, the Notes may become due and payable on an accelerated schedule.

On March 16, 2012, our Board of Directors declared a $3.00 per share special cash dividend on the outstanding common stock totaling $171.1 million, which was paid on April 2, 2012 to stockholders of record at the close of business on March 26, 2012. Additionally, under the anti-dilution provisions in our underlying stock option plans, on April 2, 2012, we made a corresponding cash payment of approximately $13.5 million on certain stock options, reduced the exercise price on certain other stock options by an equivalent per share amount and, in certain circumstances, both reduced the stock option exercise price and made a cash payment totaling $3.00 per share.

On April 2, 2012, we also accrued an estimated $2.4 million for payments to be made as certain performance-based restricted stock grants vest. The dividend and related dividend equivalent payments were funded with the remaining proceeds from the 2012 Recapitalization and cash on hand. These anti-dilution payments were accounted for as modifications/settlements and were recorded as increases in total stockholders’ deficit. As of December 30, 2012, total cash paid for common stock dividends and related anti-dilution equivalent payments was approximately $185.5 million and the total estimated liability recorded for future cash dividend payments on certain performance-based restricted stock was approximately $1.5 million. As of December 28, 2014, the total estimated liability recorded for future cash dividend payments on certain performance-based restricted stock was approximately $0.6 million.

During fiscal 2012, in connection with the 2012 Recapitalization, we incurred approximately $10.5 million of net expenses. Additionally, we recorded an additional $32.5 million of deferred financing costs as an asset in the consolidated balance sheet during fiscal 2012. This amount, in addition to the $7.4 million recorded on the consolidated balance sheet at January 1, 2012 is being amortized into interest expense over the seven-year expected term of the debt.

 

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Our primary source of liquidity is cash flows from operations and availability of borrowings under our Variable Funding Notes. As of December 28, 2014, we had $44.1 million of outstanding letters of credit and $55.9 million of available borrowing capacity under our Variable Funding Notes. The letters of credit are primarily related to our casualty insurance programs and supply chain center leases. The Company has collateralized these letters of credit with $43.9 million of restricted cash to reduce its fees on the Variable Funding Notes, and has the ability to access this cash with minimal notice. Borrowings under the Variable Funding Notes are available to fund our working capital requirements, capital expenditures and, subject to other limitations, other general corporate purposes including dividend payments.

The Company has a Board of Directors-approved open market share repurchase program of the Company’s common stock, which was reset during the first quarter of 2014 at $200.0 million. The open market share repurchase program has historically been funded by excess cash flows. The Company used cash of approximately $82.4 million in 2014 and $97.1 million in 2013 for share repurchases. The Company had approximately $132.7 million left under the $200.0 million authorization as of December 28, 2014. We expect to continue to use ongoing excess cash flow generation and (subject to certain restrictions in the documents governing the Variable Funding Notes) availability under the Variable Funding Notes to, among other things, repurchase shares under the current authorized program.

In the past three years, we have invested between $29.3 million and $71.8 million annually in capital expenditures. In 2014, we invested $71.8 million in capital expenditures which primarily related to investments in existing Company-owned stores, supply chain centers and training facilities, the purchase of a corporate airplane, investments in our proprietary internally developed point-of-sale system (Domino’s PULSE), our digital ordering platform and other technology initiatives. We expect to continue capital expenditures of $50 to $60 million in the future as we see continuing opportunities to invest in our industry leading technology platform, the reimaging of our corporate stores and other initiatives to grow our brand. We did not have any material commitments for capital expenditures as of December 28, 2014.

The following table illustrates the main components of our cash flows:

 

     Fiscal Year Ended  

(In thousands)

   December 28,
2014
     December 29,
2013
     December 30,
2012
 

Cash Flows Provided By (Used In)

        

Net cash provided by operating activities

   $ 192.3       $ 194.0       $ 176.3   

Net cash provided by (used in) investing activities

     (57.4      (99.7      7.3   

Net cash used in financing activities

     (118.9      (134.8      (177.4

Exchange rate changes

     0.5         0.1         (1.7
  

 

 

    

 

 

    

 

 

 

Change in cash and equivalents

   $ 16.5       $ (40.4    $ 4.5   
  

 

 

    

 

 

    

 

 

 

Operating Activities

Cash provided by operating activities was $192.3 million in fiscal 2014. Our cash provided by operating activities was mainly the result of net income of $162.6 million that was generated during the year, which included non-cash expenses of $29.7 million.

During fiscal 2013, cash provided by operating activities was $194.0 million, mainly the result of net income of $143.0 generated during fiscal 2013 and which included non-cash expenses of $39.5 million. The changes in operating assets and liabilities also generated $11.5 million of cash inflows during 2013.

Cash provided by operating activities was $176.3 million in fiscal 2012. Our cash provided by operating activities was mainly the result of net income of $112.4 million that was generated during the year and which included $43.8 million of non-cash expenses. The changes in operating assets and liabilities also generated $20.1 million of cash inflows, primarily from the timing of payments of operating liabilities.

We are focused on continually improving our net income and cash flow from operations, and management expects to continue to generate positive cash flows from operating activities for the foreseeable future.

Investing Activities

During fiscal 2014, cash used in investing activities was $57.4 million, which consisted primarily of $70.1 million of capital expenditures (driven by increased investments in Company-owned stores and supply chain centers, investments in our technology initiatives, and the purchase of a corporate airplane). Proceeds from the sale of assets of $9.2 million and a $4.5 million net change in restricted cash offset the use of cash in investing activities.

 

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During fiscal 2013, cash used in investing activities was $99.7 million, which consisted primarily of a $65.4 million net change in restricted cash and cash equivalents and $40.4 million of capital expenditures, offset by $4.5 million of proceeds from the sale of assets.

Cash provided by investing activities was $7.3 million in fiscal 2012. The main drivers of this change were the net change in restricted cash that provided $32.6 million of cash, and the use of cash through $29.3 million of capital expenditures.

Financing Activities

We used $118.9 million of cash in financing activities in fiscal 2014 compared to $134.8 million during fiscal 2013, both primarily related to purchases of common stock, funding dividend payments to our shareholders and making payments on our long-term debt obligations. The tax impact of equity-based compensation offset the use of cash in financing activities in both fiscal 2014 and fiscal 2013.

In fiscal 2012, we used $177.4 million of cash in financing activities. During fiscal 2012 we issued $1.6 billion of debt in connection with our 2012 Recapitalization, which was more than offset by the $1.5 billion repayment of our existing debt at that time, the payment of $185.5 million of special dividend payments to our shareholders, $88.2 million purchases of common stock, and $32.5 million of cash paid for financing costs related to our 2012 Recapitalization.

During fiscal 2014, we experienced increases in both domestic and international same store sales and our international business continued to grow stores. These factors have contributed to our continued ability to generate positive operating cash flows. We expect to use our unrestricted cash and cash equivalents, our restricted cash amounts pledged as collateral for letters of credit, ongoing cash flows from operations and available borrowings under the Variable Funding Notes to, among other things, fund working capital requirements, invest in our core business, pay dividends and repurchase our common stock. Based upon the current level of operations and anticipated growth, we believe that the cash generated from operations, our current unrestricted cash and cash equivalents and amounts available under the Variable Funding Notes will be more than adequate to meet our anticipated debt service requirements, capital expenditures, dividend payments and working capital needs for the foreseeable future.

Our ability to continue to fund these items and continue to reduce debt could be adversely affected by the occurrence of any of the events described in Item 1A. Risk Factors. There can be no assurance, however, that our business will generate sufficient cash flows from operations or that future borrowings will be available under the Variable Funding Notes or otherwise to enable us to service our indebtedness, or to make anticipated capital expenditures. Our future operating performance and our ability to service, extend or refinance the Fixed Rate Notes and to service, extend or refinance the Variable Funding Notes will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control.

Impact of inflation

We believe that our results of operations are not materially impacted by moderate changes in the inflation rate. Inflation did not have a material impact on our operations in 2014, 2013 or 2012. Severe increases in inflation, however, could affect the global and U.S. economies and could have an adverse impact on our business, financial condition and results of operations. Further discussion on the impact of commodities and other cost pressures is included above as well as in Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

New accounting pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers. This guidance outlines a single, comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance issued by the FASB, including industry specific guidance. The guidance is effective for the Company for interim and annual reporting periods beginning on January 1, 2017, and permits the use of either the retrospective or cumulative effect transition method. Early adoption is prohibited. The Company is evaluating the effect that this guidance will have on its consolidated financial statements and related disclosures.

Accounting standards that have been issued by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on our consolidated financial statements upon adoption.

 

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Contractual obligations

The following is a summary of our significant contractual obligations at December 28, 2014.

 

(dollars in millions)

   2015      2016      2017      2018      2019      Thereafter      Total  

Long-term debt (1):

                    

Principal

   $ —         $ —         $ —         $ —         $ 1,521.8       $ —         $ 1,521.8   

Interest (2)

     79.4         79.4         79.4         79.4         19.8         —           337.4   

Capital leases (3)

     0.7         0.7         0.7         0.5         —           —           2.6   

Operating leases (4)

     38.6         36.3         32.4         28.7         22.3         45.7         204.0   

 

(1) The maturity date of the long-term debt noted within the table above reflects the Company’s expected repayment date of January 2019, rather than the legal maturity date of January 2042.
(2) The interest rate on our variable funding notes is based primarily on a current commercial paper rate plus 350 basis points. The interest rate on the Fixed Rate Notes is fixed at 5.216% per year.
(3) The principal portion of the capital lease obligation amounts above, which totaled $2.3 million at December 28, 2014, are classified as debt in our consolidated financial statements.
(4) We lease certain retail store and supply chain center locations, supply chain vehicles, various equipment and our World Resource Center, which is our corporate headquarters, under leases with expiration dates through 2024.

Liabilities for unrecognized tax benefits of $2.9 million are excluded from the above table, as we are unable to make a reasonably reliable estimate of the amount and period of payment. For additional information on unrecognized tax benefits see Note 6 to the consolidated financial statements included in this Form 10-K.

Off-balance sheet arrangements

We are party to letters of credit and, to a lesser extent, financial guarantees with off-balance sheet risk. Our exposure to credit loss for letters of credit and financial guarantees is represented by the contractual amounts of these instruments. Total conditional commitments under letters of credit as of December 28, 2014 were approximately $44.1 million and relate to our insurance programs and supply chain center leases. The Company has guaranteed lease payments related to certain franchisees’ lease arrangements. The maximum amount of potential future payments under these guarantees is $2.2 million as of December 28, 2014. We believe that none of these arrangements has or is likely to have a material effect on our results of operations, financial condition or liquidity.

SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This Annual Report on Form 10-K includes various forward-looking statements about the Company within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”) that are based on current management expectations that involve substantial risks and uncertainties which could cause actual results to differ materially from the results expressed in, or implied by, these forward-looking statements. The following cautionary statements are being made pursuant to the provisions of the Act and with the intention of obtaining the benefits of the “safe harbor” provisions of the Act. These forward-looking statements generally can be identified by the use of words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will,” “potential,” “outlook” and similar terms and phrases, including references to assumptions, are forward-looking statements. These forward-looking statements address various matters including information concerning future results of operations and business strategy, and statements about our ability to complete our “Pizza Theater” store redesign, the expected demand for future pizza delivery, our expectation that we will meet the terms of our agreement with our third-party supplier of pizza cheese, our belief that alternative third-party suppliers are available for our key ingredients in the event we are required to replace any of our supply partners, our intention to continue to enhance and grow online ordering, digital marketing and technological capabilities, our expectation that there will be no material capital expenditures for environmental control facilities, our plans to expand international operations in many of the markets where we currently operate and in selected new markets, our expectation that the contribution rate for advertising fees payable to DNAF will remain in place for the foreseeable future, our expectation that we will not make previously scheduled amortization payments as permitted under our debt agreements and our expectation that we will use our unrestricted cash and cash equivalents, restricted cash amounts pledged as collateral for letters of credit, ongoing cash flows from operations and available borrowings under the Variable Funding Notes to, among other things, fund working capital requirements, invest in our core business, pay dividends and repurchase our common stock. Forward-looking statements relating to our anticipated profitability, the growth of our international business, ability to service our indebtedness, our operating performance, trends in our business and other descriptions of future events reflect management’s expectations based upon currently available information and data. While we believe these expectations and projections are based on reasonable assumptions, such forward-looking statements are inherently subject to risks, uncertainties and assumptions about us, including the risk factors listed under Item 1A. Risk Factors, as well as other cautionary language in this Form 10-K.

 

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Actual results may differ materially from those in the forward looking statements as a result of various factors, including but not limited to, the following:

 

 

our substantial increased indebtedness as a result of the 2012 Recapitalization and our ability to incur additional indebtedness or refinance that indebtedness in the future;

 

 

our future financial performance;

 

 

the success of our marketing initiatives;

 

 

our future cash needs;

 

 

our ability to maintain good relationships with our franchisees;

 

 

our ability to successfully implement cost-saving strategies;

 

 

increases in our operating costs, including cheese, fuel and other commodity costs and the minimum wage;

 

 

our ability to compete domestically and internationally in our intensely competitive industry;

 

 

additional risk precipitated by international operations;

 

 

our ability to retain or replace our executive officers and other key members of management and our ability to adequately staff our stores and supply chain centers with qualified personnel;

 

 

our ability to pay principal and interest on our substantial debt;

 

 

our ability to find and/or retain suitable real estate for our stores and supply chain centers;

 

 

adverse legislation, regulation or publicity;

 

 

adverse legal judgments or settlements;

 

 

food-borne illness or contamination of products;

 

 

data breaches or other cyber risks;

 

 

the effect of war, terrorism or catastrophic events;

 

 

our ability to pay dividends;

 

 

changes in consumer taste, demographic trends and traffic patterns; and

 

 

adequacy of insurance coverage.

All forward-looking statements should be evaluated with the understanding of their inherent uncertainty. We will not undertake and specifically decline any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Annual Report on Form 10-K might not occur.

Forward-looking statements speak only as of the date of this Form 10-K. Except as required under federal securities laws and the rules and regulations of the Securities and Exchange Commission, we do not have any intention to update any forward-looking statements to reflect events or circumstances arising after the date of this Form 10-K, whether as a result of new information, future events or otherwise. As a result of these risks and uncertainties, readers are cautioned not to place undue reliance on the forward-looking statements included in this Form 10-K or that may be made elsewhere from time to time by, or on behalf of, us. All forward-looking statements attributable to us are expressly qualified by these cautionary statements.

 

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Market risk

We do not engage in speculative transactions nor do we hold or issue financial instruments for trading purposes. In connection with the 2012 Recapitalization, we issued fixed rate notes and, at December 28, 2014, we are only exposed to interest rate risk on borrowings under our Variable Funding Notes. As of December 28, 2014, we had no outstanding borrowings under our Variable Funding Notes. Our fixed rate debt exposes the Company to changes in market interest rates reflected in the fair value of the debt and to the risk that the Company may need to refinance maturing debt with new debt at a higher rate.

We are exposed to market risks from changes in commodity prices. During the normal course of business, we purchase cheese and certain other food products that are affected by changes in commodity prices and, as a result, we are subject to volatility in our food costs. We may periodically enter into financial instruments to manage this risk. We do not engage in speculative transactions nor do we hold or issue financial instruments for trading purposes. In instances when we use fixed pricing agreements with our suppliers, these agreements cover our physical commodity needs, are not net-settled and are accounted for as normal purchases.

From time to time we have entered into interest rate swaps, collars or similar instruments with the objective of managing volatility relating to our borrowing costs. We had no outstanding derivative instruments as of December 28, 2014 or December 29, 2013.

Foreign currency exchange rate risk

We have exposure to various foreign currency exchange rate fluctuations for revenues generated by our operations outside the United States, which can adversely impact our net income and cash flows. Approximately 7.7% of our total revenues in 2014, 7.4% of our total revenues in 2013 and 7.1% of our total revenues in 2012 were derived from our international franchise segment, a majority of which were denominated in foreign currencies. We also operate dough manufacturing and distribution facilities in Canada, which generate revenues denominated in Canadian dollars. We do not enter into financial instruments to manage this foreign currency exchange risk. A hypothetical 10% adverse change in the foreign currency rates for our international markets would have resulted in a negative impact on royalty revenues of approximately $14.7 million in 2014.

 

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Item 8. Financial Statements and Supplementary Data.

Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors

of Domino’s Pizza, Inc.:

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Domino’s Pizza, Inc. and its subsidiaries at December 28, 2014 and December 29, 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 28, 2014 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(a)(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 28, 2014, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Annual Report on Internal Control over Financial Reporting, appearing under Item 9(A). Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

/s/ PricewaterhouseCoopers LLP
Detroit, Michigan
February 24, 2015

 

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DOMINO’S PIZZA, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

 

     December 28,
2014
    December 29,
2013
 
ASSETS     

CURRENT ASSETS:

    

Cash and cash equivalents

   $ 30,855      $ 14,383   

Restricted cash and cash equivalents

     120,954        125,453   

Accounts receivable, net of reserves of $3,361 in 2014 and $5,107 in 2013

     118,395        105,779   

Inventories

     37,944        30,321   

Notes receivable, net of reserves of $534 in 2014 and $357 in 2013

     1,996        1,823   

Prepaid expenses and other

     30,573        18,376   

Advertising fund assets, restricted

     72,055        44,695   

Deferred income taxes

     9,857        10,710   

Asset held-for-sale

     5,732        —     
  

 

 

   

 

 

 

Total current assets

     428,361        351,540   
  

 

 

   

 

 

 

PROPERTY, PLANT AND EQUIPMENT:

    

Land and buildings

     25,859        23,423   

Leasehold and other improvements

     99,804        90,508   

Equipment

     178,378        174,667   

Construction in progress

     6,179        8,900   
  

 

 

   

 

 

 
     310,220        297,498   

Accumulated depreciation and amortization

     (196,174     (199,914
  

 

 

   

 

 

 

Property, plant and equipment, net

     114,046        97,584   
  

 

 

   

 

 

 

OTHER ASSETS:

    

Investments in marketable securities, restricted

     4,586        3,269   

Notes receivable, less current portion, net of reserves of $397 in 2014 and $393 in 2013

     —          894   

Deferred financing costs, net of accumulated amortization of $17,041 in 2014 and $11,295 in 2013

     22,947        28,693   

Goodwill

     16,297        16,598   

Capitalized software, net of accumulated amortization of $54,552 in 2014 and $50,267 in 2013

     20,562        14,464   

Other assets, net of accumulated amortization of $776 in 2014 and $4,737 in 2013

     10,006        9,046   

Deferred income taxes

     2,475        3,167   
  

 

 

   

 

 

 

Total other assets

     76,873        76,131   
  

 

 

   

 

 

 

Total assets

   $ 619,280      $ 525,255   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated statements.

 

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DOMINO’S PIZZA, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Continued)

(In thousands, except share and per share amounts)

 

     December 28,
2014
    December 29,
2013
 
LIABILITIES AND STOCKHOLDERS’ DEFICIT     

CURRENT LIABILITIES:

    

Current portion of long-term debt

   $ 565      $ 24,144   

Accounts payable

     86,552        83,408   

Accrued compensation

     23,618        23,653   

Accrued interest

     14,008        14,375   

Insurance reserves

     14,465        13,297   

Dividends payable

     14,351        11,849   

Legal reserves

     4,277        4,959   

Advertising fund liabilities

     72,055        44,695   

Other accrued liabilities

     35,717        34,231   
  

 

 

   

 

 

 

Total current liabilities

     265,608        254,611   
  

 

 

   

 

 

 

LONG-TERM LIABILITIES:

    

Long-term debt, less current portion

     1,523,546        1,512,299   

Insurance reserves

     26,951        25,528   

Deferred income taxes

     5,588        7,827   

Other accrued liabilities

     17,052        15,192   
  

 

 

   

 

 

 

Total long-term liabilities

     1,573,137        1,560,846   
  

 

 

   

 

 

 

Total liabilities

     1,838,745        1,815,457   
  

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES

    

STOCKHOLDERS’ DEFICIT:

    

Common stock, par value $0.01 per share; 170,000,000 shares authorized; 55,553,149 in 2014 and 55,768,672 in 2013 issued and outstanding

     556        558   

Preferred stock, par value $0.01 per share; 5,000,000 shares authorized, none issued

     —          —     

Additional paid-in capital

     29,561        669   

Retained deficit

     (1,246,921     (1,289,445

Accumulated other comprehensive loss

     (2,661     (1,984
  

 

 

   

 

 

 

Total stockholders’ deficit

     (1,219,465     (1,290,202
  

 

 

   

 

 

 

Total liabilities and stockholders’ deficit

   $ 619,280      $ 525,255   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated statements.

 

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DOMINO’S PIZZA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)

 

     For the Years Ended  
     December 28,
2014
    December 29,
2013
    December 30,
2012
 

REVENUES:

      

Domestic Company-owned stores

   $ 348,497      $ 337,414      $ 323,652   

Domestic franchise

     230,192        212,369        195,000   

Supply chain

     1,262,523        1,118,873        1,039,830   

International franchise

     152,621        133,567        119,957   
  

 

 

   

 

 

   

 

 

 

Total revenues

     1,993,833        1,802,223        1,678,439   
  

 

 

   

 

 

   

 

 

 

COST OF SALES:

      

Domestic Company-owned stores

     267,385        256,596        247,391   

Supply chain

     1,131,682        996,653        929,710   
  

 

 

   

 

 

   

 

 

 

Total cost of sales

     1,399,067        1,253,249        1,177,101   
  

 

 

   

 

 

   

 

 

 

OPERATING MARGIN

     594,766        548,974        501,338   

GENERAL AND ADMINISTRATIVE

     249,405        235,163        219,007   
  

 

 

   

 

 

   

 

 

 

INCOME FROM OPERATIONS

     345,361        313,811        282,331   

INTEREST INCOME

     143        160        304   

INTEREST EXPENSE

     (86,881     (88,872     (101,448
  

 

 

   

 

 

   

 

 

 

INCOME BEFORE PROVISION FOR INCOME TAXES

     258,623        225,099        181,187   

PROVISION FOR INCOME TAXES

     96,036        82,114        68,795   
  

 

 

   

 

 

   

 

 

 

NET INCOME

   $ 162,587      $ 142,985      $ 112,392   
  

 

 

   

 

 

   

 

 

 

EARNINGS PER SHARE:

      

Common Stock – basic

   $ 2.96      $ 2.58      $ 1.99   

Common Stock – diluted

   $ 2.86      $ 2.48      $ 1.91   

DIVIDENDS DECLARED PER SHARE

   $ 1.00      $ 0.80      $ 3.00   

The accompanying notes are an integral part of these consolidated statements.

 

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DOMINO’S PIZZA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

 

     For the Years Ended  
     December 28,
2014
    December 29,
2013
    December 30,
2012
 

NET INCOME

   $ 162,587      $ 142,985      $ 112,392   

OTHER COMPREHENSIVE INCOME (LOSS), BEFORE TAX:

      

Currency translation adjustment

     (1,468     432        (825

Reclassification adjustment for losses included in net income

     —          —          776   
  

 

 

   

 

 

   

 

 

 
     (1,468     432        (49

TAX ATTRIBUTES OF ITEMS IN OTHER COMPREHENSIVE INCOME (LOSS):

      

Currency translation adjustment

     791        (30     359   

Reclassification adjustment for losses included in net income

     —          —          (295
  

 

 

   

 

 

   

 

 

 
     791        (30     64   
  

 

 

   

 

 

   

 

 

 

OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX

     (677     402        15   
  

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME

   $ 161,910      $ 143,387      $ 112,407   
  

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated statements.

 

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DOMINO’S PIZZA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT

(In thousands, except share data)

 

                             Accumulated Other
Comprehensive

Loss
 
           Additional           Currency     Fair Value  
     Common Stock     Paid-in     Retained     Translation     of Derivative  
     Shares     Amount     Capital     Deficit     Adjustment     Instruments  

BALANCE AT JANUARY 1, 2012

     57,741,208      $ 577      $ —        $ (1,207,915   $ (1,920   $ (481

Net income

     —          —          —          112,392        —          —     

Common stock dividends and equivalents

     —          —          (10,166     (176,820     —          —     

Issuance of common stock, net

     271,348        3        —          —          —          —     

Tax payments for restricted stock upon vesting

     (165,113     (1     (5,844     —          —          —     

Purchase of common stock

     (2,472,863     (25     (25,192     (63,021     —          —     

Exercise of stock options

     938,669        9        8,936        —          —          —     

Tax impact from equity-based compensation

     —          —          16,220        —          —          —     

Non-cash compensation expense

     —          —          17,621        —          —          —     

Other

     —          —          89        —          —          —     

Currency translation adjustment, net of tax

     —          —          —          —          (466     —     

Reclassification adjustment for losses on derivative instruments included in net income, net of tax

     —          —          —          —          —          481   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT DECEMBER 30, 2012

     56,313,249        563        1,664        (1,335,364     (2,386     —     

Net income

     —          —          —          142,985        —          —     

Common stock dividends and equivalents

     —          —          —          (44,190     —          —     

Issuance of common stock, net

     330,656        3        —          —          —          —     

Tax payments for restricted stock upon vesting

     (137,262     (1     (8,030     —          —          —     

Purchase of common stock

     (1,666,435     (16     (44,240     (52,876     —          —     

Exercise of stock options

     928,464        9        9,442        —          —          —     

Tax impact from equity-based compensation

     —          —          19,498        —          —          —     

Non-cash compensation expense

     —          —          21,987        —          —          —     

Other

     —          —          348        —          —          —     

Currency translation adjustment, net of tax

     —          —          —          —          402        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT DECEMBER 29, 2013

     55,768,672        558        669        (1,289,445     (1,984     —     

Net income

     —          —          —          162,587        —          —     

Common stock dividends and equivalents

     —          —          —          (55,300     —          —     

Issuance of common stock, net

     102,169        1        —          —          —          —     

Tax payments for restricted stock upon vesting

     (105,101     (1     (7,926     —          —          —     

Purchase of common stock

     (1,151,931     (12     (17,632     (64,763     —          —     

Exercise of stock options

     939,340        10        9,018        —          —          —     

Tax impact from equity-based compensation

     —          —          27,583        —          —          —     

Non-cash compensation expense

     —          —          17,587        —          —          —     

Other

     —          —          262        —          —          —     

Currency translation adjustment, net of tax

     —          —          —          —          (677     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE AT DECEMBER 28, 2014

     55,553,149      $ 556      $ 29,561      $ (1,246,921   $ (2,661   $ —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated statements.

 

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DOMINO’S PIZZA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

     For the Years Ended  
     December 28,
2014
    December 29,
2013
    December 30,
2012
 

CASH FLOWS FROM OPERATING ACTIVITIES:

      

Net income

   $ 162,587      $ 142,985      $ 112,392   

Adjustments to reconcile net income to net cash provided by operating activities-

      

Depreciation and amortization

     35,788        25,783        23,171   

(Gains) losses on sale/disposal of assets

     (1,107     367        540   

Provision (benefit) for losses on accounts and notes receivable

     (570     (1,257     462   

Provision (benefit) for deferred income taxes

     (132     6,055        4,193   

Amortization of deferred financing costs, debt discount and other

     5,746        6,094        14,596   

Non-cash compensation expense

     17,587        21,987        17,621   

Tax impact from equity-based compensation

     (27,583     (19,498     (16,220

Other

     —          —          (531

Changes in operating assets and liabilities-

      

Increase in accounts receivable

     (12,710     (11,001     (6,917

Increase in inventories, prepaid expenses and other

     (11,827     (242     (703

Increase in accounts payable and accrued liabilities

     22,776        21,867        24,914   

Increase in insurance reserves

     1,784        849        2,802   
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     192,339        193,989        176,320   
  

 

 

   

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

      

Capital expenditures

     (70,093     (40,387     (29,267

Proceeds from sale of assets

     9,160        4,518        2,988   

Change in restricted cash

     4,499        (65,438     32,597   

Other

     (1,009     1,574        1,030   
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     (57,443     (99,733     7,348   
  

 

 

   

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

      

Proceeds from issuance of long-term debt

     —          —          1,575,000   

Repayments of long-term debt and capital lease obligations

     (12,332     (24,349     (1,465,509

Proceeds from exercise of stock options

     9,028        9,451        8,945   

Tax impact from equity-based compensation

     27,583        19,498        16,220   

Purchases of common stock

     (82,407     (97,132     (88,238

Tax payments for restricted stock upon vesting

     (7,927     (8,031     (5,845

Payments of common stock dividends and equivalents

     (52,843     (34,241     (185,484

Cash paid for financing costs

     —          —          (32,538
  

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

     (118,898     (134,804     (177,449
  

 

 

   

 

 

   

 

 

 

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS

     474        118        (1,698
  

 

 

   

 

 

   

 

 

 

CHANGE IN CASH AND CASH EQUIVALENTS

     16,472        (40,430     4,521   

CASH AND CASH EQUIVALENTS, AT BEGINNING OF PERIOD

     14,383        54,813        50,292   
  

 

 

   

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, AT END OF PERIOD

   $ 30,855      $ 14,383      $ 54,813   
  

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated statements.

 

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DOMINO’S PIZZA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of Business

Domino’s Pizza, Inc. (“DPI”), a Delaware corporation, conducts its operations and derives substantially all of its operating income and cash flows through its wholly-owned subsidiary, Domino’s, Inc. (Domino’s) and Domino’s wholly-owned subsidiary, Domino’s Pizza LLC (“DPLLC”). DPI and its wholly-owned subsidiaries (collectively, “the Company”) are primarily engaged in the following business activities: (i) retail sales of food through Company-owned Domino’s Pizza stores; (ii) sales of food, equipment and supplies to Company-owned and franchised Domino’s Pizza stores through Company-owned supply chain centers; and (iii) receipt of royalties and fees from domestic and international Domino’s Pizza franchisees.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of DPI and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Fiscal Year

The Company’s fiscal year ends on the Sunday closest to December 31. The 2014 fiscal year ended on December 28, 2014, the 2013 fiscal year ended on December 29, 2013 and the 2012 fiscal year ended on December 30, 2012. The 2014, 2013 and 2012 fiscal years each consisted of fifty-two weeks.

Cash and Cash Equivalents

Cash equivalents consist of highly liquid investments with original maturities of three months or less at the date of purchase. These investments are carried at cost, which approximates fair value.

Restricted Cash and Cash Equivalents

Restricted cash at December 28, 2014 includes $56.2 million of cash held for future principal and interest payments, $20.8 million of cash held in a three month interest reserve, $43.9 million of cash held as collateral for outstanding letters of credit and $0.1 million of other restricted cash.

Restricted cash at December 29, 2013 included $51.3 million of cash held for future principal and interest payments, $21.0 million of cash held in a three month interest reserve, $42.0 million of cash held as collateral for outstanding letters of credit, $11.1 million of cash related to the Company’s third quarter 2013 dividend payment to shareholders and $0.1 million of other restricted cash.

Inventories

Inventories are valued at the lower of cost (on a first-in, first-out basis) or market. Inventories at December 28, 2014 and December 29, 2013 are comprised of the following (in thousands):

 

     2014      2013  

Food

   $ 31,627       $ 25,673   

Equipment and supplies

     6,317         4,648   
  

 

 

    

 

 

 

Inventories

   $ 37,944       $ 30,321   
  

 

 

    

 

 

 

 

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DOMINO’S PIZZA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

 

Notes Receivable

During the normal course of business, the Company may provide financing to franchisees in the form of notes. Notes receivable generally require monthly payments of principal and interest, or monthly payments of interest only, generally ranging from 8% to 10%, with balloon payments of the remaining principal due two to seven years from the original issuance date. Such notes are generally secured by the related assets or business. The carrying amounts of these notes approximate fair value.

Other Assets

Current and long-term other assets primarily include prepaid expenses such as insurance, rent and taxes, deposits, as well as covenants not-to-compete and other intangible assets primarily arising from franchise acquisitions. Amortization expense related to intangible assets is provided using the straight-line method over the useful lives for covenants not-to-compete and other intangible assets and was approximately $0.1 million in 2014 and approximately $0.3 million in 2013 and 2012. As of December 28, 2014, these intangible assets were fully amortized. As of December 29, 2013, the carrying value of these intangible assets was approximately $0.1 million.

Asset Held-for-Sale

During the third quarter of 2014, the Board of Directors approved the sale of the existing corporate airplane, which the Company began actively marketing in the fourth quarter of 2014. As a result of these actions, the Company met held-for-sale criteria and classified the asset as held for sale. Subsequent to year end, the Company sold the asset for approximately $5.7 million.

Property, Plant and Equipment

Additions to property, plant and equipment are recorded at cost. Repair and maintenance costs are expensed as incurred. Depreciation and amortization expense is provided using the straight-line method over the estimated useful lives of the related assets. Estimated useful lives, other than the estimated useful life of the capital lease assets as described below, are generally as follows (in years):

 

Buildings    20
Leasehold and other improvements    7 – 15
Equipment    3 – 15

Included in land and buildings as of December 28, 2014 and December 29, 2013 are capital lease assets of approximately $1.5 million and $1.9 million, which are net of $5.9 million and $5.5 million of accumulated amortization, respectively, primarily related to the lease of a supply chain center building, and to a lesser extent, leases of computer equipment. The capital lease assets are being amortized using the straight-line method over the lease terms.

Depreciation and amortization expense on property, plant and equipment was approximately $28.4 million, $20.5 million and $19.5 million in 2014, 2013 and 2012, respectively.

Impairments of Long-Lived Assets

The Company evaluates the potential impairment of long-lived assets at least annually based on various analyses including the projection of undiscounted cash flows and whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. For Company-owned stores, the Company performs this evaluation on an operating market basis, which the Company has determined to be the lowest level for which identifiable cash flows are largely independent of other cash flows. If the carrying amount of a long-lived asset exceeds the amount of the expected future undiscounted cash flows of that asset, the Company estimates the fair value of the assets. If the carrying amount of the asset exceeds the estimated fair value of the asset, an impairment loss is recognized and the asset is written down to its estimated fair value.

 

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DOMINO’S PIZZA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

 

During the fourth quarter of 2014, in connection with meeting held-for-sale criteria for its corporate airplane, the Company recorded $5.8 million of pre-tax expense to reduce the asset to its fair value less cost to sell. This impairment loss was recorded in general and administrative expenses on the consolidated statements of income. Aside from the impairment loss on the corporate airplane in 2014, the Company did not record an impairment loss on long-lived assets in 2014, 2013 or 2012.

Investments in Marketable Securities

Investments in marketable securities consist of investments in various mutual funds made by eligible individuals as part of the Company’s deferred compensation plan (Note 7). These investments are stated at aggregate fair value, are restricted and have been placed in a rabbi trust whereby the amounts are irrevocably set aside to fund the Company’s obligations under the deferred compensation plan. The Company classifies and accounts for these investments in marketable securities as trading securities.

Deferred Financing Costs

Deferred financing costs primarily include debt issuance costs incurred by the Company as part of the 2012 Recapitalization (Note 4). Amortization is provided on a straight-line basis over the expected term of the respective debt instrument to which the costs relate and is included in interest expense.

In connection with the 2012 Recapitalization, the Company recorded an additional $32.5 million of deferred financing costs as an asset during fiscal 2012. This amount, in addition to the $7.4 million recorded on the consolidated balance sheet at January 1, 2012, is being amortized into interest expense over the seven-year expected term of the debt. Additionally, in connection with the 2012 Recapitalization, the Company had write-offs of financing costs totaling approximately $8.0 million related to the extinguishment of the previous debt facility.

In connection with scheduled principal payments of its Fixed Rate Notes (Note 4), the Company expensed financing costs of approximately $0.2 million in 2014, $0.5 million in 2013 and $0.4 million in 2012. Deferred financing cost expense, including the aforementioned amounts, was approximately $5.7 million, $6.1 million and $13.8 million in 2014, 2013 and 2012, respectively.

Goodwill

The Company’s goodwill amounts primarily relate to franchise store acquisitions and are not amortized. The Company performs its required impairment tests in the fourth quarter of each fiscal year and did not recognize any goodwill impairment charges in 2014, 2013 or 2012.

Capitalized Software

Capitalized software is recorded at cost and includes purchased, internally-developed and externally-developed software used in the Company’s operations. Amortization expense is provided using the straight-line method over the estimated useful lives of the software, which range from one to three years. Capitalized software amortization expense was approximately $7.3 million, $5.0 million and $3.3 million in 2014, 2013 and 2012, respectively. The Company received $3.4 million, $3.0 million and $2.7 million from franchisees from sales and enhancements of internally developed point-of-sale software during 2014, 2013 and 2012, respectively.

 

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DOMINO’S PIZZA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

 

Insurance Reserves

The Company has retention programs for workers’ compensation, general liability and owned and non-owned automobile liabilities for certain periods prior to December 1998 and for periods after December 2001. The Company is generally responsible for up to $1.0 million per occurrence under these retention programs for workers’ compensation and general liability exposures. The Company is also generally responsible for between $500,000 and $3.0 million per occurrence under these retention programs for owned and non-owned automobile liabilities depending on the year. Total insurance limits under these retention programs vary depending on the year covered and range up to $110.0 million per occurrence for general liability and owned and non-owned automobile liabilities and up to the applicable statutory limits for workers’ compensation.

Insurance reserves relating to our retention programs are based on undiscounted actuarial estimates. These estimates are based on historical information and on certain assumptions about future events. Changes in assumptions for such factors as medical costs and legal actions, as well as changes in actual experience, could cause these estimates to change in the near term. The Company receives estimates of outstanding insurance exposures from its independent actuary and differences between these estimated actuarial exposures and the Company’s recorded amounts are adjusted as appropriate.

Other Accrued Liabilities

Current and long-term other accrued liabilities primarily include accruals for sales, property and other taxes, store operating expenses, deferred rent expense and deferred compensation liabilities.

Foreign Currency Translation

The Company’s foreign entities use their local currency as the functional currency. Where the functional currency is the local currency, the Company translates net assets into U.S. dollars at year end exchange rates, while income and expense accounts are translated at average annual exchange rates. Currency translation adjustments are included in accumulated other comprehensive income (loss) and foreign currency transaction gains and losses are included in determining net income.

Revenue Recognition

Domestic Company-owned stores revenues are comprised of retail sales of food through Company-owned Domino’s Pizza stores located in the contiguous United States and are recognized when the items are delivered to or carried out by customers.

Domestic franchise revenues are primarily comprised of royalties and fees from Domino’s Pizza franchisees with operations in the contiguous United States. Royalty revenues are recognized when the items are delivered to or carried out by franchise customers.

Supply chain revenues are primarily comprised of sales of food, equipment and supplies to franchised Domino’s Pizza stores located in the United States and Canada. Revenues from the sales of food are recognized upon delivery of the food to franchisees, while revenues from the sales of equipment and supplies are generally recognized upon shipment of the related products to franchisees.

International franchise revenues are primarily comprised of royalties and fees from Domino’s Pizza franchisees outside the contiguous United States. These revenues are recognized consistently with the policies applied for franchise revenues generated in the contiguous United States.

 

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Supply Chain Profit-Sharing Arrangements

The Company enters into profit-sharing arrangements with domestic and Canadian stores that purchase all of their food from Supply Chain (Note 11). These profit-sharing arrangements generally offer Company-owned stores and participating franchisees with 50% (or a higher percentage in the case of Company-owned stores and certain franchisees who operate a larger number of stores) of their regional supply chain center’s pre-tax profits based upon each store’s purchases from the supply chain center. Profit-sharing obligations are recorded as a revenue reduction in Supply Chain in the same period as the related revenues and costs are recorded, and were $75.7 million, $73.9 million and $69.4 million in 2014, 2013 and 2012, respectively.

Advertising

Advertising costs are expensed as incurred. Advertising expense, which relates primarily to Company-owned stores, was approximately $29.0 million, $29.6 million and $27.6 million during 2014, 2013 and 2012, respectively.

Domestic Stores (Note 11) are required to contribute a certain percentage of sales to the Domino’s National Advertising Fund Inc. (DNAF), a not-for-profit subsidiary that administers the Domino’s Pizza system’s national and market level advertising activities. Included in advertising expense were national advertising contributions from Company-owned stores to DNAF of approximately $20.9 million, $20.1 million and $17.8 million in 2014, 2013 and 2012, respectively. DNAF also received national advertising contributions from franchisees of approximately $217.7 million, $199.4 million and $173.6 million during 2014, 2013 and 2012, respectively. Franchisee contributions to DNAF and offsetting disbursements are presented net in the accompanying statements of income.

DNAF assets, consisting primarily of cash received from franchisees and accounts receivable from franchisees, can only be used for activities that promote the Domino’s Pizza® brand. Accordingly, all assets held by the DNAF are considered restricted.

Rent

The Company leases certain equipment, vehicles, retail store and supply chain center locations and its corporate headquarters under operating leases with expiration dates through 2024. Rent expenses totaled approximately $43.0 million, $40.2 million and $39.7 million during 2014, 2013 and 2012, respectively.

Common Stock Dividends

During 2014, the Company declared dividends of approximately $55.3 million, or $1.00 per share, of which approximately $41.7 million were paid in 2014. The third quarter 2014 dividend of approximately $13.8 million was paid to shareholders on December 30, 2014, which will be included in fiscal 2015.

During 2013, the Company declared dividends of approximately $44.2 million, or $0.80 per share, of which approximately $34.2 million were paid in 2013. The third quarter 2013 dividend of approximately $11.1 million was paid to shareholders on December 30, 2013, which was included in fiscal 2014.

During 2012, the Company declared dividends and dividend equivalents totaling approximately $187.0 million, or $3.00 per share, of which approximately $185.5 million were paid in 2012.

 

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Derivative Instruments

The Company recognizes all derivatives as either assets or liabilities in the balance sheet and measures those instruments at fair value. The Company had no outstanding derivative instruments as of December 28, 2014 and December 29, 2013.

In connection with its recapitalization in 2007 (the “2007 Recapitalization”), the Company entered into a five-year forward-starting interest rate swap agreement with a notional amount of $1.25 billion. This interest rate swap was entered into to hedge the variability of future interest rates in contemplation of the recapitalization-related debt issuances. The Company subsequently settled the swap agreement with a cash payment of $11.5 million, in accordance with its terms, concurrent with the issuance of debt as part of the 2007 Recapitalization. In connection with this settlement, the accumulated other comprehensive loss amount was adjusted for the after-tax net settlement amount of $7.1 million which was being amortized into interest expense over the term of the hedged item. As part of the 2012 Recapitalization, the remaining amount of this swap settlement that was included in accumulated other comprehensive loss was recorded into interest expense.

Stock Options and Other Equity-Based Compensation Arrangements

The cost of all of the Company’s stock options, as well as other equity-based compensation arrangements, is reflected in the financial statements based on the estimated fair value of the awards.

Earnings Per Share

The Company discloses two calculations of earnings per share (EPS): basic EPS and diluted EPS. The numerator in calculating common stock basic and diluted EPS is consolidated net income. The denominator in calculating common stock basic EPS is the weighted average shares outstanding. The denominator in calculating common stock diluted EPS includes the additional dilutive effect of outstanding stock options and unvested restricted stock and unvested performance-based restricted stock grants.

Supplemental Disclosures of Cash Flow Information

The Company paid interest of approximately $81.1 million, $82.9 million and $87.3 million during 2014, 2013 and 2012, respectively. Cash paid for income taxes was approximately $76.5 million, $62.8 million and $46.1 million in 2014, 2013 and 2012, respectively. In 2014, the Company had $1.7 million of non-cash investing activities related to accruals for capital expenditures.

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers. This guidance outlines a single, comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance issued by the FASB, including industry specific guidance. The guidance is effective for the Company for interim and annual reporting periods beginning on January 1, 2017, and permits the use of either the retrospective or cumulative effect transition method. Early adoption is prohibited. The Company is evaluating the effect that this guidance will have on its consolidated financial statements and related disclosures.

The accounting standards that have been issued by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on our consolidated financial statements upon adoption.

 

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Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

(2) EARNINGS PER SHARE

The computation of basic and diluted earnings per common share is as follows (in thousands, except share and per share amounts):

 

     2014      2013      2012  

Net income available to common stockholders – basic and diluted

   $ 162,587       $ 142,985       $ 112,392   
  

 

 

    

 

 

    

 

 

 

Weighted average number of common shares

     54,918,471         55,345,554         56,419,645   

Earnings per common share – basic

   $ 2.96       $ 2.58       $ 1.99   

Diluted weighted average number of common shares

     56,931,226         57,720,998         58,997,476   

Earnings per common share – diluted

   $ 2.86       $ 2.48       $ 1.91   

The denominator in calculating the common stock diluted EPS does not include 222,060 stock options in 2014, 152,340 stock options in 2013 and 210,820 stock options in 2012, as their inclusion would be anti-dilutive.

 

(3) 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 table summarizes the carrying amounts and fair values of certain assets at December 28, 2014:

 

     At December 28, 2014  
            Fair Value Estimated Using  
     Carrying
Amount
     Level 1
Inputs
     Level 2
Inputs
     Level 3
Inputs
 

Cash equivalents

   $ 16,290       $ 16,290       $ —         $ —     

Restricted cash equivalents

     93,121         93,121         —           —     

Investments in marketable securities

     4,586         4,586         —           —     

 

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The following table summarizes the carrying amounts and fair values of certain assets at December 29, 2013:

 

     At December 29, 2013  
            Fair Value Estimated Using  
     Carrying
Amount
     Level 1
Inputs
     Level 2
Inputs
     Level 3
Inputs
 

Cash equivalents

   $ 5,303       $ 5,303       $ —         $ —     

Restricted cash equivalents

     93,608         93,608         —           —     

Investments in marketable securities

     3,269         3,269         —           —     

 

(4) RECAPITALIZATIONS AND FINANCING ARRANGEMENTS

2012 Recapitalization

On March 16, 2012, the Company completed a recapitalization transaction (the 2012 Recapitalization). As part of the 2012 Recapitalization, a wholly-owned subsidiary of DPLLC and three of its wholly-owned subsidiaries completed an asset-backed securitization (ABS) by co-issuing a $1.675 billion facility in a private transaction consisting of $1.575 billion of Series 2012-1 5.216% Fixed Rate Senior Secured Notes, Class A-2 (the Fixed Rate Notes) and $100.0 million of Series 2012-1 Variable Funding Senior Secured Notes, Class A-1 (the Variable Funding Notes). Gross proceeds from the issuance of the Fixed Rate Notes were $1.575 billion. The Variable Funding Notes were undrawn upon at issuance.

The Company used a portion of the proceeds from the 2012 Recapitalization to repay approximately $1.447 billion in outstanding fixed rate notes under the 2007 Recapitalization. The proceeds were also used to pay accrued interest on fixed rate notes under the 2007 Recapitalization and transaction-related fees and expenses incurred in connection with the 2012 Recapitalization and to fund reserve accounts for the payments related to the Fixed Rate Notes.

Also on March 16, 2012, the Company’s Board of Directors declared a $3.00 per share special cash dividend on its outstanding common stock totaling $171.1 million, which was paid on April 2, 2012 to stockholders of record at the close of business on March 26, 2012. Additionally, pursuant to the anti-dilution provisions in the Company’s underlying stock option plans, on April 2, 2012, the Company made a corresponding cash payment of approximately $13.5 million on certain stock options, reduced the exercise price on certain other stock options by an equivalent per share amount and, in certain circumstances, both reduced the stock option exercise price and made a cash payment for amounts totaling $3.00 per share. On April 2, 2012, the Company also accrued an estimated $2.4 million for payments to be made as certain performance-based restricted stock grants vest. The dividend and related dividend equivalent payments were funded with the remaining proceeds from the 2012 Recapitalization and cash on hand. These anti-dilution payments were accounted for as modifications/settlements and were recorded as increases in total stockholders’ deficit. As of December 30, 2012, total cash paid for common stock dividends and related anti-dilution equivalent payments was approximately $185.5 million and the total estimated liability recorded for future cash dividend payments on certain performance-based restricted stock was approximately $1.5 million. As of December 28, 2014, the total estimated liability recorded for future cash dividend payments on certain performance-based restricted stock was approximately $0.6 million. Of the total amount of $187.0 million recorded for common stock dividends and related anti-dilution payments in 2012, $10.2 million was recorded as a reduction of additional paid-in capital and $176.8 million was recorded as an increase in retained deficit.

 

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During fiscal 2012 and in connection with the 2012 Recapitalization, the Company incurred approximately $10.5 million of net expenses. This consisted primarily of $8.1 million of net write-offs of deferred financing fees and the interest rate swap related to the extinguished debt. The Company also incurred $2.1 million of interest expense on the 2007 Recapitalization borrowings subsequent to the closing of the 2012 Recapitalization but prior to the repayment of the 2007 Recapitalization borrowings, resulting in the payment of interest on both the 2007 and 2012 facilities for a short period of time. Further, the Company incurred $0.3 million of other net 2012 Recapitalization-related general and administrative expenses, including stock compensation expenses, payroll taxes related to the payments made to certain stock option holders and legal and professional fees incurred in connection with the 2012 Recapitalization.

In connection with the 2012 Recapitalization, the Company recorded an additional $32.5 million of deferred financing costs as an asset in the consolidated balance sheet during fiscal 2012. This amount, in addition to the $7.4 million recorded on the consolidated balance sheet at January 1, 2012, is being amortized into interest expense over the seven-year expected term of the debt.

The Fixed Rate Notes and the Variable Funding Notes

The Fixed Rate Notes bear interest at 5.216% payable quarterly. The Fixed Rate Notes have scheduled principal amortization payments while the Variable Funding Notes require no scheduled principal amortization payments. The Fixed Rate Notes original scheduled principal amortization payments are $29.5 million in 2015, $37.4 million in 2016, $39.4 million in each of 2017 and 2018, and $9.8 million in 2019. During fiscal 2014, the Company made principal payments of approximately $11.8 million. If the Company meets certain conditions, including maximum leverage ratios of less than or equal to 4.5x total debt to EBITDA, as defined in the related agreements, it ceases the scheduled principal amortization payments on the Fixed Rate Notes. If one of the defined leverage ratios subsequently exceeds 4.5x, it must make up the payments it had previously not made. During the second quarter of 2014, the Company met the maximum leverage ratios of less than 4.5x, and, in accordance with the debt agreements, ceased debt amortization payments in the third quarter of 2014. The Company continued to meet the maximum leverage ratios of less than 4.5x in the third and fourth quarters of 2014 and currently does not plan to make previously scheduled debt amortization payments as permitted in the debt agreements. The expected repayment date for the Fixed Rate Notes is January 2019, with legal final maturity in January 2042.

The Fixed Rate Notes and the Variable Funding Notes are guaranteed by four subsidiaries of DPLLC and secured by a security interest in substantially all of the assets of the Company, including royalty income from all domestic stores, domestic supply chain income, international income and intellectual property. The restrictions placed on the Company’s subsidiaries require that the Company’s interest obligations have first priority and amounts are segregated weekly to ensure appropriate funds are reserved to pay the quarterly interest amounts due. The amount of weekly cash flow that exceeds the required weekly interest reserve is generally remitted to the Company in the form of a dividend. However, once the interest obligations are satisfied, there are no further restrictions, including payment of dividends, on the cash flows of the subsidiaries.

The Fixed Rate Notes are subject to certain financial and non-financial covenants, including a debt service coverage ratio calculation, as defined in the related agreements. The covenants, among other things, limit the ability of certain of our subsidiaries to declare dividends, make loans or advances or enter into transactions with affiliates. In the event that certain covenants are not met, the Fixed Rate Notes may become partially or fully due and payable on an accelerated schedule. In addition, the Company may voluntarily prepay, in part or in full, the Fixed Rate Notes at any time, subject to certain make-whole interest obligations. All make-whole interest obligations cease after July 2017. Further, the Company may elect to prepay up to $551.3 million of its Fixed Rate Notes at par and with no make-whole obligations on its quarterly payment date in October 2015 or on any quarterly payment date thereafter.

 

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(Continued)

 

The Variable Funding Notes allowed for the issuance of up to $100.0 million of financing and certain other credit instruments, including letters of credit in support of various obligations of the Company. Interest on a portion of any outstanding Variable Funding Note borrowings is payable quarterly at a rate equal to a commercial paper rate plus 350 basis points, with the remainder at LIBOR plus 350 basis points. The Variable Funding Notes have an expected maturity in January 2017, with an option for up to two one-year renewals (subject to certain conditions, including a minimum debt service coverage ratio), and a legal final maturity in January 2042. At December 28, 2014, there were $44.1 million of outstanding letters of credit and $55.9 million of borrowing capacity available under the $100.0 million Variable Funding Notes.

At December 28, 2014, management estimates that the approximately $1.522 billion in principal amount of outstanding Fixed Rate Notes had a fair value of approximately $1.597 billion, and at December 29, 2013 the approximately $1.534 billion in principal amount of Fixed Rate Notes had a fair value of approximately $1.643 billion. The Fixed Rate Notes are classified as a Level 2 measurement (Note 3), as the Company estimated the fair value amount by using available market information. The Company obtained broker quotes from two separate brokerage firms that are knowledgeable about the Company’s Fixed Rate Notes and, at times, trade these notes. Further, the Company performs its own internal analysis based on the information it gathers from public markets, including information on notes that are similar to that of the Company. However, considerable judgment is required in interpreting market data to develop estimates of fair value. Accordingly, the fair value estimates presented herein 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 calculated above.

Consolidated Long-Term Debt

At December 28, 2014 and December 29, 2013, consolidated long-term debt consisted of the following (in thousands):

 

     2014      2013  

5.216% Class A-2 Notes; expected repayment date January 2019; legal final maturity January 2042

   $ 1,521,844       $ 1,533,656   

Variable Funding Notes

     —           —     

Capital lease obligations

     2,267         2,787   
  

 

 

    

 

 

 

Total debt

     1,524,111         1,536,443   

Less – current portion

     565         24,144   
  

 

 

    

 

 

 

Consolidated long-term debt

   $ 1,523,546       $ 1,512,299   
  

 

 

    

 

 

 

At December 28, 2014, maturities of long-term debt and capital lease obligations are as follows (in thousands):

 

2015

   $ 565   

2016

     615   

2017

     670   

2018

     417   

2019

     1,521,844   
  

 

 

 
   $ 1,524,111   
  

 

 

 

 

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(Continued)

 

(5) COMMITMENTS AND CONTINGENCIES

Lease Commitments

As of December 28, 2014, the future minimum rental commitments for all non-cancelable leases are as follows (in thousands):

 

     Operating
Leases
     Capital
Leases
     Total  

2015

   $ 38,621       $ 675       $ 39,296   

2016

     36,294         736         37,030   

2017

     32,365         736         33,101   

2018

     28,721         491         29,212   

2019

     22,289         —           22,289   

Thereafter

     45,706         —           45,706   
  

 

 

    

 

 

    

 

 

 

Total future minimum rental commitments

   $ 203,996         2,638       $ 206,634   
  

 

 

    

 

 

    

 

 

 

Less – amounts representing interest

        (371   
     

 

 

    

Total principal payable on capital leases

      $ 2,267      
     

 

 

    

Legal Proceedings and Related Matters

The Company is a party to lawsuits, revenue agent reviews by taxing authorities and legal proceedings, of which the majority involve workers’ compensation, employment practices liability, general liability and automobile and franchisee claims arising in the ordinary course of business. The Company records legal fees associated with loss contingencies when they are probable and reasonably estimable.

Litigation is subject to many uncertainties, and the outcome of individual litigated matters is not predictable with assurance. Included in the matters referenced above, the Company is party to three employment practice cases, six casualty cases and one patent case. We have established legal and insurance accruals for losses relating to these cases which we believe are reasonable based upon our assessment of the current facts and circumstances. However, it is reasonably possible that our ultimate losses could exceed the amounts recorded by $4.0 million. The remaining cases referenced above could be decided unfavorably to us and could require us to pay damages or make other expenditures in amounts or a range of amounts that cannot be estimated with accuracy. In management’s opinion, these matters, individually and in the aggregate, should not have a significant adverse effect on the financial condition of the Company, and the established accruals adequately provide for the estimated resolution of such claims.

Additionally, the Company was also named as a defendant in a lawsuit along with a large franchisee and the franchisee’s delivery driver. During the third quarter of 2013, the jury delivered a $32.0 million judgment for the plaintiff where the Company was found to be 60% liable. The Company denies liability and filed an appeal of the verdict on a variety of grounds. This case is covered under the Company’s casualty insurance program, subject to a $3.0 million deductible. The Company also has indemnity provisions in its franchise agreements.

 

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(Continued)

 

(6) INCOME TAXES

Income before provision for income taxes in 2014, 2013 and 2012 consists of the following (in thousands):

 

     2014      2013      2012  

Domestic

   $ 250,730       $ 217,468       $ 180,270   

Foreign

     7,893         7,631         917   
  

 

 

    

 

 

    

 

 

 
   $ 258,623       $ 225,099       $ 181,187   
  

 

 

    

 

 

    

 

 

 

The differences between the United States Federal statutory income tax provision (using the statutory rate of 35%) and the Company’s consolidated provision for income taxes for 2014, 2013 and 2012 are summarized as follows (in thousands):

 

     2014      2013      2012  

Federal income tax provision based on the statutory rate

   $ 90,518       $ 78,785       $ 63,415   

State and local income taxes, net of related Federal income taxes

     7,320         5,880         5,179   

Non-resident withholding and foreign income taxes

     15,032         13,923         12,860   

Foreign tax and other tax credits

     (17,397      (16,423      (14,678

Non-deductible expenses, net

     1,284         1,161         1,368   

Valuation allowance

     (369      29         868   

Unrecognized tax benefits, net of related Federal income taxes

     (48      232         80   

Other

     (304      (1,473      (297
  

 

 

    

 

 

    

 

 

 
   $ 96,036       $ 82,114       $ 68,795   
  

 

 

    

 

 

    

 

 

 

The components of the 2014, 2013 and 2012 consolidated provision for income taxes are as follows (in thousands):

 

     2014      2013      2012  

Provision for Federal income taxes –

        

Current provision

   $ 70,958       $ 54,115       $ 45,110   

Deferred provision (benefit)

     (873      5,280         3,264   
  

 

 

    

 

 

    

 

 

 

Total provision for Federal income taxes

     70,085         59,395         48,374   

Provision for state and local income taxes –

        

Current provision

     10,178         8,021         6,632   

Deferred provision

     741         775         929   
  

 

 

    

 

 

    

 

 

 

Total provision for state and local income taxes

     10,919         8,796         7,561   

Provision for non-resident withholding and foreign income taxes

     15,032         13,923         12,860   
  

 

 

    

 

 

    

 

 

 
   $ 96,036       $ 82,114       $ 68,795   
  

 

 

    

 

 

    

 

 

 

 

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(Continued)

 

As of December 28, 2014 and December 29, 2013, the significant components of net deferred income taxes are as follows (in thousands):

 

     2014      2013  

Deferred Federal income tax assets –

     

Insurance reserves

   $ 10,359       $ 10,143   

Equity compensation

     11,697         12,586   

Other accruals and reserves

     12,161         11,606   

Bad debt reserves

     1,675         2,239   

Valuation allowance

     (456      (799

Other

     5,082         4,579   
  

 

 

    

 

 

 

Total deferred Federal income tax assets

     40,518         40,354   
  

 

 

    

 

 

 

Deferred Federal income tax liabilities –

     

Depreciation, amortization and asset basis differences

     899         1,772   

Capitalized software

     16,628         13,017   

Gain on debt extinguishments

     18,146         22,682   

Other

     576         —     
  

 

 

    

 

 

 

Total deferred Federal income tax liabilities

     36,249         37,471   
  

 

 

    

 

 

 

Net deferred Federal income tax asset

     4,269         2,883   

Net deferred state and local income tax asset

     2,475         3,167   
  

 

 

    

 

 

 

Net deferred income taxes

   $ 6,744       $ 6,050   
  

 

 

    

 

 

 

As of December 28, 2014, the classification of net deferred income taxes is summarized as follows (in thousands):

 

     Current      Long-term      Total  

Deferred tax assets

   $ 14,681       $ 28,312       $ 42,993   

Deferred tax liabilities

     (4,824