<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: June 20, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from: ___________ to ___________
Commission file number: 333-74797
Domino's, Inc.
(Exact name of registrant as specified in its charter)
Delaware 38-3025165
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
30 Frank Lloyd Wright Drive
Ann Arbor, Michigan 48106
(Address of principal executive offices)
(734) 930-3030
(Registrant's telephone number, including area code)
Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ ] No [X]
The number of shares outstanding of the registrant's common stock as of August
4, 1999 was 10 shares.
<PAGE>
Domino's, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
<TABLE>
<CAPTION>
June 20, 1999 January 3, 1999
(In thousands) (Unaudited) (Note)
Assets -------------- ----------------
<S> <C> <C>
Current assets:
Cash $ 19,489 $ 115
Accounts receivable 41,856 48,858
Inventories 17,587 20,134
Deferred tax assets 9,811 9,811
Other 17,718 17,927
--------- ---------
Total current assets 106,461 96,845
--------- ---------
Property, plant and equipment:
Land and buildings 14,246 14,605
Leasehold and other improvements 54,168 52,248
Equipment 112,280 109,517
Construction in progress 3,504 5,486
--------- ---------
184,198 181,856
Accumulated depreciation and amortization 117,592 116,890
--------- ---------
Total property, plant and equipment 66,606 64,966
--------- ---------
Other assets:
Deferred tax assets 72,758 71,776
Deferred financing costs 40,489 43,046
Goodwill 14,221 14,179
Covenants not-to-compete 34,249 50,058
Capitalized software 24,763 22,593
Other 24,314 24,428
--------- ---------
Total other assets 210,794 226,080
--------- ---------
Total assets $ 383,861 $ 387,891
========= =========
Liabilities and stockholder's deficit
Current liabilities:
Current portion of long-term debt $ 10,187 $ 7,646
Accounts payable 31,843 44,596
Insurance reserves 9,681 9,633
Accrued income taxes 1,670 6,501
Other accrued liabilities 58,712 46,693
--------- ---------
Total current liabilities 112,093 115,069
--------- ---------
Long-term liabilities:
Long-term debt, less current portion 714,595 720,480
Insurance reserves 12,337 15,132
Other accrued liabilities 22,482 20,985
--------- ---------
Total long-term liabilities 749,414 756,597
--------- ---------
Stockholder's deficit:
Common stock -- --
Additional paid-in capital 116,202 114,737
Retained deficit (593,633) (598,209)
Accumulated other comprehensive income (215) (303)
--------- ---------
Total stockholder's deficit (477,646) (483,775)
--------- ---------
Total liabilities and stockholder's deficit $ 383,861 $ 387,891
========= =========
</TABLE>
Note: The balance sheet at January 3, 1999 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
See accompanying notes.
2
<PAGE>
Domino's, Inc. and Subsidiaries
Condensed Consolidated Statements of Income
(Unaudited)
<TABLE>
<CAPTION>
Fiscal Quarter Ended Two Fiscal Quarters Ended
June 20, June 14, June 20, June 14,
1999 1998 1999 1998
(In thousands) ------------------------- -------------------------
Revenues:
<S> <C> <C> <C> <C>
Corporate stores $ 83,802 $ 94,452 $ 170,362 $ 186,770
Domestic franchise royalties 26,543 24,659 53,159 48,947
Domestic distribution 132,785 130,911 267,512 257,986
International 12,982 12,280 25,847 24,459
--------- --------- --------- ---------
Total revenues 256,112 262,302 516,880 518,162
--------- --------- --------- ---------
Operating expenses:
Cost of sales 181,089 190,046 366,697 379,171
General and administrative 55,471 55,896 113,112 108,424
--------- --------- --------- ---------
Total operating expenses 236,560 245,942 479,809 487,595
--------- --------- --------- ---------
Income from operations 19,552 16,360 37,071 30,567
Interest income 216 204 329 594
Interest expense 16,911 1,047 34,162 1,843
--------- --------- --------- ---------
Income before provision (benefit)
for income taxes 2,857 15,517 3,238 29,318
Provision (benefit) for income taxes (1,490) 1,136 (1,338) 2,285
--------- --------- --------- ---------
Net income $ 4,347 $ 14,381 $ 4,576 $ 27,033
========= ========= ========= =========
</TABLE>
See accompanying notes.
3
<PAGE>
Domino's, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Two Fiscal Quarters Ended
June 20, 1999 June 14, 1998
------------- -------------
<S> <C> <C>
(In thousands)
Cash flows from operating activities:
Net cash provided by operating activities $ 33,001 $ 33,580
-------- --------
Cash flows from investing activities:
Purchases of plant and equipment (12,156) (19,901)
Other 668 (1,831)
-------- --------
Net cash used in investing activities (11,488) (21,732)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of long-term debt -- 28,200
Repayments of long-term debt (3,685) (5,362)
Capital contribution from Parent 1,465 --
Distributions to Parent -- (29,663)
-------- --------
Net cash used in financing activities (2,220) (6,825)
-------- --------
Effect of exchange rate changes on cash 81 (53)
-------- --------
Increase in cash 19,374 4,970
Cash, at beginning of period 115 105
-------- --------
Cash, at end of period $ 19,489 $ 5,075
======== ========
</TABLE>
See accompanying notes.
4
<PAGE>
Domino's, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
June 20, 1999
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions of Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments, consisting
of normal recurring accruals, considered necessary for a fair presentation have
been included. Operating results for the fiscal quarter and two fiscal quarters
ended June 20, 1999 are not necessarily indicative of the results that may be
expected for the year ended January 2, 2000. For further information, refer to
the consolidated financial statements and footnotes thereto for the year ended
January 3, 1999 included in the Domino's, Inc. Form S-4 Registration Statement
No. 333-74797.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying condensed consolidated financial statements include the
accounts of Domino's, Inc., formerly known as Domino's Pizza International
Payroll Services, Inc., a Delaware corporation, and its wholly-owned
subsidiaries (collectively, Domino's). All significant intercompany accounts and
transactions have been eliminated. Domino's, Inc. is a wholly owned subsidiary
of TISM, Inc. (TISM).
TISM's Recapitalization
On December 21, 1998, TISM effected a merger with TM Transitory Merger
Corporation (TMTMC) in a leveraged recapitalization transaction whereby TMTMC
was merged with and into TISM with TISM being the surviving entity. TMTMC had no
operations and was formed solely for the purpose of effecting the
recapitalization. As part of the recapitalization, Domino's incurred significant
debt and distributed significantly all of the proceeds to TISM, which used those
proceeds, along with proceeds from the issuance of two classes of common stock
and one class of preferred stock, to fund the purchase of 93% of the outstanding
common stock of TISM from one of TISM's directors and certain members of his
family.
Prior to December 1998, Domino's, Inc. was an indirectly wholly-owned subsidiary
of Domino's Pizza, Inc. During December 1998 and before the recapitalization,
Domino's Pizza, Inc. distributed its ownership interest in Domino's, Inc. to
TISM. TISM then contributed its ownership interest in Domino's Pizza, Inc.,
which had been a wholly-owned subsidiary of TISM, to Domino's, Inc., effectively
converting Domino's, Inc. from a subsidiary of Domino's Pizza, Inc. into
Domino's Pizza, Inc.'s parent.
The accompanying condensed consolidated financial statements and these Notes to
Condensed Consolidated Financial Statements include the results of operations of
Domino's Pizza, Inc. and its wholly-owned subsidiaries (including Domino's,
Inc.) for the periods prior to the recapitalization.
Fiscal Year and Fiscal Quarters
Domino's fiscal year ends on the Sunday closest to December 31 and generally
consists of fifty-two weeks. The 1998 fiscal year, however, which ended January
3, 1999, consisted of fifty-three weeks.
Domino's first three fiscal quarters of a fiscal year each consist of twelve
weeks and the fourth quarter of a fiscal year consists of either sixteen or
seventeen weeks depending upon whether the fiscal year consists of fifty-two
weeks or fifty-three weeks, respectively. The second fiscal quarters of 1999 and
1998 consisted of the twelve week periods ended June 20, 1999 and June 14, 1998,
respectively.
5
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3. Accounting Pronouncements
The American Institute of Certified Public Accountants has issued Statement of
Position (SOP) 98-5, "Reporting on the Costs of Start-up Activities," which
requires entities to expense the costs of start-up activities, including
organizational costs, when incurred. We adopted this SOP in the first quarter of
fiscal year 1999. The adoption of this SOP did not have a material impact on our
financial statements or our operations.
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and
Hedging Activities," which requires that an entity recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. In June 1999, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS) No. 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133". The Company will be required to adopt these
Statements beginning with the first fiscal quarter of fiscal year 2001. We have
not determined the reporting impact, if any, of the adoption of these
Statements.
4. Change in Accounting Estimates
During the first quarter of 1999, we initiated a review of the estimated useful
lives we use for depreciating or amortizing our plant and equipment and goodwill
assets. The review included consideration of the estimated life of our stores as
determined through quantitative analysis performed in late 1998 and analysis of
the historical longevity of operating assets used in our operations. We
concluded the review late in the first quarter of 1999.
Based on this review, we modified the useful lives for several asset categories.
For equipment, estimated useful lives were extended for certain assets from
seven years to either ten or twelve years and were shortened for other assets,
primarily computer equipment, from either five or seven years to three years.
For leasehold improvements, estimated useful lives were extended from five years
to ten years, which generally will result in amortization of these assets over
the term of the respective leases plus one renewal option period. For furniture
and fixtures, estimated useful lives were extended for certain assets from seven
years to ten years. For goodwill, which primarily arises from purchases of
stores from franchisees, estimated useful lives were shortened in certain
circumstances to ten years from the beginning of fiscal 1999. In accordance with
generally accepted accounting principles, these changes in useful lives are
being applied on a prospective basis to existing assets and will be applied to
assets acquired in the future. These changes in accounting estimates have been
effected as of the beginning of fiscal 1999, resulting in increases in income
from operations and net income as follows (in thousands):
<TABLE>
<CAPTION>
Fiscal Quarter Ended Two Fiscal Quarters Ended
June 20, 1999 June 20, 1999
------------- -------------
<S> <C> <C>
Net impact of changes in useful lives $ 1,350 $ 2,775
Non-recurring charge to eliminate assets which
had no remaining useful lives -- (1,025)
------- -------
Increase in income from operations 1,350 1,750
Income tax effect 540 700
------- -------
Increase in net income $ 810 $ 1,050
======= =======
</TABLE>
6
<PAGE>
5. Comprehensive Income
The Financial Accounting Standards Board has issued SFAS No. 130, "Reporting
Comprehensive Income," which establishes standards for reporting comprehensive
income and its components in a full set of financial statements. Comprehensive
income is defined as the total of net income and all other non-owner changes in
equity. We adopted this Statement in 1997. Our total comprehensive income was as
follows (in thousands):
<TABLE>
<CAPTION>
Fiscal Quarter Ended Two Fiscal Quarters Ended
June 20, June 14, June 20, June 14,
1999 1998 1999 1998
--------------------- --------- ----------
<S> <C> <C> <C> <C>
Net income $ 4,347 $ 14,381 $ 4,576 $ 27,033
Currency translation adjustment 14 (52) 57 (39)
Unrealized gain (loss) on investments, net of tax 36 (94) 31 53
-------- -------- -------- --------
Total comprehensive income $ 4,397 $ 14,235 $ 4,664 $ 27,047
======== ======== ======== ========
</TABLE>
6. Segment Data
The Financial Accounting Standards Board has issued SFAS No. 131, "Disclosures
About Segments of an Enterprise and Related Information," which supercedes SFAS
No. 14, "Financial Reporting for Segments of a Business Enterprise," replacing
the "industry segment" approach of reporting segment information with the
"management" approach. The "management" approach designates the internal
organization that is used by management for making operating decisions and
assessing performance as the source of the reportable segments. We adopted this
Statement in 1998. Adoption of this Statement only affects the presentation of
the notes to the financial statements.
We have three reportable segments as determined by management using the
"management" approach as defined in SFAS No. 131: (1) Domestic Stores, (2)
Domestic Distribution and (3) International. Our operations are organized by
management on the combined bases of line of business and geography. The Domestic
Stores segment includes operations with respect to all franchised and
corporate-owned stores throughout the contiguous United States. The Domestic
Distribution segment includes the distribution of food, equipment and supplies
to franchised and corporate-owned stores throughout the contiguous United
States. The International segment includes operations related to our franchising
business in foreign and non-contiguous United States markets and our food
distribution business in Canada, Alaska, Hawaii, France and, in 1998, Puerto
Rico. In December 1998, we sold our Puerto Rico food distribution business to
our master franchisee in that market.
The accounting policies of the reportable segments are the same as those we use
on a consolidated basis. We evaluate the performance of our segments and
allocate resources to them based on earnings before interest, taxes,
depreciation and amortization ("EBITDA").
The tables below summarize the financial information concerning our reportable
segments for the fiscal quarter and two fiscal quarters ended June 20, 1999 and
June 14, 1998. Intersegment revenues are comprised of sales of food, equipment
and supplies from the Domestic Distribution segment to the Domestic Stores
segment. Intersegment sales prices are market based. In 1998, the "Other" column
as it relates to EBITDA information below includes charitable contributions,
salary of a TISM Director and former majority TISM stockholder and other
corporate headquarters costs that we do not allocate to any of the reportable
segments. In 1999, such column includes only corporate headquarters costs that
we do not allocate to any of the reportable segments. All amounts presented
below are in thousands.
7
<PAGE>
<TABLE>
<CAPTION>
Fiscal quarter ended June 20, 1999 and June 14, 1998
----------------------------------------------------
Domestic Domestic Intersegment
Stores Distribution International Revenues Other Total
------ ------------ ------------- -------- ----- -----
Revenues -
<S> <C> <C> <C> <C> <C> <C>
1999 ...... $110,345 $154,677 $ 12,982 $(21,892) $ -- $256,112
1998 ...... 119,111 157,387 12,280 (26,476) -- 262,302
EBITDA -
1999 ...... 30,905 7,063 2,234 -- (8,737) 31,465
1998 ...... 27,256 4,047 1,985 -- (11,830) 21,458
<CAPTION>
Two fiscal quarters ended June 20, 1999 and June 14, 1998
---------------------------------------------------------
Domestic Domestic Intersegment
Stores Distribution International Revenues Other Total
------ ------------ ------------- -------- ----- -----
Revenues -
<S> <C> <C> <C> <C> <C> <C>
1999 ...... $223,521 $311,594 $ 25,847 $(44,082) $ -- $516,880
1998 ...... 235,717 311,576 24,459 (53,590) -- 518,162
EBITDA -
1999 ...... 61,408 12,452 4,334 -- (16,504) 61,690
1998 ...... 52,337 8,061 3,899 -- (23,982) 40,315
</TABLE>
The following table reconciles total EBITDA above to consolidated income before
provision for income taxes:
<TABLE>
<CAPTION>
Fiscal quarter ended Two fiscal quarters ended
June 20, 1999 June 14, 1998 June 20, 1999 June 14, 1998
--------------------------- ---------------------------
<S> <C> <C> <C> <C>
Total EBITDA $ 31,465 $ 21,458 $ 61,690 $ 40,315
Depreciation and amortization (11,882) (4,950) (24,692) (9,580)
Interest expense (16,911) (1,047) (34,162) (1,843)
Interest income 216 204 329 594
Gain (loss) on sale of plant and equipment (31) (148) 73 (168)
-------- -------- -------- --------
Income before provision (benefit)
for income taxes $ 2,857 $ 15,517 $ 3,238 $ 29,318
======== ======== ======== ========
</TABLE>
No customer accounted for more than 10% of total consolidated revenues in the
fiscal quarter or two fiscal quarters ended June 20, 1999 and June 14, 1998.
8
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The 1999 and 1998 second fiscal quarters referenced herein represent the
twelve-week periods ended June 20, 1999 and June 14, 1998, respectively. The
1999 and 1998 half years or two fiscal quarter periods referenced herein
represent the twenty four-week periods ended June 20, 1999 and June 14, 1998,
respectively.
Results of Operations
Revenues
General. Revenues include sales by corporate-owned stores, royalty fees from
domestic and international franchises and sales by our distribution commissaries
to domestic and international franchises. Total revenues decreased $6.2 million,
or 2.4%, to $256.1 million for the second quarter of 1999 from $262.3 million
for the second quarter of 1998. Total revenues decreased $1.3 million, or 0.2%,
to $516.9 million for the first half of 1999 from $518.2 million in the same
period in 1998. These decreases resulted primarily from reductions in corporate
stores revenues, partially offset by increased revenues from domestic
distribution and domestic franchise royalties.
Domestic Stores
Corporate Stores. Revenues from Corporate Stores decreased 11.3% to $83.8
million for the second quarter of 1999 from $94.5 million for the same period in
1998. Corporate Stores revenues decreased 8.8% to $170.4 million for the first
half of 1999 from $186.8 million for the same period in 1998. These decreases
were due primarily to a reduction in the number of corporate stores resulting
from our store rationalization program, under which we closed or sold to
franchisees 142 stores, primarily in the fourth quarter of 1998. These decreases
were partially offset by increases of 5.8% and 8.9% in average corporate store
sales for the second quarter and first half of 1999, respectively, over the same
periods in 1998. Same store sales for corporate stores decreased 1.6% for the
second quarter of 1999 and increased 2.2% for the first half of 1999 as compared
to the same periods in 1998. Same store sales during the second quarter of 1999
were negatively impacted by aggressive pricing promotions by competitors. Ending
corporate stores decreased by 123, to 645 as of June 20, 1999 from 768 as of
June 14, 1998, due mainly to the store rationalization program completed in
December 1998.
Domestic Franchise. Revenues from Domestic Franchise operations are derived
primarily from royalty income. Revenues from Domestic Franchise operations
increased 7.3% to $26.5 million for the second quarter of 1999 from $24.7
million for the same period in 1998. Domestic Franchise operations revenues
increased 8.8% to $53.2 million for the first half of 1999 from $48.9 million
for the same period in 1998. These increases are attributable primarily to 1.4%
and 2.9% increases in average store sales for the second quarter and first half
of 1999, respectively, as compared to the same periods in 1998, and an increase
in the average number of domestic franchise stores, due mainly to sales of
corporate stores to franchisees in the store rationalization program and
additional franchise store openings. Same store sales for domestic
franchises increased 1.8% and 4.1% for the second quarter and first half of
1999, respectively, as compared to the same periods in 1998. Similarly to
corporate stores, domestic franchise stores same store sales trends were
negatively impacted by aggressive price discounting by competitors during the
second fiscal quarter of 1999. Ending domestic franchise stores increased by 173
to 3,880 as of June 20, 1999 from 3,707 as of June 14, 1998.
Domestic Distribution. Revenues from Domestic Distribution operations are
derived primarily from the sale of food, equipment and supplies to domestic
franchise stores and, to a lesser extent, the sale of equipment to international
stores, and exclude sales to corporate-owned stores. Revenues from Distribution
operations increased 1.4% to $132.8 million for the second quarter of 1999 from
$130.9 million for the same period in 1998. Revenues from distribution increased
3.6% to $267.5 million for the first half of 1999 from $258 million for the same
period in 1998. The increase was mainly due to an increase in food sales to
franchisees, primarily relating to the increases in Domestic Franchise store
sales and number of stores discussed above, partially offset by decreased
equipment sales during the first half of 1999 and a shift in dough product mix
from par-baked deep dish and thin crust shells toward lower-priced fresh dough.
During the first half of 1998, equipment sales were at high levels resulting
from the roll-out of our HeatWave(R) hot bag systems.
International. International revenues, which are derived mainly from food sales
to international franchisees, master franchise agreement royalties and, to a
lesser extent, franchise and development fees and corporate owned international
stores, increased 5.6% to $13 million for the second quarter of 1999 from $12.3
million for the same period in 1998. International revenues for the first half
of 1999 increased 5.7% to $25.8 million from $24.5 million for the same period
in 1998. The increases in international revenues during 1999 were primarily due
to increases in royalty income, the addition of three international corporate
stores and international commissary product sales. International franchise
royalty revenues increased by 9.7% to $4.7 million and 10.5% to $9.4 million for
the second quarter and first half of 1999, respectively, due principally to an
increase in the number of international franchise stores. During the first half
of 1999, we acquired three stores in France. These stores, which had revenues of
$0.2 million in the second quarter of 1999, represent our only corporately owned
stores outside of the contiguous United States. International commissary product
sales to franchisees increased 2.2% to $7.6 million and 1.8% to $15.2 million
for the second quarter and first half of 1999, respectively, due to commencement
of commissary operations in France in early 1999 and increased sales in Canadian
commissary operations, significantly offset by the impact of the sale of Puerto
Rico commissary operations to the master franchisee in that market in late 1998.
On a constant dollar basis, same store sales increased by 3.1% and 4.1% for the
second quarter and first half of 1999, respectively, from the same periods of
1998. Ending international stores increased by 158 to 1,797 as of June 20, 1999
from 1,639 as of June 14, 1998.
Gross Profit. Gross profit increased 3.7% to $75.0 million for the second
quarter of 1999 from $72.3 million for the same period in 1998. Gross profit
increased 8.0% to $150.2 million for the first half of 1999 from $139 million
for the same period of 1998. As a percentage of revenues, gross profit increased
1.7% and 2.2%, to 29.3% and 29.1% for the second quarter and first half of 1999,
respectively, compared to the same periods in 1998. These increases were driven
primarily by reductions in corporate stores food, labor and insurance costs that
resulted mainly from elimination of underperforming stores through the store
rationalization program as well as improved shift scheduling, minimized
overtime, reduced insurance premiums and favorable product mix and pricing.
Also, Distribution food cost as a percentage of sales decreased slightly, due
mainly to a shift in product mix from par-baked deep dish and thin crust shells
to higher margin fresh dough. In addition, the cost of sales component of
depreciation and amortization expense decreased slightly due to the modification
of estimated useful lives for several fixed asset categories effective in the
first quarter of 1999.
General and Administrative. General and Administrative expenses consist
primarily of regional support offices, corporate administrative functions,
corporate store and distribution facility management costs and advertising and
promotional expenses. General and administrative expenses decreased 0.8% to
$55.5 million for the second quarter of 1999 from $55.9 million for the same
period of 1998. General and administrative expenses increased 4.3% to $113.1
million in the first half of 1999 from $108.4 million for the same period of
1998. As a percentage of revenues, general and administrative expenses increased
0.3% to 21.7% for the second quarter of 1999 and increased 1.0% to 21.9% in the
first half of 1999, compared to the same period in 1998. These increases are due
primarily to increased amortization expense of $7.7 million and $15.4 million
for the second quarter and first half of 1999, respectively, with respect to a
covenant not-to-compete we entered into with TISM's former principal stockholder
9
<PAGE>
at the time of the recapitalization in December 1998, increased information
systems costs, primarily for amortization of our recently developed financial
and supply chain systems, and a $1.6 million employment severance charge
incurred in the second quarter of 1999. These increases in expenses were
partially offset by the impact of eliminating a corporate stores field office as
part of the store rationalization program and elimination of related party
transaction expenses of $5 million and $10.1 million for the second quarter and
first half of 1999, respectively, which were primarily comprised of lease
payments in excess of current levels to entities controlled by TISM's former
principal stockholder and charitable contributions to a foundation managed by
TISM's former principal stockholder.
Interest Expense. Interest expense increased $15.9 million to $16.9 million for
the second quarter of 1999 and increased $32.3 million to $34.2 million for the
first half of 1999 compared to the same periods from the prior year. The
increases in interest expense are due to the interest costs, including deferred
financing cost amortization, resulting from Domino's December 1998 borrowings of
$722.1 million, which were incurred to fund its recapitalization.
Provision (Benefit) for Income Taxes. The benefit for income taxes was $1.5
million and $1.3 million for the second fiscal quarter and first half of 1999,
respectively, compared to a provision for income taxes of $1.1 million and $2.3
million for the same periods in 1998. In May 1999, the State of Michigan Supreme
Court upheld a favorable lower court tax ruling with respect to an issue that,
if decided unfavorably, could have resulted in significant tax cost to the
Company. As a result, during the second fiscal quarter of 1999, the Company
reversed state tax reserves and related deferred federal tax benefits that were
associated with this issue. Additionally, as part of our recapitalization, we
converted from "S" Corporation status to "C" Corporation status for federal
income tax reporting purposes in December 1998. As a result, the provision for
income taxes for the second quarter and first half of 1999 includes U.S. federal
and state income taxes and foreign income taxes whereas the provision for income
taxes for the same period in 1998 included only foreign income taxes and income
taxes of a few states for which we had been taxed at the corporate level.
Liquidity and Capital Resources
We had negative working capital of $5.6 million and $18.2 million at June 20,
1999 and January 3, 1999, respectively. We have generally had negative working
capital because our receivable collection periods and inventory turn rates are
faster than the normal payment terms on our current liabilities. In addition,
our sales are not typically seasonal, which further limits our working capital
requirements. Our primary sources of liquidity are cash flow from operations and
borrowings under our new revolving credit facility.
Operating activities provided cash resources of $33.0 million and $33.6 million
in the first half of 1999 and 1998, respectively. The cash provided by operating
activities in the first half of 1999 consisted mainly of earnings before
interest, taxes, depreciation and amortization expenses ("EBITDA") of $61.7
million, offset by interest payments of $13.8 million, income tax payments of
$6.4 million and other changes in operating assets of $8.5 million. EBITDA
increased $21.4 million over the same period in 1998 primarily due to increases
in gross profit and decreases in administrative expenses, as discussed above.
However, this increase was offset primarily by an increase in interest payments
of $12 million for the first half of 1999 due to the December 1998 borrowings
and a higher use of cash from changes in operating assets due mainly to timing
differences, resulting in nearly equal operating cash flows in the first half of
1999 as compared to 1998.
Net cash used in investing activities consists primarily of capital expenditures
and investments in marketable securities, partially offset by proceeds from
asset sales and collections on notes receivable from franchisees. Net cash used
in investing activities was $11.5 million and $21.7 million for the first half
of 1999 and 1998, respectively. The decrease in cash used in investing
activities for the first half of 1999 resulted primarily from a $7.7 million
decrease in capital expenditures.
Capital expenditures were $12.2 million and $19.9 million for the first half of
1999 and 1998, respectively. The higher capital expenditures for the first half
of 1998 were primarily attributable to development costs associated with our
financial and supply chain computer systems, higher spending for corporate store
openings and relocations and the implementation of HeatWave(R) hot bag systems
in corporate-owned stores. Management anticipates capital spending will continue
below 1998 levels for the remainder of 1999.
10
<PAGE>
We incurred substantial indebtedness in connection with the December 1998
recapitalization. As of June 20, 1999, we had $724.8 million of indebtedness
outstanding as compared to $46.3 million of indebtedness outstanding immediately
prior to the recapitalization. In addition, we have a stockholder's deficit of
$477.6 million as of June 20, 1999, as compared to stockholder's equity of $41.8
million immediately prior to the recapitalization.
Net cash used in financing activities was $2.2 million and $6.8 million for the
first half of 1999 and 1998, respectively. In connection with the
recapitalization, we borrowed $445 million under term loan facilities and
approximately $2.1 million under a revolving credit facility. Cash flows used in
financing activities for the first half of 1999 reflected $3.7 million in
repayments of long-term debt and $1.5 million received as additional capital
contributions from our parent. In 1998, the long-term debt borrowings and
distributions were incurred primarily to finance and fund the "S" Corporation
income taxes of our parent company's stockholders.
Effective February 1, 1999, we terminated the Distribution profit capitation
program. Under this program, our Distribution division had rebated to
participating franchisees all Distribution pre-tax profits in excess of 2% of
gross revenues from sales to corporate-owned and domestic franchise stores. In
addition, at the beginning of fiscal year 1999, corporate-owned stores began
participating in the profit sharing program of our Distribution division. This
profit sharing plan was amended in the first fiscal quarter of 1999 to increase
rebates to participating stores from approximately 45% to approximately 50% of
their regional distribution center's pre-tax profits. Although corporate-owned
stores had the right to participate in the program, historically only domestic
franchise stores participated. We agreed that the aggregate funds available for
rebate to participating franchisees in 1999 under the profit sharing plan would
be at least $1 million more than the aggregate payments made to franchisees
under the profit sharing and profit capitation programs in fiscal year 1998. We
agreed to pay any deficiency to participating franchisees on a pro rata basis.
Based upon the current level of operations and anticipated growth, we believe
that cash generated from operations and amounts available under the revolving
credit facility will be adequate to meet our anticipated debt services
requirements, capital expenditures and working capital needs for the next
several years. There can be no assurance, however, that our business will
generate sufficient cash flow from operations or that future borrowings will be
available under the senior credit facilities or otherwise to enable us to
service our indebtedness, including the senior credit facilities and the senior
subordinated notes, or to make anticipated capital expenditures. Our future
operating performance and our ability to service or refinance the senior
subordinated notes and to service, extend or refinance the senior credit
facilities will be subject to future economic conditions and to financial,
business and other factors, many of which are beyond our control.
Year 2000 Readiness Disclosure
We have recently either replaced or upgraded a majority of our core information
systems, including the franchise royalties system, franchise legal system,
information warehouse system and ULTRA store system, which is the point-of-sale
and operating system for corporate-owned stores. In addition, we are in the
process of implementing a full suite of financial and distribution supply chain
computer systems. We anticipate the financial systems implementation will be
complete no later than October 31, 1999. The implementation of our new
distribution supply chain systems is currently underway. We are also in the
process of a remediation effort on our legacy supply chain systems to render
them Year 2000 compliant. We anticipate the effort to bring legacy supply chain
systems into compliance with Year 2000 will be completed no later than October
31, 1999. We believe the completion of this remediation effort will mitigate the
risk associated with not completing the new distribution supply chain systems
implementation prior to December 31, 1999. Upon completion of this project
and/or relevant Year 2000 remediation efforts, we believe that all of our
critical internal information systems will operate correctly with regard to the
import, export, and processing of date information, including correct handling
of leap years, in connection with the change in the calendar year from 1999 to
2000. Each of these upgrades was part of our budgeted expenses for upgrading our
computer infrastructure and was not primarily undertaken or accelerated because
of the Year 2000 issue. We have, however, complemented our system upgrades with
an internal compliance team responsible for testing all of our information
systems for Year 2000 compliance.
11
<PAGE>
We are also in the process of addressing other less critical equipment and
machinery, such as facility equipment, that may contain embedded technology with
Year 2000 compliance problems. We expect to complete this effort no later than
September 30, 1999. We also have material relationships with franchisees,
suppliers and vendors and other significant entities, such as public utilities,
that may not have adequately addressed the Year 2000 issue with respect to their
equipment or information systems. Although we are attempting to assess the
extent of their compliance efforts, we have received written assurances from
only a portion of this group and, accordingly, cannot determine the risk to our
business.
For the fiscal year ended January 3, 1999, we spent approximately $256,000
addressing the Year 2000 issue. For the year ended January 2, 2000, we estimate
we will spend approximately $700,000 addressing the Year 2000 issue, of which we
have incurred approximately $438,000 during the first half of 1999. These
amounts do not reflect the cost of our internal compliance team or the cost of
planned replacement systems, such as the financial and distribution supply chain
systems software, which may have a positive impact on resolving the Year 2000
issue. We do not expect that additional costs required to address the Year 2000
issue will have a significant impact on our business or operating results. In
the event, however, that we are unable to complete planned upgrades, implement
replacement systems or otherwise resolve Year 2000 compliance problems prior to
December 31, 1999, or in the event our franchisees or a significant number of
our suppliers and vendors do not adequately address the Year 2000 issue before
such date, we may experience significant disruption or delays in our operations,
which in turn could have a material adverse effect on our business.
At this time, we are still assessing the likely worst case scenario that may
result from any significant disruptions or delays in our operations due to Year
2000 compliance issues associated with (1) our critical information systems, (2)
other less critical facility equipment or machinery, or (3) a significant number
of our franchisees, suppliers and vendors. We expect to complete this analysis
within the next several months. Further, except as mentioned above, we have no
contingency plans in place to address Year 2000 problems. We plan to evaluate
the status of our Year 2000 compliance efforts at the end of September 1999 to
determine whether such contingency plans are necessary.
Forward-Looking Statements
Certain statements contained in this filing relating to capital spending levels,
the future adequacy of our capital resources and Year 2000 readiness are
forward-looking. Also statements that contain words such as "believes,"
"expects," "anticipates," "intends," "estimates" or similar expressions are
forward-looking statements. Forward-looking statements involve risks and
uncertainties that could cause actual results to differ materially from those
expressed or implied by such forward-looking statements. Among these risks and
uncertainties are competitive factors, increases in our operating costs, ability
to retain our key personnel, our substantial leverage, ability to implement our
growth and cost-saving strategies, industry trends and general economic
conditions, risks and uncertainties relating to the Year 2000 issue, adequacy of
insurance coverage and other factors, all of which are described in this 10-Q
for the quarter ended June 20, 1999 and our other filings with the Securities
and Exchange Commission. We do not undertake to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
12
<PAGE>
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market Risk
The Company's use of derivative instruments is primarily limited to interest
rate swaps and foreign currency forward contracts. The Company does not enter
into financial derivatives for trading purposes.
Interest Rate Swaps
We enter into interest rate swaps with the objective of reducing our volatility
in borrowing costs. In 1999, we entered into two interest rate swap agreements
to effectively convert the Eurodollar rate component of the interest on a
portion of our variable rate bank debt to a fixed rate of 5.12% through December
2001. At June 20, 1999, the notional amount of these swap agreements was $179
million.
Foreign Currency Forward Contracts
We use foreign currency forward contracts to minimize the effect of a
fluctuating Japanese yen on royalty revenues from franchised operations in
Japan. As currency rates change, the gains and losses with respect to these
contracts are recognized in income. For the fiscal quarter ended June 20, 1999,
no significant gains or losses were recognized under the foreign currency
forward contracts.
Interest Rate Risk
The Company's variable interest expense is sensitive to changes in the general
level of United States and European interest rates. A portion of the Company's
debt currently is borrowed at Eurodollar rates plus a blended rate of
approximately 3.4% and is sensitive to changes in interest rates. At June 20,
1999, the weighted average interest rate on our $443.5 million of variable
interest debt was approximately 8.4% and the fair value of the debt approximates
its carrying value.
The Company had interest expense of $34.2 million for the first half of 1999.
The potential increase in interest expense for the first half of 1999 from a
hypothetical 2% adverse change in the variable interest rates, would be
approximately $2.5 million.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities and Use Of Proceeds
None.
Item 3. Defaults Under Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
During the second quarter of the fiscal year covered by this report, the Company
submitted several matters to a vote of its sole stockholder. On March 31, 1999,
in an action by written consent, the sole stockholder of Domino's amended the
by-laws to provide for the Company to have six directors, elected Andrew Balson
and David A. Brandon as directors of the Company, approved the execution and
delivery by the Company of an employment agreement and related agreements with
David A. Brandon and approved payments to David A. Brandon pursuant to such
agreements. The term as director of each of Robert F. White, Mark E. Nunnelly,
Jonas L. Steinman and Thomas S. Monaghan continued after the written consent.
On April 30, 1999, in an action by written consent, the sole stockholder of
Domino's amended the by-laws to provide for the Company to have seven directors
and elected Robert M. Rosenberg as a director of the Company. The term as
director of each of Robert F. White, Mark E. Nunnelly, Jonas L. Steinman, Andrew
Balson, David A. Brandon and Thomas S. Monaghan continued after the written
consent.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
Exhibit
Number Description
------ -----------
27 Financial Data Schedule which is submitted electronically
to the Securities and Exchange Commission for information
only and not deemed to be filed with the Commission.
99.1 Risk Factors
13
<PAGE>
b. Current Reports on Form 8-K
There were no reports filed on Form 8-K during the quarter ended June 20,
1999.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DOMINO'S, INC.
(Registrant)
Date: August 4, 1999 /s/ Harry J. Silverman
-------------------------------------------
Harry J. Silverman, Chief Financial Officer
14
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<PAGE>
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<S> <C> <C>
<PERIOD-TYPE> 6-MOS 6-MOS
<FISCAL-YEAR-END> JAN-02-2000 JAN-3-1999
<PERIOD-START> JAN-04-1999 DEC-29-1997
<PERIOD-END> JUN-20-1999 JUN-14-1998
<CASH> 19,489 5,075
<SECURITIES> 0 0
<RECEIVABLES> 52,662 53,645
<ALLOWANCES> 3,322 3,772
<INVENTORY> 17,587 24,647
<CURRENT-ASSETS> 106,461 86,465
<PP&E> 184,198 194,135
<DEPRECIATION> 117,592 133,966
<TOTAL-ASSETS> 383,861 225,468
<CURRENT-LIABILITIES> 112,093 128,219
<BONDS> 275,000 0
0 0
0 0
<COMMON> 0 0
<OTHER-SE> (477,646) 23,502
<TOTAL-LIABILITY-AND-EQUITY> 383,861 225,468
<SALES> 453,309 459,724
<TOTAL-REVENUES> 516,880 518,162
<CGS> 258,495 258,990
<TOTAL-COSTS> 366,697 487,595
<OTHER-EXPENSES> 113,112 108,424
<LOSS-PROVISION> 772 693
<INTEREST-EXPENSE> 33,833 1,249
<INCOME-PRETAX> 3,238 29,318
<INCOME-TAX> (1,338) 2,285
<INCOME-CONTINUING> 4,576 27,033
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 4,576 27,033
<EPS-BASIC> 0 0
<EPS-DILUTED> 0 0
</TABLE>
<PAGE>
EXHIBIT 99.1
Risk Factors
Our substantial indebtedness could adversely affect our financial health and
severely limit our ability to plan for or respond to changes in our business. In
addition, we are permitted to incur substantially more debt in the future, which
could aggravate the risks described below.
To finance the December 1998 recapitalization, we have incurred a significant
amount of indebtedness. As of June 20, 1999, our consolidated indebtedness was
$724.8 million. After giving pro forma effect to the recapitalization as if it
had been completed on December 29, 1997, our ratio of earnings to fixed charges
for the fiscal year ended January 3, 1999 would have been 1.0. Further, the
terms of the indenture relating to our senior subordinated notes permit us to
incur substantial indebtedness in the future, including up to an additional $100
million under our revolving credit facility.
Our ability to make payment 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. Based on our current level of
operations and anticipated cost savings and operating improvements, we believe
our cash flow from operations and available borrowings under our new revolving
credit facility will be adequate to meet our liquidity needs over the next
several years.
We cannot assure you, however, that our business will generate sufficient cash
flow from operations, that currently anticipated cost savings and operating
improvements will be realized on schedule, in the amounts projected or at all,
or that future borrowings will be available to us under our new revolving credit
facility in amounts sufficient to enable us to pay our indebtedness or to fund
our other liquidity needs. If we cannot generate sufficient cash flow from
operations to pay our indebtedness when due, 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. We cannot assure you that we will be
able to refinance any of our indebtedness on commercially reasonable terms or at
all or that any other action can be effected on satisfactory terms, if at all.
Our substantial indebtedness could have other important consequences. For
example, it could:
- 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;
<PAGE>
- 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
competitors that may have less debt;
- limit, by the financial and other restrictive covenants in the
indebtedness, among other things, our ability to borrow
additional funds; and
- have a material adverse effect on us if we fail to comply with
the covenants in our indebtedness because such failure could
result in an event of default which, if not cured or waived,
could result in a substantial amount of our indebtedness
becoming immediately due and payable.
The pizza delivery market is highly competitive, and increased competition could
adversely affect our operating results.
We believe we compete on the basis of product quality, delivery time, service
and price. We compete in the United States against three national chains, Pizza
Hut, Papa John's and, to a lesser extent, Little Caesar's, along with regional
and local concerns. Although we believe we are well positioned to compete
because of our leading market position, focus and expertise in the pizza
delivery business and strong national brand name recognition, we could
experience increased competition from existing or new companies and loss of
market share, which could have an adverse effect on our operating results.
We also compete on a broader scale with other international, national, regional
and local restaurants and quick-service eating establishments. No reasonable
estimate can be made of the number of competitors on this scale. The overall
food service industry and the quick-service eating establishment segment are
intensely competitive with respect to food quality, price, service, convenience
and concept, and are often affected by changes in: consumer tastes; national,
regional or local economic conditions; currency fluctuations to the extent
international operations are involved; demographic trends; and disposable
purchasing power. We compete within the food service industry and the
quick-service eating establishment segment not only for customers, but also for
management and hourly personnel, suitable real estate sites and qualified
franchisees.
<PAGE>
We do not have written contracts with most of our suppliers, and as a result
they could seek to significantly increase prices or fail to deliver as required.
We have historically had long-lasting relationships with our suppliers. More
than half of our major suppliers have been with us for over 14 years. As a
result, we typically rely on oral rather than written contracts with our
suppliers. In the case of cheese, where we have only one supplier, we have a
written agreement. Although we have not experienced significant problems with
our suppliers, there can be no assurance that our suppliers will not implement
significant price increases or that suppliers will meet our requirements in a
timely fashion, if at all. The occurrence of any of the foregoing could have a
material adverse effect on our operating results.
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
benefit costs and the availability of qualified management and hourly employees
may adversely affect our operating costs. Most of the factors affecting costs
are beyond our control. Most products used in our pizza, particularly cheese,
are subject to price fluctuations, seasonality, weather, demand and other
factors. Labor costs are primarily a function of minimum wage and availability
of labor. Cheese and labor costs of a typical store represent 7.6% and 28.5% of
store sales, although we only bear such costs at our corporate-owned stores.
If we fail to successfully implement our growth strategy, our ability to
increase our revenues and operating profit could be adversely affected.
We have grown rapidly in recent periods. We intend to continue our growth
strategy primarily by increasing the number of our domestic and international
stores. We and our franchisees face many challenges in opening new stores,
including, among others:
- selection and availability of suitable store locations;
- negotiation of acceptable lease or financing terms;
- securing of required domestic or foreign governmental permits
and approvals; and
- employment and training of qualified personnel.
The opening of additional franchises 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 revenue and operating income. In addition, although we have
successfully tested an alternative store concept called Delivery Express, we
have not yet opened a significant number of Delivery Express stores and cannot
predict with certainty the success of the concept on a widespread basis.
<PAGE>
Our international operations subject us to additional risks which may differ in
each country in which we do business.
Our financial condition and results of operation may be adversely affected when
global markets in which our franchised 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 changes in exchange rates, inflation
rates, recessionary or expansive trends, tax changes, legal and regulatory
changes or other external factors. We are currently planning to expand our
international operations which may increase the effect of these factors.
A third party has filed a patent infringement claim against us relating to the
Domino's HeatWave Hot Bag.
The plaintiffs asserted that the heat retention cores inside the Domino's
HeatWave Hot Bag infringe a patent they own. In addition to damages, the
plaintiffs are seeking an injunction to enjoin the manufacture, sale or use of
the heat retention cores inside the Domino's HeatWave Hot Bag. Although we
intend to vigorously defend against the claim, we cannot predict the ultimate
outcome of the claim.
Our business depends on retention of our current senior executives and key
personnel and the success of our new chief executive officer.
Our success will continue to depend to a significant extent on our executive
team and other key management personnel. We have entered into employment
agreements with certain of our executive officers. There can be no assurance
that we will be able to retain our executive officers and key personnel or
attract additional qualified management. In connection with the completion of
the recapitalization, Mr. Monaghan, our founder and chief executive officer,
retired and became a director. Mr. Brandon has recently joined us as our new
Chief Executive Officer. Although we are very pleased to have him assume this
role, we cannot assure you of his success.
The ability of the Company to take major corporate actions is limited by the
TISM stockholders agreement.
In connection with the recapitalization, all of the stockholders of TISM entered
into a stockholders agreement which provides, among other things, that the
approval of the holders of a majority of the voting stock of TISM subject to the
stockholders agreement will be required for TISM or its subsidiaries, including
the Company, to take various specified actions, including among others, major
corporate transactions such as a sale or initial public offering, acquisitions
and divestitures, financings, recapitalizations and mergers, as well as other
actions such as hiring and firing senior managers, setting management
compensation and establishing capital and operating budgets and business plans.
<PAGE>
Pursuant to the stockholders agreement and the Articles of Incorporation of
TISM, the Bain Capital funds will have the power to block any such transaction
or action and to elect up to half of the Board of Directors of TISM. The Bain
Capital funds may have different interests as equity holders than those of
holders of our $275 million Senior Subordinated Notes ("Notes").
Our business may be adversely affected if our critical computer systems, or
those of our suppliers and vendors, do not properly handle date information in
Year 2000.
Upon completion of the implementation of certain new computer systems and
remediation of our legacy supply chain system by October 31, 1999, we believe
that all of our critical internal information systems will operate correctly
with regard to the import, export, and processing of date information, including
correct handling of leap years, in connection with the change in the calendar
year from 1999 to 2000. We also plan to inventory and address other less
critical equipment and machinery, such as facility equipment, that may contain
embedded technology with Year 2000 compliance problems. We expect to complete
this effort no later than September 30, 1999. We also have material
relationships with franchisees, suppliers and vendors that may not have
adequately addressed the Year 2000 issue with respect to their equipment or
information systems. Although we are attempting to assess the extent of their
compliance efforts, we have received written assurances from only a portion of
this group and, accordingly, cannot determine the risk to our business. In the
event that we are unable to complete planned upgrades or implement replacements
systems prior to December 31, 1999 or in the event our franchisees, suppliers
and vendors do no adequately address the Year 2000 issue before such date, we
may experience significant disruption or delays in our operations, which in turn
could have a material adverse effect on our business.
We may not have the ability to raise the funds necessary to finance the change
of control offer required by our indenture.
Upon the occurrence of certain specific kinds of change of control events, we
must offer to repurchase all outstanding Notes. It is possible, however, that we
will not have sufficient funds at the time of the change of control to make the
required repurchase of the Notes or that restrictions in our senior credit
facilities will not allow such repurchases. In addition, certain important
corporate events, such as leveraged recapitalizations that would increase the
level of our indebtedness, would not constitute a change of control under the
indenture.
The occurrences of certain of the events that would constitute a change of
control under the indenture would constitute a default under the senior credit
facilities. Our senior indebtedness and the senior indebtedness of our
subsidiaries may also contain prohibitions of certain events that would
constitute a change of control. Moreover, the exercise by the holders of the
Notes of their right to require us to repurchase the Notes could cause a default
under such senior indebtedness, even if the change of control itself does not,
due to the financial effect on us of such repurchase. The terms of the senior
credit facilities will, and other senior debt may, prohibit the prepayment of
the Notes by us prior to their scheduled maturity. Consequently, if we are not
able to prepay the indebtedness under the senior credit facilities and any other
senior indebtedness containing similar restrictions, we will be unable to
fulfill our repurchase obligations if holders of the Notes exercise their
<PAGE>
repurchase rights following a change of control, thereby resulting in a default
under the indenture.
There can be no assurance that our current insurance coverage will be adequate,
that insurance premiums for such coverage will not increase or that in the
future we will be able to obtain insurance at acceptable rates, if at all.
Through December 19, 1998, we self-insured our commercial general liability,
automobile liability, and workers' compensation liability exposures up to levels
ranging from $500,000 to $1 million per occurrence, and maintained excess and
umbrella insurance coverage above those levels up to amounts ranging from $60
million to $105 million per occurrence on our commercial general liability and
automobile liability policies and up to statutory limits on our workers'
compensation policies. Effective December 20, 1998, we acquired first-dollar
insurance coverage for all of the above exposures, with total coverage of $105
million per occurrence on our commercial general liability and automobile
liability policies and up to statutory limits on our workers' compensation
policies. We also maintain commercial property liability insurance. These
policies provide a variety of coverages and are subject to various limitations,
exclusions and deductibles. There can be no assurance that such liability
limitations will be adequate, that insurance premiums for such coverage will not
increase or that in the future we will be able to obtain insurance at acceptable
rates, if 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.
