<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: September 12, 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 [X] No [ ]
The number of shares outstanding of the registrant's common stock as of October
22, 1999 was 10 shares.
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DOMINO'S, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(UNAUDITED)
<TABLE>
<CAPTION>
(In thousands) September 12, 1999 January 3, 1999
Assets (Unaudited) (Note)
------------------- ----------------
<S> <C> <C>
Current assets:
Cash $ 13,374 $ 115
Accounts receivable 47,166 48,858
Inventories 17,976 20,134
Deferred tax assets 9,811 9,811
Other 13,479 17,927
--------- ---------
Total current assets 101,806 96,845
--------- ---------
Property, plant and equipment:
Land and buildings 14,246 14,605
Leasehold and other improvements 55,048 52,248
Equipment 114,299 109,517
Construction in progress 3,372 5,486
--------- ---------
186,965 181,856
Accumulated depreciation and amortization 118,074 116,890
--------- ---------
Total property, plant and equipment 68,891 64,966
--------- ---------
Other assets:
Deferred tax assets 73,628 71,776
Deferred financing costs 39,083 43,046
Goodwill 16,577 14,179
Covenants not-to-compete 26,471 50,058
Capitalized software 25,565 22,593
Other 23,790 24,428
--------- ---------
Total other assets 205,114 226,080
--------- ---------
Total assets $ 375,811 $ 387,891
========= =========
Liabilities and stockholder's deficit
Current liabilities:
Current portion of long-term debt $ 13,082 $ 7,646
Accounts payable 34,216 44,596
Insurance reserves 10,368 9,633
Accrued income taxes 2,464 6,501
Other accrued liabilities 46,549 46,693
--------- ---------
Total current liabilities 106,679 115,069
--------- ---------
Long-term liabilities:
Long-term debt, less current portion 711,508 720,480
Insurance reserves 11,723 15,132
Other accrued liabilities 22,747 20,985
--------- ---------
Total long-term liabilities 745,978 756,597
--------- ---------
Stockholder's deficit:
Common stock - -
Additional paid-in capital 116,202 114,737
Retained deficit (592,879) (598,209)
Accumulated other comprehensive income (169) (303)
--------- ---------
Total stockholder's deficit (476,846) (483,775)
--------- ---------
Total liabilities and stockholder's deficit $ 375,811 $ 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
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DOMINO'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
Fiscal Quarter Ended Three Fiscal Quarters
Ended
SEPTEMBER 12, SEPTEMBER 6, SEPTEMBER 12, SEPTEMBER 6,
1999 1998 1999 1998
----------- ----------- ------------- -------------
<S> <C> <C> <C> <C>
(In thousands)
Revenues:
Corporate stores $ 88,081 $ 93,954 $258,443 $280,724
Domestic franchise
royalties 26,602 25,498 79,761 74,445
Domestic distribution 144,008 133,588 411,520 391,574
International 13,212 12,231 39,059 36,690
-------- ---------- ---------- --------
Total revenues 271,903 265,271 788,783 783,433
-------- ---------- ---------- --------
Operating expenses:
Cost of sales 195,558 197,080 562,255 576,251
General and
administrative 58,174 52,093 171,286 160,517
-------- ---------- --------- ----------
Total operating expenses 253,732 249,173 733,541 736,768
-------- ---------- --------- ----------
Income from operations 18,171 16,098 55,242 46,665
Interest income 289 177 618 771
Interest expense 17,028 987 51,190 2,830
-------- ---------- ---------- ----------
Income before provision
(benefit)
for income taxes 1,432 15,288 4,670 44,606
Provision (benefit) for
income taxes 678 1,156 (660) 3,441
-------- ---------- ---------- -----------
Net income $ 754 $ 14,132 $ 5,330 $ 41,165
======== ========== ========= ==========
</TABLE>
See accompanying notes.
3
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DOMINO'S, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Fiscal Quarters Ended
September 12, September 6,
1999 1998
------------ -------------
<S> <C> <C>
(In thousands)
Cash flows from operating activities:
Net cash provided by operating activities $ 33,235 $ 53,853
-------- --------
Cash flows from investing activities:
Purchases of plant and equipment (22,023) (34,176)
Repayments of notes receivable 6,825 1,459
Other (2,417) (2,766)
-------- --------
Net cash used in investing activities (17,615) (35,483)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of long-term debt - 28,200
Repayments of long-term debt (3,945) (11,030)
Capital contribution from Parent 1,465
Distributions to Parent - (35,595)
-------- --------
Net cash used in financing activities (2,480) (18,425)
-------- --------
Effect of exchange rate changes on cash 119 (23)
-------- --------
Increase (decrease) in cash 13,259 (78)
Cash, at beginning of period 115 105
-------- --------
Cash, at end of period $ 13,374 $ 27
======== ========
</TABLE>
See accompanying notes.
4
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Domino's, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 12, 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 three fiscal
quarters ended September 12, 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, Commission File 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 third fiscal quarters of 1999 and
1998 consisted of the twelve week periods ended September 12, 1999 and September
6, 1998, respectively.
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
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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 Three Fiscal Quarters Ended
September 12, 1999 September 12, 1999
-------------------- ----------------------------
<S> <C> <C>
Net impact of changes in useful lives $1,266 $ 4,041
Non-recurring charge to eliminate assets which
had no remaining useful lives - (1,025)
------ -------
Increase in income from operations 1,266 3,016
Income tax effect 506 1,206
------ -------
Increase in net income $ 760 $ 1,810
====== =======
</TABLE>
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 Three Fiscal Quarters Ended
Sept. 12, Sept. 6, Sept. 12, Sept. 6,
1999 1998 1999 1998
---------- --------- ------------- -------------
<S> <C> <C> <C> <C>
Net income $ 754 $14,132 $5,330 $41,165
Currency translation adjustment 38 (27) 95 (66)
Unrealized gain (loss) on investments, net of tax 8 (859) 39 (806)
----- ------- ------ -------
Total comprehensive income $ 800 $13,246 $5,464 $40,293
===== ======= ====== =======
</TABLE>
6
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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 and corporate-owned stores 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 three fiscal quarters ended September 12,
1999 and September 6, 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.
<TABLE>
<CAPTION>
Fiscal quarter ended September 12, 1999 and September 6, 1998
--------------------------------------------------------------
Domestic Domestic Intersegment
Stores Distribution International Revenues Other Total
-------- ------------ ------------- ------------ ------ -----
<S> <C> <C> <C> <C> <C> <C>
Revenues -
1999......... $114,683 $168,515 $13,212 $(24,507) $ - $271,903
1998............ 119,452 159,917 12,231 (26,329) - 265,271
EBITDA -
1999............ 30,791 6,585 2,406 - (9,720) 30,062
1998............ 26,428 4,070 2,121 - (11,266) 21,353
<CAPTION>
Three fiscal quarters ended September 12, 1999 and September 6, 1998
---------------------------------------------------------------------
Domestic Domestic Intersegment
Stores Distribution International Revenues Other Total
-------- ------------ ------------- ------------ ----- -----
<S> <C> <C> <C> <C> <C> <C>
Revenues -
1999......... $338,204 $480,109 $39,059 $(68,589) $ - $788,783
1998............ 355,169 471,493 36,690 (79,919) - 783,433
EBITDA -
1999............ 92,199 19,037 6,740 - (26,224) 91,752
1998............ 78,765 12,131 6,020 - (35,248) 61,668
</TABLE>
7
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The following table reconciles total EBITDA above to consolidated income before
provision (benefit) for income taxes:
<TABLE>
<CAPTION>
Fiscal quarter ended Three fiscal quarters ended
Sept. 12, 1999 Sept. 6, 1998 Sept. 12, 1999 Sept. 6, 1998
--------------- -------------- --------------- --------------
<S> <C> <C> <C> <C>
Total EBITDA $ 30,062 $21,353 $ 91,752 $ 61,668
Depreciation and amortization (11,883) (5,256) (36,575) (14,837)
Interest expense (17,028) (987) (51,190) (2,830)
Interest income 289 177 618 771
Gain (loss) on sale of plant and equipment (8) 1 65 (166)
-------- ------- -------- --------
Income before provision (benefit)
for income taxes $ 1,432 $15,288 $ 4,670 $ 44,606
======== ======= ======== ========
</TABLE>
No customer accounted for more than 10% of total consolidated revenues in the
fiscal quarter or three fiscal quarters ended September 12, 1999 and
September 6, 1998.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The 1999 and 1998 third fiscal quarters referenced herein represent the twelve-
week periods ended September 12, 1999 and September 6, 1998, respectively. The
1999 and 1998 three fiscal quarter periods referenced herein represent the
thirty-six-week periods ended September 12, 1999 and September 6, 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 increased $6.6
million, or 2.5%, to $271.9 million for the third quarter of 1999 from $265.3
million for the third quarter of 1998. Total revenues increased $5.4 million,
or 0.7%, to $788.8 million for the first three quarters of 1999 from $783.4
million in the same period in 1998. These increases in revenues resulted
primarily from increased domestic distribution revenues and franchise royalties,
partially offset by reductions in corporate stores revenues.
Domestic Stores
Corporate Stores. Revenues from Corporate Stores decreased 6.3% to $88.1
million for the third quarter of 1999 from $94 million for the same period in
1998. Corporate Stores revenues decreased 7.9% to $258.4 million for the first
three quarters of 1999 from $280.7 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 an 8.8% increase in average corporate store
sales for the third quarter and first three quarters of 1999 over the same
periods in 1998. Same store sales for corporate stores increased 2.2% for both
the third quarter of 1999 and the first three quarters of 1999 as compared to
the same periods in 1998. Ending corporate stores decreased by 94, to 654 as of
September 12, 1999 from 748 as of September 6, 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 4.3% to $26.6 million for the third quarter of 1999 from $25.5 million
for the same period in 1998. Domestic Franchise operations revenues increased
7.3% to $79.8 million for the first three quarters of 1999 from $74.4 million
for the same period in 1998. These increases are attributable primarily to 1.4%
and 2.3% increases in average store sales for the third quarter and first three
quarters 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 3.3% for the third quarter and first three quarters of 1999,
respectively, as compared to the same periods in 1998. Ending domestic
franchise stores increased by 171 to 3,909 as of September 12, 1999 from 3,738
as of September 6, 1998.
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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 7.8% to $144 million for the third quarter of 1999 from
$133.6 million for the same period in 1998. Revenues from Distribution
increased 5.1% to $411.5 million for the first three quarters of 1999 from
$391.6 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 a $7.9 million decrease in equipment sales during the first three
quarters 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 8.2% to $13.2 million for the third quarter of 1999 from $12.2
million for the same period in 1998. International revenues for the first three
quarters of 1999 increased 6.5% to $39.1 million from $36.7 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 an increase in international commissary
product sales. International franchise royalty revenues increased by 14.5% to
$5 million and 11.9% to $14.4 million for the third quarter and first three
quarters of 1999, respectively, due principally to an increase in the number of
international franchise stores. During the second quarter of 1999, we acquired
three stores in France. These stores, which had revenues of $0.3 million and
$0.5 million in the third quarter and first three quarters of 1999,
respectively, represent our only corporately owned stores outside of the
contiguous United States. International commissary product sales to franchisees
increased 0.9% to $7.4 million and 1.5% to $22.6 million for the third quarter
and first three quarters 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 4.3% and 4% for the
third quarter and first three quarters of 1999, respectively, from the same
periods of 1998. Ending international stores increased by 132 to 1,821 as of
September 12, 1999 from 1,689 as of September 6, 1998. Also, during the third
quarter of 1999, unfavorable economic conditions in Asia resulted in the closure
of all 23 Domino's stores in Thailand.
Gross Profit. Gross profit increased 11.9% to $76.3 million for the third
quarter of 1999 from $68.2 million for the same period in 1998. Gross profit
increased 9.3% to $226.5 million for the first three quarters of 1999 from
$207.2 million for the same period of 1998. As a percentage of revenues, gross
profit increased 2.4%, to 28.1%, and 2.3%, to 28.7%, for the third quarter and
first three quarters 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 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 increased 11.7% to
$58.2 million for the third quarter of 1999 from $52.1 million for the same
period of 1998. General and administrative expenses increased 6.7% to $171.3
million in the first three quarters of 1999 from $160.5 million for the same
period of 1998. As a percentage of revenues, general and administrative
expenses increased 1.8% to 21.4% for the third quarter of 1999 and increased
1.2% to 21.7% in the first three quarters of 1999, compared to the same periods
in 1998. These increases are due primarily to increased amortization expense of
$7.7 million and $23.1 million for the third quarter and first three quarters of
1999, respectively, with respect to a covenant not-to-compete we entered into
with TISM's former principal stockholder 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 $2 million and
$3.6 million of employment severance charges incurred in the third quarter and
first three quarters of 1999,
9
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respectively. 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 $4.7 million
and $14.9 million for the third quarter and first three quarters 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 $16 million to $17 million for the
third quarter of 1999 and increased $48.4 million to $51.2 million for the first
three quarters 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 provision for income taxes was $0.7
million for the third quarter of 1999 and the benefit was $0.7 million for the
first three quarters of 1999, respectively, compared to provisions for income
taxes of $1.2 million and $3.4 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 third
quarter and first three quarters of 1999 includes U.S. federal and state income
taxes and foreign income taxes whereas the provision for income taxes for the
same periods 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 $4.9 million and $18.2 million at September
12, 1999 and January 3, 1999, respectively. We operate with 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 $33.2 million and $53.9 million
in the first three quarters of 1999 and 1998, respectively. The cash provided
by operating activities in the first three quarters of 1999 consisted mainly of
earnings before interest, taxes, depreciation and amortization expenses
("EBITDA") of $91.8 million, offset by interest payments of $43.2 million,
income tax payments of $7.3 million and other changes in operating assets of
$8.1 million. EBITDA increased $30.1 million over the same period in 1998
primarily due to the increases in gross profit and decreases in general and
administrative expenses, net of non-cash items, as discussed above. However,
this increase was offset primarily by an increase in interest payments of $40.7
million for the first three quarters 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 a reduction in operating cash flows in the first three
quarters of 1999 as compared to 1998.
Net cash used in investing activities consisted 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 $17.6 million and $35.5 million for
the first three quarters of 1999 and 1998, respectively. The decrease in cash
used in investing activities for the first three quarters of 1999 resulted
primarily from a $12.2 million decrease in capital expenditures and an increase
in collections on notes receivable of $5.4 million.
Capital expenditures were $22 million and $34.2 million for the first three
quarters of 1999 and 1998, respectively. During the third quarter of 1999, we
acquired eleven franchise stores for $3.3 million. The higher capital
expenditures for the first three quarters of 1998 were primarily attributable to
$4.2 million for the acquisition of two commissaries, $2.6 million for the
implementation of HeatWave hot bag systems in corporate-owned stores,
development costs associated with our financial and supply chain computer
systems and higher spending for corporate store openings and relocations.
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, comprised of $445 million under term loan facilities, $275
million of senior subordinated notes and approximately $2.1 million under a
revolving credit facility. As of September 12, 1999, we had $724.6 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 $476.8 million as of September 12, 1999, as compared to
stockholder's equity of $41.8 million immediately prior to the recapitalization.
Net cash used in financing activities was $2.5 million and $18.4 million for the
first three quarters of 1999 and 1998, respectively. Cash flows used in
financing activities for the first three quarters of 1999 reflected $3.9 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 centers' 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 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 have completed the financial systems implementation and the
implementation of our new distribution supply chain systems is currently
underway. We have remediated our legacy supply chain systems to be Year 2000
compliant. 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.
Over 90% of our domestic franchised stores utilize either ULTRA or Breakaway
systems for operating their stores. Year 2000 upgrades and testing materials
for these systems has been provided to the franchisees who, to date, have
completed testing at over 56% of their stores. For domestic franchisees who use
neither ULTRA nor Breakaway store systems, we are currently working with their
store systems vendors to resolve any Year 2000 issues. We have also assessed
the likely worst case scenarios that may result from any significant disruption
or system failure in the franchisee's store operating systems and have prepared
a detailed contingency plan that will be distributed to all franchise stores
prior to year end.
11
<PAGE>
Over 58% of our international franchised stores utilize either ULTRA or
Breakaway systems for operating their stores. The remaining 42% either utilize
a country-specific system for operating their stores or are not yet
computerized. To date, 36% of the international franchised stores (including
stores that are not yet computerized) are Year 2000 compliant. Year 2000
upgrades and testing materials for those stores utilizing either ULTRA or
Breakaway systems are available to franchisees. For international franchisees
who use neither ULTRA nor Breakaway store systems, the franchisees have
communicated that they are adequately addressing the Year 2000 issue. We have
also assessed the likely worst case scenarios that may result from any
significant disruption or system failure in the franchisee's store operating
systems and have prepared a detailed contingency plan that will be distributed
to all franchise stores prior to year end.
We have addressed other less critical equipment and machinery, such as facility
equipment, that may contain embedded technology with Year 2000 compliance
problems and have confirmed that they will operate normally in the year 2000 and
beyond. We also have material relationships with suppliers, 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.
We have assessed the likely worst case scenarios 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
suppliers and vendors. We have contingency plans in place to address these
potential Year 2000 problems.
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 $1 million addressing the Year 2000 issue, of which
we have incurred approximately $873,000 during the first three quarters 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 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.
Forward-Looking Statements
Certain statements contained in this filing relating to capital spending levels,
the 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 the 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.
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
12
<PAGE>
the interest on a portion of our variable rate bank debt to a fixed rate of
5.12% through December 2001. At September 12, 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 September 12,
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 3.3% and is sensitive to changes in interest rates. At September
12, 1999, the weighted average interest rate on our $443.5 million of variable
interest debt was approximately 8.7% and the fair value of the debt approximates
its carrying value.
The Company had interest expense of $51.2 million for the first three quarters
of 1999. The potential increase in interest expense for the first three
quarters of 1999 from a hypothetical 2% adverse change in the variable interest
rates, would be approximately $3.7 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
None.
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.
b. Current Reports on Form 8-K
There were no reports filed on Form 8-K during the quarter ended September 12,
1999.
13
<PAGE>
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: October 26, 1999 /s/ Harry J. Silverman
-------------------------
Harry J. Silverman,
Chief Financial Officer
14
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