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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the fiscal year ended January 2, 2000, 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 No. 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)(Zip Code)
(734) 930-3030
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Exchange Act:
Indicate by check mark whether the registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
There were 10 shares of the registrant's Common Stock issued and outstanding on
March 15, 2000.
PART I
ITEM 1. BUSINESS.
Domino's, Inc., is the leading pizza delivery company in the United
States. We operate through a world-wide network of over 6,500 franchise and
corporate-owned stores which generated system-wide sales of approximately $3.4
billion for the fiscal year ended January 2, 2000. System-wide sales by our
domestic franchise and corporate-owned stores accounted for approximately 28% of
the United States pizza delivery market in 1999.
Domino's offers a focused menu of high quality, value priced pizza with
three types of crust (Hand-Tossed, Thin Crust and Deep Dish), along with buffalo
wings, cheesy bread and bread sticks. Our hand-tossed pizza is made from fresh
dough produced in our regional distribution centers. We prepare every pizza
using real cheese, pizza sauce made from fresh tomatoes and a choice of high
quality meat and vegetable toppings in generous portions. Our focused menu and
use of premium ingredients enable us to consistently and efficiently produce
high quality pizza.
Over the 39 years since our founding, we have developed a simple,
cost-efficient model. We offer a limited menu, our stores are designed for
delivery and we do not offer dine-in service. As a result, our stores require
relatively small, low rent locations and limited capital expenditures. Outside
the contiguous United States, we generally follow the same operating model with
some adaptations to local eating habits and consumer preferences. Our simple
operating model helps to maintain consistent food quality and to minimize store
expenses and capital commitments.
The Domino's brand is widely recognized and identified by consumers in
the United States as the leader in pizza delivery. We have built this successful
brand image and recognition through extensive national and local television,
print and direct mail campaigns. Over the past five years, Domino's and its
franchisees have invested an estimated $980 million on national, cooperative and
local advertising in the United States. The Domino's brand name is one of Ad
Age's "100 Megabrands," a list which includes other prominent brands such as
Coke(R), Campbell's(R), Kodak(R) and Wrigley(R).
Domino's operates through three business segments:
- Domestic Stores, consisting of:
Corporate, which operates our domestic network of
656 corporate-owned stores;
Franchise, which oversees our domestic network of
3,973 franchise stores;
- Distribution, which operates our eighteen regional
distribution centers and one equipment distribution center that
sell food, equipment and supplies to our domestic corporate and
franchise stores and equipment to international stores; and
- International, which oversees our network of 1,930
franchise stores in 64 international and off-shore markets,
including Alaska, Hawaii, Puerto Rico, the U.S. Virgin Islands
and Guam, and distributes food to stores in Alaska, Hawaii,
Canada and France.
INDUSTRY OVERVIEW
The United States pizza market had sales of approximately $23.8 billion
in 1999. This market has three segments: dine-in, carry-out and delivery. We
focus on the delivery segment, which accounted for approximately $7.0 billion or
30% of the total United States pizza market in 1999. Pizza delivery has been
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the fastest growing segment of this market, with compound annual growth of 6.3%
between 1997 and 1999, as compared to 3.4% for the dine-in-segment and 5.1% for
the carry-out segment over the same period.
Domestic pizza delivery sales have not only grown quickly, but have
also shown stable growth. From 1989 through 1999, pizza delivery sales in the
United States grew at a compound annual rate of 6.0%. Even in the recessionary
period during 1990 and 1991, pizza delivery sales in the United States continued
to grow at an annual compound rate of 2.5%.
We believe that growth and stability in the pizza delivery market will
persist as a result of several continuing demographic factors. In particular, we
believe that longer work schedules and the prevalence of dual career families
have led to rapid growth in the demand for delivered food. We believe that
delivered pizza is well positioned to capitalize on these trends as other food
products have difficulty matching the value, consistency and timely delivery of
pizza.
COMPETITIVE STRENGTHS
Leading Market Position. With system-wide sales accounting for
approximately 28% of the United States pizza delivery market in 1999, Domino's
is the leading pizza delivery company in the United States. Outside the United
States we generally hold either the leading market share or are a strong number
two in the key markets where we compete. Our leadership positions in these key
markets and our strong global presence provide significant cost and marketing
advantages relative to smaller delivery competitors.
Strong Brand Equity. Our brand name is widely recognized by consumers
in the United States as the leader in pizza delivery. Over the past five years,
Domino's and its franchisees have invested an estimated $980 million on
national, cooperative and local advertising in the United States. We continue to
reinforce the strength of our brand name recognition with extensive advertising
through national and local television, print and direct mail. The strength of
our brand is reflected in its selection as one of Ad Age's "100 Megabrands," a
list which includes other prominent brands such as Coke(R), Campbell's(R),
Kodak(R) and Wrigley(R).
Focused and Cost-efficient Operating System. We have focused on pizza
delivery since our founding in 1960. Over this time, we have developed a simple,
cost-efficient operating system for producing a streamlined menu offering. Our
limited menu, efficient food production process and extensive employee training
program allow us to produce our pizza in approximately ten minutes. The
simplicity and efficiency of our store operations gives us significant
advantages over competitors that also participate significantly in the carry-out
or eat-in segments of the pizza market and, as a result, have more complex
operations. Consequently, we believe these competitors have a difficult time
matching Domino's value, quality and consistency in the delivery segment.
Minimal Capital Requirements. We have minimal capital expenditure and
working capital requirements. Our capital expenditures are minimal because we
focus on delivery and because our franchisees fund all capital expenditures for
their stores. Since our stores do not offer eat-in service, they do not require
expensive locations, are relatively small (1,000-1,300 square feet) and are
inexpensive to build and furnish as compared to other fast food establishments.
A new Domino's store typically requires only $125,000 to $250,000 in initial
capital, far less than typical establishments of many of our major competitors.
Because approximately 86% of our domestic stores are franchised, our share of
system-wide capital expenditures is small. In addition, Domino's requires
minimal working capital as we collect approximately 98% of our royalties from
domestic franchisees within three weeks of when the royalty is generated and
achieve more than 50 inventory turns per year in our regional distribution
centers. We believe these minimal working capital requirements are advantageous
for funding our continued growth.
Strong Franchise Relationships. We believe our strong relationships
with franchisees are a critical component of our success. We support our
franchisees by providing training, financial incentives and infrastructure. We
employ an owner-operator model that results in our franchisees owning an average
of three stores, considerably fewer than most franchise models. We also believe
that our franchise owners enjoy some of the most attractive economics within the
fast food industry. Our strong cooperation with our
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franchisees is demonstrated by an over 96% voluntary participation rate in our
domestic distribution system and strong franchisee participation in co-operative
advertising programs. Because we experienced a contract renewal rate of over 99%
and more than 120 new franchisees entered the system in 1999, we believe our
franchise system will continue to be a stable and growing component of our
business.
Efficient National Distribution System. We operate a nationwide network
of eighteen regional distribution centers. Each is generally located within a
300-mile radius of the stores it serves. We take advantage of volume purchasing
of food and supplies, to provide consistency, efficiencies of scale and low cost
distribution. Our distribution system has an on-time accuracy rate of over 98%
and allows our store managers to focus on store operations and customer service.
BUSINESS STRATEGY
Our business strategy has been to grow revenues and profitability by
focusing on our delivery expertise: prompt delivery of high quality product,
operational excellence and brand recognition through strong promotional
advertising. This strategy has resulted in our leading market position and track
record of profitable growth. We intend to achieve further growth and strengthen
our competitive position through the continued implementation of this strategy
and the following initiatives:
Focus on Core Competencies. We believe three core competencies are
crucial to our future growth: Build the Brand, Maintain High Standards and
Flawless Execution. We have streamlined our organization and structured our
operations, marketing and advertising to achieve these objectives.
Capitalize on Strong Industry Dynamics. We believe that the pizza
delivery market will continue to show strong growth and stability as a result of
several positive demographic trends. These trends include more dual career
families, longer work weeks and increased consumer emphasis on convenience. In
addition, we believe that the low cost and high value of pizza will support
continued industry growth even during an economic slowdown. Domino's is well
positioned to take advantage of these dynamics, given our market leadership
position, strong brand name and cost-efficient operating model.
Leverage Market Leadership Position and High Brand Awareness. Domino's
is the leading pizza delivery company in the United States. System-wide sales by
our corporate and domestic franchise stores accounted for approximately 28% of
the United States pizza delivery market in 1999. Our market leadership position
and strong brand give us significant marketing strength relative to our smaller
competitors. We believe strong brand recognition is important in the pizza
delivery industry because consumer decisions are strongly influenced by brand
awareness. We intend to continue investments that promote our brand name and
enhance our recognition as the leader in pizza delivery.
Expand Store Base. We plan to continue expanding our base of
traditional domestic stores, enter new domestic markets with non-traditional
(Delivery Express) stores and increase our network of international stores. We
plan to strengthen our competitive position in strong markets and improve our
strength in under-penetrated markets. We also believe that a significant
opportunity exists to open new franchise stores in under-penetrated
international markets.
At the end of 1999, we had opened 45 Domino's Delivery Express stores which
provide both delivery and carry-out services from convenience type stores in
lightly populated markets. We intend to aggressively open these non-traditional
stores.
COMPANY HISTORY
Thomas Monaghan founded Domino's in 1960. Prior to December 1998,
Domino's was a wholly-owned subsidiary of Domino's Pizza, Inc. During December
1998, prior to the recapitalization described below, Domino's Pizza distributed
its ownership interest in Domino's to TISM, the current parent corporation of
Domino's. TISM then contributed its ownership interest in Domino's Pizza, which
had been a wholly-owned subsidiary of TISM, to Domino's, effectively converting
Domino's from a subsidiary to the parent of Domino's Pizza.
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On December 21, 1998, investors, including funds associated with Bain
Capital, management and others, acquired a controlling interest in Domino's
through a series of transactions, including a merger of a special purpose
corporation organized by Bain Capital into TISM. Specifically:
- Investors, including funds associated with Bain Capital,
management and others, invested $229.2 million to acquire
common stock of TISM, which represented approximately 93% of
its outstanding common stock immediately following the
recapitalization, and $101.1 million to acquire cumulative
preferred stock of TISM.
- The prior stockholders of TISM retained a portion of their
voting common stock in TISM equal to $17.5 million, or
approximately 7% of the outstanding common stock of TISM
immediately following the recapitalization. In the merger,
these stockholders received $903.2 million for their
remaining common stock and TISM contingent notes payable for
up to an aggregate of $15 million in certain circumstances
upon the sale or transfer to non-affiliates by the Bain
Capital funds of more than 50% of their initial common stock
ownership in TISM.
The recapitalization and related expenses were financed in part through
the sale of equity securities and retention of the common stock discussed above.
The remaining financing was obtained through:
- Borrowings under senior credit facilities with aggregate
availability of $545 million, consisting of $445 million in
term loans and a revolving credit facility of up to $100
million; and
- The sale of $275 million of 10 3/8% Senior Subordinated
Notes due in 2009.
OPERATIONS
General. We believe our operating model is differentiated from other
pizza competitors that are not focused primarily on the delivery business. Our
business model has competitive advantages, including production-oriented store
design, efficient and consistent operational processes, strategic location to
facilitate delivery service, favorable store economics and a focused menu.
Production-Oriented Store Design. Our typical store is small, occupying
approximately 1,000 to 1,300 square feet, and is designed with a focus on
efficient and timely production of consistent, high-quality pizza for delivery.
Our stores are production facilities and, accordingly, do not have a dine-in
section.
Efficient and Consistent Operational Processes. Each store executes an
operational process which includes order taking, pizza preparation, cooking (via
automated, conveyor-driven ovens), boxing, and delivery. The entire pizza
production process is designed for completion in less than ten minutes to allow
sufficient time for safe delivery within 25 to 30 minutes of ordering. This
simple and focused operational process has been achieved through years of
continuous improvement, resulting in a high level of efficiency.
Strategic Locations. We locate our stores strategically to facilitate
quality delivery service to our customers. The majority of our stores are
located in populated areas adjacent to large or mid-size cities, on or near
college campuses or military bases. The majority of our stores serve from 5,000
to 15,000 addresses. We use geographic information software, which incorporates
variables such as household count, traffic volumes, competitor locations,
household demographics and visibility, to evaluate and identify potential store
locations.
Favorable Store Economics. Because our stores do not offer dine-in
service or rely heavily on carry-out, the stores typically do not require
expensive real estate, are relatively small, and are inexpensive
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to build-out and furnish as compared to other fast food establishments. A new
Domino's store typically requires only $125,000 to $250,000 in initial capital,
far less than many other fast food establishments. Our stores also benefit from
lower maintenance costs as store assets have long lives and updates are not
frequently required.
Focused Menu. We maintain a focused menu that is designed to present an
attractive, high quality offering to customers, while expediting delivery and
avoiding errors in the order process. The menu has three simple components:
pizza size, pizza type and pizza toppings. Most stores carry two sizes of
traditional Hand-Tossed, Deep Dish and Thin Crust pizza. The typical store also
offers bread sticks, cheesy bread and buffalo wings. We also occasionally offer
new products on a promotional basis. We believe that our focused menu creates a
strong identity among consumers, improves operating efficiency and maintains
food quality and consistency.
DIVISIONAL OVERVIEW
General. We operate through three business segments: (i) Domestic
Stores, consisting of Corporate, which operates our network of 656
corporate-owned stores, and Franchise, which oversees our domestic network of
3,973 franchise stores; (ii) Distribution, whose eighteen regional food
distribution centers and one equipment distribution center supply food, store
equipment and supplies to corporate-owned and domestic franchise stores and
equipment to international stores; and (iii) International, which oversees our
network of 1,930 international franchise stores in 64 international and
off-shore markets including Alaska, Hawaii, Puerto Rico, the U.S. Virgin Islands
and Guam.
Domestic Stores. Our network of corporate stores plays an important
strategic role in our predominately franchised system. In particular, we utilize
our corporate stores as a forum for training new store managers and prospective
franchisees, and as a test site for new products and store operational
improvements. We also believe that our corporate stores add economies of scale
for advertising, marketing and other fixed costs traditionally borne by
franchisees. Corporate is divided into two geographic regions and is managed
through thirteen field offices in the contiguous United States.
Our domestic franchisees own and operate a network of 3,973 stores in
the contiguous United States. Our domestic franchises are operated by highly
qualified entrepreneurs who own and operate an average of three stores. Our
principal sources of revenue from domestic franchise store operations are
royalty payments and, to a much lesser extent, fees for store openings and
transfers.
Our domestic franchises are currently managed through five regional
offices located in Dallas, Texas; Atlanta, Georgia; Santa Ana, California;
Linthicum, Maryland; and Ann Arbor, Michigan. A sixth office in Nashville,
Tennessee is scheduled to open in fiscal 2000. The regional offices provide
training, financial analysis, store development, store operational audits and
marketing strategy services for the franchisees. We maintain a close
relationship and direct link with the franchise stores through regional
franchise teams, an array of computer-based training materials that ensure
franchise stores operate in compliance with specified standards, and franchise
advisory groups that facilitate communications between us and our franchisees.
Distribution. Distribution operates one equipment distribution center
and eighteen regional food distribution centers located throughout the United
States that purchase, receive, store and deliver uniform, high-quality
pizza-related supplies to both domestic franchise and corporate stores. Each
regional food distribution center serves an average of 250 stores, generally
located within a 300-mile radius.
Distribution services all of the corporate stores and over 96% of the
domestic franchise stores, even though we give our domestic franchisees the
option of satisfying their food and equipment needs through approved independent
suppliers. Distribution supplies products ranging from fresh dough and basic
food items to pizza boxes and cleaning supplies. Distribution drivers also
unload supplies and stock store shelves after hours, thereby minimizing
disruption of store operations during the day. We believe that franchisees
choose to obtain supplies from us because we provide the most efficient and
cost-effective alternative.
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Distribution offers a profit sharing arrangement to stores that
purchase 100% of their food and supplies from Distribution. All of our corporate
stores and substantially all franchise stores buying from Distribution
participate. We believe these arrangements strengthen our ties with these
franchisees, secure a stable source of revenue and provide incentives for
franchisees to work closely with us to reduce costs. These profit sharing
arrangements provide corporate stores and participating franchisees with
approximately 50% of their regional distribution center's pre-tax profits.
Distribution paid out $24.8 million to franchisees participating in the profit
sharing program in 1999.
Distribution's information systems are an integral part of its superior
customer service. Distribution employs routing strategies to reduce the
frequency of late deliveries, utilizing software to determine store routes on a
daily basis for optimal efficiency. Through our strategic distribution center
locations and proven routing systems, we achieved on-time delivery rates of over
98% in 1999.
International. International oversees our network of over 1,930 stores
in 64 international and off-shore markets, including Alaska, Hawaii, Puerto
Rico, the U.S. Virgin Islands and Guam. We have over 200 franchise stores in
each of Mexico, Japan, Canada, and the United Kingdom and over 100 franchise
stores in each of Australia, South Korea and Taiwan. The principal sources of
revenues from international operations are royalty payments by franchisees, food
sales to franchisees, and fees from master franchise agreements and store
openings.
We generally grant international franchises through master franchise
agreements to well-capitalized entities who have knowledge of the local markets.
These master franchise agreements generally grant the franchisee exclusive
rights to develop or sub-franchise stores in a particular geographic area and
contain growth clauses requiring franchisees to open a minimum number of stores
within a specified period. In a small number of countries, we franchise directly
to individual store operators.
FRANCHISE PROGRAM
General. The success of our unique franchise formula, together with the
relatively low initial capital investment required to open a franchise store,
has enabled us to attract a large number of highly motivated entrepreneurs as
franchisees. We consider franchisees to be a vital part of our continued growth
and believe our relationships with franchisees are excellent. The franchise
program consists of a network of domestic and international franchise stores. As
of January 2, 2000, there were 1,322 franchisees operating 3,973 franchise
stores in the contiguous United States and 496 franchisees operating 1,930
stores in 64 international and off-shore markets.
Franchisee Selection. We maintain the strength of our franchise store
base by seeking franchisees who are willing to commit themselves to operating
franchise stores and by applying rigorous standards to prospective franchisees.
Specifically, we require all prospective domestic franchisees to manage a store
for at least one year before being granted a franchise. This enables us to
observe the operational and financial performance of domestic franchisees prior
to entering into a long-term contract. We also restrict the ability of domestic
franchisees to become involved in outside business investments, which focuses
the franchisees on operating their stores. We believe these standards are unique
to the franchise industry and result in highly qualified and focused store
operators, while helping to maintain the strength of the Domino's brand.
Standard Domestic Franchise Agreements. We enter into franchise
agreements with domestic franchisees under which the franchisee is granted the
right to operate a store for a term of ten years, with an option to renew for an
additional ten years. We experienced franchise renewal rates in 1999 in excess
of 99%. Under the current standard franchise agreement, we assign an exclusive
Area of Primary Responsibility to each franchise store. During the term of the
franchise agreement, the franchisee is generally required to pay a 5.5% royalty
fee, subject in certain instances to lower rates based on area development
agreements, sales initiatives and new store incentives. We have the contractual
right, subject to state law, to terminate a franchise agreement for a variety of
reasons, including a franchisee's failure to make payments when due or failure
to adhere to specified policies and standards.
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International Franchisee Selection. The majority of franchisees outside
of the contiguous United States are master franchisees with franchise rights for
entire regions or countries. These prospective candidates are required to
possess or have access to local market knowledge required to establish and
develop Domino's Pizza stores and a distribution system. The local market
knowledge focuses on the ability to identify and access targeted real estate
sites along with expertise in local customs, culture and laws. We also require
the candidates to have access to sufficient capital to meet growth and
development plans.
Standard International Franchise Agreements. We enter into master
franchise agreements with our international franchisees under which the master
franchisee may open and operate franchise stores or, under specified conditions,
enter into sub-franchise agreements for a term of ten to twenty years, with an
option to renew for an additional ten year term. The master franchisee is
required to pay an initial, one-time franchisee fee, as well as an additional
franchise fee upon the opening of each new store. These fees vary by contract.
In addition, the master franchisee is required to pay a continuing royalty fee
as a percentage of sales, which also varies.
Franchise Store Development. We furnish each domestic franchisee with
assistance in selecting sites, developing stores and conforming to the physical
specifications for typical stores. Each domestic franchisee is responsible for
selecting the location for a store but must obtain approval for store design and
location based on accessibility and visibility of the site and targeted
demographic factors, including population density, income, age and traffic. We
provide design plans, fixtures and equipment for most franchisee locations at
competitive prices.
Franchisee Financing Programs. We have an established internal
financing program to assist domestic franchisees in opening stores. We generally
provide financing of up to $100,000 for the purpose of opening new stores to
franchisees who are creditworthy and have adequate working capital. The
franchisees may use the funds to purchase equipment, signage, leasehold
improvements or supplies, with the condition that leasehold improvements cannot
exceed $35,000. We have also historically offered to finance the sale of certain
corporate stores to domestic franchisees and the implementation of new products
and programs. At January 2, 2000, loans outstanding under the franchisee
financing programs totaled $14.2 million.
Franchise Training and Support. Training our store managers and
employees is a critical component of our success. We require all domestic
franchisees to complete initial and ongoing training programs that we provide.
In addition, under the current standard domestic franchise agreement, domestic
franchisees are required to implement training programs for their store
employees. We assist our franchisees by providing training services for store
managers and employees, including CD-ROM based training materials, comprehensive
operations manuals and franchise development classes.
Franchise Operations. We maintain strict control over franchise
operations to protect our brand name and image. All franchisees are required to
operate their stores in compliance with written policies, standards and
specifications, including matters such as menu items, ingredients, materials,
supplies, services, furnishings, decor and signs. Each franchisee has full
discretion to determine the prices to be charged to its customers. We also
provide support to our franchisees, including training, marketing assistance and
consultation to franchisees who experience financial or operational
difficulties. We have established several advisory boards through which
franchisees can contribute to corporate level initiatives.
DOMINO'S IMAGE 2000 CAMPAIGN
We have implemented a reimaging and relocation campaign called Domino's
Image 2000. The reimaging program is aimed at increasing store sales and market
share through greater brand awareness. It involves a variety of store
improvements, including upgrading store interiors, adding new signage to draw
attention to the store and providing contemporary uniforms for its employees. We
believe that average per corporate store capital expenditures for the reimaging
campaign will approximate $30,000. The relocation program is also designed to
increase store sales and market share by choosing store sites that are in more
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accessible and visible locations. The capital expenditures for relocating a
corporate store averages approximately $170,000 per store.
MARKETING OPERATIONS
We coordinate the domestic advertising and marketing efforts at the
national and cooperative market levels. We require corporate and domestic
franchise stores to contribute 3% of their net sales to fund national marketing
and advertising campaigns. The national advertising fund is used primarily to
purchase television advertising, but also supports market research, field
communications, commercial production, talent payments and other activities
supporting the brand. We can require stores to contribute a minimum of 1% to a
maximum of 3% of net sales to cooperative media campaigns. Store contributions
to cooperative media campaigns currently average 2.4% of net sales in our top 40
markets.
We estimate that corporate and domestic franchise stores also spend an
additional 3% to 5% of their net sales on local store marketing, including
targeted database mailings, saturation print mailings to households in a given
area and community involvement through school and civic organizations. The
National Print Program offers cost-effective print materials as an incentive for
franchisees to use the marketing material that we recommend, helping to reflect
our national advertising strategy at the local level.
By communicating common themes at the national, cooperative and local
market levels, we create a consistent marketing message to our customers. Over
the past five years, we estimate that we and our domestic franchisees have
invested over $980 million in system-wide advertising at the national,
cooperative and local levels.
SUPPLIERS
We believe that the length and quality of our relationships with
suppliers provides us with priority service at competitive prices. We have
maintained active relationships of over 15 years with more than half of our
major suppliers. As a result, we have typically relied on oral rather than
written contracts with our suppliers, except where we maintain only one supplier
for a product, such as cheese. In addition, we believe that two factors have
been critical to maintaining long-lasting relationships and keeping our
purchasing costs low. First, we are one of the largest volume purchasers of
pizza-related products such as flour, cheese, sauce, and pizza boxes, which
gives us the ability to maximize leverage with our suppliers. Second, in four of
our five key product categories (meats, dough and parbaked shells, boxes and
sauce), we generally retain active purchasing relationships with at least three
suppliers. This purchasing strategy allows us to shift purchases among suppliers
based on quality, price and timeliness of delivery. For the year ended January
2, 2000, only one supplier represented more than 10% of cost of sales, which was
our cheese supplier accounting for 24.8% of cost of sales.
COMPETITION
The pizza delivery market is highly fragmented. In this market, we
compete against regional and local firms, as well as three national chains,
Pizza Hut, Papa John's and Little Caesar's. We compete generally on the basis of
product quality, location, delivery time, service, and price. We also compete on
a broader scale with other international, national, regional and local
restaurants and quick-service eating establishments. The overall food service
industry and the fast food 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 fast food segment not only for customers, but also for
management and hourly personnel, suitable real estate sites and qualified
franchisees.
GOVERNMENT REGULATION
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We are subject to various federal, state and local laws affecting the
operation of our business, as are our franchisees. Each store is subject to
licensing and regulation by a number of governmental authorities, which include
zoning, health, safety, sanitation, building and fire agencies in the
jurisdiction in which the store is located. Difficulties in obtaining, or the
failure to obtain, required licenses or approvals can delay or prevent the
opening of a new store in a particular area. Our distribution facilities are
licensed and subject to regulation by federal, state and local health and fire
codes.
We are subject to the rules and regulations of the FTC and various
state laws regulating the offer and sale of franchises. The FTC and various
state laws require that we furnish to prospective franchisees a franchise
offering circular containing prescribed information. A number of states regulate
the sale of franchises and require registration of the franchise offering
circular with state authorities and the delivery of a franchise offering
circular to prospective franchisees. We are operating under exemptions from
registration in several states based on net worth and experience. Substantive
state laws that regulate the franchisor-franchisee relationship presently exist
in a substantial number of states, and bills have been introduced in Congress
from time to time which would provide for federal regulation of the
franchisor-franchisee relationship. The state laws often limit, among other
things, the duration and scope of non-competition provisions, the ability of a
franchisor to terminate or refuse to renew a franchise and the ability of a
franchisor to designate sources of supply.
Internationally, our franchise stores are subject to national and local
laws and regulations which are similar to those affecting our domestic stores,
including laws and regulations concerning franchises, labor, health, sanitation
and safety. Our international franchise stores are also subject to tariffs and
regulations on imported commodities and equipment and laws regulating foreign
investment.
TRADEMARKS
Domino's has several trademarks and service marks and believes that the
Domino's mark has significant value and is materially important to our business.
Our policy is to pursue registration of our important trademarks whenever
possible and to vigorously oppose the infringement of any of our registered or
unregistered trademarks.
EMPLOYEES
As of January 2, 2000, we had approximately 14,400 employees, excluding
employees of franchise-operated stores. None of our domestic employees are
represented by unions.
ITEM 2. PROPERTIES.
We lease approximately 185,000 square feet for our executive offices,
world headquarters and distribution facility located in Ann Arbor, Michigan
under an operating lease with Domino's Farms Office Park Limited Partnership, a
related party, for a term of five years commencing December 21, 1998, with
options to renew for two five-year terms.
We own facilities at fourteen corporate stores and five distribution
facilities. We also own and lease seven store facilities to domestic
franchisees. There are no mortgages on any of these facilities other than
mortgages on the distribution facilities granted in connection with our senior
credit facilities. All other corporate stores and facilities are leased by us,
typically with five-year leases with one or two five-year renewal options. All
other franchise stores are leased or owned directly by the franchisees.
ITEM 3. LEGAL PROCEEDINGS.
On September 10, 1998, Vesture Corporation and its corporate parent,
R.G. Barry, Inc. brought an action in United States District Court for the
Middle District of North Carolina against Domino's and Phase Change
Laboratories, Inc., Domino's supplier of the heating elements used in Domino's
Heat Wave, our pizza delivery system. The plaintiffs asserted that Domino's
purchase and use of the heating elements infringed a patent owned by the
plaintiffs. In March 2000, all claims in the action were settled. The
9
plaintiffs granted Domino's and its franchisees a license permitting them to
purchase and use the heating elements in exchange for an initial payment and
royalties. Various parties will participate in the settlement, funding
approximately 80% of the settlement expense, under various indemnification and
other agreements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
During the fourth quarter of the fiscal year covered by this report,
the Company submitted several matters to a vote of its sole stockholder. On
December 14, 1999, in an action by written consent, the sole stockholder of
Domino's approved the employment agreements and stock option agreements with
Executive officers of Domino's Pizza, and approved the Third Amended and
Restated Stock Option Plan.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
As of March 15, 2000 Domino's had 3,000 authorized shares of common
stock, par value $.01 per share, of which 10 were issued and outstanding and
held by TISM. There is no established public trading market for Domino's common
stock. Domino's ability to pay dividends is limited under the indenture related
to the Senior Subordinated Notes.
ITEM 6. SELECTED FINANCIAL DATA.
Set forth below are selected historical consolidated financial data of
Domino's and subsidiaries at the dates and for the periods indicated. The
following selected financial data, as of and for the fiscal years ended January
2, 2000, January 3, 1999, December 28, 1997 and December 29, 1996 is derived
from audited financial statements of Domino's and subsidiaries. The selected
financial data as of and for the fiscal year ended December 31, 1995 and the
historical balance sheet data as of December 29, 1996 were derived from
unaudited consolidated financial statements of Domino's and subsidiaries which,
in the opinion of management, include all adjustments necessary for a fair
presentation. The data should be read in conjunction with, and is qualified by
reference to, "Management's Discussion and Analysis of Financial Condition and
Results of Operations".
10
(In thousands) 1999 1998 1997 1996 1995
---- ---- ---- ---- ----
System-Wide Sales (unaudited):
Domestic $ 2,563,311 $ 2,505,991 $ 2,294,224 $ 2,110,324 $ 1,952,398
International 800,989 717,694 633,857 524,496 441,108
----------- ----------- ----------- ----------- -----------
$ 3,364,300 $ 3,223,685 $ 2,928,081 $ 2,634,820 $ 2,393,506
=========== =========== =========== =========== ===========
Operating Data (a):
Revenues $ 1,156,639 $ 1,176,778 $ 1,044,790 $ 969,937 $ 905,219
Income from operations 75,628(b) 70,269 65,004 56,501 49,804
Income before provision (benefit)
for income taxes and
extraordinary loss 2,504 63,948 61,471 50,611 37,244
Provision (benefit) for income taxes (c) 419 (12,928) 366 30,884 9,353
Extraordinary loss due to refinancing
of debt, net of applicable income
taxes - - - - (2,576)
Net income 2,085 76,876 61,105 19,727 25,315
Other Financial Data:
EBITDA (d) $ 131,055(b) $ 94,962 $ 83,140 $ 72,340 $ 67,367
Net cash provided by operating
activities 63,268 64,731 73,408 53,225 37,012
Depreciation and other
non-cash items 51,427 24,693 18,136 15,839 17,563
Capital expenditures 32,447 49,976 45,412 19,887 14,770
Balance Sheet Data:
Total assets $ 381,130 $ 387,891 $ 212,978 $ 155,454 $ 164,041
Long-term debt 696,132 720,480 36,438 46,224 84,146
Total debt 717,570 728,126 44,408 70,067 110,018
Stockholder's equity (deficit) (478,966) (483,775) 26,118 (34,868) (54,199)
(a) The Company's fiscal year generally consists of thirteen four-week periods
and ends on the Sunday closest to December 31. The 1999 fiscal year ended
January 2, 2000; the 1998 fiscal year, which consisted of fifty-three
weeks, ended January 3, 1999; the 1997 fiscal year ended December 28, 1997;
the 1996 fiscal year ended December 29, 1996; and the 1995 fiscal year
ended December 31, 1995.
(b) In fiscal 1999, the Company recognized $7.6 million in restructuring
charges comprised of staff reduction costs of $6.3 million and exit cost
liabilities of $1.3 million.
(c) On December 30, 1996, the Company elected to be an "S" Corporation for
federal income tax purposes. The Company reverted to "C" Corporation status
on December 21, 1998. On a pro forma basis had the Company been a "C"
Corporation throughout this period, income tax expense would have been
higher by the following amounts: fiscal year ended December 28, 1997 --
$25.4 million; fiscal year ended January 3, 1999 -- $36.8 million.
(d) EBITDA represents earnings before interest, taxes, depreciation,
amortization, loss on sale of assets (net) and in fiscal 1999, the legal
settlement expense indemnified by a TISM stockholder. EBITDA is presented
because we believe it is frequently used by security analysts in the
evaluation of companies and is an important financial measure in our
indenture and credit agreements. However, EBITDA should not be considered
as an alternative to cash flow from operating activities as a measure of
liquidity or as an alternative to net income as an indicator of our
operating performance or any other measure of performance in accordance
with generally accepted accounting principles.
The following table sets forth a reconciliation of income from operations to
EBITDA:
11
----------------------------------------------------------
Fiscal Year
----------------------------------------------------------
Dollars in Thousands 1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
Income from operations $ 75,628 $ 70,269 $ 65,004 $ 56,501 $ 49,804
Loss on sale of assets (net) (316) 1,570 1,197 353 104
Legal settlement expense indemnified by a TISM
stockholder 4,000 - - - -
Depreciation and amortization 51,743 23,123 16,939 15,486 17,459
--------- --------- --------- --------- ---------
EBITDA $ 131,055 $ 94,962 $ 83,140 $ 72,340 $ 67,367
========= ========= ========= ========= =========
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
The following discussion and analysis of the financial condition and
results of operations relates substantially to periods prior to completion of
the recapitalization. As a result of the recapitalization, in December 1998, the
Company entered into new financing arrangements, and has a different capital
structure, ownership and executive leadership. Accordingly, the results of
operations for the years end December 28, 1997 and January 3, 1999 will not
necessarily be comparable to the year ended January 2, 2000.
YEAR ENDED JANUARY 2, 2000 COMPARED TO YEAR ENDED JANUARY 3, 1999
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 $20.2
million, or 1.7%, to $1,156.6 million for the year ended January 2, 2000 from
$1,176.8 million for the year ended January 3, 1999. The decrease in total
revenues is principally attributed to the 1998 store rationalization program,
under which 142 under-performing stores were sold to franchisees or closed
primarily in the fourth quarter of 1998, and one additional week in the year
ended January 3, 1999 as compared to the year ended January 2, 2000, partially
offset by increased domestic franchise and domestic distribution revenues.
Domestic Stores
Corporate Stores. Revenues from Corporate Store operations decreased $31.3
million, or 7.6%, to $378.1 million for the year ended January 2, 2000 from
$409.4 million for the year ended January 3, 1999. The decrease is principally
attributed to a reduction in the number of corporate stores resulting from our
store rationalization program. These decreases were partially offset by an 7.3%
increase in average weekly corporate store sales for fiscal 1999 compared to
fiscal 1998. Same store sales for corporate stores increased 1.7% for fiscal
1999 as compared to fiscal 1998. Ending corporate stores increased by 14 to 656
as of January 2, 2000, from 642 as of January 3, 1999.
Domestic Franchise. Revenues from Domestic Franchise operations are derived
primarily from royalty fees. Revenues from Domestic Franchise operations
increased $4.5 million, or 4.0%, to $116.7 million for the year ended January 2,
2000 from $112.2 million for the year ended January 3,1999. This increase in
revenues resulted mainly from a 2.9% increase in same store sales and an
increase in the average number of franchise stores, due mainly to sales of
corporate stores to franchisees under the store rationalization program and
additional store openings. Ending franchise stores increased by 126 to 3,973 as
of January 2, 2000, from 3,847 as of January 3, 1999.
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 excludes sales to corporate-owned stores. Revenues from Domestic
Distribution operations increased $4.3 million, or 0.7%, to $603.4 million for
the year ended January
12
2,2000 from $599.1 million for the year ended January 3, 1999. The increase in
revenues is principally due to the increase in Domestic Franchise stores sales
and number of stores discussed above, partially offset by a $7.0 million
decrease in equipment sales during 1999 and a shift in dough product mix from
higher priced par-baked deep dish toward lower-priced fresh dough. During the
first half of 1998, equipment and supply sales to franchisees were at high
levels resulting from the roll out of the Domino's HeatWave hot bag systems.
International. Revenues from International operations, which are derived mainly
from food sales to international franchises, master franchise agreement royalty
fees and, to a lesser extent, franchise and development fees and corporate owned
international stores, increased $2.4 million, or 4.3%, to $58.4 million for the
year ended January 2, 2000 from $56.0 million for the year ended January 3,
1999. The increase was partially driven by a 10.3% increase in international
franchise royalty revenues, due primarily to an increase in same store sales, an
increase in the average number of international franchise stores and the
addition of three international corporate stores in France. On a constant dollar
basis, same store sales increased 3.6% during fiscal 1999 compared to fiscal
1998. Ending international stores increased by 200, to 1,930 at January 3, 1999
from 1,730 at January 3, 1999.
Gross Profit. Gross profit increased $16.5 million, or 5.8%, to $302.5 million
for the year ended January 2, 2000 from $286.0 million for the year ended
January 3, 1999. As a percentage of revenues, gross profit increased 1.9% to
26.2% for the year ended January 2, 2000 from 24.3% for the year ended January
3, 1999. These increases were primarily due to 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 consists
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 $3.6
million, or 1.7%, to $219.3 million for the year ended January 2, 2000 from
$215.7 million for the year ended January 3, 1999. As a percentage of net
revenues, general and administrative expenses increased 0.7% to 19.0% for the
year ended January 2,2000 compared to 18.3% for the year ended January 3, 1999.
These increases are due primarily to a $5.0 million litigation settlement
charge, which was partially offset by the elimination of related party expenses
of $21.0 million, 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, one additional week in the year ended January 3, 1999 as compared
to the year ended January 2, 2000 and the impact of eliminating a corporate
stores field office as part of the store rationalization program. The decreases
in expenses were offset primarily by increased amortization expense of $32.5
million in fiscal 1999, with respect to a covenant not-to-compete we entered
into with TISM's former principal stockholder at the time of the
recapitalization.
Restructuring: In fiscal 1999, the Company recognized approximately $7.6 million
in restructuring charges comprised of staff reduction costs of $6.3 million and
exit cost liabilities of $1.3 million.
Interest Expense. Interest expense increased $67 million to $74.1 million for
the year ended January 2, 2000 from $7.1 million for the year ended January 3,
1999. The increase in interest expense is 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 (benefit) for income taxes
increased to a provision of $0.4 million for the year ended January 2, 2000 from
a benefit of $12.9 million for the year ended January 3, 1999. As part of our
recapitalization, we converted from "S" Corporation status to "C" Corporation
status for federal income tax reporting purposes in December 1998 and
established a $27.9 million deferred
13
tax asset, which was partially offset by the establishment of tax reserves. As a
result, the provision for income taxes for fiscal 1999 includes U.S. federal and
state income taxes and foreign income taxes whereas the provision for income
taxes for fiscal 1998 included only foreign income taxes and income taxes of a
few states for which we had been taxed at the corporate level. Additionally, 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.
YEAR ENDED JANUARY 3, 1999 COMPARED TO YEAR ENDED DECEMBER 28, 1997
Revenues
General. Total revenues increased $132.0 million, or 12.6%, to $1,176.8 million
for the year ended January 3, 1999 from $1,044.8 million for the year ended
December 28, 1997. The increase in total revenues is principally attributed to
increases in domestic and international same store sales, a net increase in the
average number of domestic and international stores and one additional week in
the year ended January 3, 1999 as compared to the year ended December 28, 1997.
Domestic Stores
Corporate Stores. Revenues from Corporate Store operations increased $32.6
million, or 8.7%, to $409.4 million for the year ended January 3, 1999 from
$376.8 million for the year ended December 28, 1997. The increase is principally
attributed to a 4.0% increase in same store sales as well as a slight increase
in the average number of corporate-owned stores. Ending corporate-owned stores,
however, decreased by 125 to 642 as of January 3, 1999 from 767 as of December
28, 1997 as a result of the store rationalization program.
Domestic Franchise. Revenues from Franchise operations increased $9.8 million,
or 9.6%, to $112.2 million for the year ended January 3, 1999 from $102.4
million for the year ended December 28, 1997. This increase in revenues resulted
mainly from a 4.6% increase in same store sales and an increase in the average
number of franchise stores. Ending franchise stores increased by 183 to 3,847 as
of January 3, 1999 from 3,664 as of December 28, 1997.
Domestic Distribution. Revenues from Distribution operations increased $86.0
million, or 16.8%, to $599.1 million for the year ended January 3, 1999 from
$513.1 million for the year ended December 28, 1997. The increase in revenues is
principally due to the increase in franchise stores sales noted above, an
increase in cheese prices, and an increase in equipment and supply sales to
franchisees to roll out the Domino's HeatWave Hot Bag technology in 1998,
partially offset by increases in Distribution's profit sharing, profit
capitation and volume discount programs which were netted against revenues.
International. Revenues from International operations increased $3.5 million, or
6.7%, to $56.0 million for the year ended January 3, 1999 from $52.5 million for
the year ended December 28, 1997. The increase was partially driven by a 12.6%
increase in international franchise royalty revenues due to an increase in the
ending number of international franchise stores to 1,730 at January 3, 1999 from
1,520 at December 28, 1997, partially offset by a decrease in average store
sales caused by unfavorable changes in foreign currency exchange rates,
primarily in Asian markets and Mexico. On a constant dollar basis, same store
sales for the year ended January 3, 1999 increased 3.4% from the year ended
December 28, 1997. Sales of commissary products to international franchisees
increased $1.1 million, or 3.3%, to $34.2 million for the year ended January 3,
1999 from $33.1 million for the year ended December 28, 1997.
Gross Profit. Gross profit increased $28.3 million, or 11%, to $286.0 million
for the year ended January 3, 1999 from $257.7 million for the year ended
December 28, 1997. This increase was driven primarily by the increase in
revenues. As a percentage of revenues, gross profit decreased 0.4% to 24.3% for
the year ended January 3, 1999 from 24.7% for the year ended December 28, 1997.
This decrease resulted primarily from lower margin distribution revenues growing
faster than revenues of other divisions and
14
higher Corporate operations costs due to increases in the price of cheese and
the minimum wage, partially offset by a $6.7 million credit to insurance expense
due to a reduction in the actuarial calculation of our required insurance
reserves.
General and Administrative. General and administrative expenses increased $23.0
million, or 11.9%, to $215.7 million for the year ended January 3, 1999 from
$192.7 million for the year ended December 28, 1997. This increase is due
primarily to incentive compensation to certain executives in connection with the
recapitalization and an increase in costs that coincide with increased business
volume, including administrative and corporate store manager compensation,
computer expenses, advertising and professional service fees, partially offset
by a decrease in bad debt expenses. As a percentage of revenues, general and
administrative expenses decreased to 18.3% for the year ended January 3, 1999
compared to 18.4% for the year ended December 28, 1997, due primarily to
economies of scale created by an increase in overall business volume and the
decrease in bad debt expenses, partially offset by the recapitalization
incentive compensation.
Interest Expense. Interest expense increased $3.1 million, or 77.5%, to $7.1
million for the year ended January 3, 1999 from $4 million for the year ended
December 28, 1997 primarily as a result of a December 1998 increase in debt to
fund the recapitalization.
Provision (Benefit) for Income Taxes. The provision (benefit) for income taxes
decreased to a benefit of $12.9 million for the year ended January 3, 1999 from
a provision of $0.4 million for the year ended December 28, 1997 driven
primarily by establishment of a $27.9 million deferred tax asset upon the
conversion of the Company to "C" Corporation status from "S" Corporation status
for federal income tax reporting purposes, partially offset by the establishment
of tax reserves.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have required limited levels of working capital to
fund growth. As of January 2, 2000, our working capital was a negative $5.7
million. 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
revolving credit facility.
The Company's operating activities provided $63.3 million in cash
resources in fiscal 1999. The cash provided by operating activities in fiscal
1999 consisted mainly of earnings before interest, taxes, depreciation, and
amortization and a $4.0 million capital contribution relating to a lawsuit
settlement, which aggregates to $131.1 million, offset by interest payments of
$56.7 million, income tax payments of $8.1 million and other changes in
operating assets of $3.0 million.
Net cash used in investing activities was $26.4 million in fiscal 1999.
Net cash used in investing activities consists primarily of capital expenditures
and investments in marketable securities, partially offset by proceeds from
collections on notes receivable from franchisees and asset sales.
Capital expenditures were $32.4 million in fiscal 1999. We spent $11.3
million on domestic corporate stores, of which $6.2 million was related to the
Domino's Image 2000 campaign, $4.8 million for acquiring 20 franchise stores,
$10.2 million related to investments in technology, including $4.7 million on
our new financial and supply chain systems and $5.3 million in distribution,
primarily for new equipment and equipment upgrades.
Net cash used in financing activities was $6.9 million in fiscal 1999.
Net cash used in financing activities included repayments of long-term debt of
$5.2 million.
15
In December 1998, the Company and a subsidiary incurred significant
debt and distributed significantly all of the proceeds to the Parent, which used
those proceeds, along with proceeds from the issuance of two classes of common
stock and one class of preferred stock, to fund our recapitalization including
the purchase of 93% of the outstanding common stock of the Parent from our
former principal stockholder and members of his family. Domino's and a
subsidiary entered into new Senior credit facilities with a consortium of banks
primarily to finance a portion of the recapitalization, to repay existing
indebtedness and to provide available borrowings for use in the normal course of
business.
We incurred substantial indebtedness in connection with the
recapitalization. As of January 2, 2000, we had $717.6 million of indebtedness
outstanding as compared to $46.3 million of indebtedness outstanding immediately
prior to the recapitalization. In addition, we have a stockholders' deficit of
$479.0 million as of January 2, 2000, as compared to stockholders' equity of
$41.8 million immediately prior to the recapitalization.
Concurrent with the recapitalization, we issued $275 million aggregate
principal amount of 10 3/8% Senior Subordinated Notes due 2009 and entered into
new senior credit facilities, including term loan facilities that provide for
multiple tranche term loans in the aggregate principal amount of $445 million
and a revolving credit facility that provides revolving loans in an aggregate
amount of up to $100 million. Upon closing of the recapitalization, we borrowed
the full amount available under the term loan facility and approximately $2.1
million under the revolving credit facility. As of January 2, 2000, there were
no borrowings under the revolving credit facility and letters of credit issued
under that facility were $6.4 million. The borrowings under the revolving credit
facility are available to fund our working capital requirements, capital
expenditures and other general corporate purposes. Principal payments are
required under Term Loans A, B and C, commencing at varied dates and continuing
quarterly thereafter until maturity. The final scheduled principal payments on
the outstanding borrowings under Term Loans A, B and C are due in December 2004,
December 2006 and December 2007, respectively.
Following the recapitalization, our primary sources of liquidity
continue to be cash flow from operations and borrowings under our new revolving
credit facility. We expect that ongoing requirements for debt service and
capital expenditures will be funded from these sources.
We will incur capital expenditures related to our Domino's Image 2000
campaign, on a discretionary basis and only with respect to our corporate
stores. We believe that average per corporate store capital expenditures for the
reimaging campaign will approximate $30,000 and the capital expenditures for
relocating a corporate store will average approximately $170,000 per store.
Based upon the current level of operations and anticipated growth, we
believe that the 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, to redeem or refinance the Cumulative Preferred Stock when
required 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.
IMPACT OF INFLATION
We believe that our results of operations are not dependent upon
moderate changes in the inflation rate. Inflation and changing prices did not
have a material impact on our operations in 1997, 1998 and 1999. Severe
increases in inflation, however, could affect the global and United States
economy and could have an impact on our business, financial condition and
results of operations.
ITEM 7A. 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 January 2, 2000, the notional amount of these swap agreements
was $178 million (effective January 1, 2000).
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 year ended January 2, 2000,
no significant gains or losses were recognized under the foreign currency
forward contracts.
Interest Rate Risk
Our variable interest expense is sensitive to changes in the general
level of United States and European interest rates. A portion of our debt
currently is borrowed at Eurodollar rates plus a blended rate of approximately
3.3% and is sensitive to changes in interest rates. At January 2, 2000, the
weighted average interest rate on our $442.3 million of variable interest debt
was approximately 9.5% and the fair value of the debt approximates its carrying
value.
We had interest expense of $74.1 million for the year ended January 2,
2000. The potential increase in interest expense from a hypothetical 2% adverse
change in the variable interest rates, assuming the January 2, 2000 debt was
outstanding for the entire year, would be approximately $5.3 million.
Accounting for Derivative Instruments and Hedging Activities
The Financial Accounting Standards Board has issued 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. This Statement is
effective beginning the first quarter of fiscal 2001. We have not yet quantified
the impact, if any, of adopting this Statement.
16
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
FINANCIAL STATEMENTS
Report of Independent Public Accountants
To Domino's, Inc.:
We have audited the accompanying consolidated balance sheets of Domino's, Inc.
(a Delaware corporation) and subsidiaries as of January 2, 2000 and January 3,
1999, and the related consolidated statements of income, comprehensive income,
stockholder's equity (deficit) and cash flows for each of the three years in the
period ended January 2, 2000. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Domino's, Inc. and subsidiaries
as of January 2, 2000 and January 3, 1999, and the results of their operations
and their cash flows for each of the three years in the period ended January 2,
2000 in conformity with accounting principles generally accepted in the United
States.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the accompanying
index is presented for purposes of complying with the Securities and Exchange
Commissions rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audits of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Detroit, Michigan,
January 28, 2000
(except with respect
to the matter discussed in
Note 12, as to which
the date is March 30, 2000).
17
DOMINO'S, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
JANUARY 2, 2000 JANUARY 3, 1999
------------------ -----------------
Assets
Current assets:
Cash $ 30,278 $ 115
Accounts receivable, net of reserves of
$2,444 in 1999 and $2,794 in 1998 40,902 48,858
Notes receivable, net of reserves of
$288 in 1999 and $124 in 1998 5,172 8,271
Inventories 18,624 20,134
Prepaid expenses and other 14,890 9,656
Deferred income taxes 10,498 9,811
----------------- ----------------
Total current assets 120,364 96,845
----------------- ----------------
Property, plant and equipment:
Land and buildings 14,246 14,605
Leasehold and other improvements 54,538 52,248
Equipment 117,018 109,517
Construction in progress 3,548 5,486
----------------- ----------------
189,350 181,856
Accumulated depreciation and amortization 116,287 116,890
----------------- ----------------
Property, plant and equipment, net 73,063 64,966
----------------- ----------------
Other assets:
Investments in marketable securities, restricted 3,187 -
Notes receivable, less current portion, net of
reserves of $3,249 in 1999 and $3,041 in 1998 10,380 18,461
Deferred income taxes 73,038 71,776
Deferred financing costs, net of accumulated
amortization of $6,327 in 1999 and $234 in 1998 37,208 43,046
Goodwill, net of accumulated amortization of
$9,217 in 1999 and $7,139 in 1998 16,034 14,179
Covenants not-to-compete, net of accumulated
amortization of $43,152 in 1999 and $10,009
in 1998 16,970 50,058
Capitalized software, net of accumulated amortization
of $14,332 in 1999 and $9,932 in 1998 26,113 22,593
Other assets, net of accumulated amortization and
reserves of $6,555 in 1999 and $6,163 in 1998 4,773 5,967
----------------- ----------------
Total other assets 187,703 226,080
----------------- ----------------
Total assets $ 381,130 $ 387,891
================= ================
The accompanying notes are an integral
part of these consolidated balance sheets.
18
DOMINO'S, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
JANUARY 2, 2000 JANUARY 3, 1999
---------------- ---------------
Liabilities and stockholder's deficit
Current liabilities:
Current portion of long-term debt $ 21,438 $ 7,646
Accounts payable 35,108 44,596
Accrued interest 13,643 2,317
Insurance reserves 7,152 9,633
Accrued compensation 18,068 16,295
Accrued income taxes 804 6,501
Accrued restructuring 3,020 -
Other accrued liabilities 26,875 28,081
---------------- ---------------
Total current liabilities 126,108 115,069
---------------- ---------------
Long-term liabilities:
Long-term debt, less current portion 696,132 720,480
Insurance reserves 15,485 15,132
Other accrued liabilities 22,371 20,985
---------------- ---------------
Total long-term liabilities 733,988 756,597
---------------- ---------------
Commitments and contingencies
Stockholder's deficit:
Common stock, par value $0.01 per share;
3,000 shares authorized; 10 shares issued
and outstanding - -
Additional paid-in capital 120,202 114,737
Retained deficit (599,292) (598,209)
Accumulated other comprehensive income 124 (303)
---------------- ---------------
Total stockholder's deficit (478,966) (483,775)
---------------- ---------------
Total liabilities and stockholder's deficit $ 381,130 $ 387,891
================ ===============
The accompanying notes are an integral
part of these consolidated balance sheets.
19
DOMINO'S, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS)
FOR THE YEARS ENDED
-----------------------
JANUARY 2, JANUARY 3, DECEMBER 28,
2000 1999 1997
------------ ------------ --------------
Revenues:
Corporate stores $ 378,081 $ 409,413 $ 376,837
Domestic franchise royalties 116,715 112,222 102,360
Domestic distribution 603,441 599,121 513,097
International 58,402 56,022 52,496
------------ ------------ --------------
Total revenues 1,156,639 1,176,778 1,044,790
------------ ------------ --------------
Operating expenses:
Cost of sales 854,151 890,784 787,129
General and administrative 219,277 215,725 192,657
Restructuring 7,583 - -
------------ ------------ --------------
Total operating expenses 1,081,011 1,106,509 979,786
------------ ------------ --------------
Income from operations 75,628 70,269 65,004
Interest income 992 730 447
Interest expense (74,116) (7,051) (3,980)
------------ ------------ --------------
Income before provision (benefit)
for income taxes 2,504 63,948 61,471
Provision (benefit) for income taxes 419 (12,928) 366
------------ ------------- --------------
Net income $ 2,085 $ 76,876 $ 61,105
============ ============ ==============
The accompanying notes are an integral part of these consolidated statements.
20
DOMINO'S, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
FOR THE YEARS ENDED
JANUARY 2, JANUARY 3, DECEMBER 28,
2000 1999 1997
------------ ------------ -------------
Net income $ 2,085 $ 76,876 $ 61,105
------------ ------------ ------------
Other comprehensive income, before tax:
Currency translation adjustment 98 (44) (120)
Unrealized gain on investments in
marketable securities 518 - 439
Less: reclassification adjustments for
gains included in net income - (497) -
----------- ------------ ------------
616 (541) 319
Tax attributes of items of other
comprehensive income (189) 30 (26)
------------ ------------ -----------
Other comprehensive income, net of tax 427 (511) 293
----------- ------------ ------------
Comprehensive income $ 2,512 $ 76,365 $ 61,398
=========== ============== ============
The accompanying notes are an integral part of these consolidated statements.
21
DOMINO'S, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (DEFICIT)
(IN THOUSANDS)
Accumulated Other
Comprehensive Income
--------------------
Unrealized
Gain on
Additional Retained Currency Investments
Common Paid-in Earnings Translation in Marketable
Stock Capital (Deficit) Adjustment Securities
------ ---------- --------- ----------- -------------
Balance at December 29, 1996 $ - $ - $ (34,783) $ (139) $ 54
Net income - - 61,105 - -
Distributions to Parent - - (412) - -
Currency translation adjustment - - - (120) -
Unrealized gain on investments
in marketable securities - - - - 413
-------- ---------- ----------- ------- --------
Balance at December 28, 1997 - - 25,910 (259) 467
Net income - - 76,876 - -
Capital contributions from Parent - 50,430 - - -
Distributions to Parent - - (690,688) - -
Currency translation adjustment - - - (44) -
Reclassification adjustment for
gains included in net income - - - - (467)
Recognition of deferred income taxes
as part of Recapitalization - - 54,000 - -
Reclassification of S Corporation
undistributed earnings upon
conversion to C Corporation - 64,307 (64,307) - -
-------- ---------- ------------ ------- --------
Balance at January 3, 1999 - 114,737 (598,209) (303) -
Net income - - 2,085 - -
Capital contributions from Parent - 5,465 - - -
Distribution to Parent - - (3,168) - -
Currency translation adjustment - - - 98 -
Unrealized gain on investments
in marketable securities - - - - 329
-------- ---------- ----------- ------- --------
Balance at January 2, 2000 $ - $ 120,202 $ (599,292) $ (205) $ 329
======== ========== ============ ======== ========
The accompanying notes are an integral part of these consolidated statements.
22
DOMINO'S, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED
--------------------------------------------------
JANUARY 2, JANUARY 3, DECEMBER 28,
2000 1999 1997
----------- ---------- ------------
Cash flows from operating activities:
Net income $ 2,085 $ 76,876 $ 61,105
Adjustments to reconcile net income to net
cash provided by operating activities -
Depreciation and amortization 51,743 23,123 16,939
Provision (benefit) for losses on accounts
and notes receivable 1,971 (3,212) 1,131
(Gain) loss on sale of property, plant and
equipment (316) 1,570 1,197
Benefit for deferred income taxes (1,949) (27,587) -
Amortization of deferred financing costs 6,093 388 327
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable 6,123 (6,254) (13,130)
Decrease (increase) in inventories and
prepaid expenses and other 957 4,531 (15,512)
Increase in accounts payable and accrued
liabilities 1,006 7,989 26,156
Decrease in insurance reserves (4,445) (12,693) (4,805)
----------- ---------- -----------
Net cash provided by operating activities 63,268 64,731 73,408
----------- ---------- -----------
Cash flows from investing activities:
Purchases of property, plant and equipment (27,882) (48,359) (31,625)
Proceeds from sale of property, plant and equipment 1,769 5,587 52
Purchases of franchise stores and commissaries (4,565) (1,534) (13,692)
Repayments of notes receivable 8,307 414 2,381
(Purchases) sales of investments in marketable
securities (2,858) 5,130 (2,832)
Other (1,127) (386) (1,117)
----------- ---------- -----------
Net cash used in investing activities (26,356) (39,148) (46,833)
----------- ---------- -----------
Cash flows from financing activities:
Proceeds from issuance of long-term debt - 722,056 35,800
Capital contribution from Parent 1,465 - -
Repayments of long-term debt (5,188) (38,338) (61,583)
Cash paid for financing costs - (43,280) (293)
Distributions to Parent (3,168) (666,020) (412)
----------- ---------- -----------
Net cash used in financing activities (6,891) (25,582) (26,488)
----------- ---------- -----------
Effect of exchange rate changes on cash 142 9 (214)
----------- ---------- -----------
Increase (decrease) in cash 30,163 10 (127)
Cash, at beginning of period 115 105 232
----------- ---------- -----------
Cash, at end of period $ 30,278 $ 115 $ 105
=========== ========== ===========
The accompanying notes are an integral part of these consolidated statements.
23
Domino's, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 2, 2000
1. Description of Business and Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Domino's, Inc. (formerly known as Domino's Pizza International Payroll Services,
Inc.) (Domino's), a Delaware corporation, and its wholly-owned subsidiaries
(collectively, the Company). All significant intercompany accounts and
transactions have been eliminated. Domino's is a wholly-owned subsidiary of
TISM, Inc. (the Parent).
Description of Business
The Company is primarily engaged in the following business activities: (1)
retail sales of food through Company-owned stores in the contiguous U.S., (2)
sale of food and equipment to Company-owned and franchised stores through
Company-owned distribution centers and (3) receipt of royalties and fees
relating to support of domestic and international franchised stores.
Parent's Recapitalization
On December 21, 1998, the Parent effected a merger with TM Transitory Merger
Corporation (TMTMC) in a leveraged recapitalization transaction whereby TMTMC
was merged with and into the Parent with the Parent being the surviving entity
(the Recapitalization). TMTMC had no operations and was formed solely for the
Parent's purpose of effecting the Recapitalization. As part of the
Recapitalization, the Company incurred significant debt and distributed
significantly all of the proceeds to the Parent, which used those proceeds,
along with proceeds from the Parent's 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 the Parent from a Company and Parent Director and certain
members of his family. During 1999, the Company distributed an additional $3.2
million to the Parent, which used the proceeds to satisfy a
Recapitalization-related obligation to a Company and Parent Director and certain
members of his family.
As part of the Recapitalization, the Company entered into a $5.5 million, ten
year consulting agreement with a Company and Parent Director and former majority
Parent stockholder. In 1999, the Company paid $1.0 million under this agreement
and will pay the remaining $4.5 million ratably over nine years beginning in
fiscal 2000. The $5.5 million has been recorded as a charge to retained earnings
as a component of purchase price for the common stock.
As part of the Recapitalization, certain Company executives received stock
options for the purchase of Parent common stock and preferred stock.
Prior to December 1998, Domino's was an indirectly wholly-owned subsidiary of
Domino's Pizza, Inc. (DPI). During December 1998 and before the
Recapitalization, DPI distributed its ownership interest in Domino's to the
Parent. The Parent then contributed its ownership interest in DPI, which had
been a wholly-owned subsidiary of the Parent, to Domino's, effectively
converting Domino's from a subsidiary of DPI into DPI's parent.
The accompanying consolidated financial statements and these Notes to
Consolidated Financial Statements include the results of operations of DPI and
its wholly-owned subsidiaries (including Domino's) for the periods prior to the
Recapitalization.
Domino's amended its charter in December 1998 to increase the total number of
authorized shares of common stock from 1,000 to 3,000 and decreased the par
value of these shares from $1.00 per share to $0.01 per share.
24
Fiscal Year
The Company's fiscal year ends on the Sunday closest to December 31. The 1999
fiscal year ended January 2, 2000; the 1998 fiscal year ended January 3, 1999;
and the 1997 fiscal year ended December 28, 1997. Each of the fiscal years
consists of fifty-two weeks except for fiscal year 1998 which consists of
fifty-three weeks.
Inventories
Inventories are valued at the lower of cost (on a first-in, first-out basis) or
market.
Inventories at January 2, 2000 and January 3, 1999 are comprised of the
following (in thousands):
1999 1998
--------- --------
Equipment and supplies $ 5,659 $ 9,947
Food 14,641 12,039
--------- --------
20,300 21,986
Less - reserves 1,676 1,852
--------- --------
Inventories, net $ 18,624 $ 20,134
========= =========
Notes Receivable
During the normal course of business, the Company provides financing to
franchisees (i) to stimulate franchise store growth, (ii) to finance the sale of
Company-owned stores to franchisees and (iii) to facilitate rapid new equipment
rollouts. Substantially all of the related notes receivable require monthly
payments of principal and interest, or monthly payments of interest only,
generally ranging from 10% to 12%, with balloon payments of the remaining
principal due one to ten years from the original issuance date. Such notes are
generally secured by the assets sold. In financing these transactions, the
Company derives benefits other than interest income. Given the nature of these
borrower/lender relationships, the Company, in essence, makes its own market in
these notes. The carrying amounts of these notes approximate fair value.
During 1998, the Company modified certain criteria it uses to determine
allowance for bad debts for notes receivable. As a result of this change, the
Company recognized a benefit of approximately $3.7 million during fiscal 1998.
Property, Plant and Equipment
Additions to property, plant and equipment are recorded at cost. Depreciation
for financial reporting purposes is provided using the straight-line method over
the estimated useful lives of the related assets. During 1998 and 1997, asset
lives were generally three to seven years for equipment, twenty years for
buildings and improvements and five years or the term of the lease including
renewal options, whichever is shorter, for leasehold and other improvements.
The Company initiated a review of the estimated useful lives for depreciating or
amortizing property, plant and equipment and goodwill, respectively. The review
included consideration of the estimated lives of stores as determined through
quantitative analysis performed in late 1998 and analysis of the historical
longevity of operating assets used in operations. The Company concluded the
review in the first quarter of 1999.
Based on this review, the Company 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 goodwill, which primarily arises from purchases of stores from
franchisees, estimated useful lives were shortened in certain circumstances to
ten years.
25
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):
Net impact of changes in useful lives $ 5,616
Non-recurring charge to eliminate assets which
had no remaining useful lives (1,025)
--------
Increase in income from operations 4,591
Income tax effect (1,676)
--------
Increase in net income $ 2,915
========
Depreciation expense was approximately $11.9 million, $16.6 million and $13.4
million in 1999, 1998 and 1997, respectively.
Investments in Marketable Securities
As of December 28, 1997, the Company had investments in marketable securities of
approximately $5.6 million, comprised of both debt and equity securities. These
investments were classified as available-for-sale and were stated at aggregate
fair value. Unrealized gains at December 28, 1997 were $536,000 and unrealized
losses were $69,000, both net of tax. For purposes of determining realized gains
and losses, the cost of securities sold is based upon the specific
identification method.
The Company had placed these investments in "rabbi trusts", whereby the amounts
were irrevocably set aside to fund the Company's obligations under its
nonqualified executive and managerial deferred compensation plans (Note 5).
These plans were terminated during 1998 as part of the Recapitalization and all
related investments in marketable securities were sold with the proceeds being
paid to the participants in the plans.
As of January 2, 2000, the Company has investments in marketable securities of
approximately $3.2 million, comprised of mutual funds. These investments are
classified as available-for-sale and are stated at aggregate fair value.
Unrealized gains at January 2, 2000 are $329,000, net of tax. For purposes of
determining realized gains and losses, the cost of securities sold is based upon
the specific identification method. These investments are in a "rabbi trust",
whereby the amounts are irrevocably set aside to fund the Company's obligations
under its deferred compensation plans which began in 1999.
Deferred Financing Costs
Deferred financing costs include debt issuance costs primarily incurred by the
Company as part of the Recapitalization. Amortization is provided using the
effective interest rate method over the terms of the respective debt instruments
to which the costs relate and is included in interest expense. Amortization of
deferred financing costs was approximately $6.1 million, $0.4 million and $0.3
million in 1999, 1998 and 1997, respectively.
As part of the Recapitalization, the Company paid financing costs to affiliates
of the Parent stockholders of approximately $21.1 million. Approximately $14.4
million of these expenditures were treated by the Company as capitalizable
deferred financing costs while approximately $6.7 million of these expenditures
were made on behalf of the Parent and were treated as distributions to the
Parent.
Goodwill and Covenants Not-to-Compete
Goodwill arising primarily from franchise acquisitions has been recorded at cost
and is being amortized using the straight-line method over periods not exceeding
ten years. Amortization of goodwill was approximately $2.1 million, $2.0 million
and $1.4 million in 1999, 1998 and 1997, respectively.
26
Covenants not-to-compete, primarily obtained as a part of the Recapitalization
(Note 7), have been recorded at cost and are being amortized using an
accelerated method over a three year period for the covenant not-to-compete with
a Company and Parent Director and former majority Parent stockholder. Other
covenants not-to-compete are being amortized using the straight-line method over
periods not exceeding ten years. Amortization of covenants not-to-compete was
approximately $33.1 million, $2.2 million and $0.7 million in 1999, 1998 and
1997, respectively.
Capitalized Software
The American Institute of Certified Public Accountants has issued Statement of
Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use", which requires entities to capitalize and amortize
certain costs and currently expense certain other costs incurred for software
developed or obtained for internal use. The Company adopted this SOP in 1998.
The adoption of this SOP did not have a significant impact on the accompanying
consolidated financial statements.
Capitalized software is recorded at cost and includes purchased, internally
developed and externally developed software used in the Company's operations.
Amortization for financial reporting purposes is provided using the
straight-line method over the estimated useful lives of the software, which
range from two to seven years. Amortization expense was approximately $4.4
million, $2.0 million and $0.8 million in 1999, 1998 and 1997, respectively.
Other Assets
Other assets primarily include equity investments in international franchisees,
deposits and other intangibles primarily arising from franchise acquisitions.
Amortization of other intangibles is provided using the straight-line method
over the estimated useful lives of the amortizable assets. Amortization expense
was approximately $241,000, $376,000 and $564,000 in 1999, 1998 and 1997,
respectively.
Other Accrued Liabilities
Current and long-term other accrued liabilities primarily include accruals for
sales, income and other taxes, legal matters, marketing and advertising
expenses, equipment warranty expenses, store operating expenses, deferred
revenues, deferred compensation and a consulting fee payable to a Company
Director and former majority Parent stockholder.
Revenue Recognition
Corporate store revenues are comprised of retail sales of food through
Company-owned stores located in the contiguous U.S. and are recognized when the
food is delivered to or carried out by customers.
Domestic franchise royalties are primarily comprised of royalties and fees from
franchisees with operations in the contiguous U.S. and are recognized as revenue
when earned.
Domestic distribution revenues are comprised of sales of food, equipment and
supplies to franchised stores located in the contiguous U.S. and are recognized
as revenue upon shipment of the related products to franchisees.
International revenues are primarily comprised of sales of food and royalties
and fees from foreign, Alaskan and Hawaiian franchisees and are recognized
consistently with the policies applied for revenues generated in the contiguous
U.S.
Advertising Costs
Advertising costs are expensed as incurred. Advertising expense, which relates
primarily to Company-owned stores, was approximately $37.8 million, $41.2
million and $40.5 million during 1999, 1998 and 1997, respectively.
27
Insurance Programs
The Company is partially self-insured for property and health insurance risks
and, for periods up to December 20, 1998, was partially self-insured for
workers' compensation, general liability and owned and non-owned automobile
programs.
The Company's health insurance program provides coverage for life, medical,
dental and accidental death and dismemberment (AD&D) claims. Self-insurance
limitations for medical and dental per a covered individual's lifetime were $2.0
million in 1999, 1998 and 1997. The AD&D and life insurance components of the
health insurance program are fully insured by the Company through third-party
insurance carriers.
Effective July 1, 1996 through December 19, 1998, the self-insurance limitations
per occurrence for the workers' compensation, general liability and owned and
non-owned automobile programs were $500,000, plus a one-time otherwise
recoverable amount of $500,000 in excess of $500,000 on the combined general
liability, owned and non-owned automobile programs for each policy year, except
for the period from July 1, 1998 through December 19, 1998 for which there was
no otherwise recoverable amount.
Total excess insurance limits for all partially self-insured periods were $105.0
million per occurrence under the workers' compensation, general liability and
owned and non-owned automobile programs.
Self-insurance reserves are determined using actuarial estimates. These
estimates are based on historical information along with certain assumptions
about future events. Changes in assumptions for such things as medical costs and
legal actions, as well as changes in actual experience, could cause these
estimates to change in the near term. In management's opinion, the accrued
insurance reserves at January 2, 2000 are sufficient to cover potential
aggregate losses.
Paid claims under the Company's self-insurance programs were $13.6 million in
1999, $23.4 million in 1998 and $20.0 million in 1997. As of January 2, 2000,
the Company has deposits totaling approximately $1.0 million with the Company's
third-party insurance claims administrator. This amount is included in other
assets.
During December 1998, the Company entered into a guaranteed cost, combined
casualty insurance program that is effective for the period December 20, 1998 to
December 20, 2001. The new program covers insurance claims on a first dollar
basis for workers' compensation, general liability and owned and non-owned
automobile liability. Total insurance limits under this program are $106.0
million per occurrence for general liability and owned and non-owned automobile
liability and up to the applicable statutory limits for workers' compensation.
Insurance expense was comprised of the following (in millions):
1999 1998 1997
------- ------- -------
Self-insurance program $ 10.6 $ 22.6 $ 20.0
Combined casualty program 10.3 - -
Reduction in actuarial calculations - (6.7) -
------- ------- --------
$ 20.9 $ 15.9 $ 20.0
======= ======= ========
Foreign Currency Translation
The Company's foreign entities use their local currency or the U.S. dollar as
the functional currency, in accordance with the provisions of SFAS No. 52,
"Foreign Currency Translation." Where the functional currency is the local
currency, the Company translates net assets into U.S. dollars at yearend
exchange rates, while income and expense accounts are translated at average
exchange rates. Translation adjustments are included in accumulated other
comprehensive income and other foreign currency transaction gains and
losses are included in determining net income.
28
Financial Derivatives
During 1999, the Company entered into two interest-rate swap agreements (the
1999 Swap Agreements) to effectively convert the Eurodollar component of the
interest rate on a portion of the Company's debt under Term Loans A, B and C
(Note 2) to a fixed rate of 5.12% beginning in January 1999 and continuing
through December 2001, in an effort to reduce the impact of interest rate
changes on income. The total notional amount under the 1999 Swap Agreements is
initially $179.0 million and decreases over time to a total notional amount of
$167.0 million in December 2001. As of January 2, 2000, management estimates the
fair value of the 1999 Swap Agreements to be an asset of approximately $5.0
million.
As a result of generating royalty revenues from franchised operations in Japan,
the Company is exposed to the effect of exchange rate fluctuations between the
Japanese yen and U.S. dollar. During 1999, the Company entered into contracts to
sell 30 million Japanese yen every four weeks during fiscal 2000. In 1998, 1997
and 1996, the Company entered into contracts to sell 30 million, 35 million and
36 million Japanese yen every four weeks in the following fiscal year,
respectively.
Using foreign currency forward contracts enables management to minimize the
effect of a fluctuating Japanese yen on its reported income. Gains and losses
with respect to these contracts are recognized in income at each balance sheet
date based on the exchange rate in effect at that time. No significant gains or
losses were recognized under these contracts during 1999, 1998 or 1997. The
carryin