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

90K characters. Original on sec.gov · Markdown

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

| --- | --- |

Overview

Our fiscal year typically includes 52 weeks, comprised of three twelve-week quarters and one sixteen-week quarter. Every five or six years our fiscal year includes an extra (or 53rd) week in the fourth quarter. Fiscal 2015 consisted of 53 weeks, while fiscal 2016 and fiscal 2014 each consisted of 52 weeks.

Description of the Business

Domino’s is the second largest pizza restaurant chain in the world, with more than 13,800 locations in over 85 markets around the world. Founded in 1960, our roots are in convenient pizza delivery, while a significant amount of our sales also come from carryout customers. Although we are a highly-recognized global brand, we focus on serving the local neighborhoods in which we live and do business through our large network of franchise owners and Company-owned stores. On average, we sell more than 2 million pizzas each day throughout our global system.

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

Domino’s generates revenues and earnings by charging royalties to its franchisees. Royalties are ongoing percent-of-sales fees for use of the Domino’s brand marks. The Company also generates revenues and earnings by selling food, equipment and supplies to franchisees primarily in the U.S. and Canada, and by operating a number of our own stores. Franchisees profit by selling pizza and other complementary items to their local customers. In our international markets, we generally grant geographical rights to the Domino’s Pizza® brand to master franchisees. These master franchisees are charged with developing their geographical area, and they may profit by sub-franchising and selling ingredients and equipment to those sub-franchisees, as well as by running pizza stores. Everyone in the system can benefit, including the end consumer, who can feed their family Domino’s menu items conveniently and economically.

Our business model can yield strong returns for our franchise owners and Company-owned stores. It can also yield significant cash flow to us, through a consistent franchise royalty payment and supply chain revenue stream, with moderate capital expenditures. We have historically returned cash to shareholders through dividend payments and share repurchases since becoming a publicly-traded company.

Fiscal 2016 Highlights

•Global retail sales (which are total retail sales at Company-owned and franchised stores worldwide) increased 9.8% as compared to 2015.
•Same store sales increased 10.5% in our domestic stores and increased 6.3% in our international stores.
•Our revenues increased 11.6%.
•Our income from operations increased 12.0%.
•Our net income increased 11.4%.

During 2016, we continued our rapid global expansion with the opening of 1,281 net new stores. Our international franchise segment led the way with a record 1,110 net new store openings.

We continued our focus on growing online ordering and the digital customer experience as we introduced new innovative ordering platforms including zero-click ordering, Google Home, Facebook Messenger, Apple Watch, and Amazon Echo. Our emphasis on technology innovation helped us generate more than half of U.S. sales from digital channels in 2016, as well as reach an estimated $5.6 billion in global digital sales. Overall, we believe our focus in 2016 on global growth and technology will continue to strengthen our brand in the future.

Fiscal 2015 Highlights

•Global retail sales increased 11.1% as compared to 2014.
•Same store sales increased 12.0% in our domestic stores and increased 7.8% in our international stores.
•Our revenues increased 11.2%.
•Our income from operations increased 17.4%.
•Our net income increased 18.6%.
•The inclusion of the 53rd week in 2015 positively impacted our results.
Table of Contents

During 2015, we continued our rapid global expansion with the opening of 901 net new stores. Our international franchise segment led the way with 768 net new store openings.

We continued our focus on growing online ordering and the digital customer experience as we introduced several innovative ordering platforms, including Samsung Smart TV® as well as Twitter and text message using a pizza emoji. Our emphasis on technology innovation helped us generate approximately 50% of U.S. sales from digital channels in 2015, as well as reach an estimated $4.7 billion in global digital sales. During the year, the Company also launched its “Piece of the Pie Rewards” loyalty program, which is meant to reward customers with a program that is simple to understand and easy to use. Upon signing up for the program, customers become rewards members and can earn points for online orders. When rewards members reach a certain amount of points, they can redeem their points for free pizza.

Critical accounting policies and estimates

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

Revenue recognition. We earn revenues through our network of domestic Company-owned and franchised stores, dough manufacturing and supply chain centers and international operations. Retail sales from franchise stores are reported to the Company by its franchisees and are not included in Company revenues. Retail sales from Company-owned stores and royalty revenues resulting from the retail sales from franchised stores are recognized as revenues when the items are delivered to or carried out by customers. Retail sales are generally reported and related royalties paid to the Company based on a percentage of retail sales, as specified in the related standard franchise agreement (generally 5.5% of domestic franchise retail sales and, on average, 3.0% of international franchise retail sales). Revenues from Company-owned stores and royalty revenues and fees from franchised stores can fluctuate from time-to-time as a result of store count and sales level changes. This can occur when a Company-owned store is sold to a franchisee. If a Company-owned store that generated $500,000 in revenue in fiscal 2015 was sold to a franchisee in fiscal 2016, revenues from Company-owned stores would have declined by $500,000 in fiscal 2016, while franchise royalty revenues would have increased by only $27,500 in fiscal 2016, as we generally collect 5.5% of a domestic franchisee’s retail sales. Sales of food from our supply chain centers are recognized as revenues upon delivery of the food to franchisees, while sales of equipment and supplies are generally recognized as revenues upon shipment of the related products to franchisees.

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

Table of Contents

We have not made any significant changes in the methodology used to project the future market cash flows of Company-owned stores during the years presented. Same store sales fluctuations and the rates at which operating costs will fluctuate in the future are key factors in evaluating recoverability of the related assets. If our same store sales significantly decline or if operating costs increase and we are unable to recover these costs, the carrying value of our Company-owned stores, by market, may be unrecoverable and we may be required to recognize an impairment charge. As discussed in Note 1 to our consolidated financial statements, the Company incurred an impairment charge related to its corporate airplane in the fourth quarter of 2014. Aside from this impairment charge, the Company did not record an impairment charge during fiscal 2016, fiscal 2015 or fiscal 2014.

A significant portion of our goodwill relates to acquisitions of domestic franchise stores and is included in our domestic stores segment, specifically, our Company-owned stores division. We evaluate goodwill annually for impairment by comparing the fair value of the reporting unit (which is primarily determined using the present value of historical cash flows) to its carrying value. If the carrying value of the reporting unit exceeds the fair value, goodwill would be impaired. We have not made any significant changes in the methodology used to evaluate goodwill impairment during the years presented. At January 1, 2017, the fair value of our business operations with associated goodwill exceeded their recorded carrying value, including the related goodwill. If cash flows generated by our Company-owned stores were to decline significantly in the future or there were negative revisions to the market multiple assumption, we may be required to recognize a goodwill impairment charge. However, based on the latest impairment analysis, we do not believe it is reasonably likely that there could be changes in assumptions that would trigger impairment.

Insurance and legal matters. We are a party to lawsuits and legal proceedings arising in the ordinary course of business. Management closely monitors these legal matters and estimates the probable costs for the resolution of such matters. These estimates are primarily determined by consulting with both internal and external parties handling the matters and are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. Legal judgments can be volatile and difficult to predict. Accordingly, if our estimates relating to legal matters proved inaccurate for any reason, we may be required to increase or decrease the related expense in future periods. We had accruals for legal matters of approximately $2.7 million at January 1, 2017 and $1.9 million at January 3, 2016.

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

Our methodology for determining our exposure has remained consistent throughout the years presented. Management believes that the various assumptions developed and actuarial methods used to determine our self-insurance reserves are reasonable and provide meaningful data that management uses to make its best estimate of our exposure to these risks. Changes in assumptions for such factors as medical costs and legal actions, as well as changes in actual experience, could cause our estimates to change in the near term which could result in an increase or decrease in the related expense in future periods. A 10% change in our self-insurance liability at January 1, 2017 would have affected our income before provision for income taxes by approximately $4.4 million for fiscal 2016. We had accruals for insurance matters of approximately $43.9 million at January 1, 2017 and $40.9 million at January 3, 2016.

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

Table of Contents

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

Income taxes. We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax basis of assets and liabilities. We measure deferred tax assets and liabilities using current enacted tax rates that will apply in the years in which we expect the temporary differences to be recovered or paid. Judgment is required in determining the provision for income taxes, related reserves and deferred tax assets and liabilities. These include establishing a valuation allowance related to the ability to realize certain deferred tax assets, if necessary. On an ongoing basis, management will assess whether it remains more likely than not that the net deferred tax assets will be realized. The Company had valuation allowances recorded for deferred tax assets of approximately $0.1 million as of January 1, 2017 and approximately $0.2 million as of January 3, 2016. Our accounting for deferred tax assets represents our best estimate of future events. Our net deferred tax assets assume that we will generate sufficient taxable income in specific tax jurisdictions, based on our estimates and assumptions. Changes in our current estimates due to unanticipated events could have a material impact on our financial condition and results of operations.

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

Same Store Sales Growth

201620152014
Domestic Company-owned stores10.4%12.2%6.2%
Domestic franchise stores10.5%11.9%7.7%
Domestic stores10.5%12.0%7.5%
International stores (excluding foreign currency impact)6.3%7.8%6.9%

Store Growth Activity

Domestic Company-owned StoresDomestic FranchiseTotal Domestic StoresInternational StoresTotal
Store count at December 29, 20133904,5964,9865,90010,886
Openings—115115722837
Closings—(34)(34)(60)(94)
Transfers(13)13———
Store count at December 28, 20143774,6905,0676,56211,629
Openings121481608671,027
Closings(1)(26)(27)(99)(126)
Transfers(4)4———
Store count at January 3, 20163844,8165,2007,33012,530
Openings81861941,1781,372
Closings(1)(22)(23)(68)(91)
Transfers1(1)———
Store count at January 1, 20173924,9795,3718,44013,811
Table of Contents

Income Statement Data

(dollars in millions)201620152014
Domestic Company-owned stores$439.0$396.9$348.5
Domestic franchise312.3272.8230.2
Supply chain1,544.31,383.21,262.5
International franchise177.0163.6152.6
Total revenues2,472.6100.0%2,216.5100.0%1,993.8100.0%
Domestic Company-owned stores331.9299.3267.4
Supply chain1,373.11,234.11,131.7
Cost of sales1,704.969.0%1,533.469.2%1,399.170.2%
Operating margin767.731.0%683.130.8%594.829.8%
General and administrative313.612.7%277.712.5%249.412.5%
Income from operations454.018.3%405.418.3%345.417.3%
Interest expense, net(109.4)(4.4)%(99.2)(4.5)%(86.7)(4.3)%
Income before provision for income taxes344.713.9%306.213.8%258.613.0%
Provision for income taxes130.05.2%113.45.1%96.04.8%
Net income$214.78.7%$192.88.7%$162.68.2%

2016 compared to 2015

(tabular amounts in millions, except percentages)

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

Consolidated revenues increased $256.1 million or 11.6% in 2016. The increase was due primarily to higher supply chain food volumes as well as higher Company-owned store, domestic franchise and international franchise revenues resulting from same store sales and store count growth. These increases were offset in part by the inclusion of the 53rd week in 2015, which positively impacted revenues by an estimated $49.7 million in 2015. The negative impact of changes in foreign currency exchange rates on international franchise royalties and international supply chain revenues also partially offset the increases in revenues. These changes in revenues are more fully described below.

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

20162015
Domestic Company-owned stores$439.058.4%$396.959.3%
Domestic franchise312.341.6%272.840.7%
Total domestic stores revenues$751.3100.0%$669.7100.0%

Higher franchise same store sales, store count growth and higher domestic Company-owned same store sales drove an increase in overall domestic store revenues of $81.6 million or 12.2%. These results are more fully described below.

Domestic Company-owned stores. Revenues from domestic Company-owned store operations increased $42.1 million or 10.6% in 2016. This increase was due to a 10.4% increase in same store sales as compared to 2015 and an increase in the average number of stores open during the year, and was offset in part by the estimated $9.1 million positive impact in 2015 related to the inclusion of the 53rd week.

Domestic franchise. Revenues from domestic franchise operations increased $39.5 million or 14.5% in 2016. The increase was driven by a 10.5% increase in same store sales as compared to 2015 and an increase in the average number of stores open during the year. Revenues further benefited from fees paid by franchisees for our internally developed online ordering platform, and were offset in part by the estimated $6.1 million positive impact in 2015 related to the inclusion of the 53rd week.

Table of Contents

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

20162015
Domestic supply chain$1,408.891.2%$1,266.491.6%
International supply chain135.58.8%116.88.4%
Total supply chain$1,544.3100.0%$1,383.2100.0%

In fiscal 2016, the Company began managing the Alaska and Hawaii supply chain centers as part of its domestic supply chain business. Prior to fiscal 2016, these centers were managed as part of the Company’s international supply chain business. Revenues from these supply chain centers are included in the 2016 and 2015 domestic supply chain revenues in the table above.

Domestic supply chain. Domestic supply chain revenues increased $142.4 million or 11.3% in 2016. These increases were primarily attributable to higher volumes from increased order counts at the store level. They were partially offset by lower commodity prices and the estimated $27.8 million positive impact in 2015 related to the inclusion of the 53rd week. The lower cheese block price (passed through directly in domestic supply chain pricing to franchisees) did not have a material impact on domestic supply chain revenues in 2016. We estimate that lower commodity prices resulted in an approximate $3.0 million decrease in domestic supply chain revenues during 2016.

International supply chain. Revenues from international supply chain operations increased $18.7 million or 16.0% in 2016. This increase resulted primarily from higher volumes from increased order counts at the store level in 2016 and was offset in part by the negative impact of foreign currency exchange rates of approximately $4.3 million in 2016 and the estimated $2.6 million positive impact in 2015 related to the inclusion of the 53rd week.

International franchise. International franchise revenues primarily consist of royalties from retail sales and other fees from our international franchise stores. Revenues from international franchise operations increased $13.4 million or 8.2% in 2016. This increase was due to an increase in the average number of international stores open during 2016 as well as higher same store sales, and was offset in part by the negative impact of changes in foreign currency exchange rates of approximately $8.9 million in 2016 and the estimated $4.1 million positive impact in 2015 related to the inclusion of the 53rd week. Excluding the impact of foreign currency exchange rates, same store sales increased 6.3% in 2016 compared to 2015.

Cost of sales / Operating margin. Consolidated cost of sales consists primarily of domestic Company-owned store and supply chain costs incurred to generate related revenues. Components of consolidated cost of sales primarily include food, labor and occupancy costs. The changes to the consolidated operating margin, which we define as revenues less cost of sales are summarized in the following table.

20162015
Consolidated revenues$2,472.6100.0%$2,216.5100.0%
Consolidated cost of sales1,704.969.0%1,533.469.2%
Consolidated operating margin$767.731.0%$683.130.8%

The $84.6 million or 12.4% increase in consolidated operating margin was due primarily to higher domestic and international franchise revenues and higher supply chain margins. The increase in the consolidated operating margin was offset in part by the estimated $16.6 million positive impact in 2015 related to the inclusion of the 53rd week. Franchise revenues do not have a cost of sales component, so changes in franchise revenues have a disproportionate effect on the consolidated operating margin.

As a percentage of total revenues, our consolidated operating margin increased 0.2 percentage points in 2016, due to higher supply chain margins as a percentage of their revenues and a higher mix of franchise revenues. Lower Company-owned stores operating margins as a percentage of their revenues partially offset these increases. These changes are more fully described below.

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

20162015
Revenues$439.0100.0%$396.9100.0%
Cost of sales331.975.6%299.375.4%
Store operating margin$107.224.4%$97.624.6%

The $9.6 million or 9.8% increase in the domestic Company-owned store operating margin was due primarily to higher same store sales. The estimated $3.1 million positive impact in 2015 related to the inclusion of the 53rd week partially offset this increase.

Table of Contents

As a percentage of store revenues, the store operating margin decreased 0.2 percentage points in 2016, as discussed in more detail below.

Management has historically included costs to support online ordering as part of labor and related costs. Costs to support online ordering are now included within transaction-related expenses and the prior year costs have been reclassified to conform to current year presentation.

•Food costs increased 0.5 percentage points to 26.6% in 2016, due primarily to promotional activities. Lower overall commodity prices partially offset these increases.
•Labor costs increased 0.3 percentage points to 28.8% in 2016, due primarily to an increase in labor rates in certain markets as well as higher performance based compensation and overtime as a result of increased same store sales. The leveraging impact of higher same store sales partially offset these increases.
•Insurance costs decreased 1.2 percentage points to 2.8% in 2016, due primarily to a $4.3 million insurance expense related to updated actuarial estimates for our casualty insurance program in the third quarter of 2015.
•Transaction-related expenses increased 0.9 percentage points to 3.2% in 2016. This increase was primarily attributable to higher credit card-related expenses in certain markets in which we operate.
•Delivery expenses decreased 0.4 percentage points to 3.4% in 2016, due primarily to lower fuel prices.

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

20162015
Revenues$1,544.3100.0%$1,383.2100.0%
Cost of sales1,373.188.9%1,234.189.2%
Supply chain operating margin$171.311.1%$149.110.8%

The $22.2 million or 14.9% increase in the supply chain operating margin was due primarily to higher volumes from increased store order counts. Lower insurance expenses also contributed to the increased operating margin, as the third quarter of 2015 contained a $1.4 million insurance charge related to the Company’s casualty insurance program. The estimated $3.3 million positive impact in 2015 related to the inclusion of the 53rd week in 2015 partially offset the increase in operating margin.

As a percentage of supply chain revenues, the supply chain operating margin increased 0.3 percentage points in 2016 due to lower casualty and health insurance expenses, higher volumes from store count growth and increased store order counts, as well as lower fuel costs. Increased labor costs partially offset these increases. Decreases in certain food prices have a positive effect on the supply chain operating margin percentage due to the fixed dollar margin earned by supply chain on certain food items. Lower commodity prices decreased both revenues and costs by $3.0 million in fiscal 2016. Lower cheese prices did not have a material impact in 2016; if our U.S. cheese prices for 2016 had been in effect during 2015, the supply chain operating margin as a percentage of supply chain revenues would have remained the same. The dollar margin would also have been unaffected.

General and administrative expenses. General and administrative expenses increased $35.9 million or 12.9% in 2016. These increases were driven by continued investments in technological initiatives and labor (primarily in e-commerce, information technology and international operations) as well as higher performance-driven expenses resulting from improved operating performance and higher same store sales, including variable performance-based compensation, and Company-owned store national advertising contributions. General and administrative expenses were positively impacted by the non-recurrence of an estimated $4.7 million of expenses from the inclusion of the 53rd week in 2015.

Interest income. Interest income increased slightly to $0.7 million in 2016.

Interest expense. Interest expense increased $10.5 million to $110.1 million in 2016. The increase was driven by a higher average debt balance as a result of the 2015 Recapitalization and was offset in part by a lower cash borrowing rate.

Our weighted average borrowing rate decreased to 4.6% in fiscal 2016, from 5.1% in fiscal 2015. The decreases in the Company’s cash borrowing rate resulted from the lower interest rates on the debt issued as part of the 2015 recapitalization. Our average outstanding debt balance, excluding capital lease obligations, was approximately $2.23 billion in 2016 and approximately $1.68 billion in 2015. The increase in the average outstanding debt balance was due to the issuance of debt in connection with the 2015 Recapitalization.

Provision for income taxes. Provision for income taxes increased $16.6 million to $130.0 million in 2016, due primarily to higher pre-tax income. The Company’s effective income tax rate increased by 0.7 percentage points to 37.7% of pre-tax income in 2016.

Table of Contents

2015 compared to 2014

(tabular amounts in millions, except percentages)

Revenues. Consolidated revenues increased $222.7 million or 11.2% in 2015. The increase was due primarily to higher supply chain food volumes as well as increased sales of equipment to stores in connection with our store reimaging program. Higher Company-owned store, domestic franchise and international franchise revenues resulting from same store sales and store count growth also contributed to the rise in revenue. The inclusion of the 53rd week in 2015 also positively impacted revenues by an estimated $49.7 million. These increases were offset in part by the negative impact of changes in foreign currency exchange rates on international franchise royalties and international supply chain revenues, as well as lower cheese and other commodity prices.

These changes in revenues are more fully described below.

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

20152014
Domestic Company-owned stores$396.959.3%$348.560.2%
Domestic franchise272.840.7%230.239.8%
Total domestic stores revenues$669.7100.0%$578.7100.0%

Higher franchise same store sales, store count growth and higher domestic Company-owned same store sales drove an increase in overall domestic store revenues of $91.0 million or 15.7%. These results are more fully described below.

Domestic Company-owned stores. Revenues from domestic Company-owned store operations increased $48.4 million or 13.9% in 2015. This increase was due to a 12.2% increase in same store sales as compared to 2014, as well as an estimated $9.1 million impact of the 53rd week, offset in part by the sale of 14 Company-owned stores to a franchisee that occurred in the first quarter of 2014.

Domestic franchise. Revenues from domestic franchise operations increased $42.6 million or 18.5% in 2015. The increase was driven by an 11.9% increase in same store sales as compared to 2014, as well as an estimated $6.1 million impact of the 53rd week, and an increase in the average number of domestic franchised stores open during 2015. Revenues further benefited from fees paid by franchisees to reimburse us for expenses we incurred for our internally developed online ordering platform.

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

20152014
Domestic supply chain$1,266.491.6%$1,149.791.1%
International supply chain116.88.4%112.88.9%
Total supply chain$1,383.2100.0%$1,262.5100.0%

In fiscal 2016, the Company began managing the Alaska and Hawaii supply chain centers as part of its domestic supply chain business. Prior to fiscal 2016, these centers were managed as part of the Company’s international supply chain business. Revenues from these supply chain centers are included in the 2015 and 2014 domestic supply chain revenues in the table above.

Domestic supply chain. Domestic supply chain revenues increased $116.7 million or 10.1% in 2015. These increases were primarily attributable to higher volumes from increased order counts at the store level and increases in sales of equipment in connection with our store reimaging program, as well as an estimated $27.8 million impact of the 53rd week. They were partially offset by lower cheese and other commodity prices. We estimate that the lower cheese block price (passed through directly in domestic supply chain pricing to franchisees) resulted in an approximate $45.3 million decrease in domestic supply chain revenues during 2015.

International supply chain. Revenues from international supply chain operations increased $4.0 million or 3.5% in 2015. This increase resulted primarily from higher volumes in 2015 and an estimated $2.6 million impact of the 53rd week, and were offset in part by the negative impact of foreign currency exchange rates of approximately $16.4 million in 2015.

International franchise. International franchise revenues primarily consist of royalties from retail sales and other fees from our international franchise stores. Revenues from international franchise operations increased $11.0 million or 7.2% in 2015. This increase was due to an increase in the average number of international stores open during 2015, higher same store sales and an estimated $4.1 million impact of the 53rd week, and was offset in part by the negative impact of changes in foreign currency exchange rates of approximately $19.9 million in 2015. Excluding the impact of foreign currency exchange rates, same store sales increased 7.8% in 2015 compared to 2014.

Table of Contents

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

20152014
Consolidated revenues$2,216.5100.0%$1,993.8100.0%
Consolidated cost of sales1,533.469.2%1,399.170.2%
Consolidated operating margin$683.130.8%$594.829.8%

The $88.3 million or 14.9% increase in consolidated operating margin was due primarily to higher domestic and international franchise revenues and higher supply chain margins, as well as an estimated $16.6 million impact of the 53rd week. Franchise revenues do not have a cost of sales component, so changes in franchise revenues have a disproportionate effect on the consolidated operating margin.

As a percentage of total revenues, our consolidated operating margin increased 1.0 percentage points in 2015, due to higher supply chain and Company-owned stores operating margins as a percentage of their revenues, as well as a higher mix of franchise revenues. These changes are more fully described below.

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

20152014
Revenues$396.9100.0%$348.5100.0%
Cost of sales299.375.4%267.476.7%
Store operating margin$97.624.6%$81.123.3%

The $16.5 million or 20.4% increase in the domestic Company-owned store operating margin was due primarily to higher same store sales, a decrease in overall commodity prices and an estimated $3.1 million impact of the 53rd week.

As a percentage of store revenues, the store operating margin increased 1.3 percentage points in 2015, as discussed in more detail below.

As noted in the comparison between 2016 and 2015, management has historically included costs to support online ordering as part of labor and related costs. Costs to support online ordering are now included within transaction-related expenses and the prior year costs below have been reclassified to conform to current year presentation.

•Food costs decreased 2.2 percentage points to 26.1% in 2015, due primarily to lower overall commodity prices. The cheese block price per pound averaged $1.62 in 2015 compared to $2.13 in 2014.
•Occupancy costs, which include rent, telephone, utilities and depreciation, decreased 1.1 percentage points to 8.1% in 2015 due primarily to the positive impact of higher sales per store.
•Labor costs increased 0.9 percentage points to 28.5% in 2015, due primarily to higher performance based compensation and overtime as a result of increased same store sales.
•Insurance costs increased 1.3 percentage points to 4.0% in 2015, due primarily to a $4.3 million incremental insurance expense in the third quarter of 2015 related to updated actuarial estimates for our casualty insurance program.

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

20152014
Revenues$1,383.2100.0%$1,262.5100.0%
Cost of sales1,234.189.2%1,131.789.6%
Supply chain operating margin$149.110.8%$130.810.4%

The $18.3 million increase in the supply chain operating margin was due primarily to higher volumes from increased store order counts and an estimated $3.3 million impact of the 53rd week.

As a percentage of supply chain revenues, the supply chain operating margin increased 0.4 percentage points in 2015 due to lower commodity prices and lower fuel costs. However, the operating margin was negatively impacted by incremental casualty and health insurance expense, including $1.4 million recorded in the third quarter of 2015 related to updated actuarial estimates for our casualty insurance program, as well as increased labor and delivery costs. Decreases in certain food prices have a positive effect on the supply chain operating margin percentage due to the fixed dollar margin earned by supply chain on certain food items. Changes in our U.S. cheese prices decreased both revenues and costs by $45.3 million in fiscal 2015. If our U.S. cheese prices for 2015 had been in effect during 2014, the supply chain operating margin as a percentage of supply chain revenues would have increased by 0.4 percentage points. However, the dollar margin would have been unaffected.

Table of Contents

General and administrative expenses. General and administrative expenses increased $28.3 million or 11.3% in 2015. These increases were driven by continued investments in technological initiatives and labor (primarily in e-commerce, information technology and international operations) as well as higher volume-driven expenses resulting from improved operating performance and higher same store sales, including variable performance-based compensation, Company-owned store national advertising contributions and franchisee incentives. The non-recurring $1.7 million pre-tax gain recognized from the sale of 14 Company-owned stores during the first quarter of 2014 and an estimated $4.7 million impact of the inclusion of the 53rd week in 2015 also contributed to the increase for fiscal 2015. These increases were offset in part by the non-recurring $5.8 million impairment charge in 2014.

Interest income. Interest income increased slightly to $0.3 million in 2015.

Interest expense. Interest expense increased $12.6 million to $99.5 million in 2015. The increase was due primarily to approximately $7.3 million of expenses incurred in the fourth quarter of 2015 related to the 2015 Recapitalization, including a $6.9 million write-off of debt issuance costs and $0.4 million of interest expense that was incurred on the 2012 debt subsequent to the closing of the 2015 Recapitalization but prior to the repayment of the 2012 debt. Interest expense also increased due to a higher average debt balance, offset in part by a lower average interest rate.

Our weighted average borrowing rate decreased to 5.1% in fiscal 2015, from 5.3% in fiscal 2014. The decrease in the Company’s cash borrowing rate resulted from the lower interest rate on the new debt issued as part of the 2015 Recapitalization. Our average outstanding debt balance, excluding capital lease obligations, was approximately $1.68 billion in 2015 and approximately $1.52 billion in 2014. The increase in the average outstanding debt balance was due to the issuance of debt in connection with the 2015 Recapitalization.

Provision for income taxes. Provision for income taxes increased $17.4 million to $113.4 million in 2015, due primarily to higher pre-tax income. The Company’s effective income tax rate decreased slightly by 0.1 percentage points to 37.0% of pre-tax income in 2015.

Liquidity and capital resources

Historically, we have operated with minimal positive working capital or negative working capital, primarily because our receivable collection periods and inventory turn rates are faster than the normal payment terms on our current liabilities. We generally collect our receivables within three weeks from the date of the related sale, and we generally experience 35 to 45 inventory turns per year. In addition, our sales are not typically seasonal, which further limits our working capital requirements. These factors, coupled with the use of our ongoing cash flows from operations to service our debt obligations, invest in our business, pay dividends and repurchase our common stock, reduce our working capital amounts. As of January 1, 2017, we had negative working capital of $34.3 million, excluding restricted cash and cash equivalents of $126.5 million and including total unrestricted cash and cash equivalents of $42.8 million.

As of January 1, 2017, we had approximately $99.8 million of restricted cash held for future principal and interest payments and $26.7 million of restricted cash held in a three-month interest reserve as required by the related debt agreements, for a total of $126.5 million of restricted cash and cash equivalents.

The Company entered into a recapitalization transaction in 2015, in which certain of our subsidiaries, among other things, replaced $551.3 million of the outstanding Series 2012-1 5.216% Fixed Rate Senior Secured Notes, Class A-2 (the “2012 Fixed Rate Notes”) and its 2012 variable funding notes with new notes (the “2015 Fixed Rate Notes”) issued pursuant to an asset-backed securitization. The 2015 Fixed Rate Notes consist of $500.0 million of Series 2015-1 3.484% Fixed Rate Senior Secured Notes, Class A-2-I (the “2015 Five-Year Notes”), $800.0 million Series 2015-1 4.474% Fixed Rate Senior Secured Notes, Class A-2-II (the “2015 Ten-Year Notes”) and $125.0 million of Series 2015-1 Variable Funding Senior Secured Notes, Class A-1 (the “2015 Variable Funding Notes”). The 2012 Fixed Rate Notes and the 2015 Fixed Rate Notes are referred to collectively as the Fixed Rate Notes. Additional information related to the 2015 Recapitalization transaction is included in Note 4 to our consolidated financial statements.

The Fixed Rate Notes have original scheduled principal payments of $38.6 million in each of 2017 and 2018, $878.5 million in 2019, $488.0 million in 2020, $8.0 million in each of 2021 through 2024 and $728.0 million in 2025. However, in accordance with our debt agreements, the payment of principal on the outstanding senior notes (i) shall be suspended if the leverage ratios are less than or equal to 4.5x total debt to EBITDA and there are no scheduled principal catch-up amounts outstanding; provided, that during any such suspension, principal payments will continue to accrue and are subject to catch-up upon failure to satisfy the leverage ratios, or (ii) on and after the payment in full of the 2012 Fixed Rate Notes, may be suspended if the leverage ratios are less than or equal to 5.0x total debt to EBITDA and no catch-up provisions are applicable. During the second quarter of 2014, we met the maximum leverage ratios of less than 4.5x, and, in accordance with our debt agreements, ceased debt amortization payments in the third quarter of 2014.

Table of Contents

The Company continued to meet the maximum leverage ratios of less than 4.5x in each of the quarters prior to the 2015 Recapitalization and accordingly, did not make previously scheduled debt amortization payments in accordance with the debt agreements. Subsequent to the 2015 Recapitalization, the Company’s leverage ratios exceeded 4.5x and, accordingly, the Company began making the scheduled amortization payments as well as the required catch-up payments.

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

A portion of proceeds from the 2015 Recapitalization were used to make an optional prepayment of approximately $551.3 million in aggregate principal amount of the 2012 Fixed Rate Notes, at par, pay scheduled principal catch-up amounts on the 2012 Fixed Rate Notes, make an interest reserve deposit, pre-fund a portion of the principal and interest payable on the 2015 Fixed Rate Notes and pay transaction fees and expenses. In connection with the issuance of the 2015 Variable Funding Notes, the Company permanently reduced to zero the commitment to fund the 2012 variable funding note facility and the 2012 variable funding note facility was cancelled.

In connection with the 2012 Recapitalization, the Company recorded $39.9 million of debt issuance costs. In connection with the 2015 Recapitalization, the Company wrote off approximately $6.9 million of these costs in connection with the extinguishment of $551.3 million of the 2012 Fixed Rate Notes. The remaining debt issuance costs related to the 2012 Recapitalization are being amortized into interest expense over the seven-year expected term of the 2012 Fixed Rate Notes. Additionally, in connection with the 2015 Recapitalization, the Company recorded $17.4 million of debt issuance costs, which are being amortized into interest expense over the five and ten-year expected terms of the 2015 Fixed Rate Notes.

During fiscal 2015 and in connection with the 2015 Recapitalization, the Company incurred approximately $8.1 million of net expenses. This consisted primarily of a $6.9 million net write-off of debt issuance costs. The Company also incurred approximately $0.4 million of interest expense on the 2012 Fixed Rate Notes subsequent to the closing of the 2015 Recapitalization but prior to the repayment of the 2012 Fixed Rate Notes, resulting in the payment of interest on both the 2012 and 2015 Fixed Rate Notes for a short period of time. Further, the Company incurred $0.9 million of other net 2015 Recapitalization-related general and administrative expenses, including legal and professional fees.

Our primary source of liquidity is cash flows from operations and availability of borrowings under our 2015 Variable Funding Notes. As of January 1, 2017, we had $44.3 million of outstanding letters of credit and $80.7 million of available borrowing capacity under our 2015 Variable Funding Notes. The letters of credit are primarily related to our casualty insurance programs and supply chain center leases. Borrowings under the 2015 Variable Funding Notes are available to fund our working capital requirements, capital expenditures and, subject to other limitations, other general corporate purposes including dividend payments.

As part of the 2015 Recapitalization, on October 23, 2015, the Company’s Board of Directors authorized a new share repurchase program to repurchase up to $800.0 million of the Company’s common stock. This repurchase program replaced the remaining availability under the Company’s previously disclosed $200.0 million share repurchase program. On October 27, 2015, the Company entered into a $600.0 million ASR Agreement with a counterparty.

Pursuant to the terms of the ASR Agreement, on October 30, 2015, as part of its new $800.0 million share repurchase authorization, the Company used a portion of the proceeds from the 2015 Recapitalization to pay the counterparty $600.0 million in cash and received approximately 4.86 million shares of the Company’s common stock. During the first quarter of 2016, the Company received and retired 456,936 shares of its common stock in connection with the final settlement of its $600.0 million accelerated share repurchase program.

The Company’s open market share repurchase program has historically been funded by excess cash flows. The Company used cash of approximately $300.3 million in 2016 and $738.6 million in 2015 for share repurchases. The Company had approximately $149.1 million left under the most recent $250.0 million authorization as of January 1, 2017. We expect to continue to use ongoing excess cash flow generation and (subject to certain restrictions in the documents governing the 2015 Variable Funding Notes) availability under the 2015 Variable Funding Notes to, among other things, repurchase shares under the current authorized program.

In the past three years, we have invested between $61.5 million and $71.8 million annually in capital expenditures. In 2016, we invested $61.5 million in capital expenditures which primarily related to reimaging our existing Company-owned stores and investments in our supply chain centers and training facilities, our proprietary internally developed point-of-sale system (Domino’s PULSE), our digital ordering platform, our internal enterprise systems and other technology initiatives. We did not have any material commitments for capital expenditures as of January 1, 2017.

Table of Contents

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

Fiscal Year Ended
(In millions)January 1, 2017January 3, 2016December 28, 2014
Cash Flows Provided By (Used In)
Net cash provided by operating activities$287.3$291.8$192.3
Net cash used in investing activities(0.8)(109.3)(57.4)
Net cash used in financing activities(375.8)(80.9)(118.9)
Exchange rate changes(1.3)1.00.5
Change in cash and cash equivalents$(90.6)$102.6$16.5

Operating Activities

Cash provided by operating activities was $287.3 million in fiscal 2016. Our cash provided by operating activities was mainly the result of net income of $214.7 million, which included non-cash amounts of $12.6 million. The changes in operating assets and liabilities also generated $60.0 million of cash inflows during 2016.

During fiscal 2015, cash provided by operating activities was $291.8 million, mainly the result of net income of $192.8 million, which included non-cash amounts of $45.6 million. The changes in operating assets and liabilities also generated $53.4 million of cash inflows during 2015.

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

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

Investing Activities

During fiscal 2016, cash used in investing activities was $0.8 million, which consisted primarily of $58.6 million of capital expenditures (driven by investments related to the reimaging of our existing Company-owned stores and investments in our supply chain centers and training facilities, our proprietary internally developed point-of-sale system, our digital ordering platform, our internal enterprise systems and other technology initiatives), offset in part by the change in restricted cash of $54.4 million and by proceeds from the sale of assets of $4.9 million.

During fiscal 2015, cash used in investing activities was $109.3 million, which consisted primarily of $63.3 million of capital expenditures (driven by investments related to the reimaging of our existing Company-owned stores and investments in our supply chain centers and training facilities, our proprietary internally developed point-of-sale system, our digital ordering platform, our internal enterprise systems and other technology initiatives), change in restricted cash of $60.0 million, and offset by proceeds from the sale of assets of $12.7 million.

Cash used in investing activities was $57.4 million in fiscal 2014. The main drivers of this change were $70.1 million of capital expenditures, offset by $9.2 million of proceeds from the sale of assets and the net change in restricted cash and cash equivalents of $4.5 million.

Financing Activities

During fiscal 2016, cash used in financing activities was $375.8 million. Purchases of common stock totaled $300.3 million, repayments of long-term debt and capital lease obligations totaled $122.3 million, and funding dividend payments to our shareholders totaled $73.9 million. The net tax impact of equity-based compensation was $42.5 million, proceeds from issuance of debt (from our draws on our variable funding note facility) totaled $63.0 million, and proceeds from the exercise of stock options totaled $15.2 million.

During fiscal 2015, cash used in financing activities was $80.9 million. In fiscal 2015, we issued $1.3 billion of debt in connection with our 2015 Recapitalization, which was offset by the purchases of common stock of $738.6 million, repayments of long-term debt of $564.4 million (of which, $551.3 million was an optional prepayment on our 2012 Fixed Rate Notes using a portion of the proceeds received from the 2015 Recapitalization), funding dividend payments to our shareholders of $80.3 million, and cash paid for financing costs related to our 2015 Recapitalization of $17.4 million. The net tax impact of equity-based compensation of $10.3 million increased cash from financing activities in fiscal 2015.

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

Table of Contents

During fiscal 2016, we experienced increases in both domestic and international same store sales and both our domestic and international businesses grew their number of stores. These factors have contributed to our continued ability to generate positive operating cash flows. We expect to use our unrestricted cash and cash equivalents, ongoing cash flows from operations and available borrowings under the 2015 Variable Funding Notes to, among other things, fund working capital requirements, invest in our core business, pay dividends and repurchase our common stock. Based upon the current level of operations and anticipated growth, we believe that the cash generated from operations, our current unrestricted cash and cash equivalents and amounts available under the 2015 Variable Funding Notes will be more than adequate to meet our anticipated debt service requirements, capital expenditures, dividend payments and working capital needs for the foreseeable future.

Our ability to continue to fund these items and continue to reduce debt could be adversely affected by the occurrence of any of the events described in Item 1A. Risk Factors. There can be no assurance that our business will generate sufficient cash flows from operations or that future borrowings will be available under the 2015 Variable Funding Notes or otherwise to enable us to service our indebtedness, or to make anticipated capital expenditures. Our future operating performance and our ability to service, extend or refinance the Fixed Rate Notes and to service, extend or refinance the 2015 Variable Funding Notes will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control.

Impact of inflation

We believe that our results of operations are not materially impacted by moderate changes in the inflation rate. Inflation did not have a material impact on our operations in 2016, 2015 or 2014. Severe increases in inflation, however, could affect the global and U.S. economies and could have an adverse impact on our business, financial condition and results of operations. Further discussion on the impact of commodities and other cost pressures is included above as well as in Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

New accounting pronouncements

In August 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. ASU 2014-15 requires management to evaluate, at each interim and annual reporting period, whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued, and provide related disclosures. ASU 2014-15 is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. The Company has completed its evaluation as of January 1, 2017, and concluded that there are no conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern under ASU 2014-15.

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

In March 2016, the FASB issued ASU 2016-04, Liabilities – Extinguishment of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products. ASU 2016-04 aligns recognition of the financial liabilities related to prepaid stored-value products (for example, gift cards) with Topic 606, Revenues from Contracts with Customers, for non-financial liabilities. In general, these liabilities may be extinguished proportionately in earnings as redemptions occur, or when redemption is remote if issuers are not entitled to the unredeemed stored value. ASU 2016-04 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.

Table of Contents

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. ASU 2016-09 is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. The update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is permitted. Based on a preliminary assessment, the Company expects the initial adoption of this guidance to not be material to its consolidated financial statements. Subsequent to adoption, the impact of the standard will be dependent on a number of factors, including the market value per share of the Company’s common stock at restricted stock vesting dates and the number of stock options that are exercised, as excess tax benefits or deficiencies will be reflected in the consolidated statements of income as a component of the provision for income taxes. The Company expects that the subsequent impact of adoption of this guidance will likely be material to the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients and ASU 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting. In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. These amendments provide additional clarification and implementation guidance on the previously issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606).

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

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. ASU 2016-13 requires companies to measure credit losses utilizing a methodology that reflects expected credit losses and requires a consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including those interim periods within those fiscal years. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 addresses how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230, Statement of Cash flow, and other Topics. ASU 2016-15 is effective for annual reporting periods, and interim periods therein, beginning after December 15, 2017. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18_, Statement of Cash Flows (Topic 230): Restricted Cash_. ASU 2016-18 requires that entities show the changes in total cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.

Table of Contents

In January 2017, the FASB issued ASU 2017-03, Accounting Changes and Error Corrections (Topic 250) and Investments – Equity Method and Joint Ventures (Topic 323): Amendments to SEC Paragraphs Pursuant to Staff Announcements at the September 22, 2017 and November 17, 2016 EITF Meetings. ASU 2017-03 responds to SEC staff announcements made in 2016 as it relates to the disclosure of the future impact of the effects of the new FASB guidance on revenue, leases and credit losses on financial instruments in accordance with Staff Accounting Bulletin 74. ASU 2017-03 was effective upon issuance in January 2017. As of January 1, 2017, the Company has adopted ASU 2017-03 and have made the required disclosures within this section of the Form 10-K.

In January 2017, the FASB issued ASU 2017-04_, Intangibles – Goodwill and Other (Topic 35): Simplifying the Test for Goodwill Impairment_, or ASU 2017-04. ASU 2017-04 simplifies the subsequent measurement of goodwill by eliminating “Step 2” from the goodwill impairment test. ASU 2017-04 is effective for public companies’ annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.

Contractual obligations

The following is a summary of our significant contractual obligations at January 1, 2017.

(dollars in millions)20172018201920202021ThereafterTotal
Long-term debt (1):
Principal$38.6$38.6$878.5$488.0$8.0$752.0$2,203.7
Interest (2)99.297.654.348.333.7125.6458.7
Capital leases (3)0.80.80.80.80.85.29.3
Operating leases (4)45.340.634.829.125.455.9231.1
(1)We have outstanding long-term secured notes with varying maturities. For additional information, see Note 4 of the Notes to Consolidated Financial Statements under “Part II – Item 8 – Financial Statements and Supplementary Data.”
(2)Represents interest payments on our Fixed Rate Notes and 2015 Variable Funding Notes. The interest rate on the 2015 Variable Funding Notes will be payable at a per year rate equal to LIBOR plus 219 basis points.
(3)The principal portion of the capital lease obligation amounts above, which totaled $5.7 million at January 1, 2017, are classified as debt in our consolidated financial statements. Total amount does not sum due to rounding.
(4)We lease certain retail store and supply chain center locations, supply chain vehicles, various equipment and our World Resource Center, which is our corporate headquarters, under leases with expiration dates through 2029.

Liabilities for unrecognized tax benefits of $2.0 million are excluded from the above table, as we are unable to make a reasonably reliable estimate of the amount and period of payment. For additional information on unrecognized tax benefits see Note 6 to the consolidated financial statements included in this Form 10-K.

Off-balance sheet arrangements

We are party to letters of credit and, to a lesser extent, financial guarantees with off-balance sheet risk. Our exposure to credit loss for letters of credit and financial guarantees is represented by the contractual amounts of these instruments. Total conditional commitments under letters of credit as of January 1, 2017 were approximately $44.3 million and relate to our insurance programs and supply chain center leases. The Company has guaranteed lease payments related to certain franchisees’ lease arrangements. The maximum amount of potential future payments under these guarantees is $1.0 million as of January 1, 2017. We believe that none of these arrangements has or is likely to have a material effect on our results of operations, financial condition, revenues or expenses, capital expenditures or liquidity.

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

This Annual Report on Form 10-K includes various forward-looking statements about the Company within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”) that are based on current management expectations that involve substantial risks and uncertainties which could cause actual results to differ materially from the results expressed in, or implied by, these forward-looking statements. The following cautionary statements are being made pursuant to the provisions of the Act and with the intention of obtaining the benefits of the “safe harbor” provisions of the Act.

These forward-looking statements generally can be identified by the use of words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will,” “potential,” “outlook” and similar terms and phrases, including references to assumptions, are forward-looking statements. These forward-looking statements address various matters including information concerning future results of operations and business strategy, and statements about our ability to complete our “Pizza Theater” store redesign, the expected demand for future pizza delivery, our expectation that we will meet the terms of our agreement with our third-party supplier of pizza cheese, our belief that alternative third-party suppliers are available for our key ingredients in the

Table of Contents

event we are required to replace any of our supply partners, our intention to continue to enhance and grow online ordering, digital marketing and technological capabilities, our expectation that there will be no material capital expenditures for environmental control facilities, our plans to expand international operations in many of the markets where we currently operate and in selected new markets, our expectation that the contribution rate for advertising fees payable to DNAF will remain in place for the foreseeable future, and our expectation that we will use our unrestricted cash and cash equivalents, ongoing cash flows from operations and available borrowings under the 2015 Variable Funding Notes to, among other things, fund working capital requirements, invest in our core business, pay dividends and repurchase our common stock.

Forward-looking statements relating to our anticipated profitability, the growth of our international business, ability to service our indebtedness, our operating performance, trends in our business and other descriptions of future events reflect management’s expectations based upon currently available information and data. While we believe these expectations and projections are based on reasonable assumptions, such forward-looking statements are inherently subject to risks, uncertainties and assumptions about us, including the risk factors listed under Item 1A. Risk Factors, as well as other cautionary language in this Form 10-K.

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

•our substantial increased indebtedness as a result of the 2012 Recapitalization and the 2015 Recapitalization and our ability to incur additional indebtedness or refinance that indebtedness in the future;
•our future financial performance;
•the success of our marketing initiatives;
•our future cash needs;
•our ability to maintain good relationships with our franchisees and their ongoing level of profitability;
•our ability to successfully implement cost-saving strategies;
•increases in our operating costs, including cheese, fuel and other commodity costs and the minimum wage;
•our ability to compete domestically and internationally in our intensely competitive industry;
•additional risk precipitated by international operations;
•our ability to retain or replace our executive officers and other key members of management and our ability to adequately staff our stores and supply chain centers with qualified personnel;
•our ability and that of our franchisees to open new restaurants and keep existing restaurants in operation;
•our ability to pay principal and interest on our substantial debt;
•our ability to find and/or retain suitable real estate for our stores and supply chain centers;
•adverse legislation, regulation or publicity;
•adverse legal judgments or settlements;
•food-borne illness or contamination of products;
•data breaches or other cyber risks;
•the effect of war, terrorism or catastrophic events;
•our ability to pay dividends and repurchase shares;
•changes in consumer taste, demographic trends and traffic patterns; and
•adequacy of insurance coverage.

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

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

Table of Contents

Previous: Item 6. Selected Financial Data. · Next: Item 7A. Quantitative and Qualitative Disclosures About Market Risk.