DOMINOS PIZZA INC - Quarter Report: 2009 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 6, 2009

OR

For the transition period from:              to             

Commission file number 001-32242

Domino’s Pizza, Inc.

(Exact Name of Registrant as Specified in Its Charter)

(734) 930-3030

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x     No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act). (Check one):

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

As of October 6, 2009, Domino’s Pizza, Inc. had 58,434,101 shares of common stock, par value $0.01 per share, outstanding.

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Domino’s Pizza, Inc.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

Domino’s Pizza, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(Unaudited)

Note: The balance sheet at December 28, 2008 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

See accompanying notes.

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Domino’s Pizza, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(Unaudited)

See accompanying notes.

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Domino’s Pizza, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

See accompanying notes.

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Domino’s Pizza, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited; tabular amounts in thousands, except percentages, share and per share amounts)

September 6, 2009

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the consolidated financial statements and footnotes for the fiscal year ended December 28, 2008 included in our annual report on Form 10-K.

In the opinion of management, all adjustments, consisting of normal recurring items, considered necessary for a fair presentation have been included. Operating results for the fiscal quarter and three fiscal quarters ended September 6, 2009 are not necessarily indicative of the results that may be expected for the fiscal year ending January 3, 2010.

The following table summarizes revenues, income from operations and earnings before interest, taxes, depreciation, amortization and other, which is the measure by which management allocates resources to its segments and which we refer to as Segment Income, for each of our reportable segments.

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The following table reconciles Total Segment Income to consolidated income before provision for income taxes.

The denominator in calculating diluted earnings per share for common stock for the third quarter of 2009 does not include 8,661,245 options to purchase common stock, as the effect of including these options would have been anti-dilutive. The denominator in calculating diluted earnings per share for common stock for the first three quarters of 2009 does not include 8,981,563 options to purchase common stock, as the effect of including these options would have been anti-dilutive. The denominator used in calculating diluted earnings per share for common stock for the third quarter of 2008 does not include 7,839,519 options to purchase common stock, as the effect of including these options would have been anti-dilutive. The denominator used in calculating diluted earnings per share for common stock for the first three quarters of 2008 does not include 7,815,519 options to purchase common stock, as the effect of including these options would have been anti-dilutive.

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In June 2008, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) Emerging Issues Task Force (EITF) 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities. Under FSP EITF 03-6-1, unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are considered participating securities and should be included in the computation of both basic and diluted earnings per share using the two-class method. FSP EITF 03-6-1 is effective for the Company in the current fiscal year beginning December 29, 2008. The Company evaluated the impact of FSP EITF 03-6-1 and determined that the basic and diluted earnings per share amounts as reported are equivalent to the basic and diluted earnings per share amounts calculated under FSP EITF 03-6-1 for all periods presented. Therefore, the Company did not apply the provisions of FSP 03-6-1 in calculating its basic and diluted earnings per share.

During the third quarter of 2009, the Company repurchased and retired approximately $71.8 million in principal amount of its 5.261% Fixed Rate Series 2007-1 Senior Notes, Class A-2 (Class A-2 Notes). The total purchase price for the repurchases was approximately $57.8 million, including $0.3 million of accrued interest. During the first three quarters of 2009, the Company repurchased and retired approximately $140.0 million in principal amount of its Class A-2 Notes for a total purchase price of approximately $92.4 million, including $0.7 million of accrued interest. These activities resulted in pre-tax gains of approximately $14.3 million in the third quarter of 2009 and $48.4 million in the first three quarters of 2009, which were recorded in Other in the Company’s consolidated statements of income. In connection with the aforementioned transactions, the Company wrote-off deferred financing fees of approximately $0.8 million in the third quarter of 2009 and approximately $1.7 million in the first three quarters of 2009, which were recorded in interest expense in the Company’s consolidated statements of income.

Subsequent to the third quarter of 2009, the Company repurchased and retired an additional $20.9 million in principal amount of its Class A-2 Notes for a total purchase price of approximately $17.5 million, including $0.2 million of accrued interest, that resulted in a pre-tax gain of approximately $3.6 million. The pre-tax gain will be recorded in the fourth quarter of 2009 in Other in the Company’s consolidated statements of income. This $20.9 million principal amount of Class A-2 Notes is classified as a current liability in the Company’s consolidated balance sheet as of September 6, 2009.

During the third quarter of 2009, Domino’s Pizza LLC (DPL), a wholly-owned subsidiary of the Company, entered into a Letter of Credit Agreement (the L/C Agreement) pursuant to which the counterparty may issue, at DPL’s request, up to $50.0 million of standby letters of credit (the Commitment) for the account of DPL and its subsidiaries. Pursuant to the L/C Agreement, DPL will maintain a cash collateral account holding an amount equal to 105% of any outstanding letters of credit and pay to the counterparty quarterly commitment fees of 0.375% per annum of the unused portion of the Commitment and quarterly letter of credit fees of 0.75% per annum of the undrawn face amount of any outstanding letters of credit. During the third quarter of 2009, the counterparty issued $33.5 million of standby letters of credit and the Company restricted an additional $35.2 million of cash on its consolidated balance sheet as collateral for these outstanding letters of credit. These letters of credit primarily relate to our insurance programs and supply chain center leases.

As a result of and concurrent with the L/C Agreement, the Company terminated substantially all of its pre-existing letters of credit in order to provide additional borrowing availability under its variable funding notes. During the third quarter of 2009, the Company borrowed an additional $35.1 million under the variable funding notes. Subsequent to the third quarter of 2009, the Company borrowed an additional $1.2 million on the variable funding notes and currently has no remaining borrowing capacity available under the $60.0 million variable funding notes facility.

During the third quarter of 2009, the Company reduced the liability for unrecognized tax benefits related to certain state income tax matters. Approximately $300,000 of the decrease was related to gross unrecognized tax benefits and approximately $62,000 of the decrease was related to interest and penalties. Of these amounts, approximately $197,000 decreased the Company’s effective tax rate.

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During the first three quarters of 2009, the Company increased the liability for unrecognized tax benefits related to certain state income tax matters. Approximately $1.9 million of the increase was related to gross unrecognized tax benefits and approximately $575,000 was related to interest and approximately $449,000 was related penalties. Of these amounts, approximately $1.7 million increased the Company’s effective tax rate.

During 2008, the Company reduced the liability for unrecognized tax benefits related to certain state income tax matters. Specifically, in the third quarter of 2008 approximately $1.0 million of the reduction was related to gross unrecognized tax benefits and approximately $2.6 million of the reduction in the first three quarters of 2008 was related to gross unrecognized tax benefits. In the third quarter of 2008, approximately $400,000 of the reduction was related to interest and approximately $700,000 was related to penalties. In the first three quarters of 2008, approximately $1.0 million was related to interest and approximately $1.2 million was related to penalties. In connection with these items, the Company’s effective tax rate was reduced by approximately $1.4 million in the third quarter of 2008 and $3.0 million in the first three quarters of 2008.

The Company applies the provisions of Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value and provides guidance for measuring fair value and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but rather applies to all other accounting pronouncements that require or permit fair value measurements.

In February 2008, the FASB issued a final Staff Position to allow a one-year deferral of the adoption of SFAS 157 for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. The Company elected this one-year deferral and began applying the provisions of SFAS 157 to nonfinancial assets and nonfinancial liabilities that are recognized at fair value in the financial statements on a nonrecurring basis in the current fiscal year beginning December 29, 2008. The Company had no nonrecurring measurements recognized at fair value during the three fiscal quarters ended September 6, 2009. We generally apply fair value techniques on a nonrecurring basis associated with (1) valuing potential impairment loss related to goodwill and indefinite-lived intangible assets accounted for pursuant to SFAS No. 142, and (2) valuing potential impairment loss related to long-lived assets accounted for pursuant to SFAS No. 144. The FASB also amended SFAS 157 to exclude FASB Statement No. 13 and its related interpretive accounting pronouncements that address leasing transactions.

SFAS 157 enables the reader of the financial statements to assess the inputs used to develop those measurements by establishing a hierarchy for ranking the quality and reliability of the information used to determine fair values. SFAS 157 requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market data.

The fair values of the Company’s cash equivalents and investments in marketable securities are based on quoted prices in active markets for identical assets. The following table summarizes the carrying amounts and fair values of certain assets at September 6, 2009:

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At September 6, 2009, management estimates that the over $1.4 billion of outstanding Class A-2 Notes had a fair value of approximately $1.2 billion and the $100.0 million of outstanding fixed rate subordinated notes had a fair value of approximately $58.7 million. We believe that these decreases in fair value from their carrying amounts are primarily due to current economic conditions and the current state of the credit markets for similar debt instruments. The Company determined the estimated fair value amounts by using recent trade activity, available market information and commonly accepted valuation methodologies. However, considerable judgment is required in interpreting market data to develop estimates of fair value. Accordingly, the fair value estimates presented herein are not necessarily indicative of the amount that the Company or the debtholders could realize in a current market exchange. The use of different assumptions and/or estimation methodologies may have a material effect on the estimated fair value.

In March 2009, the Company’s Board of Directors authorized a stock option exchange program that allowed eligible employees the opportunity to exchange certain options granted under the Domino’s Pizza, Inc. 2004 Equity Incentive Plan (the 2004 Plan) for a lesser number of replacement options with lower exercise prices. The Company’s shareholders approved the stock option exchange program at the 2009 Annual Meeting of Shareholders, held on April 28, 2009, and the Company executed the program in the second quarter of 2009. This amendment was accounted for as a modification in accordance with the guidance in SFAS No. 123(R), Share-Based Payments (SFAS 123(R)). The incremental value to the option holders created as a result of the modification is being recognized as additional compensation expense over the remaining service period. This amount was calculated to be approximately $1.3 million (after-tax), of which approximately $0.1 million (after-tax) was recognized in the third quarter of 2009; and $0.7 million (after-tax) was recognized during the first three quarters of 2009.

Separately, and as previously announced, the Company’s Board of Directors authorized management to amend existing stock option agreements currently issued under the 2004 Plan, and all future stock option agreements issued under the 2004 Plan. These amendments provide for accelerated vesting and extended exercise periods upon the retirement of option holders who have achieved specified service and age requirements. The amended terms of the relevant stock option agreements became effective in the second quarter of 2009. The amendments to the existing awards were accounted for as a modification in accordance with the guidance in SFAS 123(R). The incremental value to option holders created as a result of the modification is being recognized as additional compensation expense over the remaining service period. This amount was calculated to be approximately $0.3 million (after-tax), of which approximately $0.2 million (after-tax) was recognized during the first three quarters of 2009. Additionally, the Company is required to accelerate previously unrecognized compensation expense that it would have been required to expense in future periods for these stock options. This resulted in the acceleration of approximately $2.1 million (after-tax) of compensation expense in the second quarter of 2009 for employees who accepted the amendment and who will meet the specified service and age requirements prior to the original vesting date. The $2.1 million (after-tax) of compensation expense recognized in the second quarter of 2009 was not incremental expense, but merely an acceleration of expense that would have been recognized in future periods.

During the third quarter of 2009, the Company issued approximately 687,000 shares of performance-based restricted stock to certain employees of the Company. The performance-based restricted stock awards are separated into three tranches and have time-based and performance-based vesting conditions with the last tranche vesting three years from the issuance date. These awards also contain provisions for accelerated vesting upon the retirement of holders that have achieved specific service and age requirements. These awards are considered granted for SFAS 123(R) accounting purposes when the performance target is set, which is generally in the fourth quarter of each year. During the third quarter of 2009, the Company recognized approximately $524,000 of expense in general and administrative expenses related to the first tranche of these awards.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (SFAS 161). SFAS 161 requires entities that use derivative instruments to provide qualitative disclosures about their objectives and strategies for using such instruments, as well as any details of credit-risk-related contingent features contained within derivatives. SFAS 161 also requires entities to disclose additional information about the amounts and location of derivatives located within the financial statements, how the provisions of SFAS 133 have been applied and the impact that hedges have on an entity’s financial position, financial performance, and cash flows. The Company does not currently hold derivative instruments and was not impacted by the adoption of SFAS 161.

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In April 2009, the FASB issued FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (FSP 157-4), and FSP FASB 107-1 and Accounting Principles Board (APB) 28-1, Interim Disclosures about Fair Value of Financial Instruments (FSP 107-1). These two staff positions relate to fair value measurements and related disclosures. The FASB also issued a third FSP relating to the accounting for impaired debt securities titled FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (FSP 115-2). These standards are effective for interim and annual periods ending after June 15, 2009. The Company has determined that FSP 157-4 and FSP 115-2 do not currently apply to its activities and has adopted the disclosure requirements of FSP 107-1.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events (SFAS 165). SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 requires public companies to evaluate subsequent events through the date the financial statements are issued. This standard is effective for interim and annual periods ending after June 15, 2009. The Company adopted the provisions of SFAS 165 in the third quarter of 2009. The Company evaluated subsequent events occurring after September 6, 2009 through the date the financial statements were issued and filed with the Securities and Exchange Commission on October 13, 2009. The Company determined there were no additional subsequent events that required recognition or disclosure.

In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets, an amendment to SFAS No. 140 (SFAS 166). SFAS 166 eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets and requires additional disclosures in order to enhance information reported to users of financial statements by providing greater transparency about transfers of financial assets, including securitization transactions, and an entity’s continuing involvement in and exposure to the risks related to transferred financial assets. SFAS 166 is effective for fiscal years beginning after November 15, 2009. The Company will adopt SFAS 166 in fiscal 2010 and is evaluating the impact it will have on the consolidated results of the Company.

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS 167). The amendments include: (1) the elimination of the exemption for qualifying special purpose entities; (2) a new approach for determining who should consolidate a variable-interest entity; and (3) changes to when it is necessary to reassess who should consolidate a variable-interest entity. SFAS 167 is effective for the first annual reporting period beginning after November 15, 2009 and for interim periods within that first annual reporting period. The Company will adopt SFAS 167 in fiscal 2010 and is evaluating the impact it will have on the consolidated results of the Company.

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (SFAS 168). SFAS 168 replaces FASB Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles, and establishes the FASB Accounting Standards Codification ^TM (the Codification) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with generally accepted accounting principles (GAAP). SFAS 168 is effective for interim and annual periods ending after September 15, 2009. The Company will begin to use the new Codification when referring to GAAP in its annual report on Form 10-K for the fiscal year ending January 3, 2010. This will not have an impact on the consolidated results of the Company.

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(Unaudited; tabular amounts in millions, except percentages and store data)

The 2009 third quarter referenced herein represents the twelve-week period ended September 6, 2009, while 2008 third quarter represents the twelve-week period ended September 7, 2008. The 2009 first three quarters referenced herein represents the thirty-six week period ended September 6, 2009, while the 2008 first three quarters represents the thirty-six week period ended September 7, 2008.

Overview

We are the number one pizza delivery company in the United States and have a leading international presence. We operate through a network of Company-owned stores, all of which are in the United States, and franchise stores located in all 50 states and in more than 60 countries. In addition, we operate regional dough manufacturing and supply chain centers in the United States and Canada. In 2009, we converted one of our dough manufacturing and supply chain centers in the United States to a thin crust manufacturing and supply chain center. This facility will supply the majority of thin crust product for our domestic stores.

Our financial results are driven largely by retail sales at our Company-owned and franchise stores. Changes in retail sales are driven by changes in same store sales and store counts. We monitor both of these metrics very closely, as they directly impact our revenues and profits, and strive to consistently increase both same store sales and our store counts. Retail sales drive Company-owned store revenues, royalty payments from franchisees and supply chain revenues. Retail sales are primarily impacted by the strength of the Domino’s Pizza^® brand, the results of our marketing promotions, our ability to execute our store operating model, the overall global economic environment and other business strategies.

During the third quarter and first three quarters of 2009, we continued our trend of positive international same store sales growth and store count growth. Our domestic same stores sales were flat in both the third quarter and first three quarters of 2009, which we believe demonstrates the stability of our business during these tough economic times. We continued to experience net negative domestic store growth as a result of continued economic challenges and our continued efforts on exiting underperforming franchisees from the system. We also continuously evaluate our domestic Company-owned stores for viability. These evaluations have in the past led us to alter our store mix and may lead us in the future to close or refranchise additional stores. We believe all of these efforts will allow us to strengthen our overall system of stores. However, our international division continues to grow, which resulted in positive global store growth during the third quarter of 2009. We believe our new product platforms, investments made in the Company, including marketing and technology initiatives, and improved margins have positioned us well for the future.

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Global retail sales, comprised of retail sales results at both our franchise and Company-owned stores worldwide, declined 1.9% in the third quarter of 2009 and declined 3.7% in the first three quarters of 2009. This was driven primarily by the negative impact of foreign currency exchange rates on our international sales. However, when excluding the impact of changes in foreign currency exchange rates, global retail sales increased during the third quarter and first three quarters of 2009, driven primarily by same store sales growth in our international markets as well as an increase in our worldwide store counts during the trailing four quarters. International same store sales growth reflected continued strong performance in the key markets where we compete. The third quarter and first three quarters of 2009 also benefited from same store sales growth in our domestic franchise stores which reflected the success of several initiatives, including the launch of two new product platforms: Domino’s Breadbowl Pasta ^TM and Domino’s American Legends ^TM pizzas, as well as the introduction of Domino’s Chocolate Lava Crunch Cakes.

Revenues decreased $20.9 million, down 6.5% in the third quarter of 2009; and decreased $55.8 million, down 5.6% in the first three quarters of 2009. These decreases were a result of lower domestic supply chain revenues (driven primarily by lower cheese prices), lower Company-owned store revenues resulting from the impact of the store divestitures in 2008, and lower international revenues due to the impact of changes in foreign currency exchange rates.

Income from operations increased $0.3 million, up 0.5% in the third quarter of 2009; and decreased $17.4 million, down 12.2% in the first three quarters of 2009. The increase in the third quarter of 2009 was due primarily to higher margins in our Company-owned stores, domestic supply chain and international businesses as well as lower bad debt expense. The increase was offset in part by the impact of $1.8 million of gains recorded in the third quarter of 2008 on the sale of certain Company-owned stores, higher variable administrative labor and the negative impact of foreign currency exchange rates in our international business. The decrease in the first three quarters of 2009 was due primarily to higher income from operations in the first three quarters of 2008 during which the Company benefited from $13.0 million of gains on the sale of certain Company-owned stores to franchisees. The gains in the first three quarters of 2008 were offset in part by approximately $1.4 million of separation and other costs recorded related primarily to the Company’s restructuring action. Additionally, the first three quarters of 2009 were negatively impacted by approximately $4.9 million of expenses incurred in connection with the stock option exchange program as well as the incremental expense and acceleration of expense for the retirement provision added to existing stock option agreements. Furthermore, the first three quarters of 2009 were negatively impacted by changes in foreign currency exchange rates affecting our international operations and higher variable administrative labor. These decreases were offset in part by higher margins in our Company-owned stores and domestic supply chain business in 2009.

Net income increased $7.7 million, up 76.6% in the third quarter of 2009; and increased $13.2 million, up 30.7% in the first three quarters of 2009. The increase in the third quarter of 2009 was due primarily to $14.3 million of pre-tax gains recorded on the extinguishment of debt, lower interest expense resulting primarily from our lower debt balances and the aforementioned increase in income from operations. The increase in the first three quarters of 2009 was due primarily to $48.4 million of pre-tax gains recorded on the extinguishment of debt. The impact of the gain was partially offset by the aforementioned decrease in income from operations.

Revenues

Revenues primarily consist of retail sales from our Company-owned stores, royalties from our franchise stores and sales of food, equipment and supplies from our supply chain centers to the majority of our domestic franchise stores. Company-owned store and franchise store revenues may vary significantly from period to period due to changes in store count mix while supply chain revenues may vary significantly as a result of fluctuations in commodity prices, primarily cheese and meats.

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Domestic Stores Revenues