DOMINOS PIZZA INC - Quarter Report: 2010 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 12, 2010

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.

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 12, 2010, Domino’s Pizza, Inc. had 60,041,774 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 January 3, 2010 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 12, 2010

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 January 3, 2010 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 12, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ending January 2, 2011.

The following tables summarize revenues, income from operations and Segment Income, the measure by which management allocates resources to its reportable segments. Management defines Segment Income as earnings before interest, taxes, depreciation, amortization and other.

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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 does not include 681,535 options to purchase common stock for the third quarter of 2010 and does not include 970,827 options to purchase common stock for the first three quarters of 2010, as the effect of including these options would have been anti-dilutive. The denominator used in calculating diluted earnings per share for common stock did not include 8,661,245 options to purchase common stock for the third quarter of 2009 and did not include 8,981,563 options to purchase common stock for the first three quarters of 2009, as the effect of including these options would have been anti-dilutive. The basic and diluted earnings per share amounts calculated under the two-class method, which include unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents, are equivalent to the basic and diluted earnings per share amounts above for all periods presented.

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During the third quarter of 2010, the Company repurchased and retired $20.0 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 was approximately $19.2 million, including $0.2 million of accrued interest. During the first three quarters of 2010, the Company repurchased and retired a total of $100.0 million in principal amount of its Class A-2 Notes and approximately $0.4 million in principal amount of its 7.629% Fixed Rate Series 2007-1 Subordinated Notes, Class M-1 (Class M-1 Notes) for a combined purchase price of approximately $92.2 million, including $0.4 million of accrued interest. These activities resulted in pre-tax gains of approximately $0.9 million in the third quarter of 2010 and $8.6 million in the first three quarters of 2010, which were recorded in Other in the Company’s consolidated statements of income. In connection with the aforementioned repurchases, the Company paid and expensed required insurance fees and also wrote off deferred financing fees totaling approximately $0.4 million in the third quarter of 2010 and approximately $1.5 million in the first three quarters of 2010, which were recorded in Interest Expense in the Company’s consolidated statements of income.

During the second quarter of 2010, and as a result of a retroactive change to state law, the Company reduced its liability for unrecognized tax benefits related to a state income tax matter by approximately $2.9 million. Approximately $1.9 million of the decrease was related to gross unrecognized tax benefits and approximately $1.0 million was related to interest and penalties. As a result, approximately $1.7 million was recognized as an income tax benefit and reduced the Company’s effective tax rate in the first three quarters of 2010. Additionally, the Company’s effective tax rate for the first three quarters of 2010 benefited from changes made to its overall tax structure.

Fair value measurements enable 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.

The Company classifies and discloses assets and liabilities carried at fair value 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 tables summarize the carrying amounts and fair values of certain assets at September 12, 2010 and January 3, 2010.

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At September 12, 2010, management estimated that the over $1.3 billion in principal amount of outstanding Class A-2 Notes had a fair value of nearly $1.3 billion and the $99.6 million in principal amount of outstanding Class M-1 Notes had a fair value of approximately $94.9 million. The Company determined the estimated fair value amounts by using available market information. The Company obtained broker quotes from three separate brokerage firms that are knowledgeable about the Company’s fixed rate notes, and at times, trade these notes. Further, the Company performed its own internal analysis based on the information it gathered from public markets, including information on notes that are similar to that of the Company. 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 June 2009, the FASB amended the consolidation guidance associated with variable-interest entities. The amendments included: (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. This guidance 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 adopted the new consolidation guidance during the first quarter of 2010 and it did 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 2010 third quarter referenced herein represents the twelve-week period ended September 12, 2010; while the 2009 third quarter represents the twelve-week period ended September 6, 2009. The 2010 first three quarters referenced herein represent the thirty-six week period ended September 12, 2010; while the 2009 first three quarters represent the thirty-six week period ended September 6, 2009.

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 international markets. In addition, we operate regional dough manufacturing and supply chain centers in the United States and Canada.

Our financial results are driven largely by retail sales at our franchise and Company-owned 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 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 the success of our business strategies.

During the third quarter of 2010, we continued the domestic sales momentum we experienced in the first two quarters of 2010. This momentum began in 2009 when we experienced positive customer traffic throughout the year, which we believe stemmed from our concerted efforts and investments to improve upon our menu, marketing, technology, operations and franchise base. At the end of 2009, we launched an improved pizza recipe, which we believe has resonated with existing and new customers and has driven both trial and repeat orders. This has resulted in continued positive customer traffic throughout 2010. Combined with an innovative and effective advertising campaign, continued focus on operational excellence and efforts to strengthen our franchisee base made in 2009, we experienced another quarter of traffic and sales increases in both our domestic Company-owned and franchise stores. We believe that the sales momentum we have created in both 2009 and the first three quarters of 2010 will result in positive year-over-year sales growth during the fourth quarter of 2010. Additionally, our international division continued to post strong same store sales growth (7.0% in the third quarter of 2010) marking the 67^th consecutive quarter of positive same store sales for this division. Continued strong same store sales growth combined with continued store count growth, demonstrate the consistency and reliability of this business segment.

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These strong results from both our domestic and international stores have produced significant earnings per share growth and increased free cash flow for the first three quarters of 2010. We believe that our new product platforms, investments made in the Company, including marketing and technology initiatives, and improved operating margins have improved unit economics at our stores and positioned us well for the future.

Global retail sales, which are total retail sales at Company-owned and franchise stores worldwide, increased 12.5% in the third quarter of 2010; and 14.1% in the first three quarters of 2010. Retail sales for franchise stores are reported to the Company by its franchisees and are not included in Company revenues. These increases were driven primarily by both domestic and international same store sales growth as well as an increase in our worldwide store counts during the trailing four quarters, and, to a lesser extent, the positive impact of foreign currency exchange rates on our international sales. Domestic same store sales growth reflected the continued success of our improved pizza, the effectiveness of our advertising and our continued focus on operational excellence. International same store sales growth reflected continued strong performance in the key markets where we compete.

Revenues increased $44.7 million, up 14.8% in the third quarter of 2010; and $149.7 million, up 15.9% in the first three quarters of 2010. These increases were driven by higher domestic supply chain revenues resulting from increased volumes and higher commodity prices, including cheese, higher same store sales domestically and abroad and international store count growth.

Income from operations increased $7.7 million, up 19.2% in the third quarter of 2010; and $34.6 million, up 27.6% in the first three quarters of 2010. These increases were due primarily to higher royalty revenues from domestic and international franchise stores and larger volumes in our supply chain business. Additionally, income from operations in the first three quarters benefited from higher domestic Company-owned store margins. These increases were offset, in part, by higher variable general and administrative expenses, including higher performance-based bonuses as a result of our strong operating performance, as well as continued investments in growth initiatives. Additionally, the comparable results for the first three quarters from the prior-year period were negatively impacted by approximately $4.9 million of expenses incurred in connection with the Company’s stock plan changes in 2009.

Net income decreased $1.2 million, down 6.9% in the third quarter of 2010; and increased $7.6 million, up 13.6% in the first three quarters of 2010. The decrease in the third quarter of 2010 was due primarily to lower pre-tax gains recorded on the extinguishment of debt, offset in part by the aforementioned increase in income from operations, lower interest expense resulting from lower debt balances, and the positive impact of a lower effective tax rate in the quarter. The increase in the first three quarters of 2010 was due primarily to the aforementioned increase in income from operations, lower interest expense resulting from lower debt balances, and the positive impact of a lower effective tax rate, offset in part by lower pre-tax gains recorded on the extinguishment of debt.

Revenues

Revenues primarily consist of retail sales from our Company-owned stores, royalties from our domestic and international franchise stores and sales of food, equipment and supplies from our supply chain centers to significantly all of our domestic franchise stores and certain international 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