Item 7.
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Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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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 53
rd
) week in the fourth quarter. Fiscal 2019, 2018 and 2017 each consisted of 52 weeks.
In this section, we discuss the results of our operations for the year ended December 29, 2019 compared to the year ended December 30, 2018. For a discussion of the year ended December 30, 2018 compared to the year ended December 31, 2017, please refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form
10-K
for the year ended December 30, 2018.
Description of the Business
Domino’s is the largest pizza company in the world based on global retail sales, with more than 17,000 locations in over 90 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 neighborhoods locally through our large network of franchise owners and Company-owned stores.
Our business model is straightforward: Domino’s stores handcraft and serve quality food at a competitive price, with easy ordering access and efficient service, enhanced by our technological innovations. Our hand-tossed dough is made fresh and distributed to stores around the world by us and our franchisees.
Domino’s generates revenues and earnings by charging royalties and fees to our franchisees. Royalties are ongoing
percent-of-sales
fees for use of the Domino’s brand marks. We also generate 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 food 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 purchase Domino’s menu items for themselves and their family 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 in 2004.
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Global retail sales, excluding foreign currency impact (which includes total retail sales at Company-owned and franchised stores worldwide) increased 8.0% as compared to 2018.
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Same store sales increased 3.2% in our U.S. stores and increased 1.9% in our international stores.
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Our revenues increased 5.4%.
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Our income from operations increased 10.1%.
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Our net income increased 10.7%.
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Our diluted earnings per share increased 14.5%.
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During 2019, we continued our rapid global expansion with the opening of 1,106 net new stores. Our international franchise segment led the way with 856 net new store openings. We also continued our strong U.S. and international same store sales performance with 35 straight quarters of positive U.S. same store sales and 104 straight quarters of positive international same store sales. Our U.S. carryout business experienced continued strong growth. While our overall U.S. delivery business continues to grow, our U.S. delivery same store sales growth has been pressured by our fortressing strategy, which includes increasing store concentration in certain markets where we compete, as well as from aggressive competitive activity.
We remained focused on improving the customer experience through our technology initiatives, including the recent launch of our GPS delivery tracking technology, which allows customers to track the progress of their pizza delivery through the Domino’s ordering platforms. Our emphasis on technology innovation helped the Domino’s system generate more than half of global retail sales from digital channels in 2019. Overall, we believe our focus in 2019 on global growth and technology will continue to strengthen our brand in the future.
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 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:
. We earn revenues through our network of U.S. Company-owned and franchised stores, dough manufacturing and supply chain centers and international operations. Retail sales from franchise stores are reported to us by our franchisees and are not included in our 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 us based on a percentage of retail sales, as specified in the related standard franchise agreement (generally 5.5% of U.S. franchise retail sales and, on average, 3.0% of international franchise retail sales). We also generate revenues from U.S. franchise advertising contributions to DNAF, our consolidated
not-for-profit
advertising fund (generally 6.0% of U.S. franchise retail sales). Although these revenues are restricted to be used only for advertising and promotional activities to benefit franchised stores, we have determined there are not performance obligations associated with the franchise advertising contributions received by DNAF that are separate from our U.S. royalty payment stream and as a result, these franchise contributions and the related expenses are presented gross in the consolidated statements of income. Revenues from Company-owned stores and revenues from franchised stores (including U.S. franchise royalties and fees and U.S. franchise advertising revenues) can fluctuate from
time-to-time
as a result of store count and sales level changes. 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.
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 we have 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, we estimate 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.
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.
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 $1.8 million at December 29, 2019 and $1.9 million at December 30, 2018.
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. Analyses of historical trends and actuarial valuation methods are utilized to estimate the ultimate claim costs for claims incurred as of the balance sheet date and for claims incurred but not yet reported. 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 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 insurance liability at December 29, 2019 would have affected our income before provision for income taxes by approximately $5.8 million in 2019. We had accruals for insurance matters of approximately $58.4 million at December 29, 2019 and $53.3 million at December 30, 2018.
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 the 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. We account for forfeitures as they occur. 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.
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.
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. 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.
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U.S. Company-owned stores
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%
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%
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%
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International stores (excluding foreign currency impact)
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%
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%
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%
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(1)
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In 2018, we began managing our franchised stores in Alaska and Hawaii as part of our U.S. Stores segment. Prior to 2018, store counts, retail sales and royalty revenues from these franchised stores were included in our international operations in the tables above. Consolidated results have not been impacted by this change and prior year amounts have not been reclassified to conform to the current year presentation due to immateriality.
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(tabular amounts in millions, except percentages)
Revenues primarily consist of retail sales from our Company-owned stores, royalties, advertising contributions and fees from our U.S. franchised stores, royalties and fees from our international franchised stores and sales of food, equipment and supplies from our supply chain centers to substantially all of our U.S. 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 $185.9 million, or 5.4%, in 2019 due primarily to higher supply chain food volumes as well as higher global franchise revenues resulting from retail sales growth. These increases in revenues were partially offset by lower U.S. Company-owned store revenues resulting from the sale of 59 Company-owned stores to certain of our existing U.S. franchisees during the second quarter of 2019 (the “2019 Store Sale”). These changes in revenues are more fully described below.
Revenues from U.S. stores are primarily comprised of retail sales from U.S. Company-owned store operations and royalties, advertising contributions and other fees from U.S. franchised stores, as summarized in the following table.
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U.S. Company-owned stores
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$
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%
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$
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%
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U.S. franchise royalties and fees
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%
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%
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U.S. franchise advertising
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%
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%
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Total U.S. stores revenues
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$
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%
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$
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%
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U.S. Company-owned stores.
Revenues from U.S. Company-owned store operations decreased $61.2 million, or 11.9%, in 2019 due primarily to the 2019 Store Sale. This decrease in revenues was partially offset by a 2.8% increase in same store sales as compared to 2018.
U.S. franchise royalties and fees.
Revenues from U.S. franchise operations increased $37.0 million, or 9.5%, in 2019. The increase was driven by a 3.2% increase in same store sales as compared to 2018 and an increase in the average number of stores open during the year resulting primarily from net store growth and, to a lesser extent, the 2019 Store Sale. U.S. franchise royalties and fees further benefited from an increase in revenues from fees paid by franchisees for the use of our technology platforms.
U.S. franchise advertising
. Revenues from U.S. franchise advertising increased $32.3 million, or 9.0%, in 2019 due primarily to higher same store sales and an increase in the average number of U.S. franchised stores open during the year resulting primarily from net store growth and, to a lesser extent, the 2019 Store Sale.
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 U.S. franchised stores and certain international franchised stores. Supply chain revenues increased $161.6 million, or 8.3%, in 2019. This increase was due primarily to higher volumes from increased orders resulting from an increase in the average number of U.S. franchise stores open during the year and an increase in market basket pricing to stores. Our market basket pricing to stores increased 1.7% during 2019, which resulted in an estimated $31.8 million increase in supply chain revenue.
International franchise royalties and fees.
International franchise revenues primarily consist of royalties from retail sales and other fees from our international franchise stores. Revenues from international franchise operations increased $16.3 million, or 7.2%, in 2019. This increase was due primarily to an increase in the average number of international stores open during 2019 as well as higher same store sales. The negative impact of changes in foreign currency exchange rates of approximately $8.9 million in 2019 partially offset these increases. Excluding the impact of foreign currency exchange rates, same store sales increased 1.9% in 2019 as compared to 2018.
Cost of sales / Operating margin.
Consolidated cost of sales consists primarily of U.S. Company-owned store and supply chain costs incurred to generate related revenues. Components of consolidated cost of sales primarily include food, labor and occupancy costs. The changes to the consolidated operating margin, which we define as revenues less cost of sales are summarized in the following table.
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$
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$
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%
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Consolidated cost of sales
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%
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%
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Consolidated operating margin
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$
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$
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%
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The $99.8 million, or 7.7%, increase in consolidated operating margin was primarily driven by higher global franchise revenues and higher supply chain volumes, but was partially offset by lower Company-owned store margins resulting from the 2019 Store Sale. Franchise revenues do not have a cost of sales component, so changes in these revenues have a disproportionate effect on the operating margin.
As a percentage of total revenues, our consolidated operating margin increased 0.9 percentage points in 2019 due to higher global royalty revenues and an increase in Company-owned store and supply chain operating margins. Company-owned store operating margin increased 1.0 percentage point in 2019 and supply chain operating margin increased 0.3 percentage points in 2019. These changes in margin are more fully discussed below.
U.S. Company-owned stores.
The changes to U.S. Company-owned store operating margin, which do not include other store-level costs such as royalties and advertising, are summarized in the following table.
The $9.2 million, or 7.9%, decrease in the U.S. Company-owned store operating margin was due primarily to the 2019 Store Sale. Operating margin in 2019 was also negatively impacted by higher labor costs, partially offset by higher same store sales. As a percentage of store revenues, the store operating margin increased 1.0 percentage point in 2019, as discussed in more detail below.
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Food costs decreased 0.3 percentage points to 27.1% in 2019, due primarily to the leveraging of higher same store sales. This decrease was partially offset by higher food prices.
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Labor costs decreased 1.1 percentage points to 29.0% in 2019. The 2019 Store Sale contributed to the reduction in labor costs as a percentage of store revenues due to the high labor rates in the market in which the sold stores operated. The reduction in labor costs as a percentage of store revenues was partially offset by an increase in average labor rates in our remaining Company-owned store markets.
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Insurance costs increased 0.4 percentage points to 3.4% in 2019, due primarily to unfavorable claims experience.
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The changes to the supply chain operating margin are summarized in the following table.
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$
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Supply chain operating margin
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$
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$
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%
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The $23.5 million, or 11.2%, increase in the supply chain operating margin was due primarily to higher volumes from increased franchise retail sales. As a percentage of supply chain revenues, the supply chain operating margin increased 0.3 percentage points in 2019, due primarily to procurement savings and lower delivery costs, offset in part by higher labor costs.
General and administrative expenses.
General and administrative expenses increased $9.8 million, or 2.6%, in 2019. A
pre-tax
gain of $5.9 million recognized from the sale of 12 Company-owned stores in 2018 resulted in an increase in general and administrative expenses as compared to the prior year. Lower advertising expenses, resulting primarily from the 2019 Store Sale, partially offset these increases. Continued investments in technological initiatives and other areas also contributed to the increase in 2019.
U.S. franchise advertising
. U.S. franchise advertising expenses increased $32.3 million, or 9.0%, in 2019, consistent with the increase in U.S. franchise advertising revenue. U.S. franchise advertising costs are accrued and expensed when the related U.S. franchise advertising revenues are recognized, as our consolidated
not-for-profit
advertising fund is obligated to expend such revenues on advertising and these revenues cannot be used for general corporate purposes.
Interest income increased $0.7 million to $4.0 million in 2019 due to a higher average cash and cash equivalents balance and higher interest rates earned on our cash and cash equivalents.
Interest expense increased $4.5 million to $150.8 million in 2019. This increase was driven by a higher weighted average debt balance, primarily due to our 2019 Recapitalization and increased borrowings under our variable funding notes. A higher weighted average borrowing rate also contributed to higher interest expense. Our weighted average borrowing rate was 4.1% in 2019 and was 4.0% in 2018. The increase in interest expense in 2019 was partially offset by $3.3 million of incremental interest expense recorded in 2018 in connection with the 2018 Recapitalization.
Provision for income taxes.
Provision for income taxes increased $15.2 million to $81.9 million in 2019 and the effective tax rate increased to 17.0% in 2019 as compared to 15.6% in 2018. Higher
pre-tax
income and a $4.3 million valuation allowance, primarily related to expected limitations on foreign tax credits, contributed to the increase in tax expense. Higher excess tax benefits on equity-based compensation, which are recorded as a reduction to the income tax provision, partially offset these increases. Excess tax benefits recorded were higher by $1.9 million in 2019 as compared to 2018.
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 multiple inventory turns per month. 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 December 29, 2019, we had working capital of $121.0 million, excluding restricted cash and cash equivalents of $209.3 million, advertising fund assets, restricted, of $105.4 million and advertising fund liabilities of $101.9 million. Working capital includes total unrestricted cash and cash equivalents of $190.6 million.
As of December 29, 2019, we had approximately $157.4 million of restricted cash and cash equivalents held for future principal and interest payments and other working capital requirements of our asset-backed securitization structure, $48.7 million of restricted cash equivalents held in a three-month interest reserve as required by the related debt agreements and $3.2 million of other restricted cash for a total of $209.3 million of restricted cash and cash equivalents. As of December 29, 2019, we also held $84.0 million of advertising fund restricted cash and cash equivalents, which can only be used for activities that promote the Domino’s brand.
Our primary source of liquidity is cash flows from operations and availability of borrowings under our variable funding notes. In connection with the 2019 Recapitalization, we issued a variable funding note facility which allows for advances of up to $200.0 million of Series
2019-1
Variable Funding Senior Secured Notes, Class
A-1
Notes and certain other credit instruments, including letters of credit (the “2019 Variable Funding Notes”). As of December 29, 2019, we had no outstanding borrowings and $158.6 million of available borrowing capacity under our 2019 Variable Funding Notes, net of letters of credit issued of $41.4 million. The letters of credit are primarily related to our casualty insurance programs and certain supply chain center leases. Borrowings under the 2019 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 and share repurchases.
On November 19, 2019, we completed the 2019 Recapitalization in which certain of our subsidiaries issued $675.0 million Series
2019-1
3.668% Fixed Rate Senior Secured Notes, Class
A-2
with an anticipated term of 10 years (the “2019
Ten-Year
Fixed Rate Notes”) pursuant to an asset-backed securitization. Concurrently, we also issued a new variable funding note facility which allowed for advances of up to $200.0 million of Series
2019-1
Variable Funding Senior Secured Notes, Class
A-1
Notes and certain other credit instruments, including letters of credit (the “2019 Variable Funding Notes”). Our previous variable funding note facility was canceled. Gross proceeds from the issuance of the 2019
Ten-Year
Fixed Rate Notes was $675.0 million. Additional information related to the 2019 Recapitalization transaction is included in Note 4 to our consolidated financial statements.
The proceeds from the 2019 Recapitalization were used to
pre-fund
a portion of the principal and interest payable on the 2019
Ten-Year
Fixed Rate Notes, pay transaction fees and expenses and repurchase and retire shares of our common stock. In connection with the 2019 Recapitalization, we capitalized $8.1 million of debt issuance costs, which are being amortized into interest expense over the expected term of the 2019
Ten-Year
Fixed Rate Notes.
On April 24, 2018, we completed the 2018 Recapitalization in which certain of our subsidiaries issued notes pursuant to an asset-backed securitization. The notes consisted of $425.0 million Series
2018-1
4.116% Fixed Rate Senior Secured Notes, Class
A-2-I
with an anticipated term of 7.5 years (the “2018
7.5-Year
Fixed Rate Notes”), and $400.0 million Series
2018-1
4.328% Fixed Rate Senior Secured Notes, Class
A-2-II
with an anticipated term of 9.25 years (the “2018
9.25-Year
Fixed Rate Notes” and, collectively with the 2018
7.5-Year
Fixed Rate Notes, the “2018 Notes”) in an offering exempt from registration under the Securities Act of 1933, as amended. Gross proceeds from the issuance of the 2018 Notes were $825.0 million. Additional information related to the 2018 Recapitalization transaction is included in Note 4 to our consolidated financial statements.
A portion of the proceeds from the 2018 Recapitalization was used to repay the remaining $490.1 million in outstanding principal and interest under the 2015 Five-Year Fixed Rate Notes,
pre-fund
a portion of the principal and interest payable on the 2018 Notes, pay transaction fees and expenses and repurchase and retire shares of our common stock. In connection with the repayment of the 2015 Five-Year Fixed Rate Notes, we expensed approximately $3.2 million for the remaining unamortized debt issuance costs associated with these notes. Additionally, in connection with the 2018 Recapitalization, we capitalized $8.2 million of debt issuance costs, which are being amortized into interest expense over the expected terms of the 2018 Notes.
On July 24, 2017, we completed the 2017 Recapitalization in which certain of our subsidiaries issued notes pursuant to an asset-backed securitization. The notes consisted of $300.0 million Series
2017-1
Floating Rate Senior Secured Notes, Class
A-2-I
with an anticipated term of five years (the “2017 Five-Year Floating Rate Notes”), $600.0 million Series
2017-1
3.082% Fixed Rate Senior Secured Notes, Class
A-2-II
with an anticipated term of five years (the “2017 Five-Year Fixed Rate Notes”), and $1.0 billion Series
2017-1
4.118% Fixed Rate Senior Secured Notes, Class
A-2-III
with an anticipated term of 10 years (the “2017
Ten-Year
Fixed Rate Notes” and, collectively with the 2017 Five-Year Floating Rate Notes and the 2017 Five-Year Fixed Rate Notes, the “2017 Fixed and Floating Rate Notes”) in an offering exempt from registration under the Securities Act of 1933, as amended. The interest rate on the 2017 Five-Year Floating Rate Notes is payable at a rate equal to LIBOR plus 125 basis points. We also issued $175.0 million of Series
2017-1
Variable Funding Senior Secured Notes, Class
A-1
(the “2017 Variable Funding Notes”), and our previous 2015 variable funding note facility was canceled. The 2017 Fixed and Floating Rate Notes and the 2017 Variable Funding Notes are collectively referred to as the “2017 Notes”. Gross proceeds from the issuance of the 2017 Notes were $1.9 billion. Additional information related to the 2017 Recapitalization transaction is included in Note 4 to our consolidated financial statements.
A portion of proceeds from the 2017 Recapitalization was used to repay the remaining $910.5 million in outstanding principal and interest under our then outstanding 2012 fixed rate notes,
pre-fund
a portion of the principal and interest payable on the 2017 Notes and pay transaction fees and expenses. In connection with the repayment of the 2012 fixed rate notes, we expensed approximately $5.5 million for the remaining unamortized debt issuance costs associated with these notes. Additionally, in connection with the 2017 Recapitalization, we capitalized $16.8 million of debt issuance costs, which are being amortized into interest expense over the expected terms of the 2017 Fixed and Floating Rate Notes.
On August 2, 2017, we entered into a $1.0 billion accelerated share repurchase agreement (the “2017 ASR Agreement”) with a counterparty. Pursuant to the terms of the 2017 ASR Agreement, on August 3, 2017, we used a portion of the proceeds from the 2017 Recapitalization to pay the counterparty $1.0 billion in cash and received 4,558,863 shares of the Company’s common stock. Final settlement of the 2017 ASR Agreement occurred on October 11, 2017. In connection with the 2017 ASR Agreement, we received and retired a total of 5,218,670 shares of our common stock.
On October 21, 2015, we completed the 2015 Recapitalization in which certain of our subsidiaries issued notes pursuant to an asset-backed securitization. The notes consisted of $500.0 million of Series
2015-1
3.484% Fixed Rate Senior Secured Notes, Class
A-2-I
(the “2015 Five-Year Fixed Rate Notes”), $800.0 million Series
2015-1
4.474% Fixed Rate Senior Secured Notes, Class
A-2-II
(the “2015
Ten-Year
Fixed Rate Notes” and collectively with the 2015 Five-Year Fixed Rate Notes, the “2015 Notes”). Gross proceeds from the issuance of the 2015 Notes were $1.3 billion. The 2015 Five-Year Fixed Rate Notes were repaid in connection with the 2018 Recapitalization. Additional information related to the 2015 Recapitalization transaction is included in Note 4 to our consolidated financial statements. The “2019
Ten-Year
Fixed Rate Notes,” “2018 Notes,” the “2017 Fixed and Floating Rate Notes” and the “2015 Notes” are collectively referred to as the “2019, 2018, 2017 and 2015 Notes.”
2019, 2018, 2017 and 2015 Notes
The 2019, 2018, 2017 and 2015 Notes have original scheduled principal payments of $42.0 million in each of 2020 and 2021, $897.0 million in 2022, $33.0 million in each of 2023 and 2024, $1.15 billion in 2025, $20.8 million in 2026, $1.28 billion in 2027, $6.8 million in 2028 and $614.3 million in 2029. However, in accordance with our debt agreements, the payment of principal on the outstanding senior notes shall be suspended if the leverage ratio for the Company is less than or equal to 5.0x total debt, as defined, to adjusted EBITDA, as defined, and no
catch-up
provisions are applicable.
The 2019, 2018, 2017 and 2015 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 2019, 2018, 2017 and 2015 Notes may become due and payable on an accelerated schedule.
During the third quarter of 2019, the Company had a leverage ratio of less than 5.0x, and accordingly, did not make the previously scheduled debt amortization payment in the fourth quarter of 2019. Subsequent to the 2019 Recapitalization, the Company’s leverage ratios exceeded the leverage ratio of 5.0x and, accordingly, the Company resumed making the scheduled amortization payments in the first quarter of 2020.
Under the provisions of the Company’s previously existing debt agreements, during the first and second quarters of 2017, the Company had a leverage ratio of less than 4.5x and accordingly, did not make previously scheduled debt amortization payments in accordance with the debt agreements. Subsequent to the 2017 Recapitalization and through 2018, the Company’s leverage ratios exceeded the leverage ratio of 5.0x and, accordingly, the Company began making the scheduled amortization payments.
Share Repurchase Programs
The Company’s share repurchase programs have historically been funded by excess operating cash flows, excess proceeds from our recapitalization transactions and borrowings under our variable funding notes. We used cash of approximately $699.0 million in 2019, $591.2 million in 2018 and $1.06 billion in 2017 for share repurchases. The Company’s Board of Directors authorized a share repurchase program to repurchase up to $1.0 billion of the Company’s common stock on October 4, 2019. The Company had approximately $406.1 million left under this share repurchase program as of December 29, 2019. From December 30, 2019 through February 13, 2020, we repurchased and retired an additional 271,064 shares of common stock for a total of approximately $79.6 million.
In the past three years, we have invested approximately $295.5 million in capital expenditures. In 2019, we invested $85.6 million in capital expenditures which primarily related to investments in our proprietary internally developed
point-of-sale
system (Domino’s PULSE), our internal enterprise systems, our digital ordering platform, supply chain centers, asset upgrades for our existing Company-owned stores and new Company-owned stores. We did not have any material commitments for capital expenditures as of December 29, 2019.
The following table illustrates the main components of our cash flows:
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Cash Flows Provided By (Used In)
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Net cash provided by operating activities
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$
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$
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$
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Net cash used in investing activities
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Net cash used in financing activities
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Change in cash and cash equivalents, restricted cash and cash equivalents
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$
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$
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)
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$
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Cash provided by operating activities increased $102.8 million in 2019 due to the positive impact of changes in operating assets and liabilities of $59.0 million, an increase in net income of $38.7 million and higher
non-cash
amounts of $5.1 million. The positive impact of changes in operating assets and liabilities was primarily related to the timing of payments on accounts payable and accrued liabilities during 2019 as compared to 2018.
Cash provided by operating activities increased $52.9 million in 2018, primarily due to an increase in net income of $84.1 million. This increase was partially offset by the negative impact of changes in operating assets and liabilities of $32.1 million. Our cash outflows for operating assets and liabilities in 2018 were higher than in 2017 due primarily to higher inventory balances and the timing of payments on accounts payable and accrued liabilities.
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.
Cash used in investing activities was $27.9 million in 2019, which consisted primarily of $85.6 million of capital expenditures (driven primarily by investments in technological initiatives, supply chain centers and our Company-owned stores) and $3.4 million of purchases of franchise operations and other assets. These uses of cash were partially offset by maturities of restricted advertising fund investments of $50.2 million and the proceeds from the sale of assets of $12.3 million.
Cash used in investing activities was $88.3 million in 2018, which consisted primarily of $119.9 million of capital expenditures (driven primarily by investments in supply chain centers, technology initiatives and our Company-owned stores) and purchases of restricted advertising fund investments of $70.2 million. These uses of cash were partially offset by maturities of restricted advertising fund investments of $94.0 million. We adopted ASC 606 in the first quarter of 2018, which superseded the agency guidance historically applied to present advertising fund activities net in the consolidated statement of cash flows. Refer to Note 1 to the consolidated financial statements for additional information related to the adoption of ASC 606. These uses of cash were offset in part by the proceeds from the sale of assets of $8.4 million.
Cash used in investing activities was $83.7 million in 2017, which consisted primarily of $90.0 million of capital expenditures (driven by investments in our technological initiatives, supply chain centers and Company-owned stores), offset in part by the proceeds from the sale of assets of $6.8 million.
Cash used in financing activities was $222.8 million in 2019, primarily related to repurchases of common stock of $699.0 million under our Board of Directors-approved share repurchase program, dividend payments to our shareholders of $105.7 million, repayments of long-term debt of $92.1 million (of which $65.0 million related to the repayment of borrowings under our variable funding notes), payments for financing costs of $8.1 million and tax payments for restricted stock upon vesting of $6.0 million. These uses of cash were partially offset by proceeds from the issuance of $675.0 million of debt in connection with our 2019 Recapitalization and the exercise of stock options of $13.1 million.
Cash used in financing activities was $322.8 million in 2018. We issued $825.0 million of debt in connection with our 2018 Recapitalization and borrowed $145.0 million under our variable funding notes. However, these increases in cash were offset by repayments of long-term debt of $604.1 million (of which $490.0 million was an optional prepayment on our 2015 Five-Year Fixed Rate Notes using a portion of the proceeds received from the 2018 Recapitalization and $80.0 million related to the repayment of borrowings under the 2017 Variable Funding Notes), purchases of common stock of $591.2 million, funding dividend payments to our shareholders of $92.2 million, and cash paid for financing costs related to our 2018 Recapitalization of $8.2 million. We also received proceeds of $9.8 million from the exercise of stock options and made $7.0 million in tax payments for restricted stock upon vesting.
Cash used in financing activities was $197.1 million in 2017. We issued $1.9 billion of debt in connection with our 2017 Recapitalization, which was offset by purchases of common stock of $1.06 billion, repayments of long-term debt of $928.2 million (of which, $910.2 million was repayment of the remaining 2012 fixed rate notes using a portion of the proceeds received from the 2017 Recapitalization), funding dividend payments to our shareholders of $84.3 million, and cash paid for financing costs related to our 2017 Recapitalization of $16.8 million. We also made $9.4 million in tax payments for restricted stock upon vesting and received proceeds of $6.1 million from the exercise of stock options.
Our ability to continue to fund these items and continue to service our 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 2019 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 2019, 2018, 2017 and 2015 Notes and to service, extend or refinance the 2019 Variable Funding Notes will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control.
Inflation did not have a material impact on our operations in 2019, 2018 or 2017. 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
The impact of new accounting pronouncements adopted during 2019 and the estimated impact of new accounting pronouncements that we will adopt in future years is included in Note 1 to the consolidated financial statements.
The following is a summary of our significant contractual obligations at December 29, 2019.
(1)
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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.”
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(2)
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Represents interest payments on our 2019, 2018, 2017 and 2015 Notes.
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(3)
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The principal portion of the finance lease obligation amounts above, which totaled $19.7 million at December 29, 2019, is classified as debt in our consolidated financial statements.
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(4)
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We lease certain retail store and supply chain center locations, supply chain vehicles, various equipment and our World Resource Center under leases with expiration dates through 2041.
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As of December 29, 2019, the Company has additional leases for two supply chain centers and certain supply chain tractors and trailers that had not yet commenced with estimated future minimum rental commitments of approximately $76.2 million. These leases are expected to commence in 2020 with lease terms of up to 21 years. These undiscounted amounts are not included in the table above.
Liabilities for unrecognized tax benefits of $2.8 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 7 to the Consolidated Financial Statements under “Part II – Item 8 – Financial Statements and Supplementary Data.”
Off-balance
sheet arrangements
We are party to letters of credit and other financial guarantees with
off-balance
sheet risk. Our exposure to credit loss for letters of credit and other financial guarantees is represented by the contractual amounts of these instruments. Total conditional commitments under letters of credit as of December 29, 2019 were approximately $41.4 million and relate to our insurance programs and supply chain center leases. Total conditional commitments under surety bonds were $7.6 million as of December 29, 2019. The Company also has guaranteed lease payments related to certain franchisees’ lease arrangements. The maximum amount of potential future payments under these guarantees is $16.7 million as of December 29, 2019. 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 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,” “should,” “estimate,” “expect,” “intend,” “may,” “will,” “plan,” “predict,” “project,” “seek,” “approximately,” “potential,” “outlook” and similar terms and phrases that concern our strategy, plans or intentions, including references to assumptions. These forward-looking statements address various matters including information concerning future results of operations and business strategy, 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 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 environmental compliance-related capital expenditures, our plans to expand U.S. and 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 the availability of our borrowings under the 2019 Variable Funding Notes for, among other things, funding working capital requirements, paying capital expenditures and funding other general corporate purposes, including payment of dividends.
Forward-looking statements relating to our anticipated profitability, estimates in same store sales growth, the growth of our U.S. and international business, ability to service our indebtedness, our future cash flows, 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 expressed or implied in the forward-looking statements as a result of various factors, including but not limited to, the following:
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•
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our substantial increased indebtedness as a result of the 2019 Recapitalization, 2018 Recapitalization, 2017 Recapitalization and 2015 Recapitalization and our ability to incur additional indebtedness or refinance or renegotiate key terms of that indebtedness in the future;
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the impact a downgrade in our credit rating may have on our business, financial condition and results of operations;
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our future financial performance and our ability to pay principal and interest on our indebtedness;
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the effectiveness of our advertising, operations and promotional initiatives;
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the strength of our brand, including our ability to compete in the U.S. and internationally in our intensely competitive industry, including the food service and food delivery markets;
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the impact of social media and other consumer-oriented technologies on our business, brand and reputation;
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the impact of new or improved technologies and alternative methods of delivery on consumer behavior;
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new product, digital ordering and concept developments by us, and other food-industry competitors;
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our ability to maintain good relationships with and attract new franchisees and franchisees’ ability to successfully manage their operations without negatively impacting our royalty payments and fees or our brand’s reputation;
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our ability to successfully implement cost-saving strategies;
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our ability and that of our franchisees to successfully operate in the current and future credit environment;
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changes in the level of consumer spending given general economic conditions, including interest rates, energy prices and consumer confidence;
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our ability and that of our franchisees to open new restaurants and keep existing restaurants in operation;
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changes in operating expenses resulting from changes in prices of food (particularly cheese), fuel and other commodity costs, labor, utilities, insurance, employee benefits and other operating costs;
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the impact that widespread illness, health epidemics or general health concerns, severe weather conditions and natural disasters may have on our business and the economies of the countries where we operate;
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changes in foreign currency exchange rates;
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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;
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our ability to find and/or retain suitable real estate for our stores and supply chain centers;
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changes in government legislation or regulation, including changes in laws and regulations regarding information privacy, payment methods and consumer protection and social media;
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adverse legal judgments or settlements;
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food-borne illness or contamination of products;
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data breaches, power loss, technological failures, user error or other cyber risks threatening us or our franchisees;
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the effect of war, terrorism, catastrophic events or climate change;
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our ability to pay dividends and repurchase shares;
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changes in consumer taste, spending and traffic patterns and demographic trends;
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actions by activist investors;
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changes in accounting policies; and
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adequacy of our insurance coverage.
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In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Form
10-K
might not occur. All forward-looking statements speak only as of the date of this Form
10-K
and should be evaluated with an understanding of their inherent uncertainty. Except as required under federal securities laws and the rules and regulations of the Securities and Exchange Commission, we will not undertake and specifically decline any obligation to publicly update or revise 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.
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.
Item 7A.
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Quantitative and Qualitative Disclosures About Market Risk.
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We do not engage in speculative transactions nor do we hold or issue financial instruments for trading purposes. In connection with the 2017 Recapitalization, we issued fixed and floating rate notes and, at December 29, 2019, we are exposed to interest rate risk on borrowings under our 2017 Five-Year Floating Rate Notes and our 2019 Variable Funding Notes. As of December 29, 2019, we did not have any outstanding borrowings under our 2019 Variable Funding Notes. Our 2017 Five-Year Floating Rate Notes and our 2019 Variable Funding Notes bear interest at fluctuating interest rates based on LIBOR. A hypothetical 1.0% adverse change in the LIBOR rate would have resulted in higher interest expense of approximately $3.1 million in 2019.
There is currently uncertainty around whether LIBOR will continue to exist after 2021. If LIBOR ceases to exist, we may need to renegotiate our loan documents and we cannot predict what alternative index would be negotiated with our lenders. As a result, our interest expense could increase, in which event we may have difficulties making interest payments and funding our other fixed costs, and our available cash flow for general corporate requirements may be adversely affected.
Our fixed rate debt exposes the Company to changes in market interest rates reflected in the fair value of the debt and to the risk that the Company may need to refinance maturing debt with new debt at a higher rate.
We are exposed to market risks from changes in commodity prices. During the normal course of business, we purchase cheese and certain other food products that are affected by changes in commodity prices and, as a result, we are subject to volatility in our food costs. We may periodically enter into financial instruments to manage this risk. We do not engage in speculative transactions nor do we hold or issue financial instruments for trading purposes. In instances when we use fixed pricing agreements with our suppliers, these agreements cover our physical commodity needs, are not
net-settled
and are accounted for as normal purchases.
Foreign currency exchange rate risk
We have exposure to various foreign currency exchange rate fluctuations for revenues generated by our operations outside the U.S., which can adversely impact our net income and cash flows. Approximately 6.7% of our total revenues in 2019, 6.5% of our total revenues in 2018 and 7.4% of our total revenues in 2017 were derived from our international franchise segment, a majority of which were denominated in foreign currencies. We also operate dough manufacturing and distribution facilities in Canada, which generate revenues denominated in Canadian dollars. We do not enter into financial instruments to manage this foreign currency exchange risk. A hypothetical 10% adverse change in the foreign currency rates for our international markets would have resulted in a negative impact on royalty revenues of approximately $21.2 million in 2019.