Dunkin Brands, Inc.
DUNKIN' BRANDS GROUP, INC. (Form: 10-Q, Received: 11/08/2017 17:13:43)
Table of Contents

 
 
 
 
 
FORM 10-Q  
 
 
 
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2017
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from              to             
Commission file number 001-35258  
 
 
 
DUNKIN’ BRANDS GROUP, INC.
(Exact name of registrant as specified in its charter)  
 
 
 
Delaware
 
20-4145825
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
130 Royall Street
Canton, Massachusetts 02021
(Address of principal executive offices) (zip code)
(781) 737-3000
(Registrants’ telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report.)
 
 
 
 
Indicate by check mark whether the registrant has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES   x     NO   ¨
Indicate by check mark 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   x     NO   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
x
  
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨
  
Smaller reporting company
 
¨
 
 
 
 
 
 
 
 
Emerging growth company
 
¨
If an emerging growth company, indicated by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 November 3, 2017 , 90,322,903 shares of common stock of the registrant were outstanding.


Table of Contents

DUNKIN’ BRANDS GROUP, INC. AND SUBSIDIARIES

TABLE OF CONTENTS
 
 
 
 
 
 
Page    
 
Part I. – Financial Information
 
 
 
Item 1.
Item 2.
Item 3.
Item 4.
 
Part II. – Other Information
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 


2

Table of Contents

Part I.        Financial Information
Item 1.       Financial Statements
DUNKIN’ BRANDS GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share data)
(Unaudited)
 
September 30,
2017
 
December 31,
2016
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
266,981

 
361,425

Restricted cash
76,141

 
69,746

Accounts receivable, net of allowance for doubtful accounts of $4,616 and $4,778 as of September 30, 2017 and December 31, 2016, respectively
47,136

 
44,512

Notes and other receivables, net of allowance for doubtful accounts of $500 and $339 as of September 30, 2017 and December 31, 2016, respectively
30,274

 
40,672

Restricted assets of advertising funds
57,873

 
40,338

Prepaid income taxes
9,843

 
20,926

Prepaid expenses and other current assets
33,605

 
28,739

Total current assets
521,853

 
606,358

Property and equipment, net of accumulated depreciation of $135,284 and $124,675 as of September 30, 2017 and December 31, 2016, respectively
170,269

 
176,662

Equity method investments
128,633

 
114,738

Goodwill
888,311

 
888,272

Other intangible assets, net of accumulated amortization of $245,569 and $230,364 as of September 30, 2017 and December 31, 2016, respectively
1,362,586

 
1,378,720

Other assets
67,674

 
62,632

Total assets
$
3,139,326

 
3,227,382

Liabilities and Stockholders’ Deficit
 
Current liabilities:
 
 
 
Current portion of long-term debt
$
25,000

 
25,000

Capital lease obligations
584

 
589

Accounts payable
12,416

 
12,682

Liabilities of advertising funds
57,935

 
52,271

Deferred income
37,595

 
35,393

Other current liabilities
230,487

 
298,266

Total current liabilities
364,017

 
424,201

Long-term debt, net
2,388,091

 
2,401,998

Capital lease obligations
7,209

 
7,550

Unfavorable operating leases acquired
10,164

 
11,378

Deferred income
10,729

 
12,154

Deferred income taxes, net
459,524

 
461,810

Other long-term liabilities
73,680

 
71,549

Total long-term liabilities
2,949,397

 
2,966,439

Commitments and contingencies (note 9)

 

Stockholders’ equity (deficit):
 
 
 
Preferred stock, $0.001 par value; 25,000,000 shares authorized; no shares issued and outstanding

 

Common stock, $0.001 par value; 475,000,000 shares authorized; 90,290,628 shares issued and 90,263,851 shares outstanding as of September 30, 2017; 91,464,229 shares issued and 91,437,452 shares outstanding as of December 31, 2016
90

 
91

Additional paid-in capital
746,052

 
807,492

Treasury stock, at cost; 26,777 shares as of September 30, 2017 and December 31, 2016
(1,060
)
 
(1,060
)
Accumulated deficit
(900,217
)
 
(945,797
)
Accumulated other comprehensive loss
(18,953
)
 
(23,984
)
Total stockholders’ deficit
(174,088
)
 
(163,258
)
Total liabilities and stockholders’ deficit
$
3,139,326

 
3,227,382


See accompanying notes to unaudited consolidated financial statements.

3

Table of Contents
DUNKIN’ BRANDS GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)

 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Revenues:
 
 
 
 
 
 
 
Franchise fees and royalty income
$
151,809

 
138,639

 
426,944

 
399,617

Rental income
27,713

 
26,880

 
79,543

 
75,874

Sales of ice cream and other products
27,551

 
26,568

 
85,710

 
86,425

Sales at company-operated restaurants

 
1,611

 

 
11,924

Other revenues
17,095

 
13,401

 
41,165

 
39,344

Total revenues
224,168

 
207,099

 
633,362

 
613,184

Operating costs and expenses:
 
 
 
 
 
 
 
Occupancy expenses—franchised restaurants
15,333

 
15,881

 
43,758

 
42,691

Cost of ice cream and other products
19,457

 
18,384

 
58,578

 
58,445

Company-operated restaurant expenses

 
1,682

 

 
13,472

General and administrative expenses, net
61,996

 
59,374

 
185,613

 
184,028

Depreciation
4,941

 
5,050

 
15,096

 
15,361

Amortization of other intangible assets
5,341

 
5,397

 
16,001

 
16,726

Long-lived asset impairment charges
536

 
7

 
643

 
104

Total operating costs and expenses
107,604

 
105,775

 
319,689

 
330,827

Net income of equity method investments
5,466

 
5,467

 
12,612

 
12,148

Other operating income, net
3

 
2,569

 
591

 
6,329

Operating income
122,033

 
109,360

 
326,876

 
300,834

Other income (expense), net:
 
 
 
 
 
 
 
Interest income
624

 
161

 
1,370

 
434

Interest expense
(24,436
)
 
(24,603
)
 
(74,192
)
 
(74,456
)
Other income (losses), net
155

 
(124
)
 
370

 
(596
)
Total other expense, net
(23,657
)
 
(24,566
)
 
(72,452
)
 
(74,618
)
Income before income taxes
98,376

 
84,794

 
254,424

 
226,216

Provision for income taxes
46,130

 
32,082

 
99,007

 
86,760

Net income
$
52,246

 
52,712

 
155,417

 
139,456

Earnings per share:
 
 
 
 
 
 
 
Common—basic
$
0.58

 
0.58

 
1.71

 
1.52

Common—diluted
0.57

 
0.57

 
1.68

 
1.51

Cash dividends declared per common share
0.32

 
0.30

 
0.97

 
0.90

See accompanying notes to unaudited consolidated financial statements.

4

Table of Contents
DUNKIN’ BRANDS GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(In thousands)
(Unaudited)

 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Net income
$
52,246

 
52,712

 
155,417

 
139,456

Other comprehensive income (loss), net:
 
 
 
 
 
 
 
Effect of foreign currency translation, net of deferred tax expense (benefit) of $6 and $(59) for the three months ended September 30, 2017 and September 24, 2016, respectively, and $579 and $(488) for the nine months ended September 30, 2017 and September 24, 2016, respectively
(662
)
 
6,161

 
5,309

 
8,730

Effect of interest rate swaps, net of deferred tax benefit of $216 for each of the three months ended September 30, 2017 and September 24, 2016 and $650 for each of the nine months ended September 30, 2017 and September 24, 2016
(319
)
 
(319
)
 
(955
)
 
(955
)
Other, net
24

 
(27
)
 
677

 
(230
)
Total other comprehensive income (loss), net
(957
)
 
5,815

 
5,031

 
7,545

Comprehensive income
$
51,289

 
58,527

 
160,448

 
147,001

See accompanying notes to unaudited consolidated financial statements.

5

Table of Contents
DUNKIN’ BRANDS GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

 
Nine months ended
 
September 30,
2017
 
September 24,
2016
Cash flows from operating activities:
 
 
 
Net income
$
155,417

 
139,456

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
31,097

 
32,087

Amortization of debt issuance costs
4,843

 
4,700

Deferred income taxes
(1,516
)
 
(5,595
)
Provision for bad debt
599

 
681

Share-based compensation expense
10,896

 
12,548

Net income of equity method investments
(12,612
)
 
(12,148
)
Dividends received from equity method investments
4,711

 
5,247

Gain on sale of real estate and company-operated restaurants
(29
)
 
(6,322
)
Other, net
(2,299
)
 
(1,554
)
Change in operating assets and liabilities:
 
 
 
Accounts, notes, and other receivables, net
7,712

 
43,482

Prepaid income taxes, net
10,884

 
6,569

Prepaid expenses and other current assets
(4,600
)
 
(3,552
)
Accounts payable
(1,501
)
 
(1,635
)
Other current liabilities
(68,274
)
 
(91,651
)
Liabilities of advertising funds, net
(11,232
)
 
896

Deferred income
722

 
3,800

Other, net
(3,289
)
 
4,250

Net cash provided by operating activities
121,529

 
131,259

Cash flows from investing activities:
 
 
 
Additions to property and equipment
(8,998
)
 
(10,358
)
Proceeds from sale of real estate and company-operated restaurants

 
15,479

Other, net
(101
)
 
(1,014
)
Net cash provided by (used in) investing activities
(9,099
)
 
4,107

Cash flows from financing activities:
 
 
 
Repayment of long-term debt
(18,750
)
 
(18,750
)
Payment of debt issuance and other debt-related costs
(312
)
 

Dividends paid on common stock
(87,911
)
 
(82,326
)
Repurchases of common stock, including accelerated share repurchases
(127,186
)

(30,000
)
Exercise of stock options
33,267

 
4,937

Other, net
(214
)
 
(690
)
Net cash used in financing activities
(201,106
)
 
(126,829
)
Effect of exchange rates on cash, cash equivalents, and restricted cash
576

 
20

Increase (decrease) in cash, cash equivalents, and restricted cash
(88,100
)
 
8,557

Cash, cash equivalents, and restricted cash, beginning of period
431,832

 
333,115

Cash, cash equivalents, and restricted cash, end of period
$
343,732

 
341,672

Supplemental cash flow information:
 
 
 
Cash paid for income taxes
$
89,882

 
86,460

Cash paid for interest
70,038

 
70,749

Noncash investing activities:
 
 
 
Property and equipment included in accounts payable and other current liabilities
1,919

 
1,121

Purchase of leaseholds in exchange for capital lease obligations
330

 
389

See accompanying notes to unaudited consolidated financial statements.

6


DUNKIN’ BRANDS GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
(1) Description of business and organization
Dunkin’ Brands Group, Inc. (“DBGI”), together with its consolidated subsidiaries, is one of the world’s leading franchisors of restaurants serving coffee and baked goods, as well as ice cream, within the quick service restaurant segment of the restaurant industry. We franchise and license a system of both traditional and nontraditional quick service restaurants and, in limited circumstances, have owned and operated locations. Through our Dunkin’ Donuts brand, we franchise restaurants featuring coffee, donuts, bagels, breakfast sandwiches, and related products. Additionally, we license Dunkin’ Donuts brand products sold in certain retail outlets such as retail packaged coffee, Dunkin’ K-Cup® pods, and ready-to-drink bottled iced coffee. Through our Baskin-Robbins brand, we franchise restaurants featuring ice cream, frozen beverages, and related products. Additionally, we distribute Baskin-Robbins ice cream products to Baskin-Robbins franchisees and licensees in certain international markets.
Throughout these unaudited consolidated financial statements, “Dunkin’ Brands,” “the Company,” “we,” “us,” “our,” and “management” refer to DBGI and its consolidated subsidiaries taken as a whole.
(2) Summary of significant accounting policies
(a) Unaudited consolidated financial statements
The consolidated balance sheet as of September 30, 2017 , the consolidated statements of operations and comprehensive income for the three and nine months ended September 30, 2017 and September 24, 2016 , and the consolidated statements of cash flows for the nine months ended September 30, 2017 and September 24, 2016 are unaudited.
The accompanying unaudited consolidated financial statements include the accounts of DBGI and its consolidated subsidiaries and have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial information. Accordingly, they do not include all of the information and footnotes required in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for complete financial statements. All significant transactions and balances between subsidiaries and affiliates have been eliminated in consolidation. In the opinion of management, all adjustments necessary for a fair presentation of such financial statements in accordance with U.S. GAAP have been recorded. Such adjustments consisted only of normal recurring items. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the fiscal year ended December 31, 2016 , included in the Company’s Annual Report on Form 10-K.
(b) Fiscal year
The Company operates and reports financial information on a 52 - or 53 -week year on a 13 -week quarter basis with the fiscal year ending on the last Saturday in December and fiscal quarters ending on the 13th Saturday of each quarter (or 14th Saturday when applicable with respect to the fourth fiscal quarter). The data periods contained within the three- and nine-month periods ended September 30, 2017 and September 24, 2016 reflect the results of operations for the 13-week and 39-week periods ended on those dates, respectively. Operating results for the three- and nine-month periods ended September 30, 2017 are not necessarily indicative of the results that may be expected for the fiscal year ending December 30, 2017 .
(c) Cash, cash equivalents, and restricted cash
In accordance with the Company’s securitized financing facility, certain cash accounts have been established in the name of Citibank, N.A. (the “Trustee”) for the benefit of the Trustee and the noteholders, and are restricted in their use. The Company holds restricted cash which primarily represents (i) cash collections held by the Trustee, (ii) interest, principal, and commitment fee reserves held by the Trustee related to the Company’s Notes (see note 4 ), and (iii) real estate reserves used to pay real estate obligations.

7


Pursuant to new accounting guidance for fiscal year 2017, restricted cash is combined with cash and cash equivalents when reconciling the beginning and end of period balances in the consolidated statements of cash flows (see note 2 (f)). Cash, cash equivalents, and restricted cash within the consolidated balance sheets that are included in the consolidated statements of cash flows as of September 30, 2017 and December 31, 2016 were as follows (in thousands):
 
September 30,
2017
 
December 31,
2016
Cash and cash equivalents
$
266,981

 
361,425

Restricted cash
76,141

 
69,746

Restricted cash, included in Other assets
610

 
661

Total cash, cash equivalents, and restricted cash
$
343,732

 
431,832

(d) Fair value of financial instruments
Financial assets and liabilities are categorized, based on the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to the quoted prices in active markets for identical assets and liabilities and lowest priority to unobservable inputs. Observable market data, when available, is required to be used in making fair value measurements. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.
Financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2017 and December 31, 2016 are summarized as follows (in thousands):
 
September 30, 2017
 
December 31, 2016
 
Significant other observable inputs (Level 2)
 
Total
 
Significant other observable inputs (Level 2)
 
Total
Assets:
 
 
 
 
 
 
 
Company-owned life insurance
$
10,389

 
10,389

 
9,271

 
9,271

Total assets
$
10,389

 
10,389

 
9,271

 
9,271

Liabilities:
 
 
 
 
 
 
 
Deferred compensation liabilities
$
12,851

 
12,851

 
11,126

 
11,126

Total liabilities
$
12,851

 
12,851

 
11,126

 
11,126

The deferred compensation liabilities relate to the Dunkin’ Brands, Inc. non-qualified deferred compensation plans (“NQDC Plans”), which allow for pre-tax deferral of compensation for certain qualifying employees and directors. Changes in the fair value of the deferred compensation liabilities are derived using quoted prices in active markets of the asset selections made by the participants. The deferred compensation liabilities are classified within Level 2, as defined under U.S. GAAP, because their inputs are derived principally from observable market data by correlation to hypothetical investments. The Company holds company-owned life insurance policies to partially offset the Company’s liabilities under the NQDC Plans. The changes in the fair value of any company-owned life insurance policies are derived using determinable cash surrender value. As such, the company-owned life insurance policies are classified within Level 2, as defined under U.S. GAAP.
The carrying value and estimated fair value of long-term debt as of September 30, 2017 and December 31, 2016 were as follows (in thousands):
 
September 30, 2017
 
December 31, 2016
 
Carrying value
 
Estimated fair value
 
Carrying value
 
Estimated fair value
Financial liabilities
 
 
 
 
 
 
 
Long-term debt
$
2,413,091

 
2,474,291

 
2,426,998

 
2,460,544

The estimated fair value of our long-term debt is estimated primarily based on current market rates for debt with similar terms and remaining maturities or current bid prices for our long-term debt. Judgment is required to develop these estimates. As such, our long-term debt is classified within Level 2, as defined under U.S. GAAP.

8


(e) Concentration of credit risk
The Company is subject to credit risk through its accounts receivable consisting primarily of amounts due from franchisees and licensees for franchise fees, royalty income, and sales of ice cream and other products. In addition, we have note and lease receivables from certain of our franchisees and licensees. The financial condition of these franchisees and licensees is largely dependent upon the underlying business trends of our brands and market conditions within the quick service restaurant industry. This concentration of credit risk is mitigated, in part, by the large number of franchisees and licensees of each brand and the short-term nature of the franchise and license fee and lease receivables. As of September 30, 2017 and December 31, 2016 , one master licensee, including its majority-owned subsidiaries, accounted for approximately 18% and 15% , respectively, of total accounts and notes receivable. No individual franchisee or master licensee accounted for more than 10% of total revenues for each of the three and nine months ended September 30, 2017 and September 24, 2016 .
Additionally, the Company engages various third parties to manufacture and/or distribute certain Dunkin’ Donuts and Baskin-Robbins products under licensing arrangements. As of  September 30, 2017 one  of these third parties accounted for approximately  13%  of total accounts and notes receivable. No individual third party accounted for more than 10% of total accounts and notes receivable as of  December 31, 2016 .
(f) Recent accounting pronouncements
Recently adopted accounting pronouncements
In January 2017, the Financial Accounting Standards Board (the “FASB”) issued new guidance for goodwill impairment which requires only a single-step quantitative test to identify and measure impairment and record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value. The option to perform a qualitative assessment first for a reporting unit to determine if a quantitative impairment test is necessary does not change under the new guidance. The Company early adopted this guidance in fiscal year 2017. The adoption of this guidance had no impact on the Company’s consolidated financial statements, and did not impact our annual goodwill impairment test performed as of the first day of the third quarter of fiscal year 2017.
In November 2016, the FASB issued new guidance addressing diversity in practice that exists in the classification and presentation of changes in restricted cash in the statements of cash flows. The Company early adopted this guidance retrospectively in fiscal year 2017. Accordingly, changes in restricted cash that have historically been included within operating and financing activities have been eliminated, and restricted cash is combined with cash and cash equivalents when reconciling the beginning and end of period balances for all periods presented. The adoption of this guidance primarily resulted in a decrease of $1.1 million in net cash provided by operating activities for the nine months ended September 24, 2016 and had no impact on the consolidated statements of operations and balance sheets.
In March 2016, the FASB issued new guidance for employee share-based compensation which simplifies several aspects of accounting for share-based payment transactions, including excess tax benefits, forfeiture estimates, statutory tax withholding requirements, and classification in the statements of cash flows. The Company adopted this guidance in fiscal year 2017, which had the following impact on the consolidated financial statements:
On a prospective basis, as required, the Company recorded excess tax benefits of $524 thousand and $7.3 million to the provision for income taxes in the consolidated statements of operations for the three and nine months ended September 30, 2017 , respectively, instead of additional paid-in capital in the consolidated balance sheets. As a result, net income increased $524 thousand and $7.3 million , for the three and nine months ended September 30, 2017 , respectively, and basic and diluted earnings per share increased $0.01 and $0.08 for the three and nine months ended September 30, 2017 , respectively.
Excess tax benefits are presented as operating cash inflows instead of financing cash inflows in the consolidated statements of cash flows, which the Company elected to apply on a retrospective basis. As a result, the Company classified $7.3 million and $2.0 million for the nine months ended September 30, 2017 and September 24, 2016 , respectively, of excess tax benefits as operating cash inflows included within the change in prepaid income taxes, net in the consolidated statements of cash flows. The retrospective reclassification resulted in increases in cash provided by operating activities and cash used in financing activities of $2.0 million for the nine months ended September 24, 2016 .
The Company prospectively excluded the excess tax benefits from the assumed proceeds available to repurchase shares in the computation of diluted earnings per share under the treasury stock method, which did not have a material impact on diluted earnings per share for the three and nine months ended September 30, 2017.

9


Recent accounting pronouncements not yet adopted
Leases
In February 2016, the FASB issued new guidance for lease accounting, which replaces existing lease accounting guidance. The new guidance aims to increase transparency and comparability among organizations by requiring lessees to recognize lease assets and lease liabilities on the balance sheet and requiring disclosure of key information about leasing arrangements. This guidance is effective for the Company in fiscal year 2019 with early adoption permitted, and modified retrospective application is required. The Company expects to adopt this new guidance in fiscal year 2019 and is currently evaluating the impact the adoption of this new guidance will have on the Company’s consolidated financial statements and related disclosures. The Company expects that substantially all of its operating lease commitments will be subject to the new guidance and will be recognized as operating lease liabilities and right-of-use assets upon adoption, thereby having a material impact to its consolidated balance sheet.
Revenue from Contracts with Customers
In May 2014, the FASB issued new guidance for revenue recognition related to contracts with customers, except for contracts within the scope of other standards, which supersedes nearly all existing revenue recognition guidance. The new guidance provides a single framework in which revenue is required to be recognized to depict the transfer of goods or services to customers in amounts that reflect the consideration to which a company expects to be entitled in exchange for those goods or services.
The new guidance is effective for the Company in fiscal year 2018. The Company intends to adopt this new guidance in fiscal year 2018 using the full retrospective transition method, which will result in restating each prior reporting period presented, fiscal years 2016 and 2017, in the year of adoption. Additionally, a cumulative effect adjustment will be recorded to the opening balance of accumulated deficit as of the first day of fiscal year 2016, the earliest period presented. Based on the expected impacts described below, the Company expects such cumulative effect adjustment to be material to the opening balance of accumulated deficit.
The Company expects the adoption of the new guidance to change the timing of recognition of initial franchise fees, including master license and territory fees for our international business, and renewal fees. Currently, these fees are generally recognized upfront upon either opening of the respective restaurant or when a renewal agreement becomes effective. The new guidance will generally require these fees to be recognized over the term of the related franchise license for the respective restaurant, which we expect will result in a material impact to revenue recognized for initial franchise fees and renewal fees. The Company does not expect this new guidance to materially impact the recognition of royalty income. Additionally, rental income is outside the scope of this new guidance, and therefore will not be impacted.
The Company also expects the adoption of this new guidance to change the reporting of advertising fund contributions from franchisees and the related advertising fund expenditures, which are not currently included in the consolidated statements of operations. The Company expects the new guidance to require these advertising fund contributions and expenditures to be reported on a gross basis in the consolidated statements of operations. For the fiscal year ended December 31, 2016, franchisee contributions to the U.S. advertising funds were $430.3 million , and therefore we expect this change to have a material impact to our total revenues and expenses. However, we expect such contributions and expenditures to be largely offsetting and therefore do not expect a significant impact on our reported net income.
Though the majority of the assessment phase is complete, the Company continues to evaluate the impact the adoption of this new guidance will have on these and other revenue transactions, in addition to the impact on accounting policies and related disclosures. Additionally, the Company is in the process of implementing new accounting systems, business processes, and internal controls related to revenue recognition to assist in the application of the new guidance.
(g) Subsequent events
Subsequent events have been evaluated through the date these consolidated financial statements were filed.


10


(3) Franchise fees and royalty income
Franchise fees and royalty income consisted of the following (in thousands):
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Royalty income
$
133,740

 
127,986

 
387,634

 
368,190

Initial franchise fees and renewal income
18,069

 
10,653

 
39,310

 
31,427

Total franchise fees and royalty income
$
151,809

 
138,639

 
426,944

 
399,617

The changes in franchised and company-operated points of distribution were as follows:
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Systemwide points of distribution:
 
 
 
 
 
 
 
Franchised points of distribution in operation—beginning of period
20,242

 
19,640

 
20,080

 
19,308

Franchised points of distribution—opened
326

 
310

 
928

 
988

Franchised points of distribution—closed
(189
)
 
(195
)
 
(629
)
 
(563
)
Net transfers from company-operated points of distribution

 
23

 

 
45

Franchised points of distribution in operation—end of period
20,379

 
19,778

 
20,379

 
19,778

Company-operated points of distribution—end of period

 
6

 

 
6

Total systemwide points of distribution—end of period
20,379

 
19,784

 
20,379

 
19,784

(4) Debt
Securitized Financing Facility
In January 2015, DB Master Finance LLC (the “Master Issuer”), a limited-purpose, bankruptcy-remote, wholly-owned indirect subsidiary of DBGI, issued Series 2015-1 3.262% Fixed Rate Senior Secured Notes, Class A-2-I (the “2015 Class A-2-I Notes”) with an initial principal amount of $750.0 million and Series 2015-1 3.980% Fixed Rate Senior Secured Notes, Class A-2-II (the “2015 Class A-2-II Notes” and, together with the 2015 Class A-2-I Notes, the “2015 Class A-2 Notes”) with an initial principal amount of $1.75 billion . In addition, the Master Issuer issued Series 2015-1 Variable Funding Senior Secured Notes, Class A-1 (the “2015 Variable Funding Notes” and, together with the 2015 Class A-2 Notes, the “2015 Notes”), which allowed the Master Issuer to borrow up to $100.0 million on a revolving basis. The 2015 Variable Funding Notes could also be used to issue letters of credit.
In October 2017, the Master Issuer issued Series 2017-1  3.629%  Fixed Rate Senior Secured Notes, Class A-2-I (the “2017 Class A-2-I Notes”) with an initial principal amount of  $600.0 million  and Series 2017-1  4.030%  Fixed Rate Senior Secured Notes, Class A-2-II (the “2017 Class A-2-II Notes” and, together with the 2017 Class A-2-I Notes, the “2017 Class A-2 Notes”) with an initial principal amount of  $800.0 million . In addition, the Master Issuer issued Series 2017-1 Variable Funding Senior Secured Notes, Class A-1 (the “2017 Variable Funding Notes” and, together with the 2017 Class A-2 Notes, the “2017 Notes”), which allows for the issuance of up to  $150.0 million  of 2017 Variable Funding Notes and certain other credit instruments, including letters of credit. A portion of the proceeds of the 2017 Notes was used to repay the remaining  $731.3 million  of principal outstanding on the 2015 Class A-2-I Notes and to pay related transaction fees. The additional net proceeds will be used for general corporate purposes, which may include a return of capital to the Company’s shareholders. In connection with the issuance of the 2017 Variable Funding Notes, the Master Issuer terminated the commitments with respect to its existing 2015 Variable Funding Notes.
The 2015 Notes and 2017 Notes were each issued in a securitization transaction pursuant to which most of the Company’s domestic and certain of its foreign revenue-generating assets, consisting principally of franchise-related agreements, real estate assets, and intellectual property and license agreements for the use of intellectual property, are held by the Master Issuer and certain other limited-purpose, bankruptcy-remote, wholly-owned indirect subsidiaries of the Company that act as guarantors of the 2015 Notes and 2017 Notes and that have pledged substantially all of their assets to secure the 2015 Notes and 2017 Notes.
The 2015 Notes and 2017 Notes were issued pursuant to a base indenture and related supplemental indentures (collectively, the “Indenture”) under which the Master Issuer may issue multiple series of notes. The legal final maturity date of the 2015 Class A-2-II Notes and 2017 Class A-2 Notes is in February 2045 and November 2047 , respectively, but it is anticipated that, unless

11


earlier prepaid to the extent permitted under the Indenture, the 2015 Class A-2-II Notes will be repaid by February 2022 , the 2017 Class A-2-I Notes will be repaid by November 2024 , and the 2017 Class A-2-II Notes will be repaid by November 2027 (the “Anticipated Repayment Dates”). If the 2015 Class A-2-II Notes or the 2017 Class A-2 Notes have not been repaid or refinanced by their respective Anticipated Repayment Dates, a rapid amortization event will occur in which residual net cash flows of the Master Issuer, after making certain required payments, will be applied to the outstanding principal of the 2015 Class A-2-II Notes and the 2017 Class A-2 Notes. Various other events, including failure to maintain a minimum ratio of net cash flows to debt service (“DSCR”), may also cause a rapid amortization event. Borrowings under the 2015 Class A-2-II Notes, 2017 Class A-2-I Notes, and 2017 Class A-2-II Notes bear interest at fixed rates equal to 3.980% , 3.629% , and 4.030% , respectively. If the 2015 Class A-2-II Notes or the 2017 Class A-2 Notes are not repaid or refinanced prior to their respective Anticipated Repayment Dates, incremental interest will accrue. Principal payments are required to be made on the 2015 Class A-2-II Notes, 2017 Class A-2-I Notes, and 2017 Class A-2-II Notes equal to $17.5 million , $6.0 million , and $8.0 million , respectively, per calendar year, payable in quarterly installments. No principal payments are required if a specified leverage ratio, which is a measure of outstanding debt to earnings before interest, taxes, depreciation, and amortization, adjusted for certain items (as specified in the Indenture), is less than or equal to 5.0 to 1.0. Other events and transactions, such as certain asset sales and receipt of various insurance or indemnification proceeds, may trigger additional mandatory prepayments.
It is anticipated that the principal and interest on the 2017 Variable Funding Notes will be repaid in full on or prior to November 2022 , subject to two additional one-year extensions. Borrowings under the 2017 Variable Funding Notes bear interest at a rate equal to a LIBOR rate plus 1.50% , or the lenders’ commercial paper funding rate plus 1.50% . If the 2017 Variable Funding Notes are not repaid prior to November 2022 or prior to the end of an extension period, if applicable, incremental interest will accrue. In addition, the Company is required to pay a 1.50% fee for letters of credit amounts outstanding and a commitment fee on the unused portion of the 2017 Variable Funding Notes which ranges from 0.50% to 1.00% based on utilization.
As of  September 30, 2017 , approximately  $731.3 million  and  $1.71 billion  of principal were outstanding on the 2015 Class A-2-I Notes and 2015 Class A-2-II Notes, respectively. Total debt issuance costs incurred and capitalized in connection with the issuance of the 2015 Notes were $41.3 million . The effective interest rate, including the amortization of debt issuance costs, was 3.5% and 4.3% for the 2015 Class A-2-I Notes and 2015 Class A-2-II Notes, respectively, as of September 30, 2017 . As noted above, subsequent to September 30, 2017 , a portion of the net proceeds of the 2017 Notes was used to repay the remaining $731.3 million of principal outstanding on the 2015 Class A-2-I Notes.
As of each of September 30, 2017 and December 31, 2016 , $25.9 million of letters of credit were outstanding against the 2015 Variable Funding Notes, which relate primarily to interest reserves required under the Indenture. There were no amounts drawn down on these letters of credit as of September 30, 2017 or December 31, 2016 .
The 2015 Class A-2-II Notes and 2017 Notes are subject to a series of covenants and restrictions customary for transactions of this type, including (i) that the Master Issuer maintains specified reserve accounts to be used to make required payments in respect of the 2015 Class A-2-II Notes and 2017 Notes, (ii) provisions relating to optional and mandatory prepayments, including mandatory prepayments in the event of a change of control as defined in the Indenture and the related payment of specified amounts, including specified make-whole payments in the case of the 2015 Class A-2-II Notes and 2017 Notes under certain circumstances, (iii) certain indemnification payments in the event, among other things, the assets pledged as collateral for the 2015 Class A-2-II Notes and 2017 Notes are in stated ways defective or ineffective, and (iv) covenants relating to recordkeeping, access to information, and similar matters. As noted above, the 2015 Class A-2-II Notes and 2017 Notes are also subject to customary rapid amortization events provided for in the Indenture, including events tied to failure to maintain stated DSCR, failure to maintain an aggregate level of Dunkin’ Donuts U.S. retail sales on certain measurement dates, certain manager termination events, an event of default, and the failure to repay or refinance the 2015 Class A-2-II Notes or the 2017 Notes on the applicable Anticipated Repayment Dates. The 2015 Class A-2-II Notes and 2017 Notes are also subject to certain customary events of default, including events relating to non-payment of required interest, principal, or other amounts due on or with respect to the 2015 Class A-2-II Notes and 2017 Notes, failure to comply with covenants within certain time frames, certain bankruptcy events, breaches of specified representations and warranties, failure of security interests to be effective, and certain judgments.


12


(5) Other current liabilities
Other current liabilities consisted of the following (in thousands):
 
September 30,
2017
 
December 31,
2016
Gift card/certificate liability
$
142,020

 
207,628

Gift card breakage liability
2,668

 
13,301

Accrued payroll and benefits
29,120

 
25,071

Accrued legal liabilities (see note 9 (c))
6,342

 
5,555

Accrued interest
10,621

 
10,702

Accrued professional costs
3,012

 
2,170

Franchisee profit-sharing liability
8,497

 
11,083

Other
28,207

 
22,756

Total other current liabilities
$
230,487

 
298,266

The decrease in the gift card/certificate liability was driven by the seasonality of our gift card program. The franchisee profit-sharing liability represents amounts owed to franchisees from the net profits primarily on the sale of Dunkin’ Donuts brand products such as Dunkin’ K-Cup® pods, retail packaged coffee, and ready-to-drink bottled iced coffee in certain retail outlets.
(6) Segment information
The Company is strategically aligned into two global brands, Dunkin’ Donuts and Baskin-Robbins, which are further segregated between U.S. operations and international operations. As such, the Company has determined that it has four operating segments, which are its reportable segments: Dunkin’ Donuts U.S., Dunkin’ Donuts International, Baskin-Robbins U.S., and Baskin-Robbins International. Dunkin’ Donuts U.S., Baskin-Robbins U.S., and Dunkin’ Donuts International primarily derive their revenues through royalty income and franchise fees. Baskin-Robbins U.S. also derives revenue through license fees from a third-party license agreement and rental income. Dunkin’ Donuts U.S. also derives revenue through rental income. Prior to the sale of all remaining company-operated restaurants in the fourth quarter of fiscal year 2016, Dunkin’ Donuts U.S. also derived revenue through retail sales at company-operated restaurants. Baskin-Robbins International primarily derives its revenues from sales of ice cream products, as well as royalty income, franchise fees, and license fees. The operating results of each segment are regularly reviewed and evaluated separately by the Company’s senior management, which includes, but is not limited to, the chief executive officer. Senior management primarily evaluates the performance of its segments and allocates resources to them based on operating income adjusted for amortization of intangible assets, long-lived asset impairment charges, impairment of our equity method investments, and other infrequent or unusual charges, which does not reflect the allocation of any corporate charges. This profitability measure is referred to as segment profit. When senior management reviews a balance sheet, it is at a consolidated level. The accounting policies applicable to each segment are generally consistent with those used in the consolidated financial statements.
Revenues for all operating segments include only transactions with unaffiliated customers and include no intersegment revenues. Revenues reported as “Other” include revenues earned through certain licensing arrangements with third parties in which our brand names are used, including the licensing fees earned from the Dunkin’ K-Cup® pod licensing agreement and sales of Dunkin’ Donuts branded ready-to-drink bottled iced coffee, revenues generated from online training programs for franchisees, and revenues from the sale of Dunkin’ Donuts products in certain international markets, all of which are not allocated to a specific segment. Revenues by segment were as follows (in thousands):
 
Revenues
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Dunkin’ Donuts U.S.
$
165,106

 
152,425

 
464,148

 
444,898

Dunkin’ Donuts International
5,157

 
4,449

 
14,947

 
16,917

Baskin-Robbins U.S.
13,751

 
13,781

 
38,645

 
38,080

Baskin-Robbins International
28,810

 
27,904

 
88,876

 
89,578

Total reportable segment revenues
212,824

 
198,559

 
606,616

 
589,473

Other
11,344

 
8,540

 
26,746

 
23,711

Total revenues
$
224,168

 
207,099

 
633,362

 
613,184


13


Amounts included in “Corporate” in the segment profit table below include corporate overhead costs, such as payroll and related benefit costs and professional services, net of “Other” revenues reported above. Segment profit by segment was as follows (in thousands):
 
Segment profit
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Dunkin’ Donuts U.S.
$
129,719

 
119,434

 
360,241

 
335,963

Dunkin’ Donuts International
1,439

 
705

 
4,782

 
6,438

Baskin-Robbins U.S.
10,466

 
11,085

 
28,773

 
29,123

Baskin-Robbins International
11,420

 
11,154

 
31,900

 
30,617

Total reportable segments
153,044

 
142,378

 
425,696

 
402,141

Corporate
(25,134
)
 
(27,614
)
 
(82,176
)
 
(84,477
)
Interest expense, net
(23,812
)
 
(24,442
)
 
(72,822
)
 
(74,022
)
Amortization of other intangible assets
(5,341
)
 
(5,397
)
 
(16,001
)
 
(16,726
)
Long-lived asset impairment charges
(536
)
 
(7
)
 
(643
)
 
(104
)
Other income (losses), net
155

 
(124
)
 
370

 
(596
)
Income before income taxes
$
98,376

 
84,794

 
254,424

 
226,216

Net income of equity method investments is included in segment profit for the Dunkin’ Donuts International and Baskin-Robbins International reportable segments. Amounts reported as “Other” in the segment profit table below include the reduction in depreciation and amortization, net of tax, reported by our equity method investees as a result of previously recorded impairment charges. Net income of equity method investments by reportable segment was as follows (in thousands):
 
Net income (loss) of equity method investments
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Dunkin’ Donuts International
$
9

 
351

 
(68
)
 
829

Baskin-Robbins International
4,492

 
4,266

 
9,468

 
8,644

Total reportable segments
4,501

 
4,617

 
9,400

 
9,473

Other
965

 
850

 
3,212

 
2,675

Total net income of equity method investments
$
5,466

 
5,467

 
12,612

 
12,148

(7) Stockholders’ deficit
The changes in total stockholders’ deficit were as follows (in thousands):
 
 
Total stockholders’ deficit
Balance as of December 31, 2016
 
$
(163,258
)
Net income
 
155,417

Other comprehensive income
 
5,031

Dividends paid on common stock
 
(87,911
)
Exercise of stock options
 
33,267

Repurchases of common stock
 
(127,186
)
Share-based compensation expense
 
10,896

Other, net
 
(344
)
Balance as of September 30, 2017
 
$
(174,088
)

14


(a) Treasury stock
During the nine months ended September 30, 2017 , the Company entered into and completed an accelerated share repurchase agreement (the “May 2017 ASR Agreement”) with a third-party financial institution. Pursuant to the terms of the May 2017 ASR Agreement, the Company paid the financial institution  $100.0 million  in cash and received  1,757,568  shares of the Company’s common stock during the nine months ended September 30, 2017 based on a weighted average cost per share of  $56.90  over the term of the May 2017 ASR Agreement.
Additionally, during the nine months ended September 30, 2017 , the Company repurchased a total of  513,880  shares of common stock in the open market at a weighted average cost per share of  $52.90  from existing stockholders.
The Company accounts for treasury stock under the cost method based on the cost of the shares on the dates of repurchase and any direct costs incurred. During the nine months ended  September 30, 2017 , the Company retired  2,271,448  shares of treasury stock repurchased under the May 2017 ASR Agreement and in the open market. The repurchase and retirement of these shares of treasury stock resulted in a decrease in additional paid-in capital of $18.9 million and an increase in accumulated deficit of  $108.3 million .
(b) Equity incentive plans
During the nine months ended September 30, 2017 , the Company granted stock options to purchase 1,181,777 shares of common stock and 90,342 restricted stock units (“RSUs”) to certain employees and members of our board of directors. The stock options generally vest in equal annual amounts over a four -year period subsequent to the grant date, and have a maximum contractual term of seven years. The stock options were granted with a weighted average exercise price of $55.04 per share and have a weighted average grant-date fair value of $9.87 per share. The RSUs granted to employees and members of our board of directors vest in equal annual amounts over a three -year period and a one -year period, respectively, subsequent to the grant date and have a weighted average grant-date fair value of $52.41 per share.
In addition, the Company granted 84,705 performance stock units (“PSUs”) to certain employees during the nine months ended September 30, 2017 . These PSUs are generally eligible to cliff-vest approximately three years from the grant date. Of the total PSUs granted, 37,027 PSUs are subject to a service condition and a market vesting condition linked to the level of total shareholder return received by the Company’s shareholders during the performance period measured against the companies in the S&P 500 Composite Index (“TSR PSUs”). The remaining 47,678 PSUs granted are subject to a service condition and a performance vesting condition based on the level of adjusted operating income growth achieved over the performance period (“AOI PSUs”). The maximum vesting percentage that could be realized for each of the TSR PSUs and the AOI PSUs is 200% based on the level of performance achieved for the respective awards. All of the PSUs are also subject to a one -year post-vesting holding period. The TSR PSUs were valued based on a Monte Carlo simulation model to reflect the impact of the total shareholder return market condition, resulting in a weighted average grant-date fair value of $67.52 per share. The probability of satisfying a market condition is considered in the estimation of the grant-date fair value for TSR PSUs and the compensation cost is not reversed if the market condition is not achieved, provided the requisite service has been provided. The AOI PSUs have a weighted average grant-date fair value of $52.44 per share. Total compensation cost for the AOI PSUs is determined based on the most likely outcome of the performance condition and the number of awards expected to vest based on the outcome.
Total compensation expense related to all share-based awards was $3.6 million and $4.2 million for the three months ended September 30, 2017 and September 24, 2016 , respectively, and $10.9 million and $12.5 million for the nine months ended September 30, 2017 and September 24, 2016 , respectively, and is included in general and administrative expenses, net in the consolidated statements of operations.
(c) Accumulated other comprehensive loss
The changes in the components of accumulated other comprehensive loss were as follows (in thousands):
 
Effect of foreign currency translation
 
Unrealized gains on interest rate swaps
 
Other        
 
Accumulated other comprehensive gain (loss)
Balance as of December 31, 2016
$
(23,019
)
 
1,144

 
(2,109
)
 
(23,984
)
Other comprehensive income (loss), net
5,309

 
(955
)
 
677

 
5,031

Balance as of September 30, 2017
$
(17,710
)
 
189

 
(1,432
)
 
(18,953
)

15


(d) Dividends
The Company paid a quarterly dividend of $0.3225 per share of common stock on March 22, 2017 , June 14, 2017 , and September 6, 2017 totaling approximately $29.6 million , $29.2 million , and $29.1 million respectively. On October 26, 2017 , the Company announced that its board of directors approved the next quarterly dividend of $0.3225 per share of common stock payable December 6, 2017 to shareholders of record as of the close of business on November 27, 2017 .
(8) Earnings per share
The computation of basic and diluted earnings per common share is as follows (in thousands, except for share and per share data):
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Net income—basic and diluted
$
52,246

 
52,712

 
155,417

 
139,456

Weighted average number of common shares:
 
 
 
 
 
 
 
Common—basic
90,290,361

 
91,621,553

 
91,051,458

 
91,603,653

Common—diluted
91,433,076

 
92,565,695

 
92,386,611

 
92,545,292

Earnings per common share:
 
 
 
 
 
 
 
Common—basic
$
0.58

 
0.58

 
1.71

 
1.52

Common—diluted
0.57

 
0.57

 
1.68

 
1.51

The weighted average number of common shares in the common diluted earnings per share calculation includes the dilutive effect of 1,142,715 and 944,142 equity awards for the three months ended September 30, 2017 and September 24, 2016 , respectively, and includes the dilutive effect of 1,335,153 and 941,639 equity awards for the nine months ended September 30, 2017 and September 24, 2016 , respectively, using the treasury stock method. The weighted average number of common shares in the common diluted earnings per share calculation for all periods excludes all contingently issuable equity awards for which the contingent vesting criteria were not yet met as of the fiscal period end. As of September 30, 2017 and September 24, 2016 , there were 150,000 restricted shares that were contingently issuable and for which the contingent vesting criteria were not yet met as of the fiscal period end. Additionally, the weighted average number of common shares in the common diluted earnings per share calculation excludes 1,315,258 and 4,048,878 equity awards for the three months ended September 30, 2017 and September 24, 2016 , respectively, and 1,524,739 and 4,257,237 equity awards for the nine months ended September 30, 2017 and September 24, 2016 , respectively, as they would be antidilutive.
(9) Commitments and contingencies
(a) S upply chain guarantees
The Company has various supply chain agreements that provide for purchase commitments, the majority of which result in the Company being contingently liable upon early termination of the agreement. As of September 30, 2017 and December 31, 2016 , the Company was contingently liable under such supply chain agreements for approximately $118.0 million and $136.2 million , respectively. For certain supply chain commitments, as product is purchased by the Company’s franchisees over the term of the agreement, the amount of the guarantee is reduced. The Company assesses the risk of performing under each of these guarantees on a quarterly basis, and, based on various factors including internal forecasts, prior history, and ability to extend contract terms, we accrued an immaterial amount of reserves related to supply chain commitments as of September 30, 2017 and December 31, 2016 .
(b) Letters of credit
As of each of September 30, 2017 and December 31, 2016 , the Company had standby letters of credit outstanding for a total of $25.9 million . There were no amounts drawn down on these letters of credit.
(c) Legal matters
The Company is engaged in several matters of litigation arising in the ordinary course of its business as a franchisor. Such matters include disputes related to compliance with the terms of franchise and development agreements, including claims or threats of claims of breach of contract, negligence, and other alleged violations by the Company. As of September 30, 2017 and December 31, 2016 , $6.3 million and $5.6 million , respectively, was included in other current liabilities in the consolidated balance sheets to reflect the Company’s estimate of the probable losses incurred in connection with all outstanding litigation.

16


(10) Related-party transactions
(a) Advertising funds
As of September 30, 2017 and December 31, 2016 , the Company had a net payable of $62 thousand and $11.9 million , respectively, to the various advertising funds.
To cover administrative expenses of the advertising funds, the Company charges each advertising fund a management fee for items such as facilities, accounting services, information technology, data processing, product development, legal, administrative support services, and other operating expenses, as well as share-based compensation expense for employees that provide services directly to the advertising funds. Management fees totaled $2.8 million and $2.4 million for the three months ended September 30, 2017 and September 24, 2016 , respectively, and $8.5 million and $7.3 million for the nine months ended September 30, 2017 and September 24, 2016 , respectively. Such management fees are included in the consolidated statements of operations as a reduction in general and administrative expenses, net.
The Company made discretionary contributions to certain advertising funds for the purpose of supplementing national and regional advertising in certain markets of  $33 thousand  and $1.1 million during the three months ended September 30, 2017 and September 24, 2016 , respectively, and $2.3 million and $1.1 million during the  nine months ended   September 30, 2017 and September 24, 2016 , respectively. Additionally, the Company made contributions to the advertising funds based on retail sales at company-operated restaurants of $80 thousand and $594 thousand during the three and nine months ended September 24, 2016 , respectively, which are included in company-operated restaurant expenses in the consolidated statements of operations. No such contributions were made during the three and nine months ended September 30, 2017 , as the Company did not have any company-operated restaurants during these periods. The Company also funded advertising fund initiatives of $700 thousand and $762 thousand during the three months ended September 30, 2017 and September 24, 2016 , respectively, and $1.9 million and $1.8 million during the nine months ended September 30, 2017 and September 24, 2016 , respectively, which were contributed from the gift card breakage liability included within other current liabilities in the consolidated balance sheets (see note 5 ).
(b) Equity method investments
The Company recognized royalty income from its equity method investees as follows (in thousands):
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
B-R 31 Ice Cream Company., Ltd.
$
588

 
686

 
1,464

 
1,577

BR-Korea Co., Ltd.
1,122

 
1,192

 
3,174

 
3,053

 
$
1,710

 
1,878

 
4,638

 
4,630

As of each of September 30, 2017 and December 31, 2016 , the Company had $1.1 million of royalties receivable from its equity method investees, which were recorded in accounts receivable, net of allowance for doubtful accounts, in the consolidated balance sheets.
The Company made net payments to its equity method investees totaling approximately $958 thousand and $713 thousand during the three months ended September 30, 2017 and September 24, 2016 , respectively, and $2.8 million and $2.3 million during the nine months ended September 30, 2017 and September 24, 2016 , respectively, primarily for the purchase of ice cream products.
The Company recognized $702 thousand and $790 thousand during the three months ended September 30, 2017 and September 24, 2016 , respectively, and $2.7 million and $2.5 million during the nine months ended September 30, 2017 and September 24, 2016 , respectively, in the consolidated statements of operations from the sale of ice cream and other products to Palm Oasis Ventures Pty. Ltd. (“Australia JV”). As of September 30, 2017 and December 31, 2016 , the Company had $2.4 million and $2.6 million , respectively, of net receivables from the Australia JV, consisting of accounts and notes receivable, net of current liabilities.
(11) Income taxes
In conjunction with the anticipated closing of the debt refinancing transaction and related issuance of the 2017 Notes (see note 4 ), management assessed the realizability of its unused foreign tax credits by considering whether it is more likely than not that some portion or all of the unused foreign tax credits will not be realized. The ultimate realization of these unused foreign tax credits is dependent upon the generation of future taxable income available to apply such foreign tax credits prior to their

17


expiration in fiscal years 2021 through 2026. In making this assessment, management considered all relevant factors, including projected future taxable income and tax planning strategies. Based upon the level of historical and projected future taxable income over the periods prior to expiration, including the expected incremental interest expense from the 2017 Notes, management does not believe it is more likely than not that the Company will realize the benefit of the unused foreign tax credits. As such, a valuation allowance of $8.9 million was recorded to the provision for income taxes for the three and nine months ended September 30, 2017.


18


Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
Certain statements contained herein are not based on historical fact and are “forward-looking statements” within the meaning of the applicable securities laws and regulations. Generally, these statements can be identified by the use of words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “feel,” “forecast,” “intend,” “may,” “plan,” “potential,” “project,” “should,” or “would,” and similar expressions intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. These forward-looking statements include all matters that are not historical facts.
By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. These risks and uncertainties include, but are not limited to: the ongoing level of profitability of franchisees and licensees; our franchisees and licensees ability to sustain same store sales growth; successful westward expansion; changes in working relationships with our franchisees and licensees and the actions of our franchisees and licensees; our master franchisees’ relationships with sub-franchisees; the strength of our brand in the markets in which we compete; changes in competition within the quick service restaurant segment of the food industry; changes in consumer behavior resulting from changes in technologies or alternative methods of delivery; economic and political conditions in the countries where we operate; our substantial indebtedness; our ability to protect our intellectual property rights; consumer preferences, spending patterns and demographic trends; the impact of seasonal changes, including weather effects, on our business; the success of our growth strategy and international development; changes in commodity and food prices, particularly coffee, dairy products and sugar, and other operating costs; shortages of coffee; failure of our network and information technology systems; interruptions or shortages in the supply of products to our franchisees and licensees; the impact of food borne-illness or food safety issues or adverse public or media opinions regarding the health effects of consuming our products; our ability to collect royalty payments from our franchisees and licensees; uncertainties relating to litigation; the ability of our franchisees and licensees to open new restaurants and keep existing restaurants in operation; our ability to retain key personnel; any inability to protect consumer credit card data and catastrophic events.
Forward-looking statements reflect management’s analysis as of the date of this quarterly report. Important factors that could cause actual results to differ materially from our expectations are more fully described in our other filings with the Securities and Exchange Commission, including under the section headed “Risk Factors” in our most recent annual report on Form 10-K. Except as required by applicable law, we do not undertake to publicly update or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise.
Introduction and overview
We are one of the world’s leading franchisors of quick service restaurants (“QSRs”) serving hot and cold coffee and baked goods, as well as hard serve ice cream. We franchise restaurants under our Dunkin’ Donuts and Baskin-Robbins brands. With more than 20,000 points of distribution in more than 60 countries worldwide, we believe that our portfolio has strong brand awareness in our key markets. QSR is a restaurant format characterized by counter or drive-thru ordering and limited or no table service. As of September 30, 2017 , Dunkin’ Donuts had 12,435 global points of distribution with restaurants in 42 U.S. states, the District of Columbia, and 45 foreign countries. Baskin-Robbins had 7,944 global points of distribution as of the same date, with restaurants in 43 U.S. states, the District of Columbia, Puerto Rico, and 51 foreign countries.
We are organized into four reporting segments: Dunkin’ Donuts U.S., Dunkin’ Donuts International, Baskin-Robbins U.S., and Baskin-Robbins International. We generate revenue from four primary sources: (i) royalty income and franchise fees associated with franchised restaurants, (ii) rental income from restaurant properties that we lease or sublease to franchisees, (iii) sales of ice cream and other products to franchisees in certain international markets, and (iv) other income including fees for the licensing of our brands for products sold in certain retail outlets, the licensing of the rights to manufacture Baskin-Robbins ice cream products sold to U.S. franchisees, refranchising gains, transfer fees from franchisees, and online training fees. Prior to completing the sale of all remaining company-operated restaurants in fiscal year 2016, we also generated revenue from retail store sales at our company-operated restaurants.
Franchisees fund the vast majority of the cost of new restaurant development. As a result, we are able to grow our system with lower capital requirements than many of our competitors. With no company-operated points of distribution during fiscal year 2017, we are less affected by store-level costs, profitability, and fluctuations in commodity costs than other QSR operators.
Our franchisees fund substantially all of the advertising that supports both brands. Those advertising funds also fund the cost of our marketing, research and development, and innovation personnel. Royalty payments and advertising fund contributions typically are made on a weekly basis for restaurants in the U.S., which limit our working capital needs. For the nine months ended September 30, 2017 , franchisee contributions to the U.S. advertising funds were $330.1 million.

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We operate and report financial information on a 52- or 53-week year on a 13-week quarter basis with the fiscal year ending on the last Saturday in December and fiscal quarters ending on the 13th Saturday of each quarter (or 14th Saturday when applicable with respect to the fourth fiscal quarter). The data periods contained within the three- and nine -month periods ended September 30, 2017 and September 24, 2016 reflect the results of operations for the 13-week and 39-week periods ended on those dates. Operating results for the three- and nine -month periods ended September 30, 2017 are not necessarily indicative of the results that may be expected for the fiscal year ending December 30, 2017 .
Selected operating and financial highlights
  Amounts and percentages may not recalculate due to rounding
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Financial data (in thousands):
 
 
 
 
 
 
 
Total revenues
$
224,168

 
207,099

 
633,362

 
613,184

Operating income
122,033

 
109,360

 
326,876

 
300,834

Adjusted operating income
127,910

 
114,764

 
343,520

 
317,300

Net income
52,246

 
52,712

 
155,417

 
139,456

Adjusted net income
55,772

 
55,955

 
165,403

 
149,336

Systemwide sales (in millions):
 
 
 
 
 
 
 
Dunkin’ Donuts U.S.
$
2,166.3

 
2,075.3

 
6,298.4

 
5,997.5

Dunkin’ Donuts International
189.3

 
177.5

 
533.6

 
519.9

Baskin-Robbins U.S.
177.0

 
178.2

 
493.6

 
491.1

Baskin-Robbins International
382.2

 
390.0

 
1,021.8

 
1,006.0

Total systemwide sales
$
2,914.8

 
2,821.0

 
8,347.4

 
8,014.5

Systemwide sales growth
3.3
 %
 
6.3
 %
 
4.2
 %
 
4.8
 %
Comparable store sales growth (decline):
 
 
 
 
 
 
 
Dunkin’ Donuts U.S.
0.6
 %
 
2.0
 %
 
0.5
 %
 
1.4
 %
Dunkin’ Donuts International
1.3
 %
 
(1.4
)%
 
(0.1
)%
 
(2.2
)%
Baskin-Robbins U.S.
(0.4
)%
 
(0.9
)%
 
(1.1
)%
 
1.1
 %
Baskin-Robbins International
(4.3
)%
 
(2.9
)%
 
(1.0
)%
 
(5.5
)%

Our financial results are largely driven by changes in systemwide sales, which include sales by all points of distribution, whether owned by Dunkin’ Brands or by our franchisees and licensees, including joint ventures. While we do not record sales by franchisees, licensees, or joint ventures as revenue, and such sales are not included in our consolidated financial statements, we believe that this operating measure is important in obtaining an understanding of our financial performance. We believe systemwide sales information aids in understanding how we derive royalty revenue and in evaluating our performance relative to competitors.
Comparable store sales growth (decline) for Dunkin’ Donuts U.S. and Baskin-Robbins U.S. is calculated by including only sales from franchisee- and company-operated restaurants that have been open at least 78 weeks and that have reported sales in the current and comparable prior year week. Comparable store sales growth (decline) for Dunkin’ Donuts International and Baskin-Robbins International generally represents the growth in local currency average monthly sales for franchisee-operated restaurants, including joint ventures, that have been open at least 13 months and that have reported sales in the current and comparable prior year month.
Overall growth in systemwide sales of 3.3% and 4.2% for the three- and nine-month periods ended September 30, 2017 over the same periods in the prior fiscal year resulted from the following:
Dunkin’ Donuts U.S. systemwide sales growth of 4.4% and 5.0% for the three and nine months ended September 30, 2017 , respectively, was primarily a result of 386 net new restaurants opened since September 24, 2016 and comparable store sales growth of  0.6%  and  0.5% , respectively. The increases in comparable store sales were driven by increased average ticket, offset by a decline in traffic. Growth was primarily driven by sales of breakfast sandwiches. Beverage sales increased slightly for the three months ended September 30, 2017 , led by hot coffee and espresso, offset by a decline in frozen beverages, while beverage sales decreased slightly for the nine months ended September 30, 2017 due primarily to a decline in hot coffee, offset by an increase in iced coffee, driven by Cold Brew sales.
Dunkin’ Donuts International systemwide sales growth of 6.7% and 2.6% for the three and nine months ended September 30, 2017 , respectively, was primarily due to sales growth in Southeast Asia, the Middle East, South

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America, and China, offset by a decline in South Korea. Systemwide sales for the three-month period was also driven by sales growth in Europe. Systemwide sales growth for the nine-month period was also offset by a sales decline in India. For the three months ended September 30, 2017 , sales in Europe were positively impacted by foreign exchange rates, while sales in Southeast Asia were negatively impacted by foreign exchange rates. For the nine months ended September 30, 2017 , sales in South Korea and South America were positively impacted by foreign exchange rates, while sales in Southeast Asia were negatively impacted by foreign exchange rates. On a constant currency basis, systemwide sales increased by approximately 7% and 2% for the three and nine months ended September 30, 2017 , respectively. Dunkin’ Donuts International comparable store sales grew 1.3% for the three months ended September 30, 2017 , due primarily to growth in Southeast Asia, South America, and the Middle East, offset by declines in South Korea and Europe. Dunkin’ Donuts International comparable store sales declined 0.1% for the nine months ended September 30, 2017 , due primarily to declines in South Korea and Europe, offset by gains in Southeast Asia and South America.
Baskin-Robbins U.S. systemwide sales decline of 0.7% for the three months ended September 30, 2017 was primarily a result of comparable store sales declines of 0.4% for the three months ended September 30, 2017 driven by decreases in sales of sundaes, desserts, and beverages, offset by an increase in take-home products. Systemwide sales growth of 0.5% for the nine months ended September 30, 2017 was driven by the addition of 29 net new restaurants opened since September 24, 2016 , offset by comparable sales decline of 1.1% . For the nine months ended September 30, 2017 , sales of cups and cones, desserts, and beverages decreased, offset by increased sales in take-home products. For the three and nine months ended  September 30, 2017 , traffic declined and average ticket increased.
Baskin-Robbins International systemwide sales decline of 2.0% for the three months ended September 30, 2017 was driven by sales declines in South Korea and Japan, offset by growth in the Middle East and Southeast Asia. Systemwide sales growth of 1.6% for the nine months ended September 30, 2017 was driven by growth in South Korea, Southeast Asia, India, and Canada, offset by declines in Japan, China, Europe, and the Middle East. Sales in Japan were negatively impacted by foreign exchange rates for both the three- and nine-month periods, while sales in South Korea were positively impacted by foreign exchange rates for the nine-month period. On a constant currency basis, systemwide sales increased by approximately 1% and 2% for the three and nine months ended September 30, 2017 , respectively. Baskin-Robbins International comparable store sales declines of 4.3% and 1.0% for the three and nine months ended September 30, 2017 was driven primarily by declines in the Middle East. Also contributing to the decline in comparable store sales for the three months ended September 30, 2017 was a decline in South Korea.
Changes in systemwide sales are impacted, in part, by changes in the number of points of distribution. Points of distribution and net openings as of and for the three and nine months ended September 30, 2017 and September 24, 2016 were as follows:
 
September 30,
2017
 
September 24,
2016
Points of distribution, at period end:
 
 
 
Dunkin’ Donuts U.S.
9,015

 
8,629

Dunkin’ Donuts International
3,420

 
3,379

Baskin-Robbins U.S.
2,562

 
2,533

Baskin-Robbins International
5,382

 
5,243

Consolidated global points of distribution
20,379

 
19,784

 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Net openings (closings) during the period:
 
 
 
 
 
 
 
Dunkin’ Donuts U.S.
67

 
56

 
187

 
198

Dunkin’ Donuts International
18

 
11

 
(10
)
 
60

Baskin-Robbins U.S.
11

 
3

 
24

 
4

Baskin-Robbins International
41

 
45

 
98

 
165

Consolidated global net openings
137

 
115

 
299

 
427

Total revenues for the three months ended September 30, 2017 increased $17.1 million , or 8.2% , due primarily to an increase in franchise fees and royalty income driven by additional renewal income and Dunkin’ Donuts U.S. systemwide sales growth.

21

Table of Contents

Also contributing to the increase in revenues was an increase in other revenues driven by license fees related to Dunkin’ Donuts K-Cup® pods and ready-to-drink bottled iced coffee, as well as increased transfer fee income.
Total revenues for the nine months ended September 30, 2017 increased $20.2 million , or 3.3% , due primarily to an increase in franchise fees and royalty income driven by Dunkin’ Donuts U.S. systemwide sales growth and additional renewal income, as well as an increase in rental income due to an increase in the number of leases for franchised locations. Also contributing to the increase in revenues was an increase in other revenues driven by license fees related to Dunkin’ Donuts K-Cup® pods, offset by timing of refranchising gains. These increases in revenues were offset by a decrease in sales at company-operated restaurants as there were no company-operated points of distribution during 2017.
Operating income and adjusted operating income for the three months ended September 30, 2017 increased $12.7 million , or 11.6% , and $13.1 million , or 11.5% , respectively, from the prior year period primarily as a result of the increase in revenues. The increase in revenues was offset by an increase in general and administrative expenses, as well as gains recognized in connection with the sale of company-operated restaurants in the prior year period.
Operating income and adjusted operating income for the nine months ended September 30, 2017 increased $26.0 million , or 8.7% , and $26.2 million , or 8.3% , respectively, from the prior year period. The increases were primarily a result of the increases in franchise fees and royalty income, rental margin, and other revenues. Additionally, the prior year periods were unfavorably impacted by the operating results of company-operated restaurants. The increases in operating income and adjusted operating income were negatively impacted by gains recognized in connection with the sale of company-operated restaurants in the prior year period, as well an increase in general and administrative expenses.
Net income and adjusted net income for the three months ended September 30, 2017 decreased $0.5 million , or 0.9% , and $0.2 million , or 0.3% , respectively, primarily a result of an increase in income tax expense. Net income and adjusted net income for the nine months ended September 30, 2017 increased $16.0 million , or 11.4% , and $16.1 million , or 10.8% , respectively, primarily as a result of the increases in operating income and adjusted operating income, offset by an increase in tax expense. Income tax expense for the three and nine months ended September 30, 2017 included a valuation allowance recorded on foreign tax credit carryforwards of $8.9 million primarily resulting from expected incremental interest expense from the debt refinancing transaction that closed in October 2017, negatively impacting the realizability of such carryforwards (see note 11 to the unaudited consolidated financial statements included herein). This increase in income tax expense was offset by the increases in operating income and adjusted operating income. Additionally, income tax expense for the nine months ended September 30, 2017 included $7.3 million of excess tax benefits from share-based compensation, which are now included in the provision for income taxes as a result of the required adoption of a new accounting standard in the first quarter of 2017 (see note 2 (f) to the unaudited consolidated financial statements included herein).
Adjusted operating income and adjusted net income are non-GAAP measures reflecting operating income and net income adjusted for amortization of intangible assets, long-lived asset impairments, impairment of our equity method investments, and other non-recurring, infrequent, or unusual charges, net of the tax impact of such adjustments in the case of adjusted net income. We use adjusted operating income and adjusted net income as key performance measures for the purpose of evaluating performance internally. We also believe adjusted operating income and adjusted net income provide our investors with useful information regarding our historical operating results. These non-GAAP measurements are not intended to replace the presentation of our financial results in accordance with GAAP. Use of the terms adjusted operating income and adjusted net income may differ from similar measures reported by other companies.

22

Table of Contents

Adjusted operating income and adjusted net income are reconciled from operating income and net income, respectively, determined under GAAP as follows:
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
 
(In thousands)
Operating income
$
122,033

 
109,360

 
326,876

 
300,834

Adjustments:
 
 
 
 
 
 
 
Amortization of other intangible assets
5,341

 
5,397

 
16,001

 
16,726

Long-lived asset impairment charges
536

 
7

 
643

 
104

Transaction-related costs (a)

 

 

 
64

Bertico and related litigation

 

 

 
(428
)
Adjusted operating income
$
127,910

 
114,764

 
343,520


317,300

Net income
$
52,246

 
52,712

 
155,417

 
139,456

Adjustments:
 
 
 
 
 
 
 
Amortization of other intangible assets
5,341

 
5,397

 
16,001

 
16,726

Long-lived asset impairment charges
536

 
7

 
643

 
104

Transaction-related costs (a)

 

 

 
64

Bertico and related litigation

 

 

 
(428
)
Tax impact of adjustments (b)
(2,351
)
 
(2,161
)
 
(6,658
)
 
(6,586
)
Adjusted net income
$
55,772

 
55,955

 
165,403

 
149,336

(a)
Represents non-capitalizable costs incurred as a result of the securitized financing facility.
(b)
Tax impact of adjustments calculated at a 40% effective tax rate.

Earnings per share
Earnings per share and diluted adjusted earnings per share were as follows:
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
Earnings per share:
 
 
 
 
 
 
 
Common—basic
$
0.58

 
0.58

 
1.71

 
1.52

Common—diluted
0.57

 
0.57

 
1.68

 
1.51

Diluted adjusted earnings per share
0.61

 
0.60

 
1.79

 
1.61

Diluted adjusted earnings per share is calculated using adjusted net income, as defined above, and diluted weighted average shares outstanding. Diluted adjusted earnings per share is not a presentation made in accordance with GAAP, and our use of the term diluted adjusted earnings per share may vary from similar measures reported by others in our industry due to the potential differences in the method of calculation. Diluted adjusted earnings per share should not be considered as an alternative to earnings per share derived in accordance with GAAP. Diluted adjusted earnings per share has important limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Because of these limitations, we rely primarily on our GAAP results. However, we believe that presenting diluted adjusted earnings per share is appropriate to provide investors with useful information regarding our historical operating results.
The following table sets forth the computation of diluted adjusted earnings per share:
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
 
(In thousands, except share and per share data)
Adjusted net income
$
55,772

 
55,955

 
165,403

 
149,336

Weighted average number of common shares—diluted
91,433,076

 
92,565,695

 
92,386,611

 
92,545,292

Diluted adjusted earnings per share
$
0.61

 
0.60

 
1.79

 
1.61



23

Table of Contents

Results of operations
Consolidated results of operations
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
Increase (Decrease)
 
September 30,
2017
 
September 24,
2016
 
Increase (Decrease)
$
 
%
 
$
 
%
 
(In thousands, except percentages)
Franchise fees and royalty income
$
151,809

 
138,639

 
13,170

 
9.5
 %
 
$
426,944

 
399,617

 
27,327

 
6.8
 %
Rental income
27,713

 
26,880

 
833

 
3.1
 %
 
79,543

 
75,874

 
3,669

 
4.8
 %
Sales of ice cream and other products
27,551

 
26,568

 
983

 
3.7
 %
 
85,710

 
86,425

 
(715
)
 
(0.8
)%
Sales at company-operated restaurants

 
1,611

 
(1,611
)
 
(100.0
)%
 

 
11,924

 
(11,924
)
 
(100.0
)%
Other revenues
17,095

 
13,401

 
3,694

 
27.6
 %
 
41,165

 
39,344

 
1,821

 
4.6
 %
Total revenues
$
224,168

 
207,099

 
17,069

 
8.2
 %
 
$
633,362

 
613,184

 
20,178

 
3.3
 %
Total revenues for the three months ended September 30, 2017 increased $17.1 million , or 8.2% , due primarily to an increase in franchise fees and royalty income driven by additional renewal income and Dunkin’ Donuts U.S. systemwide sales growth. Also contributing to the increase in revenues was an increase in other revenues driven by license fees related to Dunkin’ Donuts K-Cup® pods and ready-to-drink bottled iced coffee, as well as increased transfer fee income.
Total revenues for the nine months ended September 30, 2017 increased $20.2 million , or 3.3% , due primarily to an increase in franchise fees and royalty income driven by Dunkin’ Donuts U.S. systemwide sales growth and additional renewal income, as well as an increase in rental income due to an increase in the number of leases for franchised locations. Also contributing to the increase in revenues was an increase in other revenues driven by license fees related to Dunkin’ Donuts K-Cup® pods, offset by timing of refranchising gains. These increases in revenues were offset by a decrease in sales at company-operated restaurants as there were no company-operated points of distribution during 2017.

24

Table of Contents

 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
Increase (Decrease)
 
September 30,
2017
 
September 24,
2016
 
Increase (Decrease)
$
 
%
 
$
 
%
 
(In thousands, except percentages)
Occupancy expenses—franchised restaurants
$
15,333

 
15,881

 
(548
)
 
(3.5
)%
 
$
43,758

 
42,691

 
1,067

 
2.5
 %
Cost of ice cream and other products
19,457

 
18,384

 
1,073

 
5.8
 %
 
58,578

 
58,445

 
133

 
0.2
 %
Company-operated restaurant expenses

 
1,682

 
(1,682
)
 
(100.0
)%
 

 
13,472

 
(13,472
)
 
(100.0
)%
General and administrative expenses, net
61,996

 
59,374

 
2,622

 
4.4
 %
 
185,613

 
184,028

 
1,585

 
0.9
 %
Depreciation and amortization
10,282

 
10,447

 
(165
)
 
(1.6
)%
 
31,097

 
32,087

 
(990
)
 
(3.1
)%
Long-lived asset impairment charges
536

 
7

 
529

 
7,557.1
 %
 
643

 
104

 
539

 
518.3
 %
Total operating costs and expenses
$
107,604

 
105,775

 
1,829

 
1.7
 %
 
$
319,689

 
330,827

 
(11,138
)
 
(3.4
)%
Net income of equity method investments
5,466

 
5,467

 
(1
)
 
(0.0
 )%
 
12,612

 
12,148

 
464

 
3.8
 %
Other operating income, net
3

 
2,569

 
(2,566
)
 
(99.9
)%
 
591

 
6,329

 
(5,738
)
 
(90.7
)%
Operating income
$
122,033

 
109,360

 
12,673

 
11.6
 %
 
$
326,876

 
300,834

 
26,042

 
8.7
 %
Occupancy expenses for franchised restaurants for the three months ended September 30, 2017 decreased $0.5 million due primarily to expenses incurred in the prior year period to record lease-related liabilities as a result of lease terminations. Occupancy expenses for franchised restaurants for the nine months ended September 30, 2017 increased $1.1 million due primarily to to an increase in the number of leases for franchised locations, offset by the expenses incurred in the prior year period to record lease-related liabilities as a result of lease terminations.
Net margin on ice cream and other products for the three and nine months ended September 30, 2017 decreased $0.1 million , or 1.1% , and $0.8 million , or 3.0% , respectively, due primarily to an increase in commodity costs. Additionally, the decrease in net margin on ice cream and other products for the three-month period was offset by an increase in sales volume.
Company-operated restaurant expenses for the three and nine months ended September 30, 2017 decreased $1.7 million and $13.5 million , respectively, as all remaining company-operated points of distribution were sold by the end of fiscal 2016.
General and administrative expenses for the three months ended September 30, 2017 increased $2.6 million driven by increased incentive compensation expense. General and administrative expenses for the nine months ended September 30, 2017 increased $1.6 million due primarily to increased incentive compensation expense and other personnel costs, as well as costs incurred to support brand-building activities, offset by decreases in professional fees and other general expenses.
Depreciation and amortization for the three and nine months ended September 30, 2017 decreased $0.2 million and $1.0 million , respectively, due primarily to certain intangible assets becoming fully amortized and favorable lease intangible assets being written-off upon termination of the related leases.
Long-lived asset impairment charges for each of the three and nine months ended September 30, 2017 increased $0.5 million from the prior year periods. Such charges generally fluctuate based on the timing of lease terminations and the related write-off of favorable lease intangible assets and leasehold improvements.

25

Table of Contents

Net income of equity method investments for the three months ended September 30, 2017 remained consistent with the prior year period. Net income of equity method investments for the nine months ended September 30, 2017 increased $0.5 million primarily as a result of an increase in net income from our Japan joint venture.
Other operating income, net, which includes gains recognized in connection with the sale of real estate, fluctuates based on the timing of such transactions. Other operating income, net, for the  three and nine months ended September 24, 2016  includes gains of $2.5 million and $4.6 million, respectively, recognized in connection with the sale of company-operated restaurants.
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
Increase (Decrease)
 
September 30,
2017
 
September 24,
2016
 
Increase (Decrease)
 
$
 
%
 
$
 
%
 
(In thousands, except percentages)
Interest expense, net
$
23,812

 
24,442

 
(630
)
 
(2.6
)%
 
$
72,822

 
74,022

 
(1,200
)
 
(1.6
)%
Other losses (income), net
(155
)
 
124

 
(279
)
 
(225.0
)%
 
(370
)
 
596

 
(966
)
 
(162.1
)%
Total other expense
$
23,657

 
24,566

 
(909
)
 
(3.7
)%
 
$
72,452

 
74,618

 
(2,166
)
 
(2.9
)%
Net interest expense decreased $0.6 million and $1.2 million for the three and nine months ended September 30, 2017 , respectively, driven primarily by an increase in interest income earned on our cash balances, as well as a decrease in interest expense due to a lower principal balance as a result of principal payments made on our long-term debt since the prior year periods.
The fluctuation in other losses (income), net, for the three and nine months ended September 30, 2017 resulted primarily from net foreign exchange gains and losses driven primarily by fluctuations in the U.S. dollar against foreign currencies.
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
September 30,
2017
 
September 24,
2016
 
(In thousands, except percentages)
Income before income taxes
$
98,376

 
84,794

 
254,424

 
226,216

Provision for income taxes
46,130

 
32,082

 
99,007

 
86,760

Effective tax rate
46.9
%
 
37.8
%
 
38.9
%
 
38.4
%
The increase in the effective tax rate for the three and nine months ended September 30, 2017 was primarily driven by a valuation allowance recorded on foreign tax credit carryforwards of $8.9 million primarily resulting from expected incremental interest expense from the debt refinancing transaction that closed in October 2017, negatively impacting the realizability of such carryforwards (see note 11 to the unaudited consolidated financial statements included herein). This increase in the effective tax rate was offset by excess tax benefits from share-based compensation of $0.5 million and $7.3 million for the three and nine months ended September 30, 2017 , respectively, which are now included in the provision for income taxes as a result of the required adoption of a new accounting standard (see note 2 (f) to the unaudited consolidated financial statements included herein).
Operating segments
We operate four reportable operating segments: Dunkin’ Donuts U.S., Dunkin’ Donuts International, Baskin-Robbins U.S., and Baskin-Robbins International. We evaluate the performance of our segments and allocate resources to them based on operating income adjusted for amortization of intangible assets, long-lived asset impairment charges, and other infrequent or unusual charges, which does not reflect the allocation of any corporate charges. This profitability measure is referred to as segment profit. Segment profit for the Dunkin’ Donuts International and Baskin-Robbins International segments includes net income of equity method investments, except for the other-than-temporary impairment charges and the related reduction in depreciation and amortization, net of tax, on the underlying long-lived assets.
For reconciliations to total revenues and income before income taxes, see note 6 to the unaudited consolidated financial statements included herein. Revenues for all segments include only transactions with unaffiliated customers and include no intersegment revenues. Revenues not included in segment revenues include revenue earned through certain licensing arrangements with third parties in which our brand names are used, revenue generated from online training programs for franchisees, and revenues from the sale of Dunkin’ Donuts products in certain international markets, all of which are not allocated to a specific segment.

26

Table of Contents

Dunkin’ Donuts U.S.
 
Three months ended
 
Nine months ended
 
September 30,
2017
 
September 24,
2016
 
Increase (Decrease)
 
September 30,
2017
 
September 24,
2016
 
Increase (Decrease)
 
$
 
%
 
$
 
%
 
(In thousands, except percentages)
Royalty income
$
118,831

 
113,281

 
5,550

 
4.9
 %
 
$
345,103

 
326,835

 
18,268

 
5.6
 %
Franchise fees
16,635

 
9,852

 
6,783

 
68.8
 %
 
35,943

 
26,257

 
9,686

 
36.9
 %
Rental income
26,786

 
25,972

 
814

 
3.1
 %
 
76,842

 
73,285

 
3,557

 
4.9
 %
Sales at company-operated restaurants

 
1,611

 
(1,611
)
 
(100.0
)%
 

 
11,924