DNKN: QUESTIONS ABOUT “RELATED-PARTY TRANSACTIONS”

I found this related-party transaction footnote in the DNKN 10Q 10 be of interest:

 

(14) Related-Party Transactions

 

(a)    Advertising Funds

 

At June 25, 2011 and December 25, 2010, the Company had a net payable of $21.3 million and $23.1 million, respectively, to the various advertising funds.”

 

This bullet is important for understanding a key item in the DNKN P&L. 

 

DNKN collects a range from 1.0% to 6.0%, of gross retail sales from Dunkin’ Donuts and Baskin-Robbins franchisees to be used for various forms of advertising for each brand.  For fiscal 2010, franchisee contributions to the U.S. advertising funds were $290.0 million. For the six months of 2011, franchisee contributions to the U.S. advertising funds were $147.8 million.

 

According the 10Q, “the contributions from franchisees in fiscal 2010, are almost exclusively franchisee-funded and cover all expenses related to marketing, advertising and promotion, including market research, production, advertising costs, public relations and sales promotions. We use no more than 20% of the advertising funds to cover the administrative expenses of the advertising funds and for other strategic initiatives designed to increase sales and to enhance the reputation of the brands.”

 

Several things come to mind:

  1. The Franchisees can’t be happy that the company is holding back some of their Advertising funds!
  2. The $21.3 million represents 14% of the advertising funds collected YTD.  If you include another 20% the company spends on administrative expenses the advertising message is weakened.
  3. The franchisee contributions to the U.S. advertising funds of $147.8 million are below the implied rate of growth in points of distribution of 3.6%.
  4. The $23.1 million at December 2010 represents 86% of the 2010 net income. 
  5. The ad fund expensing looks like a big “reserve fund” for a rainy day!  Is there now an earnings charge/change/manipulation potential in the out quarters or years?
  6. Management is in a quiet period so I can’t get much more color on why this payable is on the company’s balance sheet.
  7. I looked at MCD, DIN, WEN, and YUM, (all companies with significant franchise systems) most recent filings and do not see an equivalent entry.

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


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