達美樂 (DPZ) 2003 Q4 法說會逐字稿

After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone key pad. If you would like to withdraw your question, press star, then the number two on your telephone key pad. I would like now to turn the conference over to Lynn Liddle. Please go ahead.

Good afternoon, everyone, and thanks for joining us as we discuss the Domino's 2003 financial results. On the call today we have the Domino's Chairman and Chief Executive Officer, David Brandon and Domino's Chief Financial Officer, Harry Silverman. Mr. Brandon and Mr. Silverman are each going to present an overview of our results and then we will open the call to questions.

Members of the media will be in a listen-only mode. You will each be asked to state your name and affiliation as you come up in the queue for questions. As always, I would like to note that while it is not our habit or our intention to make forward-looking statements, if something could be construed as such, we refer to you the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. Our Safe Harbor statement was published in our 2003 earnings release issued this morning and it is also available on our Internet site at www.dominos.com.

Now I would like to turn the call over to the Domino's Chairman and CEO, David Brandon.

Good afternoon and thank you for joining our call today. We're happy to be with you and report another year of continued success at Domino's Pizza. In a minute, our Chief Financial Officer, Harry Silverman, will cover a number of specifics relative to our 2003 financial results. But I wanted to take a few minutes up front here to put those into context, and discuss the broader picture.

First of all, although we're happy to report our strong performance for last year, I am even more proud of our ability to perform over the long haul. Because the pizza business for those of you who have followed it for a while, is like most retail businesses, it has its ups and downs and ebbs and flows, and the advantage of the pizza retail business that we're in is that we're not selling a fad food, but one that has endured as a favorite of people all over the world for a long time.

We lead the pizza delivery segment and we're proud to say that this year marks the third consecutive year that we beat our direct national pizza delivery competitors in same-store sales increases. And it is important to note in light of that, that we have done this by effectively rolling over very positive sales, over positive sales results, not by declaring victory for beating a weaker comp. And we think that that is really important to emphasize, because we continue to build success upon success.

I would also like to take a moment to highlight our performance on the international front. The fourth quarter of 2003 marked an incredible milestone for us. 10 straight years of consecutive quarterly same-store sales increases in our international business. Which is just phenomenal. We're very proud of our team in international. And the accomplishments that they continue to put on the board. And we think it speaks volumes about the strength of this segment of our business.

Turning to the cost side of our business, there has been much in the news of late regarding recent spikes in the price of cheese. And I would just like to give you a little perspective on this. Clearly, cheese is a large component of our cost structure. It is something that we watch very closely. We buy a lot of cheese. I emphasize that we "watch it" rather than predict it, because what we've learned over the last 44 years or so, is that this is a commodity that goes up and it goes down, in cycles, and to the best of our knowledge, there is nobody on this earth that has been able to call the timing of these cycles.

The key learning for us over decades of being in this business, is that those cycles tend to smooth themselves out over time, which is the only prediction that we would make relative to the current situation. In the short term, our challenge will be to ride through this rather unusual cycle of sudden up pressure on cheese prices, and make reasonable adjustments to our price and promotion strategies where appropriate. After the amount of time that we've spent in this business, we realize that cheese goes up and cheese goes down, and so the cycle goes, but our business model has kind of proven its ability to perform well in these kinds of market situations.

Lastly, at the risk of sounding like a broken record, I would like to thank our franchisees. We believe and I think our results indicate that our franchise body is second to none. And we appreciate their continued dedication to this business. We are particularly blessed with the fact that our franchisees own and operate no other businesses besides their Domino's Pizza stores, so their focus is razor sharp and, again, we think that that is a distinguishing characteristic of our franchise system.

They helped us drive a very strong 2003, in terms of store growth. We came just short of 200 net new stores. Which we think is terrific. Particularly in the environment of 2003. And that represents expansion both domestically and internationally. I have great faith in our franchisees continued success, and we never forget the important role they play in the overall trends and positive direction and growth of our company.

I would also be remiss if I failed to mention the outstanding performance of our leadership team and our team members throughout the past year who worked extremely hard and accomplished much during a very challenging year.

With those remarks, I would like to turn things over to Harry to talk more specifically about our 2003 financial performance.

Thanks, Dave and good afternoon and once again thanks for joining us today. Over the next few minutes I would like to provide you with a brief overview of our 2003 financial performance primarily focusing on our full-year results. To start with, I hope everyone has had a chance to look at our press release and our 10-K that was issued earlier this morning.

Now first off, as Dave mentioned, we were very pleased with our financial performance in 2003, especially when you consider the soft economy and global uncertainty that we were operating in for much of the year. Our system-wide sales which represent retail pizza sales at all our company-owned and franchise stores were up 5.8% during the year, and were comprised of domestic sales of over $3 billion and international sales of nearly $1.2 billion.

Domestically, we believe our continued focus on store operations and marketing strategies helped drive our sales success, and in turn enabled us to once a again lead all reporting national pizza chains in same-store sales growth for the third year in a row. On the international front we had another successful year, as Dave noted. 2003 marked our 10th consecutive year of same-store sales growth. We are also very proud to announce that we added 197 stores in 2003. Which actually represents the highest amount of store additions in the past three years.

With that in mind, let's review our details. Our total revenue for fiscal 2003 were slightly over $1.3 billion, up 4.6% for the year. This increase was driven by a 5.8% increase in our systemwide sales, which led to higher royalty revenues, and increased volumes in our distribution centers. In addition, distribution revenues also benefited from higher commodity prices during the year, primarily in the areas of cheese and meats. The average food basket to our stores was up over 4% during the year, primarily driven by a 10% increase in cheese cost from $1.19 to $1.31 per pound.

As for domestic same-store sales growth we led all national reporting pizza chains with an increase of 1.3% versus 2002. Broken down, our franchise stores increased 1.7%, while our company-owned stores decreased 1.7%. One additional item of note, our 1.3% increase was like our successful 2002 and 2001 years in which our domestic stores increased 2.6% and 4% respectively.

During the fourth quarter, our domestic comp sales benefited greatly from the introduction of a new product, our Philly Cheese Steak Pizza. Our comp sales increased 5.1% during this time period, and were comprised of a 5.3% increase in our franchise stores and a 3.2% increase in our company-owned stores.

Again, on the international front, we had a very successful year. For the year, our same-store sales increased 4% on a constant dollar basis and 8% on a historical basis, reflecting a generally weaker U.S. dollar. During the fourth quarter, our constant dollar same-store sales increased 3.6%, marking the 40th consecutive quarter of sales increases.

As for store counts we ended the year with 7,427 store, comprised 577 domestic company-owned stores, 4,327 domestic franchise stores, and 2,523 international stores. During the year, we added 197 stores worldwide, which was a 39-store increase from 2002. If we break this down geographically, we added 56 domestic stores and 141 international stores.

Next let's take a look at our earnings. Our income from operations was $159 million for the year, which was up nearly 1% from 2002 and a record for the Company. Now, included in this total was a $16.8 million G&A charge incurred in connection with our recap this past June. Excluding this charge, our operating income would have been up over 11%.

This increase in operating income was driven by higher system-wide sales in our domestic and international franchise stores, which led to higher royalty income, and increased volumes in our distribution business. In addition, we also benefited from lower nonrecap related G&A expenses during the year, and these positives were offset in part by a higher food cost at our company-owned stores due to the higher food basket that we discussed earlier.

Next let's take a deeper dive into the cost components starting first with cost of sales. During 2003, our consolidated cost of sales as a percent of revenues increase .8% to 74.4%, and again this increase was primarily driven by a 4% increase in our food basket which negatively impacted our company-owned stores and distribution margins. Our domestic company-owned store cost of sales increased 2.2%, to 79.8% in '03. About half this increase was a result of higher food costs. And the remainder was due to higher occupancy costs at our stores, primarily depreciation charges, related to the installation of Domino's Pulse, our point of sales system in the second half of 2002.

Our distribution cost of sales also increased during 2003, as a result of a higher food basket. As a general rule, higher commodity prices had a negative impact on our distribution margin percentages, based on the $6 pricing to our stores for some of our products, including cheese. However, actual dollar margins are generally not impacted by increasing or decreasing commodity prices in our distribution business.

As far as G&A costs, we experienced an increase of $4.1 million to $182 million in '03. This increase was the result of the $16.8 million charge incurred in connection with our recap. As a percent of revenues our total G&A costs were $13.7 million. Excluding this recap charge, our G&A costs would have been 12.4%, versus 14% in 2002. And this decrease as a percent is consistent with our ongoing goal of reducing G&A costs as a percent of revenues each year.

Our net income for 2003 decreased $21.8 million, to $38.8 million. This decrease was due to the charges taken in conjunction with our recap this past June. Our total pretax charges related to the recap were nearly $53 million, or approximately $33 million after tax. Included in the $53 million were G&A expenses, primarily comp of $16.8 million, $15.6 million for the write-off of deferred financing fees, which is included in our interest expense, and $20.4 million of bond tender fees which is included in other expense. Absent these charges our net income would have been significantly higher than reported amounts.

At year-end our total debt stood at approximately $960 million which was up $358 million from year-end 2002. This increase was a result of the recap, whereby we used the proceeds from the recap to retire substantially all of our existing debt, redeem our parent company preferred stock, and pay a common dividend to our parent shareholders. Our year-end debt was largely comprised of senior credit facility debt of $538 million and senior subordinated debt of $415 million. At year end we had approximately $100 million of available borrowings under the $125 million revolver portion of our senior credit facility and all usages were for letters of credit.

The last thing I would like to mention is that our capital expenditures for the year were approximately $29.2 million, as compared to nearly $54 million during 2002. This decrease was primarily the result of installing new computer hardware and software at our company-owned stores in 2002, as part of our project pulse implementation.

This concludes my recap of 2003. All in all, we feel very good about the year we had in 2003 and, as Dave mentioned, attribute much of our success to our strong team members and franchisees. Wit that, Dave and I would like to entertain any questions.

At this time, I would like to remind everyone, if you would like to ask a question, press star, then the number one on your telephone key pad. We'll pause for just a moment to compile the Q&A roster . The first question comes from the line of Jeetil Patel of Deutsche Bank.

Congratulations, guys, on a great and strong year-end. A couple of questions. Wondering if you could give what your cash position and your debt balance is as of today, post -- I'm assuming the $11.2 million that you had basically called once they became callable in January.

Well, I think as everyone knows we did call the bonds it was $11.2 million, and as far as what we paid down to date, we're not going to disclose that today.

Okay. Great. Then if you could maybe give some more specifics regarding the G&A improvement, to the 12.4% versus the 14%. Is there a way to sort of maybe talk about what comprises that 160 basis point improvement?

The main improvements came in the area of labor, administrative labor. Okay. Also, there were improvements in professional fees, travel and entertainment, and one of our goals, and if you look at our numbers over the past several years, has been to continue to bring down our G&A as a percent of sales, so we've been able to grow our revenue, we haven't grown the G&A as much. We take a very hard look at what we call "office overheads" here in our business. As well as, the G&A costs at our stores. And we've been for the most part, been able to keep us flat than going up slightly over the last several years, and that's the primary reason why we've been able to improve on those margins.

Okay. And then I'm wondering if you could give us an idea of any unit expectations for '04, company unit expectations and also maybe Capex or what your rent expense would be in '04?

Okay. This is Dave. I think as it relates to unit growth, we don't really give projections or that number for our forecast in terms of growth, but I think what we've made is a general statement that we think the rate and pace of growth that we've experienced in the recent past is something that we think continues to have significant potential, and is a reasonable expectation, both domestically and internationally. So we don't give guidance on that, but we think that the kind of rate and pace that we've experienced is probably a good proxy. What was your other question?

Rent and Capex for '04.

As far as the rent question, you can see that the number I think was in the mid-30s, versus 20s in the 10-K from last year, a couple of things came into play there. One is that we just made a reclass uncertain of our cost, our common area maintenance, we put into rent expense versus what was categorized in another place before. Also in 2003, we reclassified some of our delivery lease payments out of delivery expense in our commissary business and we put that into rent. For those who are comparing from year over year you can see the increase, it is not because there was an inflationary increase or change in our business, it was a change in classification.

As far as the capital expenditures right now, as you can see, we had a run rate of around $29, $30 million in 2003. We believe we can be somewhat in that range going forward on the operating side of our business. I think we've said before, that we are in the process right now of renovating our world resource center. This is a project we've been working on for several years in the planning stages, 2004 is going to have the bulk of the actual capital being spent, and we are expecting to spend somewhere between $20-25 million dollars this year on the completion of the upgrade and renovation of our headquarters. Operating will be probably in that $30 million range. And the one-time impact of renovating the home office will be in the $20-25 million range.

Okay. Great. And then I guess just my last question, if you could just maybe provide some thoughts and I don't mean for you guys to give out what your competitive edge is, but maybe just some general ideas on terms of new products, and the idea behind this low carb diet and, obviously I read that some people don't believe it is going to really impact pizza sales all that much, but just wondering what you guys tend to think about that, as well as with Pizza Hut's, fit and delicious, and then the four square pizza.

Yeah, it is our belief that news in this category has always been important as a way to drive consumer interest and behavior, and increase interest in your brand. It is probably getting more so as time has worn on here. So we believe that one of the things that we're very proud of, that we built, is a pipeline of product R&D that, frankly, didn't exist before. And it provides us the ability to have a protocol that we follow that we're very disciplined to, from the whole ideation stage, all the way up and through consumer testing, and then out into market test.

We've had more products out in market test in the last couple of years than probably the previous years combined -- several years combined, because we really believe that this is an important growth engine opportunity for the brand. We don't talk about those typically until they're out in the marketplace. Obviously, because the less we talk about them, the further we can get along and maintain a competitive advantage on some of them, because some of them are very unique.

But I feel very good that we have a good, strong pipeline, both existing today, and that we're building for the future that will allow us to compete out there for the attention of the customer in the new product category. Some of the products that are a part of that pipeline will clearly be products that will round out our menu and provide our customers healthy choices. Because we think that's important.

It is also, though, important to point out that we don't feel like we're under the same pressure as a lot of other QSR operators, because our customers get to choose every time they order from Domino's how healthy they want to eat or how healthy they don't want to eat. But we sell a lot of pizzas with double cheese and double pepperoni to people who want to indulge themselves and we are happy to make that sale, but we also sell a lot of pizzas with light cheese and vegetables to people who are very diet-conscious. And our product is adaptable in that way, which is a significant advantage we have over a lot of people who only offer fried food or only offer large sandwiches with high fat content.

So will we be a player in the salad arena? And will we be a player in some of the alternative pizza products that may have extra special health benefits and attributes? We likely will, but we will put those things through our test protocol before we roll them out.

Great. Thank you.

Your next question comes from the line of Jeff Kobelars with Salomon Brothers Asset Management.

Hi, just wanted to get your understanding of the drivers for this higher cheese cost. What are they?

I really wish that we could really impress you right now with our ability to help you understand that. We read the same things that you probably read. There are theories out there about lower levels of milk production, there are theories out there about stronger demand and the depletion of inventory. There is all kinds of talk out there about the economics of being a farmer today, and the population of the herd and grain and feed prices. But we hear all that noise, and other times, and we can't even begin to tell you why cheese has run up to the level that it has as fast as it did. It has run up about 60 cents in a four-week period. So a 43% increase in a four-week period. I don't know that there is any market-based rationale for that, other than the cycles come and the cycles go and that apparently seems to be what's happened with the cheese.

Do you have any feel for how long you think this higher price will continue?

That would require an additional level of brilliance. I'm sorry, I can't offer. We don't know. In the past, for whatever it is worth, medioric [ph] rises tend to set themselves up for medioric falls, but there is no absolutely no basis for that other than that is just kind of a pattern that we've seen from time to time as the cycles come and go. But time will tell.

How do you help your franchisees mitigate this higher cost of cheese?

Well, the interesting thing about our business is that with such a large percentage of the product that we sell on deal, highly sensitive promotional category, about 85% of all the resellers are on deal, is over a period of time, all of us who are engaged in the business of pricing our product as it relates to the kinds of deals that we offer, higher cheese prices get incorporated into our thinking and our planning, and it tends to smooth out through a higher ticket.

Now, the problem that we have in a very short-term sense is when it goes up so much so fast, clearly promotional plans are already set in place. So it takes a little time for us to react, particularly in something as unusual as the circumstance we're in right now. But clearly, the marketplace reacts, pricing adjusts and over time, we tend to see margins recover, even when cheese prices are higher because it is typically done through pricing strategy.

Okay. And can you comment about the competitive environments, in this first calendar quarter? Just in your category?

Yeah, in our category, both of our major national competitors had big guns to shoot in this quarter. They spent a disproportionate amount of their national ad dollars on very large big promotions, anniversary promotions, Super Bowl promotions, big product rollouts. The Pizza Hut product that was mentioned earlier. And so we knew going into this year with both of our competitors, one comping off of, I think two consecutive years of negatives, and the other comping off the two consecutive years of flat sales, we were going up against bigger comps at a time they were going up against easier comps and they were firing a lot of their media and product rollout bullets, so I think when this quarter is all said and done, it will be a quarter where our competitors will have made some advancements and we're hanging in there, we think, pretty well. But that's why you don't look at our business on a quarter-to-quarter basis, because over time, those media schedule, those new product rollouts and those business conditions tend to smooth out.

Okay. Fair enough. And then on your franchisees, do they typically have to take out a loan to enter in a franchisee agreement with you?

Well, we have about 1,350 different stories out there as it relates to the number of franchisees. We have a lot of single-store, and two-store franchisees. Many of them depending on what timing they are in the cycle, they're going out and seeking financing. A lot of our mid to larger site franchisees simply finance the build of the new store through the cash flow, operations of their existing stores.

One of the big advantages of the Domino's concept is that our franchisees can basically build a brand new store, totally up to standards, open up the door and be ready for business at a cost that is less than $200,000. And so typically, our people who are successful can fund a new-store build to a large degree, if they choose to, out of the cash flow from existing operations. But that isn't to say that some of them don't go out there and seek financing. It is really a decision they make on their own and they have independent relationships with those third party financing institutions.

Right. I guess I just was curious, that if the restaurant industry appears to be healthier, there's less price discounting as you noted in your press release, there is not that the dollar menus that were offered a year ago, and I've heard that banks may be a little bit freer about lending to franchisees for expansion. And I'm just curious if you're seeing that turn at all with your franchisees.

We don't really play in that dollar menu thing.

Sure.

So I don't know that we can comment on that. But I would think, if you pulled our franchisees they would probably tell you in the last six months to a year, financing has been a little bit more available for them than what it might have been a year and a half ago.

Okay. Thank you.

I would like to remind everyone, if you would like to ask a question, press star, then the number one on your telephone key pad. The next question comes from the line of Barrett Einont with Banc of America Securities.

Actually, all my questions have been asked. Thanks.

Your next question comes from the line of John Syches with O'Meara.

Yeah, can you just tell us what you have available under the revolver? Is that something you can share with us?

Yeah, under the revolver, it is $125 million instrument of which we have $100 million available today. The $25 million usage right now is for letters of credit.

Okay. All right. That's it. Thanks.

At this time, there are no further questions. Are there any closing remarks?

My only closing remarks is we appreciate you joining us and we're proud of our results in 2003, and we're working hard to make 2004 another year of success for Domino's. Thank you very much.

This concludes today's conference call. You may now disconnect.