達美樂 (DPZ) 2004 Q3 法說會逐字稿

Good morning.

My name is Kim, and I will be your conference facilitator.

At this time, I would like to welcome everyone to the third-quarter 2004 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS) At this time, I would now like to introduce Miss Lynn Liddle, Executive Vice President of Communications and Investor Relations.

Good morning, everybody, and thanks for joining us to discuss Domino's third-quarter financial results.

On the call today we're going to have our Chairman and Chief Executive Officer, David Brandon, and our Chief Financial Officer, Harry Silverman.

Mr. Brandon and Mr. Silverman are each going to present an overview of our results, and then we'll open up the call to questions.

Please note that members of the media will be in a listen-only mode, and you will each be asked to state your name and affiliation as you come up in the queue for questions.

We expect this call will take no longer than one hour.

As always, I think it is important to note that our comments will include forward-looking statements which may materially differ from future events, so we will refer you to the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995.

Our Safe Harbor statement was published in our earnings release issued this morning and is also available on our Internet site.

Please also remember that since our IPO, our external reporting and conference calls have focused on the results of Domino's Pizza, Inc., our equity registrant.

These results are substantially similar to those of Domino's, Inc., our wholly-owned sub and debt registrant.

However, if you need specific Domino's, Inc. numbers, I will direct you to footnote 7 of our 10-Q issued this morning for details.

Again, this conference call, though, will discuss the results of Domino's Pizza numbers.

So with that, I'll turn the call over to Dave Brandon, Domino's Chairman and CEO.

Good morning, everyone.

We are pleased to be with you today to report on a very strong quarter.

We are pleased about our across-the-board sales increases, our on-target store growth as we continue to track very (ph) in keeping with our plan relative to the opening of new stores, both domestically and internationally, and a very strong pro forma net income of $60 million or 23 cents in earnings per share.

Before I get into the details of the quarter, I would like to highlight another significant event that was announced today, and that is the declaration of our first quarterly dividend.

As many of you know, this is a fundamental part of our business story insofar as we have the capability to produce very strong cash flow that enables us to pay a significant dividend.

And the dividend that we announced today is 6.5 cents per quarter or 26 cents annualized, which drives a 1.6 percent dividend yield based on yesterday's closing price of $15.90, which we believe is one of the highest yields in the industry.

This is a dividend that is payable on December 15th to shareholders of record at December 1st.

I would like to give you some highlights now for the quarter.

I'm going to keep it relatively brief so I can give Harry Silverman, our Chief Financial Officer, enough time to clarify some of the details pertaining to this quarter.

But clearly, the headlines include the fact that our 12 percent increase in global retail sales was the strongest quarterly sales performance we have had in several years.

Our franchisees were steadfastly behind our promotional strategies for this quarter, and our system as a whole performed extremely well.

Our international business continued its amazingly consistent performance with over 10 years -- that's 43 quarters consecutively, to be exact -- of positive same-store sales growth.

I believe that our continued growth and success in our international business really validates the strategy that we have been following almost since the beginning, in the way that we built our international concept, and that is that we manage controlled growth using the Master franchise model in nearly every country in which we compete around the world.

I would like to shift over to another topic that is important.

One of the many challenges that new public companies face is dealing with the complexities associated with comparing their private company capital structure to their public company capital structure, and that is clearly the case with Domino's.

It is oftentimes tough for investors to understand the true comps, and I don't mean sales comps; those are real easy.

But I'm more referring to financial comps and the financial year-on-year comparisons in the business overall.

We are going to attempt to provide you with the most transparent information we can in order to clarify these issues, and it will only get easier as time goes on and we get into more of a normalized run rate mode.

In fact, Harry is going to take a little extra time with you this morning, more than we normally would, to walk you through much of this to try to help out in every way that we can.

However, we think it is most important to consider how we expect the Company to perform over time, and since Domino's is a single brand and single concept Company, we are not in a position to be able to smooth out sales and earnings performance with consolidated numbers that are a result of a portfolio brand and concepts.

Now while our business is cleaner and easier to understand, it also occasionally creates an uneven comparison from quarter to quarter or even every once in a while year-to-year.

This can be a result of promotional timing or competitive activity, shifts in media buying strategies as we saw this year, or just an unusual performance with a particular new product launch or promotion concept.

However, with all that in mind, the very consistent thing about our business is the earnings and cash flow stream generated by our franchise business model, both domestically and internationally.

This drives very positive overall financial results, which we have consistently delivered over the past 5 years and which have made this Company the leader in the pizza delivery category for nearly 44 years.

As a result, we feel very comfortable in providing you with broad guidance that will serve as a guideline for the expectations of our current and prospective investors with a longer term outlook.

So here is that guidance that I would like to provide, which should be very applicable over any significant period of time.

We expect domestic store growth sales to grow at a 1 to 3 percent range per year.

We expect our international same-store sales to grow at a 3 to 5 percent rate per year.

Our new unit -- and this is net new unit growth -- we expect to be in the 200 to 250 stores per year, with approximately two-thirds of that growth being international and the balance being domestic.

When you take all of those growth assumptions into account, this should drive global retail sales between 4 and 6 percent in terms of growth rates, and our net income growth as a result of all that should be within a range of 11 to 13 percent, and that is after the payment of a significant dividend.

So when you combine this net income growth range of 11 to 13 percent with our ability to use a significant amount of our cash flow to pay dividends to our investors, and the potential over time to increase that dividend as we continue to grow and succeed, we believe that this will drive substantial returns for our investors and create tremendous shareholder value.

With that, I would like to turn it over to Harry for a closer look at the quarter.

Thanks, Dave, and good morning, everyone.

Over the next few minutes, I'd like to provide you with a brief update on our third-quarter financial performance.

I'd like to set this up by reviewing again how our fiscal calendar works.

We operate on 13 four-week periods.

The first 3 quarters include 12 weeks each, but our fourth quarter includes 16 weeks.

Now, every 5th or 6th year, we have a fourth quarter with an extra or 53rd week.

You should note that 2004 is a 53-week year, and as such our fourth quarter will include 17 weeks versus the normal 16.

I hope that everyone's had a chance to review our press release and Form 10-Q that were issued earlier this morning.

As Dave noted, there are numerous challenges and complexities in our financial reporting this quarter, as we are cycling over last year's recap and recording on a quarter that included our IPO.

As a result, I'm going to spend a fair amount of time reviewing each of these anomalies in order for you to get a better picture of our core financial performance.

First up, we were very pleased with our performance in the third quarter, particularly when you consider the competitive business and economic climate that we operate in.

We were proud to report a 12 percent increase in global retail sales during the quarter, driven by strong domestic and international same-store sales and increased store count.

We were also very pleased with our earnings growth after you adjust for all the IPO and recap transaction costs, as well as certain unfavorable year-over-year swings in our G&A costs as I will explain later in greater detail.

With that in mind, let's review our financial results.

Our 12 percent increase in global retail sales was made up of domestic retail sales increase of 9.5 percent and an international increase of nearly 18 percent.

Our domestic same-store sales increased 8 percent during the quarter.

This was broken down between an increase in our company-owned stores of 6.8 percent and an increase in our franchise stores of 8.2 percent.

Both these increases were driven by positive consumer response to our third-quarter promotional and marketing activities.

Internationally, our same-store sales increased 5.9 percent on a constant dollar basis and nearly 10 percent on a historical basis, which takes into account all currency movements.

As for store counts, we ended the third quarter with 7603 stores.

During the quarter we added 73 net stores worldwide, and over the latest 12 months we've added 271 net stores to our portfolio.

Approximately 70 percent or so of those additions have been in our international market.

Now that I've given a good understanding of the topline drivers for the quarter, let's shift our attention to our income statement.

Our total revenue for the third quarter were nearly $325 million, which was up 11 percent from year-ago levels.

Now, a little over 60 percent of this increase was driven by higher distribution revenues, and this is a result of higher volumes and commodity prices, primarily cheese.

The average cheese block price for the third quarter with $1.60 per pound, which was approximately 22 cents higher than the 2003 price.

The remaining 40 percent increase in total revenues was a result of higher company-owned store sales and increased domestic and international franchise royalty revenues.

You have heard this a lot from us before, but as we have stated many times, because we are in the distribution business as well as the QSR business, we believe that our global retail sales, not revenues, are the best gauge of our topline performance because our retail sales are not impacted by changes in store operating mix or commodity prices.

Our revenues do include these factors and are consequently greatly affected by swings in cheese prices and changes in our corporate store portfolio.

And because of this variability in revenues which many times are not reflective of our true operating performance, we suggest you focus less on our changes in our consolidated revenues and more on our retail sales.

During the third quarter, our consolidated operating margin increased by $7.8 million to 79.3 million and was driven primarily by higher global retail sales.

In percentage terms, our consolidated operating margin was 24.4 percent of total revenues, which was flat as compared to 2003.

As noted on prior calls, it is important to keep in mind that higher commodity prices, specifically cheese, have a negative impact on both our company-owned store and distribution margins as a percent of revenues.

However, it is important to understand that changes in cheese costs do not impact our distribution income since these changes are a pass-through in revenues and cost of sales.

If you're interested in the year-over-year impact of cheese prices on our margins, our actual consolidated operating margins would have improved approximately 0.5 percent had cheese prices been constant quarter-over-quarter.

However, we don't view our consolidated operating margin percentage as an important measurement of our operating performance because of the variability in revenues on our different businesses.

We just like to look at the margins on an individual segment basis.

Our G&A costs on an as-reported basis experienced a $1.8 million or 3.7 percent increase during the third quarter.

If you compare our G&A for the third-quarter 2004, backing out the $10 million cost of terminating a management agreement with our sponsor (ph) company with G&A for the third quarter of 2003, backing out our recap expenses of 15.7 million, you will find that our actual G&A increased by $7.5 million during the quarter.

This increase in G&A is compared to 2003 as a result of several factors.

First off, as I mentioned during our second-quarter conference call, in 2003 we benefited from gains on the sale and disposal of certain assets, which resulted in a $3.2 million quarter-over-quarter unfavorable variance in 2004.

And nearly 2.8 million of the $3.2 million gain was recognized on the collection of one specific note relating to the sale of company-owned stores several years ago.

In addition to this $3.2 million swing, in the third quarter of 2003, we recognized another $900,000 gain relating to the collection of a different note, a fully reserved note.

As you can see, these significant gains in 2003 distort our G&A comparisons, as last year's G&A was artificially low, resulting in a larger year-over-year increase in 2004.

In addition, our G&A was impacted during the third quarter as a result of variability in our performance-based compensation plan which we refer to as a Team Achievement Dividend or TAD.

I think it would be helpful for me to briefly explain how our TAD program works.

Each year we set an annual earnings target that is approved by our Board of Directors.

The TAD program is our only variable base plan for salaried team members, including all executive positions, and costs approximately $12 million on an annual basis, assuming we meet our full-year target.

An interesting aspect of the TAD program is that it is self-funding and may increase or decrease based on our overall performance as compared to the board-approved target.

We believe that the TAD program provides the right incentive for our team members to drive profits and create shareholder value, and this program has been in effect at Domino's for the past several years with outstanding results achieved since its inception.

Now, one byproduct of the TAD program being self-funded is that the Company may experience uneven expensing during the year, depending on how the Company is performing versus the board group target at the end of any given quarter.

Again, if the Company is outperforming its targets, TAD costs increase but will be self-funded.

If the Company is underperforming, TAD costs are reduced, creating a savings in our projected G&A cost.

And there is no better example of this than what we experienced during the third quarter this year as a result of our very strong performance.

On a quarter-over-quarter basis, we incurred an incremental $1.6 million of expense during the third quarter as compared to 2003, and this is simply a result of an outstanding quarter that improved our projected position versus our annual TAD target.

Now, though there may be significant swings between quarters, these differences will typically be less pronounced on an annual basis, and we intend to update you each quarter as it relates to any significant swings in our TAD accrual for the year.

Finally, during the third quarter our G&A costs were impacted by higher rent and insurance costs as compared to 2003.

To wrap up our G&A discussion, I will say 2 things.

First, our G&A costs in the third quarter were higher than normal, primarily as a result of the IPO transaction and a higher TAD accrual, and second, management continues to be fully committed to effectively manage our G&A costs as we continue to grow our sales worldwide, and we remain very confident we can do so.

Let's now take a look at our income from operations.

Our income from operations for the third quarter was $28.4 million, which was up nearly 27 percent from 2003.

If you eliminate the transaction costs of our IPO and eliminate the 2003 recap, our income from operations would have increased about 0.5 percent, 0.6 percent.

We were actually very pleased with this increase based on the fact that our company-owned store operating margins continue to be pressured from higher food costs as compared to last year, and we were slightly over the unusual G&A costs as I just detailed.

Before I finish our review of the income statement, I would just like to touch upon 2 additional line items.

First, our interest expense for the quarter was $17.1 million, which was down 13.8 million from 2003.

This improvement or decrease was the result of a $15.6 million financing fee write-off taken in connection with our recap last year, and that was offset in part by a $3.7 million write-off in the current quarter relating to our retirement of $109 million of senior subordinated notes in connection with our IPO proceeds.

Additionally, our interest expense was positively impacted in the third quarter by a reduction in our effective borrowing rates and a decrease in our average outstanding borrowings.

Our effective borrowing rate for the third quarter was 5.6 percent.

In addition, at the end of the quarter, a little over 70 percent of our outstanding debt was fixed.

The other line item on our P&L includes a $9.8 million expense in 2004 and a $20.4 million charge in 2003.

These charges reflect losses incurred in collection with the sub debt retirements in both years. 9 million of the 2004 charge represents the loss incurred on the retirement of the 109 million of subnotes, and the remaining balance represents the loss incurred late in the third quarter as we retired an additional $10 million of subnotes.

As far as it relates to bottom-line earnings, our net income was nearly $1 million for the quarter, up from an $18 million loss last year.

Please keep in mind that both these totals include significant transaction costs related to the IPO and recap, as we've mentioned.

We think it would be more beneficial to focus on our 2004 pro forma net income of 16.1 million, which not only excludes all costs related to the IPO but also assumes that the retirement of the $109 million of subdebt notes occurred on the last day of business in 2003.

As far as EPS, we are required to show our EPS number based on the capital structure that was in place during the third quarter, which unfortunately means one period of our old capital structure and 2 periods of our new structure.

As a result, our EPS as reported is a blend of both structures and is not a very meaningful indicator of what to expect in the future.

However, we have included a pro forma EPS calculation in our press release that clearly outlines what our EPS would have been had our post IPO capital structure been in place at the beginning of 2004, and we believe that this is the most meaningful EPS information that we can provide you until we completely cycle through the reporting period where we are required to report on our old capital structure.

The EPS number that you should focus on is our pro forma EPS, which was 23 cents for the quarter, for the third quarter.

Moving on to the balance sheet, our total debt stood at $804 million at the end the third quarter, down over 155 million from year-end.

Our debt is largely comprised of senior credit facility debt of 513 million and senior subordinated debt of 284 million.

As I mentioned, we retired 109 million of senior subordinated notes in August, using IPO proceeds.

In addition, we have voluntarily delevered another $46 million during 2004, of which 20 million was paid in the third quarter.

And of that $20 million debt reduction in the third quarter, half was used to retire subdebt, and the remainder was used to retire senior credit facility debt.

At the end of the third quarter, our leverage ratio was below 4 times EBITDA, and again 70 percent fixed and 30 percent variable.

Finally, in regards to the CapEx, we incurred approximately $29 million of CapEx during the first 3 quarters of 2004, as compared to 18 million in the first 3 quarters of 2003, and this increase relates primarily to the renovation to our world resource center, which is expected to be completed in early 2005.

Now, although our 2004 full-year CapEx is expected to be approximately $50 million as a result of this renovation, our normalized CapEx expectations remain at $25 to $35 million in 2005 and going forward.

This concludes our financial update.

Once again, we want to thank you for your time today, and with that, Dave and I would like to open it up for questions.

(OPERATOR INSTRUCTIONS) Joe Buckley with Bear Stearns.

I have a couple questions.

First, on the U.S. company margins, 2 questions going in different directions.

Year-over-year given the increase in cheese costs, they were quite impressive, and I wonder if you would talk a little bit about that.

But then also looking sequentially third quarter versus second quarter, they were down despite much better same-store sales performance.

And I'm curious if you would talk about maybe the margin impact of the 5-5-5 promotion, if that is the reason.

Sure, I would love to.

I think year-over-year with the increase in overall sales, that offset some of the, what I would call, increase in cheese costs and increase in labor costs that we experienced.

And also I think as we've mentioned before -- you are referring to company-owned stores, I take it.

Yes.

When you look at the company-owned stores, the insurance cost is a little bit higher than last year and also the rents that were going up again.

When you compare to the second quarter, on a total basis I think it's important to understand that our EPS was down 1 cent from 24 cents to 23 cents, and our operating income was down 900,000 or so.

I think TAD alone, when you look at the change from the second quarter to what was booked versus the third quarter to what was booked, and remember that in the second quarter we had cheese prices at $2.01, and quite frankly our performance was not what we expected so we got hurt a little bit there; the TAD change from one quarter to next was about $1.7 million.

It had a pretty big impact, and again, I bring TAD up one more time.

It's important to understand that during any given year, you are going to have swings.

And quite frankly, those swings may be caused alone by just cheese blocks moving around, and I think you saw that happen from the second to the third quarter.

Other items impacting our operating income from the second to third quarter was that we did have higher labor costs at our stores and in our distribution business, and a big part of that was with the significant sales results that Dave and I talked about, we had significantly more orders out there which took a lot more drivers and a lot more labor.

Also in the third quarter, especially in corporate stores as well as in our distribution company, we had higher utility costs.

Also we had higher delivery costs with gasoline prices going up in our distribution business.

So I think those are the main items that had an impact from quarter to quarter, but again, the TAD was 1.7 million alone of that.

One other item I'd like to bring up when you look at quarter-over-quarter EPS is the fact that in the third quarter we retired $10 million of subdebt and we took a charge of around $750,000 for the premium that we paid, so that also would have hurt our overall EPS number.

If you could talk a little bit more about TAD, you mentioned for the quarter that it was $1.6 million greater year-over-year.

Maybe year-to-date could you share that number with us or if you averaged in the first and second quarters even?

I think year-to-date we're up a little bit from last year, but it's going to be less than the $1.6 million.

Okay, so it was down in the first half year-over-year then.

Right, and down significantly second quarter versus third quarter based on our original operating plan.

And then just on same-store sales, we appreciate the long-term parameters.

Would you kind of go over fourth quarter to date same-store sales numbers?

We are not going to do that, other than to say that we obviously have some real good momentum right now, and we feel really good about this quarter.

Obviously, when you have the kind of momentum that we produced this quarter, this is something that supersedes anything we have seen for years.

Momentum is important in this business and we feel like we've got it, but we will be more specific with you here in 3 months.

The other thing that I think we have pointed out but I will reinforce is the fact that it was a year ago that we introduced what was at that time the most successful new product introduction we've ever had, Philly cheese steak pizza, so that's one of the hurdles we're working to get over here in the fourth quarter.

So we're going up against some very tough numbers, but again, we've got a lot of momentum and we're feeling good.

Okay, thank you.

Mark Kalinowski with Smith Barney.

Two things I wanted to ask about.

First, just regarding the long-term expectations for net unit growth.

Does that represent a slight decrease from what had been communicated in the recent past?

The second is just looking at the overall pizza segment, obviously Domino's enjoyed very good sales strength in the third quarter.

A couple of your national rivals are doing quite well.

What do you think is driving the strength in the category as a whole?

Well, the first answer is that the range of net unit growth of 200 to 250 a year is very consistent with what we have been seeing steadily, and so there is no change there.

I think the only change is, as Harry mentioned, when you look at our performance on a trailing 12-month period, we are actually running ahead of that pace.

So we are currently operating at a level that goes a bit beyond that range, but we still think that range is a very good, conservative range to use in terms of expected growth.

As relates to what's going in the category, I think -- I don't like to comment on what other people are doing, but I think we are doing a very interesting -- we have a very interesting blend right now of news creation, which is really important.

We had a very successful national promotion in the third quarter that was news-oriented, high-value message that worked very well for us.

We are in the process right now of rolling out and introducing a new product offering called Double Melt, which again creates news in a category that I think responds very favorably to successful new product introductions, particularly those products that are highly innovative.

So I think the formula for us is to continue to use the value message and the news message in combination to continue to drive order count as well as ticket, and that is clearly what we have been doing in the recent past and hopefully we can continue that.

Sounds good.

John Emerich with Bricoleur.

A couple of unrelated questions.

I will ask them separately.

First can you walk me through what the unit economics are for opening a store, what it costs and what that store will produce?

Absolutely.

The average Domino's Pizza store will cost about $175,000 to build and open.

That store will on average produce revenues over the period of the year of about 625 to $650,000 so that would be kind of an average sales rate.

And the average EBITDA margins of those stores are between 11 and 12 percent.

And what would on average the rent be?

Because that 175,000 obviously assumes you are leasing the building.

What would the rent be as a percent of sales or in dollars?

The rents on average would be probably somewhere in the neighborhood of around $20,000 on an annual basis.

You would see huge variability there, obviously whether you're talking about one of our midtown Manhattan stores versus one of our rural stores, but that is probably a good average number.

Okay, and then just assuming for the year -- I did not see a cash-flow statement in the press release.

I may have missed it but any color you want to provide there year-to-date in general and specifically assuming you hit your goals as you laid them out long-term for this year as well, what will the 2 big components of free cash flow look like?

I'm talking about cash flow from operations and CapEx.

First up we have a cash-flow statement in the 10-Q, so please take a look at that.

We are not going to provide guidance on our annual number.

What I can tell you is that first up when you look at the cash-flow statement there's a lot of noise in that because of all these transaction costs.

You have to filter out that noise.

In 2003, our reported what we call free cash flow which is cash flow after our capital expenditures was in the neighborhood of around $85 million.

Last year our CapEx was a little bit less than what it's going to be this year.

This year we have the renovation of our World Resource Center, but on a go forward basis, I think if you look at our 2003 cash flow which is fairly clean and looked at our overall income from operations, our segment income numbers that was reported in the 10-Q, I think you'll find that this Company is expected and will continue to generate significant cash flow.

The 10-Q you refer to for this period is not out yet, right?

It should've been out this morning.

October 19, yes, I've got it.

And then the last question you made reference to dividend.

What is the dividend?

The dividend on an annual basis is 26 cents, which is 6.5 cents per quarter.

And based on today's price or yesterday's price that would be about a 1.6 percent yield.

Great, thank you very much.

(OPERATOR INSTRUCTIONS) John Ivankoe with J.P. Morgan.

I have three separate fairly unrelated questions.

The first is on the distribution segment.

If you could maybe focus longer-term in terms of how some of the initiatives are going with you in terms of your vegetable processing and also comment on thin crust and whether that is ready to be selling into the new double melt product.

Then I will ask the other two questions separately.

We are keyed up for double melt very adequately based on the relationships we have other current vendor suppliers.

Thin crust is a product that we feel very comfortable we can produce and will produce likely at some point in the future, but as it stands right now we've got ample supply and very good contracts and that is the situation there.

As it relates to some of the other what I would call integrated processes that we are working on, vegetable processing and the like, those initiatives are in place and being rolled out and we are achieving exactly the results that we projected when we put them together.

What is the separate question?

Yes, maybe for all of us or if I am the only one that is confused, go through the change in the share count between what was said this quarter and was said last quarter, just the mechanics of that.

Sure, basically last quarter we had put out an estimate of 72.6 million shares.

That was right out of the box, and that calculation did not include the windfall tax benefit in the preliminary calculations.

As you can imagine, its very complex and in the treasury method calculation you have to take the income tax benefit that you received from the deduction that the company will receive theoretically if everybody exercised their option.

I think the important thing to focus on is the 71. million share count that we provided which is the appropriate number and that is what everyone's model should be built off of.

That's simple enough.

And finally with gasoline prices I guess at the pumps I guess they should be hitting some record highs does it makes sense for the Company to look at some type of even temporary relief for the drivers?

What is the current philosophy if we go up well into the 2s here?

We have 1350 or so franchisees and each one of them gets to deal with that issue as they deem appropriate, and I think there are some regional differences and local market differences in the way it's being handled.

In some cases the drivers who are already adequately compensated for the cost of operating their automobiles, in other cases I am sure operators are inching up the costs or the allowances that we provide on a per delivery basis.

So I think you'll see things all over the map.

As it relates to our corporate stores, we're making adjustments when and where we deem appropriate, but fundamentally this is an issue where as long as the economic proposition for a driver or a prospective driver is a good one and we can adequately staff our stores, we don't see this as being a significant issue.

And as it stands today we are absolutely able to adequately staff our stores.

The compensation that a driver can earn when they combine their base rate of pay and the allowances we provide for delivery to offset the cost of operating their own automobile and the tips that they receive in combination make that hourly yield something that is still very attractive and consequently even though it has put a little pressure on us in the near term, we don't see it as being particularly onerous or significant.

Okay, that's great.

Thanks.

Randy Parrish with ING Investment Management.

Sir, your line is open at this time.

A follow up question from Joe Buckley with Bear Stearns.

Thank you.

I just wanted to ask a couple of follow-up questions.

In your answer to the prior question on unit economics, the 11 to 12 percent EBITDA margin, how far down in the income statement are you going with that?

Is that for a franchisee including the royalty payments or is that a Company margin?

Talk to little bit about that 11 to 12 percent EBITDA margin.

That is the standard average for our franchise system, Joe, and we quote that simply because that is 90 percent of our system.

And that incorporates the cost of their royalties, the cost of their marketing contribution, it includes the revenues that they receive as a result of their profit-sharing distribution plan, but it also includes paying a manager of the store, and since we have a situation where some 900 of our franchisees own 2 stores or less, in some cases their cash on cash returns can be enhanced by the fact that they may choose to manage that store themselves.

But from a fundamental how does the business operate on a unit economics basis, those numbers I provided is the clear look.

Okay and then a question looking into '05.

Is the game plan for the national ad contribution to kick up 100 basis points still in place and does that become effective in January?

Yes, it becomes effective in January and in essence we're going to be taking a 1 percent of contribution that was previously made at the local co-op level and we are moving that into our national fund, which gives us a significant yield advantage in terms of the amount of gross rating points in the overall share of voice that we can achieve.

And so it is a big idea for us, particularly when you consider the fact that our national promotions have become very powerful drivers of sales and we've had very, very good success and a great track record with them.

Our franchisees were very, very excited about taking some of that local money and putting it into a fund that will allow us to buy a lot more share voice and we are excited about what that could mean for 2005.

Okay and just one last one, would you comment on the recent management changes and just the implications on a go-forward basis?

Sure, corporate stores even though they tend to be one of -- since we are 90 percent franchised and corporate stores as a segment are smaller than some of the other things we spend a lot of time talking about, they are still a very important business unit to us.

We lead by example with those stores, and we also intend to make as much money as we can.

And we believe that there is upside there.

We believe we can operate at a higher level and we can produce better financial results, and I made the decision to make a leadership change there and put in place a member of our leadership team who has done a significantly strong and admirable job over the last 5 years in running our international business.

And that is Patrick Doyle, and this gives Patrick a great opportunity to take over a significant operational unit and add value and hopefully achieve some of the same kind of consistent sales growth and financial results that we've enjoyed on the international side of the business.

So that management change has been made and I have every bit of confidence that Patrick is going to add some value to the overall performance of our corporate portfolio.

Okay and just one final -- I know I keep saying final, but one final one, any differences in media timing that we should be aware of in the fourth quarter?

In the fourth quarter this year, we will probably be a little bit more in a steady state.

We might have a little bit of incremental advantage in the fourth quarter when you look at our total gross rating points versus last year, but we are comparing again a very, very significant and successful promotion last year with the introduction and rollout of Philly cheese, which we certainly spent a significant amount of money against.

We're going to do the same thing with double melt and we will see how the rest of the quarter unfolds.

But all in all there should be a fairly good match up year against year on the media side.

Okay, thank you.

A follow-up from John Emerich with Bricoleur.

A follow-up to the question about unit economics.

How would it change if it were a company unit where you would have to have a manager?

Again, John, the unit economics that I laid out for the franchisee accommodated the average cost of a manager, so those -- that is the EBITDA percentage after you pay a manager to run the store.

The significant differences in corporate stores are driven by the fact that we use corporate stores often times as a testing ground, so we use those stores regularly for testing processes and promotions and equipment and all kinds of technology and all kinds of other things, and certainly that is a drag on their performance.

And it is our experience after decades in this business that an owner/operator franchise model is going to always do better with their local connection in the community, their local store marketing efforts, typically they are just going to do better and typically outpace the corporate system in terms of sales growth and their ability to manage the business that they own.

And so that is one of the reasons why we kind of believe strongly in that model and we have a lower percentage of our stores in the corporate portfolio than the average QSR concept.

With that said, I am new to the investment side of this story.

The unit economics at the franchise level are really phenomenal, and even if I assume that you built the store and added back the rent and kind of doing an apples-to-apples to another bricks and mortar concept, even haircutting for some underperformance of a company-owned store relative to franchisees, these are really great returns.

Is the mix going forward as you open new units still going to be 90 percent franchised, 10 percent company-owned?

Yes, that is our intent, although the great thing about having a franchise agreement, it puts us in a first right of refusal on any transaction is that we always reserve the right if there's a particular market or group of stores that we think will be additive and that we can operate within our existing portfolio.

We will always take a hard look at that deal and if the price is right and the returns are right, we are certainly not afraid to step into those shoes and collect that incremental profit.

But over time our belief has been that franchisees are going to be the best at growing and driving the brand and that has certainly been the success that we've achieved over the many years and one of the reasons why we are the leader in our category.

But our unit economics model is phenomenal.

I think when you compare it against anybody out there and you look at the low cost of entry, which is what the average store costs to build, and you look at the kind of cash on cash returns, if you get the financing capability and put 20 percent down and finance the rest, we have operators out there who are making 60, 70, 80 percent cash on cash returns when they operate stores at the national average and obviously it gets better if they can better the average, which many of our operators do.

I can see that but I guess that -- as good as the returns are there is no better return on capital then a royalty stream, so I understand the Company philosophy.

We're going to do both and we're going to do both to the best of our ability but generally speaking, we believe strongly in our franchisees and that system and its ability to continue to drive our growth.

Thank you, Sir.

At this time there are no further questions.

Are there any closing remarks?

My only closing remarks are to thank all of you for your participation in our call this morning.

We're very proud of the third quarter and we're already fast at work to building results in the fourth quarter that we hope we can be equally as proud of and we will look forward to interacting with you all soon.

Thank you very much.