達美樂 (DPZ) 2004 Q4 法說會逐字稿

Good morning. My name is Lisa and I will be your conference facilitator. At this time, I would like to welcome everyone to the 2004 annual earnings conference call.

(Operator Instructions)

At this time, I would like to turn the call over to Miss Lynn Liddle, Executive Vice President of Communications and Investor Relations. Miss Liddle, you may begin your conference.

Thank you Lisa, and good morning everyone. Thank you for joining us on our fourth quarter and year-end 2004 conference call.

I would like to remind the members of the media who are on the call that we would appreciate your being on a listen-only mode. We will, as Lisa said, conclude our comments today with a question and answer session.

But I would like to begin by introducing our Chief Executive Officer, Mr. Dave Brandon, who will have a few comments, and then he follow with our Chief Financial Officer, Harry Silverman, who will cover the year's results.

So with that, I will turn it over to Dave.

Thanks Lynn, and good morning everyone. Since our IPO during the summer of last year, we have been explaining our story as best we can, and setting expectations for our company as a relatively new listed company on the New York Stock Exchange. Some of the things that we have continually reinforced over the last several months is the fact that we are a consistent, solid, top-line growth company, and that is driven by steady increases in our same-store sales year after year, as well as store growth. We have told you all along that that is going to come from both domestic and international.

We have suggested time and time again that you not get preoccupied with quarter-to-quarter performance because of the variations that occur as a result of media buys and promotional match-ups on the calendar, competitive activity and the like, because we really think that we are a company and a business model that should be more carefully evaluated over the period of a year.

I'm pleased to report, for those of you who may not realize this, that 2004 marks the 11th consecutive year since Domino's last had a negative same-store sales performance. We think that is a wonderful testimony to the strength of the business model and the consistency that we have delivered year after year after year.

We are a 90% franchised system, which means the majority of our income comes from franchise royalties, which does not require an intense level of extra capital investment required for our growth. It also provides us with the opportunity for continued margin expansion as we leverage our fixed costs while we continue to grow our system.

Although we have a very important corporate store unit for a variety of reasons, it certainly is not the driver of our business results. We actually think we are well positioned because our corporate store unit has significant upside potential, in that the last couple years we have experienced less than, what I would consider to be, optimal performance from that particular unit.

We have great unit economics, many of you are familiar with, as good as anybody in this business. We have a very healthy franchise base, and very, very strong relationships with those franchisees.

We have predictable cashflow, which we can and will continue to deploy to build shareholder value. The first and foremost priority will always be to reinvest in our growing business, which we continue to do. The second thing will be to pay down debt, which we understand is an opportunity as we move forward. Lastly, at least at this particular time, we continue to believe that increasing our dividend and providing our shareholders a current return on the successful cash flow that we generate is a great business strategy.

Based on our belief in our business model and our belief in ourselves and this team that continues to produce consistent and growing results, we feel very comfortable in providing you with long-term guidance, as in terms of what you should expect from Domino's Pizza.

We highlighted these statistics in our press release this morning. They include domestic same-store sales growth in the 1 to 3% range, international same-store sales growth in the 3 to 5% range, net unit growth - net worldwide unit growth in the 200 to 250 store range -- we believe about a third of that will be domestic and the other two-thirds will continue to be international -- that would put us in a position where our global retail sales should continue to grow somewhere in the 4 to 6% range, and all of that will yield us a net income growth opportunity in the range of 11 to 13% as we go forward. That is after we continue to pay what we consider to be a very, very healthy dividend.

Based on our projections for 2005 and the way the year and our budget feels to us right now, we feel confident that we will produce results within these ranges this year. Now Harry is going to conduct a more in-depth review of 2004, but I want to point out how our results reinforce the strengths of our business model.

We met and/or exceeded all of the targets in our long-term guidance in 2004, so we think we are off to a very credible start as it relates to our performance and results. We have had steady same-store sales growth, as well as strong store growth, which has driven, frankly, extraordinarily high global retail sales improvement in 2004.

We generated almost $88 million in free cash flow this past year. As many of you know, we deployed that cash flow along with the proceeds, or at least a significant portion of the proceeds from our IPO, to pay down over $180 million in debt, while we also during this period of time increased our dividend going forward.

I just want to make one final comment as it relates to the dividend. I think you are starting to see a dividend philosophy evolve at Domino's Pizza. We, as part of our announcements this morning, are announcing our decision to increase our annual dividend to $0.40. That is up from the $0.26 that was previously declared late last year. That is a 54% increase.

We have always believed that our cashflow allows us for significant dividends. We started this process late last year during really a sub-year period. Soon after, we became a public company -- that was consistent the message that we sent during our road show. It was our intent to look at this more carefully at the end of the year and in conjunction with the preparation of the budget for the new year. We started out conservatively, but we feel very confident in our business model and our ability to consistently generate free cash flow.

At the current level of $0.40, which is around a 2-plus percent yield, we are one of the highest dividend payout companies in the QSR restaurant sector. We think that is appropriate based on our business model.

Going forward, it is our plan to review this dividend level each year at this time in conjunction with our year-end results, and as we finalize our budget forecast for the new year. We will certainly take a hard look at increasing that dividend appropriately based on our ongoing results.

One of the unique attributes of Domino's is the fact that cash flow is plentiful. It is plentiful enough to not only pay a significant dividend, but also reinvest in the business and de-lever as we feel appropriate along the way. Certainly over the longer term, we will look at a share buyback program as a viable alternative, but we see that as more off in the future based on our current investor profile.

Lastly, I would like to emphasize that together with our EPS growth expectation of 11 to 13% and our growing dividend payout, we are committed to continually and steadily increasing our shareholder value for you, and for all of the other shareholders, many of whom are on this call and continue to have a vested interest in the ongoing success and growth of Domino's Pizza.

With that, I want to turn it over to Harry, so that he can review the quarter and the full-year numbers.

Thanks Dave, and good morning everyone. Over the next few minutes I would like to provide you with a brief update on our fourth quarter financial performance. I would like to set it up by once again reminding everyone that our fourth quarter included a 53rd week this year. Typically our year consists of three 12-week quarters and a 16-week fourth quarter, but this year our fourth quarter had 17 weeks of operating results within it.

Let us jump into our financial results. First off, as Dave said, we were very pleased with our performance in the fourth quarter, as we continued to grow our global retail sales in line with expectation. Our global retail sales increased 14% during the quarter, driven by strong international same-store sales and increases in our total store count. In addition, we benefited from an extra week, which accounted for approximately 6% of the 14% growth.

For the full year, our retail sales were up 10.5%. Our domestic same-store sales decreased 0.2% during the quarter, and was broken down between flat franchise same-store sales and a 0.2% decrease in our corporate store sales.

I would like to take a minute and point out a couple of items related specifically to the fourth quarter. First, during the quarter we were cycling over some very strong comps as a result of the introduction of our highly successful Philly cheese steak pizza in 2003. As Dave and I have said many times, you can and should expect some lumpiness in our quarterly comps as a result of many moving parts, including new promotional ideas, changes in marketing spend, and prior-year results.

However, on an annual basis, when you smooth out these bumps and take a longer-term view, our expectations are to perform in the plus 1 to plus 3% range. For the full year, our domestic same-store sales increased 1.8%, which fell right in the midpoint of our guidance range.

One other item that I would like to point out, is that the 53rd week did not have a positive nor negative impact on the calculation of our same-store sales growth numbers, as we were comparing like weeks in those reported numbers.

Internationally, our same-store sales increased 5.9% on a constant dollar basis, and the fourth quarter marked our 44th consecutive quarter of same-store sales increases. For the full year, our international same-store sales were also up by 0.9%.

As for store counts, the end of the year was 7,757 stores. We are very pleased with the progress we made in adding new units during the year. During the fourth quarter, we added 154 net stores, and for the full year we added 330 stores to our global portfolio. This represented an increase of 133 stores versus last year, and was our highest increase in store count since the year 2000.

Our international markets continued to lead the way in store openings, but we also made strong progress in our domestic markets. Broken down, we added 104 domestic stores and 226 international stores last year.

Now that you have a good understanding of our primary top-line drivers for the quarter, let us shift our attention to the income statement. Total revenues for the fourth quarter were nearly $478 million, which was up 10.5% from a year ago levels. Approximately two-thirds of this increase was attributable to the extra week, and the other third was principally due to higher commodity costs and royalty revenues.

Average cheese block price in the fourth quarter was $1.61 per pound versus $1.53 last year. For the full year the average cheese block was $1.64 versus $1.31 in 2003. As we have often said, we believe global retail sales, not revenues, are the best gauge of our top-line performance, as retail sales are not impacted by changes in store mix or commodity prices. At times, the changes in our revenues can be a deceiving number, and not be reflective of the true health and growth of our business, and as such, we suggest you focus less on changes in our revenues and more on retail sales.

During the fourth quarter, our consolidated operating margin increased $8.8 million to nearly $116 million. The primary drivers behind this increase were higher royalty revenues as well as the inclusion of a 53rd week in the fourth quarter. Offsetting these increases were margin pressures at our company-owned stores, as a result of lower same-store sales and higher commodity prices, (inaudible) cheese cost.

In addition, during the fourth quarter, operating margins were negatively impacted by approximately $3.2 million as a result of a cumulative rent adjustment reported, related to a change in accounting for leases and leasehold improvements.

In percentage terms, our consolidated operating margin was 24.2% of total revenues, which was a decline of 0.5% as compared to last year. As you can see, there were numerous non-operating factors that both positively and negatively impacted our margins during the quarter, including the effect of an extra week, the lease charge, and higher cheese cost.

As part of our press release, we included a section on items affecting comparability, in order to better highlight the impact of these three factors on our operating (inaudible) revenues. If you exclude the positive impact of the 53rd week and the adverse impact of the lease charge and higher cheese cost in our distribution business only, our adjusted operating margin as a percentage of revenues would have actually increased 0.2% versus the reported decline of 0.5%.

As far as G&A cost, we experienced an increase of $3.6 million during the fourth quarter. This increase included approximately $2.6 million of additional expenses incurred as a result of the 53rd week this year. As a percentage of revenues, G&A costs were slightly down versus last year.

Before I finish the line-item review of our income statement, I would like to touch upon our interest expense for the quarter. Our net interest expense was $15.7 million, which was down $4.6 million from last year. This improvement was primarily the result of lower average debt balances, lower effective interest rates, and a reduction in our deferred financing costs, and these were offset by the extra interest expense associated with the 53rd week. Our effective borrowing rate for the fourth quarter was 5.3%, and in addition, at the end of the quarter, 70% of our outstanding debt was fixed.

Next, let us spend a moment and talk about our bottom-line earnings. Our net income for the quarter was $27 million, up from $21.3 million last year. Please keep in mind that 2004 net income was positively impacted by nearly $3 million relating to the inclusion of a 53rd week, offset by approximately $1.7 million related to the lease charge in the fourth quarter. Our EPS for the fourth quarter was $0.38, and that does include an extra $0.02 charge for the lease adjustment.

As far as year-to-date performance, we think it would be more beneficial to focus on our 2004 pro forma net income of $80 million, which not only excludes all costs related to our IPO, but also assumes that the $109 million retirement of our sub-debt notes as part of our IPO occurred on the last business day in 2003.

As far as full-year EPS, we are required to show our EPS numbers based on the capital structure that was in place through 2004, which unfortunately means seven periods of our pre-IPO capital structure, and six periods of our post-IPO structure. As a result, our full-year EPS as reported is a blend of both structures and is not a very meaningful indicator of the past or really what we expect in the future.

However, we have included a full-year pro forma EPS calculation in our press release. It clearly outlines what our EPS would have been (inaudible) post-IPO capital structure been in place at the beginning of 2004.

We believe that this is the most meaningful EPS information that we can present, until we completely cycle through the reporting periods where we are required to report on a pre-IPO capital structure. The full-year EPS number that you should focus on is our pro forma EPS, which was $1.12 in 2004. As mentioned earlier, 2004 EPS was positively impacted by the 53rd week, which we estimate to be about $0.04, and negatively impacted by the change in accounting for leases, which rounds to about $0.03.

Moving to the balance sheet, our total debt stood at approximately $781 million at the end of the year. During 2004, we repaid nearly $181 million of debt including the $109 million in connection with our IPO, and an additional $25 million in the fourth quarter. At the end of the fourth quarter, our leverage ratio was below 3.6 (inaudible) times EBITDA, and this compares to 4.7 leverage ratio at the end of 2003.

Looking at our capital expenditures, we incurred approximately $40 million of cap-ex during 2004, as compared to $29 million last year. This increase relates primarily to the renovation of our World Resource Center, which is expected to be completed in mid-2005. Our overall cap-ex spending came in below our previous expectations of approximately $50 million, as a result of timing on the renovations of our headquarters. We anticipate that 2005 cap-ex spending will include approximately $10 million for the completion of our facility and an additional $25 to $30 million for (inaudible).

Finally, I would like to touch upon our overall free cash flow. As Dave stated earlier, our business model is one that generates significant free cash flow on an annual basis. During 2004, our pro forma free cash flow was approximately $88 million after deducting nearly $40 million of capital expenditures. From that $88 million, we paid down an additional $72 million of debt, and paid our first dividend of $4.5 million. We also ended the year with a cash balance of $40 million.

Based on our operating model going forward, we will have sufficient cash on hand and new cash generated to continue to invest and grow in our business, continue to de-lever in a meaningful way, and comfortably pay a significant dividend to our shareholders.

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)

The first question comes from Mark Kalinowski of Smith Barney.

(inaudible) surprisingly would like to ask about cheese cost. What was the cheese cost per pound in Q4, and just generally speaking -- I know it is not a straight comparison, but nevertheless think it is important to discuss -- at what level of cheese prices would an 11 to 13% EPS growth target become unrealistic?

I will handle the second part of that first. As it relates to how cheese prices will directly impact our ability to maintain that long-range growth rate, we really accommodate the fact that cheese prices are going to swing in that guidance that we are giving you going forward, because we have been dealing with this market swinging back and forth for decades.

The reality is that because of the high promotional content of pricing in the pizza category, when cheese prices go up, as long as we have some time to adjust certainly there will be a short-term hit. But as long as we have time to adjust, what you will find is those promotional price points will be adjusted. And from a margin analysis standpoint over any sustained period of time, we will accommodate those swings.

So again, on a quarter-to-quarter basis you may see choppiness -- you have in the past, you may again in the future. But over any sustained period of time, we believe that that 11 to 13% growth rate will be a good number to use, and a good expectation for our company regardless of swings in cheese prices.

Harry, I will let you give a little bit more texture to the numbers.

Yeah, Mark, for the fourth quarter the cheese price was $1.61 a pound, and that compares to $1.53 in 2003. Just to follow up what Dave said, I think we have mentioned this before in calls, the general rule in rough numbers, corporate margins move by approximately 1% for every $0.22 to $0.25 change in cheese prices.

So it is really difficult to really quantify the true impact that cheese price swings to the bottom line, but as Dave said, over time we are able to mitigate most of these swings through pricing and promotion, given that over 70% of our actual sales are on deals. You can come up with a theoretical impact, but typically, when cheese prices go up you are not hit as hard as you should be, and when cheese prices come down, you do not reap the benefits as high as you expect.

Thank you both.

The next question comes from John Ivanko of J.P. Morgan.

(inaudible) unit growth, it was obviously very strong in the fourth quarter, if you could discuss what the current pipeline is going into 2005. Whether you might be more front-end loaded this year than the fourth quarter, and if there was anything special in the fourth quarter that allowed that number to be so high. I will ask my second question as a follow-up then.

As it relates to store growth in 2004, we were actually surprised by the momentum that we built and maintained through the fourth quarter. I think our unit growth in terms of store openings is always going to be back-loaded a little bit. But that has typically been the case, because operators plan in the early part of the year. They get leases and construction plans underway, and it seems like we see more stores open in the third and fourth quarter.

No question about it, when you compare our results in 2004 versus what we are providing in terms of guidance going forward, it was somewhat of a special year. That was both a combination of some very, very robust growth rates in new store openings and at the same time we did not experience what we had budgeted for store closings, which we certainly look at every year, and will have some close every year.

The combination of a strong year of performance in terms of lack of closings, and a very, very strong fourth quarter, particularly as it relates to openings, it was an unusually strong year. We may have another year going forward where for a variety of reasons in the fourth quarter we may fall a little bit short. The reality is we think that that range we have provided you over time is the right one to use.

Okay, great. David, in your prepared remarks you mentioned some initiatives to drive your company stores in the U.S. Could you comment on sales and profit initiatives that you are currently working on, and when we might see some of those put in to place? Thanks.

As you know, it was really during the early part of the fourth quarter last year where we made a leadership team in our corporate store unit. Patrick Doyle has moved over from international, and put, I would say, a team in place now that we feel very, very confident is going to be able to take our corporate stores to the next level, and put them in a position where they are more competitive with what we are seeing on the franchise side.

Obviously I cannot comment right now on what we have seen so far this year, other than to say that my confidence level is increasing by the day that our corporate store unit has upside in it as a result of what we think we can continue to deliver in terms of results. That is both sales growth and margin. I'm feeling pretty good about where we are today in terms of that being something that we can add onto an already successful business model, and even giving it a little more push.

David, if I may, is there maybe one or two issues that the team is really focused on? Whether it is actual product quality, or it is delivery times, store cleanliness, or what have you. Are there any real hot points at the corporate stores that are different than franchise stores at this point?

Yeah, I wish there was a silver bullet to talk about. There are two main focus points. One is we just really needed to organize a stronger effort around local store marketing, a more entrepreneurial, local marketing effort. Patrick Doyle, based on his experience and the time he spent in build the brand and a very strong marketing-oriented guy, has really brought in, I think, a new, fresh perspective in terms of unleashing some of the creativity at the local level to give our operators at the local market level an opportunity to continue to drive sales (inaudible) compete in their environment. I think that has been helpful and that will continue to be helpful as we move forward.

The other thing is just operations. We have several initiatives under way to provide better service, faster delivery times (inaudible) opportunities that we have to impress our customers and retain our customers better. I think the combination of those two efforts is what it is all about.

Okay, thanks.

The next question comes from Joe Buckley of Bear Stearns.

(inaudible) questions as well. The fourth quarter domestic store-level margins, the company store-level margins, even X-ing out the lease accounting, we are down a couple hundred basis points, does it seem like a lot given the cheese cost comparison? I know you comped down a couple points, but would you walk us through what happened in the quarter to margins?

Joe, I will take this one. Yeah, on an as-reported basis our margins were down 3.1%. We adjust for that, which we did in the back of the press release -- we are actually down about 200 basis points after the 53rd and the lease charge. About half that variance came in food costs. Cheese was up, but it was not really all of it in the fourth quarter. Meats were also up anywhere from 15 to 25% as compared to last year, that would be pepperoni and sausage, which had a pretty big impact.

The other thing that hit us during the quarter, was that we had a little bit higher occupancy cost, and by the actual same-store sales being down a couple percent, we got hit on the leverage. Our actual labor dollars were down, when you look at raw dollars. But when you take it as percentage of sales, it actually had a negative impact there. But again, food costs would have been about half of that decline there in the fourth quarter.

Do you anticipate the meat increases to continue through '05?

You know what, it is kind of like cheese, you try to take your best guess. I think last year meat prices in general were up. I would say we are hoping that we see these costs level off and, if not, come down a bit. To talk about cheese as an example, for instance, today it is $1.44 per pound. You go back about three weeks ago, it was up to $1.70. You go back about three weeks before that, it was back at $1.40. As Dave and I have said so many times, you really just have to play through these margin swings, with the overall commodity costs.

Does any of the fourth quarter margin pressure in the company stores relate to the management change, to the new leadership?

No.

Okay, and then lastly, can we focus through in a little more detail how you get from 5% top-line growth to 11 to 13% bottom-line growth?

Sure, we have done pretty intensive models here for our budget, and basically, without going through all the specifics, we think the revenue growth, the 4 to 6% system-wide sales growth, will get us most of the increase, if you look at an 11% increase in overall EPS. There is really three factors that come into play here. You have got the retail sales going up, which again those dollars are coming in at a high profit margin, because 90% of our business is royalty revenues from franchisees. Also, within that, when we actually grow our store counts it benefits us on the commissary level and thereby you (inaudible)

We are also looking for a little bit of margin improvement in our company-owned stores. As Dave says, we are not happy with our margins right now. We did make some changes this year and we are excited about the possibilities there. And then finally, we are also going to continue to de-leverage here which is also going to add a little bit towards that growth.

But, by far, the bulk of that growth is going to come from the overall increase of 4 to 6% in (inaudible) sales which is going to drive higher (inaudible).

Okay, you are assuming basically 100% flow-through on royalty increases?

On the franchise side, I would not say 100%, but pretty close. At the end of the day, we feel that we have an infrastructure in place here that we do not have to add a lot more people to allow us to continue to open up that 200 to 250 (inaudible) a year. But I think for the most part that should all flow through to the bottom line.

Okay, thank you.

The next question comes from Fred Taylor.

Fred Taylor, Lord, Abbett. Yeah, could you just tell me, even though I heard you, you want to increase the dividend, and maybe not repurchase shares for a while and continue to reduce debt, what are you allowed to repurchase under your bond indentures and your bank agreements?

The bond indenture, we have a restricted basket test, which I think we have plenty of room right now, without going into specifics. Under our bank agreements we do have a pool out there of which we can go back and repurchase shares. (inaudible) Yeah, it is not a huge pool as it stands today, and you are welcome to go pull our bank agreements.

Okay, thank you.

There are no further questions at this time.

Well, this is Dave. I want to thank you all for joining our call, and I want to reemphasize a point that was very important that was just made. That is that the unique characteristics of our business model are one where we can continue to grow our global retail sales in that mid-single-digits area. The nature of this business model provides us that ability to provide you that guidance going forward of 11 to 13%, and continue to pay a very healthy dividend.

We have a great business. We feel like we are in a very good place here in terms of our momentum and our prospects going forward. We appreciate your ongoing support, and we will look forward to talking to you as the result of the results we are putting on the board in the first quarter.

Thank you all very much.

That concludes today's Domino's Pizza conference call. You may now disconnect.