達美樂 (DPZ) 2005 Q2 法說會逐字稿

Good morning, my name is Lindsey and I'll be your conference facilitator today.

At this time, I would like to welcome everyone to the 2005 second quarter earnings conference call.

At this time I would like to turn the call over to Miss Liddle, Executive Vice President of Communications and Investor Relations.

Ms. Liddle, you may begin.

Thanks, Lindsey.

Good morning everybody, and thank you very much for joining us.

As Lindsey mentioned, we will begin with opening remarks from Dave Brandon, the CEO and Chairman of Domino's Pizza, and Harry Silverman, our Chief Financial Officer, and then (inaudible) for question and answer.

To the extent of any forward-looking statements are made during our remarks, I will direct you towards our Safe Harbor statement which is in our earnings release and in the 10-Q, and note that actual results may materially differ.

So with that, I'll turn it over to Dave.

Good morning, everyone.

Once again we're very proud of our results in the second quarter and overall in the first half.

We think they were extraordinary.

And as was our feeling at the end of the first quarter, we feel that our second quarter results exceeded our kind of normal run rate expectations.

Certainly 13.5% increase in global retail sales was something pretty special.

We feel like we've gone through a time period here where just about everything that could go right did go right.

We have a lot of momentum right now, and a lot of good things are happening as a result of that momentum, and so we're feeling pretty good.

We were very pleased with the performance of our promotional events, and the sales that they helped drive during the quarter.

Our advertising message continues to resonate with both existing and new customers, and we feel very good about that.

Although we have no way of determining exactly how much of our increase national ad spending has contributed to this growth, it seems apparent the strategy has certainly enhanced our sales performance.

Our franchisees have seized upon the momentum that we're enjoying and we've worked our new product and new price promotions very hard during this period.

I think we've overall done an adequate job of operating our stores during this high sales growth environment.

Certainly we're experiencing higher sales spikes than we have in the recent past, and it's challenging our operators.

I think our performance has been adequate in the face of this challenge, but this will continue to be an area of opportunity for us as we get better and better at handling these sales spikes.

Team USA our corporate own store unit continued to improve in both sales and profitability, and I continue to be very encouraged with the trend lines that I see there.

Team prices have moderated significantly from the same period last year, easing the cost pressure on our largest cost component, obviously that's a great outcome.

The low volatility in the cheese[ph] market during the first half of the year has been a great benefit to us, versus the roller coaster environment that we were navigating through last year.

Our world wide store counts continue to grow at an accelerated rate with above plan net store growth in both our domestic and international units.

International performance was once again outstanding, as we marked our 46th consecutive quarter of positive same store sales comps.

And there were a couple of notable items.

On the international front, one of our top ten markets, Australia, completed a successful initial public offering.

And I want to single out and congratulate these great franchisees on their continued growth and success in an important market.

Really the only cloud on our international horizon continues to be disappointing performance in one of our two corporate owned international markets, the Netherlands.

All together, we have about 62 Domino's Pizza stores there, 19 of which our Company owns.

We've been experiencing below planned sales growth in these company owned stores for the past couple of years, and we are continuing to consider a number of alternatives as to how to best address and correct the problems there.

But we don't want that to overshadow what is otherwise an incredible, continued, sustained, consistent performance in our international business, and the energy and momentum that we feel here domestically, continues to exist in our international unit.

We believe that 2005 continues to be shaping up as a very special year for us, and is providing us an excellent opportunity to achieve performance that's better than the high end of the range of our stated long-term guidance.

Now at the risk of sounding like a broken record, I feel it's important to remind our investors about the long-term performance metrics of our Company.

We have a marketing philosophy of trying to produce lots of singles and doubles in terms of performance.

We want to be a study performer.

A consistent performer.

We don't knowingly, willingly swing for the fences on any particular promotion or campaign, but sometimes we do hit the ball out of the park, and that's certainly the way we feel as a result of what's been happening in the first half of 2005.

We have very tough comps to roll over in the next quarter.

A plus 8% domestic same store sales hurdle.

We have a lot of momentum right now.

We're feeling very confident and very positive, but we'll clearly need to perform well against this challenging comp if we want to continue to report these positive numbers.

Although 2005 is shaping up to be a year where we will overachieve against our long-term guidance, we still believe that the long range guidance we've provided is an appropriate expectation for Domino's pizza.

For every special year like the one we're experiencing now, we will likely experience a challenging year to offset it, that's just the nature of the business.

But the bottom line is, we're a 45-year-old Company and brand, with a very proven business model that generates significant cash flow.

We have not had a negative full year sales comp in 11 years.

We have shown an ability to produce and sustain long-term reliable performance, and with that we are very proud.

We stated publicly that our long-term goal is to achieve 4 to 6% increases in global retial sales.

Drive 11 to 13% net income growth, and use a portion of our free cash flow to pay a healthy dividend, yielding a 13 to 15% total return for our investors.

That's the goal we're committed to, and it's a goal that we believe is an exciting yet reasonable expectation for our performance over the long range.

All of that being said, I want to reiterate we couldn't be more thrilled with the way 2005 is shaping up for us and our investors, and we commit to you that we will do our very best to take advantage of the momentum that we have, and maximize our financial performance.

With that, I'd like to turn things over to Harry for a more indebt financial review of the quarter.

(inaudible) I'd like to provide you with a brief update on our second quarter financial performance.

First off as Dave said, we simply had an outstanding second quarter.

We were very pleased with the continued progress we made in both our domestic and international markets, and I will discuss each of these in detail on the call.

With that let's start with our top line growth.

Our global retail sales increased 13.5% during the quarter, driven by strong same store sales growth, both in our domestic and international markets, and an increase in our world wide store counts.

As for same store sales, we continued to build on the momentum we generated in the first quarter by posting a 6.9% increase in domestic comps.

Broken down, our Company owned store comps grew 86%.

Same-store sales in our franchise units increased 6.6%.

This strong growth in our comp, once again driven by positive consumer response to our marketing and promotional activities, as well as our continued focus on improving our core operations.

We continue to be encouraged by these domestic results, especially when we look at our Company owned store results and what we accomplished during the first half of the year.

Before we leave domestic same-store sales, I'd like to once again remind you that you can and should expect some swings in our quarterly comps.

This was evidenced in the first two quarters of the year, as we benefited from very successful promotions and were slightly over a period in 2004, when our advertising spending was actually down, and our sales growth was relatively flat.

Keeping that in mind as Dave pointed out, we have some challenging comps in front of us in the third quarter, and we're hoping that our momentum for the first two quarters will help us through the period.

Turning for a moment to our international comps.

We grew our (inaudible) sales by 7.8%, continuing a long record of success in this area of our business.

The second driver behind our increase in sales was the continued growth in our world-wide store portfolio.

During the quarter, we added 79 stores to our portfolio, and over the trailing four quarters we have added nearly 350 units.

We continue to see most of our growth coming from our international segment, which accounted for 65 of the 79 net new stores in the quarter.

And as far as total store counts, we ended the quarter at nearly 7900 stores.

Now that you have a good understanding of primary topline drivers, lets shift our attention to the income statement.

Total revenue for the quarter were $347 million, an increase of 7% from a year ago levels.

Nearly half of this increase was attributable to our domestic franchise and Company owned stores, both of which posted strong increases as a result of higher sales comp.

Our distribution business revenues also benefited from higher domestic retail sales, however these volume increases in revenue were somewhat offset by a lower cheese price in 2005 as compared to 2004.

The average cheese price in the second quarter was $1.51 this year, versus $2.01 last year.

Lastly our consolidated revenues were positively impacted by higher international royalty and distribution revenues.

An important point that I'd like to make about revenues is to remind everyone that we continue to believe global retail sales, not revenues, are a best gauge of our topline performance, since retail sales are not affected by changes in store mix or commodity prices.

And as a great example of this, the decrease in fees prices during the second quarter, negatively impacted our year-over-year revenue comparisons by nearly $3 million, but did not have an impact on our retail sales comparison, which again is by far a more important metrics when your evaluating our performance.

Let's now take a look at our operating margins.

During the quarter our consolidated operating margin increased $10.8 million to $88.4 million.

Higher domestic and international revenues, along with the improved Company-owned store profitability led to the nearly $11 million increase.

In percentage terms, our consolidated operating margin was 15.5% of total revenue, which was an increase of 160 basis points as compared to last year.

The three primary drivers behind this 160 basis point gain were the increases in our high margin loyalty revenues, improvements in our Company-owned store performance, and the reduction in cheese costs as compared to last year.

The last item I'd like to mention in regards to our operating margin is the impact that fluctuations and cheese prices have on our consolidated margin as a percent of revenue.

As we have mentioned before, cheese price changes in our domestic distribution revenues and cost of sales.

And accordingly have no related dollar impact on income.

However, cheese prices changes do impact operating margin as a percent of revenues.

In fact, had the 2005 cheese prices been in effect during the 2004, our second quarter 2004 operating margin as a percent of revenues would have been 24.9% versus the reported 23.9%.

And this would have resulted in a 60 basis point improvement in our second quarter 2005 margin, versus the reported 160 basis point gain.

Still a very significant year-over-year investment even after the adjustment, but lower than the reported number as a result of the cheese fluctuations in our distribution revenue.

Moving on to G&A.

Our G&A costs for the second quarter were $41.8 million, which was an increase of $3.5 million from last year.

This increase was driven by higher variable G&A costs, including higher expenses related to our performance-based bonus plan, which we refer to as team achievement dividend, or TAD, in higher advertisement contributions as a result of higher Company owned store sales.

Now as we have mentioned on a n earlier call, expenses related to our TAD bonus program will fluctuate from quarter-to-quarter, based on how well we perform as compared to our return on plan.

And based on a stronger and budgeted results in the second quarter, our TAD bonus expense increased nearly $1.4 million, as compared to the same period in 2004.

The next item on our income statement that I'd like to address is our interest expense.

Our interest expense for the second quarter was $10.6 million, which was down $3.3 million from last year.

Now this improvement, which primarily was the result of lower average debt balances, and the reduction in our average filing rate.

Also approximately $2.1 million of our interest reduction was a result of our $109 billion (inaudible) callback in the third quarter of 2004.

Our effective borrowing rate for the quarter was 5.3%, which was 50 basis points lower than the second quarter of 2004.

By going forward, we are forecasting our third and fourth quarter effective rate to increase by 60 to 90% basis points, based on higher variable market rates, and the fact that we are rolling off a $300 million floating-to-fix swap agreement, that was priced at 1.62%.

And we're entering a $350 million swap agreement that's priced at 3.2%.

The last item on our income statement that I'd like to touch upon is our pass provision.

Our effective tax rate for the second quarter was 35.2%, which was down from 37.8% last year, as well as the first quarter of 2005.

And this decrease was the result of reversing an approximate $1.1 million international evaluation allowance related to net operating loss deferred tax asset.

As for the remainder of the year, we expect our effective tax rate to range between 37.5 to 38.5%in each of the third and fourth quarters.

Lets look at our bottom line earnings.

Our net income for the quarter was $23.4 million, up from $15.9 million last year.

As for EPS we've posted diluted EPS of $0.35 per share during the quarter, which was a 46% increase over last years pro forma EPS of $0.24 cents.

I'd like to remind everyone that last year's pro forma EPS assumed that our July 2004 IPO occur at the beginning of 2004, and as such, excludes $2.1million of interest expense related to our IPO debt drawback.

Now the 11% increase in EPS was due primarily to an 18.5% increase in our operating income, Lower interest expense, even after adjusting from last year's IPO, and reduction in our tax rate during the quarter, and finally our previously announced $75 million share repurchase at the beginning of the second quarter of 2005.

Moving to the balance sheet, our total debt stood at $771 million the end of the quarter, which was a $19 million increase from the end of the first quarter.

And this increase was primarily the result of borrowing $40 million on a resolver as part of the $75 million a share repurchase, offset by a $25 million revolver loan repayment during the quarter.

And finally, our total leverage ratio stood at 3.3 times at the end of the quarter, which was down from our year end average ratio of 3.6 times.

Looking at our capital expenditures, we incurred approximately $15.2 million of CapEx during the first two quarters of the year, which was down from the $17.6 million in-occurred last year.

We're still comfortable with our 2005 Cap Ex guidance of $20 to $30 million for normalized CapEx, plus approximately $10 million for the completion of our world resource center renovation, for a total of $30 to$40 million of Cap Ex for the year.

This concludes our financial update.

Once again, we want to thank you for your time today.

And with that, Dave and I would like it open it up for questions.

Your first question comes from Joe Buckley with Bear Stearns.

Thank you guys.

A couple of questions.

First on the 555 promotion that you're running here in the third quarter.

One question just in terms of timing.

Did it launch roughly the same time, same week as a year ago?

Is there any differential in that.

And then secondly kid of a broader question on the 555.

This is the third time now you've come to this promotion since first using it a year ago, and just curious.

Either your experience in the past here returning to the same promotion that frequently in that short of time span.

Joe, we try not to get into detailed discussions about our promotional strategies.

I think you have to look at the big picture. we're really pleased with the kind of bag of tricks that we've put together. over the last several months as you've seen the momentum build, and the sales result that we've enjoyed, We're using a terrific blend of local promotions that are operating, that are working really.

We have things that are working very well at the local level on a very, very tactical basis to meet competitive situations.

We've used 555, and it's been effective.

The introduction of cheeseburger pizza as a new product variation was very effective.

So it's no one lever, there's no one magic bullet.

We think we're doing a lot of things right in the promotional area, and the umbrella overall that is an advertising message that continues to resonates with the consumer.

So we're going to continue to use all the various resources that we have at our disposal.

We have a pipeline of test products, that continues to be vibrant, with some good things coming in the future, and so we feel real good about that whole side of the business.

But I hate to get into detailed discussions of any one of those, because truthfully, we think that there is some proprietary nature of where we are competitively in what we may or may not do in the future is up to us.

Just a couple of broad questions looking ahead to '06.

You mentioned a couple of times that '05 is shaping up as a special year, and we'd agree, given the performance you have Should we view '06 a little more cautiously coming off the base of a special year?

And then another promotion question or marketing question.

In general obviously you're boosting up the national ad spend again next year.

Did you test that in markets like the second ramp-up, and you feel pretty confident that you should see a pretty good sales boost from that tactic in '06?

Well obviously we wouldn't, we would not have proposed this to the system, and we would not have gotten 100% support from the system if there wasn't a fair amount of legitimate evidence that there was incremental benefit to be gained from that strategy.

So again without getting into a lot of detail, I would just tell you that when you go up to 1341 franchisees and they ask for unanimous support around a strategy and you get it, it probably indicates that they'are some pretty strong rational behind it.

As it relates to next year, we love the momentum that we're building.

We feel as though we're incremental improving our share and our category, our operators are investing significantly in marketing and store growth.

Those are all indications of an optimism that tends to feed on itself in these businesses.

And so we're going to enter next year with high expectations.

Having said that, there's a certain level of fixation in the financial community on comps, and when you're comping up against quarters they are of the kind that we're putting on the board this year, sure it's going to be challenging.

But we said from day one that don't just view us on our comp on any one quarter.

View us over any period of sustained period of time, and you're going to be impressed with our consistent ability to incrementally improve.

And I think the record is there to prove that.

Thank you.

Your next question comes from John Ivankoe, with JPMorgan.

Thanks.

A couple of questions if I may.

At first as it relates to advertising spending.

Obviously you did increase national for the sake of co-op in '05, and I guess it's going to happen again in '06.

Is there any thought with whether by you or your franchisees of taking up co-op spending or potentially taking up advertising spending in total as opposed to just advertising shifts, as advertising has benefited you so much?

Well, that's the interesting thing that we're looking at John, because as we commit more dollars to the national ads fund level, it's really up to the operators to decide how much they (inaudible) incremental at the local level, and our history has been that better sales are and the more optimism there is out there, the more people are prepared to reinvest in the business.

So we can't predict the future in that regard, but we know that the budgets of the local store marketing level continue to be strong.

Those were not touched in terms of any of these other transitions that we made.

So the local store marketing will continue to be strong and that's important in this category.

We're going to have a significant war chest as it related to the national advertising fund, and our operators at the market level will be able to decide whether they want to enhance their overall investment by doing more on a market-by-market basis.

And I'm sure you'll see a little bit of everything out there.

There's hundreds of different co-ops out there that will make decisions that they feel are appropriate for them in their market conditions.

David, if I may ask you.

Certainly reading the release and listening to your comments, I'm having a little bit of trouble interpreting I guess the conclusion that you want us to take on the third quarter.

Obviously comparisons are more difficult, and that's in the numbers, and you're running the same promotion on a year-over-year basis.

And we're six weeks into the quarter as well.

Is there a clarification of what you'd like to make in terms of, expect something lower in the second quarter, above positive within overall annual comp guidance.

At least I'm a little bit confused in terms of where you want expectations to be end of current quarter.

We're trying not to manage expectations quarter-to-quarter.

We've been clear about that, and we're not in the business of providing short-term forecasts for a variety of reasons.

That I'm sure you understand.

If you're looking for reading between the lines, I think what I've said a couple of time is that we got tremendous momentum, we're optimistic.

We continue to carry that momentum into the third quarter.

I think anyone who is concerned that the first quarter was an anomaly, and now look at the second quarter and see that we got significant momentum, we feel good about our progression.

We are clearly bumping up against the tougher comp, but in terms of profitability and our ability to continue to make this a special year, we feel optimistic.

Okay, that's very good.

And finally as it relates to cheese costs.

As you have pointed out, this is been probably one of the lowest volatility is in cheese costs that I can remember.

Has something changed in the market, and does it begin to make sense at some point you actually entering into contracts and cheese?

Well this is certainly a more stable market than we've seen in the last years, number one, so I agree with that.

Whether this represents some kind of a structural change in the market, I'm way too is superstitious to even suggest that, because if I do, something will happen tomorrow.

And as it relates to contracts, contracts don't make any more sense in this environment than they have in previous environments for all the reasons that we've discussed.

Cheese is a very, very difficult thing to hedge on and I don't know anybody out there doing that effectively because it's a bi-product of milk and cheese doesn't always follow milk, and theses too many moving parts out there, and it would be a very very difficult hedge for us to make.

So as we've done the analysis, we don't plan to hedge.

We're going to continue to follow the market and price against it.

And as a result of that, we feel we're confident steady as she goes mode, and we're hopeful that the cheese market will continue to stay within a more reasonable band of variation week-to-week, quarter-to-quarter, because it's certainly a lot easier to operate in that environment than what we were looking at last year.

Okay great, thanks.

Your next question comes from Mark (inaudible) with Buckingham.

Hi, just a house keeping item, and I apologize if I missed this.

The diluted share count for the second quarter actuals.

Do you happen to have that?

I think it's around $68 million shares.

You can take the net income in the 555 and the EPS will get you pretty close.

There's no exact figure, though?

We'll see if we can get that for you Mark, before the call is over.

Any other questions, Mark?

Not for the conference call, but to look forward to chatting with you later today.

Mark, just go to the queue, and that will give you the numbers where we do the EPS.

Thanks.

Page 7

Page 7 of the queue, Mark Great, thanks.

You bet.

Your next question comes from Steven Weise[ph] from Manford[ph] Capital.

Thank very much.

Dave, it'sgreat to hear after the last conference call made that cheese prices down and now significantly you guys are really achieving a lot of your objectives, so congratulations on that.

A couple of questions regarding some of your raw material and packaging costs.

On the last quarterly call back in May you had mentioned (inaudible) especially packaging., How are you making sure you're keeping the costs low by establishing a better line of communication (inaudible) to improve your overall supply chain efficient?

I think we had the same discussion at the last quarter.

It sounds like the question is almost been read word for word.

We've been at this for 45 years.

We've got very very close relationship with our vendors.

We've been buying virtually the same things for decades.

We buy in massive quantities based on the 5000 plus stores we have domestically and nearly 8,000 stores internationally.

We feel like we have excellent relationships with our vendors.

Their quality companies, and we negotiate as tough a deals as we can to make sure that we provide our franchisees operators the lowest possible costs. and I think that that's a strength of ours.

Beyond that, I don't know exactly what you're looking for.

One thing I've noticed why you guy are able to achieve good results over the last several years qualities always been a top priority within Domino's.

How you guy's make sure that your suppliers are meeting up to your quality standards.

Are you meeting with your global platforms, are you score carding them?

What are you doing to make sure they're meeting your standards?

We have a balanced quality score care approach with every one of our stores.

Every one of our stores receives an unannounced audit at a minimum of two times per year, where our auditors will go in and do a detailed assessment of how the store is operating, and those rankings and ratings are very important to the franchisees.

They are among other reasons become determining factors as to whether we'll even allow a franchisees to grow their store base.

Plus there's a lot of positive recognition and regards that come as a result of those outcomes.

So we have a very comprehensive audit program that we think is very effective, and in addition to that, we have a leadership team here who makes in-aggregate thousands of store visits a year.

It's a very important part of what we all do, and we're out there observing both announced and unannounced basis what's happening in our stores.

So it's a great question, but it's key core of the business, but it's an area again I think that we have focussed on very hard over the last several years, and it's one of the secrets behind our ongoing success.

Final questions.

Do you feel like most of your (inaudible) are willing to work with you, or do some of them feel like they're being in-squeezed since you have alternatives, where are most of them willing to work with you and help you guy out in this economy?

I think when you look at where the world's largest pizza delivery company with nearly 8,000 outlets and been around as long as we have, I think for our vendors we're an important part of our business.

We represent a significant portion of their revenues and their ability to be profitable, and so I think when you have the kind of pencil that we have, here in terms of how much business we do with the vendors, it gives us a great opportunity to have great relationships, negotiate tough, but yet come out with deals that are good for both sides.

So that's an area I think is strength and not one I would be concerned about from an investors prospective.

Thanks.

Congratulations on outstanding results.

Thank you for your kind words, we appreciate it.

At this time there are no questions.

I would like to thank everyone for participating in our call, and let you know that this leadership team continues to being committed to having positive reports like this, and we are absolutely appreciative of your ongoing support.

And we'll look forward to communicating with you again soon.

Have a good day.

Thank you for attending.

You may disconnect.