達美樂 (DPZ) 2005 Q3 法說會逐字稿

At this time I would like to welcome everyone to the third quarter 2005 Domino's Pizza earnings conference call. (OPERATOR INSTRUCTIONS). Ms. Lynn Liddle, Executive Vice President of Communications and Investor Relations, you may begin your conference.

Thank you, everyone, for joining us this morning. On the call today we're going to have Domino's Chairman and Chief Executive Officer, David Brandon. He's calling remotely from Gulfport, Mississippi. And Domino's Chief Financial Officer, Harry Silverman, who is here with us at our World Resource Center in Ann Arbor. David and Harry are each going to present an overview of our third quarter results today, and then we will open the call to questions after they're finished.

I'd like to remind members of the media they will be in a listen-only mode. (OPERATOR INSTRUCTIONS). We expect the call will take no longer than an hour. As always, I need to add that our comments may include some forwarding statements which may materially differ from future events, so we're going to refer you to the Safe Harbor that is published in our earnings release and also available on our website.

Additionally, I'd like to remind everyone about our upcoming investor day in New York City on November 8th. We still have some available space, so if you're interested in attending please contact Marsha Eichle (ph) or Jenny Fouracre (ph) at 734-930-3008. With that I'd like to turn the call over to Dave Brandon, Chief Executive Officer.

Good morning everyone. I'm happy to report another quarter of strong performance for Domino's Pizza. I'm extremely proud of our results, with EPS of over up over 30% and global retail sales up almost 8% despite year ago comps that we as we all know were very challenging.

Domestic same-store sales were up 1.1% and frankly, we would have called flat performance versus our plus 8% a year ago, a big win. So we feel this kind of performance lapping the very special quarter a year ago is something we take great satisfaction and pride in.

We succeeded on the international front as well, with same-store sales up 4.5% and we were rolling over a nearly 6% increase a year ago. Overall I would say the momentum we had in the first half of 2005 carried right into the third quarter and we've enjoyed the continuation of that momentum.

This is the sixth earnings conference call that we've conducted as a public Company, and I'm proud of the fact we continue to deliver positive sales and earnings which reinforce the steady and dependable nature of our business model. And we continue to build trust with our investors as they learn more about the way our business performs even during some very challenging times.

Before Harry gets into the specifics of our financial performance, I'd like to review a few important topics that should be of interest to you. We made a couple of important announcements in the very recent past. By now, most of you have probably seen the announcement appointing David Mounts as our new Chief Financial Officer. David brings a career's worth of great retail and delivery experience from UPS, where he's been for the last 22 years.

We're most fortunate to have attracted him after a long and careful national search. He will physically join us the first week in November. He will be attending our investor meeting in New York on November 8th that Linda alluded to a minute ago, where many of you will have a chance to meet him and welcome him in person. We are excited to have David on the team, and we're looking forward to the positive impact he will have on our future business.

David will be filling some very big issues in taking over for Harry. After devoting 19 years of hard work and dedication to Domino's, Harry Silverman announced late last year his decision to retire from our Company at end of this year. He's been incredibly helpful in our search for his successor and he has been in countless other ways helpful over the years, and we're going to miss him. But he will remain with us through the end of the year to assist with the transition of his responsibilities to David Mounts.

I just want to take this moment on behalf of our team members, our franchisees and our investors to thank Harry. We want him to know it has been a privilege to work with him for me in the better part of the last seven years.

Secondly I am also proud to welcome Diana Cantor to our Board of Directors. She holds a J.D. from New York University School of Law and is admitted in the states in New York, Florida and Virginia. She's also a CPA and an executive director of the Virginia College Savings Plan as well as serving on the board of Media General and numerous other not-for-profit boards. She is obviously a very well rounded and experienced, accomplished individual, we look forward to her contributions. We really feel she will strengthen what has already been a very experienced and high-caliber Board of Directors. We welcome Diana and we're looking forward to her being on board.

I want to talk about fuel prices for a minute. Hopefully the recent drop and gas prices will sustain throughout the coming months. But it is by far and away the most frequently asked question of us over the last quarter, from both investors and the media. And that has been just how do these high prices at the pump impact a company that's in the business of pizza delivery? So I wanted to spend a couple minutes on this topic.

As you all know, during this quarter we experienced a highest fuel prices in US history, and I'm happy to say our business has been very resilient, which is what we've told you all you should expect from Domino's. This has to do primarily with the way our delivery model works.

And as a reminder to those of you have heard this before, and a bit of new information for any who haven't, the pizza delivery driver provides his or her own car and pays for his or her on gas and car maintenance. And we are certainly aware that this expense has risen for them, but we feel the model continues to work for them too. And I'll comment why.

The drivers are paid an hourly rate which is at or near minimum wage, and they're also compensated to cover the cost of gas and car maintenance in another fee that is paid. And of course when our customers are generous and the driver is doing a great job, which thankfully is the case in most instances, they will make up additional amounts of money in the form of tips.

The combination of those three sources of revenue, if you will, for those drivers, sets this job apart from the typical QSR position. It can add up to an overall hourly pay scale that far exceeds most other entry-level jobs in the retail industry.

The risk to us is, and always has been, if the economic proposition no longer works for the drivers, in other words if they can't make enough money and days' pay, their per run fees and their tips, to cover the cost of gas and still have enough left over to allow for a competitive wage, then that would be problematic for us because it would be hard for us to hire or keep drivers.

But it's always been a part of our business to keep a steady complement of drivers employed. As the majority of people who work in this job are, by its nature, part-time. So we do experience a fair amount of turnover, which is natural and it's always been the case. But as a result of that factor, we hire as many as 10,000 drivers a year to meet the needs of our 574 Company-owned stores.

As we've analyzed the last 90 days of elevated gas prices, we have not seen a material change in our ability to attract and hire drivers. Certainly our experience varies from market to market. However, overall, we have not seen a big change in driver turnover or in our ability to hire new drivers.

The second part of this equation has to do with the struggle all businesses are facing, and that is how rising costs of fuel and energy will affect pricing strategies to the customer. Although our basic pizza delivery model is fairly resilient despite some gas prices, we're not immune to the effects of rising costs of natural gas to run our stores and distribution centers. And our franchisees face these same challenges in their own pizza stores, even though this is has had no direct effect on our bottom-line in the shorter term.

Like our competitors, we had responded to these and other cost factors by adding delivery charges on a market by market basis. In most cases Domino's has not taken the lead on this, and has not usually been the one that is first in the market to institute a delivery charge. Instead, we've waited to see if there has become, if you will, an accepted way of doing business by the customers in that area based on the competitive set.

And for the most part where it has been enacted, our customers seem to be taking it in stride. They understand why a delivery charge in today's world is appropriate, and they're willing to pay something extra for the convenience of a home delivered meal.

Currently 93% of our Company-owned stores charge a $1 delivery charge. This has been evolving over the past couple years. We estimate 60% our franchise-owned stores have delivery charges which average $1.20. The range is wide. It goes anywhere from $0.50 to as high as $2.75 in a couple of unique, very limited areas where there are unusually high gas prices and business costs.

As is the case with any consumer product, if costs increase so will consumer prices. In the pizza business, which is based on discount deal pricing, these increases have come really in the form of both delivery charges, which I discussed. Which appear to been an expected and accepted practice with our customers. And in our industry the changes that occur in our promotional bundles and price points.

Because it is so much promotionally-driven business, we have the flexibility of changing those bundles and price points to accommodate changes in our basic cost structure. Our operators have developed strong skills in reacting to these fluctuations in cheese and gas prices and other commodities that we're going to experience, have experienced over the last 4 to 5 years and will continue to experience as we go forward.

The last thing I would like to comment on is the whole issue with Hurricane Katrina. I'd like to explain how this terrible hurricane season has affected our business. As we mentioned in our press release, our largest domestic franchisee, RPM Pizza, is located at the center of Hurricane Katrina's devastation. We spent most of the day yesterday and this morning touring areas and meeting with the team here, so I'm very conversant with what's happening in this area.

And rather than talk about what you would expect, which is the large cost associated with this disaster and so many companies have been affected in dealing with cost issues, I'd really like to focus on something very different. And that is the resiliency, teamwork and passion that exist within Domino's Pizza.

We've incurred 14 store closings out of the 149 stores owned and operated by RPM Pizza as a result of this hurricane. For the most part, not as a result of our inability to get these 14 stores open, because truthfully this crew down here has done an amazing job of reopening stores. But those 14 stores are going to be closed for a while because of a lack of consumers in these areas.

Those stores have to be located in areas where, frankly, people have just not come back to because the devastation is so great. And we'll certainly be a holding pattern for a while until the customers returned to those areas, before we have a commercial business reason to get those 14 stores reopened.

But for the most part when everybody else was trying to get out of this area of devastation, our people were working to get into the area to get set up and do business. There are incredible numbers of heartwarming and courageous stories to tell of our franchisees, who are both in this area and who came from outside this area to help and support, that are just incredible.

Driving trucks full of generators to get some of these stores open quickly. Bringing personal RVs for sleeping quarters and water and power. Selling hundreds of thousands of dollars through our portable stores, excuse me, selling thousands of pizzas through portable stores that were set up in certain areas. But also giving away up to 40,000 pizzas, free pizzas to support victims and rescue workers, fire and police.

The amazing amount of help we're able to provide for people who frankly just needed something warm to put in their stomachs during this time is just amazing. Our system has contributed hundreds of thousands of dollars to our Domino's partners pizza, Domino's Partners Foundation, which is a not-for-profit organization that is there for the sole purpose of supporting team members during these kinds of times, and that included an $100,000 donation from us corporately.

We have countless heroes among our franchisees and team members who work in our distribution center down here in the marketplace, and people who left the World Resource Center and came down to assist in this effort and keep this business going. And I just very proud, as I always am, to be CEO of this great Company. But I think I have seen something in the last few weeks down here that is truly beyond the norm and very special.

We didn't make a big deal about it publicly because that's not our style. We just did what was right and helped a lot of people, and we got a lot of stores opened quickly so we can service the needs of the communities in this devastated area. It was just simply the right thing to do, and we did it.

So with that, I'd like to turn things over to Harry, who will review the financial results of the third quarter and demonstrate how all this positive energy and passion we have for the business also translates into shareholder value.

Good morning everyone. Over the next few minutes I'd like to provide you with a brief update on our third quarter financial results. First off, as Dave said, we're very pleased with our third quarter performance. Especially when you consider the very tough domestic sales comps we were rolled (ph) (technical difficulty) over. Despite these hurdles we posted a solid increase in our same-store sales, and we continue to improve the operations and margins of our Company-owned stores.

With that in mind, let's review our results, starting with our (technical difficulty). Our global retail sales increased 7.8% during the quarter, driven by solid same-store sales growth both in our domestic and international markets, and an increase in our worldwide store comps (ph). (technical difficulty) As for same-store sales, domestically we grew our sales 1.1% for the quarter. Broken down, our Company-owned store comps increased 4.2%, while same-store sales at our franchise units grew 0.7%.

We continue to be encouraged by these domestic results, especially when we look at that 8.9% year-to-date increase in comps at our Company-owned stores.

Before we reach (ph) domestic same-store sales, I'd like to once again remind you that you can and should expect some swings in our quarterly comps. I think the first three quarters of 2005 have been a prime example of this, as during the first two quarters of the year we posted very strong sales comps. And we benefited from successful promotion, and we reflected over a period in 2004 when our advertising spending was down and our sales growth was relatively flat.

Inversely, during the third quarter we continue to post positive year-over-year comps, but at a slower pace as compared to the first half of the year. As during the third quarter we were rolling over a period in 2004 when we were up 8%, making this quarter that much more difficult.

As far is international comps, we grew our same-store sales 4.5% during the quarter, which marked the 47th consecutive quarter that we produced year-over-year increases in international sales. In addition to the continued growth in our same-store sales, we also continued to grow our worldwide store counts (ph). During the quarter we added 67 net new stores to our portfolio in (technical difficulty) over (ph) trending (ph) four quarters we have added 342 units.

We continue to see most of our growth coming from our international segment of which actually added 70 net new stores for the quarter, three more of them reported as a consolidated business. Which brings me to my next point.

As a result of the significant damage caused by Hurricane Katrina, we recorded 14 franchise store closings in the Gulf region that we do not foresee opening in the near-term. This coordinates (ph) (technical difficulty) in our domestic store counts actually decreased by three during the quarter. Having said that, we ended the quarter at 7945 stores.

Next, let us shift our attention to the income statement. Our total revenues for the quarter were $338 million, an increase of nearly 4% from year ago levels. This increase was driven by higher revenues in each of our business segments. Our domestic store revenues grew as a result of higher sales comps and higher year-over-year store counts. In turn, these increases drove higher volumes in our domestic distribution business.

However, these volume increases in distribution revenues were somewhat offset by lower cheese prices in 2005 as compared to 2004, as the average cheese block price in the third quarter was $1.48 per pound versus $1.60 last year. Finally, our consolidated revenues were also positively impacted by higher international royalty distribution revenues.

An important point I'd like to make about revenues is to remind everyone we continue to believe our global sales (indiscernible) not revenue are the best gauge of our topline performance, since retail sales are not affected by changes in-store mix or commodity prices. As a great example of this, the decrease in cheese prices during the third quarter negatively impacted our year-over-year revenue comparisons by nearly $3.2 million, but did not have any impact on our retail sales comparison.

Let's now take a look our operating margins. During the quarter our consolidated operating margin increased 7.2 million to $86.5 million. Higher domestic and international royalty revenues, along with improved Company-owned store profitability, led to this increase.

In percentage terms, our consolidated operating margin was 25.6% of total revenues, which was an increase of 120 basis points as compared to last year. The primary drivers behind this 120 point basis gain was increase in our high margin domestic (ph) sales, both international and domestic, and improvements in our Company-owned store performance driven by higher sales and lower food and insurance costs.

Moving onto G&A, our G&A costs for the third quarter were $41 million with a decrease of 9.8 million from last year. This decrease was largely due to a $10 million payment that we made a year ago to an affiliate, in connection with our 2004 IPO, to terminate its management agreement with us.

As a percent of revenues G&A costs were 12.2%, which was down from last year's percentage even after adjusting for the $10 million payment.

Next item on our income statement that I'd like to address is our interest expense. Our interest expense for the third quarter was $11.7 million, which was down 5.6 million from last year. This improvement resulted from lower average debt balances, and in the third quarter 2004 we incurred approximately $4.2 million of deferred financing and bond discount expenses for the redemption of approximately $130 million of outstanding bonds.

Now offsetting these reductions to our interest cost was an increase in our effective rate which went from 5.6% to 6%. And this increase was largely due to the fact that we had an existing $300 million floating fixed swap agreement expire at 162 basis points in the third quarter, and we entered into a new $350 million swap agreement at 321 basis points.

Moving on, you'll note our 2005 earnings growth also benefited from a $9.8 million other expense incurred in 2004. These other expenses related to bond premiums we paid when we retired $130 million of our bonds last year, including 9 million of expenses that we incurred when we retired 109 million of bonds in connection with our IPO.

The last item on our income statement that I'd like to touch upon is the tax provision. Our effective tax rate for the third quarter was 38.4%, up from 37.8% last year and 35.2% in the second quarter of this year. As mentioned in our last conference call, we reversed approximately $1.1 million of valuation allowances relating to an international net operating loss carryforward, which reduced our effective tax rate in the second quarter.

Next I will spend a moment and talk about our bottom-line earnings. Our net income for the quarter was $20.8 million, up from 16.1 million as reported on a pro forma basis in 2004. As for EPS, we posted diluted EPS of $0.30 during the quarter, which was a 30% increase over last year's pro forma EPS of $0.23.

I'd like to remind everyone that last year's pro forma EPS assumes that our July 2004 IPO occurred at the beginning of the year, and as such includes $15.1 million of after-tax expenses relating to our IPO. Included in our press release is a reconciliation that details these pro forma adjustments.

Moving to the balance sheet, our total debt for the 755 million at end of the quarter, which was nearly a $16 million decrease from the end of the second quarter. This decrease was primarily the result of us repaying the remaining $15 million of borrowings on a revolver that we originally used for the $75 million share repurchase in the second quarter.

Our total leverage ratio stood at 3.2 times at the end of the quarter, which was down from our year end leverage ratio of 3.6 times and our IPO ratio of four times. Finally, during the quarter we received an upgrade from Standard & Poor's, raising the ratings on our corporate credit lines.

Looking at our CapEx, we deferred (ph) approximately 20.7 million of CapEx during the first three quarters of the year, down from 28.6 million last year. We're still comfortable with our 2005 CapEx guidance of $20 to $30 million for normalized CapEx, plus approximately $8 million for the completion of our World Resource Center renovations, for total of 28 to 30 million of total CapEx for the year.

Last item I'd like to cover is our 2005 free cash flow, which is defined as net cash provided by operating activities straight off our cash flow statement, less capital expenditures. Our free cash flow for the first three quarters was approximately $88 million. Please note there was nearly $18 million of tax benefits resulting from the exercise of stock options included in this number. Keep that in mind when you're modeling out your full-year free cash flow numbers.

This concludes our financial update. Once again we want to thank you for your time today. With that, Dave and I would like to open it up for questions.

(OPERATOR INSTRUCTIONS) Jeff Bernstein, Lehman Brothers.

Thank you very much. Two questions actually. First, just on your long-term view for share repurchase, I know last quarter you repurchased and retired shares from a particular investor through a private transaction. Just wondering going forward when you might anticipate sort of having an open share purchase program, and what metrics or approach do you use in determining when you should be repurchasing shares? Then I have follow up.

I will handle that. Clearly this is a Company based on -- Harry just covering the ability that we have to generate cash. This is a Company that should be repurchasing stock, and I think an authorization to purchase to open market purchases is something that will clearly be part of our future.

We think since we just completed our first year as a public Company, and we still have some of our original investors who continue to hold a significant block of shares of stock, that at this particular time rather than going out and decreasing this (ph) load by purchasing on the open market we will, as we have shown an ability to do in the past, opportunistically look at buying back shares on block trade basis with some of our existing original investors.

So that something we will continue to look at opportunistically and could very much be a part of our plans going forward. No other specifics at this time because obviously that transaction requires a willing seller and a willing buyer. But that would be something we would continue to consider. What's your follow-up question?

Just on follow-up, more general for the business. Seems that you've maintained a rather simplified menu, limiting new pizza product intros to one or two per year. It does compare to peers that are somewhat more aggressive with new pizza product rollouts. Can you talk about your approach to new pizza introductions and thoughts on a greater number going forward to drive new product news? It looks like you did two this year, seems like it's driving greater success. I was just wondering your thought process on a greater number going forward.

It's a good question, thank you. We never felt we want to become a member of the product of the week club, because we think it puts enormous pressure on our operational execution. And at some point in time it becomes self-defeating in terms of getting all those messages out to the consumer.

Having said that, news is definitely an important part of what drives order count and traffic in this category. And all we want to be able to have is a pipeline of products that are tested and proven to choose from when we think that particular tactic is required. We've built an architecture for that. We have a very strong pipeline of products in various stages of test protocol.

And what we will attempt to do over the next months and quarters and years is to always be in a position where if we need to rollout something that can drive traffic and order count, if we need to roll out something tactically to increase ticket, we've got tested and proven products in place to allow us to have those levers to pull.

We are in good shape today, I think we've got very nice backlog, and we have a lot of things in test now and planned for testing in 2006. I think this will continue to be a strength of our Company.

Joe Buckley, Bear Stearns.

Two general lines of questions. First, Dave, I was wondering if you could talk about the state of the category, what you've seen in terms of growth in the category this year, and just the competitiveness and maybe state of the independents?

Sure. Our view of 2005, this has been a very robust year for the category, certainly that has been our experience. We've seen opportunities to drive our order count significantly during different periods of time. Our ticket has been healthy. The consumers reacted very well to our promotions. We think value continues to be a very important tactic in this particular market environment with all of the issues that confronted us during the year.

And we think we have an important place in kind of that value perception out there in the hearts and minds of our customers. So we think we are a brand that is in the right place at the right time with the right kind of promotional and marketing message. And for us it appears to have been a very, very good time for the category in terms of our ability to grow.

From a market share standpoint, we think at least so far during the year, based on the most recent data that we've accumulated, we're growing our market share in the delivery segment which is the area we're focused on. We also continue to perform very well in the carryout segment, which becomes an increasingly important segment for us and for the category. Because it means value-oriented time to the customer, in some cases, tend to look for the greatest value possible. And in some cases that's the carryout special or something that doesn't provide the convenience of delivery, but provides a slightly lower cost. So we think we're well positioned to participate in the both of those dynamics we think we have, and we continue to feel good about our position going forward.

Secondly, some more questions on the fuel side. The delivery charges that you mentioned, are those included in same-store sales? And for the franchisees who are charging them, do you collect royalties on those delivery charges?

Yes. Answer is yes to both questions.

Can you answer me how much of your same-store sales increase in the quarter might been driven by the delivery charges?

I don't have that number, I don't think it's an easy one to get to. Because we clearly had been in a period where some people are rolling them out initially, some people are increasing them. That's not something we get separate real-time data on. So that is a hard number to get at Harry. I don't know if you can offer any more specifics.

I would agree with you. I think some of the difficulty too is what we've seen with delivery charges, sometimes that actually becomes a competitive tool between yourself and your competition as far as the ultimate price you're charging for a package. So it's nothing we have directly what impact is. We have had a positive impact, but it's very hard to determine that number.

Can you determine it for the Company stores?

What ends up happening is a lot of the actual pricing at the store is based on various factors, including the competition. So we are on the phone and our phone people are going through the menu and giving two or three different options that may have an impact there. I don't have that number in front of me.

The thing that would make that a tough number to really learn anything from is that just becomes part of the equation in terms of what the customer has to pay for certain bundles and offers. So to a degree, sometimes there's adjustment in other sides of the pricing to get to a certain price point to satisfy that customer's needs. So it's not a number we're managing or one we're measuring very carefully, because we're not sure there's a lot of value in it.

Is most of the pass-through to the drivers, or does it have margin implications as well?

It has margin applications. Most of it is not passed through to the drivers, because again as I commented on pretty extensively earlier, our job is to make sure that the combination of the three ways the drivers earn income is both competitive and attractive. But that doesn't mean when we implement or increase the delivery charge that most of that goes to the driver. In many cases, that's going to offset other energy and cost related pressures the business has.

Just the 93% of the Company stores that are charging on average $1, what might that have looked like a year ago, or maybe even in the first or second quarter?

It's been ramping up. Probably a year ago, it would've been 60%, and I'm kind of guessing at that because it's rolled out market to market. So it's been ramping up obviously as we've gotten more and more into the year and energy prices.

Most importantly, rather than reacting specifically to energy prices, oftentimes what we're reacting to it is the competitive set of the marketplace. But we're not going to allow our competitors to implement a delivery charge and then lower their advertised price points in such a way that makes us look less than value competitive. So in some cases, we're simply responding to dynamics of the marketplace to make sure we can competitively price our offers.

So in effect it get priced into the whole pricing -- you factor it in rather into the whole pricing decision to the consumer.

Absolutely.

Don Avenko, JP Morgan. (ph)

Maybe a follow-up on what Joe perhaps was alluding to. The Company margins were tremendous in the quarter. Given the cheese costs, which I think would've probably added about 70 basis points or so, and even given the comps which were pretty strong. Could you make some comments given the company store margin performance in the quarter?

I'm really proud of team USA. We continue to get great leadership there and great improvement. We're executing at the store level better than we have. We're training people better than we have, we're retaining people better than we have. So in all those key dimensions that from a pure operation standpoint I measure, and areas that we have been fumbling two and three years ago as we kind of got into a trendline that was less than where we want to be. We are reversing those trends and making progress.

So the combination of better operations and clearly some very strong sales push, obviously you're seeing how the business model works. If you can drive those same-store sales and push more sales through those boxes with the fixed expenses that are associated with them, it definitely is enhancing margin.

When you combine that with a change in cheese prices you start to see how we've been able to get back on a good footing. The trajectory is good. I continue to believe this is a business that has upside, but obviously operating 600 stores out there day in and day out is challenging. I'm pleased with the progress the team is making. Hopefully we can keep going in the same direction.

Perhaps in the context of pricing or even more specifically, the delivery charge change year-over-year, was the majority of the comp ticket or was it order count? In the third quarter?

Both. In the third quarter probably more ticket than order count. If you look at the year-to-date, more order count than ticket.

I actually have a margin question on the distribution side as well. Again, it's come with a relatively short amount of time you've been a public Company. Franchise comps were kind of flat and there was some franchise store growth and certainly distribution costs, so I would have assumed would've been higher in the third quarter versus last year, given fuel. Could you walk through the year-over-year change in operating income growth on the distribution segment, and what particularly surprised you or you're proud of in the quarter?

I think the thing in line with the positive sales during the third quarter was the fact that last year we were rolling over some enormous volumes at our stores. And this year -- and I say that I mean traffic, and we look at that, we continue to get a little bit of traffic. And as Dave mentioned also, probably a little bit more of ticket during the quarter. So I think we have benefited tremendously in our distribution business because of that high volume.

And again, our distribution business, all things being equal, when there's moderate increases or decreases in cheese prices, the increase in volume should lend itself an increase in overall margins. Albeit not that much at any given point, but you should be able to move up a couple tenths based on those (technical difficulty) increased volumes.

One other thing I want to point out, and we talked about a little bit in our 10-Q, was insurance costs. Insurance is a fixed cost to a certain extent for us. We are self-insured, and we are beginning to see a little bit of softening in the overall insurance market. That is both in what I would consider health as well as the casualty market.

We have had some very favorable trends there which has benefited our Company-owned stores because that's where most of our employees are located that are under our health plan, as well as our distribution Company. When you put all these things together with the continuing increase in your topline, you start to see a margin improvement as we did during the quarter.

A couple of follow-ups on that. Are you actually reversing insurance accruals or are you just accruing less going forward?

Insurance accrual is a combination of both. We found this year's -- our experience is much lower than what we had anticipated coming into the year. And we also are finding there's probably less of a population that we're actually insuring, coupled with the fact that, again, the increase in sales is bringing that down as a percent of revenues.

Can I ask you on the distribution side, I'm sorry if I'm not totally right on this (indiscernible) as you can -- you know everyone is kind of jammed this morning. My numbers show that distribution segment operating income was up something like 18% year-over-year. Are my numbers right? In the third quarter versus last year? I guess it's possible. If I'm not, we were both really quick on that.

That would be in the ballpark.

18%. When I -- (multiple speakers) from 9.9 million I think to 11.7 million? That was the opening question I asked you regarding how you got that kind of operating income growth out of that segment. It's obviously impressive if those numbers are right.

Those numbers are correct. Part of it is just the reduced labor costs. I'm just looking here at the P&L, the utilities, rents, depreciation, all those things have been going our direction --

Utilities have been going in your direction?

We haven't really seen that big of an increase yet during the third quarter. Obviously with gas coming up in the fourth quarter, that may be more of an issue. But I think at our distribution business, a lot of our utilities are pre-bought anyway. We've not been impacted like you would have imagined some of these other companies have been, where it's kind of more of a floating basis.

Is there an event that we should be sensitive to where you lapse some of your utility contracts, for example, or is that just a really small number for you anyway?

It's a relatively small number for us.

Finally, and I know going into the third quarter, David specifically we're talking about some good momentum in the business. Could you just give us some color on the current Steak Fanatic, especially versus two years of relatively successful LTOs? In the fourth quarter?

As much as you know I'm going to give you, we're not going to jeopardize any of our plans going forward, particularly as we complete the fourth quarter, by talking to -- specifically about current promotions. It's such a great product, we've got great customer response. We've got a mix (ph) that's very much in keeping with what we anticipated we were going to get as a result of our test market experience.

So I would say steady as she goes. But how we're going to use that and how long we're going to use that and how that fits with other plans that we have between now and end of the year is something we're not going to talk about.

Can I ask a slightly different question on the '06 spend? I know there is yet another change going from co-op to national in '06. Does that mean you're going to run the same amount of campaigns more, or should we actually see more campaigns in '06 relative to '05?

I think what we have said pretty loudly is that we're going to continue to buy media more efficiently, which gives us the opportunity to increase our share of voice (ph) and have more weapons in our arsenal as it relates to our marketing activities at the national level next year. That step up and shift creates more resources. How much of that we devote to television, how much we devote to print, how we break that up in terms of the number of national windows that we have and national events versus other activities that underlie that is something we obviously are not going to talk about.

That's fair. Thank you very much, good quarter.

Mark Kalinowski, Buckingham Research.

Mark Kalinowski of Buckingham Research. Two questions. First on the insurance front. You're one of the few companies I'm talking with that's talking about insurance costs going down. Just curious why you think that's happening. I know Harry made some comments very briefly in response to the last question, but I was hoping to dive into that a little bit more.

And second, more of a housekeeping item. I do not have access as best as I can tell to the specific amounts of basic and diluted shares outstanding for the quarter that was just reported. I was hoping I could get those exact numbers from you.

I'll comment on the insurance and let Harry comment on the shares. I think what Harry is alluding to is that obviously we're buying a lot of different kinds of insurance to operate our business. In many respects, rather than insurance rates going down substantially, in some cases they're just -- the costs that we're incurring are less than we had budgeted and forecasted.

So we're not seeing massive reductions in some categories of insurance, but we're clearly buying insurance better than we thought we were going to buy it. And in the health area we've had less incidences of a major magnitude that have allowed us to have a better year than we would have otherwise planned.

Harry, I will defer to you to share the information on the shares.

One of the things in insurance which think is important to note is in our different lines of insurance on the casualty front, auto and workers comp, we're self-insured upwards of 1 to 3 million depending on what type of insurance it is. And after 9/11 -- we have coverage over $100 million, we saw our excess insurance just explode. We have been seeing those numbers come down every year. We're starting to see the benefit of that. Does that answer your insurance question?

That's very good, thank you.

As far as the share count, I don't have it exactly in front of me but it's about 68.5 million. It just -- you can just do the division and get the exact number. It's on page 7, 68.4 million.

Page 7, --

Of the press release.

Of the Q.

That's precisely what I don't have access to, unfortunately. Do you have that right in front of you, by any chance?

68.407 (multiple speakers)

And what's the basic amount, if that's there?

Basic is 66 (technical difficulty)

379? Great. Thank you very much.

Joe Buckley, Bear Stearns.

A question on the CapEx range. It looks pretty wide with one quarter to go. Where are the variables in that?

In the fourth quarter, you have to remember that we also have an extra four weeks. And typically a lot of your highest quarter of the year, your highest is definitely the fourth quarter because of the four weeks in just year end getting some projects in. I think we've been pretty consistent in our investor calls, in our presentations of talking about normalized CapEx of $20 to $30 million.

And the $8 million we talked about on the completion of home office, which is all done right now. So it is a wide range. I think back out the 8 million from the spending year-to-date and probably take into account your fourth quarter has got an extra four weeks. And typically it's a little bit higher; you should come pretty close to a proper number.

One more if I could. The international business just continues to perform very, very well. Are there any particular regions or areas of focus that you would draw our attention to?

I would just suggest to you that our major market activity has been very strong throughout the year, and we also have gotten some kind of emerging markets for us that continue to do very well. So I was over in Australia a few weeks ago clipping the ribbon on the opening of our 400th store in Australia/New Zealand. That team down there is doing a fabulous job of creating a lot of momentum, both in-store growth and in same-store sales. And as many of you know, that's a company that did a public offering on the Australian Exchange earlier this year and has performed very well.

Our unit in the United Kingdom continues to do extremely well. All of their markets continue to perform at a high level. We're having great success in Asia. So we are in a position where the great thing about being in as many countries as we are in, and as many currencies as we're in, we continue to see broadscale success in just about every region of the globe with a continuation of accelerated store growth and a very, very consistent picture in terms of our same-store sales.

Dean Haskell, JMP Securities.

Also on the international business, margins came down into third quarter relative to the second quarter, whereas last year they were up. Can you talk to the differences between the two years and the quarterlies?

Harry, do you want to handle that?

When you look the margins, are you looking at income from operations or segment income?

I'm looking at segment income, yes, international margins.

I am showing that the actual margins increased slightly. One thing I'd like to say about international that gets a little tricky is that we have really three different business units all in that one number. We have --first off, we collect royalties which is a very high margin business for us, and that is where the bulk of our profits come from. The other two businesses we operate is, we have eight commissaries. And we also have a little less than 20 stores between Netherlands and France.

In any given quarter, there can be a swing in the margins just because of the fact if we are opening the store or selling the store or buying the store from somebody, that could throw those margins up. Because for instance as we acquire stores internationally, those stores are going to come in at much smaller margins than what we collect on our typical royalty from our franchisee. But that all being said, I think the margins have increased slightly.

Okay, thank you. I'm using the international revenues and dividing the international other expenses together.

Okay.

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We would like to thank you all for participating in our call this morning and all your good questions. We look forward to speaking with you again soon. Thank you very much.

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