達美樂 (DPZ) 2006 Q1 法說會逐字稿

Good morning.

My name is Toni, and I will be your conference operator today.

At this time I would like to welcome everyone to the 2006 First Quarter Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

Thank you.

I would now like to turn the call over to Ms. Lynn Liddle, Executive Vice President of Communications and Investor Relations.

Ma'am, you may begin your conference.

Thanks, Toni; and good morning, everybody.

Thanks for attending our First Quarter Earnings Conference Call.

For around the next hour, we will be discussing progress that we made during the quarter, and then we'll open it up for Q&A.

With us today we have our Chief Executive Officer, Mr. Dave Brandon; and our Chief Financial Officer, David Mounts.

A couple of housekeeping things before we begin.

We ask that the media be in a listen only mode today; and then also, in the event that we do make any forward looking statements, I will refer you all to our Safe Harbor Statement that you'll see in our press release.

And with that, I'd like to turn it over to Dave Brandon.

Good morning, everyone.

Thanks for joining us this morning.

As many have anticipated for quite some time, the first quarter of 2006 proved to be very challenging for us here at Domino's, as we rolled over the toughest quarterly sales comp the pizza industry has seen in the last seven years.

So, we knew going into this, that this was going to be a very, very difficult [comp], and it proves to be just that.

It resulted in our posting a negative comp for the quarter, and I'm certainly not here to make excuses or complain about that.

We wish it were different; but, I am here to remind you that ours is a story of consistency and positive annual results; and, we spoke about that continuously.

And no matter how you slice it, we simply had an incredible quarter last year that we all knew it was going to be hard to top.

We tried.

We tried very hard, and it would have been a tremendous accomplishment had we succeeded; but we just couldn't make it happen.

If you recall what we had told you about the way we approach our businesses; we really try to hit singles and doubles every event on our marketing calendar.

It's really our philosophy and our approach to the business.

And we found that that results in a consistent and winning batting average over time.

But, sometimes we do, and often times we're not even sure why, but we do hit the ball out of the park, and that's certainly what happened during the first half of 2005.

However, I want you to know, we've stuck with our plan this year; and we did not go to extreme measures to try and beat this unusual comp.

And what I mean by "extreme measure" is by way of example, our first quarter 2006 [media] spend was virtually flat with what we did in the first quarter of 2005.

Meaning, we did not go to extraordinary efforts to try to disproportionately invest in this quarter to chase that comp.

That's inconsistent with our philosophy and our approach.

We take a longer term view, and our job is to get within that long-range forecast that we provided you, that says we're going to figure out a way to grow sales between 1% and 3% domestically on a same store basis year after year.

And that's what we're shooting for, as opposed to chasing one individual quarter.

We do want to let you know that we are a management team who knows what our job is--and that is to deliver consistent bottom-line earnings; and figure out ways to overcome any obstacles that happen to jump in our way.

And as such, we're very pleased that we're recording and 11% increase in our EPS, despite the same-store sales hurdle that we faced in the first quarter of the year.

This 11% increase in earnings was driven by increased net income through strong international sales.

I think we did a very good job of diligently controlling our G&A costs and we certainly had a very positive [accretive] of share repurchase during the quarter.

Our 3 plus percent international same-store sales results for the quarter is something we're very proud of.

This is the 49th consecutive quarter of positive same-store sales for our international business.

So, we continue to move forward in a very, very positive way.

We had a very accretive stock repurchase from our shareholders, Bain Capital, during the quarter, which was negotiated at a discount, and has been very well received by the market.

We also announced, during the quarter, our second dividend increase as a public company; and, we continue to remain on of the highest dividend yields in our industry.

Earlier in the quarter, we also celebrated the opening of our 8000th store worldwide, which is simply a sign that this 45-year old company continues to move forward and grow--both in the U.S. and across the globe in terms of our unit growth.

Last but not least, pertaining to unit growth, our 12-month rolling net store count at the end of the quarter continues to be strong at 325 net new stores worldwide over the last rolling 12 months.

So, as I look back at our first quarter, I don't really feel any need to apologize for the fact that we weren't able to get over that sales hurdle.

Rather, I want to applaud and thank the Domino's franchisees and team members who continue to operate at high unit volume levels, controlling our costs, deploying our cash-flow effectively, and delivering bottom-line results.

Now, during these calls, I try to anticipate any of the current issues that our investors might be interested in, and within all three major pizza companies having reported this week, it's my sense that people are focused on some of the macro issues affecting the overall industry, and I just thought I just give brief comment.

First of all, to us it appears as though consumers are feeling the impact of rising gas prices and interest rates, and may be out there shopping with a little less disposable income then they had last year.

To us, the market in general feels a bit softer than what we were experiencing in 2005.

We're not particularly concerned here at Domino's about the impact that energy prices have on our business model, because our business model is pretty well protected in such a way that that really isn't the issue.

We're spending more time trying to focus on what the impact of energy price increases are on our consumer and our consumer's spending habits.

I think we'll learn more of that as the year unfolds.

I would also tell you that it'll be incumbent upon our industry to respond to consumers with value offerings if we want to maintain and grow our traffic.

We believe that we're in a very strong value oriented market environment, and we need to be responsive to that.

Now, I want to qualify that by saying, I do not mean by "value" that we simply want to be out there with discounted prices and nonsense regarding price wars.

It's not about that.

It's really about bundle value packages that break through and resonate with the consumer.

It's far more about that, than it is just going out there with cheap price points that simply lower your margins.

We think that value positioning will be extremely important to consumers and the economic environment that we're in; and truthfully, that's always been the case with the pizza category.

We don't expect that this will change measurably in the near future.

With that, I'd like to turn things over to David for a more in-depth review of our first quarter financials.

Thanks Dave, and good morning everyone.

As Dave mentioned, we were faced with difficult sales comps during the first quarter.

Last year's 11% set a very high bar.

Despite this, we were able to post an 11% increase in diluted EPS at $0.39 per share.

This was driven by our net income growth and the impact of our share repurchases--both which I'll take you through in a little more detail.

Let's review what drove our net income growth, starting with our top line.

Global retail sales were up 0.7% during the quarter.

As Dave mentioned, same-store sales growth and our international business, and our overall worldwide store comps of the last trailing four quarters are the driving factors.

Same-store sales domestically decreased 3.8%.

Company-owned stores were down 3%, franchise operations fell 4%.

As Dave mentioned, our international same-store sales, however, increased 3%.

As we've said in the past, you should expect some swings quarterly in our domestic comps.

We anticipated the tough comps, but we run the business with the very much an annual mindset on these metrics, and we're focused on long-term value.

We do not measure momentum quarterly.

Also, driving global retail sales is our worldwide store counts.

We added 45 net new stores to our portfolio during the quarter.

Over the trailing four quarters, we've added 325 units.

Leading the way is our international group with 254 of these openings over the trailing four quarters.

On our income statement, our total revenues for the quarter were $347.7 million.

This was a $22 million, or 6% decrease from year-ago levels.

And what drove that was lower volumes in our distribution business related to the lower domestic same-store sales; and also, of course, lower cheese prices, which accounted for about $8.7 million in revenues.

The average cheese prices, which accounted for about $8.7 million decrease in revenues.

The average [cheese-bought] price in the first quarter was $1.30 pound and this was against the $1.54 pound last year, which was a 16% decrease.

We continue to believe our global retail sales, which are not affected by changes in the store mix and commodity prices, are the best gauge of top-line performance.

We saw this again in the first quarter--the decrease in cheese prices had that $8.7 million effect.

However, the cheese and other price changes did not affect our global retail sales metric.

Bottom-line earnings, as I said earlier, was $0.39 per diluted share in the quarter.

This was an 11% increase from a year ago, and it was driven by strong performance in our international business.

The lower food prices--primarily cheese, also positively impacted our company's store margins.

As Dave mentioned, we did hold the line on G&A; we had lower G&A expenses.

And another question that I get asked often is energy cost and how they affect our margins.

Energy cost, in general, [are up], and obviously, we don't like to pay additional cost in those categories if we don't have to.

But, overall energy costs are about 2% of our overall expenses.

So it's not a major factor.

Additionally, we've benefited from our share repurchases--4.4 million shares from JP Morgan in the second quarter of 2005 gave us a full year-over-year impact.

We repurchased 5.6 million shares from Bain; but we didn't do that until March 10th of the first quarter of '06, so this had less of an impact on the weighted average diluted share count.

Our weighted average shares were 67.7 million in the first quarter of '06, verses 71.3 million last year.

Our total debt was $801 million.

This was a $63 million increase from the end of the year.

It was a result of the [inaudible] of the $100 million tack-on, along with the $45 million in cash that we used to repurchase the Bain shares.

That was offset by a $35 million prepayment that we made voluntarily on our term loan in January.

Our effective rate on interest went from 5.3% to 6.3% this year.

It was due mostly to rising market interest rates and our variable rate loans.

Interest expense was 1.5 million higher at $12.1 million for the quarter.

And, our leverage ratio stood at 3.3 times EBITDA, up just slightly from our 2005 year-end leverage ratio of 3.1 times.

We did a good job managing our CapEx.

Our CapEx was $4.2 million during the first quarter.

This is down from the 6.7 we spent in the year-ago period.

And the main reason that's down is we had just under 3 million in CapEx [technical difficulty] resource center refurbishments last year, of which we completed, and will not be a factor going forward.

The last item I'd like to mention is, despite a challenging quarter, we continue to generate free cash flow.

We're very focused on using cash-flow to create shareholder value.

In the first quarter, if you look at our actions, we repurchased shares, [technical difficulty] our annual dividend 20%, and we voluntarily retired debt.

Our priorities are very clear, in that, we focus on using cash-flow, first for reinvesting in the business and paying a fair dividend; and then second, to reduce our most expensive form of financing.

This generally means, [float-equity] is available for sale, or which ever debt is most economical--bond or bank, depending on rates and spread.

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 answer you questions.

[OPERATOR INSTRUCITONS]

Your first question comes from Joe Buckley with Bear-Stearns.

Good morning.

Thank you. --A couple of questions.

Dave you mentioned a media spend being roughly equal to last year.

If I'm not mistaken your national ad spend was going to go up by 25%.

Was the initial ad spend in the first quarter, in fact, up 25% year-over-year?

Well.

As you know, we moved those co-ops-some of the co-op dollars back over to national; which was consistent with what we did a year ago; so, the [pot] that we have to deploy this year against our marketing plan is larger at the national level.

We did have some inflationary costs to bear, in terms of what GRPs cost this year verses a year ago; but, the only thing I was pointing out is that, as it relates to this particular quarter, the amount of GRPs that we applied against the calendar was virtually the same as what we did last year.

And, that's a GRP comment, and it's pertaining specifically to the first quarter.

So, does that imply that the GRP, your GRP comparison will be up significantly over the balance of the year?

There will be windows where we will have incremental dollars to spend, and some of that could be on TV, and likely will, and others of it will be other marketing programs that we will be initiating throughout the year.

Okay.

Dave, a question on that G&A line-- you mentioned diligent controls, and well-control -- it's unusual to see G&A actually down significantly in dollars.

Could you kind of walk us through what's behind that?

Sure!

As you know, Joe, we have a first of all the variable bonus system that is part of the effect.

In other words, if our results start to go down slightly then we're going to have less labor expense; and that's variable in nature, so that contributed partly to it.

We had a one-time legal settlement that affected about $1 million.

It had to do with [linear carton] settlement, so there was an effect there.

And we managed our bad debt expense down.

We've done a great job, in terms of bad debt expense.

We knocked our bad debt expense down about $600,000.

The variable bonus system, just can you just of remind us what's that based on?

So you just -- kind of gauge as the year goes on.

Yes!

I'll take this one.

The program that we've had in place for the past many years here, is one where the Board approves a specific target, and we basically have leverage on that target should we exceed it, so we're rewarded for going past the target.

And as we fall short of the target, we will under-accrue that account; so, it's a variable bonus plan based on performance and we budget the year as if the bonus is going to be paid out at 100%.

But, if we have a quarter or--we actually track this on a bi-period basis--if we run into a situation where we're tracking behind, then basically, that becomes a pick-up.

So, that's kind of how the program fundamentally works; and as David pointed out, in the first quarter we under-accrued for bonus purposes because the target that we had was higher than what we achieved.

And Dave, the target--the same-store sales target, or your profitability target, or--?

It's a EBITDA target, fundamentally based on financial performance as measured by operational execution.

Okay Thank you.

Your next question comes from John Ivankoe with JP Morgan.

Hi.

Thanks.

Actually, the first question is a direct follow-up to the first question Joe asked.

David, did you mean that national GRPs are flat year-over-year, or total GRPs and advertising are flat year-over-year?

I the first quarter, our GRP spend in 2006 was virtually the same as it was last year in the first quarter.

Is that national, or national and co-op combined?

It was the national window, so--

Okay

The answer is the same.

Okay alright, perfect.

The next question, and again to focus a little bit on the margins, the company's store margins were actually exceptional on a year-over-year basis; even after taking into consideration the lower cheese prices.

Can you walk us through the margin gain on the negative comp, and if that's your focus-or if you're more focused on company store management, or is there something else that might have been happening there?

I mean, obviously a big component of company store margins is food.

So food was a contributing factor.

We had some slight increases - so I'd say food was a big factor, with some slight increases in depreciation.

Labor was relatively flat; slight increases in utility; and we had some benefits in some of the other categories.

But the main driver of the margin improvement has been food, and I would say both pricing and mix have been factors there.

John, I'd just build on that by saying they've done a great job at managing food costs.

Part of that is certainly the relative change in cheese prices, but also just managing that; and also in the environment we're in, I think they've done a great job at managing their labor costs.

You know, David, this is a little bit of a big picture question, and I think a lot of industry observers are struggling with this.

I'm sure you've seen a lot of the casual dining traffic really fell off in March and continuing into April.

One can assume that obviously, consumers are going to have to eat, that they might be attracted to pizza on a per person basis - on a family is actually one of the least expensive ways that people can eat.

Could you walk us through what you see going on?

Is it some early weakness?

Is it even customer weakness.

Is it more like a younger generation, like the heavy fast food user, for example, that might be cutting back for pizza?

I'm trying to understand why the pizza business is showing some cyclicality here when other businesses' casual dining are also showing cyclicality.

In other words, I'm asking you to segment just a little bit further what you see in terms of the customer base or day [inaudible] that might be happening because of the gas prices.

John, it's a great question, and it is the question, and I wish I had a real crisp answer for you.

I think we'll learn more as we get a little deeper into the year.

At least our current experience was that we had terrific momentum going throughout all of 2005, even up until the very end of the year.

And then it felt like, at least to us, starting in January and moving into the balance of the first quarter that there was really just a loss of momentum in the category.

Now, we, listen, we were going up against some incredibly challenging comps, so that's part of what this is all about.

It is just no fun in this business going up against 11% [inaudible] sales from a year ago.

But having said that, we just feel like kind of the traffic activity and the general momentum in the category really softened in the quarter.

And I can't totally explain it, because over any extended period of time, you're absolutely right, it's been our finding that you can feed a family so much cheaper by ordering from Domino's than so many of the other options out there that as the consumer tends to retreat, we're probably going to be the beneficiary of some of that.

But I can also tell you, I've been doing this now for over seven years, and I've gone through a lot of quarters and a lot of cycles, and this isn't the first time it's happened and it's not the last time it will happen.

We do go through these patches where the category just feels a little bit soft.

I will simply tell you that it is our read that if you want to generate traffic and interest in the environment that we feel that we're in, it's about a really strong value message.

That's probably more important in this environment, the new fangled product innovations and highly complicated promotions.

It's really about operating at a high level, providing great service to customers, being very reliable, and having price points and value orientations that really resonate.

That's what it's all about in this environment.

Very fair.

Thank you.

Let me ask you just a couple of other housekeeping questions, if I may.

The domestic store count, I know there was actually a slight net reduction in the first quarter.

Was that just some timing issues, A)?

And B) what are you expecting for the overall year in the U.S. in terms of store growth?

It is very cyclical for us to be very kind of seasonal in the way we open stores.

It's been that way every year I've been here.

We, as you recall in the fourth quarter, we tend to have a real flurry of activity and we open a lot of stores.

And the fact that we work really hard to get a lot of stores open kind of at that end of the year time typically domestically puts us in a position where it's always our most meager quarter in terms of new store openings.

I think a lot of that is we're busy opening stores and doing the things that are required just to get stores opened in the fourth quarter, and there's a time lag before we kind of get back into the game.

So that ramp, that hockey stick has always been the case domestically, and I think you'll see it again this year.

We continue to believe that by the end of the year, we'll be at our target in terms of domestic store growth.

And obviously, international continues to do very, very well.

Just a follow-up on actually some initiatives that you're at least thinking at your analyst conference that you had in the fall, could you update us what you're thinking about other opportunities that may be presenting themselves with regards to lunch or late night for your domestic system?

We have been testing not only in the U.S. but in other markets, as well, a variety of approaches for us in the area of alternative venues, in the area of day parts, specifically lunch.

We've done some very interesting tests, with some very good results as it relates to that day part.

And late night is a business that we already feel we're in to a certain degree, but in some areas it's probably an area or category that we can exploit a little bit more.

So we think all of those are opportunistic and we've got initiatives at varying levels of development that we can strike at the heart of those opportunities.

Okay.

Thanks, very much.

You have a follow-up question from Joe Buckley with Bear Stearns.

Thank you.

David, why don't you talk about the [inaudible] purchase activity.

You did buy a sizeable piece of Bain stock back.

On the fourth quarter conference call, you made it pretty clear that was an objective for this year.

I'm curious what you're thinking in terms of further share repurchases and what you might have to do with credit agreements or anything else for that matter to make that occur, if you do have the appetite for it.

I think our position really hasn't changed, Joe.

I think we're comfortable with what we've set in the past in a leverage range kind of between three and five times.

We're at the low end of that range right now.

When those shares are available, we would repurchase them.

The issue becomes the first step.

The first step is the shares have to be available.

The second step is, you're exactly right, we would have to go in and modify our existing credit agreements and our bond agreements and those are steps that we've evaluated and we know what we'd have to do in the event of that.

I don't have any predictions for you of any time horizons or when we expect that to happen, but I would just tell you that we always remain ready and we plan for those events and the opportunity or availability of those shares that are non-float.

If that opportunity comes up, we're going to be ready for it.

If it doesn't we continue to plan.

We have, I think if you go into the middle of next year, we've got some refinancing decisions to think about.

We have some opportunities there as well, so we're looking at how to maximize and optimize based on those opportunities.

So we're constantly not only looking at share repurchases, but we're looking at the whole financing structure and seeking to optimize that, whatever the situation will be.

And you can expect that if those shares come available, we would take whatever actions were necessary to accumulate them.

Okay.

Thank you.

Your next question comes from [Nitin Dahiya]

Morning.

This is Nitin Dahiya with Lehman Brothers.

I work with [inaudible].

A couple of questions.

One is, do you know offhand what your restricted payments [inaudible]?

I'm sorry could you repeat the question?

What's the restricted payments basket at this stage?

Most of the basket is used at this point.

Okay.

So it's just earnings based now going forward, is that right?

That's correct.

Also I didn't quite get your comment on the [refin] that you just made.

Could you please repeat that?

The comment that I made was that we don't have any plan refinancing decisions in this time horizon.

And I wasn't giving any predictions on that.

But the question that Joe asked was with regards to share repurchase, and if share repurchase opportunities came available, would we consider refinancing.

And my answer is that if those shares became available, we would look at our refinancing options and we would certainly be interested in accumulating any available shares.

Thank you, very much.

Your next question comes from [Zafar Nazem].

Just a follow up question on the restricted payment basket.

As you said, that has been it been almost completely exhausted.

And going forward it's going too based upon earnings accretion.

Any thoughts on - bonds are not callable until July of next year, I believe.

So any thoughts on potentially taking those bonds out ahead of the first call day?

It's a capital structure decision.

It's a financing decision.

It's an economic decision.

If the shares come available, then I'll look at the options; and if it makes financing sense to tender for the bonds or do something like that, we would look at that.

Obviously, the bonds are callable next years; so the time horizon is relatively short; and we're going to consider all of those factors in our decision making.

But our focus is always the same.

We seek to out the most expensive financing we can, which generally is going to be shares.

And if they're available, we focus on getting those.

And just one more question.

With respect to dividends, what kinds of restrictions do have with respect to your dividends payout either from your bond indentures or credit agreement?

We have plenty of room to increase dividends.

Okay.

Thank you.

[OPERATOR INSTRUCTIONS]

We seem to have no further questions at this time.

Let me just briefly say in closing, I want to thank all of our investors' support of Domino's Pizza and emphasize that we're hard at work to make 2006 yet another successful chapter in our growth and success story.

And I want to remind everybody how we define success.

Single digit, same store sales growth, which when coupled with our business model, produces steady double digit earnings growth.

It's one of the things that we continue to repeat because it's so important in terms of how our business model works.

We are going to continue to put sustained and controlled net store growth out there both domestically and internationally, and we've emphasize the fact that those are new stores that we opened and we operate at a high level.

So it's controlled and sustained growth.

And as David has mentioned we continue, in all environments to produce strong and reliable cash flow that we can deploy to enhance our earnings and a pay highly attractive dividend.

So we're proud of our track record for achieving this success and our team continues to be committed to continuing those trends.

So we're off to sell some pizza.

Thank you for attending our conference call.

This concludes today's conference call.

You may now disconnect.