達美樂 (DPZ) 2007 Q2 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the 2007 second-quarter earnings conference call.

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

After the speakers' remarks, there will be a question-and-answer session.

(OPERATOR INSTRUCTIONS).

Thank you.

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

Ma'am, you may begin your conference.

Thanks, Tracy.

Good morning, everybody.

With me today I have Dave Brandon, Domino's CEO and Chairman, and David Mounts, our Chief Financial Officer.

The gentlemen will take you through a review of our second quarter, and then we will open it up to questions.

I will also refer you, in our press release and our 10-Q, to our Safe Harbor statement, in the event that any forward-looking statements are made.

Then I would also ask the members of the press to be in a listen-only mode.

So with that, I will forward it on to Dave Brandon.

Good morning, everyone, and thanks for taking the time spend with us reviewing our second-quarter results.

As I assess the situation, I believe that we can sum up the quarter's results with a couple of key headlines.

One would be positive sales momentum returns.

The second would be high cost environment.

I am extremely pleased to report today that we experienced positive order count and increased ticket for the second quarter in our domestic stores.

As you all know, this has been an important focus for us since we lost our sales momentum during 2006.

The momentum that we started to build towards the end of the fourth quarter 2006 that I spoke about and continued into the first quarter of 2007 has finally culminated in the positive quarter that we've been looking for for awhile, and we feel very good about that.

I believe that our Team USA corporate stores have led the way to this positive turnaround in our domestic franchise stores because many of the franchisees have adopted some of the programs that were successfully tested and developed by Team USA going all the way back to the second half of last year.

Many of our franchisees have, in turn, successfully executed the programs in their own stores, which has had a very positive impact on both their customer service and their local store marketing results.

As I said before and you'll likely hear me say this many more times in the future, Domino's franchisees are strong owner-operators who have the talent, experience and motivation to run great pizza stores.

That's what many are doing today.

We are seeing it reflected in the sales numbers that we announce today.

Positive domestic comps, combined with yet another quarter of positive same-store sales growth from our international business -- which by the way is our 54th consecutive growth quarter -- is what drove significant growth in our global retail sales, just under 8%.

Suffice to say it is great an important to have some sales momentum again, and we again feel very, very good about that.

International store growth also contributed to our strong global retail sales performance for the quarter.

We continue to open stores at an impressive rate and pace thanks to the continued expansion of our international store base.

Following our recent bout of struggling with domestic sales, our team is feeling good about these strong topline results and about our diversified geography and continued growth and success internationally.

Our positive sales momentum, both domestically and internationally, is particularly important at this time, as we are experiencing a very challenging and I would describe it as unprecedented inflationary cost environment.

As you all know, minimum wage issues are coming into effect this week.

That affects us in what I think to be around 19 states where, in fact, the federal minimum wage increase is going to have a direct impact.

Commodities are operating at a level that's different than anything I've seen in my nearly nine years at Domino's.

We are used to volatility across the commodities at different times, but we have never experienced a situation like the one that we are currently in where we could talk about cheese prices, chicken prices, beef and pork prices, wheat prices, corrugated box prices.

Just about across all of the commodities that we purchase we are operating at or above ten-year historical highs in terms of costs.

When you combine that with energy cost increases and gasoline prices at the pump, it's certainly put an unprecedented amount of pressure on our operating costs and margins.

Although we have nearly a 47-year history of managing through these commodity price cycles and these fluctuating cost situations, these increases coming at us all at once certainly have put a strain on our store margins.

That's whether we're talking about Team USA stores or our franchisees.

By the way, I'm sure that pertains to anyone that's in the pizza business right now.

I believe that these cost pressures will likely lead to a significant price increase in the pizza category.

Unless we see an abrupt change in the cost environment, which we do not forecast here at Domino's, I see no other way to restore margins at the store level than to significantly increase prices.

History has taught us that commodity markets will naturally rise and fall.

However, when legislative actions affect the cost of wheat and corn by restricting its use for ethanol versus food or when wages are not determined by job or market demand but by state and/or federal government intervention, it's hard to predict when these costs will moderate.

You simply have no choice but to pass along these costs in the form of higher prices to the consumer.

Now, our category has always been very promotional.

We estimate that approximately 85% of everything sold in the pizza category is discounted in some way.

I believe price increases in the category will be achieved through higher price points on bundled promotions and, in some cases, higher price points on nationally advertised items.

Certainly, consumers are not strangers to inflationary increases, and these cost increases are being well-publicized.

Based on the cost charts that I'm reviewing, with so many commodities at or near ten-year highs, chances are consumers will have to get used to many price increases in the months ahead across a lot of categories.

These cost pressures have also had another negative short-term impact on our business.

That is that, when you combine the current pressure on store margins with the soft domestic sales we experienced in 2006 and early 2007, it has created a less-than-favorable environment for domestic store growth.

We will likely open fewer domestic stores 2007 than we originally planned.

However, we continued to expect that, in most years, including this one, we will grow our worldwide system by a net of 200 to 250 stores.

We don't see any reason to kind of revise this store growth expectation that we've put out there for quite some time now, but store growth for this year will likely be skewed even more towards international than in past years.

Over the past few years, international has made up 70% or so of our net store growth.

This year, that percentage will likely be a bit higher.

As domestic sales momentum continues and as some of the cost pressures are relieved either through cost declines or pizza price increases, or some combination of both, we expect domestic store growth to resume at what we would characterize as more normalized levels.

This is another example of how our business model and our geographic diversity and the very strong international business that we have that continues to gain momentum help us maintain the strong and steady cash flows the our investors expect from us.

Now, before I turn it over to David, I would like to thank our investors for the great feedback I have received, we have received, about our recent recapitalization.

Although the expenses associated with this strategy have skewed our first-half results and frankly created a very messy quarter from a financial reporting perspective, we feel proud of the work we did to achieve an end result that enables our balance sheet to work hard on behalf of our shareholders.

We're looking forward to battling hard during the second half of 2007 to create the success that you have become accustomed to from Domino's Pizza with hopefully a much shorter list of items affecting comparability in our next couple of press releases.

So with that, let me turn things over to our Chief Financial Officer, David Mounts, to take us through a more detailed look at our second-quarter financials.

Thanks, Dave, and good morning, everyone.

As you'll note from the earnings release that was issued this morning, we had several one-to items that affected the comparability of our results when you compare against the second quarter of last year.

I will cover those shortly, but first I want to start out with the top line.

The 7.7% growth mentioned by Dave was driven by same-store sales growth that he we had, both domestically and internationally, and an increase in our worldwide store counts of 259 units over the trailing four quarters.

Same-store sales, as Dave noted, we've definitely turned the ship in the right direction.

Domestically, our sales increased 2.1% for the quarter.

This had our company-owned stores up 4.4%; our franchise stores were up 1.8% positive.

Internationally, our same-store sales increased 3.9%.

This is following a very, very strong 5.7% last year, so we're very proud of that accomplishment.

Moving on to the income statement, our total revenues for the second quarter were $340.3 million.

This was a $12.5 million or a 3.8% increase from last year.

It was driven by the higher distribution revenues and a result of higher food prices, mostly cheese, and also higher revenues from our domestic stores, which were driven by the increases in the same-store sales and the store counts that I just covered.

Offsetting the increase in revenues was the sale in our International division of the Netherlands and France, which completed and closed in the third quarter of 2006.

This drove the $3.9 million decrease in international revenues despite their continued strong performance in same-store sales and store counts.

We ask you to remember that revenues can be misleading when analyzing Domino's financials and ask that you consider global retail sales as really the key gauge of topline performance.

Let's go to our operating expenses.

As Dave mentioned, we are operating in a very high-cost environment.

Despite these challenges, we were able to hold our consolidated cost of sales, as a percentage of revenues, relatively flat in the second quarter versus the prior-year period.

We were at 73% this year versus 72.9% in the second quarter of '06.

For this quarter, our food basket cost increased, our labor increased, but we were able to offset that with improvements in ticket and benefits from our modest short-run hedging program that helped us to achieve a 1% margin improvement in our corporate stores.

For G&A expenses, when you exclude the $5 million legal reserve, which I will discuss in a moment, and expenses incurred in connection with the recap, we were able to achieve ongoing expenses that were slightly better than last year.

Before we get to the bottom line, I will cover the one-time items that affected comparability versus the prior year.

You can see these in more detail in the table in our earnings release.

First, as previously announced, we completed our recap in the second quarter.

As a reminder for the benefit of new investors, this was an extremely successful transaction where we lowered our cost of borrowing and we gave shareholders a significant return on their investment.

We informed investors, in our previous communication, that we would incur significant expenses throughout the first half of the year related to this recapitalization.

Our pretax earnings were negatively impacted by $21.7 million.

This was due to higher interest expense of $21.9 million, mainly due to the write-off of deferred financing fees on previous debt.

We also incurred $2.4 million of G&A expenses.

This included $1.3 million of non-cash compensation expense.

Offsetting these negatives was $2.6 million of additional, tax-free interest income that we earned on the recap funds prior to paying the special dividend.

Second, in addition to the impact of the recap, we also recorded a $5 million legal reserve in the second quarter, as I mentioned earlier.

We are facing pending lawsuits in California alleging that we failed to provide meal and rest breaks to our employees a few years ago.

Even though we feel these charges are ill-founded, we have strengthened our procedures and controls around the applicable laws.

However, there was a ruling in another case that we are not party to surrounding the statute of limitations for these matters.

Based on the current status of these cases and based on our best estimate of potential exposure, we felt an increase in our reserve was necessary at this time.

So looking at our bottom-line earnings, our adjusted diluted EPS was $0.28 for the second quarter, but that was $0.04 on a reported basis due to the items affecting comparability I just covered.

The recap and the California legal reserve items that we just discussed had a $0.24 per-share negative impact on our diluted EPS.

Looking at how we compare it to last year, we posted EPS of $0.39.

This was inflated by a $0.05 tax benefit recognized on the sale of France and Netherlands.

This decrease in our normalized EPS figures was mainly driven by the higher interest expense related to our increased debt levels.

Additionally, I'd like to remind everyone that the 2007 impact for the new debt levels is only a partial-year impact.

As we look to the full year of 2008, our interest expense will increase.

These rates are fixed, but in 2008, we will have 105 additional days at our increased debt level.

Regarding open-market repurchase of Domino's stock, we did not make any purchases in the second quarter.

We are required to report shares purchased and the amount spent on those shares with our filings.

I cannot discuss with you any activity occurring since then or during any quarter in the future but we will included appropriate summary of purchases with our filings at the end of each quarter.

The last point I'd like to leave you with is that we continue to be very comfortable with our new debt level in terms of leverage and interest coverage ratios.

We've operated these levels in the past, specifically after the '99 and 2003 leverage recapitalizations.

We have proven a record of operating very successfully with appropriate debt levels, given the significant free cash flow that our model generates.

As you know, there have been many times over the past several years where we have made significant share repurchases, paid industry-leading dividends, repaid our debt, or made strategic acquisitions, or have even made significant investments in our stores by doing re-imaging or upgrading technology.

All of this was accomplished while carrying appropriate debt levels.

Please know that nothing has changed in our model or strategy.

This concludes our financial update.

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

With that, we would like to open the call for questions.

(OPERATOR INSTRUCTIONS).

Ashley Woodruff, FBR.

Could you talk a little did more about store level margins?

You said, in the second quarter, you did benefit by about 100 basis points from some short-term hedging on cheese.

Do you expect to see any similar benefit in the third quarter, or should we expect those trends to be more similar to the trends in the market price of cheese?

Ashley, my policy around talking about hedging is that we tend to look at hedging net of food costs, so we look at hedging as just part of the strategy of managing our net food cost.

So I don't want to share any of the go-forward strategies other than what I said previously, which is that we tended to have a six to nine-month time horizon; it's really to allow our system the time to adjust to short-term fluctuations in these costs.

It's not meant to be a long-term strategy for managing the cost of commodities, and that's how we apply that.

So, we did certainly see a sharp increase in the first quarter in cheese prices.

As you know probably already, cheese prices are starting to come down a little bit.

We have seen, just in the last couple of weeks, some reductions in those.

Obviously, those affect us in two ways.

We get a better benefit by having better food costs going forward when the costs actually come down, but then also the value of our hedges will decrease as those positions change.

Okay.

Then on minimum wage, do you have a sense of what, with the federal minimum wage increasing now, what the incremental expense will be for Domino's company-owned stores?

It's been about -- by the time it's all in, we think it's about $0.50 impact.

So, when you think about the hourly wage rate, about $0.50, it's been about a 0.5% impact in terms of the margin at about $0.50 an hour.

So that's the simple sort of headline.

Now, much of this we've already started to see because we had several states that had increases last year, but that's our best estimate once it's all in.

Okay, so you don't expect to see it increase more in the second half of this year?

Well, there certainly will be increases because not every single state that we operate in has been affected prior to the July 24 minimum wage change.

But we expect that the total effect will be $0.50.

We've seen a majority of that impact already leading into this July 24 change.

Okay.

Then just one last question on the -- it looks like you had about $93 million in cash on your balance sheet at the end of the quarter, yet you didn't buy any stock.

I guess I'm curious.

Were you restricted or what the reasoning behind that was?

Then, can you talk about how you weigh your potential uses for cash flow in the future between share repurchase and debt paydown?

Yes, sure, a really good question.

You're right.

The cash position was up $93 million.

About $69 million of that is driven by the new ABS structure that we have in place.

There are some short-term effects of that.

One of the things that we are required to do in the first couple of quarters is maintain a little bit larger interest reserve as part of that ABS agreement with the noteholders and the bond insurer.

So that ties up $26 million of cash that we really can't get our hands on until we demonstrate performance over a couple of quarters.

So, we suspect that about two-thirds of that we will free up and the casualty available next year, and we will go down to sort of a more standard kind of one month's interest reserve.

So that's part of the issue.

In the ABS restructuring, we have also had to set up some new entities.

One of the entities we were required to set up to separate the collateralization of the franchise agreements was the new uniform franchiser.

So the formation of that entity requires a $15 million cash capitalization in order for that entity to have no restrictions on where it can go and license franchisees.

So we capitalized that, and that 15 million capitalization is all-cash at this point.

We will evaluate that going forward and see whether that needs to be all-cash, or whether other assets would be appropriate.

That's something we will have to evaluate on a go-forward basis.

Then the last point is we have a very long first quarter to make an interest payment this go around, so we have accumulated a little over $20 million in accrued interest right now that actually doesn't get paid to the bondholders until we complete the third quarter.

Okay, that's helpful.

Then could you -- this is my last question on share repurchase versus debt paydown maybe in the second half of this year?

Well, I think anything -- I don't want to be specific about the second half of this year.

I will be maybe a little more broad with that.

You know, our view obviously, as we just put very efficient financing in place, we are at a rate today -- a cash rate of 6.06%.

We like that rate; we like our debt financing.

We have a long horizon before we have to think about refinancing.

So, I would say, in the earlier stages of that five-year time horizon, we're going to be much more focused on open-market repurchases than we will be debt paydown, but obviously, you know, it's not a simplistic formula that we can apply or what makes sense this year may not necessarily make sense in year three or year four.

So as we get into the later years, we will have to evaluate the debt situation a little more carefully; we will have to think about refinancing.

That could have an impact.

But in the shorter run, I think, over the first few years of the term, it certainly makes a lot more sense to pay down the higher-cost equity than it does to pay down the lower-cost debt.

Okay, thank you.

John Glass, CIBC.

Thanks, good morning.

Can you talk a little bit more about the contributing factors to the turn in comps this quarter?

It seems like you have been working on this for a while; there's been six or five quarters predating this in which comps were negative.

In particular, could you talk about -- has pricing been a component this quarter more than in other quarters?

Is this a factor?

Well, as you know, John, we don't talk specifically about ticket and order count in any kind of real number terms, but we did advise you that we saw a lift in the second quarter from both order count and ticket, which for us is the optimal way to grow sales.

We are seeing an increase in traffic at the same time we are also seeing a lift in ticket, which is appropriate based on the cost issues that we're talking about.

I've spent probably more time than I should talking about my assessment of 2006 and kind of what happened and what we were comping up against any kind of what brought us into this year, so I will not be redundant in that regard.

I would just tell you that we have a very focused franchise group right now who is working harder at the local markets than they were a year ago in terms of engaging their customers and their communities in sales-building activities.

We are operating at the retail level more effectively today than we were a year ago to a significant degree.

We are providing better, faster customer service than we were a year ago, and in our business, that means a lot.

So, I like the trend that we've established operationally.

I like the trend that we've established in terms of our local store marketing.

Our national events during the quarter were reasonably effective, and the combination of those three factors put us to where we are today and make us happy that we have regained some momentum that we've been looking for for awhile.

I got you.

Then last quarter, you talked a little bit I guess it a generic sense about shifting from not -- more emphasis on local advertising in order to drive sales, but you didn't talk specifically about -- are you thinking about changing your mix of national versus local and co-op.

Is there anything like that in the works that we should look at for the back half of this year?

Well, the only thing I would tell you is that we are thinking about changing the mix.

Obviously, it's an important decision we want to get right because we're trying to balance the opportunities associated with efficient media buying with making sure that we've got the appropriate resources in the appropriate place to make sure that all levels of our marketing our working well together and pulling their weight.

So, we don't have anything specific to announce.

I think that's still a conversation that's taking place here as part of our 2008 marketing planning, but we're going to try to come up with an optimal media-buying strategy at the same time we make sure there are enough resources at the local market level that we can be good local store marketers, because one of the things we learned in 2006 is how important that is to drive sales.

I got you.

So it sounds like nothing can happen this year, though.

When you say nothing can happen (multiple speakers)?

Meaning you can't change a mix intra-year, you can't change your mix of advertising from local to national and national to local?

You can't change the buckets of money because those dollars have already been aggregated and deployed at the national level.

But I think what the second quarter proves is that it's not just about money; it's also about focus and activity.

So, we're certainly not waiting until 2008 to turn the ship; we've already done that.

The reality is we will potentially be able to even create more sales momentum if we get some additional resources at the local market level, leveraging more activity at the store and local community level.

John Ivankoe, JPMorgan.

The question is on pricing.

Obviously, David, in your remarks, you used the word "significant".

I guess what I'm trying to get a sense of is when you see pricing meaningfully going up.

I mean, is that a second half '07 event?

Has it already happened to the extent that it has or to the extent that it will?

If I may just kind of follow-up or dovetail onto that question, you know, how important is it going to be for Domino's to develop an everyday value message that consumers can identify with so that the pricing doesn't get away from you?

I actually think there's a lag effect.

Certainly, the combination of some -- and I'm talking about more industry-wide than just specific to Domino's, because when we talk about pricing, I think we are talking more generically in terms of what's happening in the category.

You know, a lot of operators are going to be affected by the minimum wage.

It's just hitting this week.

We all kind of saw it coming but the effect will be felt.

Some of the commodity price increases, there's a lag between the time that the commodities go up and it starts to appear in the supply chains.

So, I actually think we are in a mode where operators every day are waking up and looking at what the cost environment is.

It's tended to get more and more negative over the past several weeks and it will likely continue to feel more negative at the operational level, at the store level, in the weeks to come.

So I think we are in a mode where there is tremendous focus on pricing and at least as I talk to our operators and as we are giving leadership direction to our operators, we are in a mode where we see no other way to restore margins at the store level to the level that we all want than to really go after price and maximize price in every way we know how to do that.

I can't imagine there's anybody in the business right now that's looking at the same cost starts I'm looking at that isn't doing the same thing.

With regards to developing a daily value message, I mean is there something that's currently in the works for you or quite frankly, do you think is necessary so that consumers can identify with a certain price point or a certain product that they know they can get at a value, even if the rest of the menu does go up in price?

We believe, price increases notwithstanding, there's still a significant number of consumers out there who turn to this category and expect this category to provide value.

What likely this environment will do is create a circumstance where as opposed to pulsing on-value/off-value through national topics or specific promotional windows, I think our strategy is going to be more around trying to provide everyday value with bundles and mixes of products and promotional price points that provide margin opportunities to our operators that make them excited about selling them, but at the same time providing great value in terms of the quantity of food and the variety of food that the customer can receive for a very reasonable price point, based on other food options that are available to them in their markets.

So, everyday value is becoming more and more important, and it's an area that we, through our marketing strategies, are certainly addressing.

Jeffrey Bernstein, Lehman Brothers.

A couple of questions -- just first on the -- you mentioned, Dave, the marketing and operational initiative, continuous, say, impact I guess implemented, starting to really benefit the franchisees.

I'm just wondering if you can discuss I guess a couple of the most impactful ones, and whether the momentum that you've seen in the most recent quarter is sustainable with those initiatives as we look out over the next few.

Well, as you know, for many, many years, the trend has been that the local owner-operator who has skin in the game, lives in their community and is the leader of, in our system, on average three stores has always traditionally outperformed our corporate unit where we have corporate employees who are in fact leading those stores in those communities.

The business model has always proven that that skin-in-the-game owner-operator is going to have higher sales increases and operate their stores at a higher level.

The think it gets our system's attention when Team USA is able to go out there and outperform them and outperform them consistently in terms of sales growth and in some cases operational improvement.

So, the beauty of when that happens is that our franchise owner-operators when I look over the fence and say "What are you guys doing, because I need some of that?" And that's a moment where we can provide leadership by example.

I will just give you one example, although I could give you several.

If you recall, one of the problems we got into in 2006 is that we started to see this negative topline sales trend develop and many of our operators decided to cost-reduce their way out of that problem.

In some cases, they began to under-staff their stores, trying to carefully micromanage their labor costs and in so doing put themselves in the situation where, during the peak periods particularly, we were under-staffed and providing poor customer service.

We were taking too long to feed hungry people who were calling us expecting us to deliver a pizza within 30 minutes.

What Team USA did is they implemented some very specific incentive programs and frankly some technology in the stores that has proven to be incredibly effective at changing that mindset in the store, helping manage the labor component more carefully.

At the same time, we incentivized the teams to provide better customer service.

At the same time, we use technology to really appeal to the competitive instincts of the people in the store to improve.

The combination of that has created a circumstance where Team USA's operational improvements took a huge step forward.

It's one of the reasons why they began to outperform the franchise system.

We take that knowledge, that learning, we export it, to the franchisees.

They embrace it and they get better.

That's one example of the way that this transfer of Best Practices has occurred within the system we think to the government of our overall performance.

That's a great kind of cat-and-mouse game where they, each one follow each other.

Just looking at kind of I guess more towards, David, the international was margins, it obviously looks like you are lapping the Company operated sale at the start of the third quarter.

I'm just wondering what kind of a normalized rate is when we look at those margins.

Now that you are 100% franchised, should we assume it sits in I guess that mid to upper 50s segment margin range?

Well, I think it depends.

From time to time, we're going to make decisions to invest.

A lot of times, the investment we make in international is going to be intellectual capital; it's going to be people.

So the biggest variable there is overhead.

There tends to be a lag between when you make those investments and especially in emerging markets, and when you actually see the sales come through.

So you know, I think that's probably as good a number as any, but what I would just caution you to think about is that you should expect to see that.

There's some variability in that, as we make investment decisions in people, to expand the certain markets and those resources, you'll see those applied from time to time.

Just another footnote there -- we did close that France/Netherlands transaction on July 3 last year.

(multiple speakers) a little tail of that in the third quarter, in terms of the year-over-year comps.

Okay.

Then just lastly, you guys obviously followed up on the recap.

Just in terms of interest expense, the assumptions going forward, is it now fair to assume, for a 12-week quarter or a 16-week quarter, that's now 6.59?

Is that the number you guys gave last quarter?

Yes, that's the all-in number with the amortization.

Then the cash interest expense number is 6.06.

(multiple speakers)

What you should expect to see kind of in a normal 12-week quarter is roughly about $24 million of interest.

Flowing through the income statement?

Yes.

That's pretty much applied to just the steady $1.7 billion?

Yes, that's currently where we are.

Yes, great.

Thank you very much.

[Joe Fisher], Bear Stearns.

Sitting in for Joe Buckley here.

Just first, I wanted to touch on food costs.

It looks like food costs were down about 140 basis points, year-over-year.

I'm just wondering how sustainable that was or that will be, and if, after hedging, if cheese costs were still up.

Yes, it's very similar to that question that Ashley asked.

I think I'm a little careful there because I don't want to share more about our hedging position than I should, because that's a market that we are actively involved in.

But what I would tell you is that the benefits that we receive this year in terms of the strategy of hedging was it was supposed to offset our food costs when we had increases that were short term and particularly when they were short term and very aggressive like we just saw.

The strategy worked perfectly, and it covered the -- for the corporate stores for this particular quarter, we had a benefit that was slightly more than the actual increase in the cheese costs, and that's really good.

I can't predict for you how that will be every quarter, but that's the way the strategy was supposed to work.

Obviously, if the prices go down, we will get a benefit and we would love to see cheese prices go back down.

That's always a better situation than having the benefits of the hedge.

But then the value of those hedges would also be adjusted.

Has the percent -- you know, granted you haven't disclosed what percent you're hedging or everything, but has that changed over the past three to six months?

We actually -- I think we've talked sort of about a modest program.

We typically look at about 50% to 70% of our exposure.

It's very insurance-based and we're focused really on just managing the risk of the upside increases.

Okay.

What about wheat costs?

How significant is wheat for you guys?

Well, wheat is, as you know -- and it's a good question because wheat has been going up quite significantly.

It's a much smaller percent of the cost of a pizza.

Where cheese is about a third, you're talking about wheat is -- it tends to be a single-digit cost.

It's not a material cost element for us in the pizza, so we can tolerate a higher increase in wheat cost on a percentage basis than we can, for example, with cheese or some of the other more expensive food products.

But clearly, wheat has been a factor and wheat has been a factor recently.

It had a few hundred thousand dollar effect on our P&L, but it's not been an item that has driven our numbers significantly.

All right.

The next question I guess would be on G&A.

Year-over-year, ex kind of one-time items, it looks like it's down in dollars.

I was wondering if you could comment on that.

Yes.

There's a lot of little puts and takes there, but the major part of the story is when we sold off the France and Netherlands last year, we were able to eliminate the overhead that was in place servicing those operations in Europe.

So the elimination of the overhead has been the main driver that you see in the difference between G&A, and other than that, there's a lot of little puts and takes here and there, which are just good, old-fashioned kind of managing your G&A items and then some of those typical variability that you would expect to see.

Okay.

I guess I don't know if you guys have in the past or would consider disclosing like the number of company stores that are exposed to the minimum wage.

I believe you said the national minimum wage is (inaudible) -- I believe you said there was like 19 states that you guys were in.

No, there's 19 states nationally where, effective today, there will be a significant increase.

It's a very difficult question.

Frankly, we would spend more time that it would be worth because, first of all, you have to find the states and then the markets, and then you have to find out how many of our people in a given store are already above that minimum wage, depending on how long they've been there and how they've earned their way up the pay scale.

So it's really not a number that we're spending an inordinate amount of time trying to determine.

We deal with that on a market-to-market, store-by-store basis, but it will create a lift in our cost; there's no question about it -- less for us and Team USA, in terms of the federal impact, because most of the major markets that we compete in had either local, municipal or state minimum-wage thresholds that are higher than what we're seeing federally today.

(multiple speakers) feel good about having those increases earlier when they occurred, but we still don't feel good about the federal increases, but obviously that was something that we experienced in a lot of the last-year numbers that you see.

Certainly.

If I could ask one more?

You talked about both tickets and traffic being up.

Is there any correlation to maybe an increased online order mix?

We believe that online ordering is helpful and beneficial to us.

We think it brings in some new customers.

We think there are people who prefer to utilize that system, or that method of ordering.

The average ticket on those orders tends to be higher, which is also positive.

So, we are thankful that we've got the majority of our domestic stores accepting orders online.

In fact, that number of stores will wrap up considerably now that we're going to start to market more strongly behind that.

Our mix, as it relates to online ordering, we think it's kind of consistent with what appears to be happening out in the industry as we hear other people talk about it, but frankly we don't like to slice and dice our marketing results in any fashion.

In terms of specifics, I will just tell you, overall, we think online ordering is a positive thing for our business and it's probably helping.

Okay.

When are you -- have you already started this additional marketing?

Yes.

Actually, if you were watching television last night, you would have seen commercials that had a tag at the end of them that offered our customers the flexibility of ordering either via phone or online.

Dan Perla, Iridian.

A couple of questions -- number one, Dave, could you just -- I didn't hear what you said about quarterly interest expense.

You said 200 -- I know it was 20-something.

I didn't hear exactly what it was.

Yes, I was just giving a ballpark number out there that if you take a normal 12-week quarter and you were looking at the cash interest level, it's going to be about $24 million a quarter.

Okay.

Just to beat a dead horse, if we stripped out all the sort of one-time items in the quarter, where (inaudible) in terms of interest expense, where are we year-to-date?

In other words, what should that number be for the full year?

Yes, we are about $9 million or $10 million over last year.

So it would be about -- for this quarter, we are about $20 million.

I think we are $22 million versus $12 million.

Okay, if you strip everything (multiple speakers).

I will doublecheck that; I'm just going off the top (multiple speakers) that's about right with everything stripped out.

Okay, two other questions -- one is there's been some chatter in the market that some of the franchisees are under significant financial pressure.

I'm wondering.

You alluded to the fact that you are going to have fewer domestic openings, in terms of all the correlation between those two things.

Just number one, could you just sort of comment on the state of the franchisees, notwithstanding your good results this quarter?

Sure.

Listen, any environment where you're coming of a soft sales environment which has a psychological impact more than anything else on franchisees and then you immediately enter a high-cost environment where all of the commodities are kind of at once going up the and putting pressure on costs and margins, operators are going to be less aggressive rather than more aggressive.

So you're going to find that typically the knee-jerk reactions to those situations in the marketplace is going to be "I think I will wait another quarter before I start building that store."

Now, that may not be the right answer and we've got people out there that are reminding our franchisees regularly that, in some cases, this is the very best environment to get that store up and ready to go because cycles come and cycles and go.

That result is we are managing owner-operators out there who are, in some cases, reinvesting in their business at the rate and pace that feels comfortable for them based on yesterday's financials.

So I think, in all the concept that I've followed, Domino's and every other one, when you're in an environment where margins are under pressure and sales are soft, you're going to have a difficult time in that environment having robust store growth.

I think that's just kind of the way the game works.

Your other question pertained to --?

(multiple speakers)

I probably didn't ask it yet.

(multiple speakers).

You know, in these environments, our franchisees who have higher-than-average A lists and who have strong market positions, they -- when you look at their cash-on-cash returns, they go down but not in a threatening way.

That doesn't mean they like it, but your best operators are going to continue to be your best operators and have great returns.

I would say your average operators in these markets feel it a little bit more, but they still are producing cash-on-cash returns that are terrific.

Most of them have been through these cycles before.

They know that when -- particularly in an environment where prices are raised across the board in the industry and the cost cycle starts to move in the other direction, there's a lot of money that can be made in that scenario as well.

In these environments, the operators in our system that we worry about the most that we stay the closest to and that we try in every way we know how to help are the ones who are burning the marginal stores, that were marginal going into this environment.

So listen.

We've got 8,400 stores out there worldwide; we've got 5000 in the U.S.

You're always going to have some percentage of the portfolio that are operating at the lowest levels of [A list] and the lowest levels of cash flow.

These pressure environments, i.e.

low sales and/or high operating costs, lower margins, put the greatest pressure on those operators.

Our job is to work with them and help them and support them as best we can to nurse them through this period, so we don't have an undue number of store closings based on financial failure.

That's what we're doing.

Okay, thank you.

I appreciate the color.

Just the last question -- just a little more color on the share repurchase or potential share purchase.

I'm also have wondering how sensitive you are to stock price in terms of buying stock back the remainder of the year, because you've certainly got the ability to do that.

Yes, Dan, the way typically I've answered that is talked about a little bit longer horizon.

You know, we like very much where the interest rates, all of our new financing are currently, especially the cash rate of 6.06.

We've got a long horizon on the term.

Five years is plenty of time for us to evaluate refinancing and other market conditions that we may need to consider.

So our bend is definitely towards share repurchase right now and not debt paydown, but generally, I can't give you any specifics around what we might be doing in any particular quarter.

But what I can do is, at the end of each quarter, we will provide a recap of what we bought and what we paid for and that will be part of our filing.

This is the other Dave.

I will just comment and say that we can only report on the history of the last quarter.

Obviously, we didn't have any activity -- then you will have to wait until the next quarter to see if we've had any activity since then.

I just want to emphasize the fact that I think there are companies out there that their directors authorize repurchase plans and it's more form over substance.

I can tell you that we authorized $200 million of investment in a repurchase plan because totally of substance.

As David has said, it's absolutely part of our strategy in terms of cash deployment.

And how and when we do that will be information to come.

Okay, great.

Much appreciated.

Thank you.

Zafar Nazim, JPMorgan.

David, I was wondering if you can talk about price elasticity in your business.

I guess if you're looking at, just hypothetically speaking, a 10% price increase in the back half of the year, how should we think about the customers that you lose either through perhaps consumers not ordering pizza or perhaps switching over to the McDonald's or the Burger Kings of the world, which may not be increasing prices?

How should we think about that?

Well, I will probably do more to confuse you than I will give you a direct answer, but it's the way the business model works.

You have to understand that we do not live in a world where we wake up one morning and say we are changing menu price across our stores and consequently we can report to that our prices are going up X%.

We have 1300 franchisees in the U.S.

who are responsible for the pricing in their markets.

We have hundreds of marketplaces that have completely different competitive sets and go into this environment at completely different price points.

So what you really have to do is step back and look at how the model works.

The model works in such a way that we empower the local operator to read what's going on not only with his own business or her own business, but also to read the competitive set around them and maximize price without having a detrimental effect on traffic and market share.

Those operators have a vested interest, a personal vested interest, in getting that right.

Now, we take a lot of Best Practices and we share what a franchisee did very effectively in one market with someone who's in a similar market.

But at the end of the day, we don't control pricing, our franchisees do.

Consequently, at the end of the day, our franchisees control their margins and what they are willing to tolerate in terms of operating margins at the local level.

That's their decision as business owner/operators.

So, we will be good partners in providing them price and direction.

We will certainly lead by example with our Team USA stores.

But how fast they raise prices and how they choose to raise prices is really something that is legally their responsibility, and we will defer to them in the regard.

What I like about the current situation is we've had a category that has been very undisciplined in terms of price increases.

To a large degree, you're paying the same for our product today as you would have paid several years ago as a result of the fact that it's hotly competitive, highly promotional and not a lot of price discipline.

I actually think that the circumstance that we've encountered today with all these concurrent price increases and the kind of inflationary cost pressures that we're dealing with will force the industry to take a more aggressive posture in terms of increasing prices.

I think, ultimately, that will be good for all of us who compete in this category.

Great, excellent.

Thank you.

If there are no other questions, we appreciate the time that you've all given us today.

It raps up our discussions of our second quarter, and we will be doing our part to raise the bar and keep our positive global sales momentum as we now are in the third quarter.

We wish you all well and we will look forward to reviewing our results with you at the end of the third quarter.

Thank you.

This concludes today's conference call.

You may now disconnect.