達美樂 (DPZ) 2007 Q4 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everybody to the fourth quarter and year-end 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)

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

Please go ahead, ma'am.

Thanks, Carmen, and thank you everybody for joining us today.

We'll spend just about an hour on the call, and we'll open up with some general comments about the quarter and the year, and then we will open it up for Q&A.

A couple of housekeeping reminders, we generally don't make a lot of forward-looking statements but to the extent that we do, I will refer you to the Safe Harbor statement that's in our press release.

And then I would also ask the members of the media to be in a listen-only mode.

And with that, I would first like to introduce our CEO, David Brandon, who will have a few comments, followed by Bill Kapp, our interim CFO.

Good morning, everyone, and thank you for participating in our fourth quarter and year-end 2007 earnings call.

I'm not going to take much time this morning to review the macro economic environment in our domestic market.

I don't think I could add anything new or different to what is already being widely reported.

The US economy looks weak, and consumers are clearly reigning in their spending.

And as you have heard from me and others, food costs, particularly the commodities that we rely on in the pizza business, continue to be extraordinarily high.

All of this is real, and we continue to navigate our way through it, along with many other retailers and restaurant companies.

So instead of focusing on those things we can't control and/or certainly making excuses based on these external factors, I'm going to briefly discuss those things we're doing to positively impact the things we can control and steps that can make a significant difference in our overall performance.

Our focus is primarily on improving our domestic franchisee sales and returning them to our historic run rate of growing 1% to 3% annually.

Two years of negative domestic franchisee comps isn't acceptable to me, and it isn't acceptable to most of the franchisees in our system.

And the fact that our Team USA stores have done a significantly better job is of little consolation.

Franchisee performance drives the performance of our entire domestic system, and the interests of our shareholder, our franchisees and our team members are closely aligned.

Nobody wins until we get our domestic franchisees' sales moving in a positive, consistent direction.

A couple of points to build on that.

First of all, after adjusting for our $13.50 dividends, the special dividend that we paid to our shareholders in the middle of 2007, our share price at the year-end 2007 was down about 4.5% from where it ended 2006.

We believe our domestic franchisees' weak comps during 2007 have contributed to this loss of positive momentum in our stock price, and we know that our shareholders need and expect to do better than that.

Our domestic franchisees cannot increase their profits in the current high-cost environment, particularly without achieving positive same-store sales.

Most of our franchisees will have experienced a profit decline in 2007, and certainly our franchisees need and expect to do better than that.

Finally, my team and I cannot gain benefit from any of our incentive plans without achieving positive sales growth in our domestic system.

Based on the shortfalls we experienced in our 2007 domestic franchisees' same-store sales and store growth, and the resulting loss of volume through our supply chain business, no bonus checks were distributed under our TAD annual incentive plan, and like our shareholders, we too suffered from a pullback in our stock price and our stock option values.

2007 will be the first year we have all been shut out from participating in the growth and success of our company during my nine-year tenure at Domino's, and I can assure of you this.-- my team and I need and expect to do better than that.

So for all of these reasons, job number one is for us to get our domestic franchisees' sales growing again, and we are taking bold action on many fronts to achieve this important objective.

First, the majority of our domestic franchise system is comprised of dedicated, passionate operators who are excellent business owners living and working in their local communities.

We respect them, we appreciate them, and we admire them.

However, we are a large franchise system who has been around for over 40 years, and we've got some disengaged operators who are not performing at an acceptable level, and they are hurting the brand and the overall performance of our domestic system.

In 2008, we're going to challenge these underperforming franchisees much more aggressively than we have in the past.

We will either get them to engage in their business and improve their performance, or help them transition their stores into the hands of operators who are prepared to do what it takes to succeed in today's highly competitive pizza delivery market.

Refranchising will be an emphasis for Domino's pizza in 2008 and beyond.

Second, we will be encouraging our very best franchisees to build more stores, or to buy distressed stores as turnaround projects, which oftentimes have considerable financial upside; or, in some cases, we will encourage our very best franchisees to buy corporate stores as a way to expand the scope of their businesses.

To summarize an important point, we need to get our domestic franchisees fired up about competing to win, and move out those who can't or don't want to engage in what it takes to succeed.

Third, we need to obsessively focus on the consistency of our products, our customer service, and the image of our stores and team members, because that is at the core of the customer experience.

I am excited and encouraged by several things that are happening.

First, the new organizational leadership changes that we've announced over the past few months are important, and very relevant to the turnaround that we're attempting to achieve with our franchise organization in the US.

I like my team.

Under Patrick Doyle's leadership, Jim Stansik, Scott Hinshaw, and Asi Sheikh, we are waking up every morning and focusing on the issues that we need to address to get stronger marketing, more momentum in our domestic franchise system, and certainly making sure we've got the right group of franchisees out there working every day to build their businesses.

I'm pleased with the evolving work of our new advertising agency.

We learned a lot from our first effort with our new agency in January of this year, and we will only get better with more time to work together and continue our partnership.

I'm very pleased with our new brand message, "You've got 30 minutes." "You've got 30 minutes" really strikes at the heritage of our brand, and it has really become an internal call to action that has created positive change in the operational execution of our stores.

The expansion of our pulse point-of-sale technology throughout our system is a significant, positive event for Domino's Pizza.

It drives more online orders and provides other technology innovations that we think are real and important to our customers.

Things like pizza tracker, which has received a lot of press of late, as it affords our customers the ability to literally track online their order from the moment the order is placed until it comes out of the oven, on its way and delivered to the consumer.

It's a great way for customers to feel connected with that order once they place it with their local store.

Pulse incorporates labor scheduling technology which affords us the ability to more efficiently manage our labor.

It has a functionality called ticker, which gives our stores the ability to compete with surrounding stores in terms of their in-store performance, operational and service times.

It creates a competitive energy that we've found to be very, very positive in the way our crews behave at the retail level.

It has a theft-detection capability which has afforded us the ability it identify where in-store theft, internal theft is occurring, and address those issues very early on.

It affords us the ability to have alternative ordering methods, and so many other technology breakthroughs that we think will be a part of the pizza category, particularly for those of us who can play at the national level and develop these kinds of technologies, and put significant pressure on the smaller, weaker players who really don't have these capabilities.

The fourth thing I want to mention is we're working very hard to create excitement in our category, with marketing that makes the phones ring and drives traffic.

We know we're not the only retail dinner concept with traffic problems right now, but we want to help lead the pizza dinner segment out of the traffic doldrums.

We are working to get our value positioning right by implementing pricing that takes the cost environment into consideration but also drives traffic and sales.

We clearly need to speak to and attract those consumers who are fearful of recession, and just continuing to increase our prices isn't going to make us the safe haven that we want to be for families who are looking for a place to order dinner during a time of economic worry.

Getting back some level of traffic growth is first and foremost for Domino's Pizza in 2008, and we will be taking some bold action to hopefully make that happen.

My final comment on our domestic business is that you'll notice from our year-end numbers that most of our net store growth during 2007, which was well within the range that we have kind of given people the -- the expectation of, it came to us primarily from our international division.

Clearly, we struggle to increase our net domestic store growth when we are not growing sales and, in some cases, our stronger operators are buying stores from failing franchisees rather than building new ones.

We obviously hope to get this situation turned around, as we gain some additional momentum in our domestic franchise business.

Our international business of the star of 2007, with same-store sales up 6.7% over 2006, a positive 4% annual sales increase.

I'm very proud of our international team, and while I purposefully started off my remarks today focusing on the domestic business, which needs much attention, I can tell you that our international business needs no fixing.

It's going gangbusters.

The international business has definitely reached critical mass.

It's now 40% of our global retail sales and nearly 30% of our profits.

Just a few examples to illustrate this.

Our UK master franchisee just reported a 33% increase in their 2007 profits.

Our Australian-based franchisee, who bought the rights to France, the Netherlands, and Belgium last year, recently announced that their same-store sales in those countries are up 15%.

Our business in India had revenue growth of 54% last year, and they are the market leader in that country.

I want to point out that the momentum in our international business isn't due to a magic bullet, it's not occurring in just one country or with one great promotion.

The commonality is that we have operators who are completely engaged in the business and have created and sustained their sales momentum.

This is exactly the kind of passion and focus we are working to recreate in the hearts and minds of our domestic franchisees.

Now despite our almost intense, overly intense internal focus on our domestic sales issues, particularly as it relates to franchisee sales, we continue to keep our shareholders top of mind.

Once we got our open market share repurchase program up and running this year, we used it to aggressively repurchase shares, particularly in the fourth quarter.

By the end of the year, we had gone through over a quarter of our authorization, and we intend to continue to be aggressive with repurchases.

This is an easy decision for us with our stock trading at current levels.

In conclusion, I just want to say things are clearly tough out there.

The end of the fourth quarter saw some very challenging soft weeks for us, and I think everybody, and regaining traffic growth in our category continues to be a difficult task.

But we are moving fast on all of the actions I've outlined, plus others you'll hear about in the coming weeks and months, all focused squarely on turning domestic franchise sales around and prudently managing our costs during this difficult environment.

We know it will take time to gain the benefits of some of the initiatives I've outlined for you today, but our track record for growth and success is there for the world to see, and I remain very confident in our ability to get our franchise -- our domestic franchisee partners' sales back on the track in terms of their overall performance.

Now with that, I'd like to turn things over to our Interim Chief Financial Officer, Bill Kapp, and he'll run you through some numbers.

Bill?

Thanks, Dave, and good morning, everyone.

As you'll note from our earnings release, we had several items that affected the comparability of our results to those of the fourth quarter of last year.

I'll cover those shortly, but first I'll start with the top line.

We ask you to keep in mind that revenues alone do not necessarily give you the complete picture, and instead consider global retail sales as a clearer gauge of top-line performance.

Our global retail sales increased 7.4% during the quarter, driven primarily by same-store sales growth in our international business, and an increase in worldwide store counts of 258 units over year-end 2006.

Moving to same-store sales, domestically our sales decreased 3.5% for the quarter.

Company-owned stores decreased 1.1% versus a negative 1% in Q4 2006, while franchise same-store sales decreased 3.9% versus a negative 4.9% in Q4 2006.

Full-year comps, however, were slightly better, with company-owned stores up 1% and franchise down 2.1%.

Internationally, same-store sales increased 9.5% over last year's positive 3.9% in Q4.

Full-year comps were up a very strong 6.7%.

This also marked the 56th consecutive quarter of international same-store sales growth.

Moving on to the income statement.

Our total revenues for the quarter were $445 million, up $10.7 million or 2.5% from last year.

This was driven by higher revenues from our international stores.

Also we had higher domestic supply chain revenues, we formerly called that distribution, caused by elevated food prices, mostly cheese.

Our consolidated operating margin as a percent of revenue decreased 1.5% in the quarter versus prior year, 25.1% versus 26.6% a year ago.

I'll now cover each of the three operating divisions.

First, our international franchise business, which has no cost of sales, grew as a percent of revenue, thus improving our overall consolidated margin for the quarter.

Second, our company-owned store margins were negatively impacted by higher food costs, primarily cheese, and also higher labor and ordering costs.

Third, our supply chain margins were down, primarily due to two factors.

Cheese prices accounted for 1.2% of the 1.5% decrease in the consolidated margins.

Remember that cheese prices are a pass-through, and will impact the percentages but have no impact on the dollars earned.

The average cheese block for the quarter was $2.01 per pound versus $1.30 last year, a 55% increase.

The second supply chain factor was the impact of the wheat market.

The higher wheat costs decreased the margin percentage by approximately .8%, but also impacted the dollar margin, unlike cheese.

We had previously committed to our franchisees a full year of constant store pricing for dough, which had been our customary practice when wheat prices were much more consistent.

Therefore, we did not pass on the significant wheat cost increases experienced in 2007.

We have already adjusted our store pricing for Q1, 2008, and will adjust quarterly moving forward.

Thus our supply chain margins should return to more normal levels.

Given the volatile market conditions that we experienced in 2007, we decided to lock in the cost of our 2008 flour during the fourth quarter of last year.

While this price lock was a significant increase over historic costs, it is below current market levels.

Next, bottom line earnings.

Our diluted EPS on a GAAP basis was $0.26 or $0.21 as adjusted for the quarter.

This is a $0.23 decline from the prior-year quarter.

We benefited almost $0.06 from non-recurring events, a $3.5 million after-tax impact from certain state tax reserve reversals, and a $1.1 million after-tax gain on the sale of our corporate aircraft.

Our recapitalization had a significant impact on interest expense, which produced a decrease of $0.20 year-over-year in the quarter.

Our total interest expense for the quarter was $34.6 million.

An additional $0.09 decrease was driven by our operating results.

We experienced a decrease in our domestic supply chain profits, due to the lower domestic sales volumes and the increased wheat cost.

We also had lower corporate store margins.

Our G&A expenses increased primarily due to an investment in our domestic store development team and increases in health insurance.

These decreases were offset in part by the continued strong performance in our international operation.

Additionally, our effective tax rate was 24.8% in the quarter.

During the fourth quarter of 2007, and as I discussed previously, we reversed reserves related to certain ongoing state tax matters.

We anticipate a more normalized 39% to 40% over the foreseeable future.

As mentioned earlier, we sold our corporate aircraft for a gain during the quarter.

The proceeds from that sale are reflected in the cash flow statement in the proceeds from sale lines, while the investment in a replacement was included in the capital expenditures line.

We continue to expect that our recurring capital needs will be between 20 and $30 million annually.

As stated in our earnings release, the company repurchased approximately 2.6 million shares of its common stock under our share repurchase program, or $36.4 million during the quarter.

We funded $15 million of this by borrowing on our revolver and still have over $100 million in capacity available.

We will continue to be opportunistic buyers in the market.

Turning to our leverage, we continue to be very comfortable with our debt level, and we have seen no economic effects on our current financing or our capital structure due to the recent turbulence in the credit market.

Since our rates and terms are fixed, we can expect the same conditions during the balance of our five-year term.

Our Q4 debt service coverage ratio was not high enough this quarter to allow us to release approximately $17 million in restricted cash.

We've had some questions about our covenants under the new ABS debt.

The primary covenant on the debt is a debt-service coverage ratio that cannot be calculated using publicly-released numbers.

However, basically the numerator in the calculation is closest to our segment income; not exact but a rough estimation.

The denominator in the calculation is senior interest expense.

The exact formula can be found on page 55 of the base indenture definitions and was attached to our Q1 2007 10-Q.

Since the denominator is fixed, we estimate that our numerator, or segment income, would need to drop by $60 million to $70 million annually before our first pay-back trigger is reached.

This significant cushion and our strong cash flows should help to explain why we are comfortable with our debt level.

This concludes our financial update.

Once again, we'd like to thank you for your time today.

We appreciate your support, and would like to answer your questions.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Jeffrey Bernstein with Lehman Brothers.

Thank you.

A couple of questions.

First, David, you mentioned, you know, some disengaged franchisees.

Just wondering if you can give bit more color in terms of whether this is really very new that you're seeing o perhaps something that you've seen for a while, and perhaps how you assess what makes somebody a disengaged franchisee in terms of key metrics, and maybe how many there are.

Just trying to get more color in terms of what you view as "disengaged"?

You bet, Jeffrey.

You know, we don't have a problem in the world right now that's flipping our one-point negative, 1.7 sales number to a positive one or two, which is where we've been able to operate with our Team USA business.

That is the essence of our issue.

And as we have pushed hard to get our franchise community to get more aggressive in the environment that we're in, and to understand that the game has changed and that we need to be sharper in the way that we approach pricing and our local marketing, we have a number of our franchisees who are proving to us that that -- that they can fall into line with a lot of the same things that we've done effectively in our corporate stores, and achieve terrific results.

But that bottom 10% frankly has -- is dragging us down, and in many instances as we've pushed harder and delved deeper into what's going on with their businesses, we feel some of them are simply not engaged at the level that they need to be engaged in operate in the environment that we're in.

So our job as a franchisor, for the good of the whole system, is to either fix those problems or change the ownership of those stores in such a way that we can improve our overall results.

So the whole concept of refranchising, which is not something that we've really focused on, I think, is as a result of a certain level of impatience and a certain level of frustration over the fact that we just need to operate better at the local level with some of our franchisees.

I definitely want to make sure we don't paint the world with a big brush here because we stand on the strength of our franchisees, and we have some of the best in the world.

And we're very proud of them, and they're -- they're leading in a lot of different ways.

Having said all of that, though, we think it's time for us to be more aggressive in terms of transforming the composition of our franchise system to a higher performing group.

Are you able to broad brush, kind of quantify, give or take that bottom 10% what they're delivering in terms of whether it's sales or profitability versus the clear majority of your system?

Yes.

I would just tell you that we're focused on the bottom 10%.

And the bottom 10%, when you look at their store-level economics, their sales, their sales shortfalls over the last two years, and our ability to get them to step up and arrest the trends and fix them, you know, that's the area that we're focused on, and we think there's a significant amount of value to either getting those folks to step up or, if we can't, getting the stores under the ownership of operators who in fact will quickly lift them to a better level.

Okay.

And actually, the -- this is a separate question, obviously international business looks like it's doing extremely well.

Just wondering, you said it's growing gangbusters and making up the majority of the unit growth.

What's the likelihood of the -- the possibility that you can accelerate the international unit growth or can you talk about the barriers to faster growth in that market, since it is doing so well and there seems to be a lot of room for it?

Well, we continue to believe that as -- as the business feeds on itself, so as you see these countries that are putting these significant sales growth levels together and some of them are -- are getting to the scope and scale where they can go on television and that even creates greater brand awareness which allows for faster growth, you know, we believe there is an acceleration growth opportunity in many of our international markets.

We're also looking at the possibility of opening up some new markets.

We're in nearly 60 countries around the world, and obviously there's places we're not currently competing where we think, you know, we -- we have viable opportunities today.

So yes, we think there's -- there's acceleration opportunities going forward.

But managing the rate and pace of growth in any country is one of the most important things you do, and we're not going to get into the business to see how fast we can open stores, we're going to be in the business of seeing how fast we can open stores that operate at a high level.

And for that reason we're going to have controlled growth as opposed to just trying to go out and seeing how many stores we can throw up in any given year.

It's not the right way to build the business to last.

Great.

Okay, then I -- lastly, you mentioned potential for more aggressive share repo.

Just wondering perhaps what metrics you use to determine what the appropriate amount is.

Obviously we saw a big ramp-up in the fourth quarter.

Just trying to come up with an estimate going forward in terms of how you look at it.

Yes.

I don't think we're in a position right now to offer you a whole bunch of details as it relates to how we think about that, other than my general comment that we think, at these share price levels, our stock is a great buy and we'll continue to deploy capital against those opportunities.

Got it.

Thank you very much.

You bet.

Your next question comes from the line of John Ivankoe with JP Morgan.

Hi, can you hear me?

Yes.

This is Diana Campbell on behalf of John.

I have some questions for you.

The first one was that you said you had softer weeks at end of the fourth quarter.

Do you have any update on the momentum continuing into the first quarter?

Yes.

We don't comment on existing, you know, market conditions or we don't give statements or are not in a position to give reports on what's happened so far this quarter.

I would just emphasize the point that when you looked -- when you look at the overall results of our fourth quarter, a significant part of that was skewed by the last few weeks, in which we experienced a significant softness in terms of traffic and basic consumer spending.

Okay.

My second question, could you tell or update us on what sort of effect your cheese hedges could have on '08 results?

We don't have any cheese hedges, as we've reported previous.

We have a purchase agreement with our cheese supplier that we don't go into great specifics on.

It certainly collars some of the volatility in cheese.

And so our operators are blessed in this environment to not be paying at the top of the market or at the current market price as a result of that collar.

But we do not have hedges in place that afford us any significant economic benefit in the current environment.

Okay.

And then you guys were mentioning your G&A spend and how you made an investment in your domestic system.

Was that like a one-time thing that we should expect for the fourth quarter, or something that should be ongoing into '08?

And could you give us any color on what that investment was?

Yes.

We -- I think we spoke about this last year, but we as part of this whole recruiting new franchisees, refreshing the system, and putting a focused development activity in place, both franchise recruitment development in addition to store development, we made an investment in that that really became more apparent and showed up in a bigger way in our financials during the fourth quarter.

That investment will continue.

However, you know, as we move through 2008, we're making other compensating management decisions as it relates to our G&A, and again going forward, I'm not in position to comment on that.

But that's the specific investment that Bill was alluding to when he talked about G&A.

Okay.

You can't give us an update as to whether we should expect G&A to go up or down like on a margin basis?

I mean, the only thing I will tell you is that we're going to be very, very prudent in the environment that we're operating in with our G&A spending, and we will be taking some actions to make sure that our spending flexes with the revenue realities that we're dealing with.

Great.

Thank you very much.

Your next question comes from the line of Glen Petraglia with Citi Investment Research.

Good morning.

Dave, I was hoping maybe you could comment on, you know, the bottom 10%, presumably those are the franchisees that are struggling most from a financial perspective.

Do you think that there is -- they're at a significant risk of closing, hence you're being more aggressive to try to make sure that you don't necessarily see that - unit closures but you're trying to manage the process appropriately?

Yes.

I think that's exactly right.

We're -- we're willing in this environment, if there's a terrific operator out there who's thinking about building a new store, but he's got an operator next door who's failing and isn't being aggressive on their pricing tactics and isn't driving traffic, and is financially in trouble, we'd rather direct that franchisee to buy those two failing stores next door and turn them around and fix them, even if it's the expense of that new store that they were contemplating, because under the circumstances that we're operating in right now, we think that that refranchising opportunity will ultimately yield greater benefit.

So does that speak -- is there a reluctance within the system of franchisees who are doing better to make the investments in growth at this point, because of the commodity environment?

Because of the consumer environment and real estate costs, etc.?

Well, you'll know, we opened up a number of new stores in the US last year, so we still have people who were growing and building stores, and there's plans in place, and there's stores opening as we speak.

But the reality is, as long as the commodity pressures are extraordinarily high and as long as the sales are soft, and with many of our good operators, as long as there are stores coming on the market in adjacent areas that are very opportunistic in terms of price, we will line see a diminished performance in terms of our new store activity until that correction kind of works its way through the system.

Okay..

And when you say refranchising, that's not necessarily the reducing of the percent of the system that's run by company-owned but it's more keeping it, you know, roughly the same general level?

Just to clarify?

Actually, our -- our objective at the end of this year would be to have a high -- a lower number of franchisees and a higher ratio of stores to franchisees on the domestic system.

But we are trying to focus more on our better operators and weed out, if you will, some of our weaker operators.

And I would also tell you that we will likely be more aggressive as it relates to taking a look at our corporate store portfolio and if there are franchisees that we feel can operate at a higher level, we'll be sellers and we'll allow them to grow that way, as well.

Okay.

In terms of the weakness in the same-store sales in the US, is there any way to break it out?

You know, maybe if you could just speak on general competitive dynamics, do you think that competition has stepped up?

Do you feel like some of the initiatives over at your largest competitor are having a negative impact on you?

Maybe you can talk about that?

Yes.

Sure.

I -- I think what's happened to us as a category and -- and we all know that people in kind of the cutback mode they're in, they're doing less at the dinner day part.

So everybody in the dinner day part is being hit with this.

And certainly we're a dinner-focused product, so we're caught up in that, probably to a greater degree than we have in the past.

In the past, we actually would have -- in these market conditions, we'd have seen people who were reluctant to spend $50, $60, $70 at a sit down, fast, casual restaurant or whatever, we see them kind of retreat to us as a value choice, and I'm sure some of that has happened and some of that will continue to happen.

But what's unusual about this situation is that our category, at the same time the consumer is crying for value, we've been out there raising prices substantially.

If you look at the average ticket in this category, you know, in the independent research that we purchased, shows that the average ticket in this category has gone up several dollars over the last few years.

And against a relatively small base, it's created a real value problem.

Where consumers typically saw this as the category they could retreat to and get great value on price, the combination of the industry in the last few years getting very focused on delivery charges, which is just another tax on the ticket, at the same time being hit with this extraordinary food cost inflation, has really put the category and our operators in a situation where price comes first, and we keep pushing up the average ticket of the bundle of food that we're selling.

I believe that the people who are doing the best job of navigating in this period come up with value platforms that still provide appeal to those consumers who are looking for value in this environment.

And as I look back, as we've been, you know, dancing on the head of a pin trying to get our prices aligned with costs at the same time we're trying to get our traffic moving, you know, I believe this is an area where we haven't been as aggressive as we need to be, the people who have been more aggressive with low price point value menu approaches I think have performed better.

So I don't telegraph our plans, and I don't want to tip off our competition other than to say we believe in this environment for us to get our traffic moving, we're going to have to have a stronger value message to our customer, and we're working hard on that.

Okay.

And then just lastly, David Mounts has been over running the district or supply chain business now for the last, I don't know, four, five months.

Anything that -- that's changed, any areas of potential efficiency pickups, etc., that maybe you'd be willing to share?

I don't want to be real specific other than I can tell you that having a new set of eyes on that business has been productive.

We've made organizational changes that we've already seen some benefit from.

Clearly, whether it was David or anybody else, we're in a very different marketplace right now in terms of how we procure the commodities that we need to buy, and we're putting, you know, aggressive collars and protections in place as best we can to kind of take some of this volatility out.

You know, wheat is a classic example.

That's a commodity that last year we were fundamentally naked in the wind, and eating all those increases that were coming by almost the day and the hour; whereas, you know, now we've got forward contracts in place with our supplier that protects us.

And all of these increases that have occurred even thus far in 2008, our operators are not going to have to incur because we did a longer, better job of locking in our wheat prices through our supplier.

And those are all initiatives that are a sign of the times, it's also a sign of the fact David's over there challenging the status quo and looking at ways in which we can be more efficient, and I think they're all adding value.

So I'm very comfortable with what's going on there, and I think there are savings that will be -- we've already experienced savings that will be a result of our activity and our focus there, and we'll see as the year unfolds how big that number can be.

Thanks.

Your next question comes from the line of Joe Buckley with Bear Stearns.

Thank you.

I want to go back to the refranchising for a moment.

So I originally thought what you were talking about was sort of brokering the underperforming franchise stores into better -- better hands, you know, better franchisees.

It sounds like, though, like you're looking to buy the stores and fold them into the company mix.

Is that the game plan?

No.

No.

If you heard me say that, I was clumsy in my communication.

That is not what we're saying.

What we are saying is that we are going to be doing refranchising, which means we'll either be bringing in new franchisees, new blood into the system, or we'll be selecting carefully some of our existing, high-performing franchisees, and we'll try to move underperforming stores into their hands and control.

What I also said is that we may see situations where we'll take those same, high-performing franchisees, and they will be buyers and the corporate stores will be sellers to facilitate opportunities for those excellent franchisees to gain bigger business opportunities as a result of taking over some corporate stores.

We do not intend to invest significant amounts of capital in growing our corporate store unit.

Okay.

All right.

I understand then.

Do you have the means to force the underperforming franchisees to sell?

What -- what sort of has to take place to -- to start some -- making transactions occur?

Yes.

Our franchise agreement affords us the ability to hold our franchisees accountable to certain standards as it relates to their operational execution, the -- the way that they protect and portray the image of the brand, there are certain financial metrics that need to be upheld.

We can't unilaterally, though, just throw someone out of the system, nor do we want to do that.

But what we can have is serious conversations with people in terms of expectations, and their responsibilities and obligations to the system.

And to the extent those operators are not responsive, we do have the ability and we certainly have ways of trying to facilitate changes in ownership.

We have not been particularly aggressive in that mode over the last several years, because obviously our performance has been such that, frankly, we haven't had to.

I think where we are today, with the nature of the business and what it takes to be successful, this is an area that we just need to put greater focus.

Okay.

Then a question on the traffic for the category, where do you think it's going?

What are people doing in lieu of ordering home delivery pizza?

Well, I -- you know, I think the Mia experiment that Pizza Hut came out with was very creative.

They architected a cheap-down product and put a very low price point on it, and fundamentally I view that as kind of their value entry.

And I think that's -- that's the way they're positioning that, is that they -- if you want to think about a value menu in the pizza business, much like we've learned to understand value menus in the burger business, I think they're positioning themselves in that way.

The -- the Little Caesar's of the world and the take-and-bake players, the people who can afford a very, very low price point for their dinner options I think are doing the best in this environment, because of the nature of the consumers' interest and the consumers' attitude.

So we can -- we can, as I said in my opening remarks, we can continue to go out there and kind of beat the fact that we deserve to have higher prices because food inflation is so significant and so impactful.

The reality is I think the people who win are going to be the ones who capture the imagination of customers in this environment as being a very, very aggressive value option for them.

And -- and I would also tell you that, you know, as we look at the world out there, a lot of the dollars that, you know, used to be spent at dinner are still being spent, in some cases they're being spent at different day parts.

So we think that lunch day part and the snack day part, which are day parts that we should be well-positioned to pursue, have opportunities associated with them, because again if we can come up with the right platform of products and price points, we can compete for some of those lower-ticket spenders and those day parts and extend our business.

And as we look at the benchmark against people who have grown in this difficult environment, those are some of the tactics that they've employed, and we're going to steal a page from their playbook.

Okay.

Then a question on the -- on the commodities.

Bill, I think you mention the cheese cost of $2.01 per pound.

Under the new contract, were you paying significantly less than that in the fourth quarter?

And if you can, share what you did pay.

I don't think the word "Significant" is the word to use.

We were paying less as a result of this collar.

So the way our arrangement works with our provider -- we're going to sell you less than the top of the market when the market is high, and we'll pay a little bit more than the market when the market is low.

But that is not -- that is not a number that's measured in quarters.

It's a -- a number that's measured in nickels and dimes.

And I think I need to leave it at that.

Okay.

And then locking in the flour costs for '08, let's talk about the implications for that.

I mean, I guess you get a price quarterly.

Does that become less relevant because you've locked in the flour for '08, or --

Yes.

What we did last Fall, late last year because we were just getting killed by this commodity, we went to our suppliers and worked out an arrangement where we took go-forward contracts at that particular time, which really took care of our purchasing needs as forecasted for the entire calendar year 2008.

And at the time, the numbers we were looking at for flour seemed astronomical, but based on the irrational behavior and the volatility of the category, we just -- or the commodity, we just decided to block it in and put ourselves in a position where we had protection.

In this particular case, we were brilliant.

We didn't know how brilliant at the time because from the time we locked those in, flour continued to go up through year-end 2007, and it has gone up dramatically higher thus far in 2008.

So we're pleased that we've got that protection, and it will afford our operators to be dealing at a flour price that's measurably higher than it was a year ago at this time, and certainly higher than historical norms, but substantially lower than what current market pricing would create.

Okay.

For the full year '08, do you think flour costs will be up?

Flour costs will be up '08 versus '07 for sure.

However, keep in mind that we had a policy last year of not imposing those flour increases on the system because we hadn't historically done that.

We've clearly changed the pricing of flour through our distribution business and our dough ball pricing starting at the beginning of the year.

So corporately, even though at the store level they'll be paying higher, corporately we're in a much stronger position in 2008 as a result of that price increase that we put in place.

Okay.

And then last question be just on the CapEx, obviously the plane replacement is what drove the CapEx so high for '07.

Is there anything looking ahead that is going to goose up CapEx over the next couple of years, or will we see a pull back to the $20 million to $30 million --

No.

As Bill said, $20 million to $30 million is the regular run rate, and the situation with the sale of the plane which shows up in one category, and the replacement which shows up in the CapEx is a one-timer, and, you know, we're well positioned and don't know of any one timers that are looming out there that -- that certainly are part of any of our plan, that $20 million to $30 million range should be a very good one to use.

Okay.

Thank you.

Your next question comes from the line of Colin Guheen with Cowen and Company.

Hi, there.

Just one more question on the wheat contract.

How much pricing -- how much affected pricing for 2008 would the franchisees need to take to offset the inflation in wheat from the distribution channel?

We don't, you know, we don't share our cost per dough ball information, and frankly a lot of that has to do with a lot of moving parts, including the fact that as you know our distribution business is on a profit-sharing basis.

So the larger operator you are and the higher percent you control of whatever distribution center you purchase from, and the profitability of the distribution center creates rebates.

So I think to try to answer your question directly would -- would require so many moving parts, I'd probably confuse you more than I would help you.

So -- suffice to say that the biggest cost factor in a pizza continues to be cheese.

It's 35% to 40% of the cost of a pizza.

Flour is an important ingredient, and we saw last year how important it had become.

But it's still a much smaller percentage of the cost of that product.

So cheese -- if you gave me a --

Okay.

Thank you.

If you gave me a choice now of the flour market weakening or the cheese market weakening, I can tell you I'd choose cheese in a minute.

Okay.

Great.

And then on the technology front, how many number of franchise stores are basically compliant with the ordering?

You know, the expanded ordering capabilities in the POS system, and does that rollout kind of get wrapped up in the next three to six months will it kind of [gradually] -

Yes.

Yes.

The mandatory requirement is to have that installed by the middle of this year.

We typically, whenever we have one of these mandatory dates we have stragglers based on stores under construction and stores being relocated, and some cases stores being bought and sold.

And so we -- we will give some relief.

But we are to the point now where I think we have somewhere in the neighborhood of 3,500 stores that are fully installed and operational with pulse, and we're adding more virtually every day.

Great.

And on the company, just one more question on the company franchise mix.

Over the next three to five years, I think if I take your comments, it could dip below the 10% company-owned mix that you guys maintained over the last three or four -- for a long time now I guess, is that correct?

Yes.

We don't tip our hand in terms of where we're buyers and where we're sellers and when we're buyers and when we're sellers, because obviously we're out there kind of making a market.

But I would tell you that my general sense is that we will be -- you know, we'll number a situation where there are certain markets where we me invite some of our better operating franchisees to have bigger businesses, and we would be sellers.

If we buy corporate stores, they will be very opportunistic and they will be adjacent to existing markets where we have infrastructure, and I would not anticipate that our percent control of the system is - by virtue of corporate store ownership would go up.

If anything, I would predict that it would go down.

Okay.

And then just one model question.

The gain, did that show up from a P&L perspective in the G&A line?

Is that correct?

Yes.

Okay.

Great.

Thank you very much.

Your next question comes from the line of Mitch Speiser with Telsey Advisory.

A couple of questions.

First, on the US distribution, I did check in your 10-K, I believe for the full year US distribution income from operations was down 14%, in the fourth quarter down 31%.

Just trying to get a sense, as we look out to '08, given these new contracts you have in place and just say assuming, you know, just say a positive 1% comp, should that US distribution income from ops, you know, be flat or so on a year-over-year basis?

Well, I think that the -- you know, the first is the fourth quarter and the margins were definitely impacted by not passing along the wheat.

And secondly, but more importantly, on the big picture number is the - getting traffic turned around and getting traffic in our domestic operations was a bigger impact than the wheat number.

The wheat affected the margin number, but the the overall dollars were just driven in the soft traffic for the current year.

Yes.

And I mentioned this in my remarks, but I'll emphasize it because it's very important.

One of the many reasons why getting traffic back is important is if we continue to see ticket go up and traffic go down, which has been kind of the problem that we've been confronting for the last 18 months, from a distribution company perspective, we lose a lot of efficiency.

We're selling a lot less dough balls, we're leveraging that infrastructure to a much lesser degree.

And so one of the ways our business model is going to operate the best is to get that plus 1, plus 2% growth, and have some of that come from traffic, because that accelerates the efficiencies of our dough-making activities as well as the, you know, the efficiencies of the supply chain.

So that's far more a bigger issue for us in terms of the benefit that comes from that than any of the commodity issues.

Thank you.

And moving along, was there any foreign exchange benefit to earnings per share this quarter?

Yes.

Our -- our FX rates for the quarter are sales benefited by about $50 million in FX, the sales number.

Got it.

And we can translate that into EPS through, you know, the international margins or -- or if you can give us some guidance on that or --

Yes.

Our international royalty rates are less than our domestic royalty rates.

They average - they're different by country but they average somewhere in the 3% range.

Yes.

If you take that $50 million you use -- call it a 3.5% kind of average royalty rate, and there will be some noise in that calculation, because it depends on where the FX came from, but that will get you close.

Okay.

Thanks.

And lastly, David, talked about this in previous quarters.

It seems like you want to do less unnecessary discounting, yet you do have to provide a value message, you know.

So I guess as we look to '08, do you expect there to be net pricing increases, you know, through that mix, or on the -- the question is how do you balance it?

Yes.

And believe me, this is one of those says easy, does hard, but it is absolutely the question.

You have asked the question.

And it's challenging, but it's what -- it's the work that needs to be done.

Again, if you look at Team USA, our corporate-owned unit for calendar year 2007, they increased prices higher than our franchise system did.

So their average ticket went up on a higher percentage basis than the franchisees, yet their traffic loss was lower.

So what that says is they did a much better job, which is a daily activity of maximizing price where you can maximize price; at the same time, driving traffic when you need to with the right kind of value-targeted promotions.

And much of that is done at the local level.

So we need to re-create that with a broader array of our franchisees, where they're continuing to manage price carefully because, hell, you have to, look at the commodity costs that everybody's paying.

You can't be insensitive to your pricing.

But you also have to balance that with very careful and, in some cases, aggressive promotional tactics that will continue to stimulate your traffic.

Team USA did it better in 2007 than the rest of the system.

If we can get rest of the system to operate where Team USA did, I'd be a much happier guy right now.

Understood.

Thank you.

The next question comes from the line of Mark [Hudson] with Cedar Rock Capital.

I wanted to drill down a little more on the variation that you're seeing around the country.

Where you're seeing particular weakness, is there any kind of geographic concentration of that?

Is it in poorer neighborhoods?

Is it in high-volume stores, low-volume stores?

Is there any kind of consistency in this?

Does that tell you what's going to happen next?

Yes.

We're teasing through a lot of that data.

I can tell you that geographically, in terms of any kind of macro regional factors, there's just no correlation.

We've run it against real estate markets, we've run it against everything, you know, energy, gallon of gas, we've run it against all the different factors out there that could be affecting the consumer, and we don't see the correlation.

We do believe, going back to this value positioning, that some of the customers that we're losing as a result of our traffic problems over the last year and a half could very well be in some of the areas where we have consumers that are very, very value-oriented and very, very price sensitive.

So in some cases, we may have priced some of those consumer out of the market.

And I would just as soon not tell you where they are and who they are, because I think that's giving my competitors more than you want me to give them.

You're seeing less sort of attachment rate?

You're seeing that in other kinds of retailers, where people will buy a TV but won't buy anything else to go with it.

You're certainly now known for pizzas not a TV, but they're not buying the chicken kickers or the -- the, you know, the cheesy bread or something?

Yes.

We're seeing price sensitivity out there on behalf of certain customers, and we need to be responsive to that.

Although, frankly, our problem isn't as much upselling and getting more on the ticket, our problem is traffic.

Though in some cases the problem we have is those consumers who were purchasing from us have kind of gone into stall mode, and we have to figure out a way to track them back.

So literally just -- just stopped ordering.

Yes.

I mean, we just had too many customers that were, you know, were -- they liked the value equation before, and they don't like it as well now, and we think this is systemic.

It -- if this was us just going off and doing something crazy, you know, I think I'd really be concerned.

But the reality is we believe that, based on all the [crushed] data that we've seen and what we pick up from our competitors' comments, we think that this is a systemic issue.

In the category, we've lost some of our value positioning.

We already talked about what Pizza Hut is doing in their attempt to address it, I don't know what Papa John's is doing, I know what Domino's is going to do, because we really think it's important to go after that.

And you've seen this film before, presumably, at some stages in your history, and what did you do then, and did it work?

Well, you know what?

This is a new film.

You know, the one thing that's very different, and even in my nine years, I mean, I've seen consumer confidence really low, and I've seen - you know, we've seen moments where cheese prices were really high, you know, we've been through a whole bunch of different, you know, hurdles that were thrown in front of us over the last nine years.

You know, we're talking about 9/11, and Katrina, and all kind of things, and energy price volatility and the like.

The thing that's particularly strange about this situation is normally when the consumer goes into retreat mode, our category is there with open arms saying here's the best value in town.

This is the first time we've been forced into a situation because of what's going on with cheese and wheat and corrugated and meats and -- and energy and minimum wage and -- and gas prices at the pump, and you name it.

This is the first time we've been in a situation where we're trying to increase our prices at the same time everybody else is out there causing the consumer to choke.

So this is a different set of circumstances for us as a category and for us as a company, and to that extent we're kind of picking our way through it.

We're learning as we go, and, you know, I think we're locking in more and more on kind of what we need to do and how we need to get there.

But these are uncharted waters to a large degree.

This is a working-class recession, is what you're saying?

Based on our experience, absolutely.

Absolutely.

This is a consumer - you know, forget about what they're doing with interest rates on capital goods.

Right now, we have a consumer who I think, you know, I think at holiday time when they started buying presents they stopped buying a lot of other things.

I think they ran up their credit cards, and I we have a consumer now who is very, very uncertain in terms of their spending patterns, and I think you see that across a whole bunch of retailers, and certainly we're caught up in that to a certain degree.

Thank you very much.

Your next question comes from the line of Dan Perla with Iridian.

How are you?

Two questions.

Number one, could you just talk about -- there's still moving pieces and interest expense.

Is a reasonable proxy for '08 somewhere in the $105 million range, if you simply take the $1.7 billion times 6.1%, is that a reasonably proxy for interest expense?

Yes.

Yes.

Okay.

And secondly, just so I understand, the -- the $80 million-plus of cash is now classified as restricted cash, I think you touched on it, but I'm still a little confused what your flexibility is to use that cash in '08 for share repurchase, or whether you -- you know, whether that's truly restricted.

It's -- that $80 million is truly restricted.

In there, there is $26 million that is a restricted three-month interest payment, that we had negotiated an opportunity to release 2/3 of that if we hit certain debt service coverage ratios.

Okay.

Didn't hit that level in Q4.

If we are able to hit certain covenant levels for two quarters in a row, we would have the ability to release 2/3 of that, 2/3 of that 26.

But that didn't happen in -- it didn't happen in Q4, and so it's got to happen two quarters in a row before it would release.

So the soonest it would release would be into the Fall.

Okay.

And just so I understand, does your comment that, just to paraphrase, you anticipate a healthy level of share repurchase in '08, is that in any way dependent on the release of that -- of any piece of that restricted cash?

No.

Okay.

Okay.

Thanks.

That's all the time we have for today's question-and-answer session.

Do you any closing remarks?

No.

I just want to say in closing that, you know, as always, I take personal accountability for this company's performance, as does every member of my leadership team, and we're working long and hard to maximize the results we can achieve on behalf of all of our shareholders, and that will continue, and I'll look forward to reviewing the first-quarter numbers with you a little later in the year.

Thank you all very much.

This concludes today's conference.

You may now disconnect.