達美樂 (DPZ) 2008 Q1 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the 2008 first 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)

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

Thank you.

Miss Liddle, you may begin your conference.

Good morning and thank you for attending our conference call this morning.

We are likely to take a few extra minutes today to review some franchise statistics that we think are going to be helpful in understanding our current environment.

I would like to note though that these are taken from a large sample of P&Ls that are reported to us by our franchisees; they are not included in DPZ financials that published in the 10-Q and released this morning.

As always, I will reference our Safe Harbor statement in the release, in the event that any forward-looking statements are made.

And of course, my last bit of housekeeping, I ask that the media remain in a listen-only mode.

I think I'm done, other than that.

With that, I will turn it over to the Chairman and CEO, David Brandon.

Good morning, and thanks everyone for joining us today.

My objective for this particular quarterly conference call is to give you our assessment of the current state of our domestic business, and most important, the plans and initiatives we have underway to get this part of our business turned around and growing again.

Normally, I offer brief remarks as it relates to the bigger picture and then I turn things over to Bill Kapp, our Interim CFO, for a more detailed presentation of the financials.

For today, I will switch things up and ask BIll to briefly take you through the key financial measures for the first quarter, and then following his remarks I will do my best to achieve my objective for the call.

And following my comments, obviously we will be prepared to take your questions.

I will introduce Bill Kapp, our Interim CFO.

BIll, take it away.

Thank Dave, and good morning, everyone.

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

I will cover those shortly, but first let's start with the top line.

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

Our global retail sales increased 5.6% for the first quarter, driven primarily by same store sales growth in our International business, and an increase in worldwide store counts of 247 units over the trailing four quarters.

Same store sales.

Domestically, our sales decreased 5.2% for the quarter.

Company-owned stores decreased 2.4% versus a positive .6% in Q1 2007, while franchise same store sales decreased 5.5% versus a negative 3.4% in Q1 '07.

International same store sales, however, increased 8.8% over last year's positive 3.8%.

As a result of our global retail sales, our total revenues for the first quarter were $339 million, a $300,000 decrease from last year.

Domestic supply chain revenues declined due to lower volumes, offset in part by higher revenues due to higher pass through commodity costs.

Our consolidated operating margin as a percent of revenues decreased .8% in the first quarter versus the prior year period, 26% in Q1 '08 versus 26.8% in Q1 '07.

I will now cover our three operating divisions.

First, our International franchise business, which has no cost of sales, grew as a percent of revenues, thus improving our overall consolidated margin in the quarter.

Second, our company store operating margin declined 2% from the prior-year period.

Food costs accounted for one third of the decline.

Labor costs accounted for another third of the decline, and the loss of fixed cost leverage accounted for the final portion.

Third, our supply chain margins declined 1.5%.

.7% of that decline was due to higher cheese prices in 2008, and had no impact on dollar margins.

The other .8% of margin decline was due to pass through costs of other non-cheese commodities, such as wheat, boxes and fuel.

This also had no impact on dollar margins.

The entire dollar margin decline was due to reduced volume from lower same store sales, and traffic declines.

Turning to G&A.

G&A expenses decreased $1.7 million in the quarter versus the prior year.

G&A benefited by a net $2.8 million due to the gain recognized on the sale of 29 stores, offset in part by the separation expenses from our restructuring plan.

G&A would have been up $1.2 million, excluding those non-recurring activities.

We are continuing to aggressively manage G&A in this challenging environment.

As we had previously announced, we are planning to sell a total of approximately 60 company-owned stores by the end of the second quarter.

These sales will not have a material impact on ongoing net income.

Next, bottom line earnings.

Our diluted EPS, as reported on a GAAP basis, was $0.23, or $0.21 as adjusted, for the first quarter.

This is a $0.17 decrease from the as-adjusted amount of $0.38 in 2007.

Our recapitalization impacted the comparison by $0.14, due to increased interest expense.

Our share repurchase program benefited us by $0.01.

Our 40% tax rate hurt us by nearly $0.01 during the quarter.

As previously indicated, we anticipate a 39 to 40% rate in the foreseeable future.

Our operating results impacted us by $0.04 for the quarter.

This was all driven by lower domestic sales and traffic that we have experienced.

As stated in our earnings release, we repurchased approximately 1.4 million shares of our common stock under our OMR program, for $18.4 million during the quarter.

Our OMR program was implemented during the second quarter of 2007, and we continue to be opportunistic buyers in the market.

We have now completed 36% of our repurchase authorization.

Turning to leverage.

During the quarter, we repaid $15 million on our revolver and currently have no outstanding revolver borrowings.

We continue to be very comfortable with our debt level, which remains fixed for another four years.

This concludes the financial update.

I would now like to turn it over to Dave.

I want to thank Bill not only for that update but for his service as our Interim Chief Financial Officer over the past few months, post our decision to move David Mounts, our previous CFO, into the position of Executive Vice President of our Supply Chain Business.

Bill has done a wonderful job.

I bring that up only to reinforce the fact that you will be hearing today an announcement that is being made of the appointment of our new Executive Vice President and Chief Financial Officer, and that individual's name is Wendy Beck.

Wendy is a 15-year veteran of the food service business.

Her most recent position was that of Chief Financial Officer, Senior Vice President and Treasurer of Whataburger Restaurants, located in Corpus Christi, Texas.

Wendy comes to us as a result of a very, very careful and deliberate national search that has been underway for the past several months, and I could not be more pleased to announce her appointment.

The leadership council and I here at Domino's Pizza are thrilled to have Wendy be joining us.

She will be starting officially on the 19th of May, and we look forward to her and her family relocating here to Ann Arbor, joining the team, and adding a lot of value to our growth and our future.

There will be more details as it relates to Wendy's background in the press announcement that is going out virtually as we speak.

What I would like to do now is provide a fairly detailed update, as I promised I would, on the state of our business.

And I really want to break that down into three key components.

One is an assessment of our current unit economics of the domestic franchise stores, and the overall financial strength of our system.

We get a lot of questions as it relates to how do the stores perform in the environment that we are in, and what is the financial stability of the system, and I want to address that very specifically.

Second is our domestic traffic problem, and the aggressive plans we have in place to drive more traffic into our stores.

That is clearly our big issue right now and it is one I want to address very specifically.

And then the third area I want to talk about is really a progress report on our efforts to upgrade our franchise system by identifying poor operators and facilitating their exit from the system.

This is a topic that I brought up at our last call and I want to continue that conversation today.

Let me summarize the situation regarding each of these areas of our business and provide you with some of the things we are going do to change the game for Domino's Pizza.

First, an assessment of the current unit economics of our domestic franchise stores and the financial strength of the system.

We have gone through a process where we raided our franchise system according to several factors, including operational execution, local store marketing performance, the store image, sales results, and the franchisees specific leadership and involvement in the business.

In evaluating our 2007 year-end P&L that we receive from our franchisees, we have learned that our A franchisees, and these are the franchisees that we have identified as being the 143 best operators in our system, and they happen to represent 21% of our stores, they reported for 2007 average store level EBITDA margins of approximately 11%.

Now based on their average sales per store, these franchisees are receiving cash-on-cash returns of approximately 40% on the average cost of a new Domino's Pizza store.

Clearly, for those who purchased the store below the new billed cost and turned it around, their cash-on-cash returns are greater than the 40%.

This group of franchisees proved the strength of the Domino's unit economic model even during difficult times.

Clearly, these franchisees wish the economics were even better, as they could be, but their businesses are very viable and very profitable.

Our next segment of franchisees we call our B franchisees, and this represents 80 - 830 good franchisees, who represent 65% of our system, and they're working to get better.

They reported store level EBITDA margins of approximately 9% in 2007.

Based on their average sales per store, these franchisees reported receiving cash-on-cash returns of over 25% of the cost of a new store.

And like many of the A franchisees, many of them paid less for a previously-owned underperforming store that they were able to turn around, and the returns on those stores are clearly much higher.

Our B stores can greatly improve their returns by driving higher volume levels in their stores, and we are working with them to help make this happen.

However, the cash-on-cash returns they are receiving are certainly strong enough to keep their businesses viable and keep them focused on getting better.

We have identified 246 franchisees in our system, who represent about 14% of our stores, that we call - or we categorize them as F franchisees.

They are currently failing themselves, and our brand, and our system.

Their average reported store level EBITDA margins in 2007 were approximately 6%.

Based on their average reported sales per store, this group of franchisees are still receiving over 15% cash-on-cash returns.

Understanding these numbers are averages of those franchisees, I can tell you there are some franchisees in this category who are failing financially.

There is no question about that.

But as I will cover in greater detail in a few minutes, we believe that approximately 50% of these F franchisees are interested in recommitting to fixing their businesses and remaining Domino's franchisees, and we intend to give them that opportunity.

The other 50% will be attempting to sell their stores and they will be exiting the system.

, Again, I will get into that in a little more detail later.

I think another area that is important to focus on as it relates to the viability and the strength of our system, even during these tough times, is the area of store growth.

As you all know, in 2007 we were not able to drive strong domestic store growth, as a result of the weaker returns across our system and the economic pressure that was a result of weak sales in a high-cost environment.

However, it is also important to consider the fact that we grew - I want to underscore that - we grew our domestic system by a net of 12 stores during the year.

In other words, despite the difficult times, we opened a few more stores than were closed during the year.

Now, in the first quarter of 2008, our domestic unit economic model continues to be under pressure.

There is no question about that.

Our costs are actually higher than they were a year ago.

However, I believe the specific numbers I have shared with you today will bring comfort to anyone concerned about the viability of our franchise system or our franchising model, and whether we have any material risk of a vast number of store closures in the current environment.

We believe we do not.

I plan to discuss the aggressive activities we have underway to address the F franchisees in our system.

Suffice to say, there will be some churn over the next couple of years, as we facilitate changes in ownership of many stores, and we invite franchisees who are not doing an appropriate job of representing our brand to leave the system.

Let me shift over to the next point, and that is our domestic traffic problem.

We have a distinct advantage over other food retailers, because we have a record of who our customers are.

We know then by name, by address, and their phone number.

I recently appointed a cross-functional team here at Domino's, and tasked them with the duty of attempting to learn as much as we could about the traffic declines we've experience over the past couple of years, not only just at our company but in the category overall.

We've also leveraged the experience and input of many of our A franchisees.

We have consulted with important leaders from our franchise organization, including those who serve on the advisory boards that we utilize to provide input and direction when we make decisions impacting the system overall.

And we have a very important summit coming up in a couple weeks, as we will host a combined session of all of our advisory boards, to further gain franchisees knowledge and input.

Although there have been no silver bullets coming our of any of the work we've done so far, nor did we expect any, we have confirmed some important factors and trends that will guide as as we continue to address the traffic problems facing our category and company.

We increased our delivery prices by nearly 10% in 2007.

This dramatic price increase had the most detrimental impact on the purchasing habits of our single pie, low-ticket delivery customers.

We have chased many of them away, and we need to get them back.

We believe a value platform is now a requirement in our category, and we will utilize our new 10-inch pizza product that is currently being launched nationally with our 4/4/4 promotion that hopefully you have all seen on television, to provide our value customers an alternative.

We also need to expand our growth into the lunch and late-night day parts.

We are not taking advantage of growth trends in these day parts, and we need to do so, if we want to grow sales in the current environment.

We will be testing new products, new packaging and new price points to better position ourselves to pursue these opportunities.

We will be requiring all of our operators to adhere to expanded store hours, to ensure that all of our stores are open for lunch, and we will adjust the closing hours of stores where necessary to compete for customers interested in both delivery and carry out during these important parts of the day.

We also want to offer a value platform, as I mentioned before, but we also know that we have many customers who will pay for and who enjoy a more premium-priced pizza product.

So we will be exploring the possibility of launching a specialty line of higher-end pizzas to complement our menu in the months ahead.

Team USA has outperformed our franchise system over the past two years, for a number of reasons.

However, one of the major reasons that we've identified has been their more disciplined approach to pricing our products.

Our analysis team found many instances of franchisees offering prices to customers that were inconsistent, including some selling policies that had the net effect of down-selling, and other pricing policies that severally penalized customers for paying menu prices for our products.

We have developed a pricing model we will be sharing with our franchisees which is designed to help guide them to more rational, sensible pricing that will maximize sales, margin, and overall customer satisfaction.

Finally, we know that our A franchisees experienced positive same store sales growth in 2007.

We know that our B franchisees experienced negative same store sales but their average unit sales were still high enough to create very acceptable financial returns.

Our F franchisees reported their sales in 2007 as $4,300 lower per week than our A franchisees, and their same store sales were nearly 6% negative, which is over three times more negative than the average of our domestic system in 2007.

This demonstrates the opportunity for us to create a stronger organization and better results through better operators and better operations, as we transition stores from F franchisees to A and B operators, we expect to see positive change.

We have launched an aggressive franchisee recruiting program designed to help us carefully select both internal and external franchise candidates.

We are hosting what we call Discovery Days every month here in Ann Arbor, and we plan to create a strong pipeline of franchise candidates to help us replace some of those Fs with candidates who will bring new energy, new investment and new commitment to our brand and system.

The third area I want to touch upon as it relates to our domestic business is a progress report on our effort to upgrade our franchise system, and I plan to be very specific.

As I indicated earlier, we have identified 246 F categorized franchisees in our system.

We have had very direct discussions with all of these franchisees, and we have reached agreements with 127 of them to sell their stores and leave the system.

We are currently engaged in this process, and we have already removed 22 of our F-rated franchisees from our domestic system.

This number will continuously grow as we move through the second half of 2008 and into 2009.

The rest of the franchisees currently rated F have recommitted themselves both personally and financially to their businesses, and we plan to watch them closely.

We hope many will move into the B level or better in the near future.

Those who can't or won't will be added to the list of franchisees leaving our system.

We will be compassionate with those who demonstrate a sincere desire to fix what is broken quickly, and pull themselves out of the F category.

We will not be patient with any of those who do not make immediate improvements in their store operations.

I want to point out that 830 B franchisees are a source of great opportunity.

The more of them we can develop into A performers, the stronger our system will be and the better we can withstand the kind of economic pressures we are currently facing.

We will be offering more training and development programs to this group than we ever have, in an effort to better support them and help them perform at a higher level.

Now before I end my remarks regarding the status of our domestic business, and I apologize this is taking longer than I normally do, but I think these points are very important, I want to make a couple of things very clear.

With the advantage of 20/20 hindsight, I want to openly admit to some mistakes that we have made that have contributed to the difficulties we have had during this period of surging costs, rising prices and consumers' reluctance to spend, particular at the dinner day part.

First, we were slow to recognize the impact of our continuously-increasing average ticket prices, and the impact they were having on our traffic.

We lost a lot of momentum in 2006 while we were still trying to push higher ticket growth, when we should have been doing more to address the traffic issue.

This caused us to enter the severe economic downturn in 2007 with no sales momentum, and it made us even more vulnerable to continued traffic losses.

Second, as the value entry in the pizza delivery category, we should not have pushed our prices as high and as fast as we did in 2007 and early 2008.

We are known for value and convenience, and we lost many customers who felt we forget them as we were adding delivery charges, menu price increases and higher promotional prices during a time when our customers were really being frustrated by higher gasoline and food prices.

Third, we allowed some of our franchisees to get complacent.

After 12 consecutive years without a negative same store sales year, we did not recognize and react as quickly as we should have to the number of franchisees who decided to put their businesses on autopilot, both in terms of their effort and their investment.

Fourth, our company, and truthfully the pizza category overall, has in the recent past viewed menu innovations as primarily offering different topping combinations and catchy names on specialty pizzas, but not really truly innovating.

We need to take innovation to a higher level.

We need product innovation that will broaden our menu, create more choices, penetrate more day parts, and leverage technology in a way that is far more than just accepting orders online.

You will see a vast number of new innovative products and initiatives from Domino's Pizza in the months and quarters ahead, all intended to take a category that has been sleepy and wake it up.

I have given you a fairly in-depth view of the domestic business.

I want to just briefly switch gears and highlight our International business, which continues to do an extraordinarily fine job.

Retail sales in our International division have been growing overall at a 17% compound annual growth rate for the past 4 years.

Our top 10 markets have grown at a rate almost equal to the overall, with a 16% [kegger] during that time, while our middle-tier markets have seen growth of 27% during the same period.

So while we still have significant growth left in our top 10 markets, we have vast growth potential in those middle markets, as demonstrated by our recent results.

The top 10 markets include those we've spoken a lot about in the past; the U.K., Mexico and Australia, but also include India, France and recently Turkey, who has now made the top 10.

The second-tier markets include up-and-comers such as The Netherlands, Brazil, the Middle East and Malaysia, markets we haven't highlighted much, but that have shown tremendous potential for the future of our business.

Meanwhile, we still have approximately 2,400 stores to build in just our top 10 markets alone, with room to triple the store count potential in a number of those markets.

Store counts in International have grown at roughly an 8% compound growth rate over the past 4 years, and same store sales have grown at a rate of 6% during the same period of time.

The international division was only 18% of Domino's operating profit four years ago, and by 2007 it was nearly 30%.of our operating profit.

Based on their continued growth trends, the contribution of our International growth engine to our overall business results will continue to increase, and we are very pleased and proud with the work they are doing.

And a reminder, our model of growing through master franchise agreements enables us to attain great geographic expansion, with very little investment; again, driving our pre-cash flow business model.

I have given you a lot of facts and figures to digest here, and I understand that, but I hope it has been helpful.

What I would like to do now is open up the call, and take questions from any of you who may want to ask

(OPERATOR INSTRUCTIONS)

Your first question comes from John Glass with Morgan Stanley.

Hi, thanks very much.

David, first question is, how do you facility the transition of the F stores to new ownership?

Does the company need to be the intermediary, or can you do that directly?

I may have missed this, but how many F stores are there?

I think you said how many F franchisees there were, but I did not catch how many actual stores this represents?

The stores, the 600 stores are total Fs, the Fs represent, as I recall, 14%.

We will look that up, and make sure we give you the right number there.

Okay.

The situation is really the facilitating of the sale.

Our franchise agreement affords the company to have the ability to have the first right of refusal on the sale of any store, so we are actively involved in those transactions from the moment the operator decides to sell until ultimately we decide whether we want to purchase the store, and we have the right to approve whoever does purchase the store.

So we are in the middle of those transactions, and we can make sure that we are facilitating the ownership of that store to the appropriate new owner, who will hopefully take it and operate it at a higher level.

The number of F franchisees that we have is 246.

We indicated that is 14% of our stores, which is 633 stores.

About half of those F franchisees we've identified as people that we truly believe can get things turned around.

The other half are the ones that will be exiting.

Just to clarify, does "facilitate" mean you buy and resell, or are you just helping - are you a broker?

It is not our intention purchase these stores.

It is our intention to broker these to A and B franchisees, and any of our new external candidates that we feel are capable of taking those stores over and investing and operating them appropriately, and operating them appropriately.

One more.

You are talking about value.

Can you provide some context about what has happened to your average check over the last couple of years?

I know you said delivery costs or charges - could you broaden that, and how have you worked up the average check over the last few years?

When you think about value, are you going do a high/low approach to hope to keep the average check about steady but provide a value alternative, or are you actually thinking that you need to lower your average check?

We actually, in the delivery customer, which is our most important customer, obviously 15-20% of our business is carry out, and it's a little bit of a different scenario.

But as we focus on our delivery customer, the ticket increased approximately 10% in 2007.

If you were to go back and include 2006 and before the advent of delivery charges and some increased inflationary pressure, you would see that over the past two to three years that ticket has probably gone up more to the tune of 15-20%, and that's including the delivery charge as part of what kind of happened in our business.

We believe that the barbell strategy is an appropriate one for us.

The launching of the 10-inch pizza, if you will the $4 Pizza, which is currently being launched as a 4/4/4 promotion, affords to truly provide alternatives to those customers, much like you have seen in other categories, who are looking for a much smaller ticket category to participate in the brand.

And we also believe, as I indicated, that parallel with that, to continue to be out there developing a more premium line, premium priced pizza line is a good strategy for us, because we know based on analysis there are many customers who enjoy that kind of product and they certainly not as price-sensitive.

But you are doing the value promotion now and I presume it will take some time to develop those premium products, or are they closer in?

That is exactly right.

We have two or three of those product platforms already built, as a result of limited-time only promotions that we have that have very done well.

So you may see some of those resurrected as part of the premium platform line, but we also have others that will be going in to test that will round out that line.

When and how that all evolves is something that is to be determined, but we're pretty excited about the prospect.

Thank you.

Your next question comes from Joe Buckley with Bear Stearns.

Thank you.

Just a couple of questions.

You ran through the returns - the cash-on-cash returns that franchisees are getting.

But how leveraged are the franchisees?

What kind of [interest rate] coverage ratios are those groups of stores showing?

Again, Joe, when you understand the composition of our franchise system is that the average operator owns three to three and-a-half stores.

That is the average.

We only have a handful of franchisees that own over 50 stores.

As opposed to having major corporations who are going out and doing refinancing deals with high levels of leverage, we are dealing with a lot of owners who own their businesses outright, many of whom have long since paid for their stores.

So we do not believe that we are in a situation where we have a lot of exposure to highly leveraged franchisees.

The diversification of our portfolio of franchisees, if you will, really reduces that risk.

Do we have certain franchisees out there who would run up their borrowings, and they are more at risk?

Certainly, we do in this environment, but not to a material degree.

A number of this earnings season conference calls, people have talked about how hard it is to sell restaurants and get financing for restaurant deals.

Are you helping the buyers of some of those F stores in any way, to raise cash for the deals?

We have relationships that are long-standing with financing organizations that we certainly enjoy working with and have the ability to facilitate their involvement in some of these transactions.

We don't like to be the bank in these transactions, so it is rare for us to get involved in any kind of a financing way, but we are helpful in helping put the transaction together to bring financing to the table.

Joe, you are absolutely right, in today's environment it is tougher than it has been in a long, long time.

So we have to work harder, and in some cases there is probably more of a premium paid for some of the financing.

But one of the advantages that we have versus a lot of people that you're talking to is that the average new store build for us is $175,000.

When some of these failing stores are sold, in a failing mode, the price tags for these stores can be less than $100,000.

So the financing challenge is very different than if you are out there talking about a burger concept or something, where the original store costs a million and a half and there is big real estate and leverage on the property.

That is helpful.

Just one more.

The extended hour opportunity, how significant is that?

Can you give us a sense of what precent of the system might not be open for lunch currently, or maybe the late night opportunity?

I can tell you that we have been a concept that for a long time that has really been focused on the dinner day part, almost obsessively.

Up until the not-too-recent past, we had a significant number of stores that weren't even open until the middle of the afternoon.

We have worked on that hard, and we are to a point now where about 85% of the domestic system is open for lunch.

But I will tell that in some cases that is a relatively recent development.

So we still have many stores to get open for lunch.

We also have the same issue with late night.

We are kind of traditionally known as a food alternative that stays open really late on the weekends, but in many cases we have been closing down too early during the week.

We know that 40% of America is working less than what would be considered to be traditional hours.

So we see that in all of the different concepts, where for instance the burger guys who are being open - who are staying open for 24 hours a day, people are extending their hours, there is benefit because there are people that want to eat at those times that previously were considered fringe, now they are becoming more mainstream.

So we want to get into that game, both in terms of operation and in terms of menu and price point and packaging, because those are all related, and that's a big commitment that we are making, and it is something that the system will be getting benefit from in the months and years ahead.

Okay.

Thank you.

Your next question comes from John Ivankoe with JPMorgan.

One thing that I noticed in the release was that company store margins were actually higher than I expected given the comp and the higher cheese prices, and distribution revenue was actually a lot lower.

Was any of that a function of the cheese hedges that you had in place or perhaps had in place in the first quarter?

There was no cheese hedge year-over-year in place at all.

Okay.

So moving on from that, again, given the franchise revenue - or excuse me, the distribution revenue, was there any kind of, you know, forgiveness or perhaps price control that was given to the franchisees in the distribution segment that was unusual in the first quarter relative to the previous quarters?

Revenue declines in distribution were simply volume offset by higher commodity pricing.

The cheese contract that we put in midyear, John, mitigated a little bit of that cheese difference, $1.33 block a year ago versus a $1.93 block this year.

We did not see that entire amount just due to new pricing on the cheese.

But there was nothing going on.

Our distribution model stayed true to what it has always been.

Okay.

Am I right that this was the quarter, the first quarter that you passed on the higher wheat prices, the flour prices to the franchisees, to the distribution segments?

We did.

And we stepped that up.

We took a significant jump right at the beginning of the year, and then we stepped it up during the quarter again, to reflect - we kind of blended that increase so that it did not happen all at once.

But yes, this is a quarter where we basically passed on the impact of the wheat increases on our dough prices.

Now continuing on this line of questioning, obviously, company store economics are challenged, franchised store economics are challenged.

Of course I understand that half of the distribution segment profit is given back to the franchisees in terms of rebate, but are franchisees really calling for more at this point?

Are they calling for better pricing terms in 2008 and 2009, and if so, is and if so, is that something that you would consider?

No, we are constantly, through our distribution advisory board and our general communications with our franchisees, we are constantly benchmarking our distribution prices against the other concepts out there.

It is not hard for us to find out what the other people in the pizza delivery business are charging their franchisees and operators at the store level.

So we are benchmarking against that, and we have specific objectives in terms of competitiveness of our pricing.

The fact that we have the profit sharing agreement that affords our operators to participate in the efficiencies and success of those organizations is helping us a great deal.

Because as we have looked at things about product engineering, as we have looked at delivery frequency, some of the efficiency initiatives that David Mounts has put in place with our supply chain business,, our franchisees have been very receptive because obviously it helps their economics and it makes profit sharing checks larger.

Okay.

And just one more, if I may.

One thing that you're identified in terms of - kind of the difference between the A/B and the F franchisees is pricing.

It's menu pricing and how they have managed their menu in terms of what's being offered to customers at what price.

Is there anything else, anything specific or even very few factors that you can point to, you know, that I can say hey, if the F franchisee can -- whether it's delivery times or answering the phones or the cleanliness of the restaurant, what have you.

Are there a few factors that you can focus on or that you can identify that can make an F franchisee perform in line with the average?

Or is it just an overall - things need to be better across the board effort?

I think you highlighted a lot of key factors, John.

It is really a situation of whether you are in the game or not.

We have some franchisees who are a victim of their own success.

Over however many years they have done very well, they've made very good money and good returns.

They become more distant from their business.

One thing I can tell you is we are in an environment right now where if you want to be successful, you have to work harder and operate better and bring more leadership focus to your business than ever before.

There is nothing about the business right now that comes easy, either on the sales side or cost management side.

If you delegate that to people who you either cannot trust or people who are not prepared for the challenge of that, you will pay the price.

And generally speaking, if you want to come up with one characterization of our F franchisees, they are not engaged in their business at the level they need to be to afford those stores the ability to be successful.

Okay.

Thank you, David.

It manifests itself in stores that are below image standards, that are operating and providing poor service to customers, that are providing inconsistent product, all the things that are detrimental to your business.

It shows up in their sales results, it shows up in their margins and it shows up in their cash-on-cash returns.

Okay.

Thank you.

Your next question comes from Jeffery Bernstein with Lehman Brothers.

Thank you.

A couple of questions.

One is to follow-up on the day part expansion, I think you said late night and lunch.

I'm just curious whether that focused primarily on the traditional pizza product, or can you give any type of more qualitative color in terms of other products that might be tested during either of those day parts?

We think that our pizza product works really well in both day parts, particularly when we start coming up with a smaller portion size at a lower price point.

And so we plan on selling a lot of pizza at lunch, and we plan on selling a lot of pizza at late night day parts.

I will also tell you that we have test platforms in place for other products, other than pizza, which we think will complement pizza, and afford us the ability to be offering more choice in both of those day parts to customers who are looking for choice.

The stores that have done the expanded hours, I guess the stores in Tes - can you give color in terms of the [communal] traffic or some of the benefits that they are seeing?

I think the best illustration is Team U.S.A.

They got on the lunch bandwagon than we were able to coax our franchisees in many cases.

One of the reasons we would attribute their outperformance of the franchise system would be their commitment to lunch.

It is one of those day parts where, when you have not been in lunch, in many cases for years and years; when you first put that open sign out, you will not get an avalanche of business because it takes a while to create awareness that you are in that day part and that you are open.

What we found is that if you have the perseverance to stick in there and market hard and commit to lunch, and make sure your customers know you are committing to lunch, that over time we can build a very, very significant business.

That's what we've done with Team U.S.A., and that's what we plan on leaving with the rest of the system.

Okay.

And then you mentioned the value focus.

I know you have the three pies for four dollars each.

I'm just wondering, in terms of profitability of some of these promotions, and targeting the lower end - obviously increased delivery charges and prices to offset margin pressures, in this high cost environment, the profitability at the expense of driving higher traffic and comps?

WIthout question, the food cost was an offer like a 4/4/4.

It is higher than other promotional offers we may have launched in the recent past.

It's still within an acceptable range, our Operator still selling that the 10-inch pizza, one topping, because it provides this opportunity to upsell any topping that we can add to one of those pizzas becomes an upsell opportunity.

There's a lot of other things that we can do to try to take that Core $12, we may have launched in the recent past.

It is still within an acceptable range.

Our operators still enjoy selling that three 10-inch pizza one topping because it provides great opportunity to yep sell.

Every topping becomes an upsell opportunity.

There is a lot of things to take that core $12 ticket and move it up.

So it is a platform that works well for us and, frankly, our focus right now and has to be traffic.

I suppose in an ideal world we would have one customer a week - or one customer a year that we would sell a million dollar pizza to, but the reality is we need to get into the business of driving traffic, creating [a trial] and getting momentum into our store.

To the extent the value platform will help us do that, we think overall that's going to be benefit of our operators, both in terms of traffic and sales, but also in terms of profitability.

Okay.

And then just lastly, I believe I heard you make comment, or perhaps it was last quarter, in terms of [inaudible] on leverage, and why you do not think it is a near-term concern in terms of the interest-only payments.

Are you willing to be down some debt earlier if the option presented itself.

I am just wondering if you can give an update on that?

Is that something you guys are perhaps pursuing?

We continue to evaluate our capital structure and the capital markets, and we continue to look at our stock price, and we continue to look at the free cash that is coming out of the business.

The Board of Directors and those of us in leadership roles at the Company will continue to watch that carefully, and make prudent decisions for the betterment of our shareholders.

As it stands today, based on the 6% - sixth death that we had and the runway that we have a heard, and the runway we have ahead, and the amount of cash, that the business is still generating, obviously we still believe the best deployment of that capital is in the form of stock repurchase, and we are pleased to do that.

If we get to a point where we feel differently, we obviously have the flexibility of making that shift.

But for right now, we think that's the best value in town, and we're going to continue to use our free cash in that way.

Great.

Thank you.

You next question comes from Colin Guheen with Cowen & Company.

I guess my question is, given an outlook where you're rebuilding perception around value, but also building awareness around especially product and extended hours of operation, what is the forward marketing strategy going to look like?

The core marketing strategy?

The forward marketing strategy, yes, that you would be exchanging some of the way you market to your customers and who you market to?

I think you will see a lot of news being generated as a result of the things I am talking about.

New product platforms, new things on the menu that will not only add value to some of the day part expansion, but will also be exciting to some our regular customers at dinnertime.

I think to launch a value platform concurrently with the fact that we're working on a premium pizza line affords us a lot of news generation.

In the low-traffic world that we're in right now, news is important.

Anything that cuts through and allows the customer to kind of reconsider you as an alternative I think is a positive thing.

So, our marketing calendar will be busy with news, new topics, new products, and a lot of things we hope will generate excitement, not only for the brand but for the category.

So we can expect to see some of the specialty platform integrate into the marketing strategy sooner than later, I guess?

Yes, we have a lot of test markets that are under way, and obviously we will be setting priorities for national windows based on the results of those tests.

But we have a lot of things in the hopper right now that I think you will see a lot of in our commercials as we go into the latter part of this year, and certainly into 2009.

Will you look to offset value messages with specialty product messages or rotate them, or how do you envision that working?

Yes, we think the people who have done this the best are out there with concurrent messages that really appealing to a broader section of customers.

We do not want to just be the value pizza, we also want to take care of those customers who are less price-sensitive and more into premium products.

So to do that, you will have to balance that spend and that marketing message, both with your television and your print and menus, to communicate to both those customer segments that we have something that is attractive to them.

And when from an hours of operation standpoint do you think you will be able to start marketing system-wide late night and lunch?

Our hope would be that if a couple of the test platforms that we have underway right now work out as well as preliminarily they seem to be working, we will be able to put a major marketing push behind lunch.

I don't want to tip our hand here, but in the fairly near future.

We think one of the ways to get all of our stores open, and to really get a lot of energy behind that is not only the introduction of our 10-inch pizza product, which is a really nice platform for lunch, but also to launch that concurrent with other entrees and products that will create even more excitement around that day part.

I really do not want to go any further than that, other than to let you know that that's one of things that we are working on long and fast.

and one other financial question.

The $8.2 million that showed up on the cash flow statement, was that the total proceeds from the company-owned store sales?

A portion of it was that and a portion of that was due to a selling of pulse systems during the first quarter as well.

Okay.

Can you give the number that was actually the proceeds from the sale of those stores?

Yes, $6.5 million were the cash proceeds from the sale of the stores in Q1.

From 29 stores?

Yes.

And that's the total amount that you are going to receive for the sale of those stores, or is there some deferred payment or something?

That - that's pretty much all of it.

Okay.

Great, thank you.

Your last question comes from Chris [Sippell] with Blue Lion Capital.

Hi.

I have two questions.

First one, can you take about the 41 franchise stores that closed in the quarter?

Were those part of the F group or were they parts of other groups?

The 41 stores would have been stores that closed, and a high percentage of those would have been F operators.

Some of those stores will be permanently closed but some of those stores will likely be reopened by other operators.

Okay.

In the future, as you guys call the F portion of the herd, if you want to use those terms, how many stores will be closed versus successfully sold to better operators?

That is a really tough number to give you specifically.

I would tell you that last year we began this process, although not as vigorously as we are currently engaged.

As I already reported to you, we were able to open more stores than we closed.

In the environment we are operating in in 2008, if we were get to the end of the year and be anywhere near close to break-even in terms of having the number of closures equal the number of opens, I would view that in the current environment as a pretty successful outcome.

There is always a chance that we could end up with 20 or 30 net closes in the environment that we're in.

We could always catch a break, depending on sales trends and activity in the second half, where maybe we could get a more robust growth plan put together.

I want to give myself some wiggle room there, but we do not see material impact in terms of store closures in 2008 versus what you have grown to expect from us.

Okay.

One housekeeping question.

What was the foreign exchange gain in the quarter?

The foreign exchange gain for the quarter for royalty income was about $850,000.

Okay.

And there was none for the company-owned stores internationally?

We don't have any company owned stores internationally.

They are all franchises?

Correct.

Okay.

Thank you.

There are no further questions at this time.

Mr.

Brandon, do you have any closing remarks?

I just want to quickly summarize.

I hope today has been able to demonstrate to you the strength of our franchise model, particularly during times of challenge and duress.

But we know full well the real proof is in the free cash flow that this business continues to generate.

Despite the tough times, as you all know we generated nearly $17 million of free cash flow during the quarter.

We deployed continuously into our share repurchase program.

We are at about 36% of open market authorization that we received from our Board, and we continue to operate against that authorization.

I like the things that are happening in our business in terms of change.

We continue to operate in a pretty ugly environment, but nevertheless we continue to keep our feet moving and I look forward to telling you more about how we are progressing here in a few months.

Thank you all for your time and attention today.

This concludes today's conference.

You may now disconnect.