達美樂 (DPZ) 2009 Q3 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 everyone to the Domino's Pizza 2009 third quarter financial results 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.

Ms.

Liddle, you may begin your conference.

Thanks, Carmen.

Good morning, everybody.

Welcome to our third quarter earnings call, and I'd like to direct your attention in the press release to our Safe Harbor statement as it relates to forward-looking statements, and I would kindly ask the members of the media on the call to be in a listen-only mode.

We have some prepared remarks this morning that we will follow with an open Q&A.

So with us today we have our Chief Financial Officer, Wendy Beck; and our Chief Executive Officer, David Brandon.

And we'll start today with some prepared comments from Wendy.

So if you want to take it over, Wendy.

Thanks, Lynn, and good morning everyone.

We are pleased with our overall results for the third quarter.

Our global retail sales increased through positive international same-store sales and flat domestic same-store sales growth.

Equally as important, we grew our bottom line over prior year levels and drove improvements in our operating margins at all three divisions.

Additionally, we continued our trend of repurchasing debt this quarter, which benefits our EPS, our balance sheet, and our debt service coverage ratio.

Walking down the P&L, let's start by taking a look at our top line for the quarter.

Our global retail sales grew 3.9% during the quarter when excluding the impact of foreign currency.

However, when including this negative impact, our global retail sales were down 1.9%.

The increase this quarter was driven primarily by international same-store sales growth as well as store count growth in our international business.

Now looking at the different business unit components, domestically our same-store sales were flat for the quarter versus the third quarter of 2008.

Franchise same-store sales were up 0.3% while company-owned stores were down 2%.

We continued to see domestic store closures with a net 30 stores closed this quarter.

These were a result of our efforts to eliminate weak operators, but also a sign of the difficult economy over the past 18 months.

Going forward, we see some easing of this and are seeing some improvements economically.

Additionally, these net domestic closures are going to be buffed by our strong international store growth, so we still expect to end the year with positive global store growth between 175 to 225 net new stores.

And speaking of our international division, our international same-store sales were positive 2.7% on a constant dollar basis and our international division grew by a net 43 stores in the quarter.

As a result of this domestic and international topline performance, our total revenues for the third quarter were $302.7 million, a $20.9 million or 6.5% decrease from prior year.

This was due primarily to lower cheese prices which affected our domestic supply chain revenues, the impact of the store divestitures in 2008 on our company-owned store revenues and lower international revenues driven by the negative effect of foreign currency.

Breaking down the decrease, domestic supply chain revenues decreased approximately $14.7 million or 8.3%, which is primarily the result of lower cheese prices during the quarter versus the prior year quarter.

Our company-owned store revenues declined $5.1 million or 6.6% mostly due to the 82 stores we divested in 2008, and to a lesser extent lower same-store sales.

International revenues declined $700,000 or 2.1% due to the negative impact from foreign currency, partially offset by higher same-store sales and store count growth.

Throughout the year we have discussed the negative impacts caused by the strengthening of the US dollar.

Our royalty revenues were again negatively impacted during the third quarter by approximately $2.3 million.

Based on our current forecast, we do not anticipate to be negatively impacted in the fourth quarter of this year versus the fourth quarter of 2008.

As you may recall, we were negatively impacted $3.6 million from the significant strengthening of the US dollar in the fourth quarter of 2008.

Foreign currency also negatively impacted international supply chain revenue by $600,000 during the quarter.

These declines in international revenues were offset by approximately $2.2 million of revenue improvements, primarily due to higher same-store sales and increased store count.

Moving on to our operating margin, our consolidated operating margin as a percentage of revenues increased 3.2% in the third quarter versus the prior year period.

The increase in our consolidated operating margin was mainly caused by the impact of lower cheese prices.

Lower cheese prices hurt our supply chain revenues, but do not impact our supply chain dollar margin.

They do, however, impact our supply chain margin as a percent of revenues.

Our supply chain margin increased 1.9% from the prior year quarter.

Commodities have dropped significantly year-over-year.

The majority of this increase was due primarily to lower cheese prices in the quarter that had no impact on dollar margins.

The average cheese block price in the third quarter was $1.19 per pound versus $1.98 last year or approximately a 40% decrease.

Also contributing to our margin improvements was a deflation in other non-cheese commodities.

Additionally, our supply chain margins benefited from reduced fuel prices and operating efficiencies put in place over the past year.

Our company-owned store operating margin increased 4.5% from the prior year period.

Lower food, delivery, and utility costs accounted for a majority of the margin increase.

Food cost as a percent of revenues dropped 4.2%, mostly due to commodity price deflation.

As a reminder, the third quarter of 2008 was our highest peak when looking at commodity costs and we are seeing the effect of this in 2009.

Delivery costs were lower because our driver delivery reimbursement dropped with lower fuel prices, and utilities were down as a result of lower gas and electric rates.

Offsetting these lower costs were higher labor expenses in the quarter resulting from another round of federal minimum wage rate increases.

However, had we not had these rate increases, we would have seen a decline in our overall labor expenses.

We continue to closely manage this line item.

Now looking at our G&A expenses, G&A increased $4.2 million in the quarter versus the prior year.

Breaking down the increase, $1.8 million of the increase was from gains recorded in the third quarter of 2008 related to the sale of company-owned stores.

Excluding this item, normalized G&A increased $2.4 million versus the prior year quarter, due primarily to targeted investments we have discussed over the year.

Partially offsetting this increase in the quarter were lower bad debt expenses, which we see as a strong indicator of the strengthening of our franchise system.

As for our income taxes, the only item of note this quarter is that we recorded approximately $200,000 of tax reserve reversals related to certain state income tax matters.

This had minimal impact on our effective rate for the quarter and is also outlined in the Items Affecting Comparability table in the earnings release.

Next, our bottom line earnings.

Our third quarter diluted EPS as reported on a GAAP basis was $0.31 or $0.17 when adjusted for items affecting comparability.

The $0.17 as adjusted EPS figure is a $0.04 increase from the $0.13 in 2008.

Our improved operating results benefited us by $0.04 in the quarter, and our lower net interest expense as a result of our lower debt balances also benefited us by $0.02 in the quarter.

Foreign currency negatively impacted us by $0.02.

Now, turning to our balance sheet, in the third quarter we repurchased at a discount $71.8 million of principal on our senior notes for a pretax gain of $14.3 million.

Subsequent to the quarter, we repurchased an additional $20.9 million of principal on our senior notes for a pretax gain of $3.6 million in the fourth quarter.

Year-to-date, including our fourth quarter purchases, we have now repurchased $160.9 million of principal on our senior notes for $108.9 million, resulting in $52 million of pretax gains.

Thee debt repurchases will save us an estimated $3.1 million of interest expense in the fourth quarter, and $5.5 million in fiscal 2009.

As mentioned on our second quarter call, during the third quarter we entered into a new $50 million letter of credit facility which allowed us to transfer existing letters of credit and draw down an additional $35 million on the revolver that is currently at an interest rate of under 2%.

So we now have $33.5 million outstanding letters of credit under the new facility and $35.2 million of cash restricted on our balance sheet.

In closing, I hope this financial recap has been helpful in putting some additional context around the information we released this morning.

With that, I'll turn it over to Dave.

Thanks, Wendy and good morning everyone.

First of all, we're very pleased over the fact that we're holding our own on the domestic sales front.

It's still very difficult out there, but we certainly feel like we're doing better than most and there are reasons why that's happening.

We've driven positive traffic in the US for the first three quarters of this year, and that has been a very important focus of ours -- to get more people involved with our brand and connected with our brand, and we feel very good about that.

We've had slightly positives same-store sales through the first half of the year in our domestic business, and again, we think in the context of what's happening out there, that's a very positive sign.

The third quarter was obviously flat, but as we benchmark versus other players out there and look at the overall environment, we feel very good about this.

And clearly, as Wendy indicated, our profit picture continues to improve.

While a lot of other players out there in our industry are shrinking, we feel pretty good about the fact that we're both building and we're growing.

And it's further indication in a clear way that even the worst of times, our business model works well and we believe strongly that we should achieve even better results as the economy and the consumer spending environment improves.

Now, our global retail sales grew steadily, thanks to another strong performance by our international business.

We continue to be blessed by the fact that our diverse portfolio of businesses around the globe drive growth and it really minimizes risk because of the diversification that we have.

We're going to be celebrating our 49th anniversary in a few weeks, and we'll continue to celebrate that we have a very proven, easy to understand business model and how fortunate we are to have so many levers that we can pull to drive sales and profits during all kinds of economic cycles, particularly the difficult one that we're working through now.

I feel like we're very well positioned for the future, based on where the brand and the company sits today.

We've done a lot of work in the area of cost cutting and controls.

I know everybody's talking about that right now, because in many instances it's out of necessity.

But we really started this process a few years ago and I really feel we got ahead of the curve.

We sold off, as you recall, some of our corporate stores in instances where we thought franchisees could run them better and our profit opportunities weren't as great.

We reduced headcount so that we could run lean overheads at our home office.

We took some tough measures for a couple years where we were paying very minimal salary increases.

We had no bonus payments.

It was tough, but it was necessary based on what we needed to do to prepare for the current economic circumstance.

We did a lot of work in our supply chain area, cutting costs, moved to a twice a week delivery process which saved us significant amount in fuel and mileage and created a lot of efficiencies.

We worked on a special cheese contract that has added a lot of value.

We've worked on our purchasing efficiencies and certainly have done a great job overall in our supply chain area.

So while others are hunkering down and cutting costs out of the necessities of the moment, we're able to be investing in and growing our business in really three key areas that I just want to briefly mention -- marketing, franchise operations, and technology.

First of all, in marketing, we're investing in our marketing in a number of ways, particularly in the new product innovation area.

We've created several new product platforms, Domino's Legends pizzas, our Bread Bowl Pasta products, Lava Cakes and of course the one that I'm going to highlight a little bit more specifically today is Oven Baked Sandwiches.

If you dial back, it was only a few quarters ago that for just $250 per store, to purchase a few smallwares, we literally became the largest sandwich delivery company overnight.

In the past year, sandwiches have become nearly a $200 million business for us.

We've sold nearly 40 million sandwiches in 12 months, and as you know, we're on air right now with four new varieties, a line extension of this platform, and we expect that these will further extend our reach in the delivered and carry-out sandwich category.

We've also increased our marketing spend this year.

We have more weeks on TV in a substantial way versus a year ago, which provides us with a more robust marketing plan overall and certainly allows us to get more heavily involved in online marketing, which continues to be a very important and growing segment of our marketing spend.

I'm also pleased to announce that our franchisees have voted to increase the national ad spend for next year, which will put us in a position where in 2010, Domino's Pizza will have a record year as it relates to the number of weeks that we will be on television as well as other important marketing initiatives.

Now, something that we're very proud of, we continue to increase traffic at a time of consumer malaise, something that makes both our team and our franchisees very happy.

And speaking of our franchisees and franchise operations, we believe that we've done a great job over the last year to 18 months in investing in the most important aspect of our business, and that's our franchisees.

We're helping them to stay healthy and making sure that our good operators are rewarded with acceptable levels of profit.

Franchisees have always been and continue to be the key to the success of our brand and our company, and I'm pleased to state that our relationship with our franchise community is currently working as well as it has in my 10 plus years here at Domino's.

We're just working together really, really well in the spirit of cooperation and getting things done and moving the business forward.

We've closed a few weak stores and we've talked about that.

We've exited some poor operators.

We've talked about that in the past.

The net of that is it's really created a stronger franchise base.

We've also invested in improving our auditing system to keep our store operations at the top of their game.

One of the indicators that that's working is that we were rated number one in the American Consumer Satisfaction Index this year.

We led everyone in fast food, including Starbucks and Papa John's.

We improved from our first year score by 15%, and being number one not just in the pizza category but in overall QSR we think says a lot about the work that we're doing at the retail level.

We're very focused on increasing our franchisee profits and getting them healthier and getting them better returns on their investment.

It's our number one corporate objective for 2009.

We've been identifying areas of opportunity for profit enhancements and we've been promoting them heavily across the system.

And it's important to note that our franchisees today are receiving profit sharing checks from our supply chain centers that are currently at record high levels, which just further adds to their profitability during the year.

We spoke a while back about our mandatory franchisee training program that was part of our commitment to strengthening the system.

I'm pleased to report that over 90% of our franchisees will have completed our high performance franchisee training program by the end of the year, which means we have put over 1,000 franchisees through this program since the beginning of the year, something we're very proud of.

It was a big initiative and it's going extremely well.

Last I want to talk a little bit about technology.

A large part of our franchisee retraining includes a focus on technology and how our Pulse system can be used to help them improve their business going forward.

The Pulse system has excellent tools for efficient labor scheduling and theft prevention, features that our franchisees love because they improve their bottom lines.

It also gives us a chance to promote online ordering nationwide, and online ordering for us now is 19% of our sales on average.

We have online order penetration as high as 45% in some of our stores.

This affords us the ability to increase our ticket, because the ticket is naturally higher with online orders.

And it's important to note that we are now America's fourth largest eCommerce site, just behind Amazon, Staples, and Office Depot in terms of the numbers of transactions that are taking place online.

According to NPD CREST, we have leapfrogged the competition by becoming the leader of online ordering market share.

Our growth in online sales has outpaced the category in the last 12 months.

I just want to speak a minute about international.

It's been growing stores and posting positive results for 63 consecutive quarters.

We've had yet another positive quarter in terms of same-store sales in the third quarter of this year.

We're still on track for our long-term outlook for this business unit of sales comps of between 3% and 5%.

Interestingly enough, the US only has about 1,000 more stores presently than our international business, as we expect to cut the ribbon on our 4,000th international store sometime in the next four months.

And based on current store trends, our growth in international should put us in a position where our international store count would surpass our domestic store count in the next four to five years -- something that is truly unbelievable, based on how far we've come in the last 10 years or so.

International currently contributes nearly half of our global retail sales and 35% of our profits, and Wendy mentioned the negative impact of currency exchange that has been hurting us during the first half of the year.

That seems to be improving in our direction this quarter and as we project forward.

And we try to stay out of the business of projecting currencies, but it looks like that's an area where we potentially can have some better news in the quarters that come ahead.

This brings me to our last topic, and that is our balance sheet -- and a topic of overall importance, and that's our capital structure.

To be clear, we are very -- and I want to underscore very -- comfortable with our current debt levels.

We have a long history at this company now of levering up the balance sheet, rewarding our shareholders in tax efficient ways, delevering as a result of the cash flow that we generate, and doing it all over again.

That 3.5% to 5.5% leverage ratio is really our normal and it has been our normal for really the past 11 years.

Our primarily franchise store model and the resulting free cash flow we generate makes increasing the leverage on our business the right corporate finance decision.

It was back in 2007 when we refinanced our debt via a very attractive securitization method, and it continues to be the right decision today.

Our asset backed securitization facility is unique and we want to keep it as long as we can because we recognize we may not be able to duplicate it in the future.

It has a 6% fixed interest rate with only one major covenant and one that we've discussed in the past, the DSCR or debt service coverage ratio.

It is a five year financing with interest only payments until 2012, and we have the option to extend this for two additional years.

And in fact we have the ability to automatically extend it if we reach a certain level with our debt service coverage ratio.

It has been our plan and our intention to extend this financing and take full advantage of it until 2014 when it will end.

I'm pleased to report that based on our current EBITDA trends and projections, and our aggressive debt buyback activities so far this year that Wendy reviewed with you, our current projections show that we will meet the necessary DSCR covenant levels to qualify for this extension, and that is even using our most pessimistic assumptions.

Our normal approach to managing our business, which we believe is prudent, is to model three different scenarios as we look out into the future.

One is the worst case, one is the expected case, and one is the optimistic case.

In the worst case, we assume that our sales comps are below our stated long-term outlook.

And in the optimistic case, we assume our sales comps are above that outlook.

And I am -- I want to mention that even under our worst case scenario, we are able to comfortably meet the DSCR hurdle that would automatically extend the ABS financing for another two years.

So we feel very confident we will be able to achieve this important objective not only for our company, but as a significant benefit to our investors.

Now, once we start to approach the end of this financing, we plan to refinance this debt in whatever manner is most attractive at the time.

And based on our projections, this will not be a problem.

In fact, the leverage ratio that we'll likely achieve in the next refinancing of our current debt will be lower than any of our past refinancing events.

So we like where we are and we like where we're going as it relates to our capital structure, and I wanted to make sure I emphasized this at the present time.

So in conclusion, I am as excited and as optimistic about the direction of our business as I have been in quite some time.

It's still very challenging out there in terms of the overall environment, but we are executing better in all phases of the business.

And I am particularly excited about some of our aggressive plans for driving growth in all of our operating units in the future.

So with that, I'll turn things over to the operator, and we'd love to entertain your questions.

(Operator Instructions).

And our first question comes from the line of John Glass with Morgan Stanley.

Hi.

Thanks.

A couple of questions.

One is on the international comps, and understanding they're still better than the US, but they've slowed sequentially.

Is there anything behind those numbers?

In other words, are there markets that are significantly underperforming or outperforming that would make the numbers slow sequentially?

Yes, we had a couple of events, John, in the quarter in a couple of our key markets that we would characterize at least at this point as more extraordinary than anything we that see as a pattern or a trend, and one of the reasons that I particularly emphasize the fact that we think that 3 to 5% growth rate in international continues to be a good kind of long-term expectation is for the fact that we still think that that's a very good run rate for that business.

So it was a little softer than that by a small amount in this quarter, but we don't see that -- at least at this stage, we don't see that as any kind of a trend or problem.

What were those events or where did they occur?

What was the nature of them, I guess?

That would be a much longer discussion than we can have today, and probably one that I would need some help from the team in terms of being as thorough and as specific as I would like to be.

Okay.

You mentioned that you've invested in marketing and franchise -- your franchisees in technology.

Just want to clarify.

You talked about those investments as largely being in the past in the script, but in the release you talked about being prepared to invest in the future.

Are there future investments that are material that we need to be aware of in any of those areas that might have an impact in either the capital spending or the margins of the business in the upcoming quarters?

Well, in the release when I talk about how we are now prepared to invest, it's really an affirmation of the investments that we have already talked about -- the fact that we have done a lot of work in retraining our franchisees, the whole initiatives around our F-rated franchisees and forcing some of those transactions, the new OER program that we've got out there that's lifting the quality performance of our stores.

What I'm really relating to is the ongoing initiatives that we continue to invest in.

I'm really not announcing anything new or different.

Last question -- can you clarify how many weeks you'll be on TV in 2010 versus 2009 with the new franchisee vote?

I could, but I won't.

That's not something that we're going to advertise for reasons that I think are pretty obvious.

But I am comfortable in telling you that it will be more weeks than we've ever had in our history, and we feel very good about that.

Okay.

Thank you.

Your next question comes from the line of Jeffrey Bernstein with Barclays.

Great.

Thank you.

Couple of questions as well.

One, thinking about the broader category, the segment obviously faces the ongoing headwinds of the higher average check.

But it does seem like and you mentioned that perhaps you're happy where you are relative to the broader category.

I was wondering whether you could talk about the lower priced items perhaps countering that headwind, and where you see the category and where you're currently positioned versus perhaps some of your national and local competitors, perhaps what the broader industry is comping in the US versus what you're doing at this point.

Just some broader color on the category and how you're bucking that trend?

As we set the table for this year, we believed that it was going to be a very, very difficult year for our category and most categories, particularly at the dinner day part.

And our whole strategy was to focus on traffic, with the notion being that during these difficult times, if we could hold traffic or even increase traffic in this environment, get more people involved with the brand, more phones ringing, more people visiting our stores -- even if we were using some lower ticket items as ways to attract that consumer and getting into some day parts that have traditionally lower tickets associated with them, that overall we were going to be in a much stronger position not only for performance this year, but how that was going to set us up for growth when the consumer comes back and the dinner day part gets healthier.

And at least through the first three quarters, we're excited about the fact that we're traffic positive.

I don't think there's a lot of people out there who are.

But we've got more people coming into the brand.

We think that speaks highly of what we've done with expansion of our menu and working on day part with sandwiches and some of the other things that we've incorporated.

Since our sales are only slightly positive for the year, year-to-date, you can see that we're trading off a little bit of ticket in terms of some of the menu variations that we put out there, but we think it's absolutely the right strategy because again, when the dinner day part starts to become healthier, we're going to be the beneficiary of that.

So the category is still tough.

The dinner day part is still tough.

We're glad that we're out there with more diversified expanded menu.

We think the players out there that don't have those levers to pull and those things working on their behalf are probably going to take hits as a result.

The more that they are a one ball juggler at the dinner day part, I think the more difficult it's going to be for them to grow traffic and ultimately grow sales.

So I like where we are.

As it relates to the local and regional players, that's 150 different discussions and it's really by market, by operator.

But all in all, we think our menu expansion has helped us, because oftentimes those local competitors, one of the advantages they had was a broader menu offering.

And the fact that we now have sandwiches, we have pasta, we have dessert items, we have some of the things that traditionally we have not offered -- we think puts us in a better position where we can go toe to toe with those guys.

So generally we feel good about our positioning, but again, that varies greatly as you go market to market.

I hope that's responsive to your question.

Yes, I'm just wondering versus your relatively flat US comp what you're hearing from your own industry sources as what the category is growing at this point or what the category is shrinking I should say at this point?

The category generally is experiencing negative traffic, and the only players that we can monitor with great specificity are the public companies who report.

And one of our major competitors has already reported and one hasn't yet.

But that's as specific a data as we can get in terms of individual brands and companies, but the industry data that we have overall shows that the dinner day part continues to be hurt and that the overall traffic continues to be negative.

Great.

And then just talking about commodities, just wondering whether you can give us an update for perhaps the remainder of 2009 and whether you have any initial thoughts on 2010 based on what you were able to secure?

I know you said after the second quarter that you thought your basket for 2009 would be down high single digits.

Obviously we've seen further easing for most of the quarter on cheese.

I was just wondering if we could get an update on that.

And just as it relates to cheese, it seems like it's down significantly year-over-year, but rallied huge in recent weeks.

Just wondering how that perhaps volatility changes your approach or perhaps that of the broader category when it comes to discounting?

I'll defer to Wendy on that.

I'll just caution you to say that we've -- after 49 years, we are not too proud to admit that we have no idea as to where commodities are going and how quickly they can move, particularly cheese.

But we'll tell you what we know at this point, and most of that's based on what we're experiencing today.

So overall, we anticipate the majority of the commodities to be relatively flat in quarter four, but down significantly year-over-year from the fourth quarter of 2008.

Cheese, as you mentioned, is rising.

Right now, current forecasts show that it could be as much at $0.30 a pound rising in the fourth quarter but again, it's hard for us to forecast that.

So we're looking at that at this time, that it may be rising, and yet relatively still gaining a benefit from the prior year.

Kind of an initial basket for 2010, if you were to just use current prices?

Obviously not being able to forecast much better than anybody else, but how's the basket look for 2010?

I have all kinds of people in the room shaking their head at me that we don't project baskets for 2010.

We're obviously beginning to work on our budget for next year.

We're starting to wrestle with some of those issues, but we're not prepared to go public with any point of view.

Just lastly, the shareholder value topic, I know you've often mentioned $1 million a week in free cash -- that's a healthy $50 million a year.

I'm just wondering the best approach to creating such value.

I know you don't currently have an ongoing dividend or any share repurchase activity going on -- just wondering whether we might see either of those increased or perhaps further debt paydown, what you're seeing as the best opportunity, especially if discounts on the debt you're buying back are more limited going forward?

Well, as we've shown, and history is the best teacher, we've at various times thought that the right thing to do is deliver a very tax efficient dividend.

At other times, we've bought back stock at substantial levels.

And other times, we've bought back debt to deleverage.

That's all based on a variety of assessments that we make in terms of what's in the best interest of our shareholders.

In the most recent past, you can see that our primary objective has been to make sure that we positioned our company to take full advantage of the securitization, and the way to do that is to extend it two years, and the way to make sure that happens is to manage that debt service coverage ratio to a level where we can be assured that that's going to happen.

The best way to make that -- those numbers work is to make sure that our EBITDA continues to increase.

At the same time, we reduce that debt by repurchase, and certainly if you can go out there and repurchase that debt at a substantial discount, it has an even greater multiplier effect.

So in the recent past, we felt that the best way for us to deploy capital in the best interest of our shareholders long-term is through debt repurchase.

And although we never telegraph what we're going to do going forward, that certainly has been the most recent strategy that we've embarked upon and we think is yielding us significant benefits.

Even if a discount wasn't perhaps available going forward, that would still be the preferred approach in the near term?

Well, right now, all things considered, we believe that deleveraging the company and creating the benefit that that achieves for our shareholders is a very intelligent thing to do, and it's also important to note that current tax law is encouraging us to embark upon that strategy because we get a significant tax deferral benefit as we deleverage the company.

And that's a new rule that has provided us a new incentive to make the economics of debt repurchase even stronger than they once were.

So we're going to take advantage of that and think about tax consequences as we think about extending the financing, and as we think about what creates the greatest shareholder value.

Great.

Appreciate the color.

You bet.

Your next question comes from the line of Greg Badishkanian with Citi.

Great.

Thanks.

Just a little bit of more color on the US market.

Obviously, same-store sales were pretty decent relative to the industry, and you didn't see the deterioration that some of your other competitors have seen.

How much of that is due to new product versus promotions?

And how -- with the industry slowing down, and you have low commodities, what's the level of promotions that you're seeing from your competitors, both chains as well as mom and pops?

It's hard to separate new products from promotions because sometimes they overlap.

We promote new products.

Sometimes we put new products in combination with existing products, so I'd more basket under the umbrella of marketing, and I think our marketing right now is in a very good place.

Our advertising is scoring well and working well.

Our new products are doing well.

We're achieving our mix objectives.

Our promotions seem to be driving consumer behavior and providing us some benefit in terms of lift.

And overall, I'm extremely pleased with what our marketing group is doing in combination with our franchise partners, because national marketing is really important, but also equally important is the local store marketing and the marketing that we're doing at the market level.

So I feel really good about how that's working and I see us building momentum.

And one of the reasons I said I'm as excited as I've been in a while is it really feels like we're starting to see some of these things really catch hold, and they'll make even a bigger difference as we move forward.

What was the back half of your question?

I'm sorry.

Sure, just the level of promotions coming out of mom and pops as well as the chains.

We are not seeing what I would characterize as unusual behavior out there in terms of crazy discounting or people using price as a lever in desperation to try to gain some share.

And that's a comment in terms of the national outlook.

Now, I can tell you about a couple of markets, and I think it's more prevalent in markets that were substantial growth markets.

You take a market where there was huge growth, real estate inflation, back three or four years ago, tracks of homes were being built by the day.

And so retailers went out and in some cases built spec stores based on anticipated growth.

And then all of a sudden these markets hit the skids and real estate goes to hell in a handbasket, and at the same time these homes don't get built.

And you've now got a situation where you're overbuilt with the number of stores and everybody's trying to keep those stores alive and you discount as a strategy to try and build some share and support your infrastructure.

That type of scenario is pretty limited.

It's only occurring in a handful of markets where -- you could probably guess where those markets are, where the growth trajectory went from extreme meteoric rise in growth to substantial reductions in growth.

Other than that, though, other than that specific Sun Belt markets, I would tell you on a national basis the pricing has been fairly disciplined, and I don't see it as a threat to what we're doing to our marketing or our margins.

Good.

Very helpful.

Thank you.

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

Sorry if I missed this point.

What is the shift in national advertising from 2009 to 2010 as a percentage of sales?

Have you quantified that?

We haven't really released that.

We'll talk about that.

That's maybe something we'll go into more detail in the future.

It was a relatively recent event and it was something that we worked out with our franchisees.

We got 100% participation and support that affords us the ability to really have a larger, more robust national advertising fund for next year that will afford us the ability to do some pretty exciting things.

But in terms of how that mechanism works, I'm not sure what we've said and what we can say at this point, and so we'll come back to you later.

In the past, it's come out of regional co-op.

Is it -- should we think about something similar in this case, or is it an actual increase in spend?

It's more of a shift.

But time will tell whether it's an increase in spend, because the shift is occurring to national, but then the co-ops have the ability to replace with additional spend at the local level.

And oftentimes history has shown us that that's what happens.

So time will tell in terms of how this all works its way out, but under any of the scenarios that we can imagine, it's an extreme positive for the brand for us to have the leverage that we're going to have in our national advertising fund.

You've obviously outperformed significantly in 2009.

Could you put that in the context of -- I just remember a few years ago where you guys really had to firm up your new product testing, market testing, in terms of properly predicting the success rate of your products.

Do you feel that you're in the right place at this point, or are you continuing to fix what you've done in terms of your capabilities in predicting future success?

I really like where we are, John.

I think the platforms that we've chosen have all been good ones.

They've all proven to resonate with consumers.

They're all great products.

They're lifting the quality image of our brand.

The Oven Baked Sandwiches, when we have a two to one preference over the leader in the category, that's huge and it lifts the overall brand.

When we're out there with Lava Cake dessert products and Legends high end pizzas, these are things that are having more of just an impact on mix and incremental sales -- they're really lifting the quality image of our brand.

And we think that's extremely important.

I really like where we are.

We're going to market faster than we ever have.

It used to take us too long once we had an idea that we felt was a good one to be able to get it to market.

We're getting to market really quickly.

We're able to react and move fast.

And we have a pipeline now, where once upon a time we might have a meeting and we decide which one of our two choices we would use to fill a marketing window, now we have a list of choices.

And depending on the scenarios we're looking at, we have the ability to be flexible and move in one direction or another.

So I like where we are.

I like what our marketing team is doing.

I feel some momentum we didn't have before.

It feels pretty good.

One last thing for me.

A lot of companies have obviously flexed down their cost structures, given what is a challenging topline environment.

Is there anything that you foresee, assuming the topline environment improves, that you may need to flex back -- in other words increase your cost structure?

Or do you think you can accept any increases in revenue whether same store or new store growth on the cost structure that you manage your business down to?

It's a great question.

We've made those investments.

The training investment has been made and it's in the plan and it's part of our performance this year.

The OER and the more careful oversight of what's going on at the retail level, that's been made.

The technology investments for the most part have been made, and anything that we have to make will have paybacks associated with it that will be attractive.

We feel really good about the investment that we made in the thin crust plant that affords us the ability to do a vertical integration play that allows us to be manufacturing a product that we were paying a significant margin to have somebody else manufacture for us.

That plan is up and operating.

I visited.

It looks great.

It's doing a terrific job and the payback on that CapEx project is going to be extraordinarily fast.

So we've made a lot of the investments.

We're well positioned.

There's no big needs out there -- just big opportunities.

And so the only thing we'll be talking about in terms of net investment would be something that comes along that we believe can give us a great payback and really jumpstart the business.

Okay.

Great.

Thank you.

You're welcome.

Your next question comes from the line of Joe Buckley with Merrill Lynch.

Thank you.

Couple of questions.

The company store performance lagging the franchisees -- is that still a function of geography more than anything else in your view?

You bet.

Interestingly enough, Joe, we have corporate markets where we are dramatically outperforming our franchisees and doing a terrific job.

But as I think I've mentioned on past calls, we have certain strategic concentrations in terms of market positions in places like Las Vegas and Phoenix and southern Florida that are having a significant impact currently on the overall performance of Team USA.

Those are just very, very tough markets and I think they are for everybody in the retail industry.

And then Dave, a question on the extension to 2014 on the debt.

EBITDA is still down year-over-year, was down last year as well.

In that worst case scenario, can you give us some sense of what EBITDA has to do worst case that you would still qualify for the extensions?

Joe, our worst case scenario is very pessimistic.

We really create a situation where we close a bunch of stores that we don't ever believe that would be closed.

We have significant negative sales.

We stress test this pretty well in terms of how we look at the negative scenario.

And when you look at the impact of that on our EBITDA, I mean, it really creates a situation where our EBITDA does not grow a substantial amount.

It maintains a pretty flat posture when you stress test the model at that level.

And what I'm here to report is even at that what I consider to be overly pessimistic approach to stress testing the model, when you combine that EBITDA and that free cash production with the continued deleveraging of the company, we get there.

And to me, that's a very important, significant outcome.

It's a very -- that's the reason we're highlighting it today, because we've reached a point in terms of our debt repurchase and what we consider to be reasonable EBITDA trend assumptions where we feel comfortable that that's a scenario that's going to live its way out.

Okay.

Last question.

The product pipeline, from what you've described, can we assume that there's a pretty robust product pipeline for 2010 that might include some new introductions?

And I guess I'd ask whether or not there might even be new categories as there were in the past 12 months?

I'll just say, this is a tough area for me, because I'm excited and I would love to yap on about some of the things I'm most excited about.

We have a very busy calendar for 2010, very busy.

It will include a number of different topics that I think will resonate with the consumer and will create news.

I better shut up beyond that, other than that's where we are and that feels pretty good to me.

Okay.

Thank you.

Your next question comes from the line of Mark Smith with Feltl and Company.

Hi, guys.

Couple of questions for you.

First, can you give us any insight on comp trends during the quarter and if there was any impact from Labor Day and some of the back-to-school shopping pushback a little bit?

I think one of the things that really is difficult right now is that patterns are really difficult to establish.

We see gyrations of consumer behavior out there that's unlike anything we've ever seen.

Normally you get in a certain track and that track is consistent, and if it's a positive track it stays positive, and if it's a negative track it stays negative.

We're seeing much more volatility from week to week, weekend to weekend, topic to topic.

So my general response to your question is that as opposed to a lot of times in my past where it feels like you can say gee, the back half of the quarter was stronger than the first half or vice versa, it's really all over the place and it's really difficult for us to forecast.

I think it's just a sign of the times.

The consumer changes and reacts very quickly to whatever the news of the moment is.

It does have an impact on their behavior.

So no real pattern of -- no real trend or pattern of behavior in the quarter that I think would be material or useful as it relates to projecting that forward.

Okay.

Then to follow up on some questions from earlier, you've talked a bit about product mix and some of your new products and the impact on check.

Can you talk at all about the profitability as you've seen a shift in some of this mix, especially for your franchisees?

Certainly our margins at the store level will be up this year, and that's a result of the fact that not only have commodities come our way, but as traffic has improved, it certainly has a significant impact.

You'd have to go into each one of these products one by one and talk about their food cost and their margin.

But we won't do that any more than our competitors will do that, other than I can tell you that the food costs and the margin opportunities associated with these products that we're -- that we have launched and that we are launching are all within the band of what's acceptable in terms of our operating model.

We can't sell our franchisees to get excited about a product that they don't make money on.

Now, in some cases, we do a lot of coaching about penny profit versus margins, because you don't take percentages to the bank.

But when you combine the impact of commodities and the fact that we're traffic positive and the fact that our sales are trending better than they have in the last couple years, the combination of that is improving unit economics at the retail level substantially, and everybody views that as a good thing.

For instance, we wouldn't be rolling out four new variations of our Sandwich line if we weren't very pleased with the profitability of that product.

And we wouldn't be devoting entire windows to Bread Bowl Pasta and Sandwiches if we didn't really like what that was doing for our profit at the store level.

Last question.

Can you talk at all about your franchisees' health, especially regarding changes in the credit markets and opportunities to increase some growth?

And also, again, looking at their profitability and any significant increase in cheese prices and how that may affect them?

Our franchisees are healthier than they've been in quite some time.

Obviously if margins are increasing and sales are better, they're going to feel that.

When their profit sharing checks are at record levels from the supply chain center, they're going to feel that.

We've gotten rid of some of our poorest performers and some of our stores around the edge, and frankly we've closed some stores that were not particularly viable based on who owned them and where they were positioned.

So we've done a lot of that work, and by far and away our franchise system is stronger and more secure today than it was a year ago or even earlier this year.

So we feel very, very good about that, and we continue to monitor that closely and work hard at trying to get those margins at the retail level up to the point where our franchisees are really getting the kinds of returns that they like to have.

The financing market is improving a bit, still tough.

There's some transactions happening out there.

There will probably be some more.

We've got some of our healthier franchisees who are generating enough cash now that they're looking opportunistically at investments.

So we're still putting together our plan for 2010, but I think generally, we feel that it's going to be a much more positive plan in terms of net store growth in our domestic business than what we've seen in the last couple years.

And that feels pretty good to us.

Excellent.

Thank you.

Your next question comes from the line of Tom Forte with Telsey Advisory Group.

Great.

Thank you.

Two questions and one to some degree was just answered.

On store closures, looks like you had a comparable number to last quarter.

If you had a continued challenging sales environment and a tight credit market, do you feel any differently today about purchasing stores versus letting the stores close?

And then second real quick, I think you made a comment earlier about seeing encouraging data points regarding economic -- the economic behavior.

Are there any around the dinner day part that you could share?

As it relates to the whole store growth situation, as the unit economics improve at the store level, you're just going to see less closures because some of the more marginal franchisees -- and you always have the bottom 20%, particularly in a system as large as ours -- you're always going to have those that are on the bubble.

When those margins start to improve, they come off the bubble and they become more encouraged.

You also see your stronger franchisees start to invest in growth.

So comparing quarter-to-quarter on store closings I think can probably mislead you as much as it can help you, because some of those are timing issues and some of them are planned.

And the point is, in the big picture, we see a deceleration of closings, the potential for an acceleration of openings.

We'll have more opportunities for franchisees to buy some of these failing stores as opposed to having them either close permanently or temporarily close.

That's a positive thing.

Whether we as a corporation are a buyer or a seller really depends on a number of opportunistic factors that we can consider and we will continue to do that as we move forward.

I just think the big picture here is that we've got a lot of the heavy lifting behind us in terms of closures and the exiting of poor performing franchisees.

And as I look forward, I think that's going to be a much better, stronger picture in terms of our domestic business.

As it relates to economic indicators out there, I hopefully didn't miscommunicate or mislead anybody.

I think generally speaking, the dinner day part continues to be under substantial pressure.

I think it's getting tougher out there.

I don't think it's getting a lot easier.

I don't see any indications that there is a significant releasing of discretionary spending on behalf of consumers at the dinner day part.

I still think consumers are pretty much in the bunker and being very careful and that's one of the areas they can save the most money.

So I think the industry generally is continuing to experience a reduction in the out-of-home meals at the dinner day part, and that's probably going to continue for a little while.

And that's why I'm glad we don't have all our eggs in that basket anymore, because we've now diversified the menu to the point we can play in some of these other day parts.

And we have the benefit, and this should never be overlooked, we have the benefit when that dinner day part gets under pressure in some cases we become a beneficiary, because we do get trading down opportunities and we're certainly less volatile than most other dinner day part players, simply because we do get that tradedown effect.

Thank you.

Your next question comes from the line of Michael Wolleben with Sidoti & Company.

Thanks, guys.

Just two quick questions here.

Can you guys give us an indication here of what the FX impact would be here in the fourth quarter if currency stays flat to where it is now?

Would you actually be seeing a benefit, or would it be really more of a neutral compared to fourth quarter last year?

I'll pass it over to Wendy.

Okay.

So for fourth quarter last year, that was where it significantly took a turn, and we had a negative impact of $3.6 million in the prior year same quarter or $0.04 EPS.

So what we're anticipating this year is that we will be relatively flat year-over-year, possibly with a small benefit.

But that's based on the latest consensus report that we've received and that can change drastically.

And then the last thing here, positive traffic through the first three quarters here.

Can you guys give us an idea of the breakdown, how much of that traffic is stemming from being open now for the lunch day part and what traffic looks like at the dinner day part compared to that?

Quick answer, no.

We start to get into some details that, again, we think are a bit proprietary and would be helpful to our competitors, and we never like to do that.

What we will tell you is getting the stores open and having a lunch business is an ongoing opportunity for us because it's building and it's growing.

And having the stores open and getting people out there, detailing local companies and people and saying hey, we're open for business and oh, by the way here's our menu and we've got a lot of things for you to choose from -- we like where we are today and we think there's a lot of upside there.

We're also pleased over the fact that sandwiches by way of example, there's a significant number of our pizza orders at the dinner day part that go out with sandwiches.

That shows us that that's a product category that's not just about lunch, but also has helped create a greater level of interest in the brand even at the continue your day part.

And furthermore, we've been delightfully surprised at how many sandwiches we sell at late night.

It seems there's a lot of people that enjoy that opportunity at a later day part than just ordering pizza.

So the platform is working for us across a number of dimensions and we feel really good about that.

But to quantify that and give that specific information is probably more than we want to talk about.

All right.

Thanks.

Your last question comes from the line of Colin Guheen with Cowen.

Most of my questions have been answered.

But I guess just stemming from the last question, as you look at the lunch platform, is there real opportunity looking to 2010 and 2011 to start putting products that have shorter cook times at lunch into the units and/or some merchandising strategy that we might be seeing?

Yes, there may be opportunities for either shorter cook times or products that will hold heat and still perform at a high level in terms of taste and quality.

So we're experimenting with a lot of different things that would afford us to be more of a player in the quick serve area, where people don't have to wait 10 minutes for something to bake.

We think there's some opportunities there, and there's some people out there that have proven there are opportunities there, and that's certainly not an area of the business that we're afraid of pursuing.

So we've got some interesting thoughts in mind as relates to how some of these products might work in that environment.

Thanks a lot.

There are no further questions.

Do you have closing remarks?

My only closing remark is to thank you all for participating in our call today.

We had some great questions and I hope this has been helpful.

We're pleased and proud of what we did in the third quarter, and we're already fast at work trying to make the fourth quarter equally successful.

And we look forward to reporting that to you in the early part of next year.

Thank you for participating in today's conference.

You may now disconnect.