達美樂 (DPZ) 2013 Q2 法說會逐字稿

Good morning.

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

At this time I would look to welcome everyone to the Q2 financial results earnings conference call.

I'll lines have been placed on mute to prevent any background noise.

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

(Operator instructions).

Thank you.

Ms. Lynn Liddle, you and begin your conference.

Good morning, everybody.

Thanks for joining us.

We did file our 10-Q this morning, so any additional details you can find there.

And of course, included in that is our Safe Harbor statement for any forward-looking statements that we had made in there or we will make today in this call.

I would also like to remind members of the media to be in listen-only mode, since this is primarily a call for investors.

We expect to keep it fairly short today, to less than an hour.

We have some prepared remarks and we will follow that with the Q&A.

And with us today we have our Chief Financial Officer, Mike Lawton; and our CEO, Patrick Doyle.

We will begin with some prepared comments from Mike.

Thank you, Lynn, and good morning, everyone.

This quarter our momentum continued as we posted strong same-store sales results in both our domestic and international businesses.

Our international division opened a significant number of new stores and our EPS grew 21.3% over the prior year.

I will start my review of the quarter by looking at our system-wide sales, also known as global retail sales, which are the total retail sales at franchised and Company-owned stores worldwide.

Global retail sales grew 10.4% when excluding the impact of foreign currency.

When we include the impact of foreign currency in the quarter, global retail sales grew by 9.3%.

The drivers of this growth included domestic same-store sales which rose 6.7% in the quarter, lapping a positive 1.7% in the second quarter of 2012.

This was comprised of franchisee same-store sales, which were up 6.8%, and Company-owned stores, which were up 5.7%.

We opened nine net stores domestically in the quarter, consisting of 20 store openings and 11 closures.

As we mentioned previously, we expect to see modestly positive domestic store openings for the full year.

Our international division had another solid quarter as same-store sales grew 5.8%, lapping a strong prior-year quarter increase of 5.7%.

Our international division grew by 101 stores this quarter, made up of 116 store openings and 15 closures.

Turning to revenues, our total revenues were up $37.9 million, or 10.1% from the prior-year quarter.

This increase was primarily a result of two factors -- first, higher supply chain revenues resulting from increased volumes from higher order counts; a change in the mix of products sold per order and an increase in commodity prices; and, second, higher domestic and international royalty revenues due to same-store sales growth and international store count growth.

Moving on to our operating margin, as a percentage of revenues our consolidated operating margin for the quarter was essentially flat at 30.4% compared to 30.5% in the prior-year quarter.

Some of the related activity that occurred during the quarter included the following.

Company-owned store operating margins decreased slightly as a percentage of revenues due to higher food cost, which were partially offset by higher volumes that leveraged labor and occupancy cost.

Our supply chain margin percentage increased slightly from 10.8% to 11.1%, due to the positive impact of product mix and higher volumes, offset in part by an increase in commodity cost.

The average cheese block price in the second quarter was $1.77 per pound versus $1.52 last year, which contributed to a 3.9% increase in our overall market basket during the quarter.

As a reminder, food commodities are generally priced on a constant dollar markup to our franchisees, therefore higher cheese prices do not impact our supply chain dollar profit.

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

Overall, we expect a commodity increase of 2% to 3% in 2013, which we believe will be manageable in the overall context of our business.

Currency exchange rates have been slightly negative for us due to the dollar strengthening against most currencies and could become a stronger headwind if the dollar remains at current levels.

Turning to G&A expenses, G&A increased by $3.3 million or 6.8% quarter over quarter.

The increase was primarily due to higher variable performance-based and non-cash compensation expense as well as investments in the international and technology areas of our business.

We have previously indicated that we estimate our full-year G&A to increase an additional $9 million to $13 million over 2012, and at the current time we expect to be at the high end of that range.

This is due to planned investments to expand our international support team, e-commerce and technology support and an increase in non-cash compensation expense.

Also, note that we charge franchisees for providing e-commerce and technology support and we expect to have increased revenues of $1.5 million to $2 million in 2013 related to these services to partially offset the cost increases.

Keep in mind that G&A expense can vary up or down by, among other things, our performance versus plan as that affects variable performance-based compensation expense as well as the timing of hiring of new team members.

Regarding income taxes, our reported effective tax rate was 37.7% in the quarter.

We continued to expect that 37.5% to 38.5% will be our effective tax rate for the foreseeable future.

Our second-quarter net income was up $5.2 million or 18.4%.

This increase was primarily driven by higher domestic and international same-store sales, international store growth and higher supply chain profit.

Our second-quarter diluted EPS was $0.57, which is a $0.10 or a 21.3% increase from the 47% EPS in the second quarter of last year.

Here's how that $0.10 difference breaks down.

Our improved operating results benefited us by $0.085 and our lower diluted share count, primarily due to share repurchases, benefited us by $0.015.

Now turning to our use of cash, during the second quarter we repurchased and retired approximately 655,000 shares for $38 million or an average price of $58.05 per share.

We also returned over $11 million to our shareholders as part of our $0.20 per share dividend that was declared in the first quarter, and we ended the quarter with $40.8 million of unrestricted cash.

I would also like to point out that subsequent to the quarter, we repurchased and retired approximately 189,000 shares for $10.9 million.

In closing, we are pleased with the results this quarter as we continue to grow our business and drive strong EPS growth.

We are committed to continue to drive improved results and return value to our shareholders.

Thanks for your time today, and now I will turn it over to Patrick.

Thanks, Mike, and good morning, everyone.

I'm delighted to report another great quarter with excellent same-store sales growth in the US and overseas, strong supply chain volumes, continued store growth and a healthy increase in earnings.

Our brand continues to evolve and improve and we are now about how we connect with consumers, leverage technology and deliver a great product for a good value to customers worldwide.

As an example of this, in the US this quarter we posted strong sales despite the fact that we didn't feature a new product.

We did promote our Handmade Pan Pizza, continuing the momentum from its fourth-quarter launch.

While we are not lapping our toughest comps of last year, we are still pleased with the excellent domestic results in the quarter.

As we have discussed before, we've got a new base of consumer sales volume, backed by quality products such as our new Pan Pizza, value offerings for consumers and great advertising and digital marketing.

We have developed a bigger brand message around transparency and consumer engagement that we believe is carrying us to a different place.

We believe this is part of why we don't need constant new pizza news or limited-time products to drive our business.

We continue to be pleased with the positive traffic we are seeing, an indicator we monitor very closely.

Our digital platform and Handmade Pan Pizza were both a big part of what drove this traffic.

We were also able to hold our ticket fairly steady.

We also continued to see some positive signs of store growth in the US.

And in fact, on a trailing 12-month basis we added a net 31 domestic units.

We've got a top-notch team focused on store growth and store image and all new stores built in the US will carry this new store design rolled out last September, which is getting early positive customer reviews.

We are also very pleased with the results in our international business, which continues its unprecedented track record of sales growth and robust store expansion.

We again saw broad strength among both developing and mature economies.

This strength was due to the basics that have been proven out in country after country -- offer great products at a good value and with excellent service.

Our international business has been doing a great job of producing positive results now for 78 straight quarters.

A few highlights include South Korea, where great value promotions and a strong focus on driving volume through digital channels paid off with double-digit sales increases; and Brazil, where improved operations and better pricing have resulted in a strong quarter for them.

And in Canada, we've seen some good results from the release of the Handmade Pan Pizza.

Second quarter also brought more news on our commitment to staying on the cutting edge of technology and innovation with of the launch of a Domino's Pizza app for Windows Phone 8. In a first for a Domino's mobile app, the Windows Phone release has voice capabilities.

The app also takes advantage of the unique Windows Phone operating system by allowing customers to pin their current order directly to their start screen, allowing direct access to track an order using Domino's tracker.

Just like our iPhone, Android and Kindle Fire apps, Windows Phone 8 users will be able to get Domino's full national menu, do a coupon search and find their local store.

The app is getting very good reviews from customers.

So we are proud to say that we now have an app for 95% of the smart phones sold in the US.

Our focus on technology and consumer access via digital ordering continues to give us an edge over our competition as we lead our pizza delivery competitors in digital ordering market share, particularly versus the smaller players that continue to lag behind.

Even if the regionals catch up to the level of technology we currently offer, we are already several years ahead of them and expect to keep pushing to lead the industry on technological innovation.

Lastly, we believe it's our strong free cash flow and the deployment of that cash to benefit shareholders that has helped to drive our share price.

We produced over $2 million a week in free cash flow on average in the first half of the year and we use that cash on both a recently established quarterly dividend and share repurchases.

And we will, of course, continue to be open and flexible in the way we deploy cash to best benefit shareholders.

So in conclusion, I want to congratulate our team on a great first half of the year.

We are seeing good momentum and I couldn't be happier with our performance.

Operator, I'm now ready for questions.

(Operator instructions) Michael Kelter, Goldman.

I wanted to just follow up.

You mentioned first off that ticket was fairly steady in the quarter.

Can you help us understand that a little better by just breaking out the 6.7% same-store sales between transaction and ticket?

I know you don't do it quantitatively, but can you at least help us with whether transactions was higher than same-store sales and ticket lower from value-oriented promotions, or was ticket also up in the quarter?

No, it was all orders for the quarter, in fact even a little bit more orders.

I think ticket was slightly negative for the quarter.

Thanks.

And then labor -- actually, one of the surprises for me is that you only generated 10 basis points of labor leverage in the quarter despite the 6.7% same-store sales.

And that's well below what you had been doing the last several years worth of quarters.

Why not more leverage on labor this particular period?

We are continuing to work on that.

I think the numbers -- we have been seeing pretty good, steady increase there.

I think, as we continue to focus on improving service and all those things, it's always about hitting that balance.

I would like to have seen a little bit more in the quarter in terms of the labor line, but it's certainly something we are focused on.

I don't think it's more than that.

It's just pure execution, and we could have used just a little bit more off that line, as you said.

Maybe lastly, any update on your appetite for taking debt leverage up a little bit within your existing facility to enhance shareholder returns?

I think the answer is, we are in the range that we have talked about before.

Kind of 3 to 6 times leverage is where we think our weighted average cost of capital is optimized.

We are essentially in the middle of that range right now.

So we look at it, but right now I think we feel pretty good about where we are.

All right, thanks, Patrick.

Jeffrey Bernstein, Barclays.

A couple of questions -- one, I know you don't give too much granularity in terms of comps sequentially or whatnot, but I'm just wondering if you can give maybe some qualitative color, because it does seem like as an industry things are doing okay at the start the quarter, and then maybe there was somewhat of a pause or deceleration in the June into July time frame.

Just wondering if you could talk about the trend line that you are seeing and how much benefit you think you are getting from greater value focus.

The value focus has been very, consistent.

We have been talking about really the same price points for a while, and it has clearly continued to work for us.

And as I emphasized, I think the great learning for us and something we are very excited about is that we are able to do this without this quarterly or monthly new product launches coming to support that.

We just think we are in a very, very different place with our customer base than we have been in the past.

And we are going to continue to have new product launches.

But what we think is important is that we are driving these results with bigger individual launches that are meaningfully changing consumers' views about the quality of Domino's Pizza, as opposed to simply creating news for news' sake.

And so we see this building on itself.

And as we bring new customers in, maybe with the Pan Pizza or through the digital side, they have a strong experience with the core of the brands, as opposed to simply trying something that is new and they like it or not and then maybe don't come back after that.

In terms of the quarter itself and how that is made up, we don't get into breaking out the quarter.

All I can tell you is that 6.7%, and as I said, that all being traffic, the answer is, it was a really strong quarter and we are really happy with it.

But I'm not going to break it apart more than that.

Absolutely.

And then the online ordering obviously seems to be a huge driver.

I think you've told us it's 35 to 40%.

If I remember correctly, it has increased 5 percentage points per year over each of the last five years.

I'm just wondering if it does drive a higher average check and drives a higher margin, it seems like you would want that to grow as fast.

One, I'm wondering where you think that ultimately stops.

Can it keep growing 5% per year?

Is there anything you can do other than advertise it to incentivize people to use it even -- it just seems like that's the desired endgame.

Is there a way to incentivize people to use it via discounting or otherwise to build even faster, or do we think we are close to a certain level that it's not going to go above 50% or whatever it might be?

Yes, I certainly think that will see it above 50% out into the future.

We've got three or four countries that are now at that level.

Our corporate stores in the US were online ordering, all of the stores about a year or so earlier than our franchise stores, and they continue to run nicely ahead of the overall franchise system on digital ordering.

And so I don't see any reason why we are not going to be able to get this number north of 50% over time.

And clearly, from our perspective, based on all the reasons, Jeff, you just said around ticket and order profitability and customer satisfaction, the faster we can push that, the better.

So we continue to invest in that area.

The one thing I would say is you mentioned the 35% to 40% range -- that's still the right answer.

To give you a little bit of color, we tend to get gains on that in the fall and winter.

And then it tends to go a little bit flat in the summer each year.

So we are still up kind of that 5% year-over-year, but it's an interesting pattern.

When people head back indoors, we tend to see the growth in the digital mix.

And when they go back outdoors in the summer, it tends to flatten out for a bit during the summer.

And so probably the answer is we stay in this range through the summer, and then hopefully we continue to see it move up.

So that's the short answer.

We are continuing to focus very hard on it.

It's why we launched the Windows 8 platform, the app, this quarter.

And you are going to continue to see a lot of innovation from us in this area.

Lastly, on the international side, obviously it's hard to find anything to question about those results for 78 straight quarters.

You talked about markets that are, surprise, exceeding expectations.

But the fact that most of your peers are having a tough time posting, would like modest positive comps and you are doing these mid-single digits -- are there any markets that you are seeing that are seeing the pain and suffering that others are facing?

I know we had heard Germany might have had tougher times, whether for Domino's or for the broader market and I just wondering if you size up seeing any signs of slowing trend, Germany or otherwise, outside the US.

Not in big material markets, no.

There are always going to be quarters here and there that are a little bit off, but it is broad geographically and it is broad when you split it by more developed economies and more developing economies.

And so overall, it is awfully good.

You mentioned Germany.

Germany is still very early in its development.

Sales growth has actually been pretty good there.

What I think you may be referring to is Germany is owned by our master franchisee out of the UK, and they gave a little bit of an earnings warning around it in terms of just the amount of resources they had to put into it to get it going.

But from a pure sales perspective and sales growth perspective, it is still looking good.

So clearly, it's working.

I'm seeing the same numbers that obviously you are looking at from some of our peers in the industry, and we feel awfully fortunate that we are continuing to drive these kinds of results.

But there just are no really material pockets of weakness out there to speak to.

That's great, congratulations, Patrick.

Joe Buckley, Bank of America Merrill Lynch.

Just wondering if you could elaborate a little bit on your comments about the US marketing.

The numbers have been outstanding, and clearly you are in a sweet groove or a sweet mode.

But I'm curious that you are describing it as a material change from the product news and maybe some of the pricing news of the past.

I don't perceive it as being that dramatically different.

So could you just talk a little bit more about that?

Yes, well the first thing you said, from the pricing -- I get that.

The pricing has been fundamentally the same for a few years now.

And so we are not bringing new news on the pricing front.

We've got something that has clearly been working.

It has been connecting with the consumers, and so on that front it has been working.

If there was news in the second quarter around our Handmade Pan Pizza, it was just a different way of talking about it, which was the fact that this brand that is known for speed had actually sacrificed a little bit of speed to make a higher-quality product.

But we were still talking about a product that had launched 6 or 9 months before and continued to drive very strong results from it.

And first quarter was really the same thing.

We were talking about the two mediums for $5.99, and it worked.

So I guess the answer is, Joe, I think what is different -- and I guess I would say not that different from the last 3 or 4 years since our brand relaunch, but really previous to that, and we have been watching it very, very carefully.

We've got a strong pipeline of new products that we can still use as we move forward.

But what we have been finding is very effective, is talking about the things that are differentiating the brands on an ongoing basis in the minds of the consumer as opposed to just hitting them with a lot of specific new news items in any given quarter.

And overall, it has worked.

And are the national media -- I know you shifted more to national media effective January.

Is there any lumpiness in the year-over-year advertising weights that we should think about?

Not materially, no.

No.

Okay, thank you.

John Glass, Morgan Stanley.

Struck by your US numbers versus what the industry has been experiencing, specifically McDonald's is talking very specifically about real retrenchment in the consumer.

My question there for you is, Patrick, do you have a view on is it the pizza category, or how much of what you are seeing is experienced in the category in general versus idiosyncratic to you?

Do you have either qualitative or do you actually have numbers on where you think the pizza category growth was in the second quarter?

Yes, our best guess, John, is that the category is flattish to maybe up.

This is mostly share gains that we are seeing right now.

And those numbers are -- I think, as you know, they are not perfect on the category, but that's our best sense is that we are in that range.

And I guess what I would say is our overall take on the consumer is that the consumer is continuing to slowly get better.

It is still more of a headwind than a tailwind for us.

You probably heard me say it many times, but the best driver, best indicator from an economic standpoint of growth for us is employment levels, more than anything else.

Employed people buy more pizza been unemployed people.

And so you are seeing that slowly getting better.

But I think that's leading to a category that is not moving a lot right now.

So really, we are feeling pretty fortunate, but it appears that it is mostly share gains for us right now.

Just to follow up on that, is the share gain -- for many quarters, it has been versus the regionals and independents.

Is the shift now becoming that your share shift is now coming at the expense of your two or three other largest competitors?

Has that changed?

I think the broad dynamic is still going to be more from smaller players and regionals.

We haven't seen Papa John's number yet for the second quarter.

Pizza Hut has released and they were a little bit negative.

I think they have been a little bit negative a couple quarters in a row now.

But overall, I think the basic thesis is still intact, which is larger players are probably going to be growing a little bit better than the smaller players and the regionals.

That is mostly as a result of technology, and there are some pretty special things that are going on with our brand and business right now that are causing us to grow a little faster even than our national peers.

But overall, I think the basics of the thesis are intact, which is larger players are going to continue to take some share from the smaller players.

That's great.

Lastly, as it relates to a recapitalization event, you have an existing securitization.

I think previously I had the sense that you were thinking more of adding to that, given the rate environment.

And it seems today that you are saying we are happy where we are.

What has changed?

Perhaps my perception was wrong, or is it really just the rate environment is shifting, and now the attractiveness of adding leverage just isn't there as it was maybe a couple months ago.

As you know, interest rates have gone a little bit -- gone up a little, but they are still very, very attractive.

And we will continue to assess whether this is something that we want to do.

I don't think that Patrick was trying to say that there's no opportunity for us.

It's just not something that we are planning on in the near-term.

Okay, thank you.

Brian Bittner, Oppenheimer.

[Mike Tamis] on for Brian.

I was just wondering, can you talk about G&A over the next 18 months?

I know you said you would be at the high end of the range for this year.

What opportunities are there for maybe that not to be high end of the range?

And any initial thoughts in 2014 and maybe any initial investments or costs that don't repeat next year that you can call out for us?

I don't think there's a lot of opportunity that we won't be at the high-end.

We have been making -- one of the things that has an impact on the G&A is the rate and pace at which we are able to attract the right people that we wanted to add into international and into our IT group.

So over the last 18 months or so, we have been trying to add people and it came at a slower rate than we had wanted.

We have filled many of those positions now, so we have got a pretty good idea of what we're going to spend on those.

We really have not figured out where, for sure, we are going to be in 2014, so it's a little early to comment on that.

At our investor day in January, I'm sure that we will the giving you more information.

The only thing I would add to that is, fundamentally, the investments we are making are working.

When you look at the investments we are making in people in the international side of the business as well as in the technology side of the business, they are clearly driving results.

And so we are not trying to figure out how to scale that back.

If we are getting a good return on those investments, we are going to continue to make them.

Great, thanks.

Mitch Speiser, Buckingham Research.

Could you comment on the online ordering growth in the quarter?

I think you gave us some metrics for 2012 a few months back.

But is online -- I'm sure online orders are probably growing quicker than the comp, but any particular data would be great.

I think the answer is where still in that 5% of mix up year-over-year.

And the color I was giving before is the way that chart looks for us, and we track it fairly obsessively, the answer is you get an increase in the fall into the winter and then it flattens out spring and summer and then you get an increase again in the fall and the winter.

Year-over-year, that means you are continuing to get that 5% mix growth that we've talked about before, and we are continuing to see that.

We would love to drive it even faster, and that's why you continue to see some investments from us there.

But that's the rate and pace of growth on that.

Separately, just -- with carryout is about 40% of your sales; if you could confirm that number.

And with the new -- and I believe carryout is growing quicker than the overall pizza delivery category; if you could maybe comment on some of the dynamics behind that.

And if this new store design, what you are now building is changing the mix of carryout or delivery or any interesting dynamics to point out from the new store prototype that you are developing.

So, first off, the 40% is orders.

Sales are a little bit lower than that because the ticket is a bit lower on carryout.

So you are more in the third to -- 35% range of sales -- a third?

I'm being told a third on sales, and your more high 30%'s to 40% on orders.

And we have still got just over, what, 100, I think, of the newly reimaged stores.

So we are still reading that but we like what we are seeing.

Clearly, the biggest change on that is a better carryout experience, in-store experience for our customers without any sacrifice on our efficiency around the delivery side of the business.

In terms of the overall dynamics, there was a point over the last few years -- our business, if you would go back 10 or 15 years, carryout has clearly become a bigger part of our business over the long-term trend.

And there was a little more weakness on the delivery side of the business back a few years ago than the overall.

But right now, I think from an overall category perspective, it's pretty flat, plus or minus a bit, in both of those areas right now.

I don't think, from a category perspective that there's a lot of movement on either side.

Okay, thanks.

And my last question is for Mike, just on the balance sheet.

Can you give us where the net debt to EBITDA ratio stands in terms of how you calculate it?

And I believe at under 4.5 times, don't you -- you don't need to make principal payments?

Maybe if you can just go through those dynamics; I think you are close to that level -- and how much cash you will save once you hit that trigger.

Okay, the way that that is calculated, it takes into -- assumes that we went actually draw upon the BFN.

So you add about 0.10 points of leverage compared to just looking at the debt to EBITDA off the balance sheet.

So we are currently in the 4.6, 4.7 range, depending on how you round.

We have to get under 4.5, which could happen as early as the fourth quarter of this year, probably a little more likely it could be in the first quarter of next year.

When we get to that, you are looking at a $26 million a year cash savings, roughly.

Great, thanks very much.

John Ivankoe, JPMorgan.

At this point, the remaining question for me is on your supply chain business, which is obviously having a great first half of the year.

Do you just attribute that to product mix, things like Pan and your continued success with the two mediums?

Or is there something else that is going on, in that business, to allow such strong growth to continue in the future?

The vast majority of what has gone on in the first half of the year has to do with the order count and the mix that we have.

You may recall that last year, in the first half of the year, some of what we were doing was promoting side items, primarily Stuffed Cheesy Bread and Parmesan Bread Bites, which was really good for franchisee profitability, but really wasn't very good for our commissary, would be one way to describe it.

This year, Pan Pizza is helping us.

I would also say that the operational metrics in the commissary have been very good.

Even as we pushed up our volumes significantly, they have done a really good job of maintaining costs.

So we haven't been heard at all as they have pushed the volumes up.

The other thing I was going to say (multiple speakers).

The other thing I was going to say is -- the other thing -- kind of the flipside of that is with the volume growth, franchise profitability, store-level profitability continues to improve year-over-year, and that's a really big positive.

So I think the biggest thing driving supply chain, other than they are doing a very nice job of running it, the team running it, is we are just getting a lot of order growth, and that volume gets us some nice leverage on that.

But the flipside is, the franchisee profitability continues to improve, and that is why you are seeing that modest net store growth domestically that we have been talking about for a while.

Great, thank you.

Alvin Concepcion, Citi.

The quarter had unusually wet weather domestically.

Did this have any impact on your results at all?

No.

Okay, great.

And you talked about a strong pipeline of products coming up.

I know you can't say much, but are these pretty broad innovations across your menu, or would you expect them to be more focused on side items to help drive ticket?

And will those mostly be coming this year, or are you sort of saving them for next year?

No.

The answer is, as we have slowed the pace of introductions, it means our R&D team has the chance to work on things that we think are going to be meaningful.

And I'm not going to get into specifics on launches and all of that.

I think the real take-away from that shouldn't be, is there something really near-term coming?

I think the take-away on that should be, when you are spreading out the pace of these, it means that the R&D team, as opposed to coming up with 5 or 6 products a year, is working on a couple maybe a year that we hope are going to materially improve the overall experience for customers.

And frankly, when you are not launching 1 or 2 a quarter, it takes a little bit of the pressure off on having just so many in that pipeline.

And then just one more for me.

You talked about domestic Company restaurant margins declining and it sounds like it's mostly due to higher commodity costs.

As you look towards the rest of the year, I believe you mentioned commodity costs are going to be manageable and you are working on improving your labor on leverage.

So would you expect margins to improve year-over-year from these levels for the rest of the year?

First of all, the answer on margins from the corporate stores -- in the second quarter, it was about food; it was about commodities, and so definitely felt that a little bit in the second quarter.

We do expect that that's going to be a little more modest through the balance of the year.

You didn't ask this specifically, but I will add it.

The offset to that is exchange rates as they stand today are looking, right now, worse for the balance of the year than in the first half of the year.

If we stay in the range that we are in today, and consensus is kind of in that range, that's going to be a little bit of a negative offset in the second half of the year.

So commodities we expect to ease a bit.

And if things stay where they are right now, FX probably goes the other way.

Great, thanks a lot.

Peter Saleh, Telsey Advisory Group.

I wanted to ask about the remodels.

Are you doing anything on the back of the house in terms of on the remodel side, or are all of the remodels really happening on the front of the house?

The focus is on the front of the house, and there are really a couple of different versions of how we do it.

But front of the house is certainly the focus.

We are not changing -- there are not like specific equipment changes back of the house or anything like that.

Our cooking platform remains pretty straightforward.

We have got big ovens back there, and I wouldn't anticipate a change in that.

Then, you get into a question of is it a relocation, is it a reimage, and are they completely taking everything out?

And some of that just depends on the age of the back of the store.

If the back of the store is looking good, then you may be able to just do the lobby and it looks good.

But as you are opening it up, if the back of the store is particularly old, it means the customer is going to see that.

And so I think the answer is there has been a little bit of a mix on that in the early reimages.

Great, and then can you give us an update on where you stand with China and the initiatives to move forward there?

Yes, it's continuing to proceed.

It's still relatively small.

We like the results we are getting.

We are getting nice same-store sales growth in China.

It is -- it's something that is continuing to progress.

Obviously, given the size of the opportunity, it's something we are going to continue to focus on.

Still not a big driver of results yet, as the base that we are growing from is still relatively small.

Great, thank you very much.

Stephen Anderson, Miller Tabak.

Congratulations on the quarter.

Just one quick question on the newer stores that you have open, and I don't think I have any metrics that could compare the new store format versus the older stores, and what kind of comp lift you are seeing from comparable locations, or what kind of change are you seeing in mix.

It's still too early to get into specifics around that.

That's why we are watching that.

Obviously, I said, I think, in my prepared remarks that the customer reaction to it is positive, but still a little early on with the store base, the store counts that we have got reimaged to get into specifics around that.

Would you say with those stores, you are trying to aim for the new fast casual pizza entrants?

Because that is a category that has seen a lot of growth in the last couple years.

We want to give our customers a better in-store and carry out experience.

I don't know that it's specifically geared towards anybody; it's just -- other than our customers.

We are doing what our customers are leading us to do and they want a better looking store; they want to see the stores opened up so that they can see the food prepared.

And that's what's driving it, more than any specific reaction to competition.

Okay, thank you.

Mark Smith, Feltl & Company.

(technical difficulty) on for Mark Smith.

just one quick question.

Can you talk about the health of your domestic franchisees, in particular their ability to reinvest in stores and their capital for growth?

Yes, so their cash flow continues to improve.

I think, as I mentioned, we are continuing to see their cash flow per store numbers get better.

That's going to be -- I think we're into a fifth year of that trend.

And so that is good news.

The answer is the credit markets for larger franchisees, for those who may be borrowing $1 million or more -- those markets are very attractive right now.

For smaller players, they are still not where it needs to be in terms of the credit markets opening back up.

Now, at some level, if you are talking about a one- or two-store franchisee, if their sales are good enough and their cash flows are continuing to progress, they are going to be able to potentially do it out of cash flow and may not need to tap into those markets.

But overall, the answer is credit markets are very attractive for those looking to borrow at a significant level, and they are still relatively restricted for those looking for smaller amounts of debt.

Perfect, thank you.

There are no further questions.

All right, listen, I appreciate everybody's interest and look forward to sharing third-quarter results with you here in a couple of months.

Thanks, everybody.

This does conclude today's conference call.

You may now disconnect.