達美樂 (DPZ) 2018 Q1 法說會逐字稿

Good morning.

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

At this time, I'd like to welcome everyone to the Q1 2018 earnings call.

(Operator Instructions) Thank you.

Mr. Tim McIntyre, you may begin your conference.

Thank you, Marcella.

Hello, everyone.

Thank you for joining the call today about the results of our first quarter.

Today's call will be the final one featuring CEO, Patrick Doyle.

As you know, this call is primarily for our investor audience, so I kindly ask that all members of the media and others be in a listen-only mode.

In the unlikely event that any forward-looking statements are made, I refer you to the Safe Harbor statement you can find in this morning's release and the 8-K.

As always, we will start with prepared comments from Domino's Chief Financial Officer, Jeff Lawrence; and from Chief Executive Officer, Patrick Doyle; followed by your analyst -- the analyst questions.

With that, I'd like to turn it over to CFO, Jeffrey Lawrence.

Thank you, Tim, and good morning, everyone.

In the first quarter, our positive global brand momentum continued as we once again delivered great results for our shareholders.

We continue to lead the broader restaurant industry with 28 consecutive quarters of positive U.S. comparable sales and 97 consecutive quarters of positive international comps.

We also continued to increase our store count at a healthy pace.

Our diluted earnings per share was $2 a share, which is an increase of 59% over the prior year quarter.

With that, let's take a closer look at the financial results for Q1.

Global retail sales, which are the total retail sales at franchise and company-owned stores worldwide, grew 16.8% in the quarter.

When excluding the favorable impact of foreign currency, global retail sales grew by 13.1%.

This global retail sales growth was driven by an increase in same-store sales growth and the average number of stores opened during the quarter.

Same-store sales for our domestic division grew 8.3%, lapping a prior increase of 10.2%.

Same-store sales for our international division grew 5%, lapping a prior year increase of 4.3%.

Breaking down the domestic comp, our U.S. franchise business was up 8.4% while our company-owned stores were up 6.4%.

Both comp increases were driven primarily by order count or traffic growth, as consumers continue to respond positively to the overall brand experience we offer them.

Ticket also increased during the quarter.

On the international front, all 4 of our geographic regions were again positive in the quarter, with our Americas and Asia-Pacific region leading the way.

As I mentioned on the Q4 2017 call, our comps that quarter were negatively impacted when compared to the prior year, as our fiscal calendar did not include New Year's Day.

That shifted back favorably in Q1 as comps globally were positively impacted by approximately 0.5 point this quarter.

On the unit count front, we are pleased to report that we opened 31 net domestic stores in the first quarter, consisting of 35 store openings and 4 closures.

Our international division added 79 net new stores during Q1, comprised of 104 store openings and 25 closures.

On a total company basis, we opened 110 net new stores in the first quarter and 966 net new stores over the last 12 months, clearly demonstrating the broad strength and outstanding four-wall economics our brand and franchisees enjoy globally.

Turning to revenues.

Total revenues were up $161.2 million or 26% from the prior year quarter.

As a reminder, we adopted the new revenue recognition accounting standard in the first quarter of 2018.

As a result, we are now required to report the franchise contributions to our not-for-profit advertising fund and the related expenses gross on our P&L.

Although this had no impact on our reported operating or net income in the first quarter, it did result in an $82.2 million increase in our consolidated revenues.

It is important to note, although these amounts are now included in our P&L, they are restricted funds that can only be used to support the Domino's brand and are not available to be used for general corporate purposes.

The remaining $78.9 million increase in revenues resulted primarily from the following: first, higher supply chain center food volumes driven by strong U.S. comps and store growth resulted in higher supply chain revenues; second, higher domestic same-store sales and store count growth resulted in increased royalties and fees from our franchised stores as well as higher revenues at our company-owned stores; and finally, higher international royalty revenues from store count growth and increased same-store sales as well as the positive impact of changes in foreign currency exchange rates.

Currency exchange rates positively impacted international royalty revenues by $3.3 million versus the prior year quarter due to the dollar weakening against certain currencies.

Moving on to operating margin.

As a percentage of revenues, consolidated operating margin for the quarter increased to 38.2% from 31% in the prior year quarter.

This increase resulted entirely from the recognition of domestic franchise advertising revenues on our P&L from the new revenue recognition accounting guidance I mentioned previously.

Growth in our global franchise business benefited the overall company operating margin, while supply chain operating margin was negatively pressured by both labor and delivery costs.

Company-owned store margins remained flat for the quarter.

Let's now shift to G&A.

G&A cost increased $6.4 million as compared to the prior year quarter.

This increase resulted primarily from our planned investment in technological initiatives, including e-commerce and the teams that support them.

Please note that these investments are partially offset by fees that we receive from our franchisees, which are recorded as franchise revenues.

Moving down the P&L, you will also note a new expense line item called domestic franchise advertising.

Due to the new revenue recognition guidance, we are now showing domestic franchise advertising in our revenues with an equal and offsetting amount of expense in our operating costs.

In the first quarter, we recorded $82.2 million in expenses related to this change.

Related to these changes, certain advertising costs that were previously included in our G&A line item have been reclassified to the new domestic franchise advertising expense line item.

As a result of this expense reclass and our outlook for the rest of the year, we now estimate that our G&A line item for full year 2018 will be in the range of $370 million to $375 million.

As a final note on these accounting changes, we will not be providing an outlook on domestic franchise advertising expense.

Moving down the income statement.

Net interest expense increased by $4.3 million in the first quarter, primarily as a result of increased net debt from our 2017 recapitalization.

This was partially offset by a lower weighted average borrowing rate of 3.9% as compared to 4.6% in the prior year quarter.

Our reported effective tax rate was 14.3% for the quarter.

This was primarily due to the lower federal statutory rate of 21%, resulting from the federal tax reform legislation enacted at the end of 2017.

The impact of tax benefit on equity-based compensation also resulted in an $8.4 million reduction in our first quarter provision for income taxes.

This resulted in an 8 percentage point decrease in our effective tax rate.

We continue to expect that our tax rate, excluding the impact of equity-based compensation, will be 22% to 24%.

We also expect to see continued volatility in our effective tax rate related to equity-based compensation.

When you add it all up, our first quarter net income was up $26.4 million or 42% over the prior year quarter.

Our first quarter diluted EPS was $2 a share versus $1.26 last year, which was a 59% increase.

Here is how that $0.74 increase breaks down.

Our lower effective tax rate positively impacted us by $0.38, including a $0.32 positive impact from tax reform and a $0.06 positive impact related to tax benefit on equity-based compensation.

Lower diluted share counts, primarily as a result of share repurchases, benefited us by $0.19.

Higher net interest expense resulting from a higher net debt balance negatively impacted us by $0.05.

And most importantly, our improved operating results benefited us by $0.22, including a $0.04 benefit from the impact of foreign currency exchange rates on royalty revenues.

Now turning to the use of cash.

During the first quarter, we repurchased and retired approximately 448,000 shares for $101.1 million at an average purchase price of approximately $226 per share.

Subsequent to the first quarter, we returned $23.5 million to our shareholders in the form of a $0.55 per share quarterly dividend.

We also repurchased and retired approximately 352,000 shares for $81.3 million at an average purchase price of approximately $231 per share.

All in all, our strong momentum continued, and we are very pleased with our results this quarter.

Before turning it over to Patrick, I would like to give an update on our recently completed recapitalization transaction.

As previously announced, we have been in the process of recapitalizing our company, increasing our leverage to match our growing business, which has been the consistent pattern for many years.

The recapitalization transaction closed on April 24, with the receipt of $825 million in gross proceeds.

We are happy to report that the deal was very well received by the lending community, and the interest rates we'll be paying on this new debt are a good reflection of the investment community's confidence in our business and our brand.

Now on to some details about this deal.

The transaction, which again has taken advantage of the whole-business securitization structure, included issuing $825 million of new fixed-rate notes, which was made up of the following tranches: a $425 million tranche at a 4.116% coupon rate with an anticipated repayment date in October 2025; and a $400 million tranche at a 4.328% coupon rate with an anticipated repayment date in July of 2027.

On a blended rate basis, these 2018 notes carry pretax interest rates of approximately 4.2%.

We are very pleased to have locked in additional debt at low interest rates well into the future.

Our debt-to-EBITDA leverage ratio using a Q1 trailing 12-month EBITDA is now approximately 5.8x, up from approximately 5.2x prior to the deal and near the top end of our previously stated 3 to 6x range.

The 2018 notes have scheduled principal payments of 1% of the principal each year, which equates to approximately $8.3 million per year.

With these scheduled principal payments on our outstanding notes and our momentum in the business, we currently expect our leverage ratios to fall over the medium term, consistent with prior practice.

Use of funds from this transaction include $490 million to prepay and retire the balance of our existing 2015 5-year fixed-rate notes, which will take place tomorrow.

We also paid fees and expenses related to the deal of approximately $9 million and prefunded approximately $4.4 million for a portion of our principal interest on the 2018 notes.

We expect to decide on the use of the remaining proceeds of approximately $322 million in the near term.

One last note on the recapitalization.

We currently estimate that for full year 2018, as-reported interest expense is currently expected to be between $145 million and $147 million on a pretax basis.

It is important to note that these current estimates of interest expense may change due to borrowings under our variable funding notes and changes in LIBOR that would affect our variable-rate debt, among other factors.

All in all, another very good refinancing transaction for the company.

And with that, I will turn it over to Patrick.

Thanks, Jeff, and good morning, everyone.

I want to begin today's call, my final one as President and CEO of this amazing organization, with gratitude towards many.

I want to thank the many investors who have believed in our long-term story over the years.

It's been great to interact with you along the way.

I've learned from being challenged by your questions and observations over time, and they've helped us shape how we approach the business and, ultimately, helped us generate industry-leading shareholder returns.

I want to thank all of the sell-side analysts for the time spent in understanding Domino's long-term approach and for your belief in our strategy and fundamentals.

It's been great to get to know all of you.

And while I'm still on the job for a couple of more months, I want to also take this public opportunity to thank the tremendous second-to-none collection of people that make up our leadership team, our corporate team members, our incredible group of global franchisees and the team members in the stores who take great care of our customers.

As I've touched on in the past few months when discussing our leadership transition, the major reason for deciding it's time for me to move on is our deep bench of leadership talent and an incoming CEO who couldn't be more prepared and ready to move the brand and business forward.

I'm excited for many of you to get to know Ritch Allison better in the coming months.

I have no doubt that he will do an outstanding job.

And beyond his skills and smarts as a leader, he's a good friend and a great person who will represent our culture perfectly.

You will hear from Ritch in a few moments.

But first, I'm delighted to discuss with you our first quarter, an outstanding start to 2018.

To summarize the quarter, we delivered.

And we delivered in every way.

There was an intriguing element of our results that's worth noting, particularly in the face of many questions we've received of late regarding the current delivery landscape.

We generated significant growth in delivery during the quarter.

While both carryout and delivery have consistently grown, carryout has outpaced delivery growth most of the past several quarters.

We remain absolutely committed to carryout as a prime incremental opportunity for our business, but I was pleased to see delivery grew faster than carryout in our first quarter.

Part of the reason for this is our continued assessment of third-party aggregator delivery, which has generated significant discussion within our industry and the investor community over the past couple of years.

Simply, as our results demonstrate, we have continued to see very little impact on our business from third-party deliveries.

And between our strong overall retail sales growth as well as the particularly strong delivery growth in Q1, our viewpoint on this seemingly becomes more and more confirmed.

Delivery aggregator economics remain challenging and unproven, and those making attempts to succeed in this space are likely realizing something we have known for almost 6 decades.

Delivery is hard.

While we aren't always perfect, I'm confident in our ability to continue to fend off those who attempt to play in our space of expertise and, by utilizing the competitive advantage of owning it ourselves, remain committed to offering the best experience for our customers and most affordable platform for our franchisees.

The other major takeaway from our first quarter and a definite highlight is the tremendous retail sales performance, particularly within the domestic segment.

Clearly, our same-store sales performance was strong, but as we have stated, the best way to view the business for the long term will continue to be through the blend of comps and unit growth.

And I'm pleased to see such a strong result in that regard to kick off 2018.

This growth is leading to many things: fortressing markets to generate superior returns for our franchisees; promoting continued investments in areas such as supply chain and technology to keep up with the strong retail sales growth; and a franchisee focus on growing their businesses and seeing the long-term importance in maximizing their profit potential through both store growth and same-store sales growth.

Before I get into further specifics on the quarter, I want to take a minute to turn the call over to the next CEO at Domino's, Ritch Allison.

Thanks, Patrick.

I appreciate you allowing me a minute for some quick remarks on our call today.

The main thing I want to do today is simply to say thank you on behalf of our entire leadership team.

We are so grateful to have had the opportunity to work with you and to learn from you.

Patrick Doyle is, without question or debate, the top CEO in the industry.

And while Patrick leaves big shoes to fill, I am extremely excited to step into a role I feel incredibly prepared to take on, overseeing such a tremendous brand and such a talented collection of people.

Patrick, thank you so much for your leadership and for our friendship over the past 8 years.

It is my personal goal and that of our entire company to carry forward the tremendous momentum around this business.

To those on the call, I am also very excited about our start to 2018 and our first quarter performance.

I look forward to the opportunity to lead this phenomenal brand into the future.

In addition to my first earnings call this July, I look forward to meeting and getting to know many of you better throughout the back half of 2018 and beyond.

So with that, and with great appreciation, I'll turn it back over to Patrick.

Thanks, Ritch.

I really appreciate it.

I am absolutely confident that we are going to continue to do even better things around here under your leadership.

So continuing my first quarter comments and on our domestic business specifically, I am very pleased with an outstanding start to 2018.

One of the things I will miss most and continue to truly give Domino's its winning edge is the continued energy and commitment of our U.S. franchisees.

This group just refuses to be complacent or rest on their past success.

Their unrelenting commitment to success related to sales, service and smart growth is inspiring.

Our relationship with our franchisees is second to none.

Ritch inherits and helps build a group of people who strongly believe in what we are trying to accomplish as a brand and as a system.

Our alignment with our franchisees and our constant focus on their profitability and success is the only way we can succeed as a company.

This alignment allows us to move faster as a system to take advantage of new opportunities and make investments in areas that generate future competitive advantage.

Speaking of advantages, a quick note on technology, highlighted by yet another recently announced forward-thinking innovation that we believe could be a game changer within our space.

Announced just last week, our Hotspot program is something we think could redefine delivery convenience and adds to the long list of category firsts for Domino's.

This will allow customers to order Domino's from thousands, in fact, now almost 200,000 of parks, beaches, sports fields and other places, which will now serve as official delivery locations.

The ability to now deliver to spots without a traditional address and other rather unexpected sites will not only continue to drive incremental orders in the near term, but it is yet another meaningful step on our mission of industry-leading convenience and the ability to order from us anywhere, anytime.

This is thanks to outstanding technology helped by continued aggressive investment; sound operations, which are vital to making the Hotspots process work; and proper execution participation at the store level, a nod to our terrific franchisees, managers and drivers.

We urge you to visit the Hotspots area of our website to learn more about this very exciting, innovative and pioneering platform.

On top of Hotspots, we've also just announced another exciting advance in our technology.

Enabled by our investments in proprietary artificial intelligence, we are developing the ability to take all phone orders via Dom, our virtual assistant.

Fundamentally, we are on a path to take all orders digitally.

Doing so will mean not only a better customer experience, which should generate continued sales and store level profit growth, it allows our store-level teams to focus all their efforts on making great pizzas and giving great service to our customers.

I'm not big on hyperbole, but this could be a game changer for us and our customers.

On the international front, the business continued to perform very well, with quarterly comp performance at the higher end of our stated range to get the year off to a solid start.

I was very pleased to see our same-store sales performance be driven completely by order growth with more and more markets adopting promotional strategies and initiatives designed to grow transactions.

Within our international business, I'd like to highlight the recent top line performance of our India business.

As you've recently heard from Jubilant Foodworks, our master franchisee in India, the reacceleration of sales in the market is leading them to also reaccelerate their commitment to store growth within India, this at the same time that one major competitor has left the market and another is struggling.

Our unit openings in international were a bit slower than usual in Q1, but we remain confident in our long-term outlook of 6% to 8% net unit opening.

In closing, I'd like to reiterate my great appreciation for the opportunity to lead this organization as CEO for the past 8-plus years and for over 2 decades with this amazing brand.

I am extremely proud of what we've been able to accomplish.

And even as I pass the CEO role to Ritch, I will be a Dominoid forever.

When I took this job, I set out to achieve 3 things.

First, I wanted Domino's to provide the best return for our franchisees in the restaurant industry by creating a dramatically better experience for our customers; second, I wanted to ensure succession strength and have a leadership team and CEO in place that would be ready to take the business forward; and lastly, to become the #1 pizza company in the world by the end of the decade.

When I set this last goal, it was clearly a stretch.

But my confidence in our franchisees, our leadership and every single person who passionately works to make this brand just a little bit better each and every day, left me little doubt that we would get it done.

And here is the beauty of this organization.

No one will rest.

Victory laps and complacency just don't exist within this culture.

As it became clear we were going to become the category leader, the discussion immediately shifted to how we become dominant #1.

With Ritch, Russell and the whole team more than ready to take on the strategy of how to get there, it was time for me to step aside.

And while I will truly miss the daily interaction with our franchisees and the team, I can't wait to watch from the sidelines and cheer on this phenomenal team, phenomenal brand and phenomenal culture as it gets there.

And there is no doubt in my mind that it will.

Thank you all so very much, and we will now open it up for questions for myself, Ritch or Jeff.

(Operator Instructions) Your first question comes from the line of Brian Bittner from Oppenheimer.

And Patrick, it's just been such a pleasure to get to know you over the years.

It's just been one heck of a run you've had.

So congratulations.

It's only fitting that you go out with a bang here.

And we're certainly all going to miss you.

Thanks, Brian.

A couple questions.

Just with the fourth quarter now further in the rearview, are you able to now look back and better diagnose what that slowdown was most attributable to?

And what do you think is the biggest driver of this reacceleration or this improved trend that you've seen in the first quarter?

Yes, Brian, I mean, first of all, I -- fourth quarter was still pretty darn good.

We were pretty happy with it.

But clearly, first quarter even got a bit better.

I guess what I would say is first, remember that New Year's Day shift, so that was kind of 0.5 point out of Q4 and 0.5 point into or even a bit more into Q1.

And so there's kind of 1 point plus of swing in the quarters right there.

But if you look at it overall, our stores are executing at a very high level.

They continue to do better and better on that.

Our loyalty program and earn AnyWare is continuing to, I think, accelerate the growth in the loyalty program.

I think our advertising has been particularly effective in the first quarter.

And I would remind you that we were lapping an incredibly big number in the fourth quarter.

And normally, at the time, we're not going to talk about laps, but it was a particularly big one.

So I think those are really the things.

And at the end of the day, our guidance is 3% to 6% on the comps.

We were happy to come in, obviously, over the top of that in the first quarter, but that's where we think we're going to be more often than not.

Okay.

And just my last question, as you think about the potential to take share from smaller players going forward over a longer term, what do you think is going to be the biggest headwind for them?

Why are they going to continue to donate share?

Is it just an inability to compete on price, tough time competing on digital> What's this share shift driver going to be moving forward?

I think there are a number of things, but we think we've got our food right.

Our digital strength is clearly driving a lot of it.

Our discipline around pricing and, frankly, our focus on the profitability of our stores is allowing our franchisees to be disciplined around price.

The fact that we've been able to run a national price point for 9 years now and continue to make improvements in our franchisees' store level profitability is a big part of that.

And our understanding that at the end of the day, if you're not bringing more customers into your stores, day in and day out, it's not going to be a long-term recipe for success.

So there are just a lot of things that have played into it.

But our focus on the franchisees' store-level profitability and putting tools in place and the digital things in place that are going to do that.

And as I was just talking about Dom and how we can become a 100% digital business, don't underestimate what a big deal that could be for store-level profitability and for customer convenience.

Those are the sorts of things that are going to allow us to continue to take share.

Your next question comes from the line of John Glass from Morgan Stanley.

Patrick, I'd like to add my congratulations and best wishes to you.

We'll miss you here.

Thanks, John.

Can you -- you did call out the international store growth moderating versus a year ago and versus prior periods.

Can you just maybe amplify in your comments as to why you think that occurred and what -- is it a specific market, for example?

And what gives you the confidence that it will end up being where it was at the end of the last year or the similar growth?

John, this is Ritch.

We were a little slower out of the gate than normal in Q1 on store openings.

But across the globe, in each of our regions, cash-on-cash returns at the store level remained very, very strong.

So as we look forward, we're still quite confident in our 6% to 8% unit growth guidance.

In a 12-week period, you can get some ups and downs, but the long-term health of the business is very solid.

All right.

And then, Patrick, you indicated that this voice ordering is going to be a powerful tool.

Can you maybe, one, if there's a way to sort of dimensionalize how much time, either hours or percentage of labor, is spent on the phone at a store, so what could be removed?

And remind us also, if you can, or maybe directionally, there's got to be an uplift in check, right, or could there be an uplift in check just as there's more consistent upselling, for example, in that process?

Yes, so John, look, we are still developing this.

And we announced it because I think as of this morning, we're in about 20 stores, and it gets better every day.

It's the way that you iterate on this.

But to accelerate the pace of improvement in this, we needed more and more data points, more and more experience, finding out more different ways that customers would order, and so it continues to get better.

And so what I would say is the biggest, most important thing is how it will help grow our top line.

And it's the same as it is with all of our other digital efforts.

So there is some labor savings, although interestingly, I mean, if you figure today we are north of 60% on our digital orders and about 10% of our orders are walk-in orders, so people just walking in to the store and somebody takes the order there, and those can be handled with kiosks.

So that's how those are going to be digital.

But you're looking at today, 25% or maybe slightly more that are still old-fashioned phone orders.

And think maybe 3 minutes average on the phone for somebody to take a phone order.

But that's ultimately not the big thing.

The big thing is all of the calls are getting answered, they're going to get answered in the same way, they will all be upsold, kind of your point around ticket.

But from a labor perspective, what we think is maybe most important is the fact that people are able to focus then in the stores, fundamentally on 2 things: on making pizzas and on getting them out the door and taking care of customers who are coming into our stores.

So it is ultimately about driving sales through better customer satisfaction.

And if you're able to get an activity like taking orders entirely out of the store, it's kind of the second-order effects of that, that are more important, I think, than the direct minutes saved in taking those orders.

Your next question comes from the line of Chris O'Cull from Stifel.

Patrick, let me add that it also has been a pleasure to follow Domino's success under your leadership.

I wish you well.

Thanks, Chris.

Patrick, just to follow up on your comments about the digital phone orders, what are the challenges that still need to be overcome to have this rolled out systemwide?

And then I have a follow-up.

Look, it's going to continue to get better, and we're continuing to iterate on it.

We've been working on this for quite a while, but there is only so much progress you can make kind of in a lab setting inside the organization.

We've had it in a couple of stores for a while now, but artificial intelligence allows you to learn faster and faster the more iterations, the more reps you can get on it.

And so we are very confident that this technology is going to get there.

But moving it into more stores, and that number is going to continue to increase, is going to increase the pace of learning and the pace of improvement.

What's interesting, though, if you think about it, if you think about Siri or Amazon Alexa or any of the natural voice platforms out there, they are covering very, very broad activity.

We're talking about taking a pizza order, and it's a pretty small area for them to deal with.

So if you call one of these stores and you start talking about politics or something completely off, they're going to be very confused.

But if you call in and all you're trying to do is place an order for 2 large pepperoni pizzas and a 2-liter Diet Coke, it's going to be really good and really efficient at doing that.

So that step 1 is continuing the iterations, and we wouldn't be rolling it into more stores if it wasn't already pretty good.

But it's going to get better and better.

And then the last thing is we're going to need to have the right phone systems in the stores to manage all of that.

But we're pretty confident that the ROI on this will be very, very good and the expense of that would be well warranted.

Okay.

And then, Jeff, several companies have been talking about freight cost inflation.

What level of inflation is the supply chain experiencing now?

And will the new commissary help mitigate higher delivery cost for it?

Yes, Chris, so just on food basket inflation, we're still anchoring to the 2% to 4% for 2018.

For what the stores in the U.S. will experience will end up pretty much to what we're seeing in the rest of the industry, not really a surprise there and one that, to the great credit of our franchisees and our corporate stores, they've been able to really give the sales to help leverage and offset that increase.

As far as delivery cost of the supply chain system that we have, we were pressured in Q1 on some labor and delivery cost.

And just to be clear, we've been clear on this, we have opportunity to get better in that part of the business.

We're investing heavily in that area of the business, not just for capacity but hopefully, to get some additional efficiencies.

And at the end of the day, that benefit all accrues to the franchise operators and their P&L.

If you remember, we share half of our profits in the U.S. and Canada with our franchisees.

And so we're all aligned behind that business.

We're going to add to capacity, as we mentioned, with the Northeast center coming online in the fall.

And again, as I look at the margin forecast there, I've told you before, I don't expect any wide shifts up or down on a percentage basis once you bring the new capacity online.

Your next question comes from the line of Will Slabaugh from Stephens Inc.

I'll echo my congrats to Patrick as well.

I had a question on carryout.

So you guys have, obviously, been focusing on that, and it's been growing, as you mentioned, at a faster rate than delivery the past few quarters.

And the percentage of carryout, though, still remains below peers.

So I'm assuming it has something to do with the real estate, among others.

So can you talk about the potential to continue improving real estate sites and maybe anything else that I'm forgetting about that may continue to be an opportunity in carryout looking forward now that the remodels have largely played out?

Yes, so the best way to improve our real estate locations is to have more of them closer to our customers.

And it's something we've talked about a bit before, which is customers are not willing to drive more than 0.5-mile or 1 mile to get their own pizza.

They might be willing to let us deliver from further away.

In fact, they are willing to let us deliver from further away.

So when we add these new stores, as we have been doing, while there is a little bit of cannibalization on our delivery business, each of these new stores is 100% incremental on our carryout business, which is, again, a reflection of what I was saying about how far are customers willing to go for carryout.

So as we add stores, that's going to help.

We've gone through a lot of the relocations of existing stores in the U.S. There's still some to go, but that's frankly, going to be much less of an effect for our customers than just simply building more stores, getting them closer to our customers.

And if you look at big carryout-focused chains within the restaurant industry, so you look at Starbucks or you look at McDonald's or some of these other players, you're going to see a much greater density of stores than we have today.

And as we focus more on this, we're realizing that there was something to that, that they've understood that people are only so -- willing to go so far to get a cup of coffee or a hamburger, and the same thing is true is if they're going to get a pizza from Domino's.

Makes sense.

And if I could kind of flip that question around a little bit, you mentioned delivery actually grew faster this quarter than carryout.

Was there anything that you did, in particular, in this quarter to help drive that shift?

Or do you view that more as organic?

It is all about our execution on delivery.

And we do that extraordinarily well.

You will probably find research out there already about customers' experience with the third-party aggregators, and we remain confident that we are better at delivery than anybody out there, that we are doing it for better value for our customers.

It's a hotter pizza when it's getting to them.

It is a superior experience.

And so there's a lot of talk about delivery, and that may be helping to grow our delivery business as people understand that the best place to get food delivered is from the original delivery aggregator, Domino's Pizza.

Your next question comes from the line of Karen Holthouse from Goldman Sachs.

Really, 2 for you.

First, on the company side of things, store counts were -- or unit growth in the first quarter was really stronger than we've seen in a long time.

And sort of being careful to extrapolate 12 weeks, was there anything sort of special to this quarter with 5 unit openings?

Or is that a fair pace to think about for the balance of the year?

And then going back to sort of delivery versus carryout, inclement weather has been a pretty broad topic of discussion through earnings thus far.

Do you think that, that might have helped drive growth on the delivery side of the business and/or any comment on just sort of weather as an overall contribution to the comp in the quarter?

Yes, thanks, Karen.

So first, you know us, we never use weather as an excuse or as a driver, because it just doesn't play into our business that much that it ever gets to the point of being material.

So really nothing in that.

That doesn't mean that there aren't nights or a couple of days when we get really busy in 1 region, but we just -- our analytics all tell us over the course of a quarter, with all the different geographies, it just kind of averages out into a couple of tenths here or there.

But it's just not a big material effect on our business.

For our corporate stores, you are going to see us opening corporate stores, but you will also see us occasionally buying and selling some corporate stores as well.

But we believe strongly in our unit economics.

Our stores generate a strong return, and everything that I just said about the system in general is equally true on our corporate stores, which is we need more of them covering territories that we are already in.

And I'll give you an example.

We opened a couple of stores in New York City and Bronx, Brooklyn and Queens are 100% corporately owned, and we added a couple more in there.

We already cover all of the territory, and we know that we can cover it better by having more restaurants there.

So part of the ongoing thing.

You're not going to see us grow our corporate store counts materially, but we do see an opportunity to build some more in geographies that are already in, and some of that may be offset from time to time with some sales on geographies that may be a little further out.

Your next question comes from the line of Alton Stump from Longbow Research.

First, pass along my congrats to you as well, Patrick.

It's been quite a run.

Thanks, Alton.

I think most of my questions about the U.S. have been asked.

And obviously, it was a great quarter.

Congrats on that.

But just as I look internationally, was also strong quarter there.

Been some choppiness, obviously, over the course of '17.

As kind of look -- or over the last 2 quarters here, as you kind of look ahead to the rest of '18, is there any reason to believe that it could be a more consistent performance from a same-store sales standpoint internationally than what we saw last year?

Alton, this is Ritch.

One of the things that we're seeing, which is very encouraging for us and the international business in Q1 is that all of the same-store sales growth was driven by order count or transaction growth.

You may recall some of the choppiness we had back in '17.

We spoke about the fact that we were a little concerned that maybe we had gotten off on value in a few of our markets and had some issues with the growth coming more from ticket as opposed to transaction count.

Yes, I'm really pleased to say that in the first quarter, the growth was all driven by transaction count.

So that renewed focus back on value gives me optimism about our ability to continue to perform solidly in that 3% to 6% same-store sales growth range.

Your next question comes from the line of Gregory Francfort from Bank of America.

I thought the comments on the move to a potentially 100% digital business were very interesting, and I was wondering if you could flesh out a little bit more how you think that happens over time and then sort of where the cost savings are.

Is that just on order intake and labor?

Is it that you can change sort of the investment cost in the box and then just operationally, how that could work?

Is that kiosks that would replace sort of someone in the store taking the order?

Just fleshing out sort of your longer-term thinking on that and then maybe the timing of when you think that happens, I'd be very interested in.

Yes, it's -- Greg, what I'd say from a timing perspective, it's still going to take a little bit of time, but the team is working fast.

We've got some pretty clear metrics that I'm not going to share right now, but pretty clear metrics on what success looks like.

But certainly at the top of the list is the customer experience and customer satisfaction.

But then the rollout on that is first going to happen only after we know that it is performing better than we can perform today with the existing systems that we have in place.

And in terms of how it comes into the store, it looks like any other digital coming in -- order coming into our store.

So the order just comes up on the make line screen automatically.

And they won't know whether or not that came from voice or from a Tweet or a laptop or an app or anything else.

It just drops straight into the store.

And what I would add to that is that is one more reason why we are so confident about our business model and our integration of the ordering and the restaurants and the delivery system.

There is no handoff that has to happen where mistakes can be made.

It just drops straight into our one point-of-sale system.

So all of these foundational things that we've been doing, having one point-of-sale system, one online ordering system that is able to funnel all of these things in, this funnels into that exactly the same way.

So the order just drops onto the make line, and the people making great pizzas get to work on fulfilling that order.

And maybe just one follow-up on the Hotspots.

How do you expect stores or your franchisees to sort of tailor delivery fees to Hotspots?

Is it possible for you to go no-fee on those?

Or what's the plan in terms of the delivery fees on those orders versus maybe traditional delivery orders?

Yes, well first, franchisees set their pricing.

They control that.

But I think the answer is you're going to see delivery fees there be identical to their regular delivery fees.

That's what I would guess is going to happen.

But obviously, they control their delivery fee.

Your next question comes from the line of David Tarantino from Baird.

Congratulations, Patrick.

My question is on the unit growth in the U.S. It seems to be accelerating each quarter, and I just wanted to maybe ask about sort of overall appetite among the current franchise base to continue accelerating investment in new units.

And just at a high level, do you think you can sustain this mid-single digits or move it even higher as you think about the next few years?

David, this is Ritch.

The reason that we're seeing stronger unit growth in the U.S. really is driven by one fundamental thing, and that is strong cash-on-cash returns at the store level.

And stores don't get built because of numbers that are in contracts or because we push franchisees to do it.

They get built because the returns are there over time.

And what we've seen, as we have really focused on growing franchisee profitability over time, is that the returns are very strong.

You combine that with some incentives that we offer to the franchisees.

And the result is you get a cash-on-cash return that is better than 3 years without an incentive and approaching 2 years with an incentive.

And our franchisees have voted with their wallets and decided that that's a terrific investment for them to make.

And Ritch, have you seen a change in mentality on this since the tax reform bill was passed?

Are franchisees now gearing up to do more investment based on that dynamic?

Or is it just more based on sort of what's been the recipe all along, which is good cash flow at the unit level?

So really, the primary reason, David, is that strong cash flow.

Our franchisees averaged about $135,000, $136,000 in EBITDA at the store level in the U.S. last year.

But over and above that, most certainly, a lower tax rate and, therefore, better after-tax return certainly helps on the margin to put a little bit more incentive in there for the franchisees to grow.

Your next question comes from the line of Matthew DiFrisco from Guggenheim Securities.

A question here, a lot of detail about the digital Patrick that you're talking about getting to potentially 100%.

It's been a while since you sort of gave us an update.

I think you crossed 60%.

You've always said sort of better than 60%.

Can you give us an update on where you sit?

Are we north of 75% now as far as digital?

No, we're -- stick with north of 60%.

But the key is, it's going to be 100%.

And what we are doing with all of the data remains an incredibly important part of what we are doing to drive the business.

But it continues to grow, but now, we've figured out a way that we can get this to be in a fully digital business.

And I can't give you a time frame on when that's going to happen, but I can tell you it's going to happen.

Well, I guess with the delivery, pickup and also with the step-up in the delivery growth, is that correlated with the -- maybe an acceleration in digital?

I know you don't want to give us milestones or anything.

But historically, when you've expanded your digital, you've also seen the check grow.

You've had better personalization driving demand.

So I wonder, is this correlated with it, the digital -- an expansion of -- or a reacceleration of digital, winning more share of your sales, and that's also driving delivery?

Well, what I would tell you is, number one, overall, it just continues to move up as it always has.

But the other thing is, more and more of our carryout business is digital now.

And it used to be that there was a very big skew on digital to being about delivery.

We've put emphasis on moving more and more of our carryout business that direction.

Our loyalty program now being earned AnyWare definitely plays into that.

And so overall, it continues to grow, and it's helping our business as it has helped it in the past.

Your next question comes from Peter Saleh from BTIG.

Congrats, Patrick, on an outstanding career.

I just wanted to ask about delivery versus carryout.

I know you said that delivery grew faster this quarter than your carryout, despite the fact that your marketing creative was really focused on the carryout business.

So is there any sort of governor for the growth on the delivery side?

Or are the -- are you finding enough drivers to continue this growth on the delivery side?

Our guidance is 3% to 6%.

That is where we think we're going to be.

But no, I mean look, we continue to see a lot of opportunity if -- we are proud that we are now the largest player in pizza.

But tonight, 5 out of 6 pizzas sold in the U.S. are going to be from somebody other than Domino's.

Globally, if you add in our international, 9 out of 10 are going to be sold by somebody other than Domino's.

So our share is so low today, and you've got a category that is growing a little bit in the U.S. and a bit more than that outside of the U.S. There is clearly lots of room for growth ahead.

Great.

And then I think in the past, you guys had discussed carryout being a separate occasion.

Now that you've had a little bit more data and more time to look at it, do you still feel like it's a fairly separate occasion with about maybe a 15% overlap?

Yes, that's about right.

Your next question comes from Jeremy Scott from Mizuho.

I was hoping to talk a bit more about the Hotspots.

It seems to be a very intriguing solution to address a bunch of different issues even outside of the areas that you're initially targeting.

So I had a multipart question.

First, just wondering if you had early idea of potential sales lift as you studied this launch.

I would imagine that we're talking about predominantly incremental customer transactions or interactions.

And assuming you're going to put some marketing dollars to work.

Second, if this were to become a huge success, and you innovate your way towards better targeting the customer on the street, would this change your worldview on store density carryout mix?

And then third, in the context of your comments that delivery is complicated and hard, where do you really see this going?

I understand part of it being beaches and parks, but what about campuses and other lockdown locations?

Yes, so I'll take the last part of that first.

Yes, on all locations.

The big thing is we need to keep it safe for our drivers, which is why the stores actually set these up and can control the time so that we're not being sent to a hotspot in an alley at 3:00 a.m.

We want to make sure that we're able to deliver safely, and the most important delivery that our drivers make is them coming back safely at the end of the night.

And so that's why we've got some control around -- or complete control around where these deliveries are going to be made.

Yes, I think there is clearly going to be some incrementality to that.

As with most things that we're investing in, we're not giving a projection as to exactly how much incremental we think we're going to get out of it.

But we're excited about it.

And in terms of how that plays into the overall, it does open up a lot of exciting things.

And the fact that we can target specific spots and lat/longs and make deliveries fundamentally anywhere, plays into kind of providing ultimate convenience for our customers.

So we've been talking about our AnyWare suite of ordering and the fact that you should be able to interact with any technology.

We also think you should fundamentally be able to get a Domino's pizza delivered to any location where you're going to want it, and that includes campuses and all the different things we've talked about.

Great.

And then just operationally, maybe talk a few -- about the differences you might see in Hotspot deliveries.

Would it be more order batching?

And then how do you work it out between different franchisees that may be targeting the same -- or different locations but may be targeting the same Hotspot?

;

So they have defined delivery areas as part of their contracts.

So each address is attributable to one store, and that remains the same.

So if the hotspot that they have designated is in their territory, they're the ones who set it up, and it is theirs to service.

And so that's not going to change.

Your next question comes from the line of Stephen Anderson from Maxim Group.

Pat, congratulations to you.

To the point, I want to ask a question about the takeout guarantee that was launched very recently.

So I was going to see if it's something that's been tested and if you've seen in any test markets any incremental increase in the takeout orders after the guarantee?

Well, you've seen some things in international, I think, around takeout guarantees.

But there are ways to put more certainty around timing for people so that they can make sure that the pizza they're going to get is coming straight out of the end of the oven.

You've got the carryout insurance that we've been talking about in the U.S., which is, look, if something goes wrong with the delivery on the way home, we want you to be satisfied with your overall -- with your overall experience.

But yes, there are ways that we're looking at it, how can we make that carryout experience even better, even more predictable and making sure that the customer is getting the hottest possible pizza right out of the end of the oven when they come in to get it.

So more to come on all of that.

Your next question comes from the line of Matt McGinley from Evercore.

On the company-owned stores, the dynamic for the past few years has been you have a pretty strong comp, but the margins have declined on labor inflation and some other items.

But this quarter, you had a pretty strong comp and you had flat margins.

So the question is where are you at with labor deployment?

And is there something you're doing differently or that we should think about the future of that business where you have reasonably strong comp, where we don't see that same sort of a margin decline?

Matt, it's Jeff.

Yes, you're exactly right.

They were flat as a percentage, obviously up in dollars as they continue to grow that business.

Really can't say enough about those almost 400 stores that we have in the corporate portfolio, what they were able to achieve in the first quarter.

As you know, there are places that we're at that have some pretty significant minimum wage pressures, other regulatory pressures that are a real headwind for the business.

And for those guys to kind of, as a whole portfolio, sort of fought their way to any even percentage margin was just a great result, and we were thrilled with that.

You've also got other things bouncing around in there, obviously, as well beyond labor.

They had to overcome a little bit of food, things like that.

So we're just -- we look at that business.

It's a high ROI business.

Make no mistake, we still like being 97% franchised, but using those corporate stores to provide a good return, develop leadership talent, test some things out for the betterment of the system, all great reasons to have those.

And again, to get back to your question of the fact that they were able to sell and work their way out of some pretty significant headwinds, we believe is a big win for us in that business.

Got it.

On the G&A guidance for the year, you had $380 million to $385 million previously, and you dropped that to $370 million to $375 million.

But in the Q, the ASC 606 impact looked like it was about $4.5 million, and if I run rate that, it should be around $20 million for the year.

But the guidance only dropped by $10 million.

So was there something else in there, that the core G&A ticked up a little bit net of the revenue recognition change, or am I just thinking about that wrong in terms of a run rate?

No, you're all over it.

It was first and foremost about kind of the reclass there, but there were some things in the business as we accelerate around all of these technological initiatives that we talk about as well as performance-based comp, obviously, we got off to a pretty strong start.

A little bit of an offset there.

So the $370 million to $375 million is a number that we would tell you right now we're comfortable with for that G&A line item, what's left in there.

But no, there were a couple of puts and takes there, but the most important one was the reclass.

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

Patrick, hope our paths cross again, whether inside or outside the restaurant industry.

Thank you, Jeff.

Life wouldn't be the same if we didn't talk a little bit about delivery from the aggregators, and obviously, you guys seem to be holding up extremely well on that front.

So that's really not having much of an impact on you, yet every other call we're on and independents are talking about it as well, that they're claiming that they're seeing success from a sales perspective, even though they might be feeling it from a profit or cost perspective on the other end.

But where do you think the share is coming from?

I mean, should we just assume that the category is seeing an uptick?

Or are these other restaurants deceiving themselves, because they're just losing in-store sales, and it just seems like everyone's after delivery and everyone's succeeding in it.

But I don't see how that's possible.

Jeff, honestly, I think it's a bit of prisoner's dilemma.

If you aren't doing it, you may lose some sales, but you are not seeing a restaurant category that is growing faster than it was prior to this.

And if almost everybody is now doing it, and it is not accelerating the overall growth of the restaurant category, then I would argue, it is not in total incremental.

For an individual brand, if they don't do it and everybody else is doing it, then that may cost them a little bit.

But the question is, what does it cost their margin to be adding that in if it is not adding to the overall growth of the restaurant category.

And I think that's where we are.

Your next question comes from the line of Sara Senatore from Bernstein.

Just a couple of follow-ups on the U.S. business, if I will -- may, the top line.

First, you said that advertising was particularly effective in 1Q, and I was just wondering if you could characterize it.

Maybe it was more value driven, I mean, similar to what you said about international, just with the more ticket -- or sorry, traffic-weighted comp this quarter versus last quarter.

And just trying to understand if it was a pivot in that direction.

And if so, what drove that?

And then the second question I had is, I know consolidation remains a big story, and you mentioned 5 out of 6 pizzas are sold by somebody who's not Domino's.

But it just seems to me that you have a really good quarter.

Typically, one or both of your big competitors is struggling.

So I mean, just, I guess, what is the conviction that it isn't from the large competitors?

Just because if I look at sort of an average for the industry, the big 3, if you will, it's been more consistent with sort of the mid-single-digit range that I might expect.

Yes.

So a couple of things, so first on the advertising.

You know we test everything and our analytics team is terrific, and we know exactly how the advertising affects our business.

And we know that our advertising was a little bit more effective in Q1 than it was in Q4.

The other thing that played into it and to your point kind of about competitive activity and all of that, one of the things that probably helped us a bit in the first quarter is we have a lot of equity around 2 medium 2-tops for $5.99.

We have built that equity over 9 years, and we kind of own that price point in the minds of our customers.

And it is altogether possible that some of our competitors matching that price point helped our comp a bit in the first quarter.

So I think that played in a little bit as well into the first quarter; not in a big way, but I think at the margin, it was probably a bit helpful for us.

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

And my question was exactly on that point.

When the competition was running 2 top -- 2 medium 2-tops for $5.99, during those television advertised weeks, not only did you not see a negative impact, you actually may have seen a positive one.

Yes.

Okay.

All right, that's great.

And I guess, what does that -- I mean, I don't want to say that, that makes you overconfident, but is there anything that you think about that the competition can do to you that you can't -- not only completely fend off but even benefit from?

I mean, certainly, some number of years ago, when competitors used to copy each other's promotions, it actually used to have an impact.

And now evidently, it's actually benefiting you.

So I mean, what are, I guess, the competitive risks, if any, that you think about?

Yes, look, we've got good, big competitors that have smart people working there, and I certainly can't predict the things that they're going to do that are going to be effective that are going to grow their business.

The only thing I know is that we count on the fact that they're going to do it, and they're going to figure things out and their businesses are going to grow and get better.

And that's what causes us to wake up in the morning and feel a need to run even faster, because we are not going to underestimate their ability to do good things within their businesses.

And I think you're seeing a lot of activity at our largest competitors right now, and we'll see kind of how that plays through.

What I would tell you about the specifics of the 2 medium 2-tops for $5.99 and how that differs from the past, we've been running that for 9 years.

There is equity for Domino's in that offer.

If people see that offer, the first thing that's going to happen is they're going to be thinking about us.

And so it is a different circumstance than if everybody -- back in the old days, everybody was doing different offers and cycling in and out of it.

It's different when you've built real equity in one specific offer.

Okay.

And then the final question on the balance sheet, obviously, given your interest rates and, I'm sure, demand for your debt securities, you could have put even more debt on the balance sheet and done an even larger capital return in the future.

So like what was the decision that went into the recap that you did, considering that you presumably could have put on more at still attractive prices?

John, it's Jeff.

We went out, as I mentioned in the prepared remarks, and just found a great reception again from the lending community for our credit and our story.

All I'd like to point out that we've been doing this now for a generation.

We helped to pioneer higher leverage in the QSR industry, and no one has performed better over now a 20-year period.

And so I think that proves benefit to us and our shareholders, certainly.

This particular opportunity, I didn't originally think we'd be back in the marketplace this soon, having done a deal just last summer, but we got -- we have a really good problem, which is we continue to throw off just a bunch of organic cash flow, and we know that to optimize the capital structure here, that requires additional longer-term fixed-rate debt.

And so market was still very good.

We got up to -- if you use the Q4 trailing 12-month EBITDA gives us what got us closer to 6 turns, the problem was Q1 was a bunch better than Q1 last year, so that's why we're at 5.8 already.

And so again, it's -- we've tried to have gotten -- or we're trying to get more regimented around this with smaller deal sizes a little bit more often.

And so lengthening the weighted average length of our capital structure, adding more long-term fixed-rate debt at the rates we see, all green lights, all will accrue value to the shareholders.

And to the extent that we can continue to create really high-quality organic cash flow out into the future, I think you'll see us committed to staying properly leveraged and lower that weighted average cost of capital.

Your final question comes from the line of Brett Levy from Deutsche Bank.

Patrick, all the best.

Thank you, Brett.

If we could talk a little bit more about the penetration in the fortressing, just how we should be thinking about it, not just from a timing or an impact, but also, what kind of percentage of growth is a reasonable expectation?

And how does the margin profile differ?

And does it also allow you to possibly go in with smaller footprints in some of these more deeply penetrated markets?

Yes, yes, so Brett, so at our January meeting, we talked about the fact that we think we've got 8,000 stores in the U.S. that we can get to over the course of the next decade or so.

And so that gives you a sense of how much we think we can do.

But as you build more stores, you grow your carryout business, you also increase the efficiency of your delivery, so you're giving better, hotter pizzas to your customers.

And so we think there's a real opportunity around that, and it's part of why we're doing it.

But at the end of the day, the biggest and most important way to think about it is it has to be improving the economics for our franchisees overall.

And the reason we're building more stores is because it makes sense for our franchisees to be doing that.

And those economics are ultimately what's going to drive the long-term growth on the business.

There are no further questions at this time.

I turn the call back over to the presenters.

All right.

Thank you.

And listen, thanks, everybody, and the team looks forward to discussing our second quarter 2018 results on Thursday, July 19.

This concludes today's conference call.

You may now disconnect.