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Domino's Pizza, Inc. (DPZ)

March 08, 2013 11:15 am ET

Executives

Michael T. Lawton - Chief Financial Officer, Principal Accounting Officer and Executive Vice President of Finance

Analysts

John W. Ivankoe - JP Morgan Chase & Co, Research Division

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Good morning. John Ivankoe, JPMorgan. I'm very pleased to have Mike Lawton, who is Domino's Pizza CFO, here with us today. It's really been a terrific story in the past couple of years. It's been one of the better performing stocks in the entire stock market. From many perspectives, in terms of product development, international store growth stability, U.S. store growth and quite frankly, just not only from an analyst observation but a customer observation, some of the most substantive, meaningful and quick changes in terms of the in-store experience that I've ever seen in a brand. So really do want to congratulate Mike, his entire team, Lynn Liddle -- who many of you know from Investor Relations is also here -- and the great job that they've done in the past couple of years. So thank you very much for supporting our event and we look forward to hearing from you today.

Michael T. Lawton

What can I say after such a glowing introduction. We appreciate the fact that John has been very close to us, not just since the last 3 or 4 years, but John was involved going back before we were even a public company or before we had public equity, so he's followed us closely. He's seen some of our ups and downs and we appreciate the recognition.

Let me tell you a little about Domino's. I'll try and be relatively brief. We are a system with over 10,000 stores around the world, about half of which are in the United States, and half of which are now in international markets. Our global retail sales, which are the sales that happened at the store level, not necessarily what's in our income statement, are broke out with 48% outside the United States, and 48% in the U.S., 52% outside the U.S. In the U.S., of our 5,000 -- roughly 5,000 stores, we own 388 of them directly and we operate those, primarily in major urban centers. The rest of the business in the United States is operated through franchisees, many of which have only one store; the largest, which has about 160, and on average, they have 4 stores. In addition to the royalties that we collect from our franchisees and the profits from our corporate stores in the U.S., we also operate a value-added supply chain. We think that it's great to have a commissary business and there are 18 centers spread across the U.S. It provides a good financial return to us. It makes it easy for a franchisee to focus on running their store and we really feel a lot more comfortable about the quality and the consistency of the product that's going into the stores if it's coming out of our supply chain. Franchisees are not required to buy from us. We have to provide an alternative but virtually all of the stores buy all of their product from our U.S. supply chain.

In the international business, which represents about 43% of the retail sales and this has been our high-growth opportunity, we have over -- again, over 5,000 stores. We are entirely franchised. We operate primarily through master franchisees; 4 of these big master franchisees are actually public companies, so you can get additional transparency about our international business if you choose to look in depth into those markets, and that would be the U.K., Australia, our Indian business and the business in Mexico. But the master franchisee model has worked well for us. We collect a royalty from them. In many cases, we split royalties. Obviously, very good profits, very good stability of cash flows and it's resulted in very solid growth. In fact, we've had 76 consecutive quarters without a negative blip and we've been doing a very consistent 4%, 5%, 6% same-store sales growth year after year. We're in over 70 markets spread very well across the world, a lot of geographic diversity.

One of the things that we spend a lot of time and money on in the last few years is to improve our technology. We really do think that we can do a lot to improve our consumer experience by getting them off the telephones and onto either digital ordering platforms or online platform or through mobile. People love our service. We've always been known as a delivery company but we've known, for many, many years, that sometimes, that communication between somebody on the phone in a store and somebody at their home isn't best, plus they don't have a menu in front of them many times if they're at home. By having gone online with very good platforms and we're not the only ones who do it, but we think we're very close if not at the front end of what's going on, we've now got to a point where about 35% of the transactions in the United States and on average, about the same level outside of the U.S., are coming from online ordering. Great benefits to us because the consumers can see that we have a wider range of product than a pepperoni pizza and a coke. They buy more different things from us. We get a little bit of labor leverage, particularly in our busier stores. And most important, the customers say, we really like this experience. And if they really like what we're doing, one would hope that they keep coming back on a more frequent basis. Pizza is not a particularly loyal industry. There aren't many people that buy just from us, so we're looking to continue to try to increase the percentage of occasions that people will buy, instead of going to a competitor and this is just one more thing that we think will help.

If you look at our industry in the United States and some of other markets, you'd see that the big competitors don't typically have huge market shares. So when we start trying to gain share by doing things like invest in technology, there's a lot of opportunity. Back in the U.S., the biggest 3 competitors have less than 50% of the market.

Turning to the financials. Last year, as John said, it was a good solid year for us. We generated over 20% EPS growth with 23% in the fourth quarter. We've been a pretty good consistent performer, but when we relaunched our product 3 years ago in the United States, and when we said we're going to fix our base product, we are going to come out with something a lot better, we're going to be honest about it. We're going to try and keep the pricing just as competitive as it's ever been before but we are going to put something better out there. We had a very big jump in sales 3 years ago and good steady growth in same-store sales the last 2 years. Obviously, that's helped our bottom line for both us and for our franchisees, and that's very important because we want our U.S. franchisees to feel like they're getting good returns.

On the international side, we're getting lots of store growth. We had 392 stores last year that we opened and so we get a lot of opportunity to gain on income out of our international business, as well as the domestic side.

This is a company that has relatively stable cash flows, at least historically, as a result of that, and that's because of the heavy reliance on the franchising model. Because of that, we are a company that is very comfortable operating with meaningful levels of debt. Last year, we refinanced the company and borrowed $1.575 billion in asset-backed securitization. We've had to pay down a little of that debt through required amortization. Between the increase in EBITDA that we had last year and the pay-down of debt, by the time we got to the end of the year, our debt to EBITDA ratio was at 4.8x. We have mandatory amortization for the remainder of this year but hopefully, in the not too distant future, we will actually get our debt to EBITDA ratio down below 4.5x, at which point, we can actually cease amortizing our debt, and it would not be unlikely that we would do that.

We also have a good history of deploying cash to shareholders. Our typical CapEx requirements range in the $25 million to $35 million a year range. Against EBITDA, that's way up well above $300 million and a lot of free cash flow. So we have a lot of excess cash. We deploy that in different ways including meaningful stock buybacks. Last year, we paid a $3 one-time dividend. And most recently, we initiated a $0.20 per quarter dividend, the first of which will be paid this month.

So with that, I will turn to John because I'm sure he's got a list of questions for me.

Question-and-Answer Session

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Let's start with your mobile and online. I mean, what you've done with loyalty, what you could do with loyalty, does loyalty makes sense for pizza, more specifically, Domino's Pizza?

Michael T. Lawton

And you're speaking specifically to standardized loyalty program or?

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Well, like for example, I mean, I'm a fairly frequent orderer of your pizza. I mean -- and I love having the online application -- actually, I'm kind of -- I'm old-fashioned in that I actually use a computer as opposed to do it on my iPhone. So I mean, I do use the computer application. You have my e-mail address so maybe I ordered from you 10 or 15 times. I do get offers, I don't have a sense that they're customized offers. I haven't gotten a, hey, thank you for your loyalty. You don't have to do that by the way. But I mean, as a customer, it's okay, I'll buy my pizza on my own account, I can do that. But I mean, I haven't really seen that. So I mean, is it -- like to what extent do you have an opportunity to really customize the reach? And as some people say, surprise and delight; other people, it's 1, 3 out of 12. There's a lot of different ways to do it but I haven't noticed -- it doesn't mean you're not -- I haven't noticed that you're doing it.

Michael T. Lawton

The answer is there are a whole raft of things that we can do yet. I mean, we've been focused heavily on getting a very quick and efficient online ordering platform and very reliable. And we've been very focused on getting the mobile apps out there that we want. But there are a lot more things we can do and I think that's going to be what keeps us ahead of some of the other competitors that could try to mimic what we're doing in the industry. For instance, 2 weeks ago, we actually got ourselves set up so that you can now go in and put your credit card in, just like you do on Amazon, and leave it there to make it easier. Now we did that, we made that choice to be focused on card on file, instead of some things we could do for customer relations management but they're all coming. It's just a matter of prioritizing what comes first. We can't do everything at once even though we'd like to but -- and we also have to do some research into what types of things can we do that actually the customer likes as opposed to irritates them. Like we know, if we send you too many e-mails, you don't like that. And we also know that we are doing it and sometimes our franchisees do, so we may inadvertently send you more than you like even though you've opted in. We have to do -- so we've still got some learning going on as to what is it consumers want us to do? What's going to make them happy as opposed to irritate? But there are definitely opportunities. The other part of this that gets where there's a bigger opportunity down the road is still to get a better idea of you as a customer that may or may not be loyal to one way to enter to be able to track you all the time. Because you may have different behaviors and we're still learning these things but maybe your behavior online is different that if you're using your mobile or just using the telephone. Maybe you've got different ordering patterns. How do we respond to that? And we have to do all that while keeping in mind that our #1 -- one of the top priorities for customers when they order online or order with mobile is it still has to be fast. And some of the things that we -- that get thrown at me as really interesting ideas or gets thrown at the marketing department, they are great ideas but they slow the process down and you have to weigh those out because customers don't want to be slowed down too much. So lots of opportunities. It's just a matter of where we go with them.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

And how high has -- I mean, non-telephone ordering, how high is it in markets around the world? I mean, what do you think the -- I mean, like what's kind of the near-term opportunity in the U.S.? Longer-term, is it 100% do you think?

Michael T. Lawton

100% is hard to see. I don't think -- we will always want to offer the opportunity.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Why wouldn't it be almost?

Michael T. Lawton

But it's going to get big. The top markets right now exceed 50% of orders between mobile and online and the top markets would be primarily markets like Japan and Korea, where mobile is a very big percentage of the ordering. Here, it's far less. And partly, that's because of the timing of when we launched the apps. It's also because the U.S. consumer has been a little slower to adapt mobile than what the consumers did in Japan and Asia, and it's partly because of the type of menus we have there. But we're going to -- we've consistently seen our digital ordering going up in the range of about 5% a year. You look at least the next 3, 4, 5 years, I see no reason, based on what's gone on in the international markets that, that's going to slow down and what the ultimate peak is, it's probably not -- we haven't seen anybody that thinks that they've peaked out.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

So let's dovetail, I mean, obviously, this is -- there's economic advantage at the store level. So let's dovetail this into how are the store level economics, specifically newbuilds, is changing in the U.S. So maybe we can talk about average store profitability in the U.S. in the past couple of years, look at that relative to investment cost, the current margin and what the new store ROI looks like and what your potential is for expansion which we haven't talked about obviously in, I don't know, 5 years or so?

Michael T. Lawton

For those of you that haven't followed our business, the fact is the U.S. store growth has been fairly limited. And that goes back more than 5 years, it goes back for a long time. We've got over 5,000 stores. We know there's room for hundreds and hundreds more based on uncovered territory but we haven't had a lot of store growth. Part of that is because the economics had been in decline and we hit a low point back in 2008. And at that point in time, an average store was cash flowing, on average, right around $50,000. Each year, since then, we've improved that. And we don't have the final numbers accumulated for last year and these are numbers that are self-submitted by franchisees but we think we're certainly going to see numbers in the $75,000 to $80,000 range when we get them all totaled up. That would be better than the year before, which was better than the year before. So we've had 3 straight years, though, that are probably $70,000 to $80,000 for the average store in the U.S. Now that compares to the cost of building a brand new store and in line, which if a franchisee is doing it, can be anywhere from $150,000, $200,000 if they're using some used equipment. More likely, $225,000, $250,000, $300,000, depending upon where they're at. So the cash on cash return is in the 3 to -- best case, a little less than 3, more likely 3, 3.5, 4. Those are levels that we get a lot more people interested in talking about building stores than when they were looking at an average store doing $50,000 a year on the same -- roughly the same investment. We are testing some new images. We're doing some things because we know we need to keep the system from getting stale. We don't think we're at that point yet but we know we can't wait until we're there. Those cost of reimages to a new look. The first ones we've done don't look a lot different but we're also going to put some stores together that we think would have probably a bigger opportunity for sales and maybe a little higher cost, so we're still working on that. But last year, we did go positive. We had 21 net positive stores in the United States. We'd like to think that, that's the beginning of at least a modest trend in the right direction.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

And when you look at your approximate 5,000 stores in the U.S., and you draw your kind of trade areas, I'd assume that there's a delivery time radius at kind of rush hour that you want to be below?

Michael T. Lawton

Yes. We try to map out areas that are generally about 9-minute radius.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

And so -- I mean, when you do that map and you look at customer density, how many stores do you think there should be?

Michael T. Lawton

There's lots of ways to look at it but as I say, it's hundreds and hundreds more. And part of the reason it's hard to evaluate sometimes when you just do site models is if you do a site model that's based on what current levels of Domino's purchases are in a city, you may wind up with lower optimism than what happens when you get to a city that we dominate. You take a city like Detroit, where we've been very weak and you look at what a typical store is doing on its sales per address and it's somewhat pessimistic, but if you can turn around and say but now I'm going to go after this as a market, get stronger in this market, sales per address go up -- actually gives you the opportunity not just for same-store sales growth but potentially more stores. But even as it is today, I mean, you can map out and it's not hard to get 600, 700, 800, maybe 1,000, but it's -- that's getting the last ones are always the hard part.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Okay. One of the interesting things that is happening -- in Dunkin', if you heard them in the previous meeting, was talking about kind of getting more involved in their international store growth. I mean, whether it's a capital-light joint venture or even investing some money in markets that make sense that haven't been fully developed. Off my memory, I think, 60% of your international stores are in 4 public companies, is that correct?

Michael T. Lawton

That's about right.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

But there still is a lot of white space around the world. I mean, so -- I mean, are you at the point, I mean, looking at some value that like a Burger King has gotten, maybe like a Dunkin' will get, of taking more direct ownership in some of these international markets?

Michael T. Lawton

There are -- we've had discussions over the years and at different points, we did own and operate a couple of the countries as kind of like the master franchisee ourself, particularly in some markets in Europe. We would always look at that. It is not our top priority. Our top priority is to generate the people to support the existing master franchisees but it's not something that we would ever rule out. I think it's much more likely if you did see us make an investment, it'd be in something like that as opposed to taking on another brand. What you won't see us do is go way far afield. It could certainly make sense. Right now, in the world, there's not a lot of a need for us to get involved in order to -- us putting money in won't accelerate store growth because in very few countries is money the problem right now. Most countries, our limitation on growth is either getting people trained or it's real estate. It's not financial. But certainly, in a market -- we'd be more inclined to get involved when we really thought that our money was going to spur growth in a meaningful way.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Could you -- you maybe make some parallels of your experience in India for what could be in markets like Brazil, China, Russia, Indonesia, Malaysia, Singapore, what have you, I mean, you just kind of -- you've achieved a lot. So just in terms of the benefit of education, I mean, what you've accomplished in India and what that could mean for other major markets that are difficult to do business in?

Michael T. Lawton

India, for those of you that aren't familiar with it, is our fastest growing international market. Last year, we opened up approximately 100 stores. We were there for a significant period of time before we were able to establish a brand. And when you come in as an international company, you may get some quick hits and you may have a lot of business for, at least in our experience, for, 2 or 3 or 4 weeks. And then the fact that you may have slightly higher product prices than the local product, even though it's higher-quality, it loses a bit of allure until you've established a brand. And it took time in India. It took time in Turkey, which is certainly a market with higher economics than India was when we were trying to do business there. But if you've got the patience and the persistence and you stick with trying to put a quality product out there, eventually you build a reputation. And 3 years ago, when we said we've got to fix our reputation in the U.S. for food that wasn't particularly well-liked, we didn't have that reputation in a lot of our foreign markets. In fact, we typically had a better reputation compared to the local alternatives than we did in the U.S. So we don't have those kind of things working against us. We work really hard to build a good strong reputation in India. The owners of the business there were very determined that this was going to operate like an international brand at international standards. They use McDonald's as their benchmark. It's like McDonald's doesn't slack off, we're not either. And we built a reputation that way. I think we're in Indonesia, which you mentioned, and we're trying to do the exact same thing, and we're making some good progress there. Brazil is actually a tale of 2 countries because there's Sao Paulo which is really tough for pizza because there's so much mom-and-pop competition. In the rest of the country, we're making very good headway right now. So we see some opportunity there.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

And China? Russia?

Michael T. Lawton

Russia is -- we've got some issues there we're trying to work out with our franchisee. We think there's some opportunity but we've got to get through some issues. We're getting more -- and we've seen some success at the store level, but we've got some things that have to happen there. In China, China has been obviously one area where we have grown far slower than some other competitors mostly because they've been focused on sit-down and done a very good job. We do not -- we made a very conscious decision that we are not going to do sit-down table service and run restaurants. It's not what we are. And at a certain stage in the development of a pizza category, that can be a good place to be. Over the longer-term that hasn't necessarily been the best place to be. We'd much rather go into markets after people -- after consumers are familiar with pizza and try to take the channel of distribution that we play in best, which is delivery first and carryout second, so it's all premised with some very casual seating. I mean, we do have, outside the U.S., many restaurants that have counter service and you may find a McDonald's, old-style McDonald's style seating or Burger King, QSR seating level but we stay away from trying to run restaurants. It's just not what we think we're good at and we don't think that when you try and run a restaurant and deliver out the back door, we think that's a pretty hard thing to do as a system so we stay away from it.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Some markets where you're exposed -- I mean, I think, Japan, Spain, Germany, U.K. that weren't necessarily good markets for a lot of companies in 2012, I mean, I think were very strong markets for you. So I mean, is it things like you're online and mobile and maybe improved product that's just kind of outweighing the cycle or, I mean, are people actually trading down to you? Describe just from a macro perspective what's happening there? And of course -- and after that, we'll walk into the U.S. from a macro perspective.

Michael T. Lawton

As John said, if you look at the -- our sales trends, what we've said is that even though some countries are certainly struggling economically, we continue to have positive same-store sales. We have a couple like Greece where that's not the case and it's been really tough. But if you look back over history, I mean, go back over many years, we are the type business and I say we, I think, being delivered pizza and carryout pizza, where when countries are struggling a little bit and GDP is down a little bit, we still typically do just fine. It does not have a big adverse impact on us. When GDP gets down in the minus 7%, 8%, 9%, we hurt just like everybody else but I think that what we've typically seen is that whatever we're losing in business, people are trading down to us when times get tough and I think one of the reasons it still works is you can feed a group of people or a family very economically with pizza. Maybe not 1 person, it's hard to get 1 person to buy a small pizza delivered to you cheap, but if you're going to feed 4, 5, 6 people, we are very economical, and I think that, that's helped us. With the advent of some of the things we're doing in technology, I think that probably plays into it but I think the history goes back further. I think it's got to do with the type industry that we're in.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

The U.S. in the first quarter, I mean, whether it started on January 15 -- or sorry, January 31, I mean, a number of companies in a variety of different customer demographics, I mean, really took a fairly major swoon from an economic perspective and then they had kind of the lapse of what were significant weather benefits in the previous year. I mean, do you feel like you kind of have an economically insensitive U.S. consumer at this point based on some important new products like pan pizza, that's the first point? And then secondly, good weather isn't a good thing for you necessarily. When it's 80 in Detroit, people probably are just enjoying being in the sun as opposed to being in the snow. So I mean, like is this a good winter for you or a bad winter for you otherwise?

Michael T. Lawton

John knows I'd never say anything about the quarter that we're in. But let me try and answer. First is we are one of the restaurant companies that you will rarely, if ever, have us talk about the weather as being an impact. Last year, when weather was negative, weather was positive for some change, negative for others, we came out after the end of the first quarter and said, we did the best analysis we could using our -- some of our modeling and that net-net, weather had hardly made any difference on us. And John's right, we don't like 80 degree sunny weather as much as we like a little bit of rain but over the course of 30-day -- 90-day quarter and over the course of the whole U.S., it just doesn't seem to matter for us. So weather really isn't a key. We know the consumer that is out there in the United States today is certainly focused on value and we knew that coming into the quarter, there's no surprise there. We've also felt like they've been focused on value for about 3 years. A good part for us, as we go forward, has been that when we relaunched our product 3 years ago, we did a lot of researching, decided that we were going to pick a price point that was going to be very attractive to customers and that was 2 pizzas at $5.99. It's worked out well, we've been able to stick with that for 3 years. Consumers view that as a good value proposition. We do other things in addition to that but you can pretty much always -- with most stores that will be in your area, you can usually find that offer and customers don't think of us as being the $5.99 pizza guys because they do a lot of other things but if they're looking for value, they know they can come and find it. So we went into the quarter knowing that we had to be thinking about value but we have been throughout and I just don't think it's -- it's not something that was a big change for us.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

I mean, pan pizza was a very major change in terms of the product this year versus the products in the previous year. I mean, do you have other substantive opportunities of product improvement left? I mean, or has it -- being of the last 3-year cycle have been most of what you can do?

Michael T. Lawton

Pan was certainly big. I mean, the biggest thing that we could do over the last 3 years was to redo our core product, our hand-tossed. There was nothing that we could do that -- there's nothing that I'm aware of that's ever going to top what we did when we came out and said our core product needs to be fixed, we need to start over. Pan is one of the biggest things we've done since then. We have other products on the menu. We can always look at other product platforms but do I think we could find things that compare with pan? That's definitely got potential but we're never -- we aren't thinking about the type things that compare to the hand-tossed. And pan is big, for those -- pan is 20% of the pizza industry. And the offering that we had in that industry was noncompetitive. So we've now put a very, very good product out, trying to compete against other pan pizza producers and to offer something else to our current customers, but we've got other things that we've done in our line that have also been very meaningful to customers. We came out with a Brooklyn pizza that was totally different that anything we've done. That was meaningful. We've done the Artisan. There are still other things to look at.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

I mean, what percentage of the pizza market is thin? Almost like a crispy thin? I know you have a product -- I mean, I don't love it. I mean, I don't think it's as good as your pizzas are now in my opinion, if you don't mind me saying.

Michael T. Lawton

Offhand, I am not sure of the number, it's meaningful. And when you describe thin, thin can be different -- really be different things to different people because it can be a product...

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Not New York thin but almost like a crispy thin like a St. Louis thin, I guess, people would say.

Michael T. Lawton

I am not really sure. I'd misquote numbers.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

But still -- and then -- different things like add-ons, I mean, you are a business that you come to work every day trying to drive the top line, I would assume, I mean, that's how your shareholders make money, that's how your franchisees make money. So I mean, are there any other significant product category -- I don't think salads have ever gone anywhere. You've made some changes to your chicken. I mean, is there anything else that you can really kind of put into your system that's not going to burden what is a very elegant operating platform?

Michael T. Lawton

Well, we can always go back and still make things better. I mean, we've still got what we do in the way of desserts, which have strike rates that are meaningful but it's a pretty limited variety. And you mentioned salads, which -- if you do a survey of customers, everybody thinks that we should have salads. It's not easy to do and it's not easy to do well and profitably but still there's always opportunities to improve there. There's still things to look at with chicken and with other side items. We're still looking for what is it that the customer really wants. I think there was a time when, as a company, we were a little more on the selling side as opposed to the marketing side and sometimes marketing starts with what do people really -- what is there that they would like whether they realize it or not? What is there that you can offer them that's hard for them to do at home that offers convenience that you can do and make money? But I think, over the last few years, part of the reason we've had more success is I think we've become a better marketing company as opposed to a selling company just an operational company. And I think, now, you have to start with some of those fundamentals and say, what are we really trying to accomplish? Why are we going to put this product into the marketplace?

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Being an asset-light company, I mean, you do -- onto your point earlier, 18 distribution centers. I mean, is it -- and I think you -- I mean, you've been with the company now a long time and I have done this analysis. I mean, is it something that you look at every year to ask yourself if that's a business that you need to own or if there's other companies that could get involved and take over that part of the business while you focus on things like technology and marketing and product-building activities?

Michael T. Lawton

We definitely have looked at both in the U.S. and outside the U.S., whether this is the best model. And outside the U.S., most of our master franchisees use the same model that we're using in the U.S. for distribution of food, but we have the experience in some international markets where we have done it both ways or we've changed or where we are still using third parties. So we've got, other than just some models, we've got some real-life experience that we can compare it to and we keep coming back to the answer that, for us, this is the right way to do it. As I said, we do get good financial returns, the return on assets that we employ is good and the people that are involved in that business are somewhat isolated away from the real marketing people and so I don't see it as a big distraction of resources. But we definitely -- I mean, we've looked at different changes. We've looked at whether you could outsource the logistics, whether you outsource the processing. We have evaluated these over time. And as I said, we got the real-life experiences and we still feel pretty good about the way we're doing it.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

I mean, is the pizza industry, I mean, since when I was in high school, I mean, if someone told me in 20 years that there'd be 2 medium pizzas, 2 toppings for $5.99 each and any large for $9.99 each. I mean, the pricing of products today is lower than it was 20 years ago in some cases, which is pretty remarkable. I mean, is it -- has the industry kind of locked itself into these price points? Or to the extent that you have a -- it's like a 2008 event, which was very high commodities, still reasonably high labor, very high utilities and sales that were coming down and yet the industry didn't have any pricing power. So like do you think the industry is kind of in a -- I mean, do you think we're at a permanent level of pricing now or when you do study the consumer and the industry, do you think you have flexibility to bring prices up at some point to the extent that you need to? We are in a little bit of a golden age right now. I mean, you're making as much money as you are with such low prices.

Michael T. Lawton

But it's -- to me, there's -- I always think of a pizza store as a little manufacturing plant. And when you think of it that way, you don't just think about what is your price versus your food cost. You think about your prices versus your fully-loaded cost of getting something out the door. Well, how do you price it cheaper and still make money? You run more volume through it. The great part about our model is we don't have tables and chairs. We rely on getting product through the oven, the bottleneck is the oven and we have 2 ovens and if we have to, we can put a third oven. So if we price at what you would -- I think you're referring to as lower prices than what history would indicate you should be, as long as you're getting the volume through the stores, it works. You lose the volume, now you start taking the prices back up, you may look better on what your food margin is, but overall, you're taking less money to the bottom line. And again, I'll say it, because we don't have tables and chairs, you can think that way easier than if you got a restaurant with 50 seats, once you fill the seats, what are you going to do? Well, in our case, we can run -- there are stores that can run 200 orders out the door, 200 pizzas in an hour, and they do it on a Friday night. So we can price a little bit lower than might have been thought about because we're running good volumes and the higher the volume gets, the better profitability gets, and sometimes, even gives us even more margin to actually take prices down to levels that wouldn't necessarily have been expected. We don't have prices that we view as -- when we do things at a national level, we're trying to make sure those are prices that we can be comfortable with. And certainly, a big surge in cost is going to make us rethink that but we've been trying to do things that are not -- put it out there for a month or put out there for 6 weeks because if all you're going to talk about is the price, then you don't get to talk so much about your brand. We'd rather be talking about the brand and what we're trying to do to make our product better and our technology better.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Have you studied ACA, the effective ACA for your franchisees and is there anything that you can do to help mitigate the increasing cost for them and they're obviously not all going to be affected?

Michael T. Lawton

A lot of our franchisees won't be affected because they're 1 store, they're 2 store. We are certainly continuing to try to assess it but we've been struggling because until the final rules come out, it is really hard to figure out what the real impact is going to be. And we need to see more on the regs. We're not -- it's not like we're ignoring it, we're just saying we keep hearing a lot of different things, we keep seeing different possibilities and we need some clarity. Our best understanding is that this is not something that's going to all hit at one time, it's likely to hit over a period of years. And we're not seeing things that we don't think are manageable.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

And you are set up at many -- especially your delivery drivers do not work 30 hours a week, they can't -- I mean, they have other jobs. They can't work 30 hours a week in many cases.

Michael T. Lawton

There are some full-time delivery drivers in stores and there are a large number of part-time drivers already. And we do offer medical to some employees.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

And the final question for me, I mean, your -- you're already at the bottom end of your band in terms of balance sheet and you must be increasing confidence of EBITDA growth and keeping your CapEx low. Your CapEx is more or less what it was when you went public in 2004. So I mean, I don't think, there aren't going to be any surprises there. What are your thoughts on leverage? I mean, at one point, you're levered at 7x but that was kind of at the peak of the credit market and probably wasn't some -- probably had some not as comfortable moments as you would have liked because of that but obviously, the cash flow, covenants and everything was fine. But like what do you think is kind of the right upper band of leverage as the credit markets are obviously extremely open to a company like you?

Michael T. Lawton

Well, we -- as I said earlier, the debt that we have is asset-backed securities. That is a different market than doing traditional bank and bond. We recognize that. We certainly want to make sure that we don't get into a situation where if we needed to refinance and the EBS market wasn't there, that we'd have a problem. That means 7x is not an option. I mean, 7x, if we ever did it, if we ever decide to do something and took it up to that, we'd be trying to pay down debt very quickly. We're certainly comfortable. The last time that we refinanced, they were at 5.4x. We think that, that was not a bad place to be. If we get too far down below 4.5x, then we think that we're lower than what would be ideal, so we're pretty comfortable where we're at and continue to assess markets.

John W. Ivankoe - JP Morgan Chase & Co, Research Division

Okay. And thank you, Mike.

Michael T. Lawton

Thank you. Thank you for your time.

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