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Executives

Lynn Liddle – Executive Vice President Communications, Investor Relations

Wendy Beck – Chief Financial Officer

David Brandon – Chairman, Chief Executive Officer

Analysts

Gregory Badishkanian – Citi

Joseph Buckley – Bank of America, Merrill Lynch

Jeffery Bernstein – Barclays Capital

Steve Reese – J.P. Morgan

Michael Wolleben – Sidoti & Co.

Tom Forte - Telsey Forte Group

Colin Guheen - Cowen and Company

Domino’s Pizza (DPZ) Q2 2009 Earnings Call July 22, 2009 11:00 AM ET

Operator

At this time I would like to welcome everyone to the 2009 second quarter earnings conference call. (Operator Instructions) I would now like to introduce our host for today's call, Miss Lynn Liddle, Executive Vice President of Communications and Investor Relations.

Lynn Liddle

Thank you everyone for joining us this morning. With us today are Wendy Beck, our Chief Financial Officer and David Brandon, our Chairman and CEO and they'll be both making some comments. We'll follow with Q&A.

But before we begin, a couple of points I'd like to make. This morning there was an inaccurate wire report written about us and I just want to make sure I clarify the record for everyone. They reported $0.16 of EPS and we in fact had $0.21 in EPS as adjusted, so I just want to make sure everybody has that information correctly. We think that erroneous report may have led to some others and caused a little bit of confusion in the market this morning.

Additionally, I'll turn your attention to our safe harbor statement in the event that forward-looking statements are made and I will ask the reporters on the line to be in a listen only mode.

So with that, I'd like to turn it over to our Chief Financial Officer, Wendy Beck.

Wendy Beck

Good morning everyone. We are overall very pleased with our results and I'm happy to run you through those results for the quarter. Then I'll turn it over to Dave who will give you more color.

Turning to our results for the quarter, let's start with the top line. Our global retail sales were down 4.7% for the second quarter resulting from a negative impact of foreign currency and lower domestic same store sales.

However, excluding the impact of foreign currency, our global retail sales grew 3.8% during the second quarter. This was driven primarily by international same store sales growth as well as store count growth in our international business.

Looking at those individual components, our domestic same store sales were slightly negative, down .7% for the quarter versus the second quarter of 2008. Franchise same store sales were down .4% while company owned stores were down 3.3%.

As Dave will touch upon later in the call, our domestic stores were negatively impacted by an unfortunate viral video incident within the quarter.

As anticipated, we had additional domestic store closures during the second quarter, closing a net 20 stores. These closures reflect both the continued economic challenges as well as our efforts to strengthen and improve our franchise base over the long term.

International same store sales were positive, 4.1% on a constant dollar basis, making the 62nd consecutive quarter or over 15 straight years of international quarterly same store sales growth. Additionally, our international division grew by a net 164 stores in the quarter which included 90 new stores in Spain that Dave will discuss in a moment.

As a result of this top line performance, our total revenues for the second quarter were $316.6 million, a $17.7 million or 5.3% decrease from prior year that is due primarily to the impact of store divestitures in 2008, lower cheese prices on our domestic supply chain revenues, and lower international revenues driven by the impact of foreign currency.

Breaking down the decrease, our company owned store revenues declined $8.3 million or 9.7%, the majority of which was due to having fewer stores as a result of the 2008 store divestitures and to a lesser extent, lower same store sales.

Domestic supply chain revenues decreased approximately $7.1 million or 3.9%. Lower cheese prices hurt our supply chain revenues, but do not impact our supply chain dollar margin. However, these lower cheese prices benefited our domestic store unit economics. The decrease in cheese prices was partially offset by increases in non cheese commodities such as boxes and chicken during the second quarter.

International revenues declined $2.3 million or 6.8% due to the negative impact of foreign currency partially offset by higher same store sales and store count growth.

As mentioned on both our year and first quarter calls, we anticipated a negative impact from foreign currency throughout fiscal 2009. This did negatively impact our royalty revenues by approximately $3.2 million in the second quarter.

Foreign currency also negatively impacted international supply chain revenue by $1.4 million. These declines in international revenues were offset by approximately $2.3 million of revenue improvements primarily due to higher same store sales and increased store count.

Moving on to our operating margins, our consolidated operating margin as a percentage of revenues increased .9% in the second quarter versus the prior year period. As a reminder we define operating margin as revenue less cost of sales.

The increase in our consolidated operating margin was mainly caused by the impact of lower cheese prices. Our supply chain margin increased 6% from the prior year quarter. This increase was due to lower cheese prices in the quarter that had no impact on dollar margins.

The average cheese block price in the second quarter was $1.20 per pound versus $1.91 last year, or a 37.2% decrease. Offsetting these supply chain margin increases was the impact of higher non cheese commodity prices such as chicken and boxes.

Our company owned store operating margin increased .3% from the prior year period. Lower food and delivery costs accounted for a majority of the margin increase. Food costs as a percent of revenues was lower because of cheese costs, while delivery costs were lower because our driver delivery reimbursement dropped with lower fuel prices.

Offsetting these lower costs were higher labor expenses in the quarter resulting primarily from last summer's minimum wage rate increases. As a reminder, we will be impacted by another round of Federal wage increases at the end of this week as the third successive annual increase takes effect.

Turning to G&A expenses, G&A increased $11.5 million in the quarter versus the prior year. Breaking down the increase, $6.9 million of the increase was from gains recorded in the second quarter of 2008 related to the sale of 27 stores while $4.9 million of the increase was due to stock compensation expense and professional fees recorded in the quarter as a result of our stock option plan changes.

As previously announced, we implemented a stock option exchange program during the second quarter which resulted in an incremental stock comp expense of approximately $1 million pre tax.

Separately and also as previously announced, we amended stock option agreements to include a retirement provision, resulting in $3.7 million pre tax of stock comp expense, of which we were required to accelerate approximately $3.4 million pre tax of existing expense during the quarter which is in line with our first quarter disclosure.

Offsetting these increases in G&A was $2 million of net proceeds received in the second quarter for our insurance settlement related to the viral video incident that Dave will discuss in more detail.

Excluding the items I just mentioned, G&A increased $1.7 million versus the prior year quarter due primarily to an increase in our labor costs resulting from additional bonus expense recorded during the second quarter 2009 versus the second quarter of 2008 as a result of us not meeting our performance related targets in 2008.

Also, we saw the effect of merit increases and the investments we made in our new franchise audit and training team in G&A in the second quarter of 2009. So our G&A expenses for the second quarter excluding the non recurring items just mentioned is fairly indicative of our anticipated run rate for G&A for the remainder of the year this year.

On the income statement, you will also note that we had a $12.9 million gain on extinguishment of debt which I will discuss further in a moment. As for our income taxes, we recorded approximately $2.2 million of tax reserves related to certain state income tax matters. This increased our effective rate to 46.8% for the quarter and is also outlined in the items affecting comparability in the tables in the earnings release. However, as previously indicated, we anticipate approximately 40% normalized rate for the foreseeable future.

Next, look at our bottom line earnings. Our second quarter diluted EPA as reported on a GAAP basis was $0.25 or $0.21 when adjusted for items affecting comparability. The $0.21 as adjusted EPA figure is a $0.01 decrease from the $0.22 in 2008.

Foreign currency negatively impacted us by $0.03 and our improved operating results primarily from our international supply chain segment benefited us by $0.02 in the quarter.

Now let's look at our balance sheet. In the second quarter we repurchased at a discount $25 million of principal on our senior note for a pre tax gain of $12.9 million in the quarter. Subsequent to the quarter, we repurchased an additional $20 million of principal on the senior notes for a pre tax gain of $4.6 million in the third quarter.

Year to date, including our third quarter purchase, we have now repurchased $88.3 million of principal on our senior note for $49.6 million, resulting in $38.7 million of pre tax gain. Subsequent to the quarter, we entered into a new $50 million letter of credit facility. We are in the process of moving our existing letters of credit from the variable funding note facility or our VFN to the new facility.

This will allow us to draw down the VFN completely, and to date we have borrowed an additional $35 million subsequent to the quarter. Given the uncertainty in the financial markets, we felt it was prudent to maintain and control as much liquidity as possible at a low variable interest rate that approximately 1.8% in the second quarter.

So looking at where we stand currently with our letter of credit, we now have $33.5 million outstanding letters of credit under the new facility. We continue to generate strong free cash flow which feeds our robust cash position, ending the quarter with $61.7 million of restricted cash.

In closing, we believe that during these uncertain times, we continue to maintain a strong cash position while demonstrating that we will opportunistically deploy our cash in a manner that drives shareholder value.

We are satisfied by our overall results, especially in light of both the economic and internal challenges within the quarter. As we have continued to show, we have a proven business model that is resilient even during these challenging times.

This concludes our financial update. Now I'll turn the call over to Dave.

David Brandon

Good morning everyone. I'd like to begin by saying that I'm pleased with how we fared in the second quarter and I want to remind you all why we love our business model and why we think we are very well positioned during this challenging economic environment.

During these times of uncertainty and volatility, our shareholders benefit from a number of factors which include the fact that we're primarily franchised and that we can bundle the entrepreneurial energy, the investment, and the passion of our dedicated franchisees. We have very steady and predictable cash flows.

We have a unique capital structure that provides a lot of flexibility for years into the future and we believe we have a very sound strategic plan with some very important growth initiatives that continue to show great promise.

Now thankfully all this helps us weather the current economic storm much better than most brands and companies will. And in spite of the fact that we've had to endure an unfortunate incident early in the quarter that killed our momentum for a couple of weeks, we saw an overall continuation of much of our positive momentum from the first quarter and held steady on many trends that indicate that we're continuing to lead in our category.

I'm proud to outline some of those, but first I'll start with my final comments, and I mean final comments regarding the bad news event that took place during the quarter and is thankfully now behind us. But it did have an impact on our domestic sales comparisons so it needs to be included in this briefing.

You likely heard about the shot heard round the world that we experience when two now ex team members of a Dominoes franchisee who had a serious warped sense of humor, decided one day to pull a hair brain prank in a store. They inappropriately handled the food in some fairly disgusting ways and they posted it on You Tube and it went viral everywhere.

We took quick and decisive action. With the help of some online customers, we identified the culprits. The franchisee fired them immediately and they are being prosecuted. We set the record straight for our customers and we moved on as quickly as possible.

Unfortunately we experienced a short term hit to sales primarily in the weeks following the incident that we estimate cost us between 1% and 2% in domestic same store sales for the quarter. So while this impeded our second quarter same store sales progress, we think we are past this unfortunate event and we believe it will not have a lasting negative impact on the overall image of our brand.

Now I'm pleased to report that we did have business interruption insurance in place and as Wendy has already told you, we were able to negotiate a net settlement with our insurance provider of $2 million which clearly has eliminated any short term negative financial impact of this problem for our shareholders.

Now the other bad news that we have to talk about is no surprise to anyone. It's what we're talking about and wading through every day in the retail sector and in our overall economy. And that is, we have an anemic economy and a consumer that's nervous. Some may say that the consumer is in panic mode and they're very reluctant to open their pocket books.

They continue to witness rising unemployment, concerns over the underwater mortgages, the whole credit card debt issues, failing industries and companies, volatile gas prices, threats of tax increases, all the unrest and uncertainty in the world, all manifesting itself as it relates to Dominoes Pizza in an overall retail sector that is at best, limping along.

Consumers are looking for value, or better said, they're obsesses with value in this environment. A sluggish quick service restaurant industry particularly in the recent past and the pizza and dinner day part segment is being hit as hard or harder than any other segment that we study.

So watching all the industry news, it appears as the early predictions of a second half recovery may have been a bit optimistic and that flat sales may be the new up 5% for awhile based on the way the economy is performing.

So in this context, we feel pretty good about our previously stated forecast for 2009 being flat sales for Dominoes, and as I mentioned earlier, we've been able to put several of our initiatives in the win column that makes us feel good, grateful to be leading our category, encouraged on where we can go from here and of course knowing that we have to continue to work hard and smart as a system to keep things going.

Now during the second quarter we executed against our strategies of bar-bell price points for every customer and menu expansion with our Big Taste Bail Out promotion and the rollout of Bread Bowl Pasta. Both promotions performed well and achieved important traffic gains. In fact, I'm pleased to report that we've now experienced our second consecutive quarter of positive traffic growth for Dominoes Pizza, and that was a very important goal as we set out the plan for the year, and we're really proud of that. We want to keep it going.

Additionally, Bread Bowl Pasta has added yet another product platform to our brand which we can continue to build upon, and our lunch business continues to grow and thrive giving us great incremental lift.

Notably, without product at day part expansion, our results would not have been nearly as positive as they have been this year and we feel good about the direction we're headed with our menu management.

Proof that our execution is making a difference is a recent win for us, and that is that we were ranked number one in the fast food segment in the American consumer satisfaction index, and as you know, this is an important measure of customer satisfaction. It gets a lot of visibility across the country every year. We've had one of our competitors who's made a real big deal about this every year because they've been very proud of their position and they've haven't been quite as vocal this year because we took over as number one.

The consumers rated us higher than anyone in the Pizza category, and we were even higher than all of the major players in the fast food industry as a whole. We are now the overall most improved since the survey began. We improved our first year score by nearly 15% which is huge.

Additionally, the most recent MPV Crest market share report ranks us number one in on-line sales with a 28% share of that market ahead of both Papa John's and Pizza Hut. This is up from an 11% share just 24 months ago.

Our push to drive technological leadership is an important part of increasing our market share and it provides consumers with lots of ordering options which helps our top line sales and helps our store profits.

Our franchisees remain engaged in line with these strategies. They've been executing well and continue to outperform corporate stores again this quarter in sales which obviously we want to do better and better with our corporate stores, but the fact that our franchisees are leading the way is a very important for our business model and for the overall success of our brand.

We recently held our world wide rally for our franchisees in Las Vegas and it served as a great opportunity to keep moral high and relationships strong.

Recent improvements in our supply chain profits have also led to improved profit sharing payments which helps improve unit economics for our franchisees. We've even featured some of our franchisees in our ad campaign for Dominoes American Legends Pizza. Since our franchisees are really the heart of our business, and they really were the inspiration for each one of the pizzas in our American Legends line, we decided to include them in our consumer messaging.

Now turning to another important element of our business, the cost environment, it continues to be favorable with cheese close to record lows and with the rest of the food basket only slightly higher than a year ago. However, as Wendy mentioned, there's another increase this month in the Federal minimum wage which will impact our corporate stores and to a certain degree, our franchisee's profitability as it has over the past few years.

The company will continue to invest this year and make targeted G&A investments in our franchisees and team members. And as you've heard before, we're doing that through training and motivational programs, holding everyone accountable but also offering rewards and incentives to reinforce positive behavior and results, and these costs will continue to show up in a higher G&A year over year as Wendy has already discussed.

One division that continues to see great success is our international group. We're very proud of them. They've had robust sales comps in store growth again. Last quarter we announced the opening of Spain. We're pleased to report that we now have 90 Dominoes Pizza stores open and running which adds a new European country to our footprint, and we're very proud of what we've accomplished in a very short period of time.

This presence in Spain will not have a material impact on our 2009 earnings, but our international team did a great job in getting this market open and it's going to mean big things for us in the years to come.

Another important factor of our international success, particularly in today's economic environment is that this business remains a low risk model for us with no significant capital investment spend. We believe that sustained profit results are proof that the master franchise model is the right one for us internationally.

Now we've reinforced again and again that Dominoes is a strong cash flow generator over the course of the year. We continue to generate about $1 million a week in free cash flow and we use that cash in opportunistic ways to benefit our shareholders.

We've recently deployed cash against debt reduction, taking advantage of both a favorable tax treatment and attractive prices on our debt. We will continue to do this opportunistically. Our CapEx investments remain lower than most any company our size and scope and we will continue to show great discipline around this spending with every investment requiring either a very short payback or a very long term important positive business building opportunity for the company.

With that, I'll pause and Wendy and I will open things up for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Gregory Badishkanian – Citi.

Gregory Badishkanian – Citi

A few questions on same store sales and I think you had a 1% to 2% impact from the You Tube video for the quarter, so would you say that same store sales are running in the positive range at this point?

David Brandon

Yes, if we were to take away the impact which was pretty abrupt and pretty measurable of that incident, we would have completed the quarter positive somewhere between a point to two points, a continuation of the momentum that we saw in the first quarter. So we feel very good about the quarter and the fact that we were able to collect on this insurance payment, we think although we would have loved to have had a positive number, we wish it never would have happened. It really lessened the blow in terms of any impact it had on the financial results of the quarter.

Gregory Badishkanian – Citi

Talking a little bit about initiatives, oven baked sandwiches, pasta, if you could let us know in terms of how they've been performing relative to your expectations and anything new in the horizon that you can share with us knowing that your competitors are listening to this as well.

David Brandon

Right. Thanks for referencing that. It was only a couple of years ago if you put in football vernacular, we had a playbook of one play in it, and it was pizza, and now what's really interesting and fun and exciting about where we sit is that we carefully described what we're doing as platforms.

We have a sandwich platform. We have a pasta platform. We have a brand new high end premium pizza platform. And the recent platform is appropriate is because we can build upon what we already have. It opens up a whole new realm for us in terms of flavors and varieties, line extensions, the kinds of things that give us the chance to not only expand our menu, but create more news so that new things are not one time events.

So I think what you should for from us is to continue to build upon all of these proven platforms. We've driven the mix of each one of them up well into the double digits and proved that we have a lot of people out there who are interested in these products, who enjoy them, and we can build upon that as we move forward. So we couldn't be more pleased.

Operator

Your next question comes from Joseph Buckley – Bank of America, Merrill Lynch.

Joseph Buckley – Bank of America, Merrill Lynch

Could you talk a little bit more about the company store performance versus the franchise performance and why you think the disparity was so great?

David Brandon

Two factors; one is our franchisees are getting better. The training programs that we're putting them through, the fact that we've weeded out a lot of the F franchisees, the fact that we put a new OER system in place which raises the bar in terms of accountability of operational performance. Our franchisees are running a tougher race than they were before and that's good thing and we feel good about that.

As it relates to what's going on with our team USA, our team USA has pocketed investments and our portfolio stores located in specific markets. We don't have the ability to kind of homogenize the whole United States in terms of their results. We kind of live on the basis of how certain markets are performing and without going into a lot of detail, when you have a significant corporate store presence in Las Vegas, Nevada, in Southern Florida, in Phoenix, Arizona, you start to see that we've got some very material assets of our corporate store business located in some of the hardest hit areas of the economy.

And so unfortunately, they're in a situation right now where I love the results they're achieving in certain markets, but they're overall average is being negatively impacted by what I would call disproportionate negatives in some of the other markets. We're going to have to slog through that and we're working with our marketing and operations to do better, but without question our team USA unit is flying into some significant headwinds in some of these markets that have really been impacted particularly in the real estate area.

Joseph Buckley – Bank of America, Merrill Lynch

You mentioned the second consecutive quarter of traffic being up. Could you provide some details on that, just what the traffic check mix might have been and what's causing the pressure on check? Part of it I'm imagining has to be the mix as you introduced the sandwiches and the pasta, but I'm curious if you're seeing more competitive pressures on check more recently.

David Brandon

This is an area where we really tip toe because we're not looking to give away anything that could be helpful to us. I think your overall assumption for the quarter can be that we did have positive traffic, so our new product platforms continue to bring in new customers and open up a new realm for us in terms of new interactions with new potential long term customers, and we like that.

Obviously we ran a very high value promotion during the quarter in terms of the Bail Out promotion. At the same time, some of our new products offer lower price points for different day parts and so that's going to have a pressure on ticket.

And make no mistake about it, if the stupid incident down in North Carolina wouldn't have happened, we'd be here reporting significant traffic uptick and whatever happened with the ticket would not have been enough to offset another positive quarter when everybody else is reporting some pretty significant negatives.

So all in all, we think it fits together well and we like the way we're balancing traffic and ticket right now to grow the business.

Joseph Buckley – Bank of America, Merrill Lynch

On the You Tube incident, it sounds from what you said that you're comfortable with the insurance proceeds so we shouldn't think that EPS would have been higher. We should just think that same store sales would have been higher if the incident had not occurred.

David Brandon

Certainly if we have a couple of weeks where we have significant down turn in sales, that affects royalty streams. It affects snowball sales. It's certainly going to affect the profitability of the business, but it was very short lived. I think the insurance company recognized that we had certainly experienced some negative financial impact with this. They were interested in doing a quick settlement. We agreed with that strategy because we want to move on and that's the way it happened.

But a $2 million injection into the quarter, I would safely say covers any of the negatives associated with that incident.

Operator

Your next question comes from Jeffery Bernstein – Barclays Capital.

Jeffery Bernstein – Barclays Capital

A question on the U.S. comp again. Excluding the You Tube, it sounds like you said you would have been system wide comp maybe up 1% or so, but then you did mention obviously that the macros presumably got tougher with my take. I'm just wondering if you remove the You Tube then going into the second quarter you are cautiously optimistic.

Would you say that trends got worse because of the macros or actually you were pleased with the sequential improvement throughout the quarter after the incident?

David Brandon

We keep a quarterly score card in terms of our reporting to you and if it weren't for the incident we'd be reporting a 1% to 2% positive domestic same store sales performance and we've already had one of our major national competitors report their results and we sure feel good about how we fare against that one, and there's another one yet to come and we don't know what they're going to report. But we think it was a strong quarter for Dominoes Pizza considering all the factors.

We don't get into month to month sales reporting and we're not going to because there's too many things that can influence it, but I would tell you my take overall of the economy is that there is a very jittery consumer out there that is behaving in a very difficult way to predict. So you're going to have periods of time where you feel like it's getting better and you're going to have periods of time where it clearly feels like it's gone the other way.

It's going to be very choppy. That's what we've experienced over the last year, and I don't see that changing for at least the next couple of quarters. So I wish I was smart enough to tell you there was some kind of a pattern that had developed that would afford more predictability in terms of sales, but I just don't think it's the case.

Jeffery Bernstein – Barclays Capital

It seems like the second quarter we saw additional debt pay down for a nice discount and then again in the third quarter. I'm just wondering if at this point, I know you said it's more opportunistic, but could it accelerate in terms of more meaningful pay down on your longer term debt or is it really just short term smaller buckets but not likely to change the longer term.

David Brandon

We think it's in everybody's best interest to keep our cards pretty close to our vest in terms of what we might do and what we can do and what options are available to us. As it stands today, we have not done any capital raising event. What we've done is simply take all this terrific free cash flow, while also maintaining very, very adequate, I would say beyond adequate, and I would describe them as conservative cash balances, and then we take some of this free cash flow and we go out and opportunistically claw back some of this debt, and we feel like we've done it in a very smart way and a very efficient, attractive way in terms of price.

Who knows what the future holds, but depending on how much debt is available, what the price is, how our business continues to perform, there's all kinds of options available to us as we move forward to continue to deleverage the company and do it in a way that's very accretive to our shareholders and we'll continue to explore that.

Jeffery Bernstein – Barclays Capital

You mentioned the commodity basket and you mentioned cheese was down 7%, but the rest of the basket was up modestly. I'm just wondering as you look out to the back half of the year, I think you said the basket as a whole would be down single digits. Obviously with the benefit of cheese, and I'm just wondering what the outlook is now for the back half and the full year in terms of cheese and the combined baskets and whether based on that we can assume we would see some meaningful margin expansion in a way that's sustainable in the different margins that you report where you could see that benefit in the back half.

Wendy Beck

First off I would want to remind you that we're rolling over in the third quarter the highest prices that we saw in 2008. So year over year you're definitely going to see improvement in third quarter. It went as high as $2.21, the cheese block in the third quarter, so we will see that.

As far as trying to understand where we think commodities are going to go for the later part of the year, there's lots of speculation that cheese can't stay at the same prices that they are. We do think over all we will see some deflation and then again, we'll run better numbers comparatively to the prior year.

Jeffery Bernstein – Barclays Capital

But it will be down single digit basket. Is that a reasonable number for the combined basket?

David Brandon

We are really reluctant to forecast the future as it relates to commodities because we've already proven how bad we can be at that. I would say if current trends continue, we should have a better year against year comparison than maybe even the high single digits.

But I say that very reluctantly because those things can change very quickly. But for right now, based on where cheese is, and as Wendy indicated we're going into a really, really favorable comparison, the third quarter could be a really good period for us as it relates to cost comparison and the potential for margin expansion.

I'll tell you more about that in about three months.

Operator

Your next question comes from Steve Steve Reese – J.P. Morgan

.

Steve Reese – J.P. Morgan

One of the things we worry about when cheese prices are at record lows and we're seeing the consumer chasing value like perhaps never before and as the competition starts to get aggressive and ratchet promotion. Have you seen this yet and how do you think the brand is positioned with value if things start to get more aggressive on the price points?

David Brandon

It's a great question and it's an important question. I would tell you based on how everybody's unit economic model is performing when their top line is contracting, and thankfully ours isn't contracting as much as others, but in this environment where sales are hard to come by, I really believe that the pressure on operators is such that nobody's interested in just giving away the product to somehow make themselves feel better.

I think you can see it in the promotional price points, in the overall strategies that people are employing out there. Other than the really, really cheap pizza guys, and I would characterize them as the guys that don't deliver and kind of the carry out cheap product, cheap price that's their niche in the market, other than segment that's always been there and will always be there, I see probably more price discipline right now than we've seen in a long, long time with cheese prices being as low as they are only because I think there are factors that are creating other pressure that are precluding people from feeling like happy days are here again, let's see how low we can drive price so we can gain some share.

It just doesn’t seem to be happening.

Steve Reese – J.P. Morgan

On the international side, we really haven't talked about that yet. Still solid but a little softer on the both the one end to your base, so maybe you could talk about if there were any markets that softened that impacted the overall comp or any comment on the international side would be helpful.

David Brandon

You get a pretty good look at how some of our really largest international businesses are performing because our Mexican partner is public as is our U.K. and Ireland partner and our Australian partner which includes both Australia and parts of Europe, specifically France, The Netherlands and Belgium.

I think generally speaking, we're in a situation where we have not incurred the same kind of global slowdown that I've heard so many of my peers talk about. We seem to persevere pretty well in terms of our same store sales gains, continuing to open up stores, continuing to open up new markets.

So all in all, we still feel very, very positive about the way this business is performing. Now we're watching it very carefully because we hear everybody around us talking about global recessions and slow downs in the global economy, and we don't think we're bullet proof in terms of experiencing that.

So we watch it period to period and quarter to quarter, but as it stands right now, we feel pretty good about the numbers the way they're coming in.

Steve for John Ivankoe – J.P. Morgan

I think in the past, last year you embarked on an intense operational focus for your franchise system, reallocating stores to stronger franchisees. So maybe you can update us on where you stand today with respect to sub par franchisees versus where you were a year ago and what you're doing to address this if anything still.

David Brandon

For several quarters, as we got into the A, B and F classifying of our franchisees, and we were in the thick of that program, we actually reported that on a quarterly basis in terms of how that pie chart moved and how many F's had exited the system and all those things.

We basically indicated a call or two ago that we were going to kind of get out of that business, because as you can appreciate for us internally for the CEO to get on a public announcement and talk about how many kids we kicked out of class yesterday is probably not the most positive energy thing I could be doing.

I'm just here to report to you that we have raised the bar substantially in terms of what it takes to maintain your position as a franchisee at Dominoes Pizza. We continue to rank them and communicate where they rank. We continue to move more B's to A's which is great, and more F's to B's and we continue to put significant pressure on franchisees that are not making the grade and either get them to change quickly or move them out.

That process is one that's ongoing and it will likely never stop, at least under my watch because we're going to continue to hold that bar really, really, high. But beyond that, I'd really like to get out of the specifics of that simply because it's kind of family business and I'm not sure it serves a useful purpose to keep parading those numbers out there other than to say we feel very good about where we are.

Operator

Your next question comes from Michael Wolleben - Sidoti & Company.

Michael Wolleben - Sidoti & Company

With the positive traffic here in the past two quarters, how much of that is attributable to the extended hours that you've put in place domestically?

David Brandon

It's difficult because extended hours were connected with menu changes so is it sandwiches? Is it extended hours in the lunch day part? Is it some of the extended hours that we've done late night? Is it Bread Bowl pasta?

We really put a lot out there in terms of changes so I don't think this in a one trick pony in terms of what's created the positive traffic. I think it's the combination of several things that we've done well.

Certainly getting our stores open earlier and keeping some of them open later is part of that, but I don't think that in and of itself has been the real factor. I think it's a lot of what we're feeding people. We're feeding them better food than we've ever offered and more variety than we've ever offered.

Michael Wolleben - Sidoti & Company

With that as well on the new products, sandwiches and the Bread Bowl pastas, can you comment on how that traction has held up after the initial sales levels?

David Brandon

We really don't disclose a lot about mix and those kinds of things because I sure wish I knew that about some of our competitors. I would just tell you that all of those overachieved in the national roll outs versus what we had experienced in test. The mix ramped up as high or higher than what we would have expected or hoped for which means we got terrific trial.

The repurchase on them has been terrific and we're glad we're in every one of those categories. There's not one of those platforms that are even on the watch list in terms of are they earning their way, are they making sense, are they making money for our operators and are they being really well received by our customers.

Every one of them is a winner as they currently stand as part of the menu, and you'll be seeing that we'll invest further in those platforms in terms of line extensions and more variety.

Michael Wolleben - Sidoti & Company

On the debt repurchases, the debt that was done here subsequent to the close of the quarter looks like it was done at a more expensive price, still at a discount, but is that a sign of the market in general changing. If we saw further debt repurchases in the future, would you expect them to be closer to those levels? Can you just comment on that?

David Brandon

Not only will I not comment on the future of the cheese market, I have no idea where the debt markets are going other than to say really early in the game we were able to buy some tranches to bonds that were phenomenally priced, when you start talking about $0.50 or below cost on the dollar. We didn't run any model that would continue over any sustained period of time.

As our results continue to improve and as we continue to assume the leadership position that we've always held in the category and as people understand our balance sheet better and they see less risk and more opportunity, we have always believed that we would be repurchasing debt at a higher rate than $0.50 on the dollar.

So the models that we run are at substantially higher levels than that, and that's just what we believe is going to happen. However, markets swing and we're going to be opportunistic and we're in a position where we can be pretty selective and when we decide to do a transaction and when we don’t, and we'll kind of look at each one of those on their own merit.

Beyond that, I can't really predict where that price will be going. There's not an easy way to assess it because there's not a daily public market out there. It's really very anecdotal in terms of if you've got a willing seller and we can come with a price that fits within our model, then we may be a willing buyer.

Michael Wolleben - Sidoti & Company

We're still seeing some domestic closures on the franchisee side. Can you comment on the financial health of the franchise system here domestically?

David Brandon

We're still putting as I indicated earlier, we're still putting some pressure on some people that are not all in, and that's creating some closings. We hope some of those will be temporary closings as we continue building a pipeline of new franchise candidates.

I would tell you based on our original assumption of how many stores we thought were going to close during the economic environment of 2009 with some of the pressure that we're putting on some of our lower end performers; we would have actually forecasted that we would have closed more stores by now.

So we're feeling like the economic model is improving. Our solid franchisees are feeling better about their financial results. We don't see a lot of financial closures out there as a result of the high commodities, depressed margins, and good operators that want to close down stores because they don't feel they're viable. That's now what we're dealing with now.

We're just dealing with the clean up of some marginal operators and some marginal stores. So we're not going to adjust, earlier in the year we gave you our outlook of what we thought was going to happen with the stores, we're not going to adjust that right now other than if anything, the trend seems to be a little bit positive.

By the way, we're opening up new stores which we think is really significant and tells you about the unit economic model and the prospects for the future because nobody knows this business better than the franchisee community and they're out there building new stores and investing in the future in the environment and that says a lot.

Operator

Your next question comes from Tom Forte - Telsey Forte Group.

Tom Forte - Telsey Forte Group

I wanted to know if you could give, the subject has been kind of discussed but I wanted to know on the capital of your franchise operators have. Do they have access to capital? Do your better performing franchise operators, is the bank answering their call now and giving them an opportunity to buy some of the under performers or is that environment as difficult as it's been recently.

Maybe if you don't want to comment so much on mix or on days of week as far as what sales are like Monday to Thursday versus weekends, when you think about just the general state of the consumer and using some of those as guideposts, are there mix of purchases or weekdays versus weekends would you say that the consumer is significantly weaker now than they were earlier this year or about the same?

David Brandon

I'll handle the second part of it first. The pattern that we were slugging through last year, particularly in the back half of last year, was that we were actually feeling pretty good about our sales Monday through Thursday and then we got into that kind of weekend period where people typically spent some extra money and partied a little bit more and where we would have expected to see our bigger volume, and that's where we were having same store comparison problems because it seemed like people were really kind of nesting on the weekends, holding back and not spending like they were during better times.

I don't know how much of what has happened is a result of the change in consumer behavior or how much of it has been driven by talented people in our marketing department, but we've been doing a lot to address that issue with some of our local promotion activities, some of the things we've done with our internet marketing.

We've really worked hard to try to bolster the buzz around our brand and the opportunities associated with accessing our brand during those important weekend time periods and we've seen a much more level performance and we feel better.

Now whether we're just getting that right or whether the consumer is acting a little differently than they were I'm not sure other than I feel better about where we are.

The lunch day part has helped us for sure, but we're also selling a lot of sandwiches and Bread Bowl pasta at dinner time, so we also know that we've helped our dinner business because we've provided more variety. We've probably lifted the pizza veto a little bit with families who wanted more selection and we can now offer.

So again, I can't point to any one magic bullet here. It seems to be a combination of a number of smaller bullets.

Your first question was?

Tom Forte - Telsey Forte Group

The ability of your franchise operators to have access to capital, especially the better performers to buy some of the weaker players, has that improved or same as it was before?

David Brandon

My sense of it which is pretty anecdotal, and that is are we seeing some deals getting done and are we seeing some people building some stores and are we seeing some sign that there is some capital available. I would say it's slightly better than it was the last time I was asked this question.

It's certainly not worse and it's probably modestly better, but we're still in a situation where the banks are inclined to lend money to the businesses that don't need it, and they're reluctant to lend money to the businesses that really do, so that conservatism out there in terms of the credit committees and the lending practices of the banks, appreciably have not changed. If it's better, it's only better a little bit.

Operator

Your next question comes from Colin Guheen – Cowen and Company.

Colin Guheen – Cowen and Company

Can you give us your opinion about competition outside the channel, especially the grocery channel and just how you see that and how that figures into a broader context of long range strategy for pizza delivery companies?

David Brandon

We've studied that hard in the recent past because we always look at it with one eye, but we decided to really dig in to find out whether it was a material change and what was going on in the whole take and bake area with some of the chains, some of the grocery stores, the Wal Marts of the world who have gotten in the pizza business, certainly looking at the frozen category.

Their products have certainly improved in terms of quality and are they making inroads. Our general assessment is that they're experiencing a lot of the same pressures that we are, that this is really not about anybody benefiting from anybody else's demise in the category. We just think there's overall pressure in spending and from everything that we can tell the frozen guys and the take and bake guys are experiencing the same kinds of pressures.

We don't believe there's a big winner in this. The only quasi big winner is in this is if you've got your brand position as standing for quality is not important, service is not important, competitive advantages are proprietary, positioning is not important, just cheap is important. If you've got a business model that affords you ability to just sell cheap, there is a segment, there's always been a segment out there, but there's a bigger segment today of people who will opt into that at least temporarily because they're just looking for the best deal in town.

So if there's any beneficiary, it's a brand that stands for that kind of positioning. Other than that, I think we're all basically in the same situation.

Colin Guheen – Cowen and Company

Where are you with awareness around your online ordering platform and might the different levels of media, might there be more of a message devoted to the technology platform?

David Brandon

We monitor on a monthly basis. We're improving but it's got to get better and we need it to get better. As you can see we're tagging all of our commercials. It's in all of our print. In some cases, we're creating incentives where there's two tier pricing; one if you order from us through regular channels and a better price if you order online.

I believe that you will continue to see more investment and more activity from Dominoes driving people to that online activity. The ticket is better. In many instances the experience is better. It accesses tracker and some of the other amenities that we found that our consumers really appreciate.

So we're pleased with our progress but we have a lot of improvement that's still out there and we're very, very focused on it.

Colin Guheen – Cowen and Company

Is the improvement in awareness or is it more in use?

David Brandon

Both. We need to continue to let people know that that experience is available to them and how easy it can be and as that awareness grows, we get more people who give a trial and our view is that the more people that try it, the more people get hooked on it.

Colin Guheen – Cowen and Company

Where in the evolution of the chicken business and how would you frame that for us generally.

David Brandon

We have two products right now that I would call them both very successful, very meaningful in terms of their combined mix, in terms of the number of orders that go out of a Dominoes Pizza store with chicken being one of the products. Our bone in chicken is we think the superior product in the entire industry and we've stood for that for a long, long time.

I challenge anybody to go out and buy an order of wings from all the players in the industry and line them up; ours are going to be the highest quality without question, particularly of all the deliver guys, but even the sit down guys. We are just really proud of that product and it does a great job.

Our boneless product, our kickers is a smaller product line for us, but it's definitely held it's own over the years and people really enjoy it. We've experimented, and we've had tests and we continue testing ways that we could potentially build upon that platform. It hasn't a high emphasis area for us, but it's certainly not one we're ignoring. We watch very carefully what other people are doing in managing the wing business, so it's not something we have a deaf ear to, but as it stands today, we like where we are.

We see some opportunity there but a lot more work needs to be done before we're ready to talk about it.

Colin Guheen – Cowen and Company

I was just looking back on the 2009 possibilities and units, is it more the middle or the bare case that you laid out at the beginning of the year, as we're half way through the year.

Wendy Beck

As far as the outlook for the year?

Colin Guheen – Cowen and Company

The 2009 possibilities. I know you don't give guidance, but during the analyst day we talked about a bull case, a middle case and a bare case and those had different unit counts associated with them. I was wondering now that we're halfway through the year if one of those looks more probable than the others.

David Brandon

We're probably closer to the middle than either one of the other examples, although I would tell you that when we put that together, which was last fall, I would describe the overall economic condition and pressures being more severe than we would have anticipated. But having said that, I think we're doing a better job than we would have anticipated in terms of how we're hanging in there and where our closing and openings are falling and certainly how we're holding our own in terms of sales.

Operator

There are no further audio questions.

David Brandon

I want to thank you all for being on the call. As we've tried to communicate honestly, it continues to be tough out there. There's nothing easy in this environment and that's not news to any of you. But I'm really proud of my team and the accomplishments that we've achieved in the recent past.

We're regaining our rightful position as the leader in our industry and our franchisees are engaged in improving and performing. They've got a lot of passion and a lot of excitement for what can be and there's been a bit of a reigniting of that passion in the recent past and we're very excited about that.

We're upbeat about our results in the first half. When traffic is growing in the retail industry, good things happen and the fact that we're getting more customers into our stores opens up a whole new realm for us in terms of opportunity.

We look forward to updating you on the results of our third quarter and hopefully if we continue to execute really well and we can get a little bit of help from the consumer and the overall spending environment out there, we will continue to be as upbeat as we are today.

So thank you participating in the call and we look forward to talking with you soon.

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Source: Domino’s Pizza Q2 2009 Earnings Call Transcript
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