Good morning. My name is Emily, and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter 2018 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then 1 on your telephone keypad. To withdraw your question, you may press the pound key. Thank you. It is now my pleasure to turn the conference over to Tim McIntyre, Executive Vice President of Investor Relations. You may begin your conference.
Thank you, Emily. Hello, everyone. Thank you for joining the call today about the results of our second quarter. Today's call will be the first one featuring Richard Allison, who became CEO officially on July 1st. Rich will be joined as usual by Chief Financial Officer Jeffrey Lawrence. As you know, this call is primarily for our investor audience, so I kindly ask all members of the media and others to be in a listen-only mode. In the unlikely event that any forward-looking statements are made, I refer you to the safe harbor statement you can find in this morning's release and the 8-K. We will start with prepared statements from CFO Jeffrey Lawrence, excuse me, and then from CEO Richard Allison, followed by analyst questions. With that, I will turn it over to CFO Jeffrey Lawrence.
Thank you, Tim. Good morning, everyone. In the second quarter, our positive global brand momentum continued as we once again delivered great results for our shareholders. We continue to lead the broader restaurant industry with 29 consecutive quarters of positive U.S. comparable sales and 98 consecutive quarters of positive international comps. We also continue to increase our store count at a healthy pace. Our diluted EPS as adjusted, which excludes the impact of our recapitalization completed during the quarter, was $1.84, which is an increase of 39% over the prior year quarter. With that, let's take a closer look at the financial results for Q2. Global retail sales grew 12.6% in the quarter. When excluding the favorable impact of foreign currency, global retail sales grew by 11%.
This global retail sales growth was driven by an increase in same-store sales and the average number of stores opened during the quarter. Same-store sales for our domestic division grew 6.9%, lapping a prior year increase of 9.5%. Same-store sales for our international division grew 4%, rolling a prior year increase of 2.6%. Breaking down the domestic comp, our U.S. franchise business was up 7%, while our company-owned stores were up 5.1%. These comp increases were driven by higher order counts and also ticket growth as consumers continue to respond positively to the overall brand experience we offer them. Our Piece of the Pie loyalty program also continues to contribute meaningfully to our comps.
On the international front, all four of our geographic regions were again positive in the quarter, with our Americas and Asia Pacific regions leading the way. Our same-store sales performance for the quarter was driven entirely by higher order counts. On the unit count front, we are pleased to report that we opened 43 net domestic stores in the second quarter, consisting of 44 store openings and one closure. Our international division added 113 net new stores during Q2, comprised of 148 store openings and 35 closures. On a total company basis, we opened 156 net new stores in the second quarter and 905 net new stores over the last 12 months, clearly demonstrating the broad strength and outstanding four-wall economics our brand enjoys globally.
Although we are generally pleased with our continued store growth, we recognize that our store growth internationally is slower than we expected for the first half of this year. We do not believe there is any structural or material market-specific reason for the net store growth result in the first half of the year. We reiterate our global net store count guidance of 6%-8% annual growth over the next three to five years. Turning to revenues. Total revenues were up $150.8 million, or 24% from the prior year quarter. As a reminder, we adopted the new revenue recognition accounting standard in the first quarter of 2018. As a result, we are now required to report the franchise contributions to our not-for-profit advertising fund and the related expenses gross on our P&L.
Although this did not have an impact on our reported operating or net income in the second quarter, it did result in an $80.9 million increase in our consolidated revenues. It is important to note, although these amounts are included in our financial statements, they are restricted funds that can only be used to support the Domino's brand and are not available to be used for general corporate purposes. The remaining $69.9 million increase in revenues resulted primarily from the following. First, higher supply chain center food volumes, driven by strong U.S. retail sales, resulted in higher supply chain revenues. Second, higher domestic same-store sales resulted in increased revenues at our company-owned stores, as well as increased royalties and fees from our franchise stores. Store count growth also contributed to the increase in royalties and fees from our domestic franchise stores.
Finally, higher international royalty revenues from higher retail sales, as well as the positive impact of changes in foreign currency exchange rates. Currency exchange rates positively impacted international royalty revenues by $1.1 million versus the prior year quarter due to the dollar weakening against certain currencies. For the full fiscal year, we continue to estimate that the impact of foreign currency on royalty revenues could be flat to positive $4 million year-over-year. As you know, there are many uncontrollable factors that drive the underlying exchange rates, which does make this a harder part of our business to predict. Moving on to operating margin. As a percentage of revenues, consolidated operating margin for the quarter increased to 37.7% from 30.7% in the prior year quarter.
This increase resulted entirely from the recognition of domestic franchise advertising revenues on our P&L from the new revenue recognition accounting guidance I mentioned previously. Supply chain operating margin was negatively pressured by delivery and labor costs. While company-owned store margins were positively impacted by lower insurance expenses and sales-based transaction fees as compared to the prior year quarter and was partially offset by higher food and labor costs. Let's now shift to G&A. G&A costs increased to $6.5 million as compared to the prior year quarter, which is net of the expense reclassification for certain advertising costs we mentioned on the Q1 call. This net increase resulted primarily from our planned investments in technological initiatives, including e-commerce and the teams that support them. Please note that the company receives fees for technology from franchisees that are reported separately as franchise revenues. Moving down the income statement.
Domestic franchise advertising costs were $80.9 million in the second quarter. As a reminder, we are now showing domestic franchise advertising in our revenues with an equal and offsetting amount of expense in our operating costs. Interest expense increased $11.5 million in the second quarter, driven by increased net debt from our most recent recapitalizations. This increase in interest expense also includes $3.3 million related to our 2018 recapitalization, which has been adjusted out as an item affecting comparability for EPS purposes. Our weighted average borrowing rate in the second quarter decreased to 4%. Our reported effective tax rate was 15.1% for the quarter. This was primarily due to the lower federal statutory rate of 21%, resulting from federal tax reform legislation enacted at the end of 2017.
The impact of tax benefits on equity-based compensation also resulted in a $6.9 million reduction in our second quarter provision for income taxes. This resulted in a 7.6 percentage point decrease in our effective tax rate. We continue to expect that our tax rate, excluding the impact of equity-based compensation, will be 22%-24%. We also expect to see continued volatility in our effective tax rate related to equity-based compensation. When you add it all up, our second quarter net income was up $11.7 million or 18% over the prior year quarter. Our second quarter diluted EPS, as reported, was $1.78 versus $1.32 last year, which was a 35% increase. Our second quarter diluted EPS, as adjusted for the 2018 recapitalization transaction, was $1.84 versus $1.32 last year, which was a 39% increase. Here is how that increase in diluted EPS as adjusted breaks down.
Our lower effective tax rate positively impacted us by $0.23, including a $0.28 positive impact from tax reform and a $0.05 negative year-over-year impact related to lower tax benefits on equity-based compensation. Lower diluted share counts, primarily as a result of share repurchases, benefited us by $0.21. Higher net interest expense, resulting primarily from a higher net debt balance, negatively impacted us by $0.09. Most importantly, our improved operating results benefited us by $0.17. Now turning to our use of cash, including the use of proceeds from our recapitalization transaction. During the second quarter, we repurchased and retired approximately 906,000 shares for $219 million at an average purchase price of approximately $242 per share. Year to date, we repurchased and retired approximately 1.35 million shares for $320 million at an average purchase price of $236 per share.
We also used cash to repay $490 million of our 2015 notes in connection with our recapitalization. We returned $23.5 million to our shareholders in the form of a $0.55 per share quarterly dividend. We continue to invest heavily in technology and have also increased the level of investment for supply chain capacity, primarily for our new U.S. supply chain center scheduled to open later this year. Given our current outlook for the U.S. business, we are pulling forward additional supply chain capacity building investment into 2018. This includes work to begin building two additional U.S. supply chain centers, which we project will be completed over the next 18 to 24 months. As a result of this acceleration, we now estimate our growth capital spending for the full year 2018 to be approximately $115 million-$120 million, up from our previously communicated $90 million-$100 million range.
All in all, our strong momentum continued, and we are very pleased with our results this quarter. With that, I will turn it over to Rich.
Thanks, Jeff, good morning. I'm excited to be with you all on my first earnings call as CEO, and I am particularly pleased to be reporting a very good quarter, as the momentum in our business continues to remain quite positive, thanks to our strong fundamentals and a steady, proven strategy. Before digging into the specifics around the quarter, there are two things I'd like to acknowledge. First, I'd like to pay one more respectful farewell to my predecessor, Patrick Doyle. It's a little odd for all of us on quarterly earnings day to look around the room and not see Patrick, his legacy and contribution toward this wonderful organization will not be soon forgotten. For me personally, I am grateful for his influence and mentorship in my progression toward the honor of succeeding him.
Thank you one more time, Patrick, for all you did to make this an outstanding business and a great place to work. We wish you well, we trust you are getting some well-deserved rest and relaxation as we speak. Secondly, I want to express my gratitude and excitement to continue working even closer with our incredible group of franchisees. During my transition, I have heard from many of our international franchisees with whom I have worked very closely over the last seven years. I have also really enjoyed getting to know many more of our U.S. franchisees. It is energizing to trade thoughts around how we can continue to maintain our incredibly strong alignment and our shared commitment to industry-leading store-level economics and cash-on-cash returns.
During my seven years leading the international business, this was a top priority for me, and it will continue to be so going forward as we lead this business into its next phase. We place major emphasis on ensuring our franchisees' success, and we promise to continue to listen, to be collaborative, and to remain as strong of a partner for you as any in the industry. Strong alignment and performance is a great segue into our discussion of the second quarter, one that was very solid across all areas. During the quarter, we officially surpassed the milestone of 15,000 stores worldwide, and retail sales growth continued its tremendous momentum. I am particularly pleased with the performance of our U.S. business, led by outstanding same-store sales and yet another quarter of solid, sustained momentum around unit growth.
Industry-leading unit economics, a focused fortressing strategy, and a committed franchisee base once again contributed toward our balanced formula for growth in the U.S. The rapid growth of our U.S. business has driven record-level volumes in our supply chain centers. With volumes up more than 50% in just the last five years, it is time to accelerate our investments in supply chain capacity, both to serve current demand and to support our growth plans going forward. We are on track to open a new supply chain center in Edison, New Jersey, later this year. We will also accelerate work in the second half of the year on two additional supply chain centers. In addition to these three new center projects, we are increasing our investment to enhance capacity in several existing centers.
We will continue to invest in the growth of our business going forward and will provide specific CapEx guidance for 2019 in January. The international business had a good quarter, with top-line comp performance within our three-to-five-year outlook and positive results from all four regions. I continue to be pleased to see our same-store sales growth being driven solely by order growth. We have a collection of top-notch master franchisees who are continuing to learn from insights and global best practices, focusing on value and emphasizing the importance of growing transactions, prioritizing traffic over ticket, and avoiding the price take trend we see taking place throughout most of the industry. As Jeffrey touched on, our international unit growth has admittedly been a bit slower than our historic norms during the front half of 2018.
I continue to stress my confidence and expectation that this will normalize on a full-year basis. Last month, we welcomed another new market into the Domino's family. Kosovo celebrated the grand opening of its first Domino's location in mid-June and set a new Domino's European record for opening week volume. We are excited to deliver hot, made-to-order pizzas helped by strong digital ordering capability to the people of Pristina. Domino's is truly a global brand, and this was on full display during our biennial worldwide rally event held in Las Vegas just two months ago. We hosted nearly 9,000 Domino's franchisees, general managers, and team members from six continents and more than 70 countries. The interaction I was fortunate enough to have with our many global operators was truly inspiring.
Our attendees learn and grow through connecting, networking, and best practice sharing, reminding us all that we are truly a global system with so much in common. Most notably, our commitment to helping one another reach success. It was another forward-thinking quarter on the technology front, as our Domino's Hotspots ordering platform got officially up and running. We are very pleased with the launch and customer reception, and most importantly, the participation and execution of our U.S. franchisees, store team members, and drivers in making this a successful start to a unique, collaborative, and clever digital platform. We now have over 200,000 Domino's Hotspot delivery locations available nationwide, and I hope customers will continue reaching out to suggest new potential locations and can do so by visiting dominos.com/suggestahotspot.
We continue to demonstrate our ability to invest and innovate in a flexible manner to maintain our unquestioned digital leadership position within this category. Getting a lead is one thing. Keeping it is another, and that demands an aggressive and nimble mindset around investments toward this area. Expect that to only continue going forward. In closing, it was an excellent second quarter. There's a reason that in addition to being quite humbled, I come into the position with utmost confidence in the continued potential for this business. I inherit an outstanding leadership team and smart, dedicated, motivated corporate team members here in Ann Arbor and throughout the world. The momentum around this brand and all that it has come to stand for has never been stronger in its nearly 60-year history.
I now have the opportunity to work even closer with the best group of franchisees in the restaurant business. We are incredibly committed to their success and will remain aligned, focused, and marching in unison toward our shared goal of dominant number one. Thanks again, and we will now open it up for questions.
At this time, I would like to remind everyone in order to ask a question, please press star followed by the number one on your telephone keypad. Once again, that's star followed by the number one on your telephone keypad to ask a question. Your first question comes from the line of Brian Bittner. Your line is open. Please go ahead.
Thanks. Good morning, guys, and Rich, congratulations to you again.
Thanks.
First question. You mentioned the loyalty program continues to be one of the largest tailwinds to your domestic comp. This is a program you launched, I think, in September 2015. Can you just help us understand what about this program almost three years later is still contributing so much to your growth trend? I have a follow-up.
Yeah, Brian. The program continues to gain active membership. We'll update you on those membership numbers again in January as we did last January. Our program just continues to resonate with our customers, and we continue to see nice, solid tailwind from it.
Just my follow-up, maybe for Jeff. The international business, after a stretch of very steady margins there, you did see a pretty big decline this quarter, and it looked like it was mostly because of G&A, which went up a lot. Can you just unpack the drivers of the international margin this quarter and help us understand maybe how these dynamics unfold from here?
First thing is, we had some FX settlements, even though we were benefited on the top line during the quarter in royalty revenues from FX. As it started to turn and people were paying their bills, that pressures us a bit on the G&A line for the international division. The other one, quite simply, is that we continue to invest in the capabilities and the team members that are in the field right now, partnering with our master franchisees to grow the brand. Again, other than that, you normally get some variability, a little higher, a little lower. Those are the two things that I'd point to for this quarter.
Okay. Thanks, guys.
Thank you.
Your next question comes from the line of Karen Holthouse. Your line is open. Please go ahead.
Hi. Thanks for taking the question. A quick one, really, on store-level margins. From disclosures in the Q, it looks like labor costs are actually leveraged in the quarter, which is certainly a divergence from trend. Is there anything you would call out that was sort of one-time in nature about that? Is that going to pick up the decrease in insurance costs year-over-year, or is that separate?
You're speaking of the corporate stores, Karen?
Yeah.
Yeah. Corporate store labor for the quarter was actually up half a point to 30% of sales. Primarily, that's labor rates. Now, partly a function of some minimum wage increases we've had in the business this year, and partly because the economy is humming and some of our stores, we're paying a little bit more to attract, retain great team members. We are doing a better job with efficiency with the labor hours that we have in the stores. We're getting some leverage because ticket and sales continue to go up. It was not enough to overcome the labor rate increase. That's why you see that 50 basis point increase in corporate store labor this quarter over last year's quarter.
One of the things that came up on the call last quarter was starting to test fully automated phone order taking. Maybe just give us an update on how that test is going, and do you have any initial thoughts on when earliest time to market?
Sure, Karen. We've got that automated phone ordering, Dom phone ordering, in about 20 of our corporate stores that we're testing, and we are continuing to learn at a very rapid rate. Don't have any update for you right now on timeline for a broader rollout, but the program is moving along at or better than our initial expectations.
Great. Thank you.
Your next question comes from the line of Matt McGinley. Your line is open. Please go ahead.
Good morning. First question's on the international unit growth. I know you both expressed confidence that this would re-accelerate, and I assume you have reasonably good visibility into that. Was there any one factor or region that would've driven that slowdown? You're in 70 countries, so it's a little bit surprising that they would all slow down at once.
Matt, it's Rich. It's interesting. No real single market or region driving the near-term slowdown. Over the course of the last year, we've had some leadership changes in a number of markets, and frankly, some markets just absorbing what was a record amount of growth across 2016, 2017. If you think about it, we opened more than 1,900 net new international stores during that two-year period. Sometimes markets just need a little time to absorb the impact that that has on the people in their organizations. As we take a look forward, our confidence is really grounded in the fact that we still have very strong unit-level economics across these markets, and that is ultimately what drives store growth over time. We feel good about that. We also have some visibility into the store pipeline through signed leases and things like that.
When we take a look at it, still very confident in the 6%-8% global net unit growth that we have put out there as our guidance for the three-to-five-year horizon.
Okay. On the company, on margin side, was the deleverage you experienced there on food related to actual food price inflation, or was it more of the labor and the supply chain? What was the overall commodity basket up?
For corporate stores, food was up mostly because of the basket. What the supply chain centers are charging the stores for that. There's a lot of gives and takes, kind of cats and dogs with commodities up, down, sideways. Net, it was up, and not a ton, but up a little bit with the basket being up in the 4% handle quarter-over-quarter.
Okay. Thank you.
Thank you.
Your next question comes from the line of Gregory Francfort. Your line is open. Please go ahead.
Hey, guys. I have two questions. The first is that the story for Domino's in the pizza category over the past several years has been the big three or four taking share from everybody else. Recently, it seems like Domino's is taking share from the other big four players. Does that increase the urgency to maybe pull forward or accelerate unit growth from here? Then my other question is just on CapEx, and I know you guys don't want to guide next year, but any early reads just on if there's going to be a material step-up around supply chain investments or not? I'm sure you guys have a read into how much more you need to add to the supply chain next year and just directionally where we should expect that number to go.
Yeah. Greg, first on share. As we've communicated in the U.S. business, we see an opportunity for an 8,000-store Domino's business potential within the next 10 years. While a lot of that share has come from the locals and the regionals, as we look forward, we see an opportunity to take share broadly across the industry. That confidence leads to our expectation that we've got strong unit growth potential in the market.
This is Jeff, on the CapEx question. Again, we're going to update 2019 in January. We're going to anchor to that, but what I can tell you is that the second and the third center that we're going to build after New Jersey, the per-center cost will be materially less than the New Jersey build. Again, we'll give you specific numbers around that when we give you a 2019 guidance. In 2018, we're just getting them going. We'll give you more details on that in January. You have good reason to show up in at our Investor Day.
Got it. Thanks.
Thank you.
Your next question comes from the line of Will Slabaugh. Your line is open. Please go ahead.
Yeah. Thanks, guys. Just a quick question on domestic comps. Last quarter, you talked about the strength of delivery and that growth rate, I think, actually outpacing carryout. I'm curious what those two growth rates may have looked like, if you could speak directionally to that this quarter here in the U.S.
Yeah. We're not going to speak specifically to the composition of growth across delivery and carryout. Both were growing during the quarter. We emphasized delivery last quarter, just given the discussion that we have been having around aggregators. Don't expect going forward that we'll break that comp down across delivery and carryout.
Fair enough. Rich, just given you've been focused on the international business for a while now, and now thinking about things obviously much more broadly, is there anything in the U.S. that strikes you as either an opportunity or even where we might see you focus a little bit more intently than maybe where we've seen in the past? I don't know, supply chain might be the answer, or if there could be something else.
Yeah. Couple of things there. One is that the strategy that we're now pushing forward in the U.S. around fortressing is actually something that a number of our international markets had been doing for some time. There were some learnings that came out of our ability to carve out territories from existing stores, and drive overall retail sales growth in the U.S. market that was spawned out of some of the efforts of some of our high-performing international master franchisees. A second area, it relates to some of the supply chain investments that we're talking about.
It has been a number of years since we opened a new supply chain center in the U.S., and as we move forward in building out that additional capacity, we're taking a lot of the learnings that we've gained over the last decade in the international business as we've built dozens of supply chain centers employing some more advanced production techniques and technology in those centers. We'll continue to look for opportunities to transfer learnings and best practices back and forth between our U.S. and our international businesses.
Got it. Thank you.
Your next question comes from the line of John Glass. Your line is open. Please go ahead.
Thanks very much. First, just on the domestic business, on the hotspots, maybe can you talk about how acceptance of that has been? Has there been an immediate uptake, or is it sort of a novelty at first and people will kind of get used to it over time? How do you ensure that doesn't interfere with speed of service? You can imagine a scenario where drivers are looking for somebody, and that just takes a little bit longer. How have you worked through that to make sure that doesn't occur?
First of all, John, we can't comment really much on the uptake so far on hotspots, just given that it's basically a Q3 event. We've been rolling it out over the course of the last month. In general, just to kind of give you a sense for how we think about it. When we think about hotspots, we think about it similarly to how we think about many of our AnyWare platforms. It really is another way for our customers to be able to access us anytime, anywhere that they want to. To your question on speed of service, the hotspots are contained inside of the delivery areas that our franchisees have already. Those hotspots are defined by our franchisees. Customers request them, but franchisees select those areas that we can deliver to.
Quite often, they're landmarks which are easier to find than someone's residential address, in many cases. It might be at a beach or at a baseball field or at a park. Areas that are well known within the community.
Got it. That's helpful. Then just another on the domestic comp. One is that the gap between domestic company operated and franchise, again, continues to favor franchise the last two quarters. It may be as simple as comparisons, but is there any other element in there? Maybe in answering the question, has fortressing accelerated, for example, in company operated markets ahead of franchise markets? Or maybe you can just talk about where you are in fortressing markets generally in the U.S. right now.
Yeah. John, it's a good question. When we look at our corporate store growth in the U.S., basically all of the stores that we're opening in our corporate store business are splitting territories. There is a bit more of downward pressure on the comp from those splits. Consistent with what we've been talking about, the strategy is really around growing retail sales within that footprint, and expanding the sales per household in each of those territories. When we take a look at those openings, we're not only looking at the sales and economics potential of the new store that we're opening, but also looking broadly across the market and trying to drive sales and profitability at that level.
Got it. Thank you.
Your next question comes from the line of David Tarantino. Your line is open. Please go ahead.
Hi, good morning. A couple questions. First, on the domestic business. If I look at the domestic franchise revenue growth, it was quite a bit below the system sales or retail sales growth this quarter. I know you had an accounting change. Maybe that was part of it, but can you talk about why the franchise revenues lagged the retail sales growth this quarter?
Yeah, David, this is Jeff. I think it's a couple things. The comp flow-through and the technology revenues that we get track the way we would normally expect it. There were a couple things that might be mucking up your model a little bit. One is a reclassification of some technology fees out of domestic into international. That might be doing it. The other thing that we disclose in the quarterly report we filed this morning is a reclassification out of franchise revenues into the advertising fund revenue line item. Those two things taken together, my guess is, will make up most of your difference there.
Jeff, was that reclassification a catch-up adjustment from prior quarters, or was that all related to this quarter?
It was related to this quarter, when you compare it to last year at this time, you'll get a little bit of wonkiness there.
Okay, great. On the international front, I was just hoping that you could give an update on your expansion of your proprietary e-commerce system and the adoption of that outside the U.S. I know it's been slower than inside the U.S. Can you maybe just talk about where you are on that and what some of the barriers are to get to 100% outside the U.S.?
Sure. David, we continue to work with our international master franchisees to leverage our investment in global technology platforms. That really is continuing on a couple of fronts. You mentioned the e-commerce side, but really the first wave on that is really with our point-of-sale system, the Pulse system, which is now in more than 12,000 of our stores globally, and we have several additional international markets that are rolling that platform out this year. Because that really is the foundation upon which we layer the e-commerce platforms. With respect to those e-commerce platforms, we continue to roll that out into new markets and also continue to have conversations with additional master franchisees about how we can take some of those core building blocks within that e-commerce platform and help to leverage the scale and investment that we're putting in.
No new markets to report specifically on that, but just know that the conversations are ongoing, and we continue over time to bring more and more of the international markets into the fold.
Great. Thank you.
Your next question comes from the line of Peter Saleh. Your line is open. Please go ahead.
Great. Thank you. Just wanted to come back to the supply chain investment for a minute. Jeff, what's changed in your thinking on the supply chain that you guys are being more aggressive and pulling forward more of the investment this year? What's changed since the investor day in January that makes you guys want to be a little bit more aggressive on the investment?
The first thing is our U.S. operators in the field and our marketing and technology teams just continue to put up amazing growth. When we look at what capacity we need to keep up with that growth, but also to hopefully continue the acceleration in unit count growth in the U.S. business, these are centers we knew we were going to have to build, probably over time. As we did almost 11%-12% retail sales growth, again in the Q2 for the U.S. business, and most of that, again, is volume and traffic driven, it simply accelerates what we knew we had to do already. We're just going to get these things going. They have a long lead time, 18-24 months is what I said in the prepared remarks.
We view this as a front-footed, a smart investment, kind of a good CapEx problem. We're going to get great, fresh, high-quality dough out to our stores that we have today, but also make sure that we can get that capacity for the stores we're going to open up over the next 1-5 years. That's really important to us. We're excited to make these investments, and more importantly, our franchisees are excited that we're making these investments.
Peter, I'll give you just a little bit more color as well, in addition to what Jeff just said. If you look back over the last 5 years, the volume that is running through our existing supply chain center network in the U.S. is up more than 50%. The team there has done a great job of absorbing what is a phenomenal increase in demand within the existing footprint. We are now at a point where you start to get inefficiencies and diseconomies of scale in some of these centers when you get capacity up past a certain point. We're both trying to absorb some of the demand that we've already driven, create a little bit of preparing ourselves, as Jeff said, for the future growth in our business going forward.
It's also, at this point in time, with the after-tax return on our investments is better this year than it was last year. It gives us another opportunity to continue to invest.
Thanks.
Great. Just one more question from me. I know you guys have been focusing a lot more on the carryout business. Given that you've had a lot more creative and more focus on this in the front half of the year, what is the data telling you about the carryout business versus the delivery businesses? Is carryout still a very separate occasion than the delivery customers? Are you still seeing unique guests coming for carryout? Are you seeing more crossover from the delivery customer into the carryout business?
We're still seeing them as two different occasions with very little overlap across. That's why you've seen us consistently market to both of those occasions. We will, 52 weeks of the year, you see our ads running on TV, and we are running certain messages that are targeted directly to the delivery segment and certain messages that are targeted directly to the carryout segment. As we mentioned back in January, that key insight is one of the things that has given us the confidence around our fortressing strategy, as the new stores that we open allow us to access a carryout customer that we weren't able to access before. Because a carryout customer will not drive as far to pick up a pizza as we will drive to deliver them one.
All right. Thank you very much. Very helpful.
Your next question comes from the line of Chris O'Cull. Your line is open. Please go ahead.
Thanks. I just had a couple of follow-ups. One was on the domestic fortressing strategy. Rich, how many stores opening this year are part of that strategy? Is there a geographic region of the country where the strategy is focused? It would seem like targeting markets where competitors were weaker would make sense.
Yep. We continue to increase the number of those units that are opening are split across the geographies in the U.S. Jeff, you may correct me here, but I believe on a trailing basis, we were just shy of, over the last 2 years, it was just shy of 300 of our units opened in the U.S. were split territories. Sometimes that's taking one store's territory and carving it in half, and sometimes it's taking some territory from several stores to create a new trading area for a new store that's opening up. We look at this on a market-by-market basis across the geographies, and we run our models to understand what the incremental sales gain can be from that new store and what the impact on the existing stores will be.
Okay. Jeff, the reclassification that impacted the franchise revenue line, the domestic line, was that new this quarter, or did that happen last quarter as well?
It was in Q3 last year we did it. Now you're looking at a Q2 versus Q2 last year, you're getting a little bit of that, again, kind of wonkiness there. When we get into all the way to Q4 and Q1, they'll start to normalize a little bit, but until then, it'll definitely mess with your percentages of retail sales there.
Yeah. One thing I'm struggling with is if you look at the first quarter, you had about 12% growth in the domestic franchise revenue year-over-year, and you had a similar comp and maybe a little lower comp this quarter, but similar unit growth rate. This year or this quarter, the second quarter, it grew by 6%. Can you help me understand what's the difference in the growth rate in that line item from the first quarter to the second quarter? What caused that?
Yeah. Again, I'm not sure, obviously, all the puts and takes in what you're modeling there, but the biggest thing I can tell you is the contractual royalty rates haven't changed. The incentive program's been pretty steady, and the technology flow through has also been what we would expect. Everything else is basically accounting and reclassifications as we think about it because really nothing else fundamentally has changed in the economics of the business.
Okay, great. Thanks, guys.
Thank you.
Your next question comes from the line of Jeffrey Bernstein. Your line is open. Please go ahead.
Great. Thank you very much. Two questions. First one, just Rich, when you're looking at the international business, and obviously this is where you're coming from, you mentioned all four geographies were positive. Just looking back over the past few years and what obviously has been very strong comp growth, but the last six or seven quarters, it looks like you've been within that long-term guidance range or maybe slightly below, whereas the prior 12 quarters were clearly every quarter consistently above the high end of your kind of 3%-6% long-term guidance.
I'm just wondering, are we in kind of a new steady state now where most of your key markets are more mature and the long-term guidance is more appropriate, or are there certain structural things going on that's changing it or I know you mentioned that there are not really any markets that are varying meaningfully from a comp growth perspective, but just wondering your thoughts as we look forward, whether the 3%-6% is now likely to be sustained versus what had been consistent outsized growth.
Yeah, Jeff, as we look forward, that 3%-6% range, I think is the range that you should be thinking about. We've had a significant acceleration in the unit growth in that international business, if you look back over the course of the last seven years. Just as we spoke about in the U.S. business, many of those store openings that we've had, in particular in the mature markets, have been stores that have been splits or carve-outs from existing store territories. That puts a little bit of downward pressure on the overall same-store sales comp. Again, we do that because the objective is driving retail sales growth.
When we take a look at retail sales growth, second quarter, we were still, even excluding the impact of foreign currency, 10.6% retail sales growth in the international business, which is in the upper end of our long-term range. I think that's how you should think about it. It is a mix of businesses out there, some wide open territory in some countries where we're still relatively under-penetrated. The balance of the growth coming from the more mature markets, where more of the store openings will be carve-outs.
Got it. My follow-up, also just on the international front. I'm just wondering, in your new seat, whether there's anything you consider doing differently as you think about international. I know in the past it often came up a lot about the royalty rate and how it's determined country by country. I'm just wondering, how often is that rate reviewed or is there option for negotiation? Obviously, the international franchises are doing so well, or would you ever consider taking an equity stake in any of these businesses, or should we just assume kind of steady as she goes?
Yeah, Jeff, we don't have any near-term plans to make a change in strategy for that business. We feel good about the way it is structured today. The master franchise business model is a model that we still believe is the right way to grow the Domino's Pizza business.
Great. Thank you.
Your next question comes from the line of Matthew DiFrisco. Your line is open. Please go ahead. Matthew, if your line is on mute, please unmute.
Sorry. A couple of follow-up questions. With the supply chain investments, I guess you answered that as far as I'm trying to understand on the margin front. Are you saying now that this will be a margin benefit as far as getting better capacity and more efficient plants right away? Is there going to be a little bit of a time to ramp those up to get to better capacity utilization, the supply chain margins, the improvement to come might be in the out years?
Yeah. Great question, Matt. We haven't, and we're not today giving any guidance specifically around margins in any of the businesses, including supply chain. What I can tell you is, as you can see with the New Jersey center that we're opening capacity and catching up on capacity, it costs a lot of money, right? These second and third centers, although they'll be materially less in CapEx than the New Jersey center, are also pretty big dollars. What we're looking to do, without giving guidance on it, is just take advantage of these new centers, some of the new technologies, capture some of the transportation centers by being closer to the customers in these two or three new spots. Obviously try to, the best we can, overcome the cost of actually building the center.
The thought I'd give you, the way I'd think about this long term is, we're running at about an 11% or so operating margin. I think it was 10.7% this particular quarter. Yeah, 10.7% this particular quarter. I don't think it's going to 15%, I don't think it's going down to 7%. I think it'll generally be within some kind of a range that makes sense for the industry. Listen, at the end of the day, we don't have a choice. We got to build this capacity and get that fresh dough, to support the stores we have and the ones we're going to grow in the future.
That's a good problem to have, though. I guess if you're looking at the franchise perspective, are their margins going to get better potentially from some new capacity that you're bringing on, or new capabilities you're doing at these facilities?
Listen, one of the nice things about having great franchise relationships is, we also have a structure where we share in all of the investment and all the profitability of these supply chain centers in the U.S. and Canada. It is a true partnership that we both benefit from greatly. When I think about franchisee profitability in the U.S., 2017 was an all-time high, and it's at a level that's supporting the growth of these units. What I would tell you is, whether it's food, labor, insurance, rent, anything around this capacity, it really doesn't matter what it is. We need to grow our way out of any kind of potential P&L headwinds. We've been able to do it very successfully, obviously for an extended period of time.
As Rich mentioned in his opening remarks, we will not lose focus on making sure that our franchisees grow right along with us. It is the secret sauce of what we've been able to accomplish. Our franchisees know that, and we're going to grow together. Big opportunity for us. As we mentioned, we're a small number one player in the U.S. pizza industry. We've got a lot more opportunity out there, and we're going to do that together with these guys.
Okay. Just a question with World Cup. How did that, if it did, have an impact on the international side of the business as far as potentially same-store sales or development? How should we look at that as any sort of impact as it didn't happen last year?
World Cup for us was a Q3 event, so we won't comment any on sales impact from that on this call.
Would it be correct to assume it's a positive historically?
We're not going to touch on it.
Okay. Thank you.
Your next question comes from the line of Alton Stump. Your line is open.
Hi. It's A.K. Good morning.
Good morning.
I think most of my questions have been asked. I just want to touch back on Hotspots and, of course, understanding that it's still very early and, I think as you mentioned, Rich, is more of a Q3 platform. What have you seen so far from them? Is there any kind of read on how much of those orders are cannibalizing versus incremental? Are they all incremental or just any kind of color, even though it is very early, that you could provide?
Yeah, it's still too early really for any of those quantitative measures. As we spoke about, it's predominantly a Q3 event. Having 200,000 of these set up already, I think speaks to the consumer interest that we've seen and also the fact that our franchisees have really embraced it. We're excited about it as we think about it fitting into, as I mentioned earlier, these AnyWare platforms. The overall message that we're really trying to bring forward is that for our customers, we want to be their pizza provider anytime, anywhere they want to access us.
Makes sense. Just one quick follow-up on Hotspots. I mean, is there an opportunity to expand the delivery territory? If a franchisee obviously can move out into a territory that isn't covered by another Domino's franchisee, is there the ability to do that and set up a Hotspot outside of their actual delivery area?
We're really focused on these Hotspots inside the existing delivery areas, and I'll describe why. When you start to venture outside of the existing delivery area, it can sometimes sound enticing because you may think it's an incremental order, but the cost of getting that pizza further away from the store is a challenge. In fact, we're moving actually in the opposite direction of tightening our delivery territories over time. When we talk about fortressing, it is about really shrinking those delivery areas so that we, A, access the carryout business in those new locations that we've talked about. Also, by having those delivery areas tighter, it allows us to get food to customers more quickly, which brings them back more often, and it reduces the delivery costs associated with each of those orders, making those delivery orders more profitable.
Got it. Makes sense. Thank you.
Your next question comes from the line of John Ivankoe. Your line is open. Please go ahead.
Hi. At this point, I think a couple short ones. Firstly, there was a slight uptick in international closures in the second quarter, and I think there was in the first quarter as well. Is there anything you'd just think about, the rate of international closures? I mean, is it just modernization of the system? Do you see better locations elsewhere like you saw in the U.S. a decade or two ago, or is that happening in specific markets?
Yeah. There's not really anything structural, John, that we're concerned about. While it upticked a bit from what we've seen historically in an individual quarter, when we take a look at on a trailing 12-month run rate, or if we look at how we think about it going forward, we don't see any major structural issues. Over time, markets close some locations as trading areas change and open up elsewhere. Nothing unique to any specific market or any specific trend that I would highlight.
Secondly, you touched on market rates kind of driving up your own labor costs. The question was around availability, specifically around delivery drivers. Whether in the U.S. or a market like the U.K., are you seeing any acute pockets of demand for your drivers to where you feel execution has been affected? In other words, do you think the current employment market may actually be constraining your ability to execute to some extent?
John, with the growth of our business, we've got open positions across the U.S. and in many markets around the world. Not at a level that has constrained our growth or that has caused any major service deficiencies. With unemployment at the level that it is in the U.S. and some of the international markets, it is a very competitive market for labor just as it is a competitive market at the customer level as well.
Thank you.
Your next question comes from the line of Jeremy Scott. Your line is open. Please go ahead.
All right. Thanks. Yeah. Just on the theme of fortressing your markets, can you talk a bit about the value proposition? It seems like the context of the promotional levels that we're seeing from Domino's and your top branded competitor in contrast with the rising menu prices from independent pizza players. I ask this question in the context that the last two years, we haven't really seen much consolidation of the market, at least on the delivery side. It seems like most of your market share has come from the other big two. Are we seeing a change this year? Are you seeing more value-driven or price-driven transactions?
We've stayed very consistently focused on value over time. We're now in our ninth year at $5.99. We've stayed on that, and I think in the minds of many customers, when they think about $5.99, that's associated directly with Domino's. We're continuing to stay focused on that on the delivery side of the business, and then we've also got a very competitive value offering out there on the carryout side as well, which has been consistently for a while now, that $7.99 large three-top. We're aggressively going after share in both of those businesses. And back to what we were talking about around fortressing, as we think about it, fortressing is really important for both of those. The carryout business is largely incremental when we open these new stores.
In order to stay competitive at $5.99 on delivery over time, we've got to continue to be more and more efficient. And by fortressing and tightening down these delivery territories, it allows us to operate a very efficient and cost-effective business model, even while bringing great value to our customers.
Got it. Just maybe a quick follow-up. We've seen a bit of a drop-off here in your core commodity cost. Do you expect that to run into the supply chain restaurant margins, or do you intend to reinvest?
For the store-level food basket, we were actually up in the quarter for our franchise and our corporate-owned stores. Food is down a little bit in supply chain as a result of procurement savings, just benefiting from the scale that we have. Certainly as the number 1 player, that's getting better, not worse. We've given guidance this year of the 2%-4% for the basket going up, we're not changing that.
Okay. Thank you.
Thank you.
Your next question comes from the line of Sara Senatore. Your line is open.
Thank you. Two follow-ups, if I may. You just touched upon something you mentioned about value and being very competitive. One of your major competitors seems to be really struggling now. I actually thought you might see even a bit of an acceleration. Granted, 7% comps is impressive, but I would've thought maybe there was a little bit more room to take share. There are other players that are also pressing on value and on their advantage, and maybe you're sort of splitting that traffic shift more evenly. That was question one, and I have another follow-up on the supply chain.
Sara, I won't comment on what other competitors are doing in the marketplace, just simply, we're going to maintain our focus on value for our customers and our focus on making sure that we're delivering great unit-level economics for our franchisees. The share will fall where it falls over time. If we do a great job on those things that we can control, I think we'll continue to be able to take share from across the industry.
Okay, thank you. Just on the supply chain, I guess philosophically, it seems like owning the supply chain is sort of sacrosanct, but not every franchise business owns their supply chain. In fact, it's more the minority, and it does have a dampening impact on operating margins and returns. I guess I was wondering if there's an opportunity or if you've ever considered outsourcing it. Other big systems seem to be able to control quality and consistency across a franchise base without necessarily owning it from the supply chain.
Yeah, Sara, when we think about it, really the core of our product offering is that fresh dough that we produce ourselves with our proprietary formula and that we distribute out to our stores. There are certainly capital implications to doing that. We are going to have to invest to continue to expand that network. We feel so strongly about the quality of our product and in controlling the quality of that product that we're going to produce that dough ourselves. I'll also tell you that I think one of the key elements of the value proposition to our franchisees is the very high level of service that they get from an integrated supply chain where we bring that fresh dough and the other products and materials that they need to their stores, increasingly three times a week for most of them.
It's a great service for our franchisees, in addition to being a key part of the customer value proposition. Of course, finally, the great thing about it is it does deliver a significant level of profitability to the business.
Thank you.
Your next question comes from the line of Jon Tower. Your line is open.
Hi, thanks for taking the question. Just first on international same-store sales, the number now trending more within your long-term guidance, and I believe you said earlier it was driven by order growth. I'm just looking back historically, you were outside of that 3%-6% long-term range. I'm just curious to know what the composition of the comp growth has been, perhaps now relative to the past, meaning order growth versus ticket growth, and how that's evolved.
John, it can ebb and flow some over time. In the first half of last year, it was more driven by ticket than it was orders. This year driven, we are very happy to say, exclusively by order count growth. Over time, what we look for in the business, and this is no different in our U.S. business, we look to drive the majority of our same-store sales gains over time through order count growth. That is the only sustained way to grow the business over time, is through transaction growth. There are times when brands will grow their same-store sales through pricing increases, and that can sometimes work in the short term, but rarely works over the long term in terms of being able to sustain the growth in the business.
When you look back at 98 consecutive quarters of positive same-store sales gains, we would not have been able to do that in the international business without driving significant order count or transaction growth over time.
I know you are pleased with store-level returns in the international markets, but has that come under a bit of pressure with perhaps a shift in that comp growth more towards the traffic and away from the ticket?
We still feel very good about where we are on cash-on-cash returns at the store level in our international markets. Again, things will ebb and flow over time in individual markets, but we have been pretty strong and steady there when you take a look at it across the board.
Okay. Last one, just a modeling question. The interest expense for the year, is the expectation still the $145 million-$147 million I think you talked about last quarter?
Yes, it is. That's the as-reported number.
Great. Thank you.
You're welcome.
The last question in queue today is from the line of Stephen Anderson. Your line is open.
Yes. Thank you. From Maxim Group. I don't want to beat the international piece of the business to death, but as you may recall, about a year ago, there were some concerns about the rise of third-party aggregators. There hasn't been as much talk about it now, but since we're lapping that, and maybe the lap hasn't been as much as had been suggested, can you tell me if there's been anything that you're seeing outside the U.S. that maybe there's a new competitor or maybe one of these competitors is gaining momentum in these markets? Can you provide some insight to that?
Steve, we don't really have anything to add there beyond what we've talked about in the past. We haven't seen any significant new players come into that market, and we haven't seen any significant new evidence that leads us to believe that the economics of that business have changed.
There are no further questions left in queue. I turn the call back to the presenters.
Well, thanks everyone. We look forward to discussing our third quarter 2018 results with you on Tuesday, October 16th.
This concludes today's conference call. You may now disconnect.