Good morning. My name is Kelly, and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter 2015 earnings conference 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 the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Ms. Liddle, you may begin your conference.
Thanks, Kelly. Good morning, everybody, and thanks for joining us. We're going to follow our usual pattern of some prepared remarks by our chief financial officer and our CEO, and then we'll open it up for question and answer. We do set this up as an investor call, so I'll kindly ask the members of the media to be in listen-only mode, and I'll also turn all of your attention to our safe harbor statement in the event that any forward-looking statements are made. With that, I'd like to introduce our new CFO, but longtime Domino's team member, Jeff Lawrence.
Thank you, Lynn, and good morning, everyone. Before we discuss the results for the third quarter, I'd like to make some brief comments on our recently announced proposed refinancing of our capital structure. As communicated in our September 28th press release, the company intends to issue approximately $1.5 billion of new fixed-rate notes in the fourth quarter. We plan to use the proceeds of the $1.5 billion issuance to call and retire at par $551 million of existing 2012 fixed-rate notes to pay transaction fees and use the remaining net proceeds for general corporate purposes. The refinancing would bring our total debt-to-EBITDA levered ratio from approximately 3.6 times at the end of Q3 to approximately 5.8 times at closing. The company also expects to enter into a new $125 million variable funding note facility, which would replace our existing $100 million facility.
Due to security law restrictions, we are unable to go into any more detail today or answer any questions regarding this proposed refinancing. We appreciate your understanding. We do plan to have a follow-up call with investors at the conclusion of the refinancing, and we will announce the date for that call at a later time. Let's now move on to our third quarter results. This quarter, our domestic and international divisions again posted very strong same-store sales growth, and we opened a significant number of new stores globally. Our earnings per share grew 6.3% over the prior year. We are pleased with these results, particularly in the face of continued foreign exchange headwinds and an insurance charge we took during the quarter that I will discuss in more detail in a moment. Global retail sales, which are total retail sales at franchise and company-owned stores worldwide, grew 6.1%.
When we exclude the adverse impact of foreign currency, global retail sales grew by 15.2%. The drivers of this retail sales growth include domestic same-store sales, which rose by 10.5% in the quarter. Broken down, our U.S. franchise business was up 10.4%, while our corporate stores were up 11.5%. Both of these comp increases were driven primarily by traffic or order count growth. We also saw some ticket growth during the quarter. We are also pleased to report that we opened 14 net domestic stores in the third quarter, consisting of 24 store openings and 10 closures. Over the past four quarters, we have opened 96 net domestic stores. Our international division had another strong quarter as same-store sales grew 7.7%, lapping a prior year quarter increase of 7.1%. This marked the 87th consecutive quarter of positive same-store sales growth for our international business.
Our international business also grew by 180 stores during Q3, comprised of 201 store openings and 21 closures. Over the past four quarters, we have added 742 net stores internationally. Turning to revenues. Total revenues were up $38 million, or 8.5% from the prior year. This increase was primarily a result of three factors. First, higher supply chain center food volumes driven by strong U.S. comps, as well as increased sales of equipment to stores in connection with our global store reimaging program. These supply chain increases were partially offset by lower commodity prices. Second, higher domestic same-store sales and store count growth resulted in increased royalties from our franchise stores and higher revenues at our company-owned stores. Finally, higher foreign currency exchange rates.
Currency exchange rates negatively impacted us again this quarter by $5.5 million versus the prior year quarter due to the dollar strengthening against most of our currencies. It has negatively impacted revenues by $13.5 million. When we look at current projections, we now estimate that foreign currency could have an $18 million-$20 million negative impact on revenues for the full year 2015. You'll note that this range is substantially higher than what we estimated back in January at our investor day. At that time, we gave you a range of between $8 million and $12 million. Foreign currencies have negatively impacted us to a much greater degree than any of us had expected. To put it in perspective, our 2015 global retail sales would have been more than $1 billion higher if we had used 2011 exchange rates.
The good news in all of this is that we have continued to drive strong sales internationally and perform well on the bottom line despite this substantial headwind. If currencies moderate over time, this could eventually become a nice tailwind for us. Moving on to operating margin. As a percentage of revenues, consolidated operating margin for the quarter decreased to 29.3% from 29.9% in the prior year quarter. The main driver of this decrease was the previously reported $5.7 million pre-tax insurance charge reported in Q3. This was related to updated independent actuarial estimates for our casualty insurance program. This $0.06 per share charge was recorded in cost of goods sold in both our supply chain and domestic store segments. Consolidated operating margin was also pressured by the aforementioned foreign exchange headwinds, which does impact international margins.
Operating margins benefited from lower commodity costs in the quarter and higher sales in all business segments. Looking at company-owned stores, operating margin there decreased to 19% from 23%, again, driven primarily by the insurance charge. Similarly, supply chain margin decreased to 10.2% from 10.3%, also due primarily to the insurance charge, offset in part by lower commodity costs. As a reminder, commodities are generally priced on a constant dollar markup to our franchisees. Lower commodity prices do not impact our supply chain dollar profit. They do, however, positively impact our supply chain margin when looked at as a percentage of revenues. The average cheese block price in the third quarter was $1.69 per pound versus $2.04 in the same period last year. This led to our overall market basket decreasing 5.7% as compared to the prior year quarter.
Based on current forecasts, we now expect that commodities we use will be down approximately 5% to 7% in 2015 compared to 2014 levels. Let's now shift to G&A. G&A increased by $4.8 million in the third quarter versus the prior year quarter due to several factors. Our planned investments in our team, primarily in e-commerce, technology, and international, drove most of this increase. Our higher same-store sales also led to increases in volume-driven expenses such as variable performance-based compensation, company-owned store advertising, and franchisee incentives. As we have noted before, this 2015 fiscal year does include an extra week. We continue to project that our G&A will be in the range of $270 to $275 million for the 53-week year. We estimate that the extra week will drive approximately $4 million of this G&A expense. Switching to income taxes, our reported effective tax rate was 37.6% for the quarter.
We continue to expect that 37% to 38% will be our effective tax rate for the foreseeable future. Our third quarter net income was up $2.2 million. This 6.2% increase was primarily driven by higher comps, both domestically and internationally, global store growth, and increased supply chain volumes. Our improved results were partially offset by the negative impact of the insurance charge and foreign currency exchange rates. Our third quarter diluted EPS was $0.67. This is a $0.04 or 6.3% increase from the $0.63 EPS in the third quarter of last year. Here's how that $0.04 difference breaks down. The insurance charge negatively impacted us by $0.06. Foreign currency negative impacted us by another $0.06. Lower diluted share count, primarily due to our share repurchases, benefited us by $0.01. Most importantly, our improved operating results benefited us by $0.15.
Now turning to our use of cash. We repurchased and retired approximately 365,000 shares for $41 million, or an average price of approximately $112 per share during the quarter. We also returned more than $16 million to our shareholders in the form of our quarterly dividend. Overall, our global momentum again resulted in great comps and store growth. Thank you for your time today. Now I'll turn it over to Patrick.
Thanks, Jeff, good morning, everyone. I'm proud to be reporting the third quarter as mostly more of the same. The business and brand continue to thrive as a top performer in the industry, and franchisees, both domestic and abroad, continually impress me with the way they meet the challenge of sustained success as they continue to pile up points on the scoreboard. I believe the fundamental strength of our business is the foundation of our success, despite some of the headwinds we faced this quarter. In fact, we were able to take those hits better precisely because we are growing so strongly. I'm proud of our results and our continued product and technology innovation. Our strategies are working, fundamentals continue to strengthen, the results and return to shareholders speak for themselves.
Franchisees, store managers, and our team members are simply getting the job done. Focusing our domestic business, our emphasis on innovation and execution continues to fuel tremendous brand momentum. Franchisees and corporate store operators are all in, executing at the highest level I have seen during my time as CEO, notably related to service and for our franchisees, strategic growth. Because of this, we delivered strong double-digit performance, marking our 18th consecutive quarter of positive same-store sales in the U.S. and continued to move forward on domestic store growth. We are also closing in nicely on our goal of having 2,000 stores in the U.S. re-imaged by year's end. There has never been a better time to grow within Domino's, and franchisee profitability is well on its way to surpassing average EBITDA of $100,000 per store for 2015.
I am pleased to see more and more franchisees understand that and act upon it as we see the strong return on investment generating increasing store growth. After thoughtful planning and testing, we announced our first nationwide loyalty program early in the fourth quarter. Both the intent and execution are simple. Sign up, order online or via mobile app, and start earning points towards free pizza. We've seen what loyalty programs do for customers across many different industries, and it was time for us to get in the game. We expect to drive order frequency and connect with customers through our unmatched digital experience. We take the same strategic approach with menu expansion and believe it is best to take our time when launching new products with the full intention of their remaining permanent menu items.
Our Marbled Cookie Brownie, which launched in mid-September, is a good example of that, and we're excited to introduce our first dessert item in over five years. Switching to technology, the story continues to be about investing in innovation. Technology is now an absolutely critical part of our brand and an undeniable element of what Domino's stands for. We don't just talk about innovating, it's generating real results. For the second time this year, we are using national television to promote a technology-driven message. We are promoting and continuing to introduce the many digital platforms available to customers, including text and tweet to order, smart TV, smart watch, Ford SYNC, and voice ordering via our virtual ordering assistant, Dom. These platforms are unmatched technology first and have been effective in keeping Domino's top of mind and at the forefront of the digital curve, something we are very proud of.
We are seeing the positive impact of our online pizza profiles. In just over two years since the launch, 40% of our digital users have now created a profile and are able to use its many benefits, including Easy Order, saved order and payment information, and now our loyalty program. Continuing the theme of keeping the momentum going, especially within the technology space, we are proud of our position as a digital leader. We respect technology's impact on our performance and results, and we continue to make the investments needed to maintain this lead. Turning to our international division, this segment performed yet again with very strong sales comp of 7.7%. Some standout sales performances included the U.K., Australia, and Canada, and we are pleased with the unit growth in India and Japan, among others. Here's an impressive number regarding store growth.
742 net store openings on a 12-month trailing basis, helped by a solid showing in the third quarter of 180 net openings. We have now exceeded 7,000 total stores outside of the U.S. This milestone is a credit to our master franchisees, who continue to introduce and grow the Domino's brand in both developed and emerging markets across the globe in remarkable fashion. One of those new markets, which we just announced on Monday, is one that may know a thing or two about pizza, Italy. We're excited to be partnering with our master franchisee, ePizza, which will operate Domino's locations under the name Domino's Pizza Italia, beginning this week from its first store in Milan. The current plan is to open three stores in Milan by year's end.
While the market will take its time and is certainly in its infancy, one thing is for certain, Italy loves its pizza as Italians reportedly eat it seven times a month. As was noted by ePizza's management in this week's announcement, we also continue to work together with our master franchisees to help them grow their digital presence or reach full digital capability within their market. We currently have 11 markets using our global online ordering platform, with digital sales mix in participating markets increasing rapidly. I'm not only pleased to see digital growth in most markets, but I'm particularly encouraged to see the results of our collaboration with master franchisees come to life. In closing, our sales and growth continue to demonstrate unparalleled strength and sustained success despite facing headwinds. We've proven we will be strategic in our decisions and growth plan.
We've proven we will innovate, we've proven to have an industry-leading international model, and we've proven we will continue to respect and aggressively pursue the challenge of sustaining our success. Thank you for your time, and I'll now open it up for questions.
As a reminder, if you would like to ask a question, simply press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question will come from the line of John Glass with Morgan Stanley.
Thanks very much. In the spirit of understanding, you don't want to talk about the current debt offering. Is there any way or anything you can say about how philosophically you view returning that amount of cash to investors?
Yeah, John, I really can't get into that right now, as we're kind of in the middle of that process.
Got it. On the two other things then, one small and one larger. One, just on the insurance charge this quarter, I understand where it came from. Is that recurring? Was that a catch-up? How does one take those numbers and think about the P&L going forward?
I think there are really a couple of things there. First, what is most important is that our team members get home safely. We had a couple of very serious accidents that drove essentially half of that charge. One was right at the end of the covered period as we went into the actuarial study that we've done annually in the past. In fact, we're going to do that twice a year going forward now, which should help smooth out any movement on that. That charge, we've gone through the same process every year in the past. We do it once a year, and we've never had a change on that accrual of more than a half a million to a million dollars. It was a big move, and there were 2 really accidents that drove a lot of it.
I will tell you at the beginning of the year, we had an increase in frequency of incidents and some of the severity of incidents, and we take that very seriously. The trend is already getting better on that, but we've got to manage that closely and carefully, and most importantly, because we want everybody who is working for us to get home safely at the end of the day. Some of that is hopefully going to be more in the 1-time category as long as we can manage this carefully going forward. That would be our expectation, is that we would get it back down. I will tell you that we had had a long-term trend of being flat to down on incidents in the system, and it was troublesome that it picked up. We're on top of it. We're going to manage it carefully.
I can't emphasize enough, what matters more than anything is that people are getting home safely, and we're going to aggressively manage it going forward.
Thanks for that. If I could just sneak in 1 more. Patrick, you said that you were advertising nationally, I think you said for the 1st time, sort of your digital capacity and all the different ways you can order. Is it true? Is that what you said? Was that a 4th quarter event, or did you do that during the 3rd quarter? If it was during the 3rd quarter, is that the kind of thing that really gives a breakthrough message and gets increases or gives a step function up of digital orders as a percentage of the total?
I think some of that platform, and as we were talking about kind of anywhere, came right at the end of the third quarter. This is the first time we've gone out and really talked about how there are all of these different places that you can order through Domino's and making it as easy as possible for people to access our brands. This is really about the fourth quarter. It may have hit right at the end of the third, but effectively, it started early in the fourth quarter.
Okay. All right. Thank you.
Your next question will come from the line of Alton Stump with Longbow Research.
Thank you, good morning.
How are you, Alton?
Doing good. Thanks. I guess just looking back on the operational front, obviously, there is a fair amount of noise of currency and also the insurance claims in the quarter. As you look at what's driving your comp performance, obviously a lot of talk about technology, have you seen any difference in the pace? Is it even better now than it was a couple of quarters ago that you are seeing as an effect from technology, or is it slowing down at all? Just want to sort of get your update on how much of a lift that we're seeing or what the pace of that lift is coming from technology on comps in general.
Yeah. We feel very good about it, clearly, the comps, both domestically and internationally, were obviously extremely strong. I think we continue to find new ways to drive the business with technology. What we're able to do with the analytics around the technology as people are on these digital platforms are terrific. I'll tell you the other thing that just adds into this tremendously is the overall momentum in the business, the energy from our franchisees, the level of execution as we're driving success overall, there is a certain amount of the success that we're experiencing right now that, frankly, can only be contributed to the collective momentum within the system. It's driving terrific profitability for the franchisees, as we said in the script.
Our expectation after $89,000 of profits last year, as average for our domestic franchisees, our expectation is that we will be 100 plus, which has been a goal of ours for some time. That means that they're excited, they're reinvesting, they're driving the business forward. There are a lot of things that are playing into this, but clearly, digital continues to be front and center and is an important part of the story, both domestically and internationally.
That's helpful. Just a quick follow-up on that, just with the new loyalty program. How big of a deal do you think that could be? Could drive even higher comp growth sort of off the base, or is it more about getting data back that you can use going forward? Just some color on that would be great.
Yeah, it just started in the fourth quarter, so I really can't get into it. I guess what I would say is we wouldn't roll it out nationally if we didn't think it was going to be a positive contributor to our success going forward. It's really a fourth quarter event.
Got you. Makes sense. Thanks, Patrick.
Thank you, Alton.
Your next question will come from the line of Karen Holthouse with Goldman Sachs.
Hi, congratulations on another fantastic quarter, guys.
Thank you, Karen.
One quick housekeeping question and then a real question. Can we get the breakdown of that insurance charge between the company store line item and the supply chain?
Yeah, Karen, the overall charge on a pre-tax basis was $5.7 million. $4.3 million of that was recorded in cost of goods sold in the domestic store segment, where Team USA, our corporate operations reside, and $1.4 million of it was booked in supply chain.
Then one other actually quick insurance question. Is there any chance that, since you say it was a handful of accidents that were at the beginning of the year, that weather might have played a factor in that, and we could hope for a reversal next year?
No.
Okay.
Some of it can be attributed to simply the growth in the business that we've had. At the end of the day, the weather, it's bad weather every winter. So, no. Look, we're going to manage it aggressively. We have been, as we saw it in the first quarter. A couple of these were, two, were severe accidents that drove about half of this. At the end of the day, that's still not acceptable. We've got to manage it well and aggressively, and we're doing that. Certainly, it is our hope that we are going to get this back down. We're already seeing some good trend on that. There are no excuses around this. With weather or anything else, we've got to manage it aggressively.
Great. Then for a real question, on the loyalty program, is it early enough that we can get any sense from test markets what expectations around how incremental it could be to check or traffic? Thinking about the ramp, what's sort of the plan for advertising it either to existing pizza profilers, to people who order digitally but aren't profiled, versus a broader just national advertising campaign for it?
Yeah. Karen, we can't get into that. It's in the fourth quarter. I guess I'll repeat what I said to Alton. We wouldn't roll it out if we didn't believe in it. We've rolled it out nationally. I'm not going to get anything that's going to kind of indicate where we are with fourth quarter results.
All right. Thank you.
Thank you.
Our next question will come from the line of Peter Saleh with BTIG.
Great. Thanks. Congrats on the quarter. Just wondering if you could talk a little bit about the discrepancy maybe between the company-owned store comps and the franchise comps. Could any of that have been due to the loyalty test that you had in place?
No. No, it was not. You're looking at about a one-point differential. I guess what I would tell you is anything within a couple of points of being the same is frankly the range that we would generally expect. We're in seven or eight markets with our corporate stores. There's always going to be some kind of regional differentiation in terms of performance. Anything within a couple of points between the two is I think kind of expected.
Great. Just the last question is, just talk about maybe a little bit about the decision to launch a dessert item. Haven't launched a new dessert item in many years. Why launch a dessert item rather than sticking with your core on something more innovative on the pizza side?
Yeah. Well, first of all, as you may have noticed, we're not advertising it on television right now. We're advertising our digital and kind of the core of our business is where the ad dollars are going. The Marbled Cookie Brownie is being done online and with print. I guess the bottom line for why do you do it is, generally when you're talking about something that is not center of the plate, it is going to have less effect on order growth than pizza or something that's kind of more the main meal. This is something that is not happening within our television right now. The answer is, this is more about kind of an add-on. It's more about potentially driving a little bit of ticket.
The assumption of your question is correct, which is something like this is not going to be as focused on order count growth as perhaps pizza might be. We're advertising around access to the brands, digital innovation. That's far more about order growth than the Marbled Cookie Brownie would be.
Great. Thank you very much.
Thank you.
Your next question will come from the line of Brian Bittner with Oppenheimer and Company.
Thanks. Congratulations, guys. A question about the assets. I understand re-imaging the assets may be a bit less important than a non-delivery company. Now that you do have pretty good amount of the domestic stores in this new image, are you in fact seeing a difference in the trends, at the re-image set versus the rest of the assets at all?
Yeah, I think it's very consistent, Brian, with what we've said before is kind of what we're continuing to see, which is an individual store getting re-imaged, will help the comp of that store by a point or two or three, when it gets done. What is far more effective or important is the effect that it has on kind of maintaining overall momentum in the business. Clearly, with the comp growth that we're experiencing year to date, we're awfully pleased with the brand momentum. We're continuing to see from that growth, far more is coming out of order count growth than out of ticket. This is about customers being excited about the experience that they're getting at Domino's, and the re-imaging of the stores clearly plays into that. The individual effect on an individual store is relatively modest as we have said in the past.
We do believe that we are seeing in the results some of the overall effect of more and more of our system being re-imaged.
Okay. Going back to the loyalty in the context of not what its impact is on the fourth quarter by any means, if you could just maybe just talk about it in general, how does the loyalty program that you put in place exactly work for your customers? Maybe if you could just talk overall some things about this program that you're most excited about as you now put a loyalty program into the system.
Yeah. What I'm really most excited about, Brian, is the simplicity of the program. Basically, you get 10 points for every order over $10. When you get 60 points, so effectively 10 orders, you're getting a free medium pizza. It's very simple. Six orders. Yeah. It's very simple, and customers understand it. We have seen how it can affect other brands. We've done a lot of research on this in designing it. Obviously, we're optimistic about it, or we wouldn't have rolled it out nationally.
Got it. It's a type of program where you know exactly what you need to do to get to an award. A reward. It's not a surprise factor situation like some other brands are doing.
No.
It doesn't matter how large. Sorry.
No, I was going to say, one of the things you learn from research on loyalty programs is, they can get very complicated, and you lose customers when they get too complicated. This is very simple. It's transparent. People understand what they need to do. Fundamentally, six orders over $10 gets you a free medium pizza.
Makes sense. All right. Thank you.
Thank you, Brian.
Your next question will come from the line of Jeffrey Bernstein with Barclays.
Great. Thank you very much. Two questions. Maybe Just first on the U.S. comp growth, it looks like now we're talking about four consecutive quarters where you've actually done double-digit comp growth.
We are.
I know you don't offer much guidance, but I'm just wondering how you even think about growth from here. You mentioned the new national digital campaign, which effectively started in Q4, and the loyalty program as well. When you think about those comps going forward, I'm assuming, like most of your peers, the focus is more on the two- and three-year trend, to be fair, and therefore, it would just seem like it's harder to sustain that level of growth. Again, I know you don't give guidance, but is it fair to say that you look at the two and three year and you'd have a tough time from a capacity constraint perspective, maintaining this type of double-digit momentum?
No. The capacity constraint issue is simply upside for us. It's something that can be dealt with. I will tell you that the best day a franchisee has, or we have in our corporate stores, is we have so much volume coming in that we need to add another oven or a longer make line or something like that to handle that capacity. I'd go back to the comments that I made about our franchisees and the system. Overall, I am just extremely pleased with how they are executing. At some point, if the volume coming into a store is simply too much to handle with the size of the overall store, then you've got an opportunity to add another store.
You're seeing that as part of the increase in net store growth. That too is a great day when you look at a store and say, "My volume, and as a result, my profits coming from the store are extremely strong, and I think it's time to add another store to handle some existing territory." Those are incredibly high-class problems. Look, obviously, we're really pleased with four quarters in a row of double-digit comps. I would point out, year-to-date, our international business is north of 7%, which, if you look at our history going back 15-plus years, that is as good as it has been over that period of time as well. Momentum is a powerful thing.
I guess what I'd say is we wake up every morning, we're trying to figure out how do we sustain momentum, how do we keep the growth going in the business. We are never satisfied with the sales that we're getting. We always want more. We're never satisfied with the execution we have in the stores, even though we're pleased with where we are. It's our job to continue to look for more opportunities to reduce friction points for customers. It's our job to keep momentum going. Obviously, I can't go into what's happening within quarters or expectations going forward, except to say that we are extraordinarily focused on keeping that momentum going.
No, that's tremendous. I assumed you were going to kind of acknowledge the year-ago compares, it seems like it's not necessarily that it's just lapping. A double-digit would imply you couldn't sustain the sequential momentum, which is obviously a little more impressive. My other question was just on the labor line, which I know it doesn't get a lot of question because you're primarily a franchise system, but from the company-operated side, there was some significant pressure in the third quarter. I'm assuming that that pressure is probably seen by the franchisees as well. I was just wondering whether you, one, had any quantitative data on the current or projected labor inflation % you're seeing, or whether in conversations with franchisees, there's feeling an inclination to price more aggressively to offset.
It seems like some other franchise systems are talking about franchisees getting more aggressive to mitigate what could be significant prolonged labor inflation. Just wondering what's your kind of sense of the franchise community.
Yeah. On labor rates, specifically around our company-owned stores first, we saw a little bit of an uptick in that line. Some of it wage rate, some of it just higher bonuses as our performance in our corporate operations have been obviously very good. On the franchisee side, on balance, we only have 375 corporate stores. I think the other 4,800 or so are generally seeing kind of the same environment around wages. The other thing I'd say is kind of despite any wage inflation, we haven't seen a ton of wage inflation, I would say that our entrepreneur independent franchisees are going to manage through it. Last year, when cheese was at an all-time high, they were able to put up their best ever on average unit economics in the 55-year history of the brand.
We have a lot of great franchisees out there that really don't look for excuses. They're really just focused on managing, and whether it's food cost or labor line item, they're going to manage through it. We're not overly concerned about wages at the moment.
The only thing I would add to that is reference the statement from before, which is we believe we're well on the way to the $100,000 of EBITDA for the average franchisee.
Different line items may move around on the P&L, but overall, at the end of the day, what we're looking at the most, and certainly what our franchisees are looking at the most is, what is the bottom line? The bottom line looks so far materially better in 2015 than it did in 2014, and 2014 was a record year.
Appreciate you easing those concerns. Thank you.
Your next question will come from the line of Stephen Anderson with Maxim Group.
Good morning. I have a couple of quick questions on foreign exchange. First, I want to ask, was the impact of the foreign exchange in the third quarter known at the time of the pre-release? Wanted to ask if you did know, why you weren't at liberty to discuss that. I have a follow-up question regarding guidance.
On FX, generally, it's been a headwind for us every quarter this year. The run rate on a material basis really wasn't that different than we've seen over the past 12 months. It's going to be $18 million-$20 million based on our current estimate. About three-quarters of that, now that we're through three quarters of the year, we've taken. Again, I don't think any surprise that FX is a headwind for us or any other QSR with international operations. When you look at the basket, we've got a real nice diversified basket of currencies. It's just that we find ourselves in 2015 where the dollar has decided to strengthen against darn near every single one of them.
Despite that headwind, we remain proud of what we've been able to do on the bottom line, and we'll monitor it going forward, I don't think the FX in Q3 was any different on a run rate basis than we had expected.
What gives you the confidence to not increase the high end of that guidance? Do you see any signs of moderation going forward?
Well, what we do as far as our estimating process on FX is we basically subscribe to an independent kind of economist consensus around FX, we get all of the best thinking around where people think FX is going to go, and that's how we derive our estimates. We're not taking our own personal view of the world or on FX markets. We just think that it's been a headwind. Q4 likely also to be a headwind with the comment I made earlier that we expect the total tally in 2015 to be $18 million-$20 million. Again, things can change, FX can change, that's our best view of it at the moment.
All right. Thank you.
Your next question will come from the line of John Ivankoe with JP Morgan.
Hi. Thank you. Can you hear me?
Yeah.
Oh, okay, good. I'm sorry. I'm in a hotel room. Just regarding the question on labor earlier. Obviously, there was kind of an increase in your company store labor cost. I think a lot of that was due to incentive compensation. My questions are several. As there has been that significant move towards digital ordering, what have you done with the labor in the store? Have you continued to reallocate the order takers that they might be able to reduce the number of labor hours in the stores? As we hear about minimum wages, at least from what I remember in the past, your drivers were paid kind of a full minimum wage, in other words, as a non-tipped employee versus a tipped employee.
In markets where the minimum wage might go to $15 an hour, your delivery driver turns into an extremely well-paid position, which I guess is fine. Do you actually have an opportunity to maybe classify some drivers perhaps as tipped employees, where the minimum wage impact might not be as significant for the franchisee? Thanks.
Yeah. First of all, we do have some tip credit team members out there, and it's kind of a market-by-market decision. We're looking at what we need to pay to get great people in markets, and that varies. Obviously, minimum wage varies. Your ability to apply tip credit at all varies state by state and sometimes city by city. It varies even more greatly with our franchisees who are making their own decisions on their compensation. There is a lot of variation on that. At the end of the day, we've got to pay at a level that's going to get us great team members. Ultimately, that's also going to include what their tips are going to be as drivers, and that also varies market to market.
Frankly, as we look at their overall compensation, we're taking into account the level of average tipping in different markets because we know that's going to be part of their decision that they're going to make whether or not they're going to work for us and what their total compensation picture is going to look like. In terms of labor and digital and kind of efficiency in the stores, I will tell you that there is still inefficiency in the stores. There's still opportunity to get better at how we manage our labor. We have an enormous advantage in our platform with our know-how with digital to be able to run our stores efficiently. When we were first getting digital ordering going
I will tell you that we expected labor efficiency faster than we saw it. We didn't really start seeing a lot of labor efficiency in the stores until we got to the 15%-20% digital order range. We were looking very carefully when we were single digit 10%, and we had to look awfully hard to see it. The reality is that you've got a fixed amount of labor in stores to cover shifts, to cover the basic functions in the store. When it was a relatively low level of digital orders, your ability to offset labor was pretty minimal. As it's gotten higher, we've started to see more impact from that. We're in the range now with digital sales around 50% that we clearly can see some savings in the store.
What's maybe more important than that, though, is not just the labor savings, it's the overall profitability of digital orders. What's most important on that is order count growth. Is the customer experience, the ability to drive frequency, retention of those customers, that's ultimately what drives better overall economics in the stores. Volume, order counts, happy customers, ultimately has more effect than labor savings or anything else. We believe, given the strength of our digital platform, it puts us in certainly a better than average position to manage the overall cost structure, particularly if we see change in that going forward. We continue to make investments that hopefully are going to continue to create even more competitive advantage around that.
That's great. Thank you.
Thanks, John.
Your next question.
Quick ones. First, just looking at pricing, looks like you had a bit of an increase in ticket. Mostly traffic. Can you guys get more ticket or take price increases in today's kind of competitive environment?
Well, we've had some ticket. Go back to the comments I made about Marbled Cookie Brownie. That helps. Getting ticket, fundamentally, you have two ways of doing it. You can sell more food or you can increase price. If you can get it by selling more food, that's going to help the overall profitability of the order. It is also something that is not going to negatively impact the customer in any way. I think my overall take is customers, their money post the downturn in 2008, 2009. That hasn't changed. They've got access to more pricing information. They're making smarter decisions. That's ultimately a great thing. That helps us because we create great value. In terms of, is there significant pricing power for us? No, there's not.
I don't think you can take aggressive price in this economy right now and not expect that it's going to hit your order counts. We do it very judiciously. When we can, we try to take it by selling more food as opposed to directly increasing price. Both of those play in, and the majority of the pricing decision is made locally by the store. They honor the national price point, but the majority of sales are being done off of local price points, local menu pricing, local coupons that are being chosen, and that gives you an ability to adapt to local market conditions, both customer demand and the cost structure that's in place market by market.
Okay. You spoke to my second question a little bit. When you do see a current order with dessert, is it typically incremental to the check, or do customers cut a little bit out of their order to fit in that dessert? I guess, just looking at Marbled Cookie Brownie, if you do move to marketing that, should we expect that to be purely incremental, or will people cut something else out?
You hope for it to be as incremental as possible, obviously, and we wouldn't do it if it wasn't incremental. Can you see it cannibalizing a little bit? Sure. We have terrific lava cakes, and you would expect to see a little bit of it come out of the lava cakes. We wouldn't do it if we didn't think that it was going to be largely incremental.
Okay. Excellent. Thank you.
Thank you.
Your next question will come from the line of David Carlson with KeyBank.
Hey, thank you. I got a couple questions for you guys, and I appreciate you guys taking the question. Jeff, first on the commissary segment, I realize that the $1.4 million of insurance claims was included in the costs during the quarter. Even when we adjust that out, the supply chain segment profit was shy of our expectations and was about $1.7 million below the profit generated in the first two quarters of 2015. I know cheese prices were about $0.10-$0.15 higher in the third quarter than they were in the first two quarters of 2015, which in all honesty, would have expected that to result in significantly higher revenue than what you guys reported. Really hoping you could discuss some of the moving pieces and parts of the supply chain and some of the factors that may be impacting profitability.
Yeah. On supply chain, if you just look at the margin, supply chain margin's $31 million for the third quarter. A year ago, it was about $29 million. We obviously have a bunch of flow-through from volumes. Most of our comp increases in the quarter and year to date have been from traffic as opposed to ticket. You do have the insurance charges you mentioned. Other than that, it's nothing really material that really sticks out to us. It was a little bit down as a percentage, the operating margin as a percentage of revenues. Again, we attribute that more to the insurance charge than anything. We're not seeing big changes in things like labor rates or things like that. Really have nothing really incremental to share with you. It's a good business for us. It's a good business for our franchisees.
They get great product, better than they can buy it anywhere else. It's got a good ROI for the business. Other than that insurance charge, really nothing else to point out.
Okay. I think my question on the loyalty program is probably a little bit more general and not necessarily specific to the fourth quarter. Can you guys discuss the plan to convert user profiles to loyalty members? Are you guys offering any incentives, let's say, anything like that? Just any sort of information that you can provide.
It's really easy. All they have to do is click a box on their pizza profile. We make that as simple for them as we possibly can.
You said 40% of the digital users include pizza profiles?
Correct.
Okay. Just out of curiosity, how much did the digital mix increase during the third quarter? I know this is the quarter usually where it's supposed to start increasing once people go back to school, et cetera.
Yeah. Except that you really see that then in fourth quarter, still very consistent.
Around 50%.
Yep.
Thank you, guys.
Thank you.
Your next question will come from the line of Joseph Buckley with Bank of America.
Thank you. A couple of follow-up questions. Just on the insurance charges, will you be accruing at a higher level going forward, like thinking about next year and maybe the out years?
Yeah. As Patrick mentioned earlier, we're all hands on deck on ensuring that the financial picture around insurance doesn't repeat itself as far as kind of this little blip we had. More importantly, it's about getting team members home safely. Our runway going forward, it will also largely be determined by an actuarial estimate for the next fiscal year. We expect that to be marginally up from our historical run rate, just because of the increase that we had early this year and some of the severity that we saw. We don't think that's going to be a materially higher run rate. Again, as Patrick mentioned, to the extent that we're successful in managing through this, I think we're going to get it down to the long-term run rate over time.
I don't expect it to be a material headwind for us or an increase really in 2016. Maybe a little bit, again, that'll be kind of done with our independent actuary, coming up in the next couple of months.
Got it. Thank you. Then, a question on the supply center revenues. You mentioned equipment sales to franchisees as the reimages, the remodels occur, I guess also maybe the new unit openings. Can you tell us what portion of the supply chain revenues that is, what is the margin on that? Is that a profitable sale for you?
Yeah. First of all, we haven't broken out exactly what those sales are, but the answer is net of the people that we needed to add to manage this process of going through the re-imaging, it will have no positive or negative effect on our bottom line P&L. If what you're kind of getting at is should you worry about whether or not as we finish the re-imaging, whether or not there will be a drop-off in profits because we're no longer selling the equipment for the re-images, the answer is no. You shouldn't worry about that because net of the people we needed to add to manage through the process, it has no positive or negative effect on our profitability.
Got it. Thank you. Then Patrick, just a big picture question. We're seeing lots of companies, lots of brands announce delivery relationships, not every business lends itself to delivery like the pizza business has, it's in the genes of the business long term. I'm curious what you think about this movement towards delivery, just broadly, what maybe are some of the things that some of these companies or brands will have to deal with that's just a natural part of your business, but it's going to be some new consideration on their side.
Well, first, clearly we're one of the world leaders in real-time delivery. We've been doing it a long time. We're very efficient at it. We've got a lot of systems built up around that, particularly operationally. I guess what I would say is there are a lot of people who have gotten into the space. My understanding is that as it relates to moving packages and food, very few, if any of them, are today making money doing that. There are folks that are doing pretty well out there moving people around, but I think people are learning that moving packages around and the scale that you need to do that, it's not easy. There are real operational complexities to it beyond building the software platform to do it. We're really good at it.
As people have tried to compete with us around the world in delivery, I think they have found out over time that it's operationally not as easy to operate as people may think. It has been a great source of advantage for us versus our competition, both what we're able to do with the digital platform and the scale of our business and the ability to spread those costs across the system has built a pretty effective competitive advantage for us. As people have tried to get into physically moving food or packages around, I think they're finding that the economies of scale on that are pretty tough. We watch it closely, both domestically and around the world. We're pretty confident of our ability to do it awfully well, and as you're aware, we've been investing heavily to continue to drive efficiencies for us in doing it.
Patrick, another big picture question. Is the movement towards delivery of restaurant meals more advanced internationally? Yum! was talking about this yesterday with respect to its China business, and I'm just curious, given your international footprint, and I know China's not a very critical market for you at this point, but if you're seeing delivery outside the U.S. gaining traction faster.
Certainly, if you look at China, you've seen both KFC and McDonald's in major cities have done delivery, That's still less common for them across their systems than more common. China, I think, has been a little bit more at the forefront for those brands in moving to delivery. There are certainly lots of aggregators out there for digital ordering, Most of which are not at significant scale yet. Then I think from the delivery service side, there are certainly markets where that's moving faster than others, but I don't know that I would say it's materially different in international than it is in the U.S. I don't know that it's any more advanced in a lot of these markets than what we're seeing in the U.S.
Our business in China, we're still under 100 stores, but we continue to be pleased with progress we're making there. Obviously, it is still a relatively small business for us.
Thank you. I appreciate that perspective.
Thanks, Joe.
There were no further questions in queue at this time.
Thank you, everybody. I look forward to seeing you at our Investor Day in January, as well as discussing our fourth quarter earnings and year-end results on February 25th.
This does conclude today's conference call. You may now disconnect.