Good morning. My name is Tanisha, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Quarter One Financial Results Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you wish to ask a question during this time, simply press star, then the number one on your telephone keypad. If you wish to withdraw your question, press the pound key. Thank you, Ms. Waddell. You may begin your conference.
Thanks, Tanisha, and thank you everybody for joining us for our first quarter results conference call. We're excited to be here. With me today, I have Patrick Doyle, our Chief Executive Officer, and Mike Lawton, our Chief Financial Officer, both of whom will speak today. As always, we ask our friends from the media to remain in a listen-only mode today. Also, I direct all of your attention to our 8-K, where we have our safe harbor statement listed in the event that we make any forward-looking statements. With that, I'd like to turn the call over to Mike, who will start with his prepared comments.
Thank you, Lynn, and good morning, everyone. I'm pleased to report that we delivered solid results for our shareholders during the quarter. Our international and domestic divisions posted strong same-store sales growth. Our international division opened a significant number of new stores, adjusted EPS grew 25% over the prior year. Now let's go through the results for the first quarter, I'll start by looking at our system-wide sales. Global retail sales, and those are the total retail sales at franchise and company-owned stores worldwide, grew 10.5% when excluding the impact of foreign currency. When we include the impact of foreign currency in the quarter, our global retail sales grew by 9.4%.
The drivers of this growth included domestic same-store sales, which rose 6.2% in the quarter, lapping a positive 2% in the first quarter of 2012. This was comprised of franchise same-store sales, which grew 6.3%, company-owned stores, which were up 5.0%. These increases were driven by our continued consumer offering of higher quality food and value pricing and increased advertising supporting Q1 promotions. We also attribute approximately 1% of the same-store sales growth to the benefit of New Year's Eve and New Year's Day falling in the first quarter of fiscal 2013, as the dates of these holidays did not fall in the first quarter of 2012. Although we don't provide specifics of order count and ticket for competitive reasons, we did drive strong order count again in the quarter.
Value pricing, combined with the many other efforts we made to build our business in the quarter, can be a strong catalyst for order count, but can also lower tickets slightly, as it did in the case of Q1. Clearly, the overall effect for us was a positive one. We closed five net stores domestically in the quarter, consisting of 10 store openings and 15 closures. As we mentioned previously, we expect to see modest positive domestic store openings for the full year. Our international division had another solid quarter as same-store sales grew 6.5%, lapping a strong 4.7% increase in the first quarter of 2012. International also benefited in the range of 1% from New Year's Eve and New Year's Day falling in the first quarter of 2013.
Our international division grew by 80 stores this quarter, made up of 85 store openings and five closures. Turning to revenues, our total revenues were up $33 million or 8.6% from the prior year. This increase was primarily a result of three factors. First, higher supply chain revenues resulting from increased volumes from higher order counts, a change in the mix of products sold per order, and an increase in commodity prices. Second, higher domestic and international royalty revenues due to same-store sales growth and international store count growth. Finally, we contracted a third party to manage our gift card program, which entailed the third party assuming the majority of our gift card liability for a small fee.
As a result, we reduced our gift card liability by $2.6 million, which was booked as revenue and reimbursed the system's advertising fund $1.8 million for its historical cost of the program. We expect future impacts to revenue and G&A expense from this program to be minimal. Moving on to our operating margin. As a percentage of revenues, our consolidated operating margin for the quarter increased by 1.3% from 29.8% to 31.1%. This change was essentially driven by three factors. First, a change in our mix of revenues positively impacted our operating margin as we now have more franchise revenues from royalty, which have no cost of sales, as well as the change in our gift card program.
Second, company-owned store operating margins increased as a percentage of revenues from the prior year quarter due to higher volumes, which leveraged labor and occupancy cost. This was slightly offset by higher food cost. Third, our supply chain margin percentage increased slightly from 10.6% to 11.3% due to the positive impact of product mix and higher volumes, offset by an increase in the commodity cost. The average cheese block price in the first quarter was $1.67 per pound versus $1.52 last year, which contributed to a 2.5% increase in our overall market basket during the quarter. As a reminder, food commodities are generally priced on a constant dollar markup to our franchisees. Therefore, the higher cheese prices do not impact our supply chain dollar profit. They did, however, negatively impact our supply chain margin as a percent of revenues.
Overall, we continue to expect a commodity increase of 3%-4% in 2013, which we believe will be manageable in the overall context of our business. Turning to G&A expenses. G&A increased by $6.5 million, or 13.6% quarter-over-quarter. The increase was primarily due to the following factors: variable performance-based compensation expense and investments in the international and technology areas of our business, an increase in non-cash comp expense, and the one-time reimbursement we made to our systems advertising fund related to their support of our gift card program, as I mentioned a moment ago. As we have previously indicated, we estimate our full year G&A to increase an additional $9 million-$13 million over 2012 due to planned investments to expand our international support team, e-commerce and technological support, and the increase in non-cash compensation.
Also note that we charge franchisees for providing e-commerce and technological support, and we expect to have increased revenues of $1.5 million-$2 million in 2013 related to these services to partially offset these cost increases. Keep in mind that G&A expense can vary up or down by, among other things, our performance versus plan, as that affects variable performance-based compensation, as well as the timing of hiring of team members. Regarding income taxes, our reported effective tax rate was 37.0% for the quarter. While this rate was slightly under our normal range, we continue to expect that 37.5%-38.5% will be our effective tax rate for the foreseeable future. Our first quarter net income was up $13.7 million, or 66%.
When you remove $7.4 million of items affecting comparability, primarily expenses related to the recapitalization from the first quarter of 2012, net income was up $6.3 million, or 22.3%. This increase was primarily driven by higher domestic and international same-store sales, international store growth, and higher company-owned store and supply chain margins. Our first quarter diluted EPS was $0.59. There are no significant items that affected comparability during the quarter, so as reported, EPS was the same as adjusted. The $0.59 is a $0.12, or 25%, increase from the $0.47 as adjusted EPS in the first quarter of last year. Here's how that $0.12 difference breaks down. Our improved operating results benefited us by $0.09.
Our lower diluted share count, primarily due to our stock repurchases, benefited us by about $0.015, and our lower interest expense and slightly lower tax rate benefited us by another $0.015. During the first quarter, we generated $42.6 million of free cash flow, which we used to make scheduled principal payments on our debt and repurchase and retire shares. We repurchased and retired approximately 363,000 shares for $18 million at an average price of $49.65 per share. We ended the quarter with $75 million of unrestricted cash. In closing, we are pleased with the results of the quarter. We will continue to focus on improving our operational performance, growing our global store base, and utilizing our free cash flow to drive shareholder value. Thank you for your time today, and I will turn it over to Patrick.
Thanks, Mike. Good morning, everyone. We're off to a great start for 2013, as you can see from the results we reported this morning. They speak not only to the strength of our franchise business model and the consistency it can produce, but also to the power of our brand, our very strong operators, our compelling technology, and our quality food at a good price. In the domestic business, we drove solid traffic despite the fact that we were not on air with a new specific product. Instead, we featured a variety of great food at the same great value we've offered for some time now, which our customers responded to. Value is something that pizza is known for.
For under $25, including a tip for delivery, you can feed a family of four with pizza, something that we feel keeps our category strong in an uncertain economy versus other segments of the restaurant industry. Our value offerings were backed up by really strong advertising during the first quarter, which included high-scoring ads that resonated well with our customers. While we did not promote our new Handmade Pan Pizza on TV in the first quarter, we know that this high-quality, fresh, not frozen dough product continued to be popular among our existing customers as well as new ones. It's a product that continues to perform well. Now that we have this additional pizza platform, it gives us room to grow in a new crust segment and take some share, which we recently have been taking from regional chains and independents.
Strong sales and traffic were the highlights for our domestic results in the first quarter, while continued sales strength and robust store openings were clearly the highlights for our international business. You may have seen that our U.K. master franchisee posted very strong results in the first quarter, not only in the U.K. but also in Ireland. They posted some encouraging results in Germany and Switzerland as well. South Korea, Turkey, and Brazil also experienced great results in the quarter, demonstrating the broad geographic strength of our brand and its resilience in a variety of economic climates. We also drove great store growth this quarter. One example was Japan, where they hit the 250-store milestone. While Japan's a developed market economically, it's not a mature pizza market yet. We see more potential for growth there.
We like our mix of both developed and emerging economies. We see excellent opportunities for sales and sales growth around the world as delivered pizza remains a very under-penetrated segment. One opportunity we're proud to be developing worldwide is our innovation around online ordering and technology. Domestically, we continue to drive orders and sales from all of our digital platforms. We are also continually improving these sites with enhancements like card on file, which is now available for online orders and will soon be available for all mobile orders as well. Digital ordering averaged over 35% of total sales in the quarter. Mobile ordering continues to be our fastest-growing segment. Technological innovation continues to be an advantage in a number of our international markets as well. In Australia, they recently launched an app that allows customers to give stores real-time feedback.
Customers can also see how their local store is rated by others and what the top five customer-rated stores in the country are. Japan recently launched an iPhone app featuring a popular Japanese Vocaloid, which is a synthesized singing animated character popular in Japan. In the U.K., ordering through mobile devices is now over a quarter of all orders, with over 60% of delivered sales coming through digital channels. Clearly, digital ordering is where the pizza industry is going, not just in the U.S., but worldwide. As Mike noted in his comments, even though we now have a regular dividend, we still have the flexibility to deploy free cash flow for share repurchases. We also deployed cash for a scheduled principal payment on our now year-old debt facility. We recognize that interest rates have come down even lower than our current favorable rate since we refinanced last year.
Provisions of our debt structure make it unattractive to restructure our existing debt now or in the near term. In conclusion, our consistent results, our technological advantage, and powerful global brand have resulted in a great start to the year. We're well-positioned for the year ahead with no plans to rest on our laurels. We intend to open more stores, offer compelling consumer promotions along with high-quality products delivered with the service that we've been known for worldwide. We're focusing on technology and staying ahead on innovation, both in the U.S. and in many of our international markets. As always, we are continuously making sure that we're also doing what we believe is best for the long-term strength of our company and our shareholders. With that, I'd like to turn it over to the operator for questions. Operator, I am ready for the first question.
Our first question is from the line of Michael Kelter with Goldman Sachs.
To check in, you had mentioned in your past analysis that weather wasn't a major driver of your business. Now that the first quarter is under your belt, do you still feel that way? Or did weather possibly help the first quarter, given how extreme the shift was this year versus last year, and maybe it fell out of the norms of your model?
Yeah, the answer is, it's possible that it slightly helped, but it's kind of the inverse of what we said last year about the first quarter, which was working against us, and the model says it's just not enough to be material to the overall results. No, don't think weather was a factor.
You mentioned no plans to refinance the debt because of the penalties that you'd incur. Are there any other options that you have available to you that you might be considering, maybe extending your leverage within the confines of the existing facility?
Yeah, we've looked at it. I think in the near term, probably no news on that front.
One last one. The stock continues to move higher, inclusive of multiple expansion, given how strong your fundamentals are. Is there a point where you stop buying back stock and look for other accretive ways to deploy the free cash flow?
The answer is, as it's always been. We're always going to look at what we think is going to give and produce the best returns for our shareholders. We're always looking at every possible way of doing that. That's going to be driven by our analysis.
All right. Thank you.
Thanks, Michael.
Your next question is from the line of Brian Bittner.
Patrick, Mike, congrats to you and your team on these excellent results once again.
Thanks, Brian.
I want to actually ask about the supply chain business. You had a 20% increase in operating profits in that segment year-over-year. It seems as though there's some type of operating leverage in that business as your volumes do increase. Is that so? What type of contribution margin does incremental throughput come at in that business? Is there something else that happened in the quarter that got you that operating leverage in that segment?
Brian, you're right. There is some operating leverage there. There's also a lot of what happens with mix because the margins on different products are not the same. You look year-on-year and last year with what we were doing with Stuffed Cheesy Bread and Parmesan Bread Bites and the fact the volumes were actually down a little bit as opposed to up. You look at that this year, we've got Handmade Pan Pizza. We've got a different mix going through there. There's a combination of factors at work.
As we go forward here, though, if you get volume upticks, you expect the profit growth of that segment to grow faster than volume growth, right?
Yes. We certainly get some leverage off the higher operating volume. I think that it is fair to say that the margin that we had this quarter is probably up on the high side of what one should be expecting.
Okay. On the technology side, are you still really in the learning phase when it comes to using this platform to actively drive incident rates and actively drive average check, whether it be one-on-one marketing or just interaction throughout the payment process? Is this something that's much more active now, kind of transitioning away from education phase and starting to apply it?
I think the answer, Brian, is probably somewhere in the middle of what you just laid out. There is still enormous learning that's taking place. We actually have the CMOs and the CIOs of our largest international markets downstairs. I was just meeting with them an hour ago. A lot of the discussion, all the discussion, is really around learning from around the world and best practices. I think there is still enormous learning and enormous leverage that we're going to get out of the digital platform. Obviously, we're doing great things with it. We continue to believe that it is a big reason why you're seeing share gains for the larger players versus the regionals and the independents. There is clearly a lot to come on that front.
Our calendar going out a few years is pretty full with innovation that we think is going to continue to drive impact with customers.
Great. Thanks, guys.
Your next question from the line of Mitch Speiser with Buckingham Research.
Great. Thanks very much. Patrick, at the Analyst Day in January, you indicated in 2012 that your online orders in the U.S. were up about 27%. I was wondering if you could share that information here in the first quarter, if that rate has sustained.
Yeah. I'm trying to find numbers here, but yes, it's clearly still growing double digits. If you look back four or five years, the answer has been mix has been growing about 5% a year, overall mix of sales. We tend to see that ramp more in the fourth quarter and into the first quarter every year than during the spring and summer and early fall. It's an interesting pattern that I'm not sure we entirely understand yet what drives that. Yeah, we're continuing to see the gains. The trajectory on growth continues to be in that same range. So I don't have the exact year-over-year number on it on growth, but it's staying at pretty much that same pace.
Okay, thanks. At the Analyst Day, it was brought out that the big three chains in the U.S. have about an 85% market share of online orders, which is obviously dominating. As we look forward, how durable do you think that is, especially with technology becoming more and more accessible? Can you maybe give us a sense of can this competitive advantage sustain on a long-term basis?
Yeah. We really think it can. We're investing very heavily in both people and capital in technology. There are solutions for regionals and independent players out there, but they simply don't give the same experience to their customers that they can get through our platform or frankly, through the platforms of Pizza Hut or Papa John's. I've described this before, but while we believe, and if you look at Google Play and iTunes and how things are rated, we do incredibly well versus our largest competitors. We think the bigger gap in technology is between the three of us and the regionals and independents. That continues to be true, and I think it's going to be something that's very difficult for them to overcome. They do have third-party platforms that they can access, but it's just not the same experience as you can get from us.
Yeah, we do think it's a serious competitive advantage. It's something that we're going to continue to invest in to try to maintain and grow. I'm sure that some of them are going to do better things into the future, but I think it's tough for them to catch up with us.
Great. Thanks very much.
Your next question from Joe Buckley of Bank of America.
Thank you. Just a couple of questions on the advertising. Was the pickup in national advertising presence through the entire quarter? Did that begin with the beginning of the year?
I think so. There are going to be some weeks that are going to bounce around a little bit, overall, the quarter had a good lift on GRPs versus last year.
Okay. The Pan Pizza wasn't featured, but did you get pretty good carry through from the fourth quarter launch and the marketing support in the fourth quarter for the Pan Pizza?
Yeah, we sure did. It is performing very well for us. First quarter was a good test for us. You learn a lot on the strength of the product once you go off air. We were off air for the entire quarter. Now we're back on air with Pan. It performed very well for us through the first quarter. Couldn't be more pleased with that product.
Okay. Just one more, Patrick. You mentioned a 35% digital order mix, I believe. Was that for domestic?
Yeah. I was talking about domestic. North of 35% of sales domestically. It's a very comparable number in international as well, with broad spread market to market. There are markets that are over 50%, there's still markets that are relatively early in their development, there are some that are still not offering online ordering. Those are relatively small. Yeah, overall, the average outside of the U.S. is about the same as the number inside the U.S.
Very good. Thank you.
Thanks, Joe.
Your next question comes Alvin Concepcion with Citi.
Hi, congrats on a great start to the new year, and just another follow-up on the Pan Pizza. I think on the last call you mentioned you were bringing in some new customers with it, but the demand was being driven mostly by existing customers. Was that still the case this quarter, particularly since you were off air? If that was the case, as Pan Pizza is being advertised again on TV, have you seen that dynamic change at all?
Well, I can't get into the second quarter, but for the first quarter, yes, that was absolutely still the dynamic. It has really been about increased frequency, increased retention. Mostly the dynamic has been customers of Domino's who have gone elsewhere when they wanted to buy Pan Pizza are now staying with us for those occasions. It does bring in new customers, but it has not been bringing in new customers particularly out of line with what we typically see when we're on air with promotions. Most of the growth has been in orders in fourth quarter and in the first quarter have really been through higher frequency from existing Domino's customers.
Great. Are you looking to launch the Pan Pizza in other markets this year? If so, what's the timing look for that?
Not going to get into specifics on that one.
Okay. Thank you.
Thanks, Alvin.
Your next question from John Glass with Morgan Stanley.
Excuse me. Just first a follow-up on the advertising spend. Is the increase ratably equal across the quarters, or will there be quarters where you've got heavier weights than you did based on the incremental spending versus a year ago?
I don't know that I want to give our competition too much information on this front, I guess what I would say is that first quarter was probably going to be a bigger increase overall than you'll see the balance of the year. I'm not going to go into more than that just for competitive reasons.
This is a bit of a left field question, but given the increases in digital technology and online ordering, is there a catering opportunity for Domino's? School lunches, for example, in some school systems, including ours, sometimes get Domino's Pizza for lunch. Is there an opportunity to nationally expand your ability to market to larger organizations or create national accounts where people can order and maybe online is sort of what unlocks that opportunity for you?
We actually already do some national account business, which has been kind of an interesting little growth area. It's still relatively little. The ability to deliver for a company function to 50 or 60 or 70 locations for some events is something that we're pretty uniquely suited to do. I think the answer is, we've looked hard at catering. I don't know that people think about Domino's the way you often think about kind of catering, we do think that there are things we're going to be able to do to make large orders easier for customers into the future, and digital clearly helps that. More to come on that. I don't know that catering exactly the way that we all kind of think about catering will be a big area.
I think there are definitely things we can do to make larger orders easier for customers.
Thanks. Just Mike, I'm sorry, the G&A commentary I lost a little bit. Can you just recap what is extraordinary this quarter about G&A? I know there's some ongoing investments, maybe you could just recap what's going to stay in the first quarter and what persists in the balance of the year.
As I said, the main components are the fact that we've got an additional contribution to our marketing fund as a result of redoing the way we handle gift cards. That was
About $1.8 million. In future quarters, that will not probably have a comparable number. Anything we do with gift cards going forward will be much smaller. We did have an increase in non-cash comp versus last year. We will continue to see that throughout the balance of the year. We also had some higher variable comp because we did have a very good quarter, and that does have a tendency to move up and down. We also had significant amounts versus last year, for we did have additional expenses for the investment we've been making in IT and in international.
Okay. That, I presume, is spread across the four quarters?
Yes.
Great. Thank you.
Your next question from Mark Smith of Feltl and Company.
Hi, guys. First off, just as we look at the consumer spending environment through the quarter and consumers maybe pulling back early in the quarter, can you give us any insight into cadence of comps and whether you benefited from a value proposition early in the quarter?
Yeah. I'd like to go into kind of breaking apart the quarter. Clearly, we had strong order count growth. We're very aware of what's been going on in the rest of the restaurant industry, that particularly January, I think in a lot of the category, looked a little bit slower. Clearly, our results were well above what most in the category were seeing. It's a little harder for us to kind of pull it apart because happily, we kind of overperformed versus, I think, a lot of the industry. I think the answer is consumers, in many ways, have cleaned up their balance sheets. I think they knew what was coming, to a great extent, with some of the changes on taxes. Our belief was, as we were watching our numbers coming in, that the impact was maybe more muted than what people had expected.
We also started seeing results from the rest of the industry, it certainly looked like there was some effect from that. It's a little hard for us to say since our numbers appear to have been better than a lot of the category. Overall, my take is customers have gotten a little more conservative about their balance sheets. That means that they're able to weather things a little bit better when there are changes, I think they knew that the changes were coming. All of that said, we're a good value, we've continued to be a good value. Our offer was consistent with what we've done in the past, we think that certainly continued to be strong for us in the first quarter and part of why we had a strong quarter overall.
Okay, great. Second, just as we look at competition, you said you continue to take share from regionals and independents. As we look at more kind of niche specialty pizza players and the fast casual space, is there anything that makes you nervous or that you see changing in the pizza category?
Yeah. First, I have no idea what fast casual is in pizza. If you look at fast casual, largely it's defined as better quality, better tasting product, and we think we have that. We think that's part of why we've had strong growth over the last few years, really since we relaunched our brand. There are a lot of people out there doing interesting things in the pizza category. We continue to watch all of those things. I would tell you none of those are at a scale that you see any real effect. Some that have gotten a lot of attention have already closed a lot of stores. We've seen that in some markets as well. Overall, the answer is, there are a lot of independents and regionals out there. Overall, we know that they have been losing share to the largest players.
Are there some brands that are doing better and on their way up within that? Absolutely. The net effect is the larger players have been taking share from the smaller players.
Okay. One last question, just as we look at the timing and getting maybe some benefit from New Year's. Any other holiday shifts that had an impact or that we should be watching through the remainder of the year?
Don't think so. It was really just New Year's in this year, but that was close to a point. The rest of the year, I don't know that we're seeing anything. We're looking at each other here. I don't think there's anything particularly big coming from a shift.
Okay, great. Thank you.
Your next question is from Peter Saleh of Telsey Advisory Group.
Great. Thanks. Congratulations on the quarter. I just wanted to ask, I mean, we've continued to see growth in comps and in the pizza category. I know we've talked about this in the past, what are your thoughts on accelerating unit growth in the U.S.?
Yeah. The answer is, we still expect some growth this year. We've been saying modest growth, and we think it's going to continue to be relatively modest in the U.S. Obviously, over time, we'd like that to become more meaningful. I think we still need to prove that. That's clearly an area where there's upside if we can get that going. I think still for the near term, I'd expect relatively modest growth on the domestic side.
Are franchisees who want to grow, are they having any trouble finding financing?
It's gotten much better for larger players. If you own 10 or more restaurants and you're looking to borrow $1 million or more, the answer is that market has gotten very robust. If you're a small player, particularly if you're looking to buy your first store, that market is still relatively tight. It's two very different markets. For our larger franchisees, the financing environment is really quite good at this point.
Just last question on China. Where do you stand on China and getting a more robust growth going there?
Yeah, we're happy with progress in China. It's still relatively small, but we're moving along there, and over the longer term, we're optimistic. In near term, given the scale of the business as we're still ramping up, I don't think it's going to be a big driver. Longer term, we're certainly optimistic about China.
Great. Thank you.
Your next question is Steve Anderson of Miller Tabak + Co.
Morning. I want to go a little bit further on the new unit development plans domestically. In light of your new prototype that you've launched, have you set any numerical goals you'd like to have, at least from a company-owned standpoint?
We have not yet, but we will move faster on re-images and relocations with our own stores than we would ask our franchisees to. We're still working through the analysis on the new designs and how they're doing, and so no conclusion on that yet. I think short answer is no. We don't have specific time frames around that yet.
How many of those do you have in operation right now?
A bit north of 100.
Okay. Thank you.
There are no further questions at this time. Do you have any closing remarks?
No. Just like to thank everybody for being on today's call and look forward to updating you further on the business in July when we report our second quarter results. Thanks everybody.
This concludes today's conference. You may now disconnect.