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Edited Transcript of DOM.L earnings conference call or presentation 6-Aug-19 8:30am GMT

Half Year 2019 Domino's Pizza Group PLC Earnings Call

London Aug 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Domino's Pizza Group PLC earnings conference call or presentation Tuesday, August 6, 2019 at 8:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* David Gregory Bauernfeind

Domino's Pizza Group plc - CFO & Executive Director

* David James Wild

Domino's Pizza Group plc - CEO & Executive Director

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Conference Call Participants

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* Heidi Mercia Richardson

UBS Investment Bank, Research Division - Associate Director and Equity Research Analyst

* Julian Kenneth Easthope

RBC Capital Markets, LLC, Research Division - Analyst

* Natasha Brilliant

Citigroup Inc, Research Division - VP

* Ned Peter Hammond

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Nigel Andrew Parson

Canaccord Genuity Corp., Research Division - Analyst

* Richard Michael Taylor

Barclays Bank PLC, Research Division - Analyst

* Richard Paul Stuber

Numis Securities Limited, Research Division - Analyst

* Ross Broadfoot

Investec Bank plc, Research Division - Research Analyst

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Presentation

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [1]

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Good morning, everybody, and welcome to our interim results presentation. I'm joined this morning by David Bauernfeind, our CFO; also our Chairman, Stephen Hemsley, is in the front row; and Bethany Barnes, who joined us in April as our new Head of IR, whom, I hope most of you have met, is also here.

Thank you for taking the time to come along this morning. This is the agenda for today. I'm going to give a very quick overview of the results, which we've announced this morning and then going to hand over to David, who's going to go in the financial performance in detail for both the U.K. and our international businesses. David will then hand back to me and I'll go into more detail about the U.K. before David and I take questions on the results and other matters.

This slide shows you the summary financials for the first half year. And as you can see, in a challenging U.K. consumer market, our retail sales or our system sales grew by 5.5% to almost GBP 600 million. That was on the back of like-for-like growth excluding splits of 3.9%, and which converted into an earnings before interest and tax number which was 7% higher than the previous year. That largely reflects the comparator of this -- the run-up in Warrington in 2018, and that explains the slight beat to the sales growth.

International lost GBP 6.4 million, and that meant that Group EBIT was declined to GBP 45.2 million, 2.6% down on the year. Underlying Group PBT dropped by 7.4%, basic EPS by 3.8%, reflecting the impact of the buybacks that were done in 2018 and early 2019. And this morning, we're announcing an increased dividend of 3.7%, 4.2p per share, reflecting the performance of the U.K. business rather than necessarily the Group performance.

Having given that overview, I'll now hand over to David, who'll go through the financial numbers in detail. But before I do that, I should just say Bethany's looking horrified. Before I do that, I just want to say a word about the franchisee relationship because I know that's important and it's certainly very important to us. We are actively involved and have been actively involved in detailed discussions with our franchisees, and we're giving this considerable focus and attention. Whilst we are in these discussions, it's inevitable that normal working practices will be affected and you may have seen that in the impact on new store openings, in other practices such as national promotions, and GPS rollouts are being impacted.

It's very important, both to us and our franchisees, that we allow sufficient time for discussions to take place and for agreements to be reached, and this will go on into 2020 we expect, rather than predicting a rapid solution. We're both confident and determined that we need to agree long-term sustainable win-win solutions with our franchisees. Fundamentally, our interest of our franchisees are aligned with ours in terms of growing the Domino's brand, and we're determined, as we manage the U.K. business in the coming months, that we reflect this in the discussions, and we make the right moves in terms of providing the right platform for future growth. And with that, I'll hand over to David.

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David Gregory Bauernfeind, Domino's Pizza Group plc - CFO & Executive Director [2]

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So thank you, David, and good morning, everyone. So I'm going to take you through the interim results. I'll start with the income statement and then cover the 2 segments before moving on to investments and cash flow. I'll then discuss franchisee profitability before handing back to David.

So before getting into the results, I want to cover of the restatement of statutory revenue that we highlighted in the announcement. The Group implemented IFRS 15 last year. At that time the Group believed that the implementation of the new revenue recognition standard had no impact on the treatment of the revenue relating to the franchisees, national advertising fund and e-commerce fund. Subsequently, in conjunction with the technical assessment undertaken by our new auditors, it's been concluded that it's appropriate to include in our income statement the revenue and costs associated with these 2 funds. We've, therefore, adopted this revised treatment in the income statement and have restated the half year comparatives accordingly. We've also provided details of the impact on last year's full year results.

This change has no impact on the profits or cash flows of the business, and does not reflect any change in the operation of the funds. We continue to believe that system sales, rather than statutory revenue, is the most appropriate top line growth measure for the business. Therefore, we will not be adopting an alternative performance measure to net off the revenue required by this adjustment. However, we will ensure that we include the revenue associated with the NAF and e-com funds in our disclosures going forward so that analysts and investors could adjust their models, should they wish to, and to identify the statutory margin impact.

So on a Group basis, system sales increased by 4.7% with good performance in the U.K. and Ireland, but a disappointing international result. Group EBIT declined by 2.6%, with the growth in the U.K. and Ireland more than offset by the weak international performance.

Going into more detail by segment, this slide highlights the difference in performance between the home markets of the U.K. and Ireland versus the international markets. In U.K., I, system sales grew 5.5%. The corporate stores revenue growth was in part driven by the acquisition of 6 stores at exactly this point last year and hence, now shown in the interims for the first time.

You can see on this slide, the revenue associated with the franchisee advertising technology funds, I mentioned earlier. We administer these funds for franchisees and the revenue is calculated by reference to system sales and matched to costs incurred. DPG earns no margin on this activity.

The U.K., I saw good performance, I'll touch on the components of this in a moment. The EBIT margin of 8.7% was in line with the 2018 full year figure. We continue to target around 8.5% margin on system sales. The performance in International was disappointing. I'll walk through each country's performance later on, so we'll only provide high-level comments here.

International system sales declined by 3.4% in sterling terms, but grew 0.4% in constant currency terms. The operating loss increased significantly from GBP 1.8 million in the first half last year to GBP 6.4 million this year. We said at the Q1 update, that we lacked visibility on the outlook for this segment and we're, therefore, unable to provide a guidance range for the full year. The second quarter performance continue the pattern of poor visibility, and the half year result was slightly worse than we anticipated at the time of the Q1 update.

Turning to the bottom half of the Group income statement. Depreciation and amortization is split GBP 4.8 million U.K., I and GBP 2.4 million International. The net underlying interest expense in the period was GBP 2.9 million, a GBP 2.2 million increase over last year as a result of the planned significantly higher debt position. The interest costs splits out is GBP 2.7 million cash cost to bank debt and GBP 0.4 million amortization of bank fees, offset by other interest income and foreign exchange of GBP 0.2 million.

The underlying effective tax rate in the first half was 22.2%, which is 2.5 percentage points higher than the prior period as we've not recognized the tax credit for the Norwegian and Swiss tax losses in the International segment.

Underlying basic earnings per share for the period was 7.5p, down 3.8% year-on-year, reflecting the decline in profit partially offset by the lower weighted average share count year-on-year.

I just want to flag, the balance sheet is in the appendix. The balance sheet now shows negative in our assets.

There were 3 key nonunderlying items in the period. Firstly, the GBP 7.1 million contribution to the franchisees e-commerce fund, which brings to a close our GBP 10 million commitment to help with the funding of the new platform build. Secondly, we've impaired GBP 2.2 million in the value of the businesses in Norway and Switzerland, given the first half performance. We've continued to use the same AWUS multiple valuation model that we established last year for these businesses. Thirdly, we invested GBP 2.5 million in our German associate on costs connected with the conversion of the Hallo Pizza stores which we acquired last year.

So I'll now turn to look at the U.K. and I performance in some more detail. As David touched upon, we're pleased with our like-for-like performance in the first half in our home markets. This slide breaks down U.K. and Ireland's like-for-likes, both excluding and including splits. As you know, we view the [ex-splits] numbers, the clearest indication of the underlying growth of the business. However, we have listened to feedback from investors and analysts that it will be helpful to have both figures. So going forward, we'll provide both. The gap between the 2 has been steadily declining recently in line with the reduction in new split and donor stores across the state.

We've historically provided this slide in the appendix, however, I know a lot of you find it useful so I thought it was worth talking to you today. It shows the key components of the U.K. and Ireland EBIT. Our supply chain center had a good first half with revenue up 4% and EBITDA up 7.7%. The EBITDA growth over and above the revenue growth was as a result of both efficiency improvements this year, as Warrington was in a ramp-up phase last year, together with lower campaign margin support in the first half of this year. David will later be going into some detail on corporate stores.

Our U.K. JV's profit decline was partly as a result of the sale of our share in the Shayban joint venture in the second half last year.

DNA remains significantly below the level of capital investment as the bulk of our U.K. investment has been in assets with long residual lives, such as supply chain equipment and leasehold improvements.

Now I'll turn to look at the International segment. So before I talk through our 4 international markets, I'll just give a few comments on the division as a whole. As we highlighted at the Q1 release, the performance in the International segment has been below our expectations. The situation has continued in the second quarter, hence, our difficulty in providing guidance on performance. Although the most significant losses are in Norway, the other 3 markets have all delivered weak financial results, although, in Iceland, this was macroeconomic driven.

I'll now walk through them market by market, and for the first time, provide the profitability in each market starting with Iceland. Iceland is the only profitable market in the -- we operate in the segment, and we continue to be the market leader. We didn't open any stores in the period, but we did invest in the relaunch of our website.

The macroeconomic environment has been challenging this year, and we've seen system sales in sterling terms decline by 10%, and AWUS, in local currency terms decline by 13%. EBIT fell by GBP 0.7 million to GBP 1.1 million. Consequently, we're focusing on improving labor productivity in the second half to drive store-level performance. Iceland remains a good business, which is well managed.

As expected, the final tranche of the minority interest in the business is being transferred to us, and hence, at the year-end, this business will join Switzerland in being 100% owned. This year we'll spend GBP 1 million of CapEx compared to GBP 2.2 million last year.

Turning next to Norway. As the table shows, the Norwegian business has suffered from weak sales and larger losses in the period. The business made GBP 4.1 million loss in the half compared to GBP 2.6 million last year, and GBP 6.6 million for 2018 as a whole.

The integration of the Dolly Dimple's acquisition in 2017 together with the rapid growth in new stores has proven operationally challenging. During the first half we opened 3 stores and converted 2 Dolly Dimple stores. We now have 47 Domino's-branded stores, of which 9 are franchised. Of the 47 Domino's stores 9 were EBITDA positive in the period.

Average weekly order count across the Domino's-branded stores declined by almost 20%. As we highlighted at the Q1 update, the new country lead is instigating a comprehensive transformation program in Norway, which covers almost all aspects of the business. The program is being implemented from this quarter. This is likely to be just the first phase of the work which will be required.

Next, Switzerland. After a poor performance in Switzerland last year, beset by operational challenges at the store level, this year started in the same vein, and losses increased from GBP 0.9 million to GBP 1.7 million. Nine stores were EBITDA positive in the half compared to 12 stores last year.

The main store locations are Geneva and Zurich, where we have 6 and 7 stores, respectively. While the store performance in Zurich has slightly improved, Geneva has been challenging, with a few stores in particular recording very disappointing trading. This is clearly visible in the AWUS figures on the table and this is a focus area for us in the second half. We've reengineered the product recently and look to drive a turnaround of our combination of this and improved labor efficiency. We plan to open 2 stores in Zurich and 1 in Lausanne in the second half.

I shall now complete the International roundup with Sweden.

The Swedish market is the least mature in this segment. In the period, sales grew 17.5% to GBP 2.2 million, driven by the 3 new stores opened year-on-year. AWUS declined by 22% in local currency terms, and only 1 store was EBITDA positive in the half compared to 4 stores last year. We've long been planning to open stores in Gothenburg, which we view as an attractive location for us in terms of demographics. And in the second half, we will open 6 stores. Opening a relatively high number of stores at the same time helps maximize the impact of local marketing launch activity.

Online penetration is low in Sweden, 44% in the first half, and this declined slightly year-on-year. Driving online and link to this delivery is important to grow overall sales as delivery tends to be incremental, and it also increases ticket. We, therefore, launched the Domino's global online ordering platform, or GOLO, in June to replace the previous local solution, and our plan is for this to replicate the success of the platform in the U.K. over time. We're also piloting our new labor scheduling tool in Sweden.

So having walked through the results by segment, I'll now turn to look at Group investment and cash flow starting with the net debt bridge.

The U.K. and I generated GBP 26.6 million cash flow in the period, and we invested GBP 7.5 million in CapEx, resulting in a total cash generation from the U.K. and I of GBP 19.1 million.

International losses, combined with CapEx on new store openings and the funding of our German associate, resulted in a total cash outflow for International of GBP 11.6 million.

We spent GBP 25 million on dividends and GBP 17.4 million on share buybacks. Net debt to EBITDA stood at 2.2x within our target leverage range of 1.75 to 2.5x.

I shall now turn to review the cash flow in more detail.

In the first half, we had a significantly larger working capital outflow than normal at GBP 22.2 million. This was driven by a GBP 7 million increase in inventory as a part of Brexit planning and a GBP 7 million of additional creditor payments as a result of seasonal fluctuations. As the year-end, high order volume of food is paid for at the start of the New Year. We expect GBP 9 million of working capital movements to unwind in the second half.

CapEx last year included significant spend on Warrington. I'll give the breakdown of CapEx this year in a moment. The free cash flow before exceptionals was GBP 9.4 million, a decline versus last year driven by the losses seen in International and in the higher working capital outflow, partially offset by lower CapEx year-on-year.

After exceptional items, free cash flow was GBP 8.9 million. We spent GBP 17.4 million on share buybacks at the start of the year at an average purchase price of GBP 2.53. Overall net debt increased by GBP 35.6 million.

I'll now move on to look at CapEx. In the U.K., the most significant investment was in the e-commerce platform and other IT assets. The International investment in the first half was in the build of 5 new stores, 2 Dolly Dimple's conversions and investment in local sales platforms. Our guidance on this year's Group CapEx spend remains unchanged at GBP 25 million to GBP 30 million, with GBP 8 million for International, which was committed as we entered this year. We've also included on this slide the key U.K. and Ireland CapEx projects that are in the pipeline over the next 2 years.

We're undertaking trials with our franchisees to assess moving to cages and dollies for the majority of our deliveries to store. Should this be successful, it would speed up deliveries and significantly reduce the amount of heavy lifting our drivers need to do. A full rollout of cages and dollies would cost between GBP 2 million and GBP 3 million.

We're going to extend and upgrade our site in Mason's Island to modernize the facility and enable it to deliver on our growth expectations. This will cost somewhere between GBP 6 million and GBP 8 million. We're also planning to open a small supply chain and production facility in Scotland, nothing like the scale of our Warrington facility, but to improve our service to Scottish stores and to deliver on our expected growth. That should, again, cost between GBP 6 million and GBP 8 million.

So we're expecting U.K. and Ireland major CapEx projects to amount to less than GBP 20 million over the next 2 years, and all 3 investments have strong business cases.

I shall now turn to add some further guidance and other aspects of the business this year.

This slide is largely self-explanatory, I'd only add that we remain unable to provide guidance on the financial performance of the business in the international markets. On cash, we expect year-end net to be -- net debt to be between GBP 220 million and GBP 230 million, including the benefit of the GBP 9 million working capital unwind I mentioned earlier. We do not expect to generate significant excess free cash flow over and above the dividend this year, and hence, do not plan any further buybacks.

I'll finish this section by going through a series of slides on franchisee profitability.

So as David talked about, we're having detailed discussions with our franchisees and we've given this considerable focus and attention. Part of our role, as a master franchisor, particularly when we have such an established and mature franchisee base, is to work closely with our franchisees to understand the challenges they face. We are making progress here, although there remains more to do. We hope that this will help to support a greater empathy with large and small franchisee groups in understanding their businesses and working with them to sustainably grow the system over time.

During the first half, we've improved our processes to gain more consistent data from franchisees on their profitability, especially looking at EBITDA below individual store level. We're embedding the new approach, and we unfortunately don't have precise comparatives. We will, therefore, not be able to give comparatives either today or at the prelims, and the figures we've given in the past are no longer comparable as they're calculated on the prior basis. However, we can say that in the first half the average franchisee enterprise EBITDA margin was 10%, although there's a significant range across our franchisee base.

The table on this slide spits out store-level profitability in the first half for all stores and separately the mature in-connect split stores. Using all 3 methods, results in an average EBITDA margin of between 13% and 14% at store level. As we said previously, although the Domino's system has some highly attractive features in terms of protection during difficult macroeconomic periods, we're not immune to the current U.K. economic climate with rising costs, scarcity of labor and a weak pound. The biggest challenge for our franchisees remains labor costs, which typically accounts for around 30% of store sales.

The national living wage increased by between 4% and 5% in April. With near full employment in the U.K., the availability of labor is a particular challenge, especially with delivery drivers given the growth of the aggregators. As we guided to as we entered this year, food cost growth for franchisees remains between 3% and 3.5%, and is likely to be towards the bottom end of this range. This is consistent with the food cost inflation that we see in the market.

In recent years, on average, the new stores have had fewer virgin addresses, and they've taken a greater proportion of the donor store address count. Consequently, donor stores are taking longer to recover their level of sales and profits than previously.

In this more challenging economic environment, our focus is on supporting franchisees to ensure that we use data and our extensive history of store openings so that we open stores in the right locations, at the right cost and at the right time.

With this section complete, I'll now hand back to David to discuss the U.K. and I performance and corporate stores in more detail.

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [3]

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Thank you, David. David has talked through the U.K. performance overall, and I would like to give you a few more details on the sales outturn.

The top half of this slide breaks the sales down between like-for-like stores, new store growth, immature growth and the negative impact of territory splits. Overall, U.K. system sales were up by 5.3%, a good performance in the context of consumer spending, roughly being flat in retail in the quarter. We were particularly pleased with the outturn online, where our online sales continued to grow more rapidly than our core business, and online sales were up by 9.3%. Over 90% of our delivered orders are now ordered online.

Collection sales up plus 3.6%, grew less rapidly and this is an area of opportunity for us as we look forward. We're providing a more detailed breakdown of the like-for-like between orders, items per order, mix and price. If we include the splits, the order count in the first half was down by 3.4% and items per order down by 0.8%. Product mix, however, grew by almost 3% as customers traded up buying bundles that were more based on large pizzas and medium pizzas and also having more dips.

Price, as David said, plus 3%, was broadly in line with the food cost inflation that we guided to, to franchisees and saw within the supply chain centers. Finally, looking at total orders. Total orders in the first quarter were down by 0.7%, but up by 1.2% in the second quarter, leaving a half one outturn of 32 million orders up by 0.2% on the year.

We continue to benefit from the strong brand and strength of franchise that Domino's has with consumers. Our prompted -- our own prompted awareness 87% is very high and we define the category. We've solidified our dominance through increased levels of sponsorship in Catch-up TV as well as other media that we deploy. So now we sponsor the ITV Hub and we also sponsor all 4. And we're very positive about the fact that our new Marketing Officer is Emily Somers, who joins us next week has a very strong track record both in QSR and advertising. She joins us as an ex-VP of Marketing from McDonald's U.K.

We continue to invest in new product development. Our Delight range launched at the start of the year, broadens our appeal with a calorie count roughly 25% lower than a standard pizza. Our Cheeseburger pizza that we launched in November last year has continued to be successful and over 2 million of these pizzas have now been sold. And our spring launch of Catalan Chicken & Chorizo has sold 1.5 million pizzas. And we introduced in April the Tabasco stuffed crust pizza which gives a spicy stuffed crust is a limited time offer. We also continue to innovate in sides with the launch of Mango and Habanero wings.

We're delighted with the continued success of our e-com business and our app demand was up by 15%. We now have over 24 million app downloads, of which around 2 million were downloaded in the first half. We're particularly pleased with the conversion on the app, which is now up to 48.2% from the level of 46.5% that we reported in 2018. On mobile in general, the combination of our mobile site, [Anderra], now accounts for 2/3 of our sales, reflecting the continued investment in the customer journey and ease of use of Domino's online.

Another area where we've invested and continue to invest is in what we call the single customer view. Harnessing the different data sources that we have of our customers to produce a picture that allows us to drive sales effectively. We delivered the single customer view database in H1, which allowed us to market to over 9 million customers. There has been significant disruption in this area because of the introduction of GDPR legislation at the end of May 2018, and at the low point we were down to 2.5 million permitted customer data addresses. We're now back up to 9 million reflecting the fact that customers actually enjoy receiving messages from Domino's. The segmentation which we have done -- been able to do through single customer view recognizes the different purchasing characteristics of our customers, and the 4 by 4 on the left-hand side talks about the different customer behaviors try -- looking at promising loyal and champion customers. Our champion customers representing about 13% of our customer base, who order 10 times a year or more. Our goal, as we indicate on the bottom of the chart, is to convert new customers to single active, which we do through a series of incentives. But we tailor the offers, as indicated on the right, to offer things that are relevant to the particular customer behavior, whether it's a single person who's looking for a GBP 12.99 offer or a family looking for a GBP 20 offer, or a customer who regularly buys for a party where we would offer 40% off when you spend GBP 40 or more. This is just one example of how we can use our rich customer base to drive sales and personalize more effectively the offers that we give to our customers.

As David said, I want to spend a few moments talking about your corporate store performance. And I'll start by recapping the reasons why we made the decision to invest in stores in London. We wanted to build operational literacy and provide a platform for developing operational talent within DPG. That would enable us to understand and learn the pressures on franchisees and other store operations, and therefore, innovate, share and pioneer.

Clearly, we're also seeking to make a financial return, but critical to the strategy is to use the London opportunity, which is currently significantly under-penetrated with only 13% of our stores in an area which represents around 25% of the market, by opening new stores and splitting territories. So far we've opened 4 stores, we've relocated 2 and done major refits in 8. And as David mentioned in his presentation, this time last year we had the opportunity to buy 6 underperforming stores in central London, which can be further expanded and improve the franchise of the brand.

Our like-for-like sales performance in London is ahead of the rest of the system, with growth excluding splits of 4.4%. Our EBITDA is slightly down on the year due to increased local store marketing spend as a result of the refits. What we've done operationally is rollout a comprehensive suite of carryout deals and driven the carryout proportion in our stores from 22% to 27%. We're delighted with the performance in orders per man hour, which is illustrated on the right-hand side. And as a result of greater store management stability, we're delivering better result for customers. Our morale in the stores is strong, our internal engagement measures show an overall engagement of 84%, with 91% of corporate store managers proud to work for Domino's.

In Ireland, we had an even better half than in the U.K., with system sales up by 8.5%, despite the increase in VAT, and remember this is ex VAT number. VAT in Ireland went up by 4.5% in the first half. This was driven by an even stronger growth in online of almost 20%. And our average weekly unit sale in Ireland of 25,000 is significantly ahead of the performance in the U.K.

Let me now summarize the presentation and the results that we're announcing this morning.

We've delivered a strong performance in a challenging consumer environment in the U.K. and Ireland. As I mentioned, we've had continued discussions with our franchisees and we're confident that we will reach a sustainable, win-win solution. But we do expect this to take time, likely into 2020. Within the business, we're very focused now on improving both operational capability and marketing effectiveness to deliver a better performance within International.

And with that, David and I are now happy to take questions.

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Questions and Answers

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Ross Broadfoot, Investec Bank plc, Research Division - Research Analyst [1]

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Ross Broadfoot from Investec. Thanks, guys, for this morning, and really appreciate the actual disclosure that we're getting now. Two questions, the first in 2 parts. On page 22, you've said donor stores taking longer to recover than previously. First part of that is, how has the percentage of addresses donated by donor stores changed over time? And second of all, sort of what percentage of pre-split revenue and EBITDA are you expecting the donor stores to return to?

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [2]

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I don't have the exact number for the scale of donor stores. Historically, donor stores, over about a 3-year period, have recovered to the level that they were before the split. As David said, the impact on donor stores is greater now than it was because of less virgin addresses. We talked at the Capital Markets Day about the hybrid and the extent to which new stores benefit from a combination of split addresses from an existing territory plus new addresses. That is -- there are less virgin addresses available, and therefore, we're more -- the impact on donor stores has been greater. But as we've said, the current split impact overall is lower than it's been for a number of years.

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Ross Broadfoot, Investec Bank plc, Research Division - Research Analyst [3]

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Okay. And then the second question which is just around the average franchisee EBITDA margin, which you've said is 10%. Is that the average of the franchisee margins that were submitted to you or is that total franchise EBITDA over franchisee revenue? Just to understand if the effective size is actually blowing that number at all.

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David Gregory Bauernfeind, Domino's Pizza Group plc - CFO & Executive Director [4]

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Is it the -- so no, it takes accounts of the size. So there is a wide range, I think is what it says. So I mean the conclusion you would draw is on an average the overheads for franchisees are about 3%, but it certainly doesn't follow that the comes through the scale drives lower overheads because quite often if you're in a situation where you've a very small franchisee with 1 or 2 stores you wouldn't really recognize the concept of overheads. And if you're a very large, very sophisticated business then obviously you're operating at scale with efficiencies and therefore, you should have quite large overheads. So it's quite a complex picture. We're just at the start really of building that knowledge, but an average is at 3%.

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Ross Broadfoot, Investec Bank plc, Research Division - Research Analyst [5]

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Fair to say that you haven't got smaller stores with low revenue and higher EBITDA bringing that number up to 10%?

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David Gregory Bauernfeind, Domino's Pizza Group plc - CFO & Executive Director [6]

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No.

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [7]

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I think the working assumption of 13% and 3%, and 10%, which is 13% at store level, 3% which creeps up to 4% in some cases, overhead, net 9%, 10% is broadly representative of the bulk of franchisees. But there's a massive variance with some very, very profitable stores and very profitable franchisees and others who are less so.

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David Gregory Bauernfeind, Domino's Pizza Group plc - CFO & Executive Director [8]

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And I think Ross key point here is not so much frankly for us to be able to produce data to be able to provide to investors so much as -- I mean we will do that, but actually more to do with working more closely with our franchisees, our customers, our direct customers and showing more empathy with them to understand their different challenges, which are very different depending on where they are in terms of size of the franchise base that they've got but this is now quite a mature system. So that's really the development.

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [9]

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And having that comparability of labor costs and food costs and [LSM] costs on average ticket provides the platform for our business partners to work directly with franchisees on improving the profitability of individual stores and franchise groups.

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Richard Paul Stuber, Numis Securities Limited, Research Division - Analyst [10]

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Richard Stuber from Numis. Two questions please. First of all, you spoke that you had low campaign support in the first of this year, what are your expectations for campaign support in the second half? And the second question is, you said you've got GBP 8 million of commitment for international CapEx for this year, do you have any commitments for the next year as well?

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [11]

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There are no commitments for next year. In terms of the campaign support, the January campaign in 2018 was supported and the January campaign in 2019 wasn't. I would expect that the level of campaign support in the final quarter will be lower than last year.

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Julian Kenneth Easthope, RBC Capital Markets, LLC, Research Division - Analyst [12]

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It's Julian Easthope from RBC. A couple of questions. Just in terms of the really broader one, the technicalities around the NAF and e-com IFRS 15 adjustments. We've seen some of the franchise systems out there, there's often a mismatch between the timing of payments and things. Are you really always be 0 profit reported or -- yes?

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David Gregory Bauernfeind, Domino's Pizza Group plc - CFO & Executive Director [13]

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Yes. So we have to separate 2 different things, so thanks for the question. We have to separate 2 different things. So one is, does the timing of the revenues and the costs of those funds naturally match? And they don't, because we've recorded deficits and surpluses depending on each fund over the period. For DPG as a business, they will always be 0, because essentially what we're doing is putting an asset and liability on our balance sheet to recognize the difference and drew it up, otherwise it would frankly confuse our own profits because we're spending franchisees money. So on the DPG P&L, it will not be impacted by the spend whether it's very high or very low. In a particular year the difference is held on the balance sheet. There's no change there. The difference has always been held on the balance sheet. The difference is only now that we're recording the revenues and the costs in our income statement which previously we didn't.

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Julian Kenneth Easthope, RBC Capital Markets, LLC, Research Division - Analyst [14]

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Second question, really resolves around so the operational side of things. We've seen in the U.S. franchise holder, they've introduced reward systems and loyalty cards, so that should have been quite a big boost over the last 3 or 4 years to their like-for-like or at least there seems to be, it is a very good coincidence between the 2 in a relatively mature state. I wonder whether you considered that? And also what you're learning from the early start of the AI sort of experiments that you're doing? And if that's actually being applied to our corporate stores? So I was just being interested sort of a bit more about the operational side of the -- that side of things?

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [15]

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We have looked very carefully at the U.S. loyalty scheme. The big difference in the U.S. -- sorry, the big difference between U.S. and ourselves is the purchase frequency. U.S. purchase frequency in the market is up to around 18 times a year. Our frequency on average is 5 or 6 times a year. And to offer a meaningful incentive with a relatively low level of frequency, the U.S. loyalty scheme is based on essentially a free pizza when you've made 6 purchases, so your seventh purchase is free. In the U.S. that takes 3 months. In our market it would take a full year. And that's always been the issue that we don't know whether with our relatively low frequency a loyalty scheme would work, which is why we've gone down the SCV route which is more targeted offers rather than explicit loyalty scheme. On the question of AI, the biggest area where we've used AI has been on pay-per-click, where we've been timing our investment in Google best using AI techniques. And we've actually seen in this quite -- actually astonishing growth in the effectiveness of PPC. I think we talked about to the prelims, but our PPC order count in the first half year is up by about 30%. It's been one of the reasons why we've driven sales so successfully. So we're really understanding much more about how to deploy pay-per-click in order to drive online sales.

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Julian Kenneth Easthope, RBC Capital Markets, LLC, Research Division - Analyst [16]

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Just one last question. There was obviously a drop in terms of volumes, I just wonder if that was a concern at all? I think -- again, the master franchise holder was a bit concerned about some of the international operations seeing reduced volumes and higher prices, as it wants to be a volume-driven operation. So just any thoughts on that?

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [17]

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Well I think we all see the benefit of growing order count. I think the environment, as we've said, is a challenging one. Franchisee margins are up but not on food. If we look at food costs they're broadly flat on the year. So what franchisees have done is pass on the food cost inflation that we've passed to them. They faced higher levels of labor inflation with living wage going by 4% to 5%, and certainly in hotspot areas of the U.K., driver cost inflation per hour going up by more than that. So what they've done is deploy techniques to use labor more efficiently, part of which is GPS, which is a system we introduced last year. But we certainly see the value of order-driven growth being ahead of inflation.

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Natasha Brilliant, Citigroup Inc, Research Division - VP [18]

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It's Natasha Brilliant from Citi. Just thinking about the turndown plan in your international markets and particularly Norway. You implied that this might be the sort of first stage of work that looking at now. Can we still expect to see improvements in Q4 or should we expect to wait a little bit longer before we see sort of meaningful improvements there? And then secondly, thinking about all of your international markets, given what you're seeing and what you know now, are they all still viable sort of long-term options for you? And are you going to continue to stick it out? And then finally, just on Iceland on the macro, do you expect any improvements in that in second half?

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [19]

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I think we're being very careful not to give guidance on International today. So I think it would be wrong for me to answer explicitly on Norway Q4. I think there's a lot of really good ideas and I'm very optimistic that we will see an improved business performance with better marketing, change in menu, change in pizza size, a whole list of stuff that's going on. But I think it would be wrong of me to -- or David to give any clue about what our internal targets are given the policy on overall guidance. As far as Iceland is concerned, we're changing the marketing approach, we talked -- David talked about, improve management of labor, reflecting the reality of the sales performance which is unusually soft in Iceland. And we are managing the business to recognize the macroeconomic environment. We don't expect a significant change in macroeconomic environment. The stats on things like tourism is 30% down in Iceland, the second largest airline in the country has gone bust and is out of business. The exchange rate is soft. So that's indicating a further decline in sterling sales. We have to manage the business according to those conditions, rather than expected to be like it was in 2017. I think on the wider question of International, we said this is a big year for us internationally. And that's what we said at the prelims, we said that at Q1, and we would say that again today. We've invested in management. We've got the best management and the most intense management we've ever had. It's taking longer for that to pay back in terms of business performance, but that's what we're monitoring very carefully. And then if there's anything you want to add David?

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David Gregory Bauernfeind, Domino's Pizza Group plc - CFO & Executive Director [20]

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No.

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Richard Michael Taylor, Barclays Bank PLC, Research Division - Analyst [21]

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Richard Taylor from Barclays. Just on International again. And I appreciate there's no guidance, but can you give us an idea of how bigger losses you would tolerate as a Board or as a CFO? And in terms of sort of decision making, is this a decision for David and his tenure or is this a matter for a future CEO in terms of how bigger losses you would tolerate and how long you would sustain those losses for?

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David Gregory Bauernfeind, Domino's Pizza Group plc - CFO & Executive Director [22]

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Well, I'll answer the first one. I mean -- so I think as a CFO...

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Richard Michael Taylor, Barclays Bank PLC, Research Division - Analyst [23]

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(inaudible) the CFO.

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David Gregory Bauernfeind, Domino's Pizza Group plc - CFO & Executive Director [24]

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Yes, I'm not in the -- generally speaking, not in the business of running business to tolerate losses so -- or breakeven. So we're in the business to make money for our shareholders, and we're not doing that at the moment. We're just drawing value in the International business. So it's not as if a lower level would be tolerable. So I think that's what I would say to that. I think David has been clear to say, 2019 is a big year for us in these markets.

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [25]

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And I think the answer to the same question is it's a Board decision. Obviously, the CEO, whether it's myself or my replacement would have a role to play in that, but the decision is not being taken by an individual executive. It's a Board decision. And so I think the timing of my departure is irrelevant.

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Heidi Mercia Richardson, UBS Investment Bank, Research Division - Associate Director and Equity Research Analyst [26]

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Heidi Richardson from UBS. Can I ask on pricing? You've talked a lot in the past about the GBP 20 price point and you haven't mentioned it this time around. Has that been a moving target or...

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [27]

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It was on the single customer view slide, Heidi.

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Heidi Mercia Richardson, UBS Investment Bank, Research Division - Associate Director and Equity Research Analyst [28]

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Okay. I'm sorry. But in terms of your focus. I mean you're still passing on food inflation to franchisees. I know there's kind of separate issues there, but did it ever cross your mind to sort of -- not this time around just to sort of help ease the pressure in terms of where your price point is going? And I suppose, just linked to that, is there -- I know you are trialing different pricing strategies in your London stores, is that still something you're doing or is that at an end? And then finally, just on London, I mean I know that some of the investment means that margin is probably lower than it would be in a normal run rate situation. But what sort of margin can those corporate stores deliver because it looks fairly low relative to the franchisee group?

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [29]

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I think our view would be that in the corporate store margin we should be aiming for the same store level margin that's achieved elsewhere in the system. London margins are more challenging because of the operational costs in London. But our long-term goal should be to operate those stores at similar level to the franchisees. The overhead that goes in has to be appropriate to a public company and that may be slightly higher. But at store level our goal should be to run those stores at a similar level to franchisees margins. As far as the point about GBP 20 is concerned, GBP 20 continues to be a key price point for us. And we -- if you look at the promotions that we've done, largely they've been based around that GBP 20 price point, and that -- and main autumn promotion for the early autumn will be based around that GBP 20 price point. So nothing's changed on that score. The trials that we're doing in London have actually been around lunch deals and collection deals. Where -- what we're seeing is a different competitor set and a different expectation on price. And we're doing various experiments around GBP 4.99 with a drink, reduce other lunch deals. And we do that always on collection deals. And I think what we've learned is that the traditional delivery time deal, which might be buy 1 get 1 free or a meal bundle, is less relevant to collection, is much more about an aggressive price point for maybe lunch consumption or an evening collection. So those trials will be ongoing and we're sharing the details of those with our franchisees to help them in their local markets, build those businesses as well.

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Heidi Mercia Richardson, UBS Investment Bank, Research Division - Associate Director and Equity Research Analyst [30]

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And your choice to pass on food inflation (inaudible)

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [31]

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We -- that's our continued policy, but then will match that, as David said, with some investment to support campaigns. So for example, the GBP 20 campaign that we're running selectively in September that will be funded in part by support from the center.

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Nigel Andrew Parson, Canaccord Genuity Corp., Research Division - Analyst [32]

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It's Nigel Parson from Canaccord. You've clearly analyzed and articulated the London opportunity very well in terms of new store openings. And David, you've put a lot of investments in terms of buying the franchisee out. But what else do you need to do to make a step change in performance in terms of new stores in such a big obvious market?

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [33]

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Well, I think it goes back to Heidi's question actually. I think one of the key areas is around collection and all day sale and the lunchtime opportunity. I think we look at our statement and many of the stores are located for delivery rather than collection and the pricing and the value mix for collection is not competitive with a wider competitive set that people have to choose at lunchtime. So I think that's the thing that we need to really focus on because ultimately, by splitting territories in London we have to drive collection harder because we're already doing a pretty good job on delivery. The incremental opportunity in London is very much around collection and broadening the time of day in which we sell.

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Ned Peter Hammond, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [34]

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Ned Hammond from Berenberg. Just a few questions on the franchisees please. Firstly, could you just clarify for a typical franchisee, are they seeing wage inflation overall above the 4% to 5% national living wage because of the driver costs? And secondly, you've said there's a significant range of franchisee profitability, I'm just wondering whether you can say any of the franchisees loss making? And the last one is just on International franchisee revenue, and that fell quite significantly. Is that because you've shifted some stores back from franchisee to corporate? Or is there another reason?

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David Gregory Bauernfeind, Domino's Pizza Group plc - CFO & Executive Director [35]

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So I'll take a bit of that. So I think in terms of the broad range of franchisee profitability. I said it's a broad range and it's a very broad range. So both at a store level and an enterprise level for franchisees. And I think you can take that as sort of the most, as clearly as I can be, it's a very broad range, both above and below the averages of 13% at store level -- 13% to 14% at store level and 10% at enterprise level, very, very broad range. And that changes over time. So I mean as an example, the stores we acquired last year were not particularly profitable stores, the ones that we've rebranded as have more fun, as an example. There are other stores and businesses that change hands that have got very high margins. Some of the businesses we've seen in Ireland for instance, have got very strong margins. So it varies enormously both at our store level and our franchisee level.

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David James Wild, Domino's Pizza Group plc - CEO & Executive Director [36]

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On the labor inflation point and I think at the hourly rate level, we would see inflation in labor rates more than 4% to 5%, particularly in hotspot areas like London, where there's a shortage of drivers on full employment. The way to mitigate that is through techniques like scheduling, GPS, labor management tools, which more and more franchisees are deploying. I think David has picked up the range of franchisee profitability. I think the other thing that we have to say is there's still an opportunity to improve accuracy by the franchisee inputs that we get because the range is almost so wide that I wanted to -- that we doubt whether the data is accurate.

On the International revenues, the big change I think in Norway was the Dolly Dimple's franchisees, where we've got significantly less now than we had this time last year. The Domino's franchise stores that -- we've increased that number year-on-year. But I think that's the trend that you picked up on the slide.

Okay. Thank you very much. Have a good day.