Domino's Pizza, Inc. (DPZ) Earnings Call Transcript & Summary

Thank you, operator. Good morning, everybody. Thank you again for joining us for the Evercore ISI's Consumer and Retail Conference. We're happy to have Domino's joining us today. Sandeep Reddy was appointed CFO on April 1 of this year. And prior to joining Domino's, Sandeep had CFO roles at Six Flags and Guess?. As many of you know, Domino's has been one of the best-performing stocks in consumer over the long term. But today, its valuation is well below its recent averages due to slowing sales and concerns about its long-term delivery share and other topics. So it makes it particularly interesting to talk to Sandeep, who has got some fresh eyes on the business, and as a company, they're trying to think about what changes they may be making to address the opportunities and challenges ahead. Sandeep, welcome.

Thank you, David. Good morning, everybody.

You're part of a new team at the top of Domino's. It's not just you, but obviously, Russell. You're taking over a business with enviable market share and long-term growth, but also with some challenges that I'm sure we'll be talking about today. You're coming into Domino's from the outside, which in a way -- in a certain way, makes you very interesting to us. What are your perspectives coming in? And what observations and priorities do you have?

Yes. I think it's a great time to be coming into Domino's and well, the world is going through and United States included a lot of change in the more recent past and a lot of disruption to traditional models has been happening. But I think what I think is very cool about Domino's, when I actually see what's going on is, yes, there has been a disruption. There has been a slowing of sales. But what I actually kind of like sift through it, it's very different from what Domino's probably went through back at the end of the decade of the -- well, back in 2008, '09, '10, where I think the business had really more of a demand problem. And I think it really was about the product and how it resonated with the consumer. Russell, our new CEO, who started pretty much -- effectively a month after I started, but has been in the company since then, really was the architect of the Pizza Turnaround story back from 2008, 2009. And I think he's done an amazing job when I just look at what's happened over the past decade plus of really going and figuring out how to understand what the consumer wanted and actually building with the analytics to ensure that we're delivering what the consumer wanted on a consistent basis, month after month, quarter after quarter, year after year. And that's what's caused the enviable position of Domino's to build over the last decade. And I think what we -- where we find ourselves now, especially as we've gone through the pandemic, is you've seen a big disruption happening in the marketplace, because of the trends of the pandemic and choices consumers made on how to consume food, which caused some shifts in channels, I mean dining pretty much shut down for a bit. And then you probably went through a phase where delivery was the most choice flow, then carryout becomes very interesting. So we're seeing a lot of shifting in the channels that are going on. And through this disruption, aggregators coming in as part of it, because of delivery being so attractive, you have a situation where capacity to serve has been constrained for Domino's. And it's -- the demand has really not changed that significantly. We have enough information to tell us that the demand is still really strong. It's more of that capacity to serve that has been worked on, which is why after taking a look at it for the last 3 months, the last couple of months that I've been in the company, I'm actually -- I was already pretty confident that at the first earnings call that I've seen and after we ensured that there wasn't an area or a big problem, I'm even more convinced as time has passed that, that is the case, and we'll talk more about it as we go through this conversation.

Well, I'm definitely curious about what insights you have. I know that Russell, as you said before, he's an insights-driven guy, and that's his background. And so I'm sure you're collecting information right now. I wonder what insights can you share with us about the factors that have limited your sales, either through consumer demand, competition, labor constraints. I think people are curious about the portions of each and what your insights are.

Yes. I think one of the things that I really dug into a little bit after getting into was the whole notion of capacity constraints and where they were coming from. There is a piece, which is labor driven. But I think as time has passed, especially as we've gotten into '22, the labor constraints have really gone from being a broader part of the employee base and the store level, to really more of the drivers themselves. And so I think that's a good sign, because it's now -- it's a much more contained issue, and it's really understanding what we should be doing on that front. Then I think specifically, when we look at what's happening on the driver side, we've done and looked at more generic and broader information on the market pace. And the total number of hours available for those intending to drive or wanting to drive hasn't really gone down. It's still there. What has actually shifted is the manner in which those would like to drive -- drivers would like to drive are interested in being engaged. They're looking for shorter shifts, much more flexibility, the ability to sign up at the last minute and actually have a much more flexible employee earn model that's available to them to engage with. And so from a Domino's standpoint, this is a shift in the marketplace in terms of how labor wants or drivers want to engage with us. And I think to the extent that we weren't already the model that maybe some of the aggregators have on engaging drivers in that fashion, we obviously got a bit disruptive. But now that we have the knowledge, we prove from a consumer technology standpoint that we can actually come up with technology that helps consumers engage with the brand. So why can't we do that with drivers? And so it's work that we're continuing to do. We're very conscious of it. And technology is one piece of it, but the other piece of it is, is to lens. So good store managers, even without the technology, have figured out that this is how drivers want to be engaged. So they figured out how to go and engage with the drivers in the slices of time that they want to be engaged with and figured out how to actually stock their stores. That goes back to the quintile discussion that we had in the last earnings call. Our top quintiles, the problem isn't really there. It's more the bottom quintiles. So it's really more a function of operational excellence that we basically want to translate from the bottom quintiles, all the way up to the top quintiles, where in the carryout business, this hasn't been a factor. So you don't really have much of a spread in the quintiles in terms of performance and relative performance. So that's why I feel pretty comfortable that, especially with the rich strength that we have in terms of talent in the company, it's just a matter of time before we actually fix a lot of this stuff. And so from a labor standpoint, I think that this is -- it's pretty clear that we'll get there. But I think the other piece of it is, when I look at evidence of what's actually happened and prove that it was demand, the cancellation rates have gone up quite a bit. And so that's proved that there was demand with folks actually canceled their orders because it is not coming in time. And that also is evidenced in the delivery times. In many cases, that had slipped past the typical 20s in terms of the delivery time. And so -- and we've seen the proportion of those longer delivery times also building up and service levels deteriorating. So all of this is evidence that there is demand, that there is interest in actually acquiring the product, but our ability to serve and the quality that it should was being constrained. And that manifested in lower operating hours, where in certain cases, because the capacity to serve wasn't there, that was reduced, and then further demand actually was lost, as the operating miles reduced. So all of that is kind of a snowball effect. And I think we -- as we improve our staffing levels, as we improve the operating effectiveness, this demand should get recaptured as we go along.

And it does sound from that answer, like you're feeling more and more confident, you can do this within the Domino's end-to-end experience rather than turning that over to a third party to create an auxiliary-type capacity? Is that fair that you're thinking -- getting more confident that you can do this yourself?

I think we're definitely getting more confident that we'll be able to reduce the gap based on what we're seeing. Is it going to go all the way to where we can fulfill all the demand ourselves? We hope that, that's going to be the case. We don't really have a clear line of sight yet to that, which is why we said if we don't really have that full capacity to return to our system, we are open to other options. So we're still looking at other options. And the options range from more of a white label option to something which is much more full service. And so we're looking at everything. Nothing is off the table. And so that's kind of where the mindset is, but Russell has talked about it beautifully on the last earnings call. If the choice is between delivering a pizza, not delivering a pizza, in the end, we won't deliver the pizza. So that's pretty much where we are.

Yes. And one of the things that I think was new is Domino's not gaining share of delivery, and that was the case in '21. I think you went through those numbers. I think that was true within pizza, probably because the independents had access to third-party delivery, but also the overall market. The consumer can now get more stuff delivered across a variety of categories, whereas pizza was the king before. So I do think that people are wondering if this is a new norm and to what degree can you become a serial share gainer again within delivery? And so could you talk about that? After there's been more diversification of delivery experiences, what is going to be the way that Domino's perhaps comes ahead in a new larger pool?

Yes. I think the answers to that are probably in the answer I gave just earlier, right? So as we improve our capacity to serve, I think some of that share that we left on the table, because we weren't able to serve the demand comes back. And I think we expect that as we move along, we will be able to get there, because the demand is there. And I think when you look at the broader brand picture, we can look at a delivery only, which is a separate business effectively, but also delivering carryout. Our carryout business actually has been doing extremely well. And that's also a representation of the brand demand being very strong. And the beautiful thing about carryout is, there as opposed to delivery where our share is already pretty strong in the 30s, that share in carryout is much lower to the teams. And so we have -- the teams have a much bigger pie, because carryout is a bigger business. And so with the momentum that we're actually seeing on that, it's one, it's reinforcement of the brand strength is very strong. And the other is there's a tremendous amount of growth that we can see in the total business when you combine both sides of carryout and delivery. But I think we want to get that to keep growing, carryout to keep growing and in a way, rapid pace, and get back the demand that we believe we should be commanding in the deliveries. I'm so super bullish about where things can go. I view '22 is more of a transition as we actually figure out all this stuff, but the demand piece is very strong.

Just when you think about the major areas that the consumer cares about, but also the employee cares about, your advantages there is sort of where I was going, I think about speed of service, the value to the consumer, the value of working as a driver at Domino's in some, I guess, one could think that the convenience advantages have been narrowed and perhaps even the driver pay advantage may have narrowed. I don't know, but in what ways do you feel like you're still left with a sizable advantage and maybe you might have a communication that you can make, to make the employee or the consumer realize that or in what ways do you need to bolster or buttress your advantages versus other delivery?

Yes. I think, David, this -- from what studies we've done, we can see that our pay advantage was substantial and still is pretty good. So I don't think pay's as much the issue. It's more about the flexibility I talked about earlier from a driver perspective in terms of shifts, in terms of the ability to sign up with very short-term lead times. That's a kind of stuff where we need to evolve our practices to make sure that we're meeting drivers where they are. And I think if we do that successfully, we'll be able to get -- grab the share of drivers that are out there, because driving for Domino's is very attractive. And I think the pay piece is very good. So the flexibility comes along with that, we actually have access to the pool, and we can do very well. But again, it's -- this is a notional construct where we see a path. We haven't gotten there yet, obviously, and we still have to keep working.

The -- a lot has been made about the delivery driver availability and the impact of sales growth. Is -- do you feel like the delivery drivers have left you and the industry? Have they gone over to third party? I mean what are -- when you do an audit of the situation and the reasons for it and where they're going, what details are you finding out?

I think it's -- I don't really have enough information to say definitely I know where they've gone. I just -- I know what the total pool is and the total pool looks pretty robust. So it's more that we know we're not getting enough of the pool to drive for Domino's, and that's what we need to go and figure out and do better. Because we've had surveys done of them. And so we know what their behaviors or their preferences are to those service. And as time is going along, in fact, if we go compare to January versus March, we saw improvements even in that. That's why we saw the quintile spreads kind of widened, but the top line is actually performing better than we figured it out as you know.

Yes. the -- I don't know if I was the only one that got an e-mail, but I did get a half price specialty pizza e-mail. So maybe we're doing the boost week. I don't know that the boost week started here, but you talked about doing one right around now anyway. So it is an interesting thing to have this -- talking about these constraints and you're leaning in and you're going to do a boost week. So what gave you the confidence to do a boost week this summer despite that headwind?

Well, I think as we talked about in the April call, our franchisees were the ones who came to us and said like it's been so long since we did a boost week, like pre-pandemic. So it's time. We needed to keep doing it. And the boost week is -- is this about promotional activity? Yes. It is promotional, but it's more about customer acquisition, and it really pays off in multiple quarters over multiple quarter cycles in the customer lifetime value. And because we haven't done it for a couple of years, the impact would have started showing if it hasn't already. And so this is more about starting to protect the long term for ourselves by actually going out and doing this again. And obviously, we got to the point where we feel confident enough that there's -- we're going to be able to service the demand and that's why we're doing it. And so -- but again, I mean, that's what we believe. That's -- let's see what happens after the end of the boost week, what the response is from both franchisees as well as the consumers. And the answers will be when we report the quarter later in July. And we look forward to actually updating you on what we saw.

One of the things that it sort of reminds me of a food company that doesn't have capacity, not doing promotions and not doing marketing. You haven't really been accessing the new consumers that you typically get from those boost weeks for a couple of years now. I mean is there -- do you see that as a big source of atrophy in your customer base?

I think potentially yes. And it may not have manifested yet because of the pandemic, because in the pandemic, you may have actually seen customers may not have traditionally come into the Domino's would come in just because of the convenience and the access. So we may have been able to kind of duck that because of the pandemic impact. But now that we're actually coming out of the pandemic, I think not continue to sustain that flow was very risky to the brand's long-term acquisition prospects. And so this was really important for us to try to do. We believe that we could do this effectively. This is why we're doing it. But again, let's see. Let's see what the results are, and then I think we'll be able to talk about that more in July.

I think people see, investors see that your pizza competitors have been working with the third-party delivery aggregators, and they wonder what barriers there would be for you to consider doing that, particularly with a somewhat -- doing something more white label where you're just using their labor. Are there -- is there any barriers that we wouldn't be considering for you doing something like that, that you would inform us about?

Well, I think, again, the preference at least over here is -- in the United States is to do everything ourselves, because we control that type of experience. And there's something to be said for Domino's driver and Domino's uniform coming in a Domino's car to deliver your Domino's pizza in a Domino's heatwave box. That experience is unique. It's Domino's. Even if you do go to a white label option, how much of that experience is maintained that the consumer values. And I think that's the part where we're really careful about how much to actually move the needle. But as Russell said, if it's a choice between delivering that pizza at the end or basically forfeiting the demand, no, we're going to deliver the pizza. So we're willing to go there. And candidly, it's not that we don't use third-party aggregators in other markets in which we operate, in India, which is where I come from. I saw this happening a lot. I mean it's not white label, it's full-fledged. Third-party aggregator is actually working with the master franchisee in India, and they do a really good job. So it's not that it doesn't work. It's more the U.S. consumer, it's a market-by-market experience, where we have the U.S. consumer very used to that Domino's driver, Domino's uniform, delivering that pizza, that it's a big deal if you're going to make that shift. And we'll make it if it makes sense, but we have to be very careful about the steps we take.

Yes. We sometimes forget even though your prices are still low, that you took pricing, too. So I'd love to hear your thoughts about that. You recently announced that your delivery national Mix & Match price is going from $5.99 to $6.99. So looking ahead, let's say, the second half of the year, do you expect this to be -- this price increase to be additive to your same-store sales growth?

I think it still remains to be seen, because I think what happens with pricing and this is what Russell was talking really well, as I've come in is, it's not that first transaction. It's the second and third and fourth transactions where you really know what the impact of that pricing is going to be. And so because we haven't gotten through those cycles, it's too early to make a call on is it working, not working and the like. And perhaps in July, we'll have a little bit more information, but may not be enough information to conclude. So I think we'll have to see. We'll have to see and keep studying it. And that's been the great thing about the approach the company has taken and Russell has been firm and said that, which is really based on analytics and insights, and understanding really over a longer-term period of time what has been the trend and what is driving it, because if there's a trade-off between [indiscernible] and ticket, obviously, when we adjust pricing and is -- but is it accretive in the end from a ticket standpoint and total value standpoint.

I wonder the same thing. Is it too early also on the digital-only carryout at $7.99? Any learnings from keeping that, but limiting that to digital?

Yes. I think it's a little bit early, because there's a lot of other things that are moving around as well in the environment in which we are. And so what happens is because of our pricing architecture, we've talked about it, I mean there's national pricing, that's great. We're talking about national pricing right now. But there are many other levels that franchisees can operate. There's local promotions, there's menu pricing itself. In the case of delivery, there's delivery fee. And it's almost other levels that impact the specific national offers as well. So it's a mix of a lot of them. And so I think you -- because it's not really what I would call [indiscernible], the only thing that changed is national pricing, but everything is changing at the same time. It's hard to kind of see it. So that's why we need to wait for more long-term settling-down effect to actually come to conclusions. And I really think it's not just for Domino's. I think in the total industry, there probably needs to be a settling down over the course of at least '22 and then maybe getting into '23, before we all know what the true impact of all the changes that have happened.

There's somebody just e-mailed a question just -- and I think I know the answer, but they're asking, if you did use a third-party aggregator for some help, would you be able to give the -- would you give the consumer still the rewards benefits? And I think that ties into just exactly how the consumer experience would go. But what thoughts there?

Yes. Again, to be explored in terms of how we can actually get to that point in terms of sharing technology and access to information and the like. But obviously, we would love to have everybody in our program and therefore, getting access to the benefits. And it's just a question of like how do we work if we do go down the path of a third-party aggregator to share that information, get access to the data, and provide those benefits to the consumer.

You mentioned the carryout. To some degree, people forget that you have a much lower share of carryout and that is an opportunity. And yet, it's still a pretty substantial portion of your business. So could you discuss the strategy to sustain there and perhaps even accelerate that as a source of your growth?

Yes. I think it is -- the pandemic actually just gave us a number of launching pads on the carryout business, right? The Carside Delivery was like amazing. And our performance ranges from in the seconds to under 2 minutes in terms of contactless Carside Delivery, which has been enormous. I mean I was just looking at this. This happens to be boost week, but even now when I go on and look at it, previously I was looking at it, it's -- we're basically advertising 13 minutes or less for Carside Delivery, which is a phenomenal service line, if you think about it. And so I really think that carryout is a huge, huge opportunity, agnostic of the delivery opportunity. So in terms of total brand health, in terms of total consumer demand, this is an area where I think it's a piece that we will continue to talk about, but I feel that there's a lot of runway for growth for the company's performance.

Yes, I think a lot of companies out there had some company-operated store margin pain lately. You're dealing with such outrageous levels of inflation and to some degree, you want to smooth out the pricing to the consumer. But the store margin was down 800 basis points in that first quarter. I guess, how should we think about the margin recovery path going forward? And how are you thinking about your decisions on how to take pricing from here?

Yes. I think there was a few things going on, on the store performance. And I think the company-operated stores, initially, I think if you go back and look at the narrative before I joined the company, a lot of the -- lot of the commentary was rural versus urban, because most of our company-operated stores were in urban centers. But as we kind of dug into it and got into the last couple of quarters, we realized that there was a bit more to it and there was probably some operational misses that were going on as well. And that's when we got into the quintile discussions and kind of the separation that we've seen. So a big chunk of the deterioration that we're seeing is coming from that opportunity to improve the operation. And so I think by just improving the operation, we could reduce the deleverage by itself, so let's start there. Then I think in terms of responsiveness to what was going on in the marketplace and adjusting pricing, we were slower to get there on the company-owned stores. The franchisees use their leverage much quicker. The reason we do that was not because we didn't feel like increasing the prices. I think the whole point was -- the belief was we were able to service the demand and get the volume to offset some of our pricing. Unfortunately, we weren't able to service the demand. So the volume didn't come and the pricing didn't come, and therefore, you saw more deleverage. So as we improve the operations, some of that will probably go away. So over time, I think whether it's franchisee or it's company-operated stores, the model should basically evolve to get into the same place from an economic standpoint. But just by nature of the way the P&L is structured, we get more leverage in both directions. When things are good, it goes up pretty fast. When things are bad, it goes down really fast. And so that's what manifested in Q1.

One of the questions we had was about the same-store sales difference between the company stores and the franchise stores. There was a 7- to 8-point gap where the franchisees outpaced. I think you might have touched on one reason in the previous answer, which was that urban exposure. But I wonder how much is also due to the franchisees being a little bit more aggressive on pricing? Could you talk about that?

Yes. I think if I pass the elements of it, I would attribute most of the difference now to operational effectiveness. And I think we definitely had gaps that were there. And we, if anything, have accelerated as we've gone through the last few quarters. And so I would start there as opposed to looking at pricing as the lever. Pricing was definitely something where it was slow in the company-operated stores. But the whole idea was we're going to drive enough volume to offset that pricing. And -- but that didn't come. Therefore, you saw that the comp actually deteriorated even further. And so I think overall -- I think the headline is we've got to get better operating effectiveness in the stores.

Okay. How fast do you think you can do that?

I think we're going to be working through it over the course of '22. As Russell said, we already have 30, 60, 90-day plans that we are working on and so I think the time we come and talk to you about in July, but we'll at least talk about some of the plans and where things are at. The numbers will only evolve depending on how things materialize in the short term. But in the medium to long term, I think we'll get -- because it's -- the company has done it many times before. So I'm very sure we'll be able to figure it out. And I've seen the plans. They make sense. It's more a question of how the numbers have manifested.

I wonder about -- by the way, we probably have time for just a couple more coming down the stretch here. But about innovation and the frequency of promotions and just the overall -- the pace of new. You've seen -- it feels like we've seen more new stuff from the competition than Domino's and it might a lot of it be tied to the capacity constraints that you've talked about. But is that going to be part of the plan going forward to step up the pace of new?

Well, I think it's going to -- innovation -- and I keep coming back to it. There's been innovation and there's been innovation with the consumer experience. The kind of stuff that the company has done from what I've seen historically is from a technology standpoint, it was unbelievable innovation that actually came in from -- even from a business model standpoint, Carside Delivery, what an amazing innovation to actually do that contactless delivery in the pandemic. That's why we actually just really explored in terms of sales that we actually did, because we were able to quickly adjust our operating SOPs basically dramatically in the space of weeks to deliver an experience for the consumer who wanted in the circumstances in which they were in the pandemic. That's innovation. Not many companies can do that turning on a dime. And so I think innovation has to be looked at in a much more broad sense. And I think Domino's does that holistically. And a lot about what Domino's does very well is apart from being an outstanding marketing organization, it is an operationally very effective organization. I've talked about the microcosm of the company on stores within that construct, but if you look at it more broadly, if I look at $5.99 as a national price offer over a decade, how do you do that? If you basically aren't very, very, very sophisticated as an operator, Domino's did that. And so I'm -- so my perspective on innovation is broad than just menu. I think that will continue to be the case, I think, with Domino's.

The -- I want to ask you -- actually I'll try to squeeze in 2 more here. Unit growth has been an average over a long period of time in that 4.5% range. Do you see potentially the U.S. unit growth accelerating as the fortressing increases with that plan of over 8,000? And I also wonder about the dilution from that fortressing. Is it still a 1%, 1.5%-type impact to comps?

Yes. I think this is an interesting one. I think number one, we talked about the pandemic and the delays in just construction and so on. We're expecting to see that growth on the units taper off, especially to the end of '22 for the next year or so. But I think overall, when I look at what the growth was pre-pandemic, it was still about 250 units a year. So not significantly higher than what we did in the last 12 months, which is a 215. So the delta we're talking about is not that significant. I think we get back probably to it once all these supply chain constraints, et cetera, ease. But I think overall, when we look at it, we've 6,600 stores at the end of Q1. So compared to 6,600 stores, 8,000 is not a million miles away. So I think whether you have it growing at 3.5% or 4% or 4.5% is just a question of when, not if. We'll get there. And I think as time goes along and the base is bigger, the impact from fortressing becomes smaller and smaller, right, because we now have open stores. And so whether it's 1%, less than 1%, slightly more than one, it's a smaller number. It's a downward trend in terms of what that impact is going to be on the comp.

And then your prior algorithm, 6% to 8% unit growth, 6% to 10% system sales growth, any reason why you can't achieve this growth longer term once you get past this labor availability issue?

I don't really see a good reason not to, because I see some tremendous growth opportunity. We just talked about the U.S. and potentially where we can do with unit growth than actually servicing demand. The international piece is something we're not really touched on. That's an unbelievable story. If I look at it from a unit growth potential, when we opened 1,000 stores in the last 12 months -- over 1,000 stores. And that's on a base of 12,000-plus stores. So it's still a really good percentage growth impact, which is going to help us to drive the total global retail sales as we go along. And I think that's the piece to really keep an eye on. And I think as far as I'm concerned, that's why I feel that there's going to be a bit of a mix shift, maybe with more growth coming from international than the U.S., but overall, the idea really works, especially as we shift to a higher rate on international.

Well, thank you, Sandeep. Great conversation. All the best with your business assessments and look forward to chatting with you after the next quarter. Thanks so much.

Sounds great. Thank you.