A common theme for this earnings season is that top line sales trends remain strong, but nearly every management team has underestimated the impact of inflation on margins and earnings.

Here is a look at what DPZ was saying about their most important commodity during the company conference call on 03/01/11.  Keep in mind that cheese prices went up 20.86% during the first quarter of 2011.  DPZ has a contract that effectively eliminates one third of the price volatility of cheese in its commodity basket.

The average cheese block price in the fourth quarter was $1.61 per pound versus $1.48 last year, an 8.8% increase.  DPZ seems to be more in tune with inflation expectations in their guidance of 3-4%.  Compared to other companies maintaining a 2-3% range for inflation, DPZ is far more realistic.

Question: Okay, and then just one more. Just in the 3% to 4% food cost inflation, what are your cheese expectations and how covered are you on your cheese needs for 2011 at this point?

Answer: Yeah, so the forward curve and kind of looking at about three different sources right now have cheese actually easing a little bit through the rest of the year. We're at almost $2 right now. And so, our expectation is that we're going to see a little bit of easing, to give you on cheese. We've talked about this in the past, we've got a contract in place that basically reduces the volatility on cheese moves by about a third. So about two thirds of increases or decreases in cheese are passed through to our system. About one third of that volatility is – does not come to us and does not come to our stores. So that has not changed on the cheese in terms of how that's kind of fixed and locked in. Other commodities we do have more locked in.

Question: Okay, and the assumption for the cheese is that prices ease as we move through the year. And then the meats you said other than chicken that you're not locked on that either or – ?

Answer: That is correct. Meat prices, which are primarily toppings for us, are not locked. But chicken is. 

[Interestingly, management was correct in its statement that prices would ease going forward; ten days later cheese prices fell off a cliff and are currently ~20% off the 03/11/11 peak]

Question:  What spot price are you assuming for cheese in fiscal '11 given the fact there we're at $2 now. I know you said lower, but how much lower is it?

Answer:  I think the consensus forecast out there right now for cheese are in the $1.70 to $1.75 range. And – you know so what you're looking at is kind of a $0.25 to $0.30 move and I think we've said in the past a $0.40 move in cheese is equal to a point at the store level P&L…so what you're looking at is – best guess is about a 0.5 point of easing from where we are today. But obviously there is – it's been a moving picture out there the last 4 to 6 weeks. But order of magnitude, if 3% or 4% up on total commodities is around a point, if cheese stayed right where it is you'd be looking at about another 0.5 point is the way to think about it. So if the consensus is wrong and it stays where it is as opposed to backing off that's about a 0.5 point.

Now just as a reminder though, while that's very important to us, it's very important to our franchisees and to our overall system. Remember we're over 90% franchised domestically, we're 100% franchised internationally. And I would point out I've been assuming that all the questions we're getting are domestically focused. And that's the way we've been answering them. But remember we're quickly approaching being 50-50 on this.


Howard Penney

Managing Director