Sonic Corp SONC
Q2 2013 Earnings Call Transcript
Transcript Call Date 03/25/2013

Operator: Good afternoon, and thank you for standing by. Welcome to today's Sonic Corporation Second Quarter Fiscal 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the formal remarks, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue for questions. As a reminder, today's conference is being recorded.

I would like to turn the conference over to Ms. Claudia San Pedro, Vice President of Investor Relations and Communication and Treasurer. Please go ahead Ms. San Pedro.

Claudia San Pedro - VP of IR, Communications and Treasurer: Good afternoon, everyone. We are pleased to host this conference call regarding results issued this afternoon for the second quarter of fiscal year 2013, which ended on February 28, 2013.

Before we begin, I would like to remind everyone that comments made during this conference call that are not based on historical facts are forward-looking statements. These statements are made in reliance on the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to uncertainties and risks.

It should be noted that the Company's future results may differ materially from those anticipated and discussed in the forward-looking statements. Some of the factors that could cause or contribute to such differences have been described in the news release issued this afternoon and the Company's Annual Reports on Form 10-K, quarterly reports on Form 10-Q, and in other filings with the Securities and Exchange Commission. We refer you to these sources for more information.

Lastly, I would like to point out that remarks made during this conference call are based on time-sensitive information that is accurate only as of today's date, March 25, 2013. The archived replay of this conference call webcast will be available through April 1, 2013. This call is the property of Sonic Corp. Any distribution, transmission, broadcast, or a rebroadcast of this call in any form without the expressed written consent of the Company is prohibited.

We have posted our second quarter fiscal earnings slideshow presentation on the Investor sector of our website for your review both during this conference call and after the conference call for up to 30 days.

Finally, we have scheduled this call, which includes the Q&A portion to last to one hour. If we have not gotten to your question within that hour time slot, please contact me at area code 405-822-4618, and I’ll make the appropriate arrangements to answer your questions.

With that out of the way, I'll turn the call over to Cliff Hudson, the Company's Chairman and Chief Executive Officer.

J. Clifford Hudson - Chairman, President and CEO: Thank you, Claudia, and thanks to all of you for joining us this afternoon. We appreciate your ongoing interest in our company and we are also, of course, particularly pleased this afternoon reporting the results for our quarter ended February, another solid quarter.

So, as you know, now a few highlights from that second fiscal quarter includes the fact that our earnings per share doubled on the quarter from $0.03 a share last year to $0.06 this year, and reported same-store sales at our company drive-ins increased almost 2%, 1.9% during the second quarter, and the system was flat during the quarter. But if you exclude the impact of the additional day from leap year that we had in 2012, the system-wide same-store sales would have been 1.3% and company drive-ins would have been 3.3%. We also experienced, what I would describe as, more normal winter weather patterns this year than we did last year, which was really unseasonably warm during the winter quarter.

So with these two items in mind, and then also combined with still pretty challenging broader environment of the economy, we’re really pleased with our second quarter result, and particularly pleased with the performance of our company drive-ins.

Now some other highlights for the second quarter include the facts that at our company drive-ins we had a 140 basis point improvement in drive-in level margins. This is, of course, driven by the 1.9% same-store sales growth at our company drive-ins that I referenced a moment ago. Then also, with regard to our capital allocation, we repurchased $6 million of our common stock during the quarter, or 626,000 shares. We also paid down $23.7 million of debt.

As a reminder, since the new share repurchase authorization in August of last summer, August 2012, we repurchased $25.6 million of common stock. This represents about 4% of our outstanding shares since the beginning of the year.

So, looking to the results, the continued improvement that we're experiencing – the improvements we've made in the business over the last year really provided nice foundation to help drive that. This includes several things, including improved customer service and as a matter of fact in that topic or that category of improved customer service, in recognition of this improvement, a recently published Temkin Experience Ratings report, 2012 edition, which measures customer satisfaction across 19 different industries, Sonic received the highest customer rating in the hamburger QSR category and was one of three QSR concepts that ranked to the 12 businesses in the Temkin report. So, we are very positive about what this meant for our improved customer service.

But other elements of that foundation in addition to improved customer service, we've effectuated more effective product pricing, improved our product quality and improved the efficiency of our media buying. And these initiatives really have provided a solid foundation to help move our business to another level. And it's important to note that the consistency of our sales and profit improvements have demonstrated over the last two years that our result of not just any one of these but all of these initiatives working together effectively supporting each other.

Shifting to the initiatives that we believe that will sustain our sales and profit growth going forward, our multi-layer growth strategy, we've highlighted this for many years and this continues to be a key to producing double-digit earnings growth going forward. Historically, we've achieved solid consistent earnings growth by layering these same-store sales growth, operating leverage, new drive-in development, the ascending royalty rate unique to us and our business and effective deployment of our free cash flow. When you look at these layers in total, sustaining positive same-store sales is a key component to providing the momentum for the others as well. The additional layers are also necessary in order for us to achieve a double-digit growth rate that we've seen over the last several quarters, and also for a number of years before the recession.

So, as we work to assess our confidence and driving consistent earnings over the next several years, the confidence is buoyed by the strong initiatives we have in place for each of these layers and in turn we believe each layer can make a meaningful contributions to the solid double-digit earnings growth rate.

For our fiscal year 2013, our revised media buying and innovative new product pipeline combined are expected to drive positive same-store sales and internalize to leverage drive-in and operating income margin improvement. When these are combined with the effective use of our excess cash to reduce debt repurchase stock, we demonstrated the solid earnings growth for the first half of our fiscal year 2013. We expect that this is going to continue through the rest of the year.

So, if we look at 2014 and subsequent years, we expect that other initiatives, some of which we’ve discussed in the past like the implementation new point-of-sales system and supply chain management system, these were to improve our profits and our margins really for the entire system, for our Company as well. When you couple improving sales and profits with the new small building prototype, we expect to see new store development pick up in 2014 as well.

And in 2015, as you may recall we have a license conversion and renewal, which is expect to result in approximately 850 stores, the license for those stores going to a higher royalty rate. This will be a meaningful contribution to our earnings growth in 2015 as well. As these initiatives are implemented, we also expect, as you would, improve sales, profits, and unit growth, which will result in increased operating cash flow for us. As always, we will evaluate the most effective use of our cash to ensure that we achieve the right balance of investment in our brand, our Company's leverage an share repurchases.

So, the combination of these components of our multi-layered growth strategy that we've talked about over the years, were if those elements working together, should result in sustained earnings per share growth and in turn increase shareholder value, both in the near-term and over a longer period of time.

Now, that multi-layer growth strategy, and specifically looking at the same-store sales drivers, for this fiscal year there really are four main initiatives that resulted in our same-store sales growth rate during the first six months of the year and we expect those to continue though as the year progress. That would include more effective media strategy, innovative product pipeline, layered day-part promotional strategy, and our iconic television creative.

So, working back through those, with regard to the media strategies, our investments in media and the allocation of media have been important drivers not only of the same-store sales but also new store development for our brand over time.

In the last decade – the earlier part of the decade, from 2003 to 2005, we experienced same-store sales growth and new unit development, which we believe is really directly related to an increase in our allocation of media dollars in local television and national cable in conjunction with other initiatives. This was particularly beneficial to our development efforts in newer markets. As we've noted, beginning in January 2013, approximately, 70% of our media dollars will be invested in national cable with the remaining portion in local television and other mediums. This is up from roughly a 50-50 split previously and that is between local and national. And should have the impact of increasing the number of times our average customer or potential customer in every market will see our commercials. We expect this increase to drive increased sales in all of the markets; it's a great thing about efficiency. It's not just in newer developing markets but all markets, and we also expect this to have a positive impact on new store developments over time.

Looking at the later day-part promotional strategies, for a lot of the years innovative distinctive products have been a hallmark of our brand and in this year, fiscal 2013 we've continued that tradition with a number of new items that are a step-up from what you may have seen in the recent past. Particularly exciting for us is that we'll have a distinctive new product news across all of our day-parts, which is very important given the role that individual day-parts have historically played and continue to play for our brands.

During the second quarter our new product news highlighting our distinctive ultimate grilled cheese sandwiches with the Philly Steak Grilled Cheese Sandwich and the BLT Ultimate Grilled Sandwich as the entree items that we offered and two new premium breakfast toasters to emphasize our breakfast day-part. This was in addition to our premium chicken sandwich that we offered earlier in the quarter and our new Sweetheart Shake.

So current examples for the third fiscal quarter include our new Spicy Jumbo Popcorn Chicken for lunch and dinner, Sweet Potato Tots as an afternoon snack, our new Molten Lava Cake Sundaes for afternoon and evening. In addition, we’re excited to be introducing new Freshly-Brewed Iced Green Tea. We’re one of the leaders in offering a product of this kind in QSR and it’s available in regular and diet. This addition increases the number of drink combinations at our drive-ins and also demonstrates our continued commitment to innovation in the drink category.

As I alluded to earlier in contrast to most of our competitors, growing each day-part is a critical element for us in driving same-store sales growth, given that over 50% of our sales occur outside of lunch and dinner hours. The later day-part promotional strategy that features a variety of our products in relatively short 60- to 90-day timeframe drives sales across all day-part. This is important to sustaining positive same-store sales for us.

So, reintroducing the Two Guys last year was a key piece to this strategy, primarily because of the recognition they provide in each of our commercials, enabling us to promote all day-parts, all of the day-parts in shorter timeframe, or promote all the day-parts within the same quarter, which is our objective and by kind of creative that they present is a great brand builder for consumers and were continually looking for ways to keep them fresh and relevant because they have worked so hard for us and closely associated with our brand.

The promotion of each of our multiple day-parts with fresh, relevant compelling products is largely why we achieved to decades of positive same-store sales prior to the recession. We believe returning to this strategy is a major reason why we see more consistent same-store sales growth through the past few quarters. We feel confident that we can sustain positive same-store sales looking forward.

Now, as you have seen in our results, improved margins have followed our improved sales and looking ahead we expect further improvements in drive-in and operating margins from the implementation of the new point-of-sale system. The point-of-sale system provide integrated back office tools like labor management, inventory controls, they increase profitability at the store level, which we believe will help us achieve return to 16%, 17% drive-in level margins on an annualized basis. We believe this point-of-sale system initiative combined with the complementary supply chain rationalization, will benefit the entire Sonic system in the mid-term and for years to come.

So, overall, we’re really very pleased with the consistency of our sales and profit improvements, driven by our multi-layered growth strategy. Historically, these strategic elements have worked together to drive consistent, strong earnings growth. Many of you may remember our efforts from 1996 to ’99 when we expanded our media coverage, emphasized uniqueness of our frozen fountain offerings and implemented retrofit for our entire system, or the same type of process to 2003 to 2007, during which we switched our media effort to national cable, added breakfast to our day-part mix, implemented pays and focused on rebuilds or reallocations, which combined to drive-in average of 6% annual sales increases and average EPS growth of 19% during that timeframe.

So for the past several quarters, we’ve seen the benefit of three of the five layers in our multi-layered growth strategy, positive same-store sales, improved operating margins, and use of cash flow. We’ve seen that drive double-digit earnings growth. So these improvements combined with initiatives we’ve outlined give us the confidence that we’re positioned well for consistent sales and earnings growth in the near and long term.

So, with that, I’m going to turn it over to Steve Vaughan.

Stephen C. Vaughan - EVP and CFO: Thank you, Cliff. New store development and our unique ascending royalty rate are two important components in our multi-layered growth strategy, and we expect to see a significant step-up in the contribution from these layers in fiscal 2014 and subsequent years.

Our core franchise business remains very solid. While we have noted that the ascending royalty rate will be constrained by development incentives and franchisee workout efforts in FY 2013, we expect positive same-store sales to produce corresponding increases in royalty revenue and in fact, in the second fiscal quarter we saw a 3 basis points improvement in the effective royalty rate. This increase was primarily a result of some agreements transitioning to a different form of the license agreement with a higher royalty rate structure. We expect our royalty rate to increase on a consistent basis in FY 2014 and subsequent years.

As same-store sales improve, development incentives wind down and development increases. Over the past year, we've seen improved same-store sales performance in both new and developing markets which we believe is the result of our emphasis on service and product improvements combined with improved media efficiency including increased national medial expenditures. We are confident this national media initiative will further strengthen the trend in these markets.

We had three new franchise drive-ins openings during the second quarter and as of the end of February, we had 3,526 total drive-ins operating in 43 states. While store closures fiscal year-to-date are higher than the prior year, we continue to expect the number of closings in fiscal 2013 to be on par or slightly less than 2012. Given the seasonality of our business closures are typically more concentrated in the first half of the fiscal year.

The improvement in our sales and profit momentum has helped to increase our franchisees' overall confidence in the business. Calendar year 2012 profit increases for our franchisees were the strongest they have been in five years. As our store level profits have grown, our franchisees' appetite for new development likewise appears to be growing and we're seeing more activity in looking at new sites.

With the improved store level profitability in the new small building prototype that improves the return on investment, we also expect development to accelerate beginning in fiscal year 2014 and subsequent years. We expect new franchise drive-in openings this fiscal year to be slightly more than fiscal 2012 similar to prior years; however, our new drive-in openings tend to be concentrated in the second half of the fiscal year.

One of the reasons we expect stronger development over the longer term is the work we've done to improve new store return on investment through a new smaller building design, which reduces non-land costs by 15% to 20%. We have opened several of these drive-ins today and we expect that this will become the primary layout for new stores in the future.

To further incentivize our franchises, we'll also continue to offer development incentives in the form of a lower royalty rate schedule, offering license type Number 6 instead of a Number 7 if franchises build new drive-ins within a certain time period. As we have noted, this development incentive does not provide for royalty abatements and the Number 6 agreement has a higher average rate than our overall average royalty rate. So it will not have an adverse impact on our royalty rate. Over time, we expect these franchisee incentives to yield long-term benefits with increased brand penetration and improved sales in addition to an ascending royalty rate as new drive-ins are built and volumes continue to grow.

I'd now like to spend a few minutes talking about our financial performance. As Cliff mentioned, excluding the extra day last year, Company drive-in same-store sales would have increased more than 3% and system-wide same-store sales would have been up approximately 1.3%. Given the more challenging consumer environment during the first part of the calendar year, we were particularly encouraged by these solid results.

Our sales increase resulted in operating income margin improvement and helped drive a substantial 67% increase in earnings per share on an adjusted basis to $0.05 versus $0.03 per share last year.

Included in our second quarter results were a $492,000 charge from the write-off of debt origination cost associated with the $20 million early pay-down of debt and a net tax benefit of $857,000 from the retroactive reinstatement of WOTC credits, as well as the resolution of other income tax matters. Combined, these items had a $0.01 positive impact on our fully diluted earnings per share.

Our strong results continue to demonstrate our ability to grow earnings at a double-digit rate with moderately positive same-store sales, leverage from that sales growth and effective deployment of our excess cash flow.

We are pleased with our overall business trends and believe the improvements we have made over the past three years in our products, pricing, and service, in combination at the refinement of our promotional strategy and a robust product pipeline, will continue to yield improved and more predictable sales growth. Going forward, we continue to target same-store sales increases in the low single-digit range.

We remain pleased with the performance of our Company drive-ins from both a same-store sales and a margin perspective. Overall, Company drive-in margins improved 140 basis points in the second quarter to 11.8%, reflecting leverage from solid same-store sales growth, a favorable commodity cost environment, and to a lesser extent, the timing of expensing our annual business meeting, as well as the refranchising of underperforming drive-ins during the second quarter of 2012.

The improvement in drive-in margins was a major factor in our second quarter earnings growth. These improvements in drive-in and corporate level margins demonstrate the potential to show significant operating leverage as we achieve positive same-store sales going forward.

Looking at each individual line item for the second quarter, food and packaging costs were slightly favorable. This improvement reflects benign commodity cost inflation, effective management of food costs and menu price increases. We are currently running approximately 3% in pricing in Company drive-ins. We have locked in the cost for over 80% of our commodities in FY 2013 and currently expect inflation to be in the 1% to 2% range for the remainder of the fiscal year. We will be lapping over a 1.5% to 2% price increase in May of this quarter. We're planning to take a small price increase in May. However, the new price increase implemented this May will be conservative in light of the still fragile consumer environment. Overall we expect to see continued moderate improvement in food and packaging cost for the year.

Payroll and employee benefits were essentially flat as a percentage of sales. For the remainder of FY 2013 we expect to see some year-over-year improvement in our payroll and employee benefit cost with our seasonally stronger third and fourth quarter volumes. Other operating expenses were favorable by 130 basis points as a result of leverage from increased same-store sales, the refranchising of lower-performing drive-ins in Q2 of last year, and a 30 basis points reduction as a result of a change in the method by which we expense our annual business meeting.

As a reminder there will be a 25 basis points reduction in other operating costs in the third and fourth quarters this year as the business meeting expense was a timing change only. Looking forward we expect to continue to see improvement in our drive-in margins dependent upon the degree to which same-store sales are positive and anticipate 2013 drive-in margins to be in the 14.5% to 15% range. Looking longer-term we believe we have an opportunity to drive further margin expansion with the implementation of a new point-of-sale system.

As most technology initiatives, development has taken a little longer than originally projected and we now expect to roll out the new system to a full test market this summer. We would then expect to implement the new system in company drive-ins over the fall and winter months. Further we expect to roll out the new systems to franchise locations over the next one to two years. As that rollout progresses, we will provide updates on timing and quantification in margin improvements we expect.

The implementation of our new supply chain management solution is underway with the benefits from rationalizing our supply chain expected to be seen in fiscal 2014 and beyond. We’re pleased that positive same-store sales have resulted in higher store level profit at both company and franchise locations. These improved sales trends have translated into improved financial health on the part of our franchisees, driving positive sales and profits across the Sonic System remains our primary focus.

For the second quarter, our SG&A expenses decreased approximately 4%. This decrease was largely attributable to two items. First, our prior year SG&A second quarter expense included a catch-up accrual on variable compensation cost. In addition, bad debt expense decreased this year, which is a result of improved drive-in level profits. We anticipate SG&A will be higher than third and fourth quarters coming in at between $17.5 million and $18 million each quarter. However, we will continue to closely monitor our overhead and we'll add resources as necessary to drive our key initiatives.

As I mentioned previously, our tax rate was down in the second quarter compared to the prior year, primarily as a result of a tax benefit associated with the retroactive reinstatement Work Opportunity Tax Credit and a resolution of some income tax matters. The states have fallen behind on processing WOTC applications making the estimation process a bit more difficult. However, with the reinstatement of the WOTC credit, we expect the tax rate to be between 37% and 38% for the third and fourth quarter of 2013, but this rate may vary depending upon future developments.

Our business model is first and foremost focused on franchising. As a result, we generate significant amount of stable and predictable cash flow with only moderate capital needs. This model gives us the flexibility to invest in our brand and reach our return on investment criteria, repurchase shares and pay down debt. As Cliff mentioned earlier, we had purchased approximately $25.6 million of stock since the new share repurchase authorization in August of 2012, and we also increased that share repurchase authorization by $15 million to $55 million in January of this year, leaving us with approximately $29.4 million of availability under our current program. Defined with our FY 2012 repurchase program, these repurchases were accretive to second quarter earnings and are anticipated to be nicely accretive in fiscal 2013.

I also want to point out; we closed on the previously announced real estate transaction at the end of December. A franchisee exercised its option to acquire land and buildings we leased or sub-leased to him related to drive-ins we refranchised in 2009. As a result of this transaction, we realized approximately $30 million of cash proceeds, and will receive another $9 million over the next 24 months. As a result of this sale, we expect to see a reduction in lease revenue to approximately $750,000 per quarter. This reduction in lease revenue should result in combined lease and other revenue at $2 million to $2.5 million per quarter in the third and fourth quarters, respectively.

We also anticipate a reduction in depreciation expense of approximately $500,000 per quarter going forward, resulting in depreciation of $10 million to $10.5 million in each of the third and fourth quarters. With the real estate sales proceeds, we prepaid an additional $20 million of debt in January, and expect a $600,000 reduction in interest expense in the second half of the year as a result of this pay-down. On a related note, we recorded a $492,000 charge from the write-off of debt origination cost associated with the early debt extinguishment.

In fiscal year 2013, we project we will generate between $45 million and $50 million in free cash flow which we define as net income plus depreciation, amortization, and stock compensation expense less capital expenditures. Looking forward, we will continue to use our free cash flow to enhance shareholder value by investing our brand with initiatives such as the replacement of our legacy POS system, repurchasing stock or paying down debt.

As we have noted, our goal over the next couple of years is to reduce our net debt to EBITDA level to the 3 times range through a combination of growing our earnings and reducing our debt. We are very pleased with our progress towards this goal as our current net debt to EBITDA was approximately 3.3 times as of the end of the second quarter. However, we will continuously evaluate all options to determine the best uses of our excess cash to provide the greatest impact to shareholder value creation. We continue to have a very solid balance sheet and exceed our debt compliance covenants by a wide margin.

So, to summarize, for fiscal 2013, we expect positive same-store sales in the low-single-digit range, slightly more franchise drive-in openings in fiscal 2013 than fiscal 2012, driven-in level margin improvement of between 50 and 100 basis points, SG&A expenses in each of the third and fourth quarters of $17.5 million to $18 million respectively, depreciation and amortization expense of $10 million to $10.5 million in each of the third and fourth quarters, net interest expense of approximately $28 million to $28.5 million excluding the debt extinguishment charge recorded in the second fiscal quarter and tax rate of between 37% and 38% for each of the third and fourth quarters and capital expenditures of $30 million to $35 million which includes partial implementation of the point-of-sale system in Company drive-ins and supply chain management for the Sonic System.

I'd now like to turn the call back over to Cliff for some closing comments.

J. Clifford Hudson - Chairman, President and CEO: Thank you, Steve. As you can see, we continue to be confident in our multi-layered growth strategy. We remain confident that it can deliver double-digit earnings growth from a foundation of improved service and product quality, as well as the effective use of promotional media strategy, and a good creative format from the television standpoint that helps keep us distinctive within our industry. So, from our viewpoint, with this consistent and sustained same-store sales, we’ll continue to benefit from increasing franchising revenue, improving operating margins, and over the next two or three years the implementation of new point-of-sale system and supply chain management system. This combined with the effective use of our cash will be the primary drivers of our earnings growth in the near term. So, for fiscal 2014 and subsequent years, new unit growth and the ascending royalty rate will also add to boost – added boost to our earnings growth.

So, this concludes our prepared remarks, and we will be happy to respond to any questions you may have.

Transcript Call Date 03/25/2013

Operator: Nicole Miller, Piper Jaffray.

Nicole Miller - Piper Jaffray: One quick numbers question. In terms of the comp, I think you talked about 3% price right now. Can we understand the rest of the comp to be mix and traffic, and could you specifically call out if you are benefiting from positive or negative mix as well as traffic?

Stephen C. Vaughan - EVP and CFO: Yes, Nicole, we are seeing the majority of our same-store sales growth is coming from a combination of price and mix, so our traffic has been basically just maintaining at existing levels, so relatively flat.

Nicole Miller - Piper Jaffray: And that's where if you back out the leap year it would be up and would be into the slightly positive territory then?

J. Clifford Hudson - Chairman, President and CEO: At Company drive-ins. That's correct.

Nicole Miller - Piper Jaffray: And then a big picture question, if you look at the limited service arena, so not just QSR and not just fast-casual, but the whole limited service umbrella, I'm going to ask about loyalty programs. Traditionally, QSR hasn't had them, but fast-casual has, and more recently they are becoming more popular even in some of the limited, more the QSR-type concepts. Is that something that you would consider doing in the future, and if so, how would you do it?

J. Clifford Hudson - Chairman, President and CEO: Well, I'll treat that as two questions. First is, would we consider doing it and the answer is yes. We are exploring that now and developing that now. So, as we reach the point where we're ready to roll that out in a public format, we will share that with you. We do think it as a place in our business and we have many very regular customers and so it makes sense to reward them for being so, but also help drive additional traffic which customers might appreciate that as well. Now as to how we would do that, we are working on that and we're working on it in a quite focused manner. However, that's not something that really want to lay out the details of that today. It'll take a variety of forms over time, but as that evolves and we're ready to share elements of it, we'll do that.

Operator: Matt DiFrisco, Lazard.

Matthew DiFrisco - Lazard: Gentlemen, I guess, I am just thinking longer-term, as you've talked now a couple quarters about some of the initiatives where you think the point-of-sale system could be a margin driver in the company owned stores, I'm assuming also the pace that you're talking about throughout the system being rolled out. Could this also be somewhat of more of a traffic driver? How do we look at this as far as your margins are improving pretty quick already without your comp turning around. So the targets you've set don’t sound that ambitious, especially given the point-of-sale system that could be pretty meaningful. Are you going to reinvest this potentially so you reach 16%, 17% margins and I think you and the franchisees would rather see a $200,000 of sales at a 16%, 17% margin maybe and start to see some pretty meaningful comp growth and reinvestments help your value position, or is this going to be let's just drive the margin as much as we can and I'm wondering how do you balance out as far as reinvesting and giving some of that value back to the customers, if you could speak to that.

J. Clifford Hudson - Chairman, President and CEO: Well, we continue to look at ways to refine our offering, you might say, and part of that's service, part of it's food, but part of it also relates to other ways we're working to improve the engagement of a customer. So even as our profitability improves, there are additional ways, Matt, that we are looking to improve the customer experience, so it's not just a question of improving margins and keeping the experience constant. Your next question was going to be, well, could you lay out what those approaches of engagement would be, and my answer to that would be much the same as it is on the loyalty program question a moment ago that Nicole asked and that is in the near term as we look to what those initiatives are, I should say we are ready to discuss those. We will lay it out for you, but I think your – it’s an interesting question. You are right to ask how are we looking at ways to in essence improve the customer. We might say engagement, but I think from the customer standpoint, we’d say the customer experience and elevate the results of what’s occurring at the drive-in. I’m not sure that I am having a more specific answer for you than that, but it’s an interesting question, one we are actively exploring.

Matthew DiFrisco - Lazard: I guess, maybe a good problem to have if you are already at those targets. Now that 16%, 17% by the time you start rolling out the point-of-sale system, so you would be going north of those targets, I would assume. I guess, just also as a follow-up, I think it was Steve that reiterated the guidance for slightly more openings and I guess the inference is there that’s slightly net openings as well. I think you had some time to explain that the closing, that’s not a pace that you would expect. So, I guess what was going on behind that? Was it just that you got to – its best during the winter time to close some of those stores down and we are not going to see 3Q and 4Q (degree of) closings, because I think 4Q was a pretty heavy closing period last year. So, is that just baked into assuming that better positive comps are going to keep those stores open or would you know already right now what type of closings you would have for 4Q coming down the pipe?

Stephen C. Vaughan - EVP and CFO: Matt, yes, so it’s a couple of things. One, we do anticipate that the closings over the winter month would represent the majority of the closings. We are able to for the most forecast when the closings will occur based on communications with franchisees and just monitoring their financial results. So, at the end of the day, yes, we do expect to have a more net openings this year than last year.

Operator: Will Slabaugh, Stephens Inc.

Will Slabaugh - Stephens Inc.: I want to ask you about the product pipeline. You guys have, obviously, been very active there. You’ve been putting up these far more consistent, strong low single digit same-store sales. I’m wondering what that looks like now, how you feel about it, maybe you could go into what that pipeline looks like now versus maybe the past four quarter, and how far out that goes, if you would.

J. Clifford Hudson - Chairman, President and CEO: Well, we’ve made an investment in human resources in the last year and more that has paid off, and so our product pipeline – new product pipeline looks better than it did 12 and 18 months ago. It looks better in terms of refinement of existing lines of products by day-part, but it also, I think, is stronger from the standpoint of new product news that’s coming down the pipe. So from an either standpoint, it does look much improved versus a year ago, and I think with the talent pool we have onboard it will continue to improve in the coming quarters.

Will Slabaugh - Stephens Inc.: Then one other question I had. Whenever you refer to some of the newer and developed markets putting out some good performances as likely benefitted from some of that shift toward a more natural media campaign, I wonder if you can talk any more specifics around what that gap may be and what you might expect from some of these newer and developing markets as you do put more media dollars into the national TV.

J. Clifford Hudson - Chairman, President and CEO: You mean a gap from a sales standpoint or what…

Will Slabaugh - Stephens Inc.: Right, from a same-store sales growth standpoint.

Stephen C. Vaughan - EVP and CFO: No, we haven't really talked about that specifically.

J. Clifford Hudson - Chairman, President and CEO: But you need to keep in mind that the lion's share of our sales come from our core markets anyway. 75% of our sales are going to come from the core markets. But the – so, I hope I'm not redundant here. So, lion's share of sales comes from core markets. However, the objective of the reallocation of media dollars whilst intended to help the whole system, which is has, a better use of – so more greater gross rating points across the entire system including core markets. Now, these new and developing markets are disproportionate beneficiaries of this. It's a bit more of a – it's a good near-term play in terms of the impact of the things to our sales, but it's also intended to be a long-term play because of the sustained benefit to these new and developing markets.

Operator: John Glass, Morgan Stanley.

John Glass - Morgan Stanley: How much visibility on the 2014 development pipeline do you have at this time of the year typically and is it greater than in the past? How much of these are firm commitments versus just sort of an idea of where development schedules shake out when you talk about an increasing development in '14?

Stephen C. Vaughan - EVP and CFO: John, we do have limited visibility into that. At this point, it tends to be more expressions of interest as we talked about our area development agreement pipeline we have gone through and really kind of cleaned that pipeline up just to a great extent. But we are seeing a lot more interest from existing franchisees and also greater interest from new franchisees. So, from that perspective, we see more development in the pipeline today than we saw this time last year. In addition to that the reduction in the costs of new building that we've worked on in implementing primarily in core markets today is increasing, so as Steve referenced to, existing franchisees, some increase in interest. The lower costs building has really enabled us to go back and look at markets that we might not have looked at over the last number of years, including a number of franchisees that may consider a secondary market in a core market or state. So, this is part of what's improving the pipeline as well, the combination of new franchisees, new and developing markets and then the lower costs and smaller building allow us to go into some secondary markets. The other thing, though, I should say in terms of the interest in development and the interest in capital expenditures by franchisees is augmented with our experience in calendar 2012, obviously the way they would look at the business calendar year and not our fiscal, but in calendar year sales and profits at the average store being up materially, and the average franchisee then beginning to look at the business differently they might have two to three years ago.

John Glass - Morgan Stanley: And then relating to that, you mentioned that you are going to open some stores under this Number 6 agreement versus the 7, so lower royalty. What qualifies a franchisee for that? Is it all openings in '14 will be under that or is it only new franchisees or only new markets, how many storage do you think, I guess, or percentage of stores do you think will be opened into that new or that Number 6 slice?

J. Clifford Hudson - Chairman, President and CEO: John, at the beginning of the fiscal year we set out a plan for our franchisee for basically in order to try to get them to kind of expedite their development. We offered this incentive – and it was really tied to how quickly they open up the drive-ins, so we anticipate all drive-ins opened in the current fiscal year will be under the Number 6 license agreement. That over time – that, in incentive will go away. Some of those are for a limited period of time, but for the most part what you'll see is in 2013 the Number 6 agreement will be what new stores will open up under.

Operator: Joe Buckley, Bank of America Merrill Lynch.

Joseph Buckley - Bank of America Merrill Lynch: Can I just follow-up on the development pipeline? Your fiscal year is only five months away, so I don't know what the lead time is on construction, but is there enough visibility at this point to think you'll have net unit growth in 2014?

Stephen C. Vaughan - EVP and CFO: Joe, we do believe we'll have net unit growth. We have a couple of things. As Cliff mentioned, we've been more aggressive in exploring opportunities with our franchises and developing in some smaller markets; the real market, where you tend to need less lead times than you might have in a more urban market. That does add a little bit of additional – another variable to a new store development that we haven't had historically in terms of focusing on some of those smaller markets with the new small building prototype. But overall, based on what we see today, we would expect to have net unit growth in 2014.

Joseph Buckley - Bank of America Merrill Lynch: And if the franchises you showed up today, you talk about the unit growth the next year, is the Number 6 deal still available to them or would it be under Number 7?

Stephen C. Vaughan - EVP and CFO: I think at this point if a new franchisee came in, it would be under a Number 7 agreement.

Joseph Buckley - Bank of America Merrill Lynch: (How about an existing franchisee stake?)

J. Clifford Hudson - Chairman, President and CEO: I'll have to go back and look at the specifics of what. We laid out, a pretty specific plan. So I'd have to look at whether it was in a certain market type that we were trying to incentivize franchisees to open in. So I think there are some other qualifications that would have to be met.

Joseph Buckley - Bank of America Merrill Lynch: Okay. Then one more just number specific question. (If you look at the) operating expense line, you've got a lot of leverage and I'm aware of the timing of the expensing for the general manager meeting. Was there anything else that leads out in that 130 basis points overall improvements?

J. Clifford Hudson - Chairman, President and CEO: Well, I had mentioned also that we have the 34 drive-ins that were refranchised in the second quarter. Those added a little bit of a benefit, about 25 basis points, Joe. In the third and fourth quarters we will have lapped over that, so you won't have the same tailwind from those refranchised drive-ins, but those were the two kind of unusual items.

Operator: Keith Siegner, Credit Suisse.

Keith Siegner - Credit Suisse: Just a quick question on the timing of the relaunch of the Two Guys last year, when does that campaign first relaunch and then how did the media weight ramp over the couple months after the launch?

J. Clifford Hudson - Chairman, President and CEO: The relaunch of the Two Guys began at the end of February, first full month was March of 2012, and media weights were improving as the year progressed, but primarily because of our hiring of a new media firm and in '11 they had effective part of the year in terms of becoming our media buyer, our prior media buyer would have had come up from buys that was staged in over time. So the new firm that came in, Zenith out of New York, would have had a partial impact in ’11 and progressive impact in ’12, the earlier part of the year. As the year progressed, their impact became greater and greater because it was more a larger portion of the media was their purchases. So we got great efficiencies from their buying as well as over time some of their strategy development as well. We have last that at this point I suspect in terms of the – well, we are well into a period of time where they are doing 100% of our purchasing.

Keith Siegner - Credit Suisse: Steve, one quick question for you. A follow-up on Joe’s question; one of the things you mentioned was maybe some smaller rural areas. I guess, is there an AUV difference between those smaller rural areas and some of the other openings? In other words, is there is a meaningful percentage of mix, will that have an impact and what we should use for our average unit volumes for that future growth?

Stephen C. Vaughan - EVP and CFO: I would say the smaller rural areas didn’t have a little bit lower volumes than some of the urban areas, although we had with the limited number of those that have occurred to date, they have actually been more successful than what we had anticipated. So I would maybe model in a slightly lower AUV, although I think it will still be above our existing system average.

Operator: Brian Bittner, Oppenheimer.

Brian Bittner - Oppenheimer & Co.: Just a question on just the thematics of just using your own capital. You got this lower cost, higher return model, and if you could tell us what those returns are, that would be nice. But the real question is, you’ve got a franchisee base that – I appreciate that net units are supposed to grow in 2014, but there seems to be a lack of visibility there. It seems as though you’re going to need development incentives to get them to grow, you’re pushing to grow, yet you have great cash flow, these returns seem to be real strong. Why not put some of your own capital to use? It seems like it’d be a good way to create shareholder value and really accelerate the earnings growth curve.

Stephen C. Vaughan - EVP and CFO: Brian, a couple of things. One, as we mentioned, we continue to see some growth in our Company-owned drive-ins. We’re targeting about three units per year currently. We see a lot of upside with driving the margins on our Company-owned units, as you saw with the second quarter results. We want to continue to focus on really turning around the Company-owned drive-in operations. We’re seeing stronger same-store sales in the system and better margin. So I think that’s something that certainly we may look at in the future, but currently we’re pretty comfortable with the level of growth that we’re experiencing.

Brian Bittner - Oppenheimer & Co.: With the lower cost model, what kind of returns are you seeing? I’m guessing there’s a little bit lower AUVs, like you guys just talked about. But what – is there cash-on-cash in terms of your total invested capital return that you could (draw in) for us on the new model?

Stephen C. Vaughan - EVP and CFO: Yes, we are seeing close to about a 20% return. We only opened one company drive-in last year, but we saw a very healthy return on that one opening. It’s a little…

Brian Bittner - Oppenheimer & Co.: That’s with the new prototype?

Stephen C. Vaughan - EVP and CFO: It was actually with the old prototype. So the company drive-in that – well, we built two company drive-ins with the new prototype, but they were both – one was a relocation, one was a scrape and rebuild, which we tend to see even higher returns on those investments. So, they actually would have exceeded a 20% pre-tax return on investments. So, it has been very encouraging?

Brian Bittner - Oppenheimer & Co.: So, they'd be – I mean, they are arguably what your hurdle rate is for putting your own capital to use for a new unit, right?

Stephen C. Vaughan - EVP and CFO: That's correct.

Brian Bittner - Oppenheimer & Co.: But if there's – I mean, if theirs is just – if there continues to be kind of just lackluster unit growth among your franchisee base, is it something you consider?

Stephen C. Vaughan - EVP and CFO: Absolutely, we would definitely consider that. Our primarily focus is making sure that we get a return on investments and if we can do that reinvesting in the brand whether it's existing initiatives like the point-of-sale systems or building more Company units if we can get our return then we will definitely look to that first.

Operator: Larry Miller, RBC Capital.

Larry Miller - RBC Capital Markets: I just have one question. Can you remind us the difference in same-stores sales between the companies which – company stores and the franchisees? It's been stronger in the company's for a couple of quarters now.

J. Clifford Hudson - Chairman, President and CEO: In terms of what it was this quarter, Larry?

Larry Miller - RBC Capital Markets: Yeah. Sorry about that. So, can you give us a sense of why the partnered stores are stronger than the franchised stores right now?

J. Clifford Hudson - Chairman, President and CEO: Well, I think you're seeing the sustained improvement here a number of quarters of owned stores versus franchised. If I understood you correctly, if you're asking what's driving that? Part of it would be, they are coming from a lower average unit volume. So, obviously if they get the same dollar of improvement, the percentage is going to be higher in Company stores. Secondly, with some of the challenges that our own stores experienced in earlier part of the recession and new talent and leadership we brought into that group in 2009, 2010, we've seen a stabilization of management not just in the executive ranks, but at the store level. So, we've seen reduced turnover at the management level in those stores, improved service scores from our customer survey feedback over a sustained period of time so that the metrics we observed in terms of customer perception and performance, speed of service, accuracy of order, overall satisfaction, et cetera, have improved dramatically over the last three and four years to move into being on par with our franchised stores. So, in essence, so it's been a real turn in that business. When you get the momentum, I think, in that business from a lower volume, there is catch-up to do in terms of closing the gap from a sales and profit standpoint. But in order to achieve that with this current business they've got to have sales growth rate outstripping the franchise. So, it's a nice story, but it's mostly a nice story for our Company stores in terms of, you might say, a turnaround from that 2009 timeframe.

Operator: It appears there are no further questions at this time. Mr. Hudson, I'd like to turn the conference back to you for any additional or closing remarks.

J. Clifford Hudson - Chairman, President and CEO: Okay. We appreciate that very much. We appreciate each of your interest in our business and as we said earlier on, we are very happy to report a very solid quarter, particularly through such a challenging period of time not just from a macro standpoint, but the winter time, which is always our most challenging portion of the year. So, we look forward to continue to talk to about our business as our business progresses. We remain very optimistic about the elements to drive the business and we look forward to visiting with you along the way. Claudia San Pedro and Steve Vaughan will be available via telephone if you need to talk to them in the accompanying days, weeks, and months, but beyond that we look forward to talking to you in the future about coming quarters and the very positive momentum of our business. Thank you very much and we'll look forward to talking to you along the way.

Operator: Ladies and gentlemen, that concludes today's conference call. We thank you for your participation.