Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Claudia San Pedro - Vice President of Investor Relations and Treasurer

J. Clifford Hudson - Chairman and Chief Executive Officer

W. Scott McLain - President, President of Sonic Industries Services Inc and Chief Strategy Officer of Sonic Industries Services Inc

Stephen C. Vaughan - Chief Financial Officer and Executive Vice President

Analysts

Matthew J. DiFrisco - Lazard Capital Markets LLC, Research Division

Nicole Miller Regan - Piper Jaffray Companies, Research Division

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

Will Slabaugh - Stephens Inc., Research Division

Sharon Zackfia - William Blair & Company L.L.C., Research Division

Keith Siegner - Crédit Suisse AG, Research Division

John S. Glass - Morgan Stanley, Research Division

Sonic (SONC) Q1 2013 Earnings Call January 3, 2013 5:00 PM ET

Operator

Hello and good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to today's Sonic Corporation First Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to turn the conference over to Ms. Claudia San Pedro, Vice President, Investor Relations. Please go ahead, Ms. San Pedro.

Claudia San Pedro

Good afternoon, everyone. We are pleased to host this conference call regarding results issued this afternoon for the first quarter of fiscal year 2013, which ended on November 30, 2012. 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 report 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, January 3, 2013. The archived replay of this conference call webcast will be available through January 10, 2013. This call is the property of Sonic Corp. Any distribution, transmission, broadcast or rebroadcast of this call in any form without the express written consent of the company is prohibited.

Finally, we have scheduled this call, which includes the Q&A portion, to last one hour. If we have not gotten to your question within that time slot, please contact me at (405) 225-4846 and I will make the appropriate arrangements to answer your question.

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

Thank you, Claudia, and thanks to all of you for joining us this afternoon. We appreciate your interest in Sonic, and we're happy to report another solid quarter.

A few of the highlights before moving to the other parts of the presentation. A few of the highlights include, as you see and you know now, a 22% increase in earnings per share to $0.11 a share from $0.09 a year ago, same quarter. Our system-wide same-store sales increased 3% during the quarter. This is an increase of 4.2% at our company drive-ins and 2.9% at franchise. So again, a nice quarter, a nice movement of the business there.

These same-store sales in turn resulted in an 80-basis-point improvement in our drive-in level margin, a nice development of the business. And then also as you see, a repurchase of more than 1.8 million shares of common stock, and that represents over 3% of our outstanding shares.

So our results continue to reflect the improvements that we've made in our business over the last several years that include improved customer service that we've talked about over time; more effective product pricing; improved product quality; a refined media buying effort that we described previously and we'll talk some more about today; layered day-part promotions; and then effective -- more effective creative in the last number of months. All these initiatives have provided a solid foundation to help move our business to another level in our view. And it's important to note, from our perspective and to come back to time and again, that our sales and profit improvements over the last 2 years are as a result of this -- these series of initiatives, not just one initiative or one promotion or one level or kind of activity in the quarter. So a series of initiatives over a couple of years that really laid a different foundation and helped move our business to another level.

Now I'd like to shift to the initiatives that we also believe will sustain the growth of our business and the building of our brand. Our multilayered growth strategy that we've talked about over time and continue to talk about now, it provides that base for our near-term and long-term earnings growth. For years, we've achieved solid, consistent earnings per share by layering these performance elements, the same-store sales, operating leverage, new drive-in development and ascending royalty rates and effective use of cash.

So sustaining positive same-store sales is kind of -- it's first base, it's square one for the remaining layers, but those additional layers are also necessary in order for us to achieve the double digits EPS growth rate that we have in the last few quarters.

As for the earnings drivers, as we look at the initiatives driving our multilayered growth strategy for fiscal year 2013 and beyond through 2015, the optimism that we feel is strengthened by the initiatives we have in place for each of these layers in this multilayered growth strategy. And in turn, each layer is then expected to make a meaningful contribution towards achieving the double-digit earnings growth just as we experienced the past quarter. For fiscal year 2013, we expect a substantially refined media buying effort initiative, and that with our innovative new product pipeline to drive positive same-store sales in this fiscal year. And as you have seen in this past quarter and would expect over time, this in turn will leverage drive-in and corporate operating income margins. These developments combined with the effective use of our cash to pay down debt and repurchase stock will result in driving solid earnings growth in this fiscal year 2013.

For next fiscal year, 2014, I should say for this year 2013, for 2014 and beyond, other initiatives such as the implementation of our new point-of-sale system and then related supply chain management system will work to increase profits and margins really for everybody in our system, all operators. You couple the improvement of sales and profits with then a new small building prototype that we've developed in the last year and more, and we expect to see a development in pickup -- new store development pickup in 2014 as well.

The following year, 2015, we will be looking at a license conversion, which we have discussed previously, through price for 900 licenses to step up their royalty rate by their existing terms, and this will be a meaningful component to earnings growth in fiscal year 2015. Now other initiatives on which we're currently working would -- should also contribute to same-store sales growth in 2014 and '15. All of these initiatives are -- as, I should say, as the -- as we move to implement these initiatives and we experience these improved sales, profit new store growth, our company's cash flow will also continue to grow. As we have in the past, we will continue to evaluate the most effective use of our cash to ensure that we achieve the right balance of investment in our brand, company leverage and share repurchases. So the combination of these components and the layers we've talked about before, talking about today, should result in sustained earnings per share growth and, in turn, increase shareholder value in the near term and over a longer period of time.

So for fiscal year 2013, there are 4 main initiatives that are -- will be driving same-store sales: the more effective use of media, our media strategy; and innovative product pipeline; layered day-part promotional efforts; and then our "Two Guys" strategy -- excuse me, our "Two Guys" creative messaging, as you see indicated here.

As it relates to the media piece, historically, our investments in media and the allocation of media have been important components in driving same-store sale and in driving new store openings, new store development as well. I can tell you that in the late '90s, this was the story -- it was the story of increased advertising dollars: the same-store sales grew, media expenditures grew, healthy new store development, et cetera. From 2002 to 2005, when we experienced same-store sales growth, this in turn fit new store development. And with the reallocation of media dollars from local to the national cable, it particularly helped drive new store development and developing in new markets in conjunction with other initiatives in our business.

So presuming this to another level, this media allocation that we have done in the past, we're starting this month allocating more of our current media dollars to national cable. In calendar 2012, approximately half of our media dollars were spent on national cable and half on local television and other local medium. In calendar 2013, about 2/3 of our media dollars will be invested in national cable and the remaining, local. The change that this had helped bring about will impact -- have an impact of increasing the number of times that the average viewer, average consumer and our potential customer, average viewer in every U.S. market will see our commercials. We expect this to -- this change in increased gross rating points for all of our markets to drive increased traffic in all markets. So we're very excited about this beginning this month and moving through the calendar year with its impact on our -- getting our word out through increased gross rating points and particularly some markets, new and developing markets, will be even more strongly affected.

So as it relates to product pipeline, I think it's fair to say that for a number of years, we've been known for introducing unique and innovative products. So I'm pleased to say that fiscal year 2013, we will feature a real step-up from what you've seen in the recent past related to our new products. It's particularly exciting for us to have distinctive new product news across a variety of day-parts as well, given the role day-parts have played in our businesses historically and continue to. These new products include our new -- a new flavor of premium burrito for breakfast; our new premium chicken sandwiches for lunch and dinner; some tasty Cheesecake Bites, which I can personally testify are delicious; and our Chocolate Mint Holiday Shake for the afternoon, which I can also testify is delicious, afternoon or evening or anytime you want to have it. So a variety of products across a variety of day-parts intended to help drive fresh news about our business, drive traffic and then sales and profitability store level.

This quarter, our new product news highlights our distinctive grilled cheese sandwiches and some real differences about those. A Philly Steak Grilled Cheese Sandwich, the BLT Ultimate Grilled Cheese Sandwich or the Cheddar Bacon Ranch Grilled Cheese Sandwich. These are entrée items. We also have 2 new premium breakfast toasters to emphasize our breakfast day-part. We are -- in this time period, we're also be highlighting the fact that we have more than 20,000 drink combinations that have less than 60 calories. So this is pointed out on lot with CLP [ph] and a nice differentiating point for our brand and our business.

On the layered day-part promotional strategy, as you can see on this slide, in contrast to many of our competitor, growing each day-part really is critical for us. It's critical in driving same-store sales growth given that over 50% of our sales are outside of lunch and -- outside of the lunch and dinner hours. A layered day-part promotional strategy featuring a variety of these products in a relatively short period of time, like a 90-day time frame to drive sales across all day-parts, is important to sustaining positive same-store sales momentum for us. The promotion of these multiple day-parts with new, fresh, relevant, compelling products was a large reason why we achieved 2 decades of positive same-store sales prior to recession. And so we believe returning to this strategy is the major reason why we see more consistent same-store sales growth during the past few quarters and it's why we're feeling better about sustaining positive same-store sale prospectively. And then in this last year, reintroducing the "Two Guys" has enabled us to promote all day-parts in shorter time frames because of the recognition of the "Two Guys" in each of our commercials, allows us to promote all day-parts within the same quarter, which is very much our objective going forward. This iconic creative that the "Two Guys" present is a great brand builder, and we'll continue to look for ways to keep them fresh and relevant in terms of breakthrough, creative and reaching out to existing and potential customers.

Now regarding technology initiatives we have underway, the next layer in our multilayered growth strategy relates to operating leverage. And if you've seen in the past 4 quarters, when we do experience improved same-store sales, we've seen improved margins. Looking ahead, we expect further improvement in driving and operating margins from the implementation of a new point-of-sale system. The new point-of-sale system will provide integrated back office tools like labor management and inventory controls to increase profitability at the store level, which we believe will help us achieve a return of 16% to 17% driving level margins on an annualized basis.

We expect to roll out the point-of-sale system at our company drive-ins starting in the spring of 2013, and our franchisees will follow in the months and years after that. This point-of-sale initiative, combined with a complementary supply chain rationalization, will benefit our entire system in the midterm and for years to come.

So for the past 4 quarters, we've seen the benefit of 3 of the 5 layers in our multilayered growth strategy: positive same-store sales, improved operating margin, effective use of cash, and we've seen them drive double-digit earnings growth. So the improvements and the new initiatives we have in place give us the confidence that we have a solid path for consistent sales and earnings growth going forward.

So with that, I'd like to turn the call over to Scott McLain, and he's going to discuss new store development and also our ascending royalty rates. Scott?

W. Scott McLain

As Cliff said, new store development and our unique ascending royalty rate are 2 important components in our multilayered growth strategy, and we expect to see a significant step-up in the contribution from each of these layers in fiscal 2014 and subsequent years. Our core franchise business remains solid as evidenced by the $844,000 increase in franchising income we experienced during the first quarter. Because of solid sales performance, we did see a slight increase in our average royalty rate for the quarter, which marked the first quarter in some time that we've received incremental benefit from our ascending royalty rate. While developments in this and franchisee workout efforts will continue to be a constraining factor in the near term, we may see our average royalty rate continue to grow depending upon the degree to which same-store sales are positive.

We've seen improved same-store sales performance in many of our new and developing markets, which we believe is the result of our emphasis on service and product improvements combined with improved media efficiency, including more balanced spending between national and local media. We believe the media initiative Cliff described earlier that allowed the effective promotion of every day-part and every market every quarter will further strengthen the trends in these markets. We had one new franchise drive-in opening during the first quarter. And as of the end of November, we had 3,549 total drive-ins operating in 43 states. We continue to actively evaluate our lower volume drive-ins, and looking ahead to 2013, we expect the number of closings to be on par with or slightly less than 2012.

We're pleased that our sales and profit momentum has improved, which has helped to continue to increase our franchisees' overall confidence in the business. 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 and a new small building prototype that improves ROI, we also expect development to accelerate and drive earnings beginning in 2014 and subsequent years.

This year, we expect new franchise drive-in openings to be slightly higher than they were in fiscal 2012. One of the reasons we expect stronger development over the longer term is the work we've done to improve new store return on investments through a new smaller building design. This new design reduces non-land cost by 15% to 20%. We've opened several of these to date, and we expect that this will become the primary layout for new stores in the future.

To further improve return on investment for our franchisees, we'll also continue to offer development incentives in the form of lower royalty rates if franchisees build new drive-ins within a certain time period. Since this development incentive does not provide for royalty abatement, it will not have a significant an impact on the royalty rate as previous development incentives. Over time, we expect these franchise incentives to yield long-term rewards 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.

Finally, in August of 2014, we expect to have approximately 900 franchise drive-ins convert to a newer form of license agreement. This conversion should result in approximately $5 million of incremental royalty revenue in fiscal year 2015.

With that, I'll turn the call over to Steve Vaughan, our Chief Financial Officer, for some more detail on the financial results.

Stephen C. Vaughan

Thank you, Scott. As Cliff mentioned earlier, for the first quarter, we reported a 3% system-wide same-store sales increase with a 4.2% improvement in company drive-ins. This sales increase resulted in operating income margin improvements and helped drive a 22% increase in earnings per share from $0.09 to $0.11. These solid results continue to demonstrate our ability to grow earnings at a double-digit rate with moderately positive same-store sales leveraged 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 2 years in our products, pricing and service, in combination with 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 a 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 margin improved 80 basis points in the first quarter to 12.2% reflecting leverage from solid same-store sales growth, a favorable commodity cost environment and, to a lesser extent, the refranchising of underperforming drive-ins during the second quarter of 2012. This improvement in restaurant margins was a major factor in our first quarter earnings growth. The 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, food and packaging costs were slightly favorable. This improvement reflects moderating commodity cost inflation, effective management of food costs and menu price increases. In November, we lapped over a small price increase and took a price increase of a little over 1% at our company drive-ins. Our current pricing is now in the range of 3%. 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 year. This level of inflation should allow us to see moderate improvement in food and packaging costs for the year.

Payroll and employee benefit improved 50 basis points as a result of leverage from higher same-store sales and improved labor efficiency. In 2013, we expect to see continued improvement in our payroll and employee benefits costs as a percentage of sales.

Other operating expenses were favorable by 20 basis points. Leverage from increased same-store sales and lower repair and maintenance costs compared to a year ago more than offset an approximate 75-basis-point impact of expensing our company drive-in annual business meeting in the first quarter. Historically, we had expensed these costs over the entire year. As a reminder, there will be a roughly 25-basis-point reduction in other operating costs from each of our subsequent 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 FY 2013 restaurant level operating 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. We'll begin implementation of the new system with the rollout to all company drive-ins beginning in the spring of 2013 with the goal of completion during calendar 2013. As that rollout progresses, we will provide updates on timing and quantification of large improvements that we expect.

The implementation of our new supply chain management solution will be underway throughout fiscal 2013, with the benefits from rationalizing our supply chain expected to be seen in fiscal 2014 and beyond. We are pleased that positive same-store sales have resulted in higher store level profits in 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 first quarter, our SG&A expenses increased approximately 4.5%. This increase was largely attributable to an increase in accruals for variable compensation costs as a result of our improved financial performance. We will continue to closely monitor our overhead and will add resources as necessary to drive our key initiatives.

An additional note on the quarter, our tax rate was 36.6%, down from the prior year of 37.7% as a result of the favorable settlement of a federal tax audit during the first quarter. Subsequent to the end of the quarter, legislation was passed that reinstated and extended certain employment tax credits. We estimate that we will realize a one-time tax benefit of $500,000 to $1 million in our second fiscal quarter related to the retroactive portion of the employment tax credit program and further expect our tax rate to be reduced to the 37% to 38% range on an ongoing basis in our third and fourth fiscal quarters. This legislation extended the program through calendar year 2013, so this positive benefit should continue through at least the first quarter of fiscal 2014. However, the processing of the applications to determine eligibility for these credits is backlogged in some jurisdictions. As additional information is available, we will refine our estimate and the impact of the reinstatement of these credits may vary from the estimated range.

Our business model is first and foremost focused on franchising. As a result, we generate significant amounts of stable and predictable cash flow with only moderate capital needs. This model gives us the flexibility to invest in our brand if it meets our return on investment criteria, repurchase shares and pay down debt. As Cliff mentioned earlier, we have repurchased approximately $18 million of stock as of the end of the first quarter and an additional $6 million in December. These repurchases, combined with the $1.1 million of stock we repurchased in August, leave approximately $14.9 million left under our existing $40 million share repurchase program. Combined with our FY 2012 repurchase program, the first quarter repurchases were accretive to earnings per share 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. As I mentioned in our October conference call, a franchisee exercised his option to acquire land and buildings we leased or subleased to him related to drive-ins we refranchised in 2009. As a result of this transaction, we realized approximately $30 million of cash proceeds, which will be classified as restricted cash, and recorded a note receivable of approximately $9 million that will be paid off over the next 24 months. We expect to see a reduction in lease revenue to approximately $500,000 to $600,000 per quarter beginning in our second fiscal quarter and a reduction in depreciation expense of approximately $500,000 per quarter going forward. We do not expect to record a significant gain or loss from this transaction. Our debt agreement allows us up to one year to reinvest the proceeds from this sale in qualifying real estate assets with a $5 million annual exclusion. After that time period, we will be required to pay down debt by the amount of proceeds not reinvested in qualifying assets excluding the $5 million basket. We plan to be opportunistic with the use of this cash, as well as the excess cash that we currently hold. We continue to evaluate our options for redeploying this cash and will keep you posted as appropriate.

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 in 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 3x range through a combination of growing our earnings and reducing our debt. 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.

For fiscal 2013, we expect positive same-store sales in the low-single digit range, driving level margin improvement of between 50 and 100 basis points; slightly more franchise drive-in openings in fiscal '13 and fiscal 2012; SG&A expenses in the range of $68 million to $69 million; and as a result of the real estate transaction I described earlier, we expect to see franchise lease revenue in the $3 million to $3.5 million range and depreciation and amortization expense of $40 million to $41 million; net interest expense of approximately $29 million. And as I discussed a moment ago, our tax provision will be reduced in the second quarter by between $500,000 and $1 million, and our ongoing tax rate is expected to be 37% to 38% for the remainder of the year as a result of the fiscal cliff legislation, which was passed earlier this week. And capital expenditures at $30 million to $35 million, which includes partial implementation of the new POS system and company drive-ins and supply chain management implementation to the Sonic system.

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

J. Clifford Hudson

Thank you, Steve. So you can see, we have continuing confidence in our multilayer growth strategy, and we remain confident that it can deliver double-digit earnings growth from a foundation of improved service and product quality, the effective use of our promotional media strategies, good creative format from a television standpoint that makes us distinctive amongst other advertisers. And with this consistent and sustained same-store sales, we'll continue to benefit from increasing franchise revenue, improved operating margins and, over the next 2 or 3 years, the implementation of the new point-of-sale system and supply-chain management system. And this, combined with effective use of our cash, will be the primary earners of our -- excuse me, primary drivers of our earnings growth. And then for fiscal '14 and subsequent years, new unit growth and the ascending royalty rate will add a further boost to our earnings.

So this concludes our prepared remarks, and we'd be happy to respond to any questions you might have.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Matthew DiFrisco with Lazard.

Matthew J. DiFrisco - Lazard Capital Markets LLC, Research Division

Just 2 clarifications, I guess. With respect to the guidance, yes, I just wanted to clarify. The same-store sales guidance is for the full year and not the remaining quarters. I'm just curious because with more difficult compares, I was wondering if there's room in there for flat to maybe even slightly negative but still being able to make your overall guidance on the same-store sales front. And then I wondered if you can give a little bit more clarity on the change in your guidance that looks like the biggest difference I've noticed is that you've narrowed downwards by $5 million the free cash flow, yet everything else seems to have stayed relatively the same or improved. Your CapEx went down, and your tax rate went down. So I'm just curious, why is the operating -- why is the free cash flow number narrowed down by $5 million from previous guidance?

Stephen C. Vaughan

Yes, so Matt, this is Steve. The same-store sales guidance that we provide or outlook, our outlook is for fiscal year 2013. From a free cash flow perspective, there were a couple of changes. One, we do have the refranchising that -- I'm sorry, the real estate sale that will result in the reduction in franchise lease revenue. That, combined with the lower CapEx is why we tightened that range by $5 million. So the $45 million to $50 million reflects those 2 changes.

Matthew J. DiFrisco - Lazard Capital Markets LLC, Research Division

But the lower CapEx -- the CapEx went down so that should have made your free cash flow go up? And I don't -- I didn't think that the lease revenue explained the entire $5 million lower.

Stephen C. Vaughan

Well, I'll need to look at that. I thought our original guidance was $45 million to $55 million, but we may need to clarify that. We'll get back with you here in a moment.

Operator

[Operator Instructions] And we'll take our following question from Nicole Miller with Piper Jaffray.

Nicole Miller Regan - Piper Jaffray Companies, Research Division

Could you just chat a little bit about the competitive environment where you think you're taking share from? If there's people coming back out of the home to eat or other QSRs or just other food service in general?

J. Clifford Hudson

So little difficult to hear, but I think the question was, do we have a sense of from whom we're taking share? I think that was the question. And I think it's a difficult thing to respond to, in no small part because we do build our business by multiple day-parts. And...

W. Scott McLain

Well, one of the things -- Nicole, this is Scott. I think what we find is that when we have really good product moves, it really helps us stay fresh and relevant with consumers. So it's difficult for us to know if products like our new premium chicken sandwiches helped us attract people from this concept or that concept. But what we do know is that when we have good product news out there, as we have had with many of our products, that seems to resonate with people. Also, the ice cream that we've had and our half-price shake promotions, those sorts of things on -- and how when we did a $0.50 corn dog promotion. These type of things, it helped us really resonate with customers and lead to higher sales. But we don't have good visibility in terms of where that's coming from.

Stephen C. Vaughan

Let me just -- just for a moment, I want to get back with a question that Matt had. Initially, our outlook was for $45 million to $55 million in free cash flow, which was based on CapEx of $30 million to $40 million. We -- because we are now anticipating a little slower rollout of the POS system, we revised our CapEx to $30 million to $35 million. So that would have lowered that free cash flow outlook or actually increased it to $50 million to $55 million, so tightened the range. We've been -- as a result of this real estate sale, are expecting to see about a $3 million to $3.5 million impact on lease revenues that we didn't originally anticipate. And, Matt, that's where we got to the $45 million to $50 million. So those 2 changes, hopefully that will make sense. But there's not really a lowering of our outlook outside of those 2 items. So just wanted to make that clear.

Operator

We'll take our next question from Joe Buckley with Bank of America Merrill Lynch.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Just a couple of questions on sales. You mentioned you have several new products and new product views, you have [indiscernible] significant behind the comps. Is there more new product news coming over the balance of the fiscal year? And I guess from a same-store sales question going forward, seems like there's been more winter this year than we had last year already. And I guess would you comment how you think about it year-over-year from a weather basis and [indiscernible] day and so forth in terms of some of the near-term comparisons?

J. Clifford Hudson

Well, in terms of the new product news piece, the answer is yes, we do have additional products in the pipeline prospectively. I think James O'Reilly and his team that's really basically here for the calendar year, particularly the product development folks that are relatively new to our team were here for the calendar '12. And the processes and the creativity they brought strengthened that pipeline. And so looking into fiscal and calendar '13, it is an improved picture versus a year ago. And so the answer is yes, we continue to expect new product news across a variety of day-parts prospectively. In terms of is it a colder winter than it was a year ago, our experience is yes, it's a colder winter than it was a year ago and a little bit more. Some precipitation but particularly just colder temperature. To the extent that, that's affecting the winter quarter, the winter quarter is always our wild card because of the effect of winter. I mean it is the one that is most affected by weather. But in terms of looking for guidance or impact, et cetera, that's all the guidance we'll give you. When the quarter's over, we'll talk about how the quarter performed. So -- but it -- I mean, it's verifiable. We can all see that we've had some colder weather versus a year ago.

Operator

We'll take our next question from Brian Bittner with Oppenheimer & Co.

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

Just want to talk about this unit growth piece because it seems like it could potentially be a large part of earnings growth. And it just seems as though you guys seem very confident in this part of the equation going forward. But if you look, you continue to on average have more franchisees that are closing than opening. And in this quarter, for instance, I think you had one open and about 8 close. I know you're taking steps to improve the returns, but other than this, what's really driving the confidence on the unit growth part improving going forward? Is there a backlog that you see that we obviously don't have access to? What's the visibility there?

W. Scott McLain

Yes, I guess a couple of things, I would say. Number one, it's our experience that the #1 thing that's correlated with new unit growth is sales and profits. And we've had sustained momentum in sales and store level profitability that is very motivating to our franchisees, and we have seen a pickup in their activity. The development cycle is a long cycle. It takes a long time to find the right piece of property, get the store built, those sorts of thing. But our confidence is really based on the fact that sales and profits continue to grow. And with the newer, smaller building, we have a vehicle that franchisees can use to get an ROI. So those 2 things give us confidence that our development should pick up moving forward.

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

Okay. And this isn't really a follow-on, more of a kind of a clarification question. The 900 licensed stores that I think you're going to basically restructure the royalty rates on in August of '14, I think you said -- did you say $5 million in pretax profits is [indiscernible]?

Stephen C. Vaughan

Yes. Brian, that's correct.

J. Clifford Hudson

And just for clarification, those -- rather than requiring a restructuring, those -- that step-up that we referred to is implicit within the contracts currently.

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

Okay. And just a quick -- my rough back-of-the-envelope math, is that -- am I out of the ballpark thinking that's a 50-basis-point increase in that 900 group?

J. Clifford Hudson

That's right. It's about a 50-basis-point on average increase.

Operator

We'll take our next question from Jeffrey Bernstein with Barclays.

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

I have 2 questions as well. The first one is a follow-up on the comps. I know we talked about the compares becoming increasingly difficult. Looks like 200 to 300 basis points starting this quarter. I'm just wondering, you talk a lot about the national media, and I know we've met with you recently, and obviously that got a lot of attention. So I'm just wondering what your anticipation is that, that national media spend shift will do to the comp? Whether you have any history or any evidence through test or what-not or how you think about what that's going to lift and what the actual GRP lift is? And then I had a follow-up.

J. Clifford Hudson

Well, we -- first of all, in terms of the history, in terms of increasing marketing expenditures, long history of positive impact from that. In terms of specifically shifting allocation of marketing expenditures from local to national cable, the answer is yes, we have very concrete experience with this in the last decade on more than one occasion. And each of the times we've stepped it up, we found a very positive impact across all markets, not just new and developing markets. So this gave us some confidence that the -- pursuing this in the last years, we began pursuing it with our franchisees. As it relates to the GRP impact, it clearly will result in an improvement in gross rating points. I don't think that we have discussed we've -- I don't think we've made any attempt to quantify that in the marketplace and don't intend to today. But in terms of as we look into this fiscal year and the questions about things getting more challenging as we move forward, the -- I'm not attempting to get off your question, but in terms of the focus of it on the media, the media in this calendar year '13, this media initiative should be a very positive -- have a very positive impact on our business. The product pipeline is better than it was a year ago as well. But we've also gone through periods of time with improvement of food quality and improvement of service, continuing focus on improvement of service. And so as the customer experience is better, food is better. Creative, I think, better versus a year ago. And then media placement better, and the product pipeline, better. The combination of these, not a single thing but it is the combination of these that make us feel good, not about a transaction but about the momentum in the business, the customer's perception of the brand, the breakthrough as the consumers are watching television, the breakthrough as they're seeing our commercials more often. They're seeing our variety of new products across a variety of day-parts and see a variety of ways to use us, that may separate us from some of our competition. So it is a whole series of things that is intended to impact the sense of momentum in our business. And I think from a brand standpoint, we can analyze these things in a transactional manner from a consumer standpoint with an element of momentum in a business -- excuse me, momentum in a brand and how they perceive the positive elements of this brand is very important. And on -- at this point versus a year ago, the momentum of our business is much healthier, and this gives us more confidence about the year.

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

Understood. And just separately, to clarify as it relates to the margin side of things. Obviously, you saw pretty significant restaurant level margin expansion this quarter of roughly 80 bps. And I think you mentioned in your prepared remarks that you think that the food and paper line is going to see leverage this year, the payroll and benefits line is going to see leverage. And what we've been most surprised to know is that operating line where I think you said you got hit by the 70-odd basis point in that line, and yet you still saw a leverage in that line as well. So if that's correct, it would seem like the 50 to 100 basis points might prove conservative. So just -- want to just try to clarify whether you're actually now going to see meaningful leverage on that other line now that you're getting 25 basis points of benefit and whether or not that's fair to say that if leverage on all lines, you could exceed that margin target.

J. Clifford Hudson

Jeffrey, I do believe it's really going to be dependent upon the level of -- or the degree of our positive same-store sales growth. Our company drive-ins had a very good quarter, plus 4.2%, and we saw very nice leverage in other operating expenses as we would have expected. So to the extent that we continue to perform strongly, we could see some upside to that 50- to 100-basis-point outlook that we gave. But we were very pleased with the leverage we saw in the first quarter.

Brian J. Bittner - Oppenheimer & Co. Inc., Research Division

But the other line item, putting aside the comp, like there's now going to be versus a 75-basis-point hit that you've just experienced, you're now going to get help of 25 basis points from the remaining 3 quarters.

J. Clifford Hudson

That is correct.

Operator

We'll take our next question from Will Slabaugh with Stephens.

Will Slabaugh - Stephens Inc., Research Division

Saw quite a bit of media around the new chicken sandwich line both in November and December. I wonder if you could talk about that success a little bit more to the extent you saw any outperformance there. And then also with the media that was running for the chicken sandwiches, if you saw that as mainly materializing through sale -- increased sales of chicken sandwiches or if you would characterize that as a general menu lift from just successful marketing, how you think about that?

J. Clifford Hudson

Well, I suppose you'd think about this -- and it's a good question. You think about this in a variety of ways. One, you think about the product from the standpoint of how it affects a day-part for long periods of time. And today, we've talked about our 5 day-parts that we attempt to drive. So you do think about a product from the standpoint of how will it move that day-part. Obviously, you'll also think about how it will affect the check for that day-part. But then you also think about it from the standpoint of effect on customer's perception of the brand more broadly and their likelihood to use the brand based on that product because you're not just wanting to push one product or one day-part. So we think about that product from a variety of ways. It was a very nice product. The chicken sandwich in that modified form is staying on our menu with the ciabatta bun and a slightly modified real chicken breast. It's a very different presentation versus our use of something historically a wheat bun but something more like a hamburger bun. So the presentation of it is different. I think it's a much more attractive sandwich. It works better as you eat it, I mean it's in some ways an easier sandwich to eat. But it also -- that base chicken sandwich has 450 calories, so it's a very nice alternative on our menu and should be something. And so it helps lunch and dinner, it helps check, and I think it also helps customer perception of brand. So even as we charge more for that item than we would a hamburger, we, at the same time, see the customer's perception of value from a survey standpoint, customer perception of value improve. So it has narrow purpose, it has broad purpose. And one of the nice things about that sandwich is, I think that it -- you can check all the boxes in terms of positive impact.

Stephen C. Vaughan

And, Will, I would just add that we underindex in chicken overall, and so we do see this as quite an opportunity for us. Chicken, as we've talked, is about 6% of our product mix versus burgers being at 18%. So we do see an opportunity here and feel very good about the results from that promotion.

Operator

We'll take our next question from Sharon Zackfia with William Blair.

Sharon Zackfia - William Blair & Company L.L.C., Research Division

I'm curious about the shifts in the national cable advertising again. So I've been following you guys for a while, and it seems like that national cable percentage has moved around over the years and had been at that half of the ad cent [ph] for quite a while in the mid-2000s. So can you remind us why you pulled back on the national cable to begin with and why now is the right time to go back to having more national cable?

W. Scott McLain

Can I remind you why? Well, the trend over time, the longer trend over time has been towards increasing that. As the recession came on, we did go through a period of time in analyzing what is the methods of getting the impressions, the greatest impressions to customers within trade areas of our stores. And so in that 2010 time frame, there was a shift in strategy that didn't work, and so we pulled away from it. And so outside of that, so you can isolate that and say that was the objective, it didn't work, we moved away from it I think relatively rapidly. So if you remove that from the longer spectrum, what we have had is over a period of time, increasing use of national cable all under the headline of how do you increase the customer's exposure to our brand, and our belief that this is the best way to do this at this point in time, we will continue to explore that over time because the way customers get news and entertainment continues to evolve quite a bit. So that's the -- I mean the 2010 thing was something we'd just soon forget. But that's life, and that's what happened. So our belief is that the path we're on at this point should be a very positive one historically has proven out. And all markets will see an increase in gross rating points in January, February, March and going forward. So it should be a very positive experience.

Sharon Zackfia - William Blair & Company L.L.C., Research Division

Okay. And then looking at the chart you had on the online presentation, it looked like non-TV is going down quite a bit. Is that the Internet there or what's in the non-TV other than just billboard? And are you finding the Web to be an effective mode of advertising for yourselves or not?

J. Clifford Hudson

The non-television, to the largest degree in terms of shift, is not online. It is more likely to be billboards and other local sort of [indiscernible]. When you go through a period of time where half of it is national and half of it is local, there's a lot more franchise businesses, a lot more engagement of franchise leadership by a market about what they believe is most effective for their individual markets. So that can vary a moderate amount from market to market in terms of what they believe, along with our agency working with them, they believe the most impactful things were. So there's a wide variety that's probably the single largest would be outdoor billboards. And that would be the single biggest shift, but there's a variety of things that will shift away from non-television, even nonelectronic to television or other electronic. The Web-based things or other digital formats, we use and we'll continue to use in selective ways. And my suspicion is over time -- not my suspicion, my belief is over time that would be a growing aspect of our business. And I believe the structure that we've put in place now in terms of how the money is collected with our franchisees will give us flexibility in how we address that over time as customers get their news and entertainment information from varying sources, almost certain to be digital format, digital form, it allows us the flexibility to move with the customers as they do that.

Operator

We'll take our next question from Keith Siegner with Crédit Suisse.

Keith Siegner - Crédit Suisse AG, Research Division

I'd like to circle back to the unit growth, and with a particular focus on the small building prototypes which we've been hearing about for a number of quarters now. How many have been opened? And maybe some color, like what markets are they opening in? Are you using them as new builds, relocates, rebuilds? How much data is in that dataset now?

W. Scott McLain

Well, let me answer that question a couple of ways. One, the smaller building prototype is not a radical departure in terms of the concept. So we've opened several, probably 5 or so, 5 or 7 of these. We've opened them in new markets, we've opened them up in core markets. But it's based on the building size that we used 15, 20 years ago. So we've got a number of buildings which are this size. What we've basically done is reduce the amount of canopy space, the number of stalls, and put a little more emphasis on the drive-thru. And so it's not a format that our operators are not used to. So we have good evidence that we can get all the throughput that we need on this design. So it's not a question of having to prove out that it will work. It's more just a question of continuing to build a pipeline and start putting it through the permitting process.

Keith Siegner - Crédit Suisse AG, Research Division

Okay, that's helpful. One quick follow-up, if I may. In the capital structure slide, the #1 use of cash to enhance value is invest in brand. And with $45 million to $50 in million free cash flow, now you've got the excess proceeds from the sale of the land. Have you thought about maybe taking some of this plenty of excess cash you have and maybe opening a few more of these small things to build that database even a little bit more further to add data to help convince the franchisees maybe of the efficacy and help that maybe in the development pipeline accelerate?

Stephen C. Vaughan

Keith, we have definitely considered that. We are continuing to look for new sites for company drive-in growth. And we anticipate that, that will pick up a little bit. From 2012, we opened one new company drive-in. We anticipate 3 openings this year in our company drive-in site, and we'll continue to evaluate those openings and to the extent that we can see our return on investment improve from this lower investment building, then you would likely see us step this up going forward.

Operator

And we'll take our final question from John Glass with Morgan Stanley.

John S. Glass - Morgan Stanley, Research Division

On the 16% to 17% store level margin target, is that a combination of supply chain and the POS with labor or are those separate items? So if you can quantify if -- if you could break those apart and if the supply chain's not included in that target, what might that add to that goal?

Stephen C. Vaughan

Well, John, we're in the process of really the implementation of both of those initiatives. And so it's pretty difficult to give you an exact quantification of what we expect will come out of each one. We have, based on what other chains have experienced based on the guidance that we've received from our vendors, we do think those will both have a meaningful impact on margins, so they will contribute to getting back to that 16% to 17% range. But we also believe that some of that will come from leverage from continued same-store sales growth. So I think really, you'll likely see both of those play a factor but also continued growth in same-store sales. And as company stores get back to that $1 million AUV, we should be able to get back to the 16% to 17% overall restaurant level margins.

John S. Glass - Morgan Stanley, Research Division

Okay. And then just as a follow-up, your pricing right now is 3%, which is exceeding your inflation, at least your food inflation by 1% to 2%. Others in QSR are electing to take price to get a more gradual approach to pricing and reinvest in value. What is the confidence level that you don't exceed or don't outrun your value proposition by pricing this way? Or have you added new sciences around pricings that you think you've got opportunities in the 3% on certain items or meaning sharp on value and other items?

Stephen C. Vaughan

Well, we are approaching pricing in a much more strategic fashion than we had 3 and 4 years ago. So we do test. All of our pricing is done in a thorough market test to make sure that we can see sustained kind of the ability to keep that -- make that pricing stick without affecting traffic negatively. So we are continuing with that process and keeping an eye on the competition and food inflation at home and away from home. So those are all things that we consider, and we believe the price that we're currently running keeps us competitive. And we'll continue to test future price increases to evaluate what opportunity we have. But we definitely are keeping an eye on food away from home and food at home inflation.

Operator

And that concludes today's question-and-answer session. Mr. Hudson, I'd like to turn the conference back to you for any additional and closing remarks.

J. Clifford Hudson

Thank you very much. We appreciate your participation this afternoon. Steve and Claudia will be available as always after this conference call and beyond for any further questions you have. But we do appreciate you're interested in the brand, interested in our stock and interest in our company, and we look forward to continued engagement with you as our year progresses. Thank you very much and a happy new year.

Operator

And that concludes today's conference. We thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Sonic Management Discusses Q1 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts