Executives
Pat Watson – Corporate Communications
J. Clifford Hudson – Chairman and Chief Executive Officer
W. Scott McLain – President
Stephen C. Vaughan – Chief Financial Officer
Analysts
Joseph Buckley - BAS-ML
Matthew Difrisco - Oppenheimer & Co.
Steven Kron - Goldman Sachs
John Glass - Morgan Stanley
Jeffrey Bernstein - Barclays Capital
Larry Miller - RBC Capital Markets
[Jonathan Wait – Precipio Research]
Keith Siegner - Credit Suisse
Sharon Zackfia - William Blair & Company
Analyst for Brad Ludington - Keybanc Capital Markets
Tom Forte - Telsey Advisory Group
Nicole Miller Regan - Piper Jaffray
Greg Ruedy - Stephens, Inc.
Robert Derrington – Morgan Keegan
Stephen Rees – JP Morgan
Howard Penney - Research Edge LLC
Christopher O'Cull - Suntrust Robinson Humphrey
Sonic Corporation (SONC) F1Q10 Earnings Call January 5, 2010 5:00 PM ET
Operator
Welcome to the Sonic Corp. first quarter conference call. Today’s call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to Mr. Pat Watson. Please go ahead sir.
Pat Watson
Thank you. Good afternoon everyone. This is Pat Watson with Corporate Communications. Sonic is pleased to host this conference call regarding results issued this afternoon for the first quarter of its fiscal year 2010, which ended on November 30, 2009. Today’s audio and video presentation may be accessed at the Investors section of the company’s website, www.sonicdrivein.com.
Before we begin I would like to remind everyone that management’s comments in 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, in 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 management’s remarks during this conference call are based on time sensitive information that is accurate only as of today’s date, January 5, 2010. For this reason and as a matter of policy, Sonic limits the archived replay of this conference call webcast to a period of 30 days. 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.
With those announcements I will turn the call over to Cliff Hudson, the company’s Chairman and Chief Executive Officer. Good afternoon Cliff.
J. Clifford Hudson
Good afternoon Pat and thank you for the introduction and I want to say good afternoon to everyone that is online this afternoon. Thank you for joining us on this conference call as well. You have now on the wire today the results for our first fiscal quarter for our fiscal year 2010 and the quarterly release that reflects a continued tough operating environment and is true obviously on a broad basis and specifically and more particularly true for Sonic just now.
The same store sales for the quarter declined 6.5%, very much in keeping with what has been a negative trend for the industry but somewhat more negative in our case with the negative 6.5%. I think it is also fair to say the dynamics that have contributed to that in the recent past will continue to persist at least for the near-term, on a broad basis because it affects the elements of higher unemployment we have been experiencing for awhile in the more recent past more negatively impacting our brand because of the late impact of the recession on some of our core markets such as Texas and Oklahoma. So with the more pronounced impact on those markets in the more recent past the shift having a more pronounced effect on our brand and our system than some of our competitors.
The environment continues to be a challenging one from the standpoint of the industry so heavily focused on price and moving in through the winter months traditionally when there is so much more sensitivity to costs anyway for this holiday season. You add to that the unpredictable weather mix we have had in December moving into January and our perspective is that same store sales will continue to be challenged moving into our second fiscal quarter; our fiscal quarter ending February.
Now, having said that I also want to move to say we continue to believe that some of the initiatives we have been working on to supplement and complement our core brand strengths and build our business will come into play more in calendar 2010 as we move through this fiscal year so we want to touch on some of those today. It is these initiatives that make us feel better as we move out of the winter and makes us feel better about the potential for our business.
As we talk about our business this afternoon on this call, we are going to go through this in a number of topics that you would expect, the overview of the first fiscal quarter 2010 including our key focus areas to improve sales, improve operational performance in the near and long term. Also we are going to have some discussion and review of the development within the system including the impact of the current credit markets and the general business outlook and its impact on the development in our system. Then also a review of the financial performance and expectations for the remainder of the fiscal year 2010.
So I will start off talking about areas which I think it is fair to say we have moved our focus a fair amount. I want to talk about value and I want to talk about it a little bit differently than we may have in the past. I am going to contrast thinking about value and how we are focusing on 2010 versus 2009. In 2009 the theme for us was value, the theme for Sonic, really had a lot more to do with catching up with what some customers that are more sensitive from a value standpoint and what many of our competitors have done historically and that is focusing on the way to affect what you see here in the value equation; the denominator and that is focusing on price.
Thinking about this value equation and the two different ways to affect the value equation from a consumer standpoint is either to improve the experience, so grow the numerator, or reduce the price thus reducing the denominator, or do both. Or increase the numerator more quickly than you increase the denominator anyway to affect positive effects to the customer’s perception of value.
In 2009 we focused a lot more on the denominator, the implementation of an Everyday Value menu and even before that time the implementation of Happy Hour across our system. Part of our objective here in doing so and what drove that to the greatest degree was the sense that this is where our competition was and had been. In addition to that it is what the environment was dictating.
So as we moved through that period of time affecting price, as you can see on the slide, we have a whole series of initiatives in 2009 and before. The Value Menu and Happy Hour is mentioned. Combo upgrades in the summertime and beginning to work, this is a little bit more of a strategic element, but beginning to work with our operators using more third-party assistance to assess where they are from a pricing standpoint by trade area and by market and assist them with the implementation of those pricing strategies.
As we look to 2010 our expectation is that we are going to be instead shifting how we focus on that affecting the value equation from the standpoint of attempting to affect the numerator rather than just focusing on the denominator. This is more consistent with what our strategy has been historically. Our long-term success if you look over time we really focused on the numerator and the experience that the customer has. Focusing on product and service differentiation and offering a unique eating experience at a reasonable price. This has really set us apart historically.
So as we move forward we are going to continue to focus on both parts of this equation, the numerator and the denominator, but moving into calendar 2010 our focus will be a good bit more on the numerator. You can see the reference to several of the elements and initiatives that would drive the numerator as we have talked about some of these in the past and will continue to. Focus on the carhops as a point of differentiation; the use of specific initiatives to improve the level of performance at the average drive-in; including tools that we put in place in 2009 in terms of customer feedback with what we saw [inaudible] and the consumer feedback by transaction. But shifting also to new product news and a focus on quality, both quality of service and quality of product, in our business.
As I said a moment ago we focused on the denominator in the past for a variety of reasons. That is because we had to, the economy and our competitors and consumers demanded it. We had some pricing strategies we had to address across the system. Now with having those in place our view is that by focusing on the numerator we can turn our attention to not just improving the quality of our core items but promoting those with consumers and I think driving our brand in a very positive way. So post-winter you will see the promotions that we have will focus on that.
To the extent we remain on value it will have some elements of focusing on the things we have previously but also a shift to thinking about value more in a Sonic way but also focusing from a promotional standpoint on the service elements that we have had for so long; made-to-order food, interaction with smiling, friendly carhops. These things consistently rank higher with customers. You will see this from a promotional standpoint but also the experience that the customer has on [live].
In the recent past as we have moved to try to shift the focus on customer feedback and in fact we have seen improved scores in the last year with these initiatives. I think this really kind of sets the stage well for this focus on service and food quality because we have in fact had consumer feedback that our performance at the store level has improved in the last year.
So this is what you will see as we move through 2010. Beyond that in terms of continued development and growth of our business, the expansion of our system let me say first of all we will continue to try to drive the initiatives we have talked about and I have already talked about here today to drive traffic, drive people on lot with some combination of value the Sonic way but also differentiated products and service, and once they are on lot continue to work to drive check and through a number of initiatives not the least of which is differentiated service which sets us apart versus our competition, working to continue to build loyalty.
We continue to build our business from a physical standpoint across the country at a rate that is really unmatched by most of our competitors. The rate of new store development has slowed somewhat in what reflects broader ongoing uncertainties. This clearly has had some impact on our business in terms of new store development. We expect to continue to have expansion of our brand though that I think outstrips our competitors. This would be true in core, developing and new markets as we continue to push out with the brand.
In addition to that, though not eluded to here, I would also like to say that in terms of continuing to drive our business our improvements and developments with our partnership drive-ins and our own drive-ins which we refer to often internally as Sonic Restaurants Inc. or SRI, we continue to see dramatic improvement in service scores that you have seen over the last year, closing the gap between our partnership drive-ins and franchisees. The new leadership we brought in to oversee SRI last September, Omar Janjua, has had a very good impact on improving operations.
His focus from a standpoint of flattening the organization and bringing more focus on the market level and unit level performance including speed of service and customer experience is a very positive one I think and one that will continue to play out over time in terms of impact on customer perceptions and customer feedback on the experience but then in turn we believe in the coming months impact sales and profitability.
In addition to that Omar is beginning to bring a focus on retaining the quality operators within SRI. Historically one of the things that has done that to the greatest degree has been the partnership program. In this environment some aspects of that has become more challenging and so we are working to refine the program. We have done that over time in some ways and are continuing to do it now in order to evaluate the effectiveness of the structure we have in place to make sure it is the right structure for our business. We are doing the same thing now to make sure that it is structured in such a way to meet the demands in this changing environment and make sure we are retaining the quality talent that we have onboard. So if this evolves to the extent it affects the business we will update you on those changes over time.
Finally, before turning it over to Scott McLain, I would say we continue to look at our use of cash in an opportunistic manner. We have more than $100 million in excess cash and we will continue to evaluate the variety of options that we have to materially increase shareholder value with those dollars.
In closing for my portion I would say that we clearly are operating in a more challenging time. That is true for all of us and is particularly true for Sonic. The challenging time presented particularly with the shift in the economy and weather and so on is going to be particularly tough through the winter and through the quarter we are operating in now, our fiscal quarter ending in February, will be a particularly challenging one. The branding promotions we have focused on spring and summer are ones that we feel very optimistic about in terms of positive impact on the brand. The improving circumstance of SRI that we believe will come into play over time and its readiness to deal with customers in a way that it wasn’t 12-24 months ago is good news for us as we move to drive our business with our promotions moving into spring and summer.
With that I am going to turn it over to the President of our Company, Scott McLain, to provide an update on developments within the system.
W. Scott McLain
Thanks Cliff. As Cliff mentioned the rate of development did slow in the first quarter, reflecting ongoing uncertainty about business conditions as well as continued credit market challenges. For the quarter franchisees opened 22 new stores and relocated or rebuilt five drive-ins.
The development incentives we announced at the beginning of the fiscal year are yielding increased interest in development with a number of franchisees both incentives. The first incentive is strategically targeted for development in some of our more challenged and under penetrated markets. The incentive package for these markets provides for free franchise fees and royalty abatement for five years for stores built by March 2011. These markets represent a little less than 25% of our system and are also markets that have the ability to reach break through local media levels with incremental development.
While they represent ¼ of our existing drive-ins they accounted for only 5% of our new drive-in development in 2009. The second incentive is for franchisees to build multiple stores during fiscal 2010. They will pay a reduced franchise fee on the second store opening and no franchise fees beginning with the third new drive-in. This program is time limited and targeted for fiscal 2010 only. We anticipate that while these incentive programs will have a dampening impact on franchise fees and royalty revenues in the short-term, they will have a positive impact to our development and brand over the longer term.
Prospects for future development over the longer term also remain solid with almost 1,000 drive-ins scheduled to open under area development agreements over the next several years; almost 50% more than what we had 3-4 years ago. On another positive note we continue to see construction and real estate prices fall in most areas. These factors together with lower interest rates should be very good for us over the longer term if they only serve to increase our franchisee’s return on investment.
Nothing is more important to our long-term development prospects than new store ROI. Based on current projects in the pipeline, we continue to anticipate opening roughly 100-110 franchise drive-ins this fiscal year. The timing of our openings, particularly in the second and third quarters can be impacted by weather and the tough weather we had in December did slow down a number of projects which can further constrain our openings for the second quarter.
Another positive sign is the continued strong performance of new drive-ins. For fiscal 2009 overall average opening volumes increased to approximately $1.5 million roughly 35% ahead of what they were just a few years ago. We now have 84 drive-ins in new markets that have been open more than 12 months and some now ready to begin their fourth year. These drive-ins as a group had average sales of roughly $1.4 million in fiscal 2009, almost 30% above system average volume.
We ended the quarter with 3,560 total drive-ins and we are now operating in 42 states making continued progress on our way to becoming a truly national brand by adding 13 new states in the just the last four years.
With that I will now turn the call over to our Chief Financial Officer, Steve Vaughan.
Stephen Vaughan
Thank you Scott. For the first quarter earnings per share totaled $0.10 which was down $0.02 from the same period last year. Our earnings reflected the decline in same store sales performance compounded by the deleveraging impact of lower sales and margins.
Our franchising income including franchise fees and royalties decreased by $84,000 versus the comparable period last year. The decrease in franchising income was caused by lower franchise fees reflecting fewer new franchise drive-in openings. We experienced an increase in franchise royalty revenue which represented the increased number of franchise stores in the system versus the same period in the prior year. The effective royalty rate for the quarter was 3.75%, a decline of 9 basis points versus the same period in the prior year reflecting the decline in franchisee same store sales.
The deleveraging impact of same store sales declines combined with higher labor costs resulted in lower restaurant level margins in the first quarter. Looking at each individual line item, food and packaging costs were consistent with the prior year. During the quarter, increased discounting related to limited time offers offset decreases in commodity costs. Looking forward most commodities are either locked in or are far enough along in the contract negotiation process to provide visibility into expected costs for the remainder of the fiscal year.
We expect that commodity costs will be slightly lower in fiscal year 2010 based on current projections. This improvement will likely be offset by increased discounting particularly as long as consumer sentiment remains weak. In addition we will have higher costs related to our product quality initiatives including the positive impact of recent pricing changes which I will discuss further in a moment. We feel confident that we will see relatively flat food and packaging costs for the remainder of fiscal 2010 depending upon the level of discounting associated with our promotions.
We completed pricing adjustments at partner drive-ins in December utilizing the new strategic pricing methodology implemented in the fall of 2008. These adjustments took our cumulative medium price increases at partner drive-ins up by approximately 2.5 percentage points on a year-over-year basis. This amount represents an average in actual price increases at individual drive-ins will vary in line with our new pricing strategy to customize price increases by trade area and take smaller, targeted increases throughout the year. These percentages do not take into consideration the impact of the Everyday Value menu which has an offsetting impact on pricing but is now lapping its introductory month.
On the labor line we continue to face higher labor costs as a result of last [December’s] minimum wage increase. This increase will keep our labor and benefit costs under pressure going forward. Other operating expenses suffered the greatest impact from the decline in same store sales. We had expected some benefit in other operating expenses from our refranchising efforts. However, a large portion of these expenses are fixed so improvement in this line item will be largely dependent on improvement in our overall same store sales trends.
I also want to point out a change in the accounting rules that required us to report minority interests in earnings of partnership drive-ins as a separate line item below net income, now called non-controlling interest. This reclassification had no impact on net income and we will continue to report a diluted earnings per share number after non-controlling interest which is comparable to our previously reported diluted earnings per share. We did experience a significant decline in minority partner share earnings during the quarter. While this decline was positive to margins, it has reduces our partners income and is not sustainable in the long-term. We have moved some partners to general manager positions as a result of the decline which essentially results in compensation being reported in the labor line as opposed to minority interest.
As Cliff discussed we are currently evaluating the partnership program and may look at alternatives to retain the spirit of the program but at the same time ensure that our partner’s earnings are not so volatile.
During the first quarter SG&A remained flat while depreciation and amortization declined by 18% reflecting the disposition of a total of 205 drive-ins in fiscal 2009 and further moderation in partner drive-in development. While we saw significant savings from the refranchising and partner drive-ins we reinvested a good portion of these savings and incremental resources on the franchise side of our business and expect this move will have a long-term positive result for the brand.
During the quarter we saw a $2 million increase in other revenue. This income is attributable to rental income in the real estate we retained when we re-franchised partner drive-ins last year and to a lesser extent reflects our share of earnings from a minority investment that was retained in the operations of 88 of the re-franchised drive-ins. We expect to continue to see a similar magnitude increase in this line item until we lap the refranchising activity which occurred primarily in the third quarter last year.
One of the most positive features of our franchising business model is our strong cash flow. This features allows us to maintain our capital expenditures at a reasonable level while also servicing our debt requirements comfortably. As of the end of the first quarter we had $187 million outstanding under our variable funding note with interest expense on these notes currently averaging approximately 1.3%. Interest expense for this portion of our debt will depend on changes in LIBOR and commercial paper rates.
We are carrying more than $100 million in excess cash and investments, over and above our normal operating needs. We do not anticipate needing to utilize any of these funds for ongoing obligations as our free cash flow after planned capital expenditures of approximately $30-40 million and $55 million in mandatory principle payments is expected to be flat to slightly positive. We continue to exceed our debt compliance covenant and we anticipate this compliance will continue into the foreseeable future.
During the first quarter our effective tax rate was 38.4% after adjusting for the non-controlling interest reclassification which was within our expected range of 37.5-38.5%. However, new developments could impact our rate in any given quarter.
As Cliff stated earlier, colder than normal weather in our core markets particularly in the month of December combined with ongoing weak consumer sentiment will likely result in the further deterioration of sales in the second quarter when compared to the first quarter. For the second half of the fiscal year we expect sales and margin trends to improve based upon our planned initiatives although further improvement will likely be dependent on external factors such as unemployment and consumer spending.
Based on these revised expectations, fiscal 2010 earnings are expected to be flat on a year-over-year basis. In addition to the sales expectations I have outlined above this outlook is based on the following: Some deterioration in restaurant level margins primarily reflecting the deleveraging impact of lower sales; SG&A expenses in a range of $64-65 million; depreciation and amortization expense of $42-43 million; interest expense of $39-40 million; capital expenditures between $30-40 million and opportunistic use of our excess cash.
In summary, while sales and earnings performance declined in the first quarter the initiatives we have implemented in the past few quarters and have planned for the next few quarters provide a solid foundation and position us for earnings growth over the longer term. Improved sales and earnings performance will likely take time but we believe our corporate strategic focus, value defined in a uniquely Sonic way, product and service differentiation and new product news, new store development and moving our business model towards a more predictable and stable cash flow model will increase shareholder value over the long-term.
As evidence of our financial strength we continue expect flat to slightly positive free cash flow after capital expenditures and debt payments now and in the longer term which will provide us with ample flexibility in utilizing our excess cash for shareholder value driving initiatives going forward.
This concludes our prepared remarks and we would now be happy to take your questions.
Question and Answer Session
Operator
(Operator Instructions) The first question comes from the line of Joseph Buckley - BAS-ML.
Joseph Buckley - BAS-ML
Could you elaborate a little bit more on the definition of developing markets and kind of the onetime breaks and the key breaks that franchisees opening in those markets get? I think you said it covered about 25% of your existing store base.
W. Scott McLain
Yes. We have two incentives. The first is for our under penetrated markets which we have referred to as developing markets over time. Under that incentive package basically you don’t pay a franchise fee and you have basically royalty abatement for five years as long as you get the store open by March of 2011. Now, while this represents about 25% of our system in terms of the number of drive-ins over the last year it only represented about 5% of our new store development. Does that make sense?
Operator
The next question comes from the line of Matthew Difrisco - Oppenheimer & Co.
Matthew Difrisco - Oppenheimer & Co.
I have a really quick clarification; I’m not sure if I missed it but did you give mix? Did you give traffic and check for the close of same store sales? Then second, I am wondering about your combo strategy. You had a pretty consistent combo strategy throughout the quarter. Is the combo strategy what you are going to pursue going forward when you talked about kind of increasing the quality? Are we going to be seeing that through a combo strategy going forward?
W. Scott McLain
In the winter months, this month, you are going to see a primary focus on value because that is what January is to the greatest degree. We want to remind the consumer that we have that and get that top of mind as we come out of the winter. Moving into the late winter and spring we will shift away, not completely, but we will shift away from the value piece and we will find ways to do value the Sonic way.
Now in terms of a traditional combo approach I guess what I should say is you will see the promotions when we get there. We will use efforts to attempt to point out product differentiation and product quality and yet at the same time do some things with a combination of items to build check. So I am trying to give you some elements of it but in terms of whether it is just a combo meal, I guess the best thing is to tune in. February, March and April you will see how we go about that.
Stephen Vaughan
To answer the first part of your question roughly 1/3 of the sales decline came from traffic and 2/3 from the check decline.
Operator
The next question comes from the line of Steven Kron - Goldman Sachs.
Steven Kron - Goldman Sachs
On the development side particularly with franchisees, I was wondering if you could spend a little bit of time talking about the financial health of the franchise system. It seems as though you have these incentive programs for kind of a finite period of time but how at risk are we that if trends don’t improve where is the break point as far as your willingness to extend those programs further to help supplement the growth profile?
Secondly, when you talk about recent sales trends you haven’t mentioned the competitive dynamics and obviously one of your competitors has been pretty aggressive with $1 promotions. Are you able to isolate depending upon your geographic exposure and how you might be faring relative to your competition whether that is having a disproportionate impact on your business right now?
W. Scott McLain
I will address your first question about the health of our franchisees. We are fortunate in that we have a very strong franchise system. We have long standing franchisees who have been in the business for a number of years who are very healthy from a financial standpoint. Also in 2005 we raised the financial requirements for our new franchisees that we brought into the system. We did bring a number of new franchisees into the system after that. Those increased requirements have been a help particularly in this period of time.
While we certainly have franchisees who are struggling, on the whole I think the health of our franchisees from a fiscal standpoint is good. Our task is to try to help their profits grow over time and we intend to do that. We try to do things where we can to help them where it makes sense for them and makes sense for our business and the development incentive is a good example of us investing alongside them to help grow our business for the long-term.
Stephen Vaughan
On the second part of your question I think we have really seen a bigger difference in performance based on the region that our drive-ins are in. In particular I would mention Texas where Cliff mentioned in his comments the economy seemed to hold up longer but is now possibly suffering more on a trend basis in terms of increasing unemployment rate and that seems to be having a bigger impact than necessarily what our competitors are doing. I would also point out that our company stores, partner drive-ins, we have a disproportionate number of drive-ins in the state of Texas. I think about 45% of our partner drive-ins are in the state of Texas and you can see that gap between partner and franchise same store sales widen again and a lot of that is being driven by the fact we have a disproportionate number of drive-ins in Texas. So that seems to be one of the bigger impacts right now in terms of recent sales trends and what is happening.
Operator
The next question comes from the line of John Glass - Morgan Stanley.
John Glass - Morgan Stanley
Could you just first clarify how you are going to address the competitive environment? It sounds like on the one hand you talked about emphasizing the experience and if you are going to do that how you plan on making people aware of that or is it just something you do in the stores? At other times you talk about a greater emphasis on value and what your margins might do if you increase value. So are you widening your value offering or are you just going to keep doing what you are doing but advertising it more aggressively?
Can you also answer the question about what is holding you back from doing buybacks now? Is it you are concerned the free cash flow is essentially nil now and you would like to see that firmed up before getting more aggressive with buybacks or is there something else you are waiting for?
J. Clifford Hudson
On your first question as it relates to the role of value and your observation let me make a comment we will be focusing more on product and service differentiation but we still also talk about value. The answer is you are right. We are going to be doing both. It is some combination at a low level, a periodic sustained reference to our value menu at a lower level to keep that awareness in place.
The second approach to value is going to be working to define value consistent with the Sonic brand. The question came up earlier how are we going to do that. The response was tune in during February, March and April and we will lay that out for you. You will see our commercials and we will talk about it later as well.
As it relates to the more pure service and product differentiation the offerings, specific product offerings and the television creative and point of purchase materials, etc. will all be utilized in such a way to emphasize the different experience at Sonic; service, carhop service, carhops on roller skates, etc., made to order food, unique product and new product offerings and so on. That too. The answer is yes we are going to push out on one and continue on the other but it is going to be a different mix than what you have seen historically in the last year.
Stephen Vaughan
As to your question on the uses of excess cash I would tell you we are very comfortable with our cash flow position. The fact we are able to continue to invest back in the brand and service our debt comfortably gives us optimism we do have the flexibility if we choose to buy back stock or if we were to buy back debt. So we continue to look at those opportunities. We will be opportunistic about that. At this point in time we have chosen not to utilize that cash but we are continuing to evaluate our options there.
Operator
The next question comes from the line of Jeffrey Bernstein - Barclays Capital.
Jeffrey Bernstein - Barclays Capital
A follow-up on the question about the franchisees and the credit environment. I think your refranchising effort is mostly complete and I believe you said your new unit targets are reiterated. I am just wondering how the credit environment is impacting Sonic whether it is more so on the reimaging or whether there was something about the unit growth that might be delayed but still reiterating the full target? Then could you just give me an update on the retrofits and what kind of sales or what are the returns you are getting on that front? Then also on marketing spend I think you mentioned you are going to be focusing more on value and experience. I know you boosted the marketing spend a year ago in the same quarter and I am just wondering where we stand now for fiscal 2010 and kind of how you break that out between global, national and TV versus other?
Stephen Vaughan
I would be happy to try to give you a little bit more color on the credit environment and how that affects franchisees. Basically we are seeing success in our new store openings. However, lenders in general are more cautious than they were 2-3 years ago so they require a lot more time to get deals done. They tend to have stiffer covenants and those kinds of things. They want to see how the first 2-3 Sonics perform before they can invest in more. Those types of things. Just the general things that a lot of businesses are facing right now in terms of credit. Most of the activity we are seeing on our side at this point is less from the retrofit. We are about 70% done with the retrofit across our system. Most of our development activity is really concentrated around new store growth as well relocations and rebuilds.
We did offer our franchisees an incentive to look at relocating their drive-ins or rebuilding their drive-ins and a significant portion of the system has done that over time. That is a good thing for our brand over the longer term. So I don’t think our franchisees are experiencing credit difficulties that are any more or any less than a lot of other businesses out there that are looking for access to capital and finding it a little tougher to come by than it has been historically.
J. Clifford Hudson
As to the second part of your question about our advertising dollars, the way those work today is consistent with where they have been the last several years. That is roughly half the dollars focused in local cooperatives, local advertising cooperatives, where the dollars are spent locally in local media and primarily it is going to be local network affiliates with some exceptions. Then the other half is in a system marketing fund we call it, SMF.
The largest part of that over a number of years has been spent on national cable. Your question seems to suggest are we looking at alternative uses of that and are there reallocations of it. There is the opportunity for refinement of the use of those dollars locally and nationally or system wide. So this is a process that is under review. In terms of specific comments for you today about different allocation of that today I don’t really have anything to offer to you. That is probably even over [time] a level of minutia we are less likely to get into.
Regardless there is really nothing to tell you today related to that.
Operator
The next question comes from the line of Larry Miller - RBC Capital Markets.
Larry Miller - RBC Capital Markets
I also had a question on the franchisees and given that you have so many business owners out there and the running of that business on a day-to-day business, what kind of suggestions or feedback are you getting in terms of driving sales and profits? Is this how this developed or is there some other things they are talking about they want to do? Secondly, I was interested in some of the potential sales differences you might see in between some of the more urban and some of the more suburban, say green field locations, that you have out there if you have looked at it? Also any variation in day part as we have seen over the last 3-6 months?
W. Scott McLain
In terms of your first question about franchisees and their attitude for lack of a better way to describe your question, I think that our franchisees obviously are not happy with the results which we had over the last few months and neither are we. I think that they as well as we feel good about what we are planning on doing in 2010 particularly the product and service differentiation that Cliff talked about. I think our franchisees are very receptive to a lot of things we are planning for moving ahead.
The other thing that is good about our franchisees, many of them have been in our business for a long time so they have seen business that has been better and then not as good. They have a lot of passion for our brand and a lot of confidence in our brand as evidenced by their continuing to build new stores, relocate and rebuild. They also have a longer-term view about the business because they are making longer term investments and I don’t sense personally their passion for the Sonic brand is any less today than it has been over time.
Stephen Vaughan
On your second and third questions I don’t have any feedback for you on the urban versus suburban. However on the day part breakout we have seen where we have the strongest value message which is Happy Hour we have had the strongest sales. So our afternoon business has remained very solid. The weakest area of our business has been evenings which is likely more discretionary and more impacted by the high unemployment rate in the teen population and we continue to see lunch and dinner to be pretty soft, more in line with what the industry is experiencing. But certainly evenings has been one of the bigger challenges for us from a day part perspective.
Operator
The next question comes from the line of [Jonathan Wait – Precipio Research].
[Jonathan Wait – Precipio Research]
A question on the weather. I think you referenced it a little bit. How much did the weather impact you in the quarter?
Stephen Vaughan
I think during the first quarter the weather was not a big factor. It was definitely cooler and wetter in the month of October. It was a little bit above normal in the month of November and I think December is really where we had a much greater impact from the weather. You probably read about the snowstorm that came across some of our core markets. It has been well below average in terms of temperature.
[Jonathan Wait – Precipio Research]
Was there any noticeable difference in November versus say September and October? I think that is when you got a lot of that wetness in Texas.
Stephen Vaughan
No, November not a huge difference in performance.
[Jonathan Wait – Precipio Research]
Let’s go to your bundled meals. It seems like some of your competitors like Wendy’s, Jack in the Box coming out with these kind of value bundled meals. You have been doing this since August. You have been doing this a little while here. Any thoughts or any tweaks you think you need to do in response to more competitors doing this? Does this kind of validate what you are doing? Does this make it tougher to do it?
W. Scott McLain
I think in terms of how we think about what we need to focus on going forward we have the value piece in place. We need to make sure of the sustained awareness of it. We do need to find a way and we believe we are on that path to talk about value in a Sonic sort of way. So there are elements of that as you see our promotions in February and March. There are elements of that which will come into play.
We also approached this even though it is a tough environment and a lot of the dynamics will remain tough with that value piece in place the best thing for us to do is to focus on our points of differentiation whether it is service or product. So in terms of a nuance that is more in response to a competitor, I think our approach is more focused on what are we best off doing with our brand to go forward rather than how are we best off responding to a competitor. That doesn’t mean we don’t have to deal with a competitive circumstance. I don’t mean to suggest that for a minute. It is very real and it is every customer and every transaction.
I want to go back just a moment to the question about weather and its impact on us and one regional thing versus another. To get the progression on the impact of how could promotional things affect us different in a geographic sort of way. It is a piggyback onto something that Steve already said a moment ago and I think I said earlier, giving more concrete data, the data we saw for Texas for sales tax collections in the month of October the sales tax collections state wide in the month of October were down 12%.
Moving into November the sales tax collections for the state of Texas were down 14%. So the progression is not a positive one in terms of indications of economic activity in the state. We have not seen anything for December yet. It is a little early but with the trend as it was we will see what that looks like. It was one that disproportionately negatively impacts our business versus most competitors on a geographic mix of our business.
Operator
The next question comes from the line of Keith Siegner - Credit Suisse.
Keith Siegner - Credit Suisse
There was an uncharacteristic diversion in the average unit growth trends and the same store sales trends for the partner stores this quarter. In the past it has really not been much more than 100 bips or so, a little bit more. This quarter it was close to 600 and I am just wondering if you could help us understand how that divergence happened. Were the average unit volumes were only down a little over 3% and maybe based on what that answer is how we should think about that going forward?
Stephen Vaughan
I believe that it related to the refranchising of underperforming restaurants. So the drive-ins we refranchised in the third quarter and also in the fourth quarter last year were on average below average drive-ins. So from a pure AUV standpoint those were a boost but for comparable store sales we actually just take into account drive-ins that continue to be operated by our partner drive-in subsidiaries. That is the reason for the large diversions.
Operator
The next question comes from the line of Sharon Zackfia - William Blair & Company.
Sharon Zackfia - William Blair & Company
I was curious on the earnings guidance that you gave for this year looking for flat earnings on a down 4-6 comp. That sounds a little out of keeping with what we saw certainly in 2009 and in the first quarter. Are there costs you have taken out of the system? Can you help us reconcile how you can get to flat earnings with the comp down of that magnitude?
Stephen Vaughan
A couple of things. One, we are expecting to see continued benefit in our cost of sales. So commodity costs versus where we were at a year ago are significantly better. We also expect that with the refranchising we will be able to utilize the excess cash we have built up to generate some additional earnings. How we deploy that excess cash we expect to have a positive benefit in the second half of the year. Through a combination of those items and just continued growth with the system we expect we will be able to get back to flat earnings.
Operator
The next question comes from the line of Analyst for Brad Ludington - Keybanc Capital Markets.
Analyst for Ludington - Keybanc Capital Markets
I had a question also on franchisees support. I was wondering if you had quantified the total amount of support in this quarter or that you are expecting for the year? Or if you could break it down on an EPS basis? Also I was wondering you mentioned that 5% of new stores were taking advantage of the developing market incentive. Is there a similar percentage for the multiple stores incentive? Is developing market the only incentive that is decreasing the royalty rate?
W. Scott McLain
I don’t have it quantified exactly how much our franchise fees and franchise royalties will be impacted by our development incentive but I don’t think it is going to be a big number. The development incentive does apply to a quarter of our system but it was only 5% of our development anyway last year and those stores that will open under the incentive likely wouldn’t open in any event. So on the net it will probably be positive for us overall.
We do have the other incentive which is a reduced franchise fee for multiple store openings. That will cost us some money. I don’t have it quantified in terms of…
Stephen Vaughan
It could potentially be in a range of $1 million. However, if we get to that we will feel pretty good.
W. Scott McLain
We will have a lot of stores open that otherwise wouldn’t have opened. So we will get royalties from those which we wouldn’t have had otherwise. It will help that we are in those markets. It will move the business. You can view it as a cost but I think it is an investment. It is an investment for the brand in stores we wouldn’t get otherwise most likely.
There was another part to the question. Did we get all of that? From a royalty standpoint and a development standpoint that should be it.
Operator
The next question comes from the line of Tom Forte - Telsey Advisory Group.
Tom Forte - Telsey Advisory Group
You talked about day part, the one you left out that I wanted to ask on was breakfast. Are you seeing anything either from competitive activity or from those states where you are seeing larger year-over-year increases in unemployment?
Stephen Vaughan
I think from a competitive standpoint it is pretty widely publicized that McDonalds is planning to introduce their value menu for breakfast. It is really too early to give you any feedback as to the impact of that. The breakfast day part has actually held up relatively well. It has not been a growing day part for us but it has not been one of our weakest day parts either.
Operator
The next question comes from the line of Nicole Miller Regan - Piper Jaffray.
Nicole Miller Regan - Piper Jaffray
You mentioned for the compound 9.1 two-thirds was check. Could you quantify what portion was menu price increase versus mix? Then as it relates to the value menu focusing really on the $1 menu, what percentage of the transactions have an add-on attach rate or an add-on sale? Of that percentage what is the average sale for $1 could you quantify what the dollar amount is on average? Then if you have it what is the break even you need on the increase in traffic to offset the discounted value menu?
Stephen Vaughan
I don’t have all the detailed answers to your very detailed question. I will tell you the average food and packaging cost for our Everyday Value menu is 32%. It is a little bit higher than our regular menu but we still feel very good about the profitability of the Everyday Value menu. It is currently about 6-7% of sales. We are promoting it more heavily this month. So we expect that to go back up as the awareness of it rises with the promotion of it. I think in terms of the decline in check we believe that the Everyday Value menu probably contributed a couple of percentage points to that decline, or roughly half of the decline but we are running pricing right now but we are seeing fewer items per transaction.
So we have a number of dynamics going on right now and it is very difficult to give you an exact percentage.
Operator
The next question comes from the line of Greg Ruedy - Stephens, Inc.
Greg Ruedy - Stephens, Inc.
You mentioned the price that you took. Your promotional strategy in recent months has been fairly constant with the bundled combo meals. Besides the pricing tool itself what gives you confidence to price ahead of your focus on the numerators? How should we view those initiatives versus some things you helped drive the top line in the past, such as pay at the stall, retrofits, move to cable TV?
Stephen Vaughan
I’m not sure I understood the first part of your question. Could you repeat it?
Greg Ruedy - Stephens, Inc.
What gives you confidence to take price ahead of introduction of new products or an adjustment to the promotion strategy, basically some changes to the menu?
W. Scott McLain
We did take a minor increase in the fall. I think it was a little less than 1%, around 1%. So it put us at a cumulative price increase of 2.5%. We do continue to do competitor analysis. We also look at sensitivity by item so those items were done strategically with the assistance of a third-party that we have engaged. We do feel like we have a good process there that we make sure we don’t go overboard on our pricing.
J. Clifford Hudson
The second part of your question you asked if we view these upcoming initiatives as they relate to some of our past initiatives. The initiatives we have described to you are promotional. They are limited time offers type promotional. It is food. In other words it is not capital investment. So it is more on the ordinary course or the manner in which we would typically drive our business especially particular to our brand on a broader basis historically. So it is kind of different altogether I think. I don’t know if I am getting to the core of your question or not. If there is some other aspect of your question we are missing feel free to reiterate it.
Operator
The next question comes from the line of Robert Derrington – Morgan Keegan.
Robert Derrington – Morgan Keegan
If I could stick with that topic for a second. With the upcoming initiatives can you give us some sort of sense of those things that you see in the future in the pipeline for the company, how well tested are they? How far in advance? Have they been field tested? What kind of consumer research do you do before you roll something out?
J. Clifford Hudson
It depends upon the initiative to the extent that something is a variation on elements of our business we already have in place. So if it is a mix and the makeup of a product, a new sauce, new cheese, etc. the lead time for implementing something like that or the easier example would be different syrup of shake or a different flavor of shake, the lead time for something like that is shorter than if it is a new product and we are trying to build for day part. A new breakfast product or something of that nature.
A new bread carrier or new product altogether is something we are going to test more completely in the market. First an operational test and then a marketing test. Allow some time for that in multiple markets and then lay this out for our franchise leadership as a proposal to roll something out. Let me add aside from the time you are talking about, a couple of questions to that and some other ones in terms of the franchisees reaction to some of these, also I think it is important if we haven’t talked about this before is to reiterate, I think reiterate, that we have a franchise advisory council. As we develop products and as we develop a calendar months in advance that is laid out for our franchise leadership that makes up our franchise advisory council and the information is shared with them about here is where this is being tested or here is how this performed last year or whatever circumstances on a specific promotion.
So as it relates to the process, it is not just a question of things taking place in a specific market or a test but also the engagement in the franchise leadership for that calendar period ordinarily done like four months at a time. So I described that process to you in the event you have some concern these things are popped on people without prior notice.
Operator
The next question comes from the line of Stephen Rees – JP Morgan.
Stephen Rees – JP Morgan
Average check was the largest pressure on comps throughout most of fiscal 2009 and I believe traffic was close to flat but now it seems to have deteriorated a bit in terms of comp deterioration. How should we think about average check now that you are lapping the value menu roll out? I guess how much the down 4-6% on an annual basis is check versus traffic?
W. Scott McLain
We certainly expect to see an improvement in that trend. Again it is too early to tell. We are now lapping over the Everyday Value menu. It is too early to tell exactly how much improvement we will see in the trend but we are optimistic it will become less of a drag. The key will be in FY2010 to try to hold the traffic that we were able to successfully hold in FY2009. We did see a weakening in our business and in the sector and in our business from a traffic standpoint in the first quarter. Again, we will see how that works out in 2010.
Stephen Rees – JP Morgan
Do you foresee any changes to or do you have any plans to reinvent some of your core beverage platform with so much innovation now coming in the category?
W. Scott McLain
To the extent we made modifications in those things we will discuss those that come into play rather than on the front end.
Operator
The next question comes from the line of Howard Penney - Research Edge LLC.
Howard Penney - Research Edge LLC
I was just trying to get a handle on the competitive environment as it relates to you and other parts of the industry that seem to be improving sequentially here in the quarter and relative to the performance of your stores especially the partner drive-ins and I understand the evidence you have presented to support the regional issue you have. But it seems like you are now maybe losing market share to the QSR and maybe even casual dining. I was wondering if you can address there are some issues with casual dining that may be also hurting or is it strictly the Texas issue, weather and maybe the unemployment rates for some of your core customers? Lastly, do you still believe and really believe that share repurchase is incremental to shareholder value?
W. Scott McLain
First of all I can get to the first part of your question. I assume you are referring to December and the fact that our sales were softer trend wise in the month of December and whether we would infer that is a competitive issue. Hopefully you were able to take away from our comments about regional performance, the weather, we don’t see that as being a competitive issue.
In terms of your question about share repurchases it is something we continue to analyze on an ongoing basis and certainly if we feel like it makes sense given where our cash balance is and capital structure we would feel comfortable doing additional share repurchases.
Operator
The next question comes from the line of Christopher O'Cull - Suntrust Robinson Humphrey.
Christopher O'Cull - Suntrust Robinson Humphrey
A follow-up question on the guidance. If you are down 6.5 for the first quarter for the system and it sounds like second quarter trend hasn’t gotten much better, does your full-year guidance for the system comp imply flat comps essentially for the third and fourth quarters?
W. Scott McLain
No it does not. I think our guidance for the fiscal year was down 4-6%. As you know our business is pretty seasonal and so the third and fourth quarters probably make up about 60% of our sales. It does imply improvement but not to the extent that you mentioned. And I would also point out we are only one month into the second quarter so we do still have January and February.
Operator
The next question comes from the line of Joseph Buckley - BAS-ML.
Joseph Buckley - BAS-ML
Could you revisit the comments you made about the partnership system and making adjustments to it? I think you have always viewed it as a key part of the fabric of your company. Is this something that is likely to disappear given the pressures in the near-term?
J. Clifford Hudson
Well I want to address that in a couple of ways. One, in terms any actions we are taking we have a lot of folks [inaudible] involved in. We have got managers at each store and assistant managers and we have supervisors overall. So in terms of talking about specifics of what we would do with any group or some group of those that is something that I would only talk about if that progresses and I wouldn’t want to sit here on the phone and talk about that. This is a process, an interim process that will occur with our partners. The focus of this is not an issue of what do we do about the partnership program. Our focus is how do we ensure a program that has had a lot of success and has been part of our growth historically, how do we make sure that the compensation arrangement particularly in this current context with our partners, how do we make sure the compensation arrangement is the healthiest one that both retains our good partners and makes it so that they can meet their obligations, etc. and stay focused on taking care of customers.
So on the one hand, in terms of how we deal with this if there are changes over time we will talk to you about those. The first answer, the first focus we need to have is how do we ensure we sustain the engagement of our best partners and have them focused on taking care of customers. If that means we go down a different path with some of them we will go down that path but we will engage them in that process. Whatever path we take it is not something we will do “to” anybody. It is something we will do with someone so it improves their circumstance.
That is ambiguous as to form and it will remain ambiguous for the purposes of this call. In terms of the objective you should be clear our objective is to help improve the business and retain them.
Operator
The next question comes from the line of Christopher O'Cull - Suntrust Robinson Humphrey.
Christopher O'Cull - Suntrust Robinson Humphrey
How many shares were actually outstanding at the end of the quarter? Not diluted but the actual shares?
Stephen Vaughan
I don’t have that number off hand. Let me see if I…I don’t have a print out a copy of the 10-Q and I don’t think it is in our press release. I don’t have a number for you but I can certainly send that to you later.
Operator
With that I would like to turn the program over to J. Clifford Hudson for any additional or closing comments.
J. Clifford Hudson
We appreciate your participation today and hope that the conference was helpful to you in terms of understanding where we are not just on the quarter completed but the challenging environment through this winter and looking into spring and summer. So as business progresses we look forward to visiting with you further. It is admittedly a very challenging time understood on a broad basis. Our perspective about our brand continues to be that it is a very strong brand. It has good service and product differentiation and a good basis for growth going forward. We appreciate your engagement and your support of the business. We look forward to visiting with you along the way. Thank you.
Operator
That does conclude today’s call. Thank you for your participation.
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