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Sonic (NASDAQ:SONC)

Q1 2014 Earnings Call

January 06, 2014 5:00 pm ET

Executives

Claudia San Pedro - Vice President of Investor Relations & Communications and Treasurer

J. Clifford Hudson - Chairman, Chief Executive Officer and President

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

Analysts

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

Matthew J. DiFrisco - The Buckingham Research Group Incorporated

John S. Glass - Morgan Stanley, Research Division

Alexander Slagle - Jefferies LLC, Research Division

Will Slabaugh - Stephens Inc., Research Division

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

Nicole Miller Regan - Piper Jaffray Companies, Research Division

Robert M. Derrington - Wunderlich Securities Inc., Research Division

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Operator

Good afternoon, everyone, and thank you for standing by. Welcome to today's SONIC Corporation First Quarter 2014 Earnings Conference. [Operator Instructions] As a reminder, today's conference is being recorded.

And I would now like to turn the conference over to Ms. Claudia San Pedro, Vice President of Investor Relations and Communications and Treasurer. 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 fiscal quarter of 2014, which ended on November 30, 2013.

Before we begin, I would like to remind everyone that comments made during this conference call that are not based on historical facts are forward-looking statements. These statements are made in reliance on the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 and are subject to uncertainties and risks. It should be noted that the company's future results may differ materially from those anticipated and discussed in the forward-looking statements.

Some of the factors that could cause or contribute to such differences have been described in the news release issued this afternoon and the company's Annual 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 6, 2014. The archived replay of this conference call webcast will be available through February 6, 2014. This call is the property of SONIC Corp. Any distribution, transmission, broadcast or rebroadcast of this call in any form without the expressed written consent of the company is prohibited.

We have posted our first fiscal quarter earnings slide show presentation on the Investor section of our website for your review, both during this conference call and after the conference call for up to 30 days. Finally, we have scheduled this call, which includes the Q&A portion, to last 1 hour. If we have not gotten to your question within that hour time slot, please contact me at (405) 225-4846, and I will make the appropriate arrangements to answer your questions.

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

J. Clifford Hudson

Thank you, Claudia, and thank you to all of you for participating this afternoon. We're very pleased to visit with you about our first quarter results, which we think demonstrate our ongoing strength of our brand, the consistency of the results. The key highlights you can see on the slide here, an 18% increase in earnings per share on an adjusted basis for that first fiscal quarter, ended November. I -- 2.2% increase in our systemwide same-store sales. This was made up of 2.3% Franchise Drive-Ins and 1.9% are company drive-ins.

Our company operating margins, company store operating margins improved by 80 basis points. We also opened, maybe not indicated here, we opened 7 new Franchise Drive-Ins, we'll talk about the increasing development activity a little later in the presentation. And we bought back $7.5 million of our SONIC Corp. stock in the quarter. So a nice quarter for almost all aspects of our business. And one that represents the improved foundation that we've talked to you about over the last several years, improved foundation that we implemented from '09 through fiscal year '13 that involved improving of the quality of our service at the average SONIC Drive-In according to our customers, our product quality and the customer's perception of the value that we are offering them.

As we built on those improvements, we also moved to our product pipeline and promotional pipeline to strengthen our business. And then a couple of years ago you recall brought back our "Two Guys", which our "Two Guys" and our creative that really helped us with Layered Day-Part Promotions. And with that, improved media buying. We really moved to provide a much stronger foundation that we have had at the outset of the recession and we now continue in our view to build on the positive results that were created by those improvements.

Also, in that calendar year '13, we went through a process reallocation working with our operators across the system to improve reallocating the media dollars. We put more into a national fund and then reallocated those between national cable and local network affiliates. And it has really gave a very good result in 2015. We'll talk more about that a little later -- excuse me, 2014 calendar year -- '13 moving into fiscal year '14, and we'll talk about it in more detail here as we go to the presentation.

Now those elements that have helped build the business in many ways play in then to our multi-layered growth strategy, which we have talked about, this filter of our business for a number of years in our franchising business, the multi-layered growth strategy continues to be a framework for driving solid earnings growth over time.

You can see from the slide pictured here on the screen that we see the -- these elements in our multi-layered growth strategy, the basis for looking towards 14% to 20% earnings growth for next several years. And as we look into fiscal year '14, we expect those elements, same-store sales, operating leverage, ascending royalty rate, use of free cash flow to continue to contribute to strong earnings per share growth in '14 and beyond. So we're also pleased with how our development pipeline is growing, and we'll talk about that a little later in the presentation for what that means this year, next year and beyond.

So those elements that contribute to the EPS growth rate that we talked about here dovetail with the elements of momentum and how we look at our business that you can see here in the flywheel, as we say. And starting with same-store sales and the elements that drive that.

So we'll talk about the issues or initiatives in our business and how they fit into each of these elements of this flywheel, the earnings drivers, so same-store sales, increased profitability at store level in particular, but increase profitability from a sales leverage, and also technology initiatives we have in place, increased unit growth and impact that will have in our business, our ascending royalty rate. And then the use of free cash flow, whether to reinvest in our brand or for share repurchases.

So each of these elements that you see depicted here colorfully on our flywheel will result in helping drive our business to a different level and help in optimizing shareholder value over the next several years. So we kind of dive into those, the elements that help drive our business starting with the same-store sales.

But before I do that, I want to mention that the quarter we've now moved into December, January, February is typically our most volatile quarter from a sales standpoint due to the impact of weather, and that the effect of weather could have on our business. And so finishing out the last quarter, November, and moving into December, we did experience some unfavorable weather, no surprise to you because many of us are experiencing that in many parts of the country. But despite some of the short-term challenges we have experienced there, we continue to remain confident in our ability to grow same-store sales in that low-single digit range during this fiscal year and beyond.

So with that comment about November, December, let's jump into some of these layers that continue to drive our business from a same-store sales standpoint. The initiatives we have in place that have done that should continue to do that are healthy and driving our business nicely. As you see listed here, more effective media strategy, innovative product pipeline, our "Two Guys" and how the "Two Guys" fit in to our Layered Day-Part Promotional strategy. And then finally, our POPS, new digital point of personalized service, I'll talk about that in more detail.

So let's move on to one of the elements that really talks to the efficiency of the media buying that we've experienced. Looking at this from a standpoint of growth in our share of voice, in calendar year 2013, as we talked about before, we reallocated a significant portion of our local media funds into a national fund that in turn was used primarily for national cable, but not exclusively. And our objective there was to increase brand awareness and ad awareness all across our system to, in turn, as you would expect drive traffic and drive sales at the average SONIC Drive-In. We were really very pleased with the results that we had in calendar 2013 with this reallocation of these dollars.

The slide that you see here should depict for you pretty well how this reallocation increased our share of voice among competitors and while not located -- why they're not identified by brand, that gives you some sense who our key QSR competitors are and what's happened to their share of voice in that same period of time. So we had something on the order of a 40% increase in our share of voice, which we were thrilled with. The effect of this reallocation of these dollars as we look into fiscal '14 and calendar '14, we are working our ways to increase media efficiency. There's no way for us to achieve the same level we achieved in calendar '13, but even still, the momentum that we've achieved with this growth -- with this reallocation of these dollars, the growth in same-store sales, store level probability, all these things will help our business from a momentum standpoint.

So another element that we talked about to continue to drive the same-store sales, our innovative product pipeline, as you know, this has been a focus of our business for many years. Hopefully, many of you have helped taste these products at SONIC Drive-ins in your market. So we continue to innovate with new distinctive flavors, products, et cetera, by day-part, by time of the year.

This past summer, our Summer of Shakes was very successful with 25 different flavors and that moved into September, we offered that Summer of Shakes into September. So the earlier part of the most recent quarter. And we followed with some other promotions involving other day-parts and other product lines chicken sandwiches, snack like Cheesecake Bites and some breakfast news. So this is very much part of our DNA, very much part of our history, we'll continue to do this, and we'll do it across multiple day-parts and product lines just as we did this past quarter, we'll continue to do that.

And I can say from my own personal standpoint, watching what's happened with our business with some of the talent we brought on the last several years and our refocus in this area, that we have a product pipeline strength that we've not had in the long time, so we'll continue to focus on this innovation of our food and drink lines, bring new news to the market to existing and potential customers on a sustained basis.

So whether it's desserts like our Real Ice Cream or these newer premium chicken products, or the Ice Tea that we're promoting, we have a view of our business and our product line of made-to-order food, differentiated service and product that we can produce -- we can provide quality products and in many cases, are on par to that, a fast casual or casual dining restaurants but we can do so on a more reasonable price, which really sets us apart from our existing competition in QSR and sets us up for better than QSR competition sets us up for competition with fast-casual dining restaurants in an advantageous way.

Now the other things that are going to continue to drive our business, major technology initiatives, you see them depicted here, we'll talk about them late in the presentation, a little more detail about some of these POPS, our point of personalized service. You see the 3 of them depicted, our POPS, the point-of-sale system. And then also our Supply Chain Management system that we have now implemented and will help the entire chain in lowering operating costs over time. So each of these initiatives, key sales and profit drivers for the average SONIC Drive-Ins for number of years.

So let's shift for a moment to talk about the initiative related to technology and not the elements related to Supply Chain Management or POS at this time, but rather the POPS piece and how we see this driving our business. You see depicted here the -- so we've kind of get all 3 of there, and that's fine, we'll leave it right there, how POPS integrates into sharing of data. So we think about this POPS system, or the point-of-personalized service, that you see in this center of the sphere here.

When you take the POPS system, and combine it with our physical drive-in format, this really should allow us to engage customers where they live and using the likes of mobile technology and social media, but on-lot and off-lot, and then provide an opportunity to more fully integrate the SONIC experience with customers, this broader sphere of communication, the methods of engagement, so the broader sphere we referred to as our integrated customer engagement or ICE. And then a piece on-lot, of courses, is POPS with that point-of-personalized service when they come -- when a customer comes on-lot.

Our view is that the impact of this initiative should really be a significant factor in growing sales and distinguishing our brand for the next several years, '14, '15 and beyond.

As we roll it out, we will continue to keep you updated on the progress of the physical implementation of POPS, so we may be less communicative about some of the content of POPS because we think this is an area that's going to be a very nice differentiator for us over time. So because of the physical drive-in format where consumers spend more time in a stall ordering, waiting for the food and having a dinner than they have spend with many of our competitors, it's our view that we have the ability to maintain and connect with the customers with targeted messaging and customized promotions in a way that our competition doesn't really have that opportunity.

So then, as I said at the outset, when you weave that with the social media, mobile app technologies, loyalty programs and so on, we should be able to drive engagement and promotions off-lot and off-lot -- off-lot and on-lot in a more targeted and personalized way than much of our competition would. And then with POPS, we integrate these on and off lot. So this will be very -- I think a very productive initiative of our business over the next several years, and we'll continue to communicate with you as we roll that out.

Now another contributor to our business, operating leverage. We've seen significant margin improvement over the last 2 years as a result of sales leverage from consistently positive same-store sales. And we expect further improvement in driving level of margins from the implementation of other elements of technology. Our new point-of-sale system and the software -- the system we have put in place for our Supply Chain Management should have very positive impact over the next several years. You see them depicted here on the right hand portion of this slide.

The new point-of-sale system is in process of being finalized and implemented in all of our company drive-ins this fiscal year. And we expect to see improved margins and revenue from the implementation as we roll this out across our system. Currently 70, or a little more than 70, company drive-ins have the new point-of-sale system. The implementation is taking a little longer than we would have hoped at the outset, but we expect to have the systems in all of our company's stores by this summer. And then, we would work to continue to roll out with our franchisees in fiscal years 2015 and '16.

We've also completed the implementation of our Supply Chain Management system, should really help us provide a greater transparency in all aspects of supply chain from our suppliers, our vendors, our distributors, down to the store level franchise, company-owned combined. The system also has a forecasting, that is the Supply Chain Management software as a forecasting system, which allow us to more effectively model the financial impact of promotions and manage inventories in our suppliers and distributors more efficiently than we've been able to historically.

So we think the combination -- we're confident that the combination of these initiatives will benefit the entire system, meaning the SONIC system over time with improved food and packaging costs. So each of these technological improvements and initiatives should yield both top and bottom line improvement for our franchisees and in turn, we think also help fuel -- with profitability, fuel growth over time as well.

So from a company-owned drive-ins standpoint, mentioned earlier the margin improvement, operating leverage at the drive-in level is an important part of our multi-layer growth strategy, has been for years, will continue to be. The margin improvement we've seen over the past 2 years has consistently or significantly contributed to our achievement of double-digit earnings growth. And we expect this improvement to continue over the next couple of years with leverage from positive same-store sales and our new point-of-sale system. And so aiming towards the 16% to 17% company drive-in margin.

Now the nice thing, of course, about that store level probability, as I mentioned earlier, is its impact on our ascending royalty rate, but more importantly as importantly, its impact on new store development. And these 2 elements, the new store development, ascending royalty rate are 2 important layers in our multilayered growth strategy that I laid out earlier that we've utilized historically. So we expect positive impact from these 2 layers to become increasingly important over the next several years as new store development kicks in.

Over the past few years, we've also focused on reducing the cost of the new SONIC Drive-in, which we've done by 15% to 20%. And we think the cost -- that cost reduction combined with store level profitability improvement. And then you layer in this national media that we've done here in the last year should really strengthen our product pipeline -- excuse me, our development pipeline. And in fact, really is doing so now. I think we've put out a release just this morning on a new area development agreement that was signed for Buffalo. And you'll all see others up coming in the immediate future in terms of additional area development agreement signed with new franchisees and new markets.

So with over 3,500 drive-ins in 44 states, we've got a lot of room to grow, particularly in new and developing markets. And then with the implementation of our sales and profit initiatives, we're talking about on a continuous basis, we talk about year-to-date, we expect to see development occur in the near-term more in core markets, but it would be followed by new and developing markets in the near and midterm.

We also expect near term to add new franchisees and new market signing new area development agreements and that will be disproportion to the remainder of the system in terms of those new area development agreements, where our objective here, as you know, is to aim toward a goal of 2% to 3% growth in units on an annual basis, and that would be a big factor in that multilayered growth strategy.

So you see depicted here on this slide, increased development contracts in the recent past. In the first fiscal quarter, we did open 7 new drive-ins, you'll see on the bar chart there on the left, compared to 1 in the same period a year ago. And in addition in the first quarter, we also signed 6 area development agreements, representing 29 stores, and that compares pretty favorably the year ago, the 2 contracts representing 6 stores, so nice step up, 3x the number of agreements, almost 5x the number of stores and this should indicate to you why we have confidence in the future of our growth of our brand, but also new franchisees coming to our system and existing franchises opening more stores.

It really does reflect the success of the same-store sales growth and store level profitability growth, the product pipeline you're seeing, the television creative and the increased media. All of these are indicators, all of these are drivers, I should say, of the motivation for new franchises coming into our system and looking to grow with the SONIC brand.

The ascending royalty rate aspect of this, which I think was depicted as one of the, of course, key drivers historically of our multi-layered growth strategy. This is a differentiated aspect of our business and our concept. From an investor standpoint, you should see it as, I think, an attractive aspect of our business. It will become increasingly important in driving earnings per share growth over the next several years. The royalty rate increases, obviously, with then with each incremental dollar from positive same-store sales, very positive flow-through for us as a franchisor.

So in addition to the organic growth of the royalty rate from positive same-store sales, there's a couple of other factors that will drive a higher royalty rate with strong profit flow-through. First is our development incentives that we put in place with some franchisees in the last several years, these -- both development incentives and also some royalty workouts, we will see an increased royalty revenues as those kind of play out in the near term.

But in addition to that, something we talked about before, in September of 2014 there's a licensed conversion that will occur, as I said, September '14, the affect of that is fiscal '15. But September '14, license conversion is going to occur with 850 drive-ins converting to a higher royalty rate. And it should drive about $5 million increased royalty revenue for fiscal year 2015. And these factors, as with the others, are expected to drive meaningful contribution to the -- our earnings growth rate over the next several years.

So you should be able to see why we remained confident in near-term and longer-term, our ability to continue to grow our sales, grow profitability and grow shareholder value with these initiatives in place that will drive each of these layers that are multi-layered growth strategy.

So with that, I'm going to turn it over to our Chief Financial Officer, Steve Vaughan, and he's going to talk about more financial results for the quarter. Steve?

Stephen C. Vaughan

Thank you, Cliff. I'd now like to spend a few minutes talking about our financial performance. We were pleased to report a systemwide same-store sales increase of 2.2% in the first quarter.

As Cliff mentioned previously, these solid results reflect a positive impact from our initiatives to improve service, product quality, value perception and media effectiveness, as well as attractive product promotions during the quarter. This solid sales growth resulted in strong operating income and earnings per share growth on an adjusted basis.

Operating income improved 80 basis points from 13.7% in the first quarter of fiscal 2013 to 14.5% for the first quarter of fiscal 2014. Adjusted earnings per share increased 18% from $0.11 in the first quarter of 2013 to $0.13 for the first quarter of 2014. These operating results do exclude the benefit of a favorable tax ruling on the accounting from our gift card program, which contributed approximately $484,000 or $0.01 per share to reported earnings per share for the quarter.

Turning to drive-in level operating margins for the first fiscal quarter, food and packaging costs were favorable by 40 basis points. This variance reflects a favorable impact of our menu price increase outpacing commodity cost inflation during the first quarter.

Looking to the remainder of fiscal 2014, we took a price increase of a little over 2% near the end of the first quarter. With this increase, we are currently running approximately 3% menu pricing at our company drive-ins. With respect to commodities, this level of pricing is expected to more than offset commodity inflation in the first half of the fiscal year. And we should again see favorable food and packaging cost in the second quarter. Our fixed-price beef contract expired on December 31. We are expecting some pressure on beef prices in the coming months.

With these expected increases, we will likely see some pressure on food and packaging cost year-over-year in the third and fourth quarters. However, we anticipate that we will begin seeing some benefit from the implementation of our new point-of-sale system in Supply Chain Software during the summer months. These benefits should more than offset the commodity cost pressures resulting in favorable food and packaging costs for the remainder of the year.

Payroll and employee benefits were 20 basis points favorable primarily as a result of leverage from positive same-store sales. Effective January 1, 2014, we began offering health care insurance to all eligible company drive-ins employees who worked more than 30 hours per week. The percentage of employees opting to take the coverage has been less than we originally anticipated. Accordingly, we only expect to see a minor amount of pressure on labor cost as a result of offering this coverage. It is our objective to be an employer of choice and we believe that making this insurance available before the mandate kicks in, positions our brand to achieve this objective.

Other operating expenses improved 20 basis points as a result of sales leverage. These solid operating results showed a leverage that is achievable with positive same-store sales growth. We are very pleased with the continued profit growth that SONIC system has achieved over the past several months and have seen these results provide our franchisees with increased optimism about the strength of their businesses.

Looking to FY 2014, the leverage from positive same-store sales, combined with the benefit from the implementation of the new point-of-sale system later in the year, are expected to result in 75 to 100-basis-point improvement in company drive-in margins.

While -- as Cliff mentioned, while the implementation of our new point-of-sale system has progressed a little slower than we had originally planned, this is often the case of technology projects, and we remain very excited about the margin opportunity we expect to achieve from the implementation of this new system.

Our SG&A expenses were $17 million during the quarter, compared to $16.1 million in the same period last year. This increase reflects increases in headcount associated with the investment in talent we have been making to support the technology initiatives Cliff described earlier, as well as increased variable compensation cost as a result of our strong financial performance, which was partially offset by a reduction in bad debt expense.

We have invested in and we'll continue to invest in additional resources to support successful implementation of our technology initiatives over the coming months. This investment is expected to result in SG&A expense increases of 5% to 6% over the course of the year.

While we will strive to pace our growth in SG&A to align with the performance of our business, it is imperative that we appropriately staff these initiatives to ensure a successful outcome. Our business is, first and foremost, a franchise business model. As a result, we generate significant amounts of stable and predictable cash flow with only moderate capital needs in a typical year. This model gives us the flexibility to invest in our brand when initiatives meet our return on investment criteria, repurchase shares or pay down debt.

We ended the fiscal year with $95.9 million -- I'm sorry, we ended the quarter with $95.9 million in unrestricted cash. This growth in cash during quarter 1 reflected our strong operating results, the proceeds from stock option exercises and the collection of a $7.5 million federal income tax refund during the quarter.

As Cliff mentioned earlier, we are making significant investments to drive sales and profits in our company drive-ins and expect to spend approximately $65 million to $70 million on capital expenditures, most of which will be spent to implement the new digital point-of-personalized service initiative and our new point-of-sale system in all of our company drive-ins in fiscal 2014. As a result, we project we will generate between $15 million and $25 million in free cash flow this fiscal year.

Using that free cash flow, and the cash on our balance sheet, we plan to purchase $40 million in stock during fiscal year 2014. We are purchasing shares on a steady consistent basis. And as of December 31, we have purchased approximately $10 million of stock fiscal year-to-date at an average price of approximately $19 per share. We are also pleased that we have continue to strengthen our balance sheet achieving a net debt-to-EBITDA ratio of 2.8x. We believe that a leverage ratio in the 3x range is appropriate for our franchise business model.

As our EBITDA continues to grow, we will continue to explore the best use of our balance sheet to grow shareholder value. We continue to have a very solid balance sheet and exceed our debt compliance covenants by a wide margin.

So in summary, same-store sales and margins are expected to continue to improve with the implementation of several key initiatives, which Cliff discussed earlier. We expect these initiatives to drive 14% to 15% earnings per share growth in fiscal 2014. This expectation is based on achieving positive same-store sales in a low-single digit range for the system. We do expect company same-store sales to perform at the higher end of this range in the final quarter of the fiscal year, new point-of-sale system and digital point-of-purchase technology are implemented.

40 to 50 new Franchise Drive-In openings and fewer drive-in closings than in fiscal 2013. Drive-in level margins to improve between 75 to 100 basis points, depending upon the degree of same-store sales growth at company drive-ins and the pace of installation of our new point-of-sale technology.

SG&A expenses of $69 million to $70 million. Depreciation and amortization expense of $42 million to $42.5 million. Net interest expense of approximately $25 million. An income tax rate of between 36.5% and 37.5%, excluding the quarter 1 tax benefit I mentioned earlier. However, this tax rate may vary depending upon the reinstatement of employment tax credit programs that expired on December 31, 2013, and pending resolution of certain tax uncertainties.

And then finally, capital expenditures of $65 million to $70 million, which assumes the implementation of the new point-of-sale system and digital point-of-purchase technology in all company drive-ins during fiscal 2014.

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

J. Clifford Hudson

Thank you, Steve, and all of you on the line. I would say that looking at this first quarter, looking at our business generally, what you should be able to continue to see is a distinctive and differentiated aspect of our products and our service, the potential for unit growth over the next several years. What you should see is a business and a brand that has solid runway for growth on both the consumer and investor perspective.

It's really the refinements of the elements that have grown our business historically, that today, in our view, provides a really good solid series of initiatives to drive our business over the next few years. So we're pleased with the first quarter, but very pleased with where the business is today, and we're happy to open it up, at this point, for questions from any of our participants.

Question-and-Answer Session

Operator

[Operator Instructions] We'll hear first from Brian Bittner with Oppenheimer & Company.

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

I'm just going to ask the obvious question first. Have you been able to decipher through what portion of the comp slowdown that you've seen in December and early January or basically since the quarter's end, is weather? And have you seen comps x weather just remain steady, accelerate or decelerate a bit?

J. Clifford Hudson

Well, it's fair to say that when the weather is not harsh, our sales are better. And we're pleased with how our promotions operate when the weather is not such a factor. When the weather is more harsh, it does have a negative impact on sales. And in terms of -- I think in terms of trying to separate out here on the phone, the gap that the one creates versus the other, we probably won't go there.

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

Okay. And you talked about the delay of the installation of the POPS and POS system, I mean, we're talking minor delays because you're still keeping your targets, your margin targets for the year, I mean this is what a quarter delay we're talking in the company-owned installment there?

J. Clifford Hudson

The way I laid that out, as I mentioned, there are 70 stores today and every time we go through a process of some next-stage implementation, we double back and look at the various patches and refinements have been made and see how those are working and then attempt to move to the next level. So it is to the extent that there is a "delay" in case this is a part of your question, it is a question of pace and timing. It's not a question of weather nor is it a question of anticipated benefit. So we continue to plow against that focusing on first implementation of the POS, and then coming back with the POPS because the POPS requires a software-based system in order for implementation operation. So you're right, it is a question of timing, it's not a question of weather. And we do expect the same benefit when we get it done.

Operator

We'll hear next from Matthew DiFrisco with Buckingham Research.

Matthew J. DiFrisco - The Buckingham Research Group Incorporated

Can you just touch on, was there any gain associated with the modest sale to company drive-ins to the franchisees of 7 stores? And if so, where is that being attributed in the revenue line?

Stephen C. Vaughan

Yes, Matt. This is Steve. There was no gain on that sale. These were drive-ins in a very small market that were basically lower performing drive-ins and no gain or loss on that at all.

Matthew J. DiFrisco - The Buckingham Research Group Incorporated

Okay. And then can you just -- I guess sort of follow-up on Brian's question, I think you're going to get a couple of questions on this. We're all wondering about comments with 2 months of the quarter sort of in the books here as far as same-store sales -- I'm sorry about 1.5 months, is the implication of that will see an acceleration of same-store sales to get to that annual guidance of low-single digits? Presumably, it sounds like, if we're interpreting it right, that you are below that low-single digit in this current quarter, given the reference to weather having a negative impact. I just want to, I mean, in the past you've had some negative comps swings from weather. Can you -- would you tell us now if you were negative or not?

Stephen C. Vaughan

Matt, first of all, we're 37 days into the quarter. So I think we're not quite far into the quarter as you mentioned but we did, I think as Cliff mentioned earlier in his comments, we had some weather challenges in November and our quarter was a solid quarter. So I think from the -- we will be impacted by weather this quarter because of the weather that we had in December, but there are several months remaining in the year that we feel like the weather could become a positive contributing factor. So I don't think in terms of us making a specific comment on sales, we don't feel like it's necessary at this time.

Matthew J. DiFrisco - The Buckingham Research Group Incorporated

Okay, that's appropriate, I guess. And just going back to your transcript last year, weather was also a factor as you we're lapping a very warm 2012, '13 winter so -- or the prior winter, the warmer weather from 2 years ago. So one was to think that the weather was a little bit more comparable. But moving over to also, I guess, just looking at as far as the rate of the royalty improvement, would we expect the royalty to, I guess, when we start looking at the back half of this year, start to improve as we -- before we even get to that reset on a little bit more of a more meaningful basis as we start to see some of these discounted or lower royalty rates start to expire?

Stephen C. Vaughan

Matt, we would really expect to see a similar level of improvement that we saw in the first quarter. Those 850 roughly conversions that Cliff described. For the most part, they all take place on September 1. So you'll really see a nice step up beginning in the first quarter of fiscal '15. But not much impact from that component before then.

Matthew J. DiFrisco - The Buckingham Research Group Incorporated

Excellent. And then the last question, with reference to sort of the delay of the investments that you're making, but still being confined to FY '14. I guess one could still then conclude that your CapEx should drop in FY '15 and supporting a meaningful improvement in free cash flow. Is there anything that would discourage us from thinking that the free cash flow will return to maybe north of significantly above the $25 million high end of the range in FY '14?

Stephen C. Vaughan

No, that's -- I should say, you're absolutely right. We would expect to see our free cash flow in fiscal '15 step back up into the range that we've had. Historically, you may recall $20 million to $30 million of what we consider more of a maintenance CapEx. And so fiscal '15 would most likely be in that range, which would mean a significant step up in our free cash flow in fiscal '15.

Operator

[Operator Instructions] We'll hear next from John Glass with Morgan Stanley.

John S. Glass - Morgan Stanley, Research Division

First, just on the projected increase in the share of voice in '14, so I think '13 versus '12 you said it was 40%, it's going to be hard to duplicate that, but just based on what you do know about your media spend for '14, what do you think your increases is this year versus last?

J. Clifford Hudson

Well, the share of voice measure, we wanted to utilize today was to show the dynamics, John, in the benefit of the shift what we did in the efficiencies in our business versus key competitors in that chart not by name, but they are key competitors in QSR business. So we use the share of voice to show the juxtaposition of us versus competitors because we think it's more meaningful than just showing a number. The share of voice thing in terms of how that will look in '14, we will have to wait to play out because that has to do just that. It has to play out over time. We will get some -- we anticipate getting some increased efficiencies this year with our buying just because of incremental tactics that we're utilizing. But in terms of comparing share of voice shift, it will take time for us to know that because we don't know what everybody else is doing. So let's wait for everybody else to report and see how it compares to us.

John S. Glass - Morgan Stanley, Research Division

Got you. That makes sense.

J. Clifford Hudson

We do expect to get some improvements this year, I'm not talking about share of voice, I'm talking about the tactics that we're utilizing, improving same-store sales and the tactics that we're utilizing to improve the efficiency of the buying.

John S. Glass - Morgan Stanley, Research Division

Great, that's helpful. And then just, Steve, you're below your leverage target now of 3. How much further below does it need to be in order for it to make sense the cost efficiency of re-levering the business. What -- give a goal in mind, is it 1 turn, is it a 1.5 turn before you feel like re-levering is worthwhile?

Stephen C. Vaughan

Well, really we look at a number of factors, John. In fiscal '14, clearly, the reinvestment back in the brand is a pretty major factor even with that, we will be able to buy back shares at a pretty healthy rate without impacting our cash on the balance sheet. I think you will see us continue to reevaluate the level -- level leverage that we have. It will depend on how fast EBITDA growth in terms of whether we feel like that we need to add additional debt, but when that -- we'll continue to evaluate that and when the time comes, certainly communicate that to the market.

Operator

Moving on, we'll hear from Alex Slagle of Jefferies.

Alexander Slagle - Jefferies LLC, Research Division

Question on same-store sales dynamics you're seeing between the core markets and the newer markets. And just if anything has changed over last year or so, any changes in how customers are using the brand in newer markets versus more established markets.

J. Clifford Hudson

The shift in the media dollars have helped all markets in this past year. This was a calendar year impact because the way it played out. So calendar '13, it helped all markets. Gross rate points grew in all markets, they grew disproportionately stronger in developing and new markets than they did in core, but all markets benefited. I think the -- we do see opportunity to communicate to our customers about the ways they can utilize us, and the marketing dollar allocation that we have now will help us do that. I think it's fair to say we're not seeing a material change in the way they're using us in calendar '13, though we did see, clearly from a sales standpoint, traffic standpoint, nice impact. I hope that answers your question, Alex.

Operator

We'll hear next from Will Slabaugh with Stephens, Inc.

Will Slabaugh - Stephens Inc., Research Division

I was wondering if you could give us a quick update on POPS and any sort of test that you've seen in the impact from any sort of sales lift that might have happened from the stores where POPS is implemented. And in that same question as it might apply to the POS system, if you're seeing that anticipated benefit on the margin that you have talked about previously.

J. Clifford Hudson

Okay. These are very different projects both technology -- technologically-based, obviously, but very different projects. One, about how the customers engage in store level, the other about the management of the business, POPS being about the engagement of the customer. So we'd now have POPS. I think it's around 60 drive-ins. Most -- almost exclusively, but not exclusive, almost exclusively company-owned. And we have seen impact, we -- I think in the first market we went to, they're actually -- is actually now beyond its second year. In other words, we're beyond 24 months post-implementation. And we continue to play with content on POPS to continue to drive sales. And we are -- I mean, this is a beauty of this thing is that it intended to be the gift that keeps on giving. It's not a one-time thing and because it's software-driven, you got the ability to continue to evolve it, evolve your thinking and evolve your testing and evolve your usage over time. So how we communicated publicly about the impact of that, the answer is no. Do we believe that it has a very worthwhile return on investment? The answer is yes. And as we roll out POS in more company stores, we will follow that with POPS. I think as it relates to point-of-sale systems, we expect -- we would expect margin improvement over time for a variety of reasons, which I think are probably standard to the industry. I don't know that we have talked about publicly the margin improvement that we would expect from that, only that we expect to continue to see margin improvement for our company stores and for the systems. Is that right, Steve?

Stephen C. Vaughan

We've given a range but, Will, I will just say we're still in what we call the limited deployment stage of that rollout. And so I think your question may have been directed towards what we've seen today. There's really -- we're still in the process of refining that system. It is in 70 drive-ins. But I think we'll be better prepared to answer that in a few months.

J. Clifford Hudson

Yes. So the process there is the refinement of the software, and then also refinement of processor adaptation by operators and get it ready to roll out to franchisees. So to Steve's point, we will be ready to communicate more effectively in a few months.

Operator

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

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

Two questions. First, following up on the margin side, the guidance for the full year is still 75 to 100 bps. I know you mentioned the commodities, I guess, beef has been increasing a little bit more recently and you no longer contracted as of this past week. I'm just wondering, order of magnitude by line item of that 75 to 100 bps. Should we assume that food cost benefits are still the greatest component? I think you said you'll see leverage on the cost line for all 4 quarters despite the beef, so I'm just wondering kind of order of magnitude in terms of different line items where would you expect the greatest benefits, perhaps if you can share it all what you think the beef component will ultimately turn out to be in fiscal '14. And then, I have a follow-up.

J. Clifford Hudson

Yes, at this point, Jeffrey, I'm not -- I wouldn't speculate on what the beef will turn out in terms of the year-over-year cost, but it is -- you may recall beef is only 10% of our overall cost of goods. So it's because of our diverse menu, we don't expect that to be a huge impact. We do anticipate that our pricing that we have in place and the implementation of the new point-of-sale system, we will really start seeing the benefit of that later in the year with the improved cost controls, that we will see improvement in food and packaging costs that will contribute to that 75 to 100 basis points. And then also just the combination of sales leverage on labor and other operating costs, along with the tools that will help us manage that labor more effectively, particularly during the summer months, give us confidence that, that 75 to 100 basis points outlook that we have is very achievable.

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

Got it. And just a follow-up, in terms of the sequential trends from a comp perspective. I think you gave the color around the November, December weather, but I'm just wondering x the weather, what you're seeing in terms of the competitive set, things like some of your larger peers if you're calling that kind of more burger direct peers are getting more aggressive on dollar menus or I should say value menus perhaps not all at dollar anymore, but I'm just wondering whether you're seeing any impact from that or whether you're seeing in any particular markets and whether you'd respond to that or whether the product you have is differentiated enough that you don't change your strategy based on what you're seeing from your larger peers from a value perspective?

J. Clifford Hudson

Well, we do, Jeffrey, continue to focus on product service differentiation. Going into the recession, we had some gaps in terms of how we are communicating value and some elements of ladder pricing is going to help with that value. So our belief is that we have that addressed, both from the value piece, both from a standpoint of pricing on the menu, nature of promotional activity, quality of service, the value proposition for us is very -- it looks very different than it did going into the recession and when I say different, much improved. So we're comfortable staying on a product and service differentiation strategy and a multi-day-part strategy. So the answer is yes, we have, to your question about seeing our competition, major competition, in particular, pursuing price discounting. And as a general approach, it's not the approach we're taking, it is about differentiated product and service and a value on the different basis versus just price.

Jeffrey Andrew Bernstein - Barclays Capital, Research Division

Got it, but we should expect -- I think you said you took 2 points of price at the end of the first quarter. So now you're running 3%, should we assume that 3% run through the rest of year? Or do we expect some roll-offs, it seems like a fair amount of price to consider.

Stephen C. Vaughan

So Jeffrey, in May, we will roll over 1% of price, but we are testing additional price increases as we always are testing, so we'll at -- probably March, April time frame, we'll have a better answer for you in terms of what we would expect to take in May, but it will be duly based on the results of the tests, what the consumer trends are at that time and how our business is going. So at this point in time, I would assume that we will rollover the 1% and probably take some level of price maybe not the full 1% back, we'll see.

Operator

Next, we'll hear from Nicole Miller with Piper Jaffray.

Nicole Miller Regan - Piper Jaffray Companies, Research Division

When you look at that comp by month for the fiscal second quarter so last year, what was the best month and what was the worst? I'm just trying to see if comparisons get easier or more difficult as you finish off the quarter, please?

Stephen C. Vaughan

Well, Nicole, we don't talk about monthly comps. I think what you may recall in the third quarter, our third fiscal quarter last year so March, April and May, we did have a pretty significant weather impact. I think we actually quantify that. It was between 3 and 4 percentage points. Who knows what the weather year-over-year, whether we'll see that benefit in the third quarter this year. We'll have to wait and see. But, certainly, going into that March, April time frame when the weather was out of the ordinary level of cold, and I think even wetter than normal, we would expect to, on average, see some type of favorable lapping. So that was probably, I would say, from a more challenging quarter, that was the most difficult quarter last year and then of course our fourth quarter was very strong, December quarter we had our strongest comps.

Nicole Miller Regan - Piper Jaffray Companies, Research Division

Okay, I don't even know if you have it in front of you or not, but maybe if you look at December of 2012 and January and February of '13, was there a big difference like 1 month was a way better than the other? Or was it tight?

Stephen C. Vaughan

I don't have that in front of me and yes, we -- yes...

Nicole Miller Regan - Piper Jaffray Companies, Research Division

Okay. And just real quick on Slide 11, you showed the sales day-part, could you talk to us about comps by day-part? Is one contributing more than the other?

Stephen C. Vaughan

Well, we have talked about the fact during the December months. In particular, we saw our evening business very strong, evening has continued to be a strength of our business particularly as we promoted our ice cream.

J. Clifford Hudson

Usually, it get some kind of -- you get a bit of a halo when you got a period of time with the promotion of a product like shakes after 8:00. So even after it goes away, you build traffic and patterns and behavior. And so for some period of time, folks stay with that. So it's one of the benefits of having a promotional for a while going away then coming back, but we've had other promotional activities since that time, not ice cream. I'm not saying ice cream is not doing well, I'm saying in addition to ice cream, we've got other products that are moving well for other day-parts. And so in a way, this is kind of the way we approach the business, so over time is for a period of time, push breakfast and then snacks and then entrées and push evening with the half-price shakes after 8:00. So it's a rotating process like that.

Stephen C. Vaughan

And Nicole, I will just add, we talked about the opportunity we have with chicken and we've been very pleased with our promotions of that product, the ability to sustain the gains that we've made in that by improving the product that we have. So a nice -- that product tend to sell lunch, dinner and really across all 4 day-parts.

Operator

We'll hear from Robert Derrington with Wunderlich Securities.

Robert M. Derrington - Wunderlich Securities Inc., Research Division

Stephen, could you give me a little bit of color if you could for a second on the difference between same-store sales and your average unit sales? It looks like your average unit sales clearly are getting benefit greater than what same-store sales are. Is that a function of the closing off the older stores from this past, I guess, the fourth quarter? Or the re-franchising of company restaurants in this most recent? How do we think about that?

Stephen C. Vaughan

Yes. So I think really the biggest -- there are 2 bigger factors in that. And I don't know if you're referring to the system or the company, I don't have those numbers in front of me, but on the company side, we did close some lower volume drive-ins at the end of the year and the we've re-franchised some lower volume drive-ins. So that's helping drive our AUV and will give us a little bit of a margin lift for the remainder of the year. In addition to that, on the system, we see new stores continuing to open up at very healthy volumes. And so that's helping to drive our AUV higher in addition to the growth in same-store sales. And then, of course, on a much smaller basis, the stores that closed do tend to be low volume stores.

Robert M. Derrington - Wunderlich Securities Inc., Research Division

Got you. I was focused principally on the company average unit sales, so that essentially is a tailwind that likely should continue through most all of the fiscal year? Is that right?

Stephen C. Vaughan

That's correct, Bob. Yes.

Operator

And we have time for one additional question today and that will come from Joe Buckley with Bank of America Merrill Lynch.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Two kind of quick ones, I hope. You gave a lot of information on pricing for the quarter you just reported, how do the same-store sales break down between check and transaction?

Stephen C. Vaughan

So the 2.2% comp was primarily driven by check, Joe.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Okay, which transactions have been positive in the mix? Or was it basically all check?

Stephen C. Vaughan

I'm sorry, can you repeat the question?

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Sure. Were transactions positive, flat or positive or was it all check?

Stephen C. Vaughan

No, transactions were roughly flat for the first quarter.

Joseph T. Buckley - BofA Merrill Lynch, Research Division

Okay, and then secondly, I just wanted to understand the POS and the POPS relationship. I know they are 2 different projects, and you mentioned 70 stores of POS, a new POS and 60 with new POPS system. Are those 60 POPS, are those all in stores with the new POS, is that sort of how it goes, POS shortly followed the POPS installation?

Stephen C. Vaughan

Well, what you described in the last part of your question there is something, somewhere to what should occur prospectively. However, the company drive-ins have had historically a software-based point-of-sale system already. So it is not as they have not had the microsystem that we are now rolling out. So these 60 and change stores that have POPS are -- have -- I wouldn't say have nothing to do, but this is not -- there is substantially no overlap between the stores that have POPS and those who have POS. And in part, this is intentional strategy to let the POPS things work and we've been testing POPS. As we've mentioned, we've been testing POPS for 2 years, whereas the POS, we're getting into stores, testing software patch, patch, test software, roll out a few more, test, test. And so we're getting the point-of-sale system to a point where it's ready for rollout and only then what we bring in the POPS behind it.

J. Clifford Hudson

So we appreciate your participation in the conference call today. We're now just 1 minute over an hour. The -- as you hopefully can tell, with the comments from Steve and from me today, we're very confident about our business. We feel good where it is, we believe we have very good series of initiatives in place that should drive our business positively for the next several years. And we look forward in the next quarter. And as the year progresses in the next several years to sharing -- we're sharing with you the effects of those initiatives that we've implemented. So happy New Year to all of you. We appreciate your participation. We look forward to visiting soon. Thank you very much.

Operator

Ladies and gentlemen, that does conclude today's conference. Again, we do thank you, all, for joining us.

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