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Sonic Corporation (NASDAQ:SONC)

F2Q10 Earnings Call

March 23, 2010 5:00 pm ET

Executives

Pat Watson – Corporate Communications

J. Clifford Hudson – Chairman and Chief Executive Officer

W. Scott McLain – President

Stephen C. Vaughan – Chief Financial Officer

Analysts

Brad Ludington - Keybanc Capital Markets

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

Sharon Zackfia - William Blair & Company

Keith Siegner - Credit Suisse

Analyst for Steve West – Stifel Nicolaus

Nicole Miller Regan - Piper Jaffray

Greg Ruedy - Stephens, Inc.

Amol Desai – Johnson Rice

Operator

Welcome to the Sonic Corp. second quarter conference call. As a reminder, 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 second quarter and first half of its fiscal year 2010, which ended on February 28, 2010. 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 only, March 23, 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. Thank you for the introduction. Thank you to each of you for participating with us in this conference call this afternoon. I would like to talk about a number of things involved in our business. The way we want to go about this this afternoon we are going to spend a few minutes as you would expect reviewing our second fiscal quarter, the performance in the quarter, but also the initiatives we have in place to improve store level sales and initiatives we have in place to improve operational performance at the store level as well as financial performance store level and with our company; each of these both in the near-term and the long run.

I also want to spend a little time talking about new store development and the impact of the credit markets currently as this is having on new store development, our general business outlook and the outlook I think our operators have that may affect development or what is occurring in that part of our business as well. Also speak some this afternoon about the financial performance expectations for the remainder of this fiscal year, our fiscal year 2010.

You each have had access now to the performance for the company for the second quarter. It was a very difficult quarter for our average drive-in but also a difficult quarter for the company because of that. Two of the biggest themes that really played heavily on our business through the quarter were first the inclement weather positions in our core markets and then in addition to that the recession really taking more hold more intensely in our core markets at a pace well behind the rest of the country in terms of when the recession really kicked in.

I will talk about each of those in a bit more detail but you have seen at this point that the system wide same store sales for our business in the winter quarter ended February declined 13.2%. That was our system wide. For partner drive-ins it was 14.9%. One of the things we felt it was important to lay out in terms of kind of the core concept in what was occurring versus the impact of weather, we did feel like it was the first time we separated this out so we contracted with a third party, a weather analytical firm, which we provided them the information by store and by market so they could look at it in a segregated sort of way.

They look at temperature and snow fall in those markets and it helped lead us to the conclusion about 2/3 of the decline we experienced in the winter quarter was related to the unusual harsh weather that was experienced in a number of our markets. The conclusion they helped us come to was the estimate of same store sales without the adverse weather conditions would have been in the negative 4-5% range. It is I think noteworthy to look at the transition that occurred in spite of all of that challenging environment that as we transitioned through the quarter and here in the recent past transitioned our promotional activity to what we might call value the Sonic way. In fact even with the negative sales we saw average check turn positive for the first time in a good while.

It was very positive. You might say [see that constant]. It is probably also important from a traffic standpoint to point out a year ago we were implementing our everyday value menu which did roll out in January 2009. This had an impact on traffic that was positive. Less impact on check, or at least not a positive impact on check. We anticipate with the nature of the promotions we have going forward through the year that we should see check continue to be positive in the second half of the year.

So those two things; weather and then the recession coming on more heavily particularly in Texas and Oklahoma as calendar 2009 came to a close, we have almost 1/3 of our system is in those two states of Texas and Oklahoma. We are in 41 states but that historical base plays a very large role in our business still. It accounts for about 1/3 of the sales. You are talking about states where we had double digit sales tax collection versus, I am talking about, though true for Sonic too, I am talking about on a very broad basis state and local governments looking at double digit declines in sales tax collection. So much more difficult operating environment. One which is now catching up with a good part of the rest of the country in terms of the recessionary environment.

As it relates to the focus of our business in looking how we see ourselves going forward and looking to drive same store sales and profit growth, this will continue to be a focus for us. At a store level, sales and profit growth, as we view that as the bread and butter indicator for the health of our business on a sustained basis. In addition to that, focusing on continued expansion of our concept across all markets and then finally the deployment of the cash which we have on hand of approximately $125 million and this will continue to be our focus on building our business.

So I want to spend a few minutes talking about one of the items that really relates to the first element and how we are going to be driving our business going forward as it relates to sales and profitability at the unit level. In the past we have made reference to this before. That is the value equation and how we see what we have done in the more recent past versus what we will be doing going forward. In fiscal 2009 a large part of what we focused on in this value equation was much more the denominator, meaning price.

Just as I spoke about a moment ago the biggest initiative we were rolling out a year ago was our everyday value menu and then as the year progressed as well focusing on assisting operators across the system with pricing strategy. So much more in terms of trying to affect the customer’s view of value at Sonic much more on the denominator than the numerator. There were some tools we put in place last year as well. I just spoke somewhat more on the quality experience the customer would have. This is a new tool. I will talk about this more in a few minutes but a tool focused on getting a level of customer feedback we have not gotten previously and assist us in improving the experience the customer has.

Going forward as we look through calendar 2010 one of the things I think you are going to see is far more focus and intense focus on the numerator. We will work to sustain what we have achieved on the denominator and not let that slip away but increase the focus on the numerator. Our view is our brand will be the better for it and our business will be better for it in the near term and the long run with us focusing on more than anything differentiation versus the competition.

I want to spend a few minutes talking about the sales driving initiatives in that category, that numerator differentiation affecting the customer’s experience. There are really kind of four primary components that make up those sales driving initiatives. The first one is focusing on a consistent and high quality customer service experience at each drive-in and I am going to talk about in a few minutes about some of the elements that go into that and will be impacting that.

The second is focusing on quality improvements on our core menu items. I think for a long time we have been looking at third-party sources on this. For a long time we have been viewed versus our competition as having a higher quality food, made to order, differentiated products, etc. and focus on new product news. But as we shift to focusing on product improvements, the improvement of our core menu items the new product news we bring out based on that I think will really help raise the bar and provide our customers and potential customers, all consumers, with a noticeable and compelling reason to come to Sonic.

The third detail I would like to talk about focuses more on the product and service differentiation and emphasizes the difference versus our competition as it relates to the creative, the television creative we are utilizing to try to continue to drive home those points of differentiation where I think we are doing so more effectively than we have in the past focusing on handmade onion rings and tater tots but also some fun aspects of the drive-in experience that will include in the commercial skating car hops, personalized service and made to order food.

The fourth thing we are talking about has to do with the new media resource reallocation of some of the same dollars we have on hand in order to maximize media impressions in every trade area of every store in the system. We will talk about in a moment how we are going about that with local mediums with a portion of what had been spent nationally to local mediums to drive consumer impression.

So as it relates to that first item, the consistent high quality execution of the brand, a little more than a year ago we implemented something we internally refer to as stay on track. A method of providing our customers a vehicle to tell us what their experience was at the Sonic drive-in and also what they want from Sonic. This is something that really has worked to improve, as you can see here it shows the percentage of respondents that gave us a 5 on a scale of 1-5 with 5 representing the best experience they could have and meaning they are more likely to return and more likely to recommend us to third parties.

As you can see from this picture in October 2008 our owned drive-ins and our partner drive-ins scored significantly below franchisees. It was a 59% score compared to franchise drive-ins at 69%. This tool was implemented in the fall of 2008. Since then it has really been our goal to improve every customer’s experience but in particular to close the gap between partner drive-ins and franchise drive-ins and then along the way to raise the score for the whole system. As you can see this last summer in July our partner drive-in’s had closed the gap with franchisees and then you can also see the entire system as the year progressed you can see we continued to improve from a consumer viewpoint we continued to improve the experience they were having so as I made reference to earlier to this numerator and the attempt to affect value through the improvement in the experience the customer is having there is some [pretty serious] indication the customer is perceiving it that way. I think it is a very positive thing for our business.

Another way we are thinking of doing this is through product quality, sales driving initiatives through affecting product quality. In the next 12 months you are going to see us focused on this in more ways. We are introducing product improvements, key aspects of our menu, focusing on highly distinctive in addition to what is on the menu day after day, highly distinctive limited time offers as well that may showcase some of these new products. The core menu will be improved along the way. Throughout the process continue to focus on unique entrees and desserts and side items, the onion rings and tater tots, etc. that we have in place.

So as we move into the spring you will see pretty near-term but we will start talking about real ice cream. The new ice cream we will have system wide I can personally testify it is richer, it is thicker, it is creamier than our current soft serve which is what we have to call it because that is what it has been; a non-ice cream, lower fat dairy product. In fact, this is real ice cream and it is coming with improved toppings, improved chocolate, improved pineapple and so on. All of us involved in this can testify how much we have enjoyed proving out this case.

In the process we expect this to really help drive traffic across many day parts. Some more than others. But also enhance our position as the QSR dessert leader. This will be a fun one to see roll out. It is a big part of our business historically and I think it will be a growing part of our business. You will also see us focusing on some of our traditional items like our chili cheese Coney and moving to summer comes on to a true foot long. We have referred to this as the extra long cheese Coney but in fact we are now making it a foot so we can call it a foot long.

It also is moving from about 2.6 ounces of meat on that Coney to ¼ pound. So this is a nice step up. The testing we have already done indicates that the customer sees a noticeable difference in the taste and the quality. I think this will be a very good thing for our brand. It will be a good thing for traffic and then for check and it will help rebuild the customer’s image of having a good product quality when they come to Sonic. These also, the things I have laid out, happen to be items that to a substantial degree are distinctive to us and this is one of the things I think will play well with the QSR customer and help take our business to another level.

I made reference as well to new product news. Those of you who have seen some of the details in the recent past with our promotional activities should be seeing some of the ways we are going about this. It is a little different than from the past. In February we have seen the Steak Melt Toaster with sirloin steak. We offered with that free onion rings. March as well but the point is new product news that focuses on a little higher end product.

Another element of this that I will talk more about in a minute has to do with value the Sonic way. Each of those cases the Steak Melt Toaster’s are coming with free onion rings and in March with free tots, focusing much again on our items that have quite a bit of difference versus our competition because of the side orders and I think they are attractive to many of our customers and should be to potential customers with the value that is offered there.

The creative you should have seen if you have seen us on national cable or your local markets in recent past you should be noticing an evolution of our creative. This is the third component of what I wanted to talk about in terms of sales driving initiatives. You have seen for a lot of years us using our two guys in the car. This is an evolution of that. In the month of February you may have seen two guys instead of simply sitting in the car at a Sonic drive-in you see them shopping around at our competitors and they are talking about the contrasting experience as our competitor shops versus ours. Right now it is focusing on the products, specifically the handmade onion rings in February.

In March that creative included skating car hops, emphasizing this point of differentiation, that is our service delivery system with the drive-in format, the personalized experience you can have with the car hop as our ambassador, as well as the element of entertainment the customer can experience in coming to Sonic. It is not a process of replacing the two guys. It is complementing what we have done in the past with them. Some with the evolution of their own piece and then with the car hops really focusing on higher awareness of the unique fun and distinctive nature of our brand.

I made a comment a moment ago in terms of our initiatives or promotional strategy and creative to drive sales and profitability. The February piece you may have noticed and I made reference just a moment ago that a year ago while we put this on the everyday value menu we have shifted in terms of what is value the Sonic way and focus on offering in the case of February a free order of handmade onion rings. In the case of March free tater tots. In February it was the purchase of the Steak Melt Toaster and in March it was the Super Sonic Cheeseburger.

The objective here is to not just entice the customer to come in because of the value that is being offered, but highlighting the distinctive profits, excuse me distinctive products, I am hoping for the latter as well, but distinctive products so we can drive check and improve sales of entrees distinctive versus our competition and again drive that point of differentiation versus the competition with the value the Sonic way.

I made reference earlier to the change in media strategies. As we move into the spring, this will really take place next month, we are going to look at reallocating some dollars we have historically spent strictly on national media. Use some of those dollars to maximize the number of media impressions for every Sonic drive-in trade area. The process here will be to reallocate a portion of the national system fund as we have had for a number of years. We will continue on national cable to the tune of about $70 million in fiscal year 2010 such that just to give you a sense of what that $70 million would get on ave4rage one commercial play once every hour, every day of the week. So it is not as though $70 million means we are going to go up in national cable. We won’t at all.

We will take the remaining funds though and reapportion to local media on a prorated basis based on penetration and demographics and trade area. We will determine market by market how those dollars are going to be used but on average we believe this is going to increase media impressions within the market by 20% for the consumers that are closest to the drive-in location. We will use different ways in each market but the most common ways are local TV and local cable TV particularly where zone to cable is permitted or available but also radio, outdoor billboards and other methods that can get the message to consumers in the more immediate area surrounding a Sonic drive-in.

In conclusion, from my standpoint I would like to say we have a number of initiatives in place as we talked about to try and improve the drive-in level sales and profitability which in turn will improve corporate profitability as well. I am of the very firm view we have the right initiatives in place to work to regain the sales momentum. As the economy and consumer spending improves over the next year it should have us in a good position for good improvement in our business as well.

Our focus on product and service differentiation and improving both is undoubtedly a very good move for our business. As it relates to unit growth rate which we are going to talk more about in a few minutes, while it may be somewhat slower than our historical average for the next year or more we have seen a process in the past that as sales and profits improve unit growth rate improves at the same time or at least it follows soon thereafter but there is a correlation of improving sales and profits soon followed by improved store level development as well.

In our fiscal year 2010 we anticipate having a positive operating cash flow after capital expenditures of about $25-30 million. We will also be making $52-53 million in principle payments. So in addition to this with more than $125 million in cash we will be looking for ways to deploy these funds for credit enhancement on the one hand or repurchasing shares by the end of the fiscal year as one opportunity or the other presents itself.

With that summary of our quarter and our business, at this point in time I would like to turn it over to Scott McLain for an update on our development activities.

W. Scott McLain

Thank you Cliff. Development has been challenging during the first six months of this fiscal year for a variety of reasons including ongoing franchisee uncertainty about business conditions as well as tough winter weather and continued credit market challenges.

During the second quarter franchisees opened 17 new drive-ins and for the first six months a total of 42 new drive-ins were opened. Our franchisees also continued to actively invest in their existing assets as evidenced by 13 relocations or rebuilds during the first two quarters of this fiscal year. We don’t count these as new store openings but they do require a new drive-in to be built and they are probably our highest ROI activity, routinely generating sales increases of greater than 25%.

As you will recall we had previously provided a license agreement incentive for relocations and rebuilds which expired at the end of calendar 2008. Over the last three years we have relocated or rebuilt roughly 150 drive-ins or 4% of the chain. It is encouraging to see franchisees continuing to actively invest in this type of activity even in the absence of a license incentive.

We are seeing some positive impact from the new store development incentives we announced during the summer which were designed to reward franchisees opening multiple stores during the year as well as encourage development in some of our more challenged and under-penetrated markets. However, even with the incentives the challenges of the tough sales and profit environment together with the rough winter will likely lead to fewer than expected new store opening this year.

As we announced in our recent press release we currently expect 80-90 franchise openings for the fiscal year. Longer term prospects for development remain solid. First year sales for new drive-ins continue to be strong with overall average opening volumes of approximately $1.5 million, roughly 35% ahead of what they were just 3-4 years ago. We also now have 84 drive-ins in new markets that have been open for more than 12 months and some now in their fourth year. These drive-ins as a group had average sales of roughly $1.4 million during the last fiscal year, almost 30% above the system average volume. While they continue to perform well as group they are not immune to tough weather and challenging economic conditions and their sales have also suffered during the winter months.

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 as they will only serve to increase our franchisees’ return on investment. However, in a recession environment and against the backdrop of a tough sales environment franchisees will often take more time than usual to make sure they have negotiated the best deal and also to make sure they see some recovery in sales momentum which may further constrain near-term openings.

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 truly a national brand by adding 13 new states in just the last four years. We did close 26 drive-ins during the first six months of this fiscal year, slightly fewer than the first six months of the previous year. Given that we are a 57 year old brand with over 3,500 stores we believe our rate of closings remains relatively low.

Although there are certainly some exceptions which we are working through, the fiscal health of our franchisees overall remains solid and we continue to benefit from financial requirements we put in place for new franchisees in 2006. Despite the near-term challenges our franchisees remain as passionate as ever about the Sonic brand and we are gratified by their continued commitment and investment in what we together believe is a bright future.

With that I will turn the call over to Stephen Vaughan, our Chief Financial Officer.

Stephen Vaughan

Thanks Scott. For the second quarter we experienced a net loss of $0.01 per share. Our earnings reflected the significant decline in same store sales compounded by the de-leveraging impact of lower sales on margins. Franchising income including franchise fees and royalties decreased by $2.5 million versus the comparable period last year. The decrease in franchise income was caused primarily by the decline in franchisee same store sales of 12.9%.

The sales decline was compounded by a decline in our effective royalty rate at 13 basis points for the quarter versus the same period in the prior year. As Scott mentioned we opened 17 franchise drive-ins during the quarter. Seven of these drive-ins opened under our incentive program with six openings with no franchise fee and one opening at ½ the normal fee. However, only two of the 17 drive-ins opened during the quarter met the criteria for royalty abatement.

The de-leveraging impact of same store sales declines combined with higher labor costs resulted in lower restaurant level margins in the second quarter. Looking at each individual line item; food and packaging costs improved slightly versus the prior year reflecting a slight decrease in our commodity costs during the quarter. Looking forward most commodities are either locked in or are far enough along in the contract negotiation process to provide visibility into costs for the remainder of the fiscal year. We expect commodity costs will be slightly lower in the third quarter and slightly higher in the fourth quarter based upon current projections. These projections include the higher costs related to our product quality initiatives including the introduction of real ice cream in May and an improved foot long Chili Cheese Coney later this summer.

With the positive impact of recent and planned pricing changes, which I will discuss further in a moment, we feel confident we will see relatively flat food and packaging costs for the second half of fiscal 2010. We are currently running cumulative menu price increases at partner drive-ins of approximately 2.% on a year-over-year basis. This level of increase will continue through the end of the third quarter where we will lapse approximately 1.5% of pricing. We expect to take a nominal increase in late May that will put our fourth quarter cumulative increase in a range of 1% to 1.5%.

On the payroll and benefits 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 to benefit in other operating expenses from our refranchising efforts. However, a large portion of these expenses are fixed, causing a 280 basis point deterioration in this line item resulting from the steep same store sales decline. We expect significant improvement in this trend as sales improve in the second half of the year.

As I pointed out last quarter a change in the accounting rules now requires us to report minority interest 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 reduced our partners’ income and is not sustainable in the long term.

Effective April 1, we will be retooling our partner compensation program to reduce the volatility of our manager and supervisor earnings from month to month. This change will have some incremental costs estimated at $1-1.5 million per quarter. However, we believe it is an investment that will provide long-term benefits through reduced partner turnover and an improved focus on store level operations. Several partners have opted to retain their ownership interest so we will continue to have a non-controlling interest line. However, much of our compensation costs will shift to the labor and benefits lines of the new program.

I also want to reiterate this program will retain the spirit of ownership with all managers and supervisors retaining the opportunity for unlimited earnings upside regardless of their status as a legal partner.

During the second quarter SG&A increased by approximately $1 million. This increase is primarily due to an increase in our provision for bad debt. As Scott mentioned the difficult sales and profit environment has created financial challenges for some of our franchisees. In recognition of these challenges we have increased our allowance for uncollectible receivables. As the seasonality of our business improves in the spring we would expect the need for additional bad debt expense to decrease.

Depreciation and amortization declined by 15% reflecting the refranchising of partner drive-ins and further moderation in partner drive-in development. While we saw significant savings from the refranchising of partner drive-ins we did reinvest a good portion of these savings in incremental resources on the franchise side of the business.

During the quarter we saw a $1.3 million increase in other revenue. This increased income is attributable to rental income from the real estate we retained when we refranchised partner drive-ins last year and to a lesser extent reflects our share earnings from a minority interest that was retained in the operations of 88 of the refranchised drive-ins. We expect to continue to see a mixed similar magnitude of increase in this line item until we lapse the refranchising activity which occurred primarily in the third quarter last year.

We continue to be pleased with our decision to move towards a more franchised business model. This model allows us to maintain our capital expenditures at a reasonable level while also servicing our debt requirements comfortably. As of the end of the second quarter we had $187 million outstanding under our variable funding notes with interest expense on these notes 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 approximately $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 $25-30 million and $50-55 million of mandatory principle payments is expected to be flat to slightly positive. We continue to exceed our debt compliance covenants and we anticipate this compliance will continue into the foreseeable future.

Due to our operating loss during the quarter our tax rate varied from our expected range of 37.5% to 38.5%. We would expect our rate to be in the expected range in the third and fourth quarters. However, new developments could impact our rate in any given quarter. As Cliff stated earlier the unseasonably cold and snowy weather in many of our core markets combined with ongoing weak consumer sentiment particularly in Texas and Oklahoma have resulted in disappointing sales in the second quarter. However, when our weather comparisons have been comparable to the prior year we have experienced sales within our flat to negative 5% range.

Accordingly for the second half of the fiscal year we continue to anticipate sales and margin trends to improve based upon our planned initiatives. We now expect fiscal 2010 earnings to be in a range of $0.55 to $0.60 per share. In addition to the sales expectation we outlined above this outlook is based on the following; Some deterioration in restaurant level margins primarily reflecting the de-leveraging impact of lower sales. SG&A expenses in a range of $65-66 million. Depreciation and amortization expense of $42-43 million. Net interest expense of $37-38 million and capital expenditures of $25-30 million.

In summary, while our sales and earnings performance declined in the first half of fiscal 2010 the initiatives we have implemented in the past few quarters and have planned for the next several 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 the uniquely Sonic way, product and service differentiation with product news focused on improving the quality of existing products, innovative approach to media expenditures and moving our business model towards a more predictable, stable cash flow model will increase shareholder value over the long term.

As evidence of our financial strength we continue to expect flat to slightly positive free cash flow after capital expenditures and debt payments which will provide us with ample flexibility in utilizing our excess cash for shareholder value driving initiatives going forward. This concludes our prepared remarks. We would be happy to accept your questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Brad Ludington - Keybanc Capital Markets.

Brad Ludington - Keybanc Capital Markets

First off, I might have missed it but I don’t think you talked about anything with same store sales trends thus far in this quarter. Is that correct?

Stephen Vaughan

We didn’t mention anything about the first three weeks of the current quarter.

Brad Ludington - Keybanc Capital Markets

Worth a shot. I wanted to ask on the refranchise sales that you did this quarter or this recent quarter are those in specific markets? What was the timing of those sales?

Stephen Vaughan

We had refranchising I believe of 16 drive-ins in the quarter. The majority of those were in a newer market. I think it was in the Atlanta market. We also had a handful of those that were refranchised in the Dallas market. So a combination of some lower performing and some better performing drive-ins.

Operator

The next question comes from the line of Joseph Buckley - BAS-ML.

Joseph Buckley - BAS-ML

Could you walk through the change in the partner compensation? Again, I think I missed some of it. You are talking about $1-1.5 million of incremental labor expense on a quarterly basis? Also if you could explain your comments that the upside is still unlimited how that works and the equation with the new compensation.

Stephen Vaughan

What has happened is with some of the sales and profit deterioration we have had at our partner drive-ins which has been disproportionate relative to the system, the partnership program in many of the drive-in’s is just not working. What we have done is gone and basically met with all of our managers and supervisors and given them the option to go to a different compensation structure that we believe will provide them with a more predictable compensation.

Right now with the partnership program, for example, during the summer months a partner’s earnings can be significantly higher than it is during the winter months. That can be difficult for a partner to manage. So what we will be doing is providing a more stable compensation across all 12 months of the year. However, they will retain the upside that comes with driving the profits of that business. So we are putting in place an incentive program we believe will retain the spirit of the partnership in the fact they drive profits their compensation will increase proportionately. Again, we will have some of our partners that are very happy with the current program and will remain on that program but a majority of our existing partners will move over to the new program.

Joseph Buckley - BAS-ML

The new $1.5 million is that the estimate of what it would run per quarter?

Stephen Vaughan

Yes that is the estimated additional cost for moving over. There are some costs associated for example with paying our share of their FICA, some health insurance costs, so there are some benefits to that. Also a more stable base salary that will be a higher amount. There will be some trade off in the beginning incentive portion of the compensation but again we are estimating about $1-1.5 million per quarter.

J. Clifford Hudson

What Steve has laid out is the incremental expense. What we would hope and expect is as a result of this is in those circumstances where we would want to see it a decreased turnover experience. You are talking about a circumstance historically where the base compensation has been on the lower end of things from a market standpoint and the incentive compensation has been quite high, the portion has been quite high. So we are changing that mix somewhat to where the base is a little bit higher and in many cases moving away from a partnership structure to a 100% owned entity but the individual still has a very serious and technically unlimited upside.

So the expectation we have is that this is going to contribute significantly towards reduced turnover and provide our partners who particularly this winter were having an unusually difficult time from a personal income standpoint and allow them to instead focus on good customer performance and rebuilding their individual business.

Joseph Buckley - BAS-ML

Is there a sales level of inflection point on sales you have to get back to make this margin neutral?

Stephen Vaughan

Yes there is. We have laid out some specific plans to achieve that. Not necessarily just through improved sales but also through improved margins. We think that over a 12-18 month time period we should be able to make this profit neutral but there will be some upfront investment cost which is where that $1-1.5 million comes in but again we feel over time it should become profit neutral.

Operator

The next question comes from the line of Matthew Difrisco - Oppenheimer & Co.

Matthew Difrisco - Oppenheimer & Co.

To be clear on that last question the $1-1.5 million was there any impact this quarter or no in the labor line yet?

Stephen Vaughan

No. We actually will be implementing this program on April 1. There was likely, we did move some of our managers to employees to a similar structure to what we will be having in place so there might have been some incremental costs but for the most part it will be effective April 1.

Matthew Difrisco - Oppenheimer & Co.

I didn’t hear the answer to the 17 store sales or 16 refranchised stores. I heard the markets. I didn’t hear the dollar amount you received. Is that in other revenues?

Stephen Vaughan

It is. We actually recorded a slight loss on those transactions combined. Again we had some lower performing and a small number of better performing drive-in’s. We did not call that out separately because it wasn’t significant.

Matthew Difrisco - Oppenheimer & Co.

You recorded a loss though so is that the driver to why 2Q other revenue came down on a sequential basis?

Stephen Vaughan

It is partially. It is also seasonal because we have our share of earnings in that investment in some of the rentals are based on a percentage of sales. There is a bonus rent. There is some seasonality to it but yes part of that decline was due to the small loss we recorded.

Matthew Difrisco - Oppenheimer & Co.

You gave us the detail for modeling purposes of the $1-1.5 million quarterly labor impact and then I guess minority interest, is it almost going to become diminimous and less than $1 million per quarter?

Stephen Vaughan

I don’t have an exact figure for you. The $1-1.5 million is incremental. That does not take into account the amount that will shift from the non-controlling interest or minority interest line to payroll and benefits. So the $1-1.5 million is an additional amount.

Matthew Difrisco - Oppenheimer & Co.

I might have missed this also, sorry if you mentioned it, but the G&A the magnitude of bad debt expense can you just break out how much of that was in G&A and I guess for the current quarter we are in you probably have a number you feel should be in there layered versus last year?

Stephen Vaughan

We had about a $1 million increase and that was virtually all attributable to our bad debt expense. In terms of projecting out for the third quarter, that is built into the guidance for the year with SG&A being in the range of $65-66 million.

Matthew Difrisco - Oppenheimer & Co.

All the expenses you outlined here, the $1-1.5 million in labor on April 1, all of that is in your $0.55 to $0.60 guidance for the year?

Stephen Vaughan

Well the $1-1.5 million in incremental labor yes it is in the guidance for the year. It is not in the SG&A guidance but it is in our overall guidance. Correct.

Matthew Difrisco - Oppenheimer & Co.

We are all looking at the dramatic improvement you are expecting in the back half versus the extremely weather impacted 2Q. I am trying to find a footing here where we are today. Would it be safe to say you are within the range of zero to down five across the base right now, both franchise and company owned? In order to give that guidance do you feel confident we are in that right now?

Stephen Vaughan

Well the statement I made in my comments when the weather has been comparable to the prior year and this is for the second quarter. Since the second quarter we have been within our flat to negative five range. We are not going to comment on three weeks of sales.

Operator

The next question comes from the line of Steven Kron - Goldman Sachs.

Steven Kron - Goldman Sachs

Following up on the bad debt expense I didn’t hear all of it before when you were commenting on it. I believe that is the uncollectibles from the franchisees. If so, can you maybe put that in context as to what percentage of the franchisees might be delinquent on payments? How does that compare to maybe a year or so ago?

Stephen Vaughan

That is a level of detail we really don’t want to go into. We have had some increase in delinquency but as Scott mentioned it is a fairly small number of franchisees.

W. Scott McLain

We do have some franchisees which are having some difficulty which we are working through and that is obviously what is giving rise to the bad debt expense but the lion’s share of the large majority of our franchisees are on firm fiscal footing.

Steven Kron - Goldman Sachs

A question on the cash build. I know you talked about future uses. I was wondering if you could talk about the decision to not utilize the cash on the balance sheet to buy back stock this past quarter and how you are thinking about it on a go forward basis weighing that between debt payments?

Stephen Vaughan

We continue to evaluate the purchase of debt at whatever price it is available at versus buying back stock. At this point we feel like the right decision is to continue to keep that cash as dry powder. I will tell you we continue to evaluate that on a regular basis and discuss our options with our board.

Steven Kron - Goldman Sachs

There is a lot of your competitors out there with a lot of beverage innovation coming through over the next few months. That is a big piece of your business. Can you talk about the percentage of your sales coming from beverages versus maybe a couple of years ago and what the strategy here is to fend off some of the competition?

J. Clifford Hudson

Our beverage business continues to remain the absolute best part of our business. We launched system-wide happy hour a couple of years ago and our beverage business has continued to grow, notwithstanding the attempt of our direct competitors and many indirect competitors to sell drinks cheaply. So we are going to continue to focus on happy hour. We are going to continue to focus on skating those fresh drinks out to customers which our competition can’t do and continue to build our business. Obviously we look at what our competition does but the fact of the matter is our drink business has held up probably as well as or better than any other part of our business over the last couple of years.

Operator

The next question comes from the line of John Glass - Morgan Stanley.

John Glass - Morgan Stanley

X weather you are implying your business has improved materially versus the first quarter? You talked about check being positive. Can you comment on where is check year-over-year or sequentially right now and how much then gets applied to the decline in traffic, please?

Stephen Vaughan

As the quarter progressed as we lapsed over happy hour and went to our new strategy of value the Sonic way we saw our average check turn slightly positive. It is not up by a huge amount but it is now slightly positive.

John Glass - Morgan Stanley

When you say value the Sonic way are you already doing the free onion ring promotion with the premium sandwiches?

Stephen Vaughan

Yes, as Cliff mentioned in February we had the Steak Melt Toaster sandwich and with the purchase of that premium sandwich we gave a free order of handmade onion rings. That is continuing, a version of that, in March with the buyer a Super Sonic Cheeseburger and the free order of tater tots.

John Glass - Morgan Stanley

Is that a permanent promotion or do you think of that just as a limited time for the next couple of weeks or months?

J. Clifford Hudson

We did the Steak Melt in February and we have the Super Sonic Cheeseburger in March. I am not sure as to the specific promotion February has come and gone. That promotion has. We will continue to focus on how to speak about value to the customer but doing it in a way we think is more aligned with our brand. If your question is will we sustain that strategy the answer is we will continue to focus on value particularly while the economy is as it is and the consumer is so sensitive to that issue.

John Glass - Morgan Stanley

I was speaking specifically of the free onion rings and tots. That’s what I meant. On the media strategy, I think you said $70 million is still being national cable. How much is being reallocated to local advertising?

Stephen Vaughan

It is going to be roughly $30 million on an annualized basis.

Operator

The next question comes from the line of Jeffrey Bernstein - Barclays Capital.

Jeffrey Bernstein - Barclays Capital

A couple of questions on the sales front. I know you talked about Texas and Oklahoma being about 1/3 of your system and I got the impression from your commentary it is only more recently you are seeing this pronounced decline in the consumer spending. I am wondering are you seeing that trend continue to weaken and perhaps a change in ordering habits or is it purely traffic you are seeing in those obviously two very large markets? Just trying to gauge the most recent trends in those two largest.

Stephen Vaughan

The sales tax trends, that is what we have been gauging the consumer spending in those markets by. The most recent figures continue to be double digit negative. They are not increasingly double digit negative but I think they remained double digit negative for the last 3-4 months at least. So that is what we have measured that off of.

W. Scott McLain

I would also make a point that in Texas and Oklahoma a tough winter is particularly tough because we don’t in this part of the world have to deal with a tough winter very often so we don’t have the kind of equipment and those sorts of things. I think if I am correct there was more snowfall in Dallas in the month of February than in Buffalo, New York. So I think the weather had very much of an impact on those core markets in addition to the sales tax receipts which occurred during the winter.

Jeffrey Bernstein - Barclays Capital

If you are using sales tax as a proxy rather than your sales I think the comment was that it is not getting worse. Is that what you are saying? It is still down double digits but it is not sequentially declining?

J. Clifford Hudson

I don’t think Steve was talking about our sales. He was talking about sales tax receipts.

Jeffrey Bernstein - Barclays Capital

Right. But you are not seeing those getting worse if we use them as a proxy for your sales. It is not like it is still deteriorating from here. It is still kind of stabilized?

Stephen Vaughan

The sales tax receipts. That is correct.

Jeffrey Bernstein - Barclays Capital

Any feedback on the pairing of the premium product and the three unique sides? I guess it has been a couple of months in terms of incidents or quantify the impact on margins or the mix of the total. It seems like a pretty unique promotion and I am wondering how it is doing so far in specific dollar standpoint?

J. Clifford Hudson

It has had a positive impact on check but with the weather we have had in the month of February it was a little difficult to get an overall read on it but again when we had comparable weather we felt good about the results.

Jeffrey Bernstein - Barclays Capital

Longer term, EPS growth target now that you are on a more heavily franchise model I know the comps are difficult to forecast for everyone but what are the expectations for underlying unit growth and margins as we look out to future years? What kind of…can you give us a ball park on some of the key metrics what you think you can do on unit growth. Can margins get back to that 20% level or do you think this change in business model and environment in general is going to make that harder? I am trying to size up the long-term growth prospects.

J. Clifford Hudson

I think the number one key to our growth is same store sales turning positive which will drive positive profits. That is our primary focus at this point. In terms of giving you a long-term target I think really it is more contingent on same store sales. I would rather wait and let’s see how the second half of the year goes.

Jeffrey Bernstein - Barclays Capital

But is 20% again achievable at some point or has it been changed in the model to make that not necessarily…

J. Clifford Hudson

We are not prepared at this point to give you a long-term forecast. Our business has performed very well over time and the fundamentals that have driven our strong performance over time are still there in large measure. We will make comments on what we expect for next year when we are ready to make comments and what we expect for the long term. In terms of the fundamentals of our business we still feel good about the fundamentals of our business and our brand.

Operator

The next question comes from the line of Larry Miller - RBC Capital Markets.

Larry Miller - RBC Capital Markets

On the bad debt we don’t often see this so I just want to understand what options you have available to you. Is this something that gets tacked onto the overall rate you might be able to charge that franchisee over time? Secondly, I wasn’t sure how you account for this. Is it you write this off in its entirety, all the future cash flows from that particular franchisee or is it you evaluate it as it is going on and therefore we might see this going on for the next couple of quarters as those franchisees have challenges with same store sales?

J. Clifford Hudson

The accounting is as franchisees have sales we accrue the royalty. So it becomes revenue and then each month you evaluate your receivables and collectability and that is essentially how we go about determining what our bad debt expense is. So it is something we feel like through February 28 we have recorded an appropriate allowance for what all of the receivables that have been booked through that date. Again if the business improves we would expect to see that decline. In terms of this being unusual, it is a larger amount than we typically record. I suspect all franchisors have bad debt over time and Sonic has always had some level of bad debt. This is just an unusually large amount and I think a lot of it is attributable to the very tough winter we just went through. We feel like things will get better in the spring.

Larry Miller - RBC Capital Markets

Is there any way in the second part of that to recoup any of that royalty?

Stephen Vaughan

The answer is working out with franchisees is what we do on a case by case basis. As their business improves you work it out. There may be some of the short-term they can cover and maybe a little longer term. It is something you work out on a franchisee by franchisee basis.

Larry Miller - RBC Capital Markets

Because of the big change in your model and the partner expense changes you are making, I want to make sure I understand, it sounds like effectively in some ways you are moving to more of a normal compensation model where you are paying a pretty predictable salary to your partner or your manager there. But I think you said they have unlimited upside which would be very different than what you typically see at other restaurants and maybe that was not the right to use. If that is the case then the same store sales got better you would expect to see these guys get a bonus but you make more money in this structure since you are taking more risk now effectively. Am I missing something in the structure?

J. Clifford Hudson

You are correct in that you could say there is less downside but more upside. You could say that. The objective is to get much closer to market in terms of the base compensation and not have such a substantial portion of their compensation be at risk because in this environment it has not been working. So as a matter of necessity and the benefit of the business have shifted. So you are correct. Moving the base salary to something closer to what they would see with competitors and yet at the same time the incentive piece which does require and is not intended to suggest with moderate performance they would make more than their peers.

It is to suggest with excellent performance they will make more than their peers. So to the extent you are talking about the [grade] of downside and upside, that is the potential scenario in which case we will be having with you a very different kind of conference call when that is the problem we have with our quarter. I look forward to that call.

Operator

The next question comes from the line of Sharon Zackfia - William Blair & Company.

Sharon Zackfia - William Blair & Company

Given all of the sales driving initiatives you outlined can you give us some insight into how you [come] to those programs and which might be the most meaningful going forward?

J. Clifford Hudson

You mean like some kind of prioritizing of the series of them?

Sharon Zackfia - William Blair & Company

You have a lot of things like the food upgrades and the changes in the media program. In terms of materiality, how did you test them and how would you rank them in terms of impact?

J. Clifford Hudson

The food piece has been going on for some time in terms of product improvement, engaging our operators and also engaging customers in terms of testing in select markets which has been ongoing and still is. So, getting customer reaction to the extent we can in the market in their reaction to the product and in some cases what is their reaction to the product that is in turn promoted by new creative as well? Now it is not possible really to get all of these initiatives in place in a test market because particularly the reallocation of the national dollars is not something we can test because you have to pull some out of the national and put it into the local and so you just have to do that and see what happens.

How would I prioritize these? I think it would be fair to say the most important when we talk about these four; the creative, the reallocation of dollars, the product and the service it is the last two that are most important by far. That is that people have a very good experience when they come to a Sonic drive-in regardless of what is happening from a creative or a media standpoint. They have a very good experience both because the operational experience was excellent and also the quality of the food. The service and the food they had was excellent. So those are much higher priority and will do well for the business over time. They need to be steadfast and more sustained whereas the issues on creative and allocation of dollars and so on are somewhat more transitory.

I don’t know if that is a good term but 12-24 months from now we may be talking to you about different things on creative and allocation of media dollars because of shifts in costs and media, available differing from market to market and so on. I don’t mean to ramble in the answer but if I were to break it up into those two I would say the experience that the customer has driven by service quality and food quality is undoubtedly far more important.

Sharon Zackfia - William Blair & Company

Did you quantify the increase in media impressions you expect when you change to a more localized approach?

J. Clifford Hudson

This is anticipated to…this is to occur April 1 forward. So it has not been implemented to date. Two, we did say in terms of impressions that the consumers and potential customers have within a trade radius of a given store we anticipate increasing on average by in the neighborhood of 20%. Now that may be lower in some markets and may be much higher in some markets but with the use of those dollars on mediums, cable, billboards, local radio, online television that can be zoned into a specific zip code, it is the same dollars but because of the focused nature of it, it will increase impressions.

Sharon Zackfia - William Blair & Company

I am curious whether you saw any discernible impact as McDonald’s rolled out their breakfast value menu?

W. Scott McLain

Not really.

Operator

The next question comes from the line of Keith Siegner - Credit Suisse.

Keith Siegner - Credit Suisse

I was wondering if you could give me a little bit more color around the guidance of cost of goods sold being flat year-over-year in the second half? If you think about the initiatives you have got continued product quality improvements. You have the attachments of free tater tots in March. You have the pricing rolling off and you have commodities a bit favorable in the third quarter and unfavorable in the fourth. How do you get to a flat cost of goods sold year-over-year?

Stephen Vaughan

Well the cost of goods when we talked about down a little bit in the third quarter and up a little bit in the fourth quarter that includes the product quality improvements so they would have been down quite a bit more had we not already rolled those costs into the projections. Then you mentioned we are still running about 2.5% of price through the end of this quarter and expect to run between 1-1.5% in the fourth quarter. So the combination of those, and we also I should point out we did discounting and promotions last year. We spent several months promoting and introducing our everyday value menu which had a higher food and paper cost than some of the promotions we are currently running. I wouldn’t assume all of the promotions we do are strictly incremental. Some of them are replacing promotions we were running last year.

Keith Siegner - Credit Suisse

You talked a lot about the changes in compensation for the managers but last year one of the big topics was the shifting of the car hop base over to a new compensation revolving more heavily around tips and so on. How has the car hop base responded to the same store sales levels given this new wage structure? Are tips down as a percent of check? What has been their response?

Stephen Vaughan

I will tell you we have been promoting the skating initiative which has been more heavily adopted in our partner drive-ins over the last few months. So I don’t have an exact figure for you but the feedback we have gotten is with the introduction of more skating in the drive-ins and the amount of tips our car hops get has actually increased by that skating initiative. There probably has been some offset there but it is very difficult to quantify.

Keith Siegner - Credit Suisse

What about turnover for that population? Where is turnover now for car hops?

Stephen Vaughan

We have actually seen our turnover decline slightly.

Operator

The next question comes from the line of Analyst for Steve West – Stifel Nicolaus.

Analyst for Steve West – Stifel Nicolaus

A question on the onion rings and tater tots promotion. Before you were pushing promoting combo meals, have you seen this cannibalize the combo meal sales since you are giving away one of the products that would have otherwise essentially been included?

J. Clifford Hudson

I think there has been a little bit of trade off. However, almost 100%, I think it is roughly 90% of these promotions go out with a full priced drink. So in terms of looking at it from a penny profit basis it is very comparable to a combo so if somebody does trade off of a combo to one of these with a full price drink we are actually from a penny profit standpoint okay with that.

Analyst for Steve West – Stifel Nicolaus

Switching gears, how much of your sales guidance in the back half of the year assumes either declining unemployment trend or stabilizing in some of those core markets we have seen a deterioration recently? Maybe Oklahoma and Texas. Are you forecasting anything there or are you just holding current rates steady?

Stephen Vaughan

The guidance we gave was flat to negative five was our expectation. As Cliff pointed out if you take the second quarter and factor out the weather we were at the low end of that range. So there may be some challenges as we look forward particularly in some of our core markets. However, the initiatives Cliff described I think give us confidence we should be able to at least offset and hopefully improve on our current sales trend.

Operator

The next question comes from the line of Nicole Miller Regan - Piper Jaffray.

Nicole Miller Regan - Piper Jaffray

On the new bundling with the free side, is there any trade away from the dollar or value menu into that promotion?

Stephen Vaughan

I don’t have an answer for you. I will tell you we have seen the value menu as a percentage of sales has declined. Some of that is most likely based on the fact we are not promoting it this year versus promoting it last year but I don’t have a specific as to whether that customer has traded over to this value promotion.

J. Clifford Hudson

There is some indication on a broad basis in the industry that a year ago or more customers wanted to know do you have a value menu. In the more recent past because the consumer inquiry has been are you going to offer me a deal on your regular items. This is in no small part, we have attempted to find a value message in a way that works with the Sonic brand and that is why we are doing what we are doing here when we are talking about buy the Super Sonic Cheeseburger and get free tots.

So the effect seems to be in part the customer at one time might have been saying I want a value menu and yet in the more recent past there does seem to be a more subtle shift that says I am not necessarily looking for the value menu. I want good food and I want enough food but I want a deal. We are seeing as Steve has mentioned we are seeing check increase during this period of time in which we have been running that promotion.

Nicole Miller Regan - Piper Jaffray

So if I understand if you could remind us what percentage of mix the value menu has been an then maybe how much it is down? Whether this new bundle takes share from another bundle or from the value menu either way it is margin neutral to positive?

Stephen Vaughan

That is correct, yes.

Nicole Miller Regan - Piper Jaffray

Did it get as high as 10%? Is that right?

Stephen Vaughan

Well the value menu a year ago was running about 11-12% of sales when we were promoting it. This year it is in the 6-7% range.

Operator

The next question comes from the line of Greg Ruedy - Stephens, Inc.

Greg Ruedy - Stephens, Inc.

Given the changes at Burger King with their double cheeseburger and the McDonalds push on the McSnap Wrap, what is your opportunity to maybe tweak your everyday value menu pricing? I know you have talked about it in the past it not being a dollar menu per se. I am just wondering if any of the May nominal pricing is landing in that part of your menu?

W. Scott McLain

I guess what we would prefer to do rather than duke it out on the everyday value menu is we would like to try to play on the playing field where we have a clear advantage. That is on our items that are distinctively Sonic like Coney's, ice cream, tater tots and like onion rings. Our view is our business will be better off if we focus on those things rather than trying to get in a battle over the everyday value menu with our competition because we believe we have a lot of great things to offer our customers particularly if we package some of our products like we are trying to do with a very unique hook with free onion rings or free tots. That historically has been a much more successful path for us than trying to out-value menu our competition.

Greg Ruedy - Stephens, Inc.

On that attachment of free tots when I pull into a stall or drive-in do I have ask for that attachment or is it automatically offered or included by the associates when we my food is delivered?

W. Scott McLain

It is automatically offered to you if you order a Super Sonic Cheeseburger, as I know you would.

Greg Ruedy - Stephens, Inc.

When I think about the average check year-over-year when I look at just the transactions that don’t have everyday value menu items on there, what sort of average check change are we looking at then?

Stephen Vaughan

With this change in promotion we saw our check go slightly positive. It had been running slightly negative. A little more than slightly negative in 2009 but as we lapped over the everyday value menu it was still slightly negative. With the change in promotion in February it turned slightly positive.

Greg Ruedy - Stephens, Inc.

Longer term how important do you think it is to broaden the drink platform to go after maybe other off-peak day parts as well as maybe generate sales from beverages that do not have high fructose corn syrup?

J. Clifford Hudson

Well if I understand your question correctly I believe what I hear you asking is how important is it to move off of other day parts which I am assuming you are talking about happy hour. I don’t know if I am understanding the question.

Greg Ruedy - Stephens, Inc.

That’s right. You have a strong happy hour business. What is the opportunity in the other off-peak parts?

J. Clifford Hudson

Well the interesting thing is our incidents of sales of soft drinks at breakfast is substantially similar to the remainder of the day on average. So we have very strong drink sales at breakfast. So I guess that goes to kind of the implicit portion of your question, i.e. it is big at happy hour and perhaps not other day parts, in fact it is very big at breakfast. As you would expect it is also big at lunch and dinner.

W. Scott McLain

I think the other part of your question related to the breadth of our product offering, I don’t think we are prepared to talk about specifics but we are constantly looking for ways to keep our edge on drinks and that includes the types of drinks we offer and the times of the day we promote those. We continue to aggressively look at that and historically it has been a real strength of ours over time.

Operator

The next question comes from the line of Amol Desai – Johnson Rice.

Amol Desai – Johnson Rice

I was looking at the store closures and at least on the franchisee side and I would have expected that to be a little bit higher just this quarter. Is there consolidation within the franchisee base where better capitalized franchisees are buying smaller ones? Is there demand for that instead of just maybe selling company stores to franchisees and consolidation within the base?

W. Scott McLain

Historically that has happened and it continues to happen at present too. We do have franchisees that have an appetite for buying stores. They bought them from us and they buy them from each other as well. When a store gets in trouble typically rather than close normally it is sold to another franchisee. I think to your point that is one of the reasons why our closings have been less than you might expect.

J. Clifford Hudson

And having that well capitalized franchisee base is a big benefit in times like these.

Amol Desai – Johnson Rice

Curious what is your average check now and how does that compare to maybe middle of 2007 or before it got a little worse?

Stephen Vaughan

We are running about a $5 check now. I think if you go back a couple of years we were around $5.35 or $5.40. With the introduction of happy hour which tends to be smaller party sizes, smaller check and a little more of our business skewing to that day part we have definitely seen some decline in check but it is right around $5 at this point.

Operator

That does concludes our question and answer session. I would now like to turn the call back over to J. Clifford Hudson for any additional or closing remarks.

J. Clifford Hudson

We do appreciate your participating in the conference call today. Our folks will be available here for additional questions. As you can see we have put in place over a period of time a number of initiatives to work to drive our business. We are excited in the coming months to see those come into play and share over time the effect of them on our business and share those with you. Thanks again for participating. We will see you along the way.

Operator

Again that does conclude today’s call. We appreciate everyone’s participation.

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Source: Sonic Corporation F2Q10 (Qtr End 02/28/10) Earnings Call Transcript
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