Sonic's CEO Discusses F2Q2014 Results - Earnings Call Transcript

Mar.24.14 | About: Sonic Corp. (SONC)

Start Time: 17:07

End Time: 18:04

Sonic Corp. (NASDAQ:SONC)

F2Q2014 Earnings Conference Call

March 24, 2014 05:00 AM ET

Executives

J. Clifford Hudson - Chairman, CEO and President

Stephen C. Vaughan - CFO and EVP

Claudia San Pedro - VP of IR & Communications and Treasurer

Analysts

Andrew Charles - Bank of America Merrill Lynch

Brian Bittner - Oppenheimer & Co. Inc.

Matthew DiFrisco - The Buckingham Research Group

John Glass - Morgan Stanley

Jeffrey Bernstein - Barclays Capital

Keith Siegner - UBS

Brittany Whitman - Longbow Research

Operator

Good afternoon and thank you for standing by. Welcome to today's SONIC Corporation Second Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the formal remarks we will conduct a question-and-answer session and instructions will be provided at that time for you to queue up for questions. As a reminder, today's conference is being recorded.

I’d 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 second fiscal quarter of 2014, which ended on February 28, 2014.

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’d like to point out that remarks made during this conference call are based on time-sensitive information that is accurate only as of today's date, March 24, 2014. The archived replay of this conference call webcast will be available through April 24, 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 second 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 in this call this afternoon. We’re pleased to be to visit with you and particularly pleased we talking about our second fiscal quarter and the results for that quarter.

The key highlights that you see here for the quarter shows why we’re happy to talk to about it. On adjusted basis, we had a 40% increase in our earnings per share versus the same quarter of fiscal 2013. Our increase in system-wide sales 1.4%, is what they were for the quarter. It’s made up of 1.5% franchise drive-ins, 1.3% for our Company drive-ins, so positive in both fronts.

Our own drive-ins also had nice margin improvement of 80 basis points. And then as you see indicated in the last bullet point there, we purchased approximately $51 million of our common stock during the quarter and on a fiscal year-to-date basis we purchased -- repurchased about $60 million representing approximately 5% of the Company’s outstanding shares. So we’re very pleased to report that to you as well.

And as we -- as you know our fiscal quarter include December, January and February, its typically our most volatile quarter from sales standpoint due to the weather and the effect of the weather could have on our business. For the quarter, the weather was estimated to have a negative impact on our business, the sources we have indicated, 2 to 3 percentage points negative impact on system-wide sales. But in spite of this we’re pleased with the fact that we did produce this 1.4% system-wide same-store sales increase for that quarter ended February.

Now as we have talked to you about for a while, we continue to focus on these initiatives we’ve had to drive same-store sales and strengthening this foundation we have for the last several years, these initiatives have included the improvement and quality of our service and our products which was more strategic pricing implementation. These -- combination of these elements have also improved our customers’ perception of the value of what we’re offering to our customers. And as we build on these improvements we’ve also strengthened our promotional pipeline brought back our Two Guys, our television creative and improved our media buying.

And the Two Guys campaign has really allowed us to move very effectively highlight with very consistent recognition highlighted of a variety of day-part offerings and promotions we have. So the combination has really strengthened the foundation of our business and we will continue to be important part of the same-store sales performance.

You might have seen in the last week, the 2014 Temkin Experience Rating and their surveys of 10,000 U.S customers across a variety of brands, about recent customer experience they’ve had and in the fast food industry SONIC ranks second in terms of customer assessment of that service. And we’re confident that this success we’re achieving today really is a direct result of the improved service, food quality, pricing, strategies that we’ve implemented across the last several years to strengthen our business and its very gratifying to see this totally independent survey of consumers across our country who gave us such strong rating, strong feedback.

As it relates to the contributors to our EPS growth rate, we talk to you for quite a while about our -- now about our multi-layered growth strategy and it continues to be the framework for driving solid earnings growth over time has been in the last -- number of year will be going forward. You can see from this slide, we’ve used this previously the earnings per share growth contributed by each of the layers of this multi-layered growth strategy to achieve a 14% to 20% earnings per share growth rate.

The same-store sales growth continues to be the most important layer in driving this and we’ve a number of initiatives, we will talk about that we will keep driving that in our view. We also expect operating leverage from the improvement in sales and the implementation of our new point-of-sale system. This will help on our Company’s stores and franchise.

We expect to increase our new driving growth over the next several years. We will talk more about that today and when that occurs with the same-store sales and new store openings we will benefit from the ascending royalty rates and then finally the increase in cash flow as you’ve seen previously. We will continue to use that improved cash flow to reinvest in our business in a variety of ways including the technology investments we will be talking more about today and the share repurchases that you saw this past quarter. So each of these type initiatives come together very well in this -- the fly wheel that we talked about for years now.

And the things I like to dive a little deeper into, I will start with the same-store sales piece. And we’ve a series of initiatives we believe we will continue to do that more effective media spending, the use of our Two Guys, so more reach with the media, more frequency with the media, great recognition with consumers of our Two Guys, promoting innovative product pipeline which has gotten far better in the last one to two years that product pipeline fitting very well with the layered day-part promotional strategy and then these all laying into this with our POPS initiative point of personalized service that will augment what occurs both on and off lot with our consumers.

These are nice initiatives that we believe will continue to drive our business very well. When they’re tied to the other elements of the marketing focus, they include the media, the product innovation, the day-part promotion. We think we’re -- we know we’re continuing to see an increase in media efficiency in calendar 2014. As you recall a year-ago, January we shifted more of our local media dollars to national cable. And this really resulted in a significant increase in brand and ad awareness. It gave us a real spike in share of voice amongst our competition.

If you look at -- look across QSR sandwich category and the share of voice, we now measure fifth in terms of strongest brand. It’s a really -- I think a very significant development for us and should continue into help drive same-store sales with new driving growth over time as well. We continue to focus on new product news that you see pictured here and it’s very much a part of our DNA. It helps drive our sales across all five day-parts. The spring and summer will be no different. We will celebrate our third year of Summer of Shakes, once again introducing 25 different flavors using the promotion of real ice cream, the delicious ice cream that we have some flavors such as chocolate jalapeno and salted caramel and it’s delicious stuff.

We are also going to be promoting this spring and summer a Summer of Slush with 25 new flavors. So really will help us with a variety of day-parts and very profitable products. And one of the nice things I think about the path we’re on and really does leverage the core nature of the business, whether we’re focusing on real ice cream, desserts, or premium chicken products that we’re now promoting more often or ice tea, its our view that we’re going to really set our brand apart from lot of our competition with our ability to provide these high quality new products. But we can do so on par with fast casual or even casual dining restaurants and we can do so across multiple day-parts. This is something I think really distinguishes us from most of our QSR competition.

And so as we look to the POPS technology, we think its going to be very positive for us over the next several years. We are very excited about it and we believe its going to enhance the customer experience. Its also we’re confident, going to drive sales and system profitability at the store level. This POPS screen it involves an interactive screen. Its in the middle of a new menu housing, that the acronym POPS is what it is Point of Personalized Service, but it also pops out in the lot, particularly in the evening. It’s a beautiful thing and it’s attracting traffic, but it also growing check.

Initial phase of rollout is mostly about suggestive sell and promotion across multiple day-parts, but we will increase the dynamic nature of it, and interactive nature of it over time. And even with those more base elements, we’ve seen a nice increase in sales in the stores that are utilizing it, increasing check with increased combo sales, but as you would expect we’re also selling the products that we promote with POPS.

As I mentioned though separately we have seen an increase in traffic. And we see customer service scores really drive up nicely at the stores where we’ve implemented this. And our view is, with this POP system combined with the physical drive-in format is going to allow us engage the customer using mobile technology and social media, engage in on-lot and off-lot and really heighten the distinctive and differentiated nature of our concept versus our competition.

So we look at that integrated customer engagement on-lot, off-lot integrated customer engagement we refer to it as ICE. Now we think POPS within this ICE element is going to help drive traffic and drive sales for us on a sustained basis. So we view it as a gift that keeps on giving, not just the first year, but the second year and we have indication from our actual experience and implementation that in fact that it does occur and will occur. Its expected to be a major factor in growing our sales of our brand and this calendar year with our company stores, but in fiscal ’15, ’16, ’17 as well and as you would expect we will keep you updated on the progress of the implementation of it as we roll it out across the system.

Now the POPS and POS really go together. The new POS, our software based system is needed in order to drive the POPS system. So the total cost is the package of these, about 135,000 bucks. The POPS is about 80,000, the POS is 30,000 and we’re also expecting our operators to do kind of a refresh little bit of a trade dress element, to help move the perception of the business in other level as well.

We’ve already implemented a point-of-sales system in about 250 of our company owned drive-ins. We expect the POPS and POS to be in all of our company drive-ins by early summer. And then we will begin large scale rollout with franchisees in the fall of 2014. So we’re moving with this in a very positive way.

The effect of this with our franchisees and a franchisee looking at implementing it, I think as real solid potential because our view is that the total cost of package is reasonable given the return on investment we’re expecting from an increase in sales and profits. And yet we’re -- we’ve moved to improve that with our franchisees because we’re working with vendors for contribution to the POPS piece and we’ve vendors in place in fact, they’re willing to subsidize roughly half of the cost of POPS.

As you can see from this slide, that’s on the screen, if we’re structuring it in such a way that if our franchisee utilizes a lending program that we set up on a system basis, they will realize the benefit, the incremental benefit of increased sales and profits for a year before having to make payments to their lender and this is because the vendor contribution is roughly equivalent to that first year’s debt service and a little more. So the vendor not only increases the return on investment for franchisees, but by reducing investment cost demonstrates the confidence our vendors have in the potential of this POPS system. Clearly, very much confidence in helping drive our business and in turn their business.

We are of the view that most of our franchisees will probably obtain financing through local or regional financial partners, but we have also partnered with the financial lender for a smaller franchise and we’re providing a small corporate guarantee that lending arrangement in order to incentivize them to do that on most attractive terms and roll it out system-wide.

So all of these elements give us great confidence, so we’re going to be able to roll out the POPS and POS package to our system over the next three fiscal years as we talk about ’15, ’16, ’17 and it will drive solid performance at the store levels and in turn solid per share growth -- earnings per share growth for us over the next several years. So we feel very positively about that.

Now operating leverage is something also that’s going to continue to layer in our growth. It’s going to provide a good return for us. We’ve seen real margin improvement over the last two years as a result of sales leverage from consistently positive same-store sales. When we look at the POS implementation and also our supply chain management, we also expect to see further improvement in margins from these two technology implementation that the new point-of-sale system and supply chain management system, both our expected to result in improved food and packaging cost, but they will also streamline order processing and we think reduced product waste, optimize labor and theft at the store level, all of which will play into improving margins for our average operator.

The implementation of the supply chain management system was completed. We already finished that. We had a complete -- it’s our Company’s investment. We completed it in calendar 2013. And we looked to it to provide greater transparency into really all aspects of the supply chain from our suppliers, our vendors, our distributors, all the way down to store level whether company-owned or franchised, so a strong addition to our system, our brand as a whole.

And as I mentioned to you a little earlier, the point-of-sale system’s already in about 250 company stores and we expect to roll -- have it completed in our company stores in the next couple of months and then we will continue to refine the program, generate the benefits we’ve described as we look to roll it out, get the benefits in our company stores and then roll it out with our franchisees in fiscal years 2015, 2016.

So the margin improvement we’ve seen over the last two years, a significant contributor to our achievement of solid double-digit earnings growth and we expect the improvement to continue from -- this improvement from leverage to continue both on positive same-store sales and a new point-of-sale system as we move forward and we aim towards the 16% to 17% margin performance that you see depicted on the slide and we talk about for some period of time.

Another element of our multi-layered growth strategy is new stores and the ascending royalty rate. And for the past couple of years we’ve seen solid earnings growth per share, mostly from the other elements in our multi-layered growth strategy. With developments in our ascending royalty rate are going to be key serious contributors to our earnings growth over the next several years.

As you can see from this slide, our new store development is gaining momentum. We had six new locations opened in the most recent quarter versus three a year-ago and we’ve opened 13 year-to-date versus four in the prior year same period. We also are starting to sign more new store commitments, four new drive-in. Our goal for this year is to sign commitments for additional 120 drive-ins. This will be for future development and we’re well on our way to meeting this.

We have 55 in place through the end of the second quarter and a good pipeline of candidates that we’re talking to in a variety of markets. And this ties, of course then to the geography of our expansion as you can see from the footprint here, we have the opportunity to expand across the country. We continue to see new drive-ins opened in all markets, core, developing and new, but most of our drive-in commitments that we’re getting are and will be in newer markets, California, Pacific Northwest and the Northeast.

With the strong national cable spending that we’re doing -- a bit doing for a while, we’re positioned really to service those areas in a way that had not been positioned previously, at least with this level of strength. So it really does position us for growth and future success in more markets, this expanded geography. With over 3,500 drive-ins now on 44 states, we’ve got a lot of room to grow, particularly in those new developing markets and our goal of the relatively near-term is to achieve a 2% to 3% growth in units on an annual basis.

I mentioned also the ascending royalty rate that has long been an important factor in our growth in earnings, so less so through this recession. The royalty rate ordinarily function such a way that with each incremental dollar, the rate increases. Each incremental dollar from positive same-store sales get very positive flow through from that standpoint. And this layer of our multi-layered growth strategy is going to become more important now going forward in driving earnings per share growth -- our earnings per share growth over the next several years.

This coming September, as many of you probably know, the conversion -- we will have a conversion of a group of stores between 818 -- 850 SONIC drive-ins are going to convert to a higher royalty rate. And we expect this is going to drive at least 5 million of increased royalty revenue for our fiscal 2015. So a lot of good news on our business, things picking up in a very positive way. We are feeling good -- we feel very good about the quarter, we are feeling good about the business generally.

Now with that, I’m going to turn it over to our Chief Financial Officer, Steve Vaughan, to let him talk a bit more about the quarter we just completed. Steve?

Stephen C. Vaughan

Thank you, Cliff. I'd now like to spend a few minutes talking about our financial performance. We were very pleased to report a system-wide same-store sales increase of 1.4% in the second quarter. As Cliff mentioned, these solid results reflect a positive impact from our initiatives to improve service, product quality, value perception and media effectiveness, as well as innovative product promotions during the quarter. These strong results occurred despite the effect of adverse weather across many of our markets.

Based on analysis by third-party analytics firm, we estimate the harsh weather had a negative impact to traffic of 2 to 3 percentage points during the quarter. Our solid sales growth resulted in strong operating income and earnings per share growth on an adjusted basis.

Operating income improved 50 basis points from 10.8% in the second quarter of fiscal 2013 to 11.3% for the second quarter of fiscal 2014. On an adjusted basis, earnings per share increased 40% from $0.05 in the second quarter of 2013 to $0.07 for the second quarter of 2014. The prior year operating results exclude the benefit of a couple of favorable tax items that were partially offset by the loss early extinguishment of debt. We believe this adjusted comparison better reflects our underlying operating results for the quarter.

Now I would like to turn to drive-in level operating margins for the second fiscal quarter, food and packaging costs were unfavorable by 10 basis points. This relatively flat cost of sales reflected the 3% menu pricing we had in place during the quarter, which was more than offset by higher commodity cost.

Looking to the remainder of fiscal 2014, we plan to take a price increase of around 1% when we rollover last year's menu price increase which occurred around the beginning of May. With this increase, we will maintain approximately 3% of year-over-year pricing at our company drive-ins. Beef, cheese and ice cream mix continue to experience extraordinary cost pressures. The expected increases for these commodities have exceeded our prior outlook and we will likely see some pressure on food and packaging cost in the third and fourth quarters.

However, we will 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 partially offset the commodity cost pressures. However, it now appears likely will experience unfavorable food and packaging costs in the third and fourth quarters.

We will look for opportunities to lock in our costs on these items, should we see a dip in the market. But some uncertainty on the degree of impact this will have on our food and packaging costs remains.

Payroll and employee benefits were 90 basis points favorable primarily as a result of leverage from positive same-store sales during the quarter. As a mentioned on our last earnings call, effective January 1st, we began offering healthcare insurance to all eligible company drive-in employees who worked more than 30 hours per week. The percentage of employees opting to take the coverage was less than we originally anticipated. Accordingly, the net annualized incremental costs was less than $1,000 per drive-in.

It’s 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. We expect to continue to see nice leverage from positive same-store sales in the latter half of this year and also believe the labor scheduling tools that are now available in over one half of our company drive-ins will provide some additional efficiencies.

Other operating expenses were flat as a percentage of sales. We are very pleased with the continued profit growth that SONIC system has achieved over the past several months. These results provide our franchisees with increased optimism and confidence about the strength and future of their businesses and the brand.

Looking to the remainder of 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, will be partially offset by pressure from higher commodity costs. As a result we expect 50 to 100 basis points of improvement in company drive-in margins in the third and fourth quarters. The implementation of four new point-of-sale system has progressed nicely over the past couple of months and we remain very excited about the margin opportunity we expect to achieve from the implementation of this new system, which should be completed in the company drive-ins next month.

Further, the roll out of our additional POPS system at the remaining 320 company drive-ins that were not a part of the original test will begin next week and should provide a nice boost in sales growth and potential for further margin leverage from increased sales growth over the summer.

Our SG&A expenses were $15.9 million during the quarter, compared to $15.5 million in the same period last year. This increase reflects increases in headcount associated with the investment in talent we’ve been making to support the technology initiatives that Cliff described earlier. We have invested in and will continue to invest in additional resources to support the successful implementation of these technology initiatives over the coming months. This investment is expected to result in SG&A expense increases of 5% to 6% over the latter half of the year.

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

We ended the quarter with $35.1 million in unrestricted cash. As Cliff mentioned earlier, we repurchased approximately $51 million of stock during the quarter and have repurchased another $2 million in March. $40 million and the $51 million of stock repurchase during the quarter was done via an accelerated share repurchase program or ASR. This ASR was initiated in early February with the delivery of 2.1 million shares of stock. The initial delivery was based on a capped price of $19.13 per share. The financial institution that conducted the ASR completed the program in early March. Since the weighted average share price over the repurchase period exceeded the capped price, we did not receive any additional shares on the completion of the program. We are continuing to make significant investments to drive sales and profits in our company drive-ins and expect to spend approximately $70 million to $75 million on CapEx most of which will be spent to implement the new digital point-of-personalized service initiatives and our new point-of-sales system in all of our company drive-ins in fiscal 2014.

Using free cash flow and cash on our balance sheet, we expect to continue repurchasing the remaining $20 million of stock authorized for repurchase through August 31st on a systematic basis over the remainder at the fiscal year. Because of our healthy cash flow we believe we will be able to fund these additional share repurchases and the investments in our business from cash on hand and operating cash flows. We are also pleased that our balance sheet remained soluble in net debt to EBITDA ratio of just over three times. We believe that our leverage ratio in the three times 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 and cash flow to grow shareholder value. I would also add that we continue to 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 the low single-digit range for the system with the company same-store sales expected to perform at the higher end of this range in the summer months as the new point-of-sale system and digital point-of-personalized service 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 50 to 100 basis points depending upon the degree of same-store sales growth at company drive-ins and the degree of offsetting commodity cost pressures for beef and dairy. SG&A expenses of $68.5 million to $69.5 million. Depreciation and amortization expense of $42 million to $42.5 million. Net interest expense of approximately $25 million and income tax rate of between 36% and 37% for the third and fourth fiscal quarters, however this rate may vary depending upon the reinstatement of employment tax credit programs that expired on December 31st, 2013 and pending revolution of certain tax uncertainties. Capital expenditures of $70 million to $75 million which assumes in the implementation of a new point-of-sale system and digital POPS technology in company drive-ins, all company drive-ins during fiscal 2014 and then finally completion of our $80 million share repurchase program.

I’d now like to turn the call back over to Cliff for a few closing comments.

J. Clifford Hudson

Thank you, Steve. So as you, I am sure can see here we are pleased with the results of the second quarter, and particularly analyze the external challenges of severe weather in so many parts of our country during those winter months. And apart from those days if could buy the weather our business fringe remained strong and we’re looking at the second half of our fiscal year with a lot of confidence and excitement about our business.

When you look at our brand where we are and you look at the improved foundation and the momentum we now have in place, what you should sense and what you should see is the business and the brand that really has a solid one way for growth from both the consumer standpoint and an investor perspective. The elements that have grown our business historically are in a refined way very much in place today. We have a solid set of initiatives to drive each of the layers of our multi-layer growth strategy. Over the next several years with development coming along in near to mid term to optimize all those combined, really optimize shareholder value and grow our earnings on average between 14% and 20%, earnings per share growth over the next several years. So we like where we are, and we like the quarter we just finished and we’ll be happy to talk to you about that or other questions you may have.

So, operator we’ll open it up now for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We’ll take our first question from Will Slabaugh with Stephens.

Unidentified Analyst

Yeah, thanks guys. This is Jay (indiscernible) here on for Will. Congrats on the impressive quarter.

J. Clifford Hudson

Thank you.

Unidentified Analyst

You gave us some nice detail on the weather impacts for the quarter, I know in December you spoke to a tough start. Just wondering if it's safe to assume that like January and February when weather maybe wasn’t as much of a factor, you saw it kind of trending to the high end of your low single-digit guidance range?

J. Clifford Hudson

Well, I think what makes it fair to say about sales and the weather in the quarter is when the weather was harsh it had a negative business on our business, when it wasn’t the business -- the foundation of the business is very healthy and we like what we saw and you see the combination of that with positive comps.

Unidentified Analyst

Thanks. And pressing more I guess limited time offers continue to succeed and do well. I am just wondering is it continuing to drive multiple day-parts, I know you spoke to the Chicken and the Pretzel Dogs at previous or the past, driving multiple day-parts, I am wondering if you saw that with the Chilly Cheese Dog and some of the other items this quarter?

Stephen C. Vaughan

Yes, we did continue to promote all of our day-parts during the quarter and we really have seen that kind of layered promotion, drive those day-parts in the months where a particularly day-part is promoted, it does tend to be a little stronger. But being able to hit every one of those day-parts with a breakthrough message every quarter has really been very helpful to driving consistent sales across the day.

Unidentified Analyst

All right, great. Thanks guys.

J. Clifford Hudson

Thank you.

Operator

And we’ll hear next from Joe Buckley with Bank of America Merrill Lynch.

Andrew Charles - Bank of America Merrill Lynch

Hi, it's Andrew Charles for Joe. Cliff, can you talk a little bit more about the off-premise efforts of ICE, is the goal here to create one-to-one direct marketing to guests?

J. Clifford Hudson

Our anticipation is that yes it will enable to do that in an increasing way over time. And I am not sure, I mean -- the answer is yes, I can talk about it. I am not sure specifically what you question is. Part of the, I mean just the POPS on premises permits individualized promotion with a customer and it will have refinement over time even based on what the -- based on the time of day, based on what that customer is ordering and then with the maturation of system so this identity as to the customer with loyalty programs and so on, each of these will have an increasing level of individualized marketing. We anticipate being able to do, have the same sort of processes off-premises with that Smartphone App, Social Media et cetera meaning identification of the customer and individualized marketing. And this is -- the nice thing as I mentioned, it is a gift that keeps un-giving because we’re entirely confident this will evolve positively over time, become more sophisticated.

Andrew Charles - Bank of America Merrill Lynch

Okay. And then Steve, are there any other headwinds besides the increased commodity cost behind the decreased margin guidance?

Stephen C. Vaughan

No Andrew that was really the primary reason for that kind of lowering of the, previously we would had anticipated 75 to 100 basis points versus the 50 to 100 and a lot of that will be contingent on what happens with those commodity costs over the summer, but that was really the additional color on that.

Andrew Charles - Bank of America Merrill Lynch

Great. Thank you.

Operator

Thank you. And we’ll take our next question from Brian Bittner with Oppenheimer & Company.

Brian Bittner - Oppenheimer & Co. Inc.

Thank you. Good afternoon. Two questions, first on margins; particularly the labor margins, you had a comp of little bit over 1% but those margins leveraged almost a 100 basis points and I guess I’m wondering first of all, was that mostly kind of POS and labor scheduling related to stuff that you’re doing that's new and number two, I mean if sales accelerate like you expect them to and the penetration of these initiatives only gets deeper, is there even a bigger margin opportunity than what we saw this quarter in the labor side?

Stephen C. Vaughan

Well Brian, I think you did see because as Cliff mentioned the kind of choppy weather during the quarter, our operators tend to really watch labor very closely, I mean that’s definitely we feel like the key driver for the quarter. We are seeing some of our operators embrace the new POS system. It wasn’t really why we rolled out during the quarter. So I think we’ll see more benefit in the third and fourth quarters. But we were very pleased with just the management of labor during that more challenging quarter in terms of sales being somewhat choppy as the weather was less favorable.

Brian Bittner - Oppenheimer & Co. Inc.

I get it. So yes, in general, weather was a positive for labor, this could cause better execution on that line, is what you’re saying?

Stephen C. Vaughan

Yes. That would be correct.

Brian Bittner - Oppenheimer & Co. Inc.

Okay. And I just want to ask a question about the royalty rate here, the core royalty rate, is there any way you can give us a little more color on maybe sensitivity, few same-store sales for instance. Same-store sales were up 5% for a year. What would that core royalty rate look like year-over-year on something like that?

Stephen C. Vaughan

Well, next year we’ll see a significant jump just because of the license conversions that take place.

Brian Bittner - Oppenheimer & Co. Inc.

Yes. And I am just trying to understand more of the core royalty rates excluding kind of the step ups in restructuring contracts.

Stephen C. Vaughan

Yes. So, the core royalty rates from just same-store sales tends to vary by about, every percentage point in same-store sales drives about 100th of a percent increase in that, one basis point increase and so …

Brian Bittner - Oppenheimer & Co. Inc.

Okay, so one basis point, okay.

Stephen C. Vaughan

Yes.

Brian Bittner - Oppenheimer & Co. Inc.

Okay, great. Thank you.

Stephen C. Vaughan

You bet.

Operator

Thank you. And we’ll hear next from Matt DiFrisco with Buckingham Research.

Matthew DiFrisco - The Buckingham Research Group

Thank you. Cliff, I guess you talked a little bit about the App there, can you tell us about the timing of that when SONIC will come out with an iPhone App and something that you could work within your point-of-sale and your new ICE technology?

J. Clifford Hudson

It is something we are testing now, and it is something we hope to spread more broadly this summer, and that’s the timing on it.

Matthew DiFrisco - The Buckingham Research Group

So maybe back half ’15 we could see a bigger more national outside of the test?

J. Clifford Hudson

We said back half of the ’15, but we would hope certainly by then we would, yes.

Matthew DiFrisco - The Buckingham Research Group

Great, okay. And then gentlemen you mentioned about the labor tools, just half of your company drive-ins have these labor tools. That is purely associated with the point-of-sale system and the rollout of that, is that correct?

J. Clifford Hudson

That is correct, Matt.

Matthew DiFrisco - The Buckingham Research Group

Okay, and then just a clarity as far as your guidance, the 14% to 15% EPS growth, I am assuming that’s based off on the $0.72 FY ’13 number?

J. Clifford Hudson

That is based on the adjusted earnings per share number, correct.

Matthew DiFrisco - The Buckingham Research Group

Okay, excellent. That is it. Thank you very much.

J. Clifford Hudson

Thank you.

Stephen C. Vaughan

Thank you.

Operator

And we’ll take our next question from John Glass with Morgan Stanley.

John Glass - Morgan Stanley

Thanks. First, just a follow-up on the labor question, what is the benefit you’re seeing in those half of your company drive throughs that have a new tool and how much better is labor?

Stephen C. Vaughan

Well John, really we’re in the midst of the rollout, so we have one or two markets that has really had this new POS system for I’d say 90 to 120 days. And as you can imagine there are varying degrees of adoption of the technology even within that depending on the operator. We are in some drive-ins where we’ve seen to operate and really embrace the technology. We’ve seen significant improvement in margins. At this point since it's so early on in the implementation, I don’t really want to quantify a number for you, but other than to say what we’re seeing gives us confidence that it will drive the margin improvement that we talked about over time.

John Glass - Morgan Stanley

Okay. And Steve what is the commodity inflation that you’re embedding in the back half of your guidance, I think it will depend, but what's your assumption?

Stephen C. Vaughan

Depending on how quickly we expect to see some easing in the dairy and beef markets, but it could be anywhere from 3.5% to 5%.

John Glass - Morgan Stanley

Okay, and just to sort of make this whole in terms of your guidance, so you beat on kind of the bottom line this quarter, your buyback was ahead, your SG&A is going to be a little lower, you thought initially so is your tax rate. Is the only negative offset then to get back to why you didn’t raise 14% to 15% to higher slow margins or is there any other component piece that’s pushed against that as well?

Stephen C. Vaughan

No, there’s not, John.

John Glass - Morgan Stanley

Okay, great. All right, thank you very much.

Stephen C. Vaughan

You bet.

Operator

And we’ll take our next question from Jeffrey Bernstein with Barclays.

Jeffrey Bernstein - Barclays Capital

Great, thank you very much. Couple of questions, just following up on the kind of the POP and POS, you said the past two quarters that you would expect I guess the company operated comp above the system in the second half, I am just wondering whether you’re some do you have increase in confidence in that guidance. I am just wondering there’s been some wide range of estimates out there, but can you talk about the early results from a store that have the POP and the POS, I know you mentioned positive traffic in check, but I guess that was having a nice impact in combo sales but can you quantify at all whether the traffic of the check were arranged based on what you’re seeing from the stores that are fully implemented?

J. Clifford Hudson

Well Steve just talked about the POS; I’ll talk about the POP. And we, I think we’re -- our answer would probably be, well it will be the same as previously we touched on this. The nice thing about POPS it is the, because of the software driven nature of it, it is something we can continue to evolve when it's in place. We have had it in some stores more than a year, and we continue to have in those stores versus their control comparison stores, we have positive same-store sales performance first year and the second year. We have not quantified that other than with some of our operators and talking about the return on investment that we anticipate for them as they implement it. So, that’s basically the deal. So, we’ll share more about the rollout as we roll it out, but it's not something we have quantified publicly and have not intended to.

Jeffrey Bernstein - Barclays Capital

I got you. I mean just the, it sounds like the POS and POPS will be fully company rolled out, it sounds like you’re saying by the beginning of the summer, should we expect the entire company operated system over the next couple of months?

J. Clifford Hudson

Yes, we expect, they are separate although you do have to have the software based system that drives POPS. You got to have a software based POS to drive POPS. We expect all of the company stores to be finished next month with POS, and we expect to finish in June with the roll out of POPS. Because the POPS will come behind those stores once they have the POS implemented.

Jeffrey Bernstein - Barclays Capital

All right. And that’s the company operated store. I think you mentioned during your slide presentation that when you think about the franchisees it's more like fiscal ’15 and fiscal ’16, did you say that can be reimbursed for 40,000 of the 80,000 spent specific to the POPS, how is that, does that work. Are they getting cut a check or is that just over time some sort of reimbursement strategy or?

J. Clifford Hudson

Well, the answer is yes, it's roughly half; it might be slightly less than 40. I mean it's roughly half of the POPS cost and we will have it set up where it is offset against offset against -- it will be in varying ways depending on how the individual wants to pay for it. If they pay cash, they will get it that way and offset to the purchase. And if it's notes, it will go get payment over time, payments made over time or due over time. So it will vary apart on how they set up these financing or the payment methods they utilize. But it is cash.

Jeffrey Bernstein - Barclays Capital

No, that’s -- obviously I would think there would be a huge incentive for them. I mean just lastly, I think last quarter you had mentioned seeing some signs of maybe some of your larger peers getting more aggressive on the value side of things and it seems that you guys have been able to steer clear of that effectively. I am just wondering whether over the best three months you’ve seen that intensify, you’re weak in your ease in terms of your peer’s aggressiveness on the value side of thing.

J. Clifford Hudson

Well, just more anecdotally we’re seeing -- I am seeing more values, I mean I am just giving you that anecdotally, as I would quantify it on a broader basis but with the major competitors we are seeing kind of value focus sort of deal, but we’re also seeing some major competitors, probably some quality of products. So, it kind of varies by nature of competitor and where they believe they are right now and what they need to do to drive their business.

Jeffrey Bernstein - Barclays Capital

Okay, as long as there is no consensus one way or the other that’s probably a healthy environment. Thank you.

J. Clifford Hudson

Well, I suppose it somewhat inevitable, but that is -- I mean you’re seeing it too, there’s some major folks that are doing value focused and then there’s some major folks that aren’t. At least they’re approaching value in a different way.

Jeffrey Bernstein - Barclays Capital

Got it. Thank you.

J. Clifford Hudson

Thank you.

Operator

(Operator Instructions) And we’ll take our next question from Keith Siegner with UBS.

Keith Siegner - UBS

Thank you folks. Cliff, I was wondering if you could talk about with the recent New Year and the developments agreements and congratulations on that. If you could talk a little about, a bit about maybe what geography the new interest and agreements are coming in. And then Steve, if you could follow-up and just remind us what the new unit return metrics or at least the target return metrics are at this point. What's the cash cost and what's the anticipated cash payback et cetera? Thank you very much.

J. Clifford Hudson

So, I’ll address the first part of that and Steve will address the second part of it. The geography -- single store development activity we have tends to be in more core markets. The area development agreement or the multi-unit commitments that are made are potentially to be more in new and developing markets. We have announced a few of those along the way Southern California, since we’ve done Seattle in the north, so north of specific north west, upstate New York in several markets and upstate New York I think we’ve announced three different deals in upstate New York. And then other isolated things along the way, new franchisee and a single-store opening in Minot, North Dakota, a small opening in Casper, Wyoming. So, the smaller building is inducing some people to look at this who might not have been otherwise, just because the land cost or building costs, the risk side of it lower with those lower costs and they have very good experience with that. I’ll turn it over to Steve on the economics, but the national -- step up in national cable 15 months ago I think has really been a contributor to the visibility of the brand on a broad basis can help to attract new franchisees. And there are number of negotiations going on with potential franchisees as we speak. So, Steve.

Stephen C. Vaughan

Yes, Keith and just on the new unit economics, really it varies by market size. As Cliff mentioned, as we go into these core markets a lot of these are backfill locations in maybe even some more rural areas where the land costs are very low. We do have this new building prototype. I guess it's not really new anymore. It's been in place now for a couple of years, but it has helped us lower the cost pretty significantly. And so what we’re really seeing is in some of those more rural markets we are seeing about a one-to-one sales investment but the sales are a little bit lower, but that’s getting out to franchisees as a cash on fully capitalized return with investment of around 18% to 20%. So very close to five year payback. The other thing that we are seeing is that we’ve now had almost 15 months of this new higher level of national media and we’re seeing the new store openings in these developing and newer markets really open up very strongly. I think time will kind of tell in terms of the ability to retain those sales. But again, with what we’re seeing today we would expect to see their return on investment being at least 20% and maybe even a little bit higher depending upon the level of sales retention.

Keith Siegner - UBS

Thank you.

Stephen C. Vaughan

Thanks Keith.

Operator

And we’ll hear next from Alton Stump with Longbow Research.

Brittany Whitman - Longbow Research

Hey, it's Britney Whitman on for Alton. Thanks, guys. Just a couple of questions, a follow-up on the POPS, are you guys seeing any impact from the cost of the system on franchisees wanting to build more stores, I am not sure if you’re gotten any feedback from them, especially since you’re offering to offset some of that cost?

J. Clifford Hudson

So a couple of things, one just for clarification, on new stores prospectively the assistance with the cost of that is not being offered. That’s for conversion of the existing stores, …

Brittany Whitman - Longbow Research

Okay. I see.

J. Clifford Hudson

… just a point of clarification. Many of these costs that we’re talking about the POPS and POS combined are costs that an operator is going to actually incur regardless. The POS, and the new system is substantially cheaper than the prototype, it's not the right term, then the historical system that has been most widely used, so they have a cost savings on the POS. The POPS is slightly more restrictive, but keep in mind the POPS includes menu housing, which a new operator has to invest and anyway the POPS includes updated payment method which a new operator is going to invest in anyways and the same thing by the way is true for our operators of existing stores needing to update those menu housings and update payments methods. So a large part of what POPS covers are expected that our operators need to be incurring in the next 12 to 36 months regardless. So, all of a sudden it is slightly more expensive, the video element et cetera, but a large part of the expenditure that our existing operators are going through, through this POPS and POS process, those expenses that they’d be incurring are expenses a new operator or a new store incurs regardless, a majority of those cost.

Brittany Whitman - Longbow Research

Okay, I see. And then on the point of sale systems, are those driving planned cost savings to date?

Stephen C. Vaughan

Yes, we're seeing benefit from the implementation of the new point-of-sale system. We don’t have a lot of history with that yet because most of those in the company drive-ins have been installed over the last 60 to 90 days which is really kind of the period where the operator is learning the new systems, but we have where it's been in place longer, we have definitely seen some positive benefit.

Brittany Whitman - Longbow Research

Okay, that’s helpful. And then just one quick clarification, the $51 million of shares repurchased, it says in the release that it was as of the beginning of the quarter, I am assuming that means the beginning of fiscal 3Q and not reported 2Q, but just wanted to clarify.

Stephen C. Vaughan

Actually the $51 million, there was $40 million that was bought in early February, that you might be reading that I guess the wording may not have been exactly clear but the -- that was 5% of the shares that were outstanding as of the beginning of the quarter. So, not -- it's not that we bought the $51 million as of the beginning of the quarter; it was primarily bought in the month of February. So you’ll see the full benefit of the share repurchase in the third and fourth quarters. You only saw about one third of it -- little bit less than one third of the benefit in the second quarter.

Brittany Whitman - Longbow Research

Okay. That’s all I got. Thank you, guys.

Stephen C. Vaughan

Thanks Britney.

J. Clifford Hudson

Thank you.

Operator

And it appears there are no further questions at this time. Mr. Hudson I’d like to turn the conference back to you for any additional or closing remarks.

J. Clifford Hudson

Okay. Thank you very much. Thanks to all of you for participating today and hopefully you can get a sense from our comments. We’re not only very pleased with the quarter, but very pleased with the status of our business and we look forward to continue to visit with you about it going forward. Thank you very much and have a good week.

Operator

And again this does conclude today's SONIC Corporation’s Second Quarter 2014 Earnings Conference Call. We thank you again for your participation.

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Sonic (SONC): FQ2 EPS of $0.07 beats by $0.01. Revenue of $109.74M (-1.3% Y/Y) misses by $1.2M.