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Sonic Corporation (NASDAQ:SONC)

F3Q10 (Qtr End 05/31/10) Earnings Call Transcript

June 21, 2010 5:00 pm ET

Executives

Pat Watson – Corporate Communications

Cliff Hudson – Chairman and CEO

Scott McLain – President

Steve Vaughan – EVP and CFO

Analysts

Brad Ludington – KeyBanc Capital Markets

Jeffrey Bernstein – Barclays Capital

Matt Van Vliet – Stifel Nicolaus

Greg Ruedy – Stephens, Inc.

Matthew DiFrisco – Oppenheimer & Co

John Glass – Morgan Stanley

Nicole Miller – Piper Jaffray

Tom Forte – Telsey Advisory Group

Robert Derrington – Morgan Keegan

Keith Siegner – Credit Suisse

Chris O'Cull – SunTrust

Operator

Good day. Welcome to the Sonic third quarter conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I'd like to turn the call over to Mr. Pat Watson. Please go ahead, sir.

Pat Watson

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 third quarter and first nine months of its fiscal year 2010 which ended on May 31st, 2010. Today's audio and slide presentation is available on the Internet. If you would like to view the slides during the presentation, please go to the investor section of the company's website, www.sonicdrivein.com and follow the link to events and presentations under Investor Info.

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 risk. It should be noted that the company's future results may differ materially from those anticipated and discussed in the forward-looking statements.

Some of the factors that could cause or contribute to such differences have been described in the news release issued this afternoon and the company's annual report on Form 10-K, quarterly reports on Form 10-Q, and in other filings with the Securities and Exchange Commission. We refer you to these sources for more information.

Lastly, I would like to point out that management's remarks during this conference call are based on time sensitive information that is accurate only as of today's date, June 21st, 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'll turn the call over to Cliff Hudson, the company's Chairman and Chief Executive Officer. Good afternoon, Cliff.

Cliff Hudson

Good afternoon, Pat and good afternoon to all of you. We you appreciate you participating with us today. In this call we're going to cover a number of topics and I will give you a quick overview of that, obviously as you would expect, we're going to talk about the sales results for the third fiscal quarter, quarter ending May. Also, I am going to spend some time talking about the initiatives that we have in place that we announced a couple of months ago, series of initiatives that will be rolled out over the coming months. So we'll spend some time talking about that.

Scott McLain is going to talk about the development review, development activities within our system. And then Steve Vaughn, our Chief Financial Officer, is going to pick up from there, talk about financial review on the quarter.

So the quarter we just finished after gaining some traction in March and April, sales deteriorated somewhat in May and April was the strongest month of the quarter. System-wide same store sales declined by 6% for the third fiscal quarter. In our partner drive-ins, we'll talk more about this little later, but in our partner drive-ins sales declined 6.3%, but they pretty much closed the gap, that is our partner drive-ins closed the gap.

In our third quarter the average check for the system was essentially level with the year earlier as we started focusing on the value of the Sonic way and we'll talk more about that in a few minutes. As it relates to the focus for our system, we continue to focus on a number of initiatives, geared towards driving our business and I'll talk more about those as we walk through it. But focus on product; focus on service, media strategies and so on. This – in our fiscal year very much focused on those initiatives as well as partnered drive-in performance and we'll talk some more about that in terms of how we have begun to closing the gap and I think you'll see in terms of comp store sales and otherwise that we're moving positively in that direction.

Continued expansion of our system as part of building, continue to build the brand and then also this year strategic use of cash which we'll report more on a little bit later, but this very much a part of our fiscal year this year and going forward. The strategy for the fiscal year, as we talked without this before, and this is not new to you, and it's not a new concept to you anyway but it's also in terms of how we're approaching this and in the past having focused before this year, focusing somewhat more on the denominator of this equation, value, the value for customer, equaling the experience divided by price and instead in the recent past, have begun focusing more on the numerator here.

Prior years between the 'Everyday Value Menu' and other elements of the pricing strategy, this was the key part – the way we tried to address this as the recession began, but by focusing on service initiatives and product quality, we believe we are here on a pretty good path to working to rebuild the numerator while sustaining the denominator. It is our view that over the long run if we elevate the customer experience with high quality, distinctive food and good Customer Service and our unique physical format of the drive-in, that this will do more to contribute to sales and earnings growth than simply offering food at a lower price.

So if we spend a few minutes talking about these sales driving initiatives. Some of these we have touched on in the past, but we continue to focus on this in an attempt to move our business forward. You can see indicated here the first item, consistent and high quality service execution. This has been an area of focus for us for a good period of time but we have stepped it up in the last 12 to 18 months with our Fan Track initiatives geared towards giving us feedback on customer perception of individual transactions and on a collective basis, help us work to drive the business forward.

In addition, as it relates to new messaging and how that is intended to affect our business at the unit level, we have focused on a variety of things in the recent past and we will continue it going forward. More recently, the value proposition, the value of the Sonic way, which focuses – moves the focus away from a value menu to focusing on premium products, and with – as an example, a full priced sandwich ordered and a free order of tots or free order of onion rings, this really helped us in the late winter and into the spring to hold our average check flat which is what occurred as the quarter progressed, so this has been a good element of our sales driving initiatives.

Third component that you could see indicated here is the – is design to emphasize how much different we are versus the typical QSR our new commercials not only – I think this may relate to looking back up here, this may relate more to the new messaging and that is focusing on handmade onion rings and tater tots but differentiating us versus our competition, working to do that from a messaging standpoint, should also help our brand moving forward in a very distinctive way.

The product quality improvements that you see referenced here is the fourth item. As we continue through this spring, we have talked about this for a while, we continued into spring with ice cream, we'll move forward in the next month to a quarter pound foot-long Coney and this is an improved product versus the extra long Chili Cheese Coney we have had historically but the product news really very much be in the product improvements, the product quality will be highlighted in our promotions, both to help drive day parts along the way, but also to assist in moving forward the customer's perception of our brand from a quality standpoint.

And then finally, the last issue you see mentioned here, that is the targeted media allocation, reallocating dollars, some of which have been used on national cable in a footprint sort of way and that is the trade radius around a drive-in in such a way to increase impressions, that consumers receive regarding our brand, so that for the same bucks or even slightly fewer bucks, we work to get the same or increased impressions that we have had versus prior media allocation.

So these are elements in this fiscal year that we're pursuing to help drive sales and in turn work to drive profitability at the average Sonic Drive-in.

Now, as it relates to our partner drive-ins, the good news in the relatively recent past, first three of these are somewhat more historical and then the fourth item being focused moving forward. But as it relates to the service gap with our franchisees; over a period of time we saw a service gap open up between our owned drive-ins and our franchised drive-ins and in the last 12 months or so we have seen that gap close really completely to the point that in some recent months our owned drive-ins have in fact performed better than franchise stores.

As it relates to the same store sales gap, we have gone through a period of time in which that gap was considerable but as you can see from this most recent quarter and this was happening over time but in the most recent quarter that gap has virtually closed. We have also completed a restructured compensation program for our store level managers which we talked about in prior meetings. We have completed that at this point. This was not implemented in every drive-in. Some of those that were more profitable where the manager desired to remain on the ownership formula, we permitted them to do that. It has continued to work in those drive-ins and so we stayed with that.

At this point, with that improved service that we have seen in our owned drive-ins, with the gap narrowed from a sales standpoint, with the restructuring of compensation to reduce turnover, with our management, we believe we're now in a position with our marketing activities to be much more likely to grow profitability at the store level, so in much better stead than we were 12 to 24 months ago with our owned drive-ins.

As it relates to the capital structure, as you know we began the year with about $125 million in cash. Throughout the year, and then as – in the more recent past, the more substantial purchases we have acquired $58 million of fixed rate notes that the company had outstanding. We also had scheduled principal payments throughout the year of $50 million. And so as the year progresses and moves to a close, we're really in a position where we'll have some improved positioning from a leverage standpoint, improved balance sheet and reduction in interest expense as we move into our next fiscal year.

Now, on the sales-driving initiatives that we talked about, referred to earlier, these elements we continue to focus on, I am going to go into a little bit more depth here, but consistent execution focusing on the nature of the customer experience and the speed of service, very much a part of what we have worked to do over the last 12 to 18 months, not just on the owned operations side, but franchise as well. And I think as you look at the performance that has occurred over that period of time, the yellow line here being our owned drive-ins, you can see that some time ago the gap was closed. You can see in the more recent past, in fact, that there have been some periods of time where our partnership drive-ins have surpassed franchise drive-ins but in either case both have stepped up considerably in such a way to be very impactful on the nature of the experience, back to that numerator, the nature of the experience that the customer is having when they come to a Sonic Drive-in.

Differentiation message I referred to earlier, focusing on real skating carhops, and high quality distinctive food. This I think if you looked at the commercials that you're seeing in the more recent past, to the extent you're seeing those, in some of your markets we have less presence, perhaps seeing them on national cable, you'll see a depiction of more folks, carhops on roller skates, but also even our two guys, and some of our other folks, rather than being parked, some comparative information about our brands and our offerings versus the competition.

The value piece I talked about versus – value of the Sonic way versus the competition, once again with things like a premium sandwich and free sides in attempt to offer that deal and offer that value message to the customer but doing so in such a way that it's a bit more true to our brand. The differentiation from the skating standpoint, we have probably showed you this before but I think once again there are a number of elements of our business that we built that are distinctive over time from the product standpoint, made to order food, et cetera, but this is the drive-in concept, the use of carhops, the skating carhops, really further differentiates us versus our competition and it's clearly something that the customer appreciates.

As you can see here, the customer rates drive-ins that have skating carhops, rates them consistently across the board, improved customer feedback measures versus those stores that don't skate. I think we're up to, with our owned stores, we're in excess of 50% of the customer experiences including skating carhops and with franchise stores, just below 50%, so we continue to grow this. It's an opportunity for continued improvement and the customer experience and one that we think further differentiates us versus the competition.

The product quality initiatives referred to earlier, series of initiatives rolling out now and sequentially over the coming months, improved quality on each of these items, further distinctiveness, customization of them again work to differentiate us versus the competition. You can see from a calendar standpoint, May into June, focusing on ice cream, July into August, focusing on this quarter pound Coney, the extra long – excuse me, the Footlong quarter pound Coney, Chili Cheese Coney, it's a delicious product, a meal in itself. So this is something that's a historical treasure of (inaudible) but well further differentiated us versus the competition and I think it will be a good traction from both a traffic and check-building standpoint.

In the fall we'll move into further differentiation of our burgers versus our competition, work on the afternoon – excuse me, work on the lunch and dinner day parts. Now, one of the questions that has come up over time about this, you know, folks say well, you started talking about these in the spring. You're now in the summer. What do we expect to see here? You have got negative comps in the third quarter, this May. And the answer is yes, that's exactly right.

The ice cream piece didn't come out until May 17th and we'll have the buy one, get one shake through the end of the month and we have now started with a late evening $0.99 sundae. So, we’ll keep the pressure on the ice cream throughout the summer, but this is kind of a day part building sort of process. They have not had the impact – the shake piece has not had the impact as an example on lunch. It has had some impact on other day parts. As you go further into the day parts, an improving impact from a traffic standpoint. But as we move more to these differentiated food items, my expectation would be these would augment lunch and dinner.

We'll keep the pressure on the ice cream from a promotional standpoint, though secondary to the Footlong, Chili Cheese quarter pound Coney. And so, as we – as the summer progresses, we'll have a better sense of the impact for these on lunch and dinner, into the fall the same quality message, differentiation versus our competition.

As it relates to maximizing media impressions, made reference to that a little earlier, optimizing the investment, moving money from national cable to more in the territories where the trade areas around the drive-in and then also diverse media messages and formats that do I think a better job of attempting to sell the points of differentiation versus our competition.

With that, I'll turn it over to the President of our company, Scott McLain.

Scott McLain

Thank you, Cliff. Development continues to be challenging for a variety of reasons, including ongoing franchisee uncertainty about business conditions and to a lesser degree, continued credit market challenges. During the third quarter, our franchisees opened up 18 new drive-ins and for the first nine months a total of 57 new drive-ins have been opened. Our franchisees also continue to actively invest in their existing assets as evidenced by 21 relocations or rebuilds during the first three quarters of this year.

We don't count these as new store openings, but they do require a new drive-in to be built. And they're probably our highest ROI activity, routinely generating sales increases of greater than 25%. As some of you may recall, we previously provided a license agreement incentive for relocations and rebuilds which expired at the end of calendar 2008. And over the last three years we relocated or rebuilt roughly 150 drive-ins or 4% of the chain. And it's encouraging to see our 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 past 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 underpenetrated markets.

However, even with the incentives, we will likely open roughly 80 new drive-ins this year, quite a bit fewer than we did a year ago. Longer term prospects for development remain sound. 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 three to four years ago. We also now have 84 drive-ins in new markets that have been opened 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 fiscal 2009, almost 30% above the system average volume.

And while these stores continue to perform well as a group, they're not immune to tough weather and challenging economic conditions and their sales also suffered during the winter months. However, we have seen an improvement in sales volumes in these markets as the weather has turned warmer.

On another positive note, we continue to see construction and real estate prices fall in most areas, and these factors together with lower interest rates should be very good for us over the longer term, as they'll only serve to increase our franchisee's return on investment. We ended the quarter with 3,570 total drive-ins and we're now operating in 42 states making continued progress on our way towards becoming truly a national brand by adding 13 new states in just the last four years.

35 drive-ins closed during the first nine months of this fiscal year. Slightly fewer than the first nine months of the previous year. Given that we're a 57-year-old brand with over 3500 stores, we believe that our rate of closing remains relatively low. And although there are certainly some exceptions which we are working through, the physical health of our franchisees overall remain sound, and we continue to benefit from the increased 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're gratified by their continued investment, an investment in what we together believe as a bright future.

Now I'll turn the call over to Steve Vaughn, our Chief Financial Officer.

Steve Vaughn

Thank you, Scott. Our earnings for the third quarter reflected continued pressure on same store sales, which was compounded by the deleveraging impact of lower sales on margins. For the third quarter we reported earnings of $0.18 per share. This figure includes a $0.03 per share tax benefit from the option exchange program that was completed during the quarter. In the prior year, we recognized refranchising gains of $0.11 per share which were partially offset by impairment charges totaling $0.08 per share. Excluding these special items from both periods, earnings per share declined 37.5%.

Our franchising income, including franchise fees and royalties, decreased by $1 million versus the comparable period last year. The decrease in franchising income was caused by the decline in franchisee same store sales of 6%. This decline was partially offset by new store openings which have higher average sales and royalty rates than existing drive-ins. The overall effective royalty rate decreased 4 basis points versus the same period in the prior year, as a result of the same store sales decline.

As Scott mentioned, we opened 18 franchise drive-ins during the quarter. 11 of these drive-ins opened under our incentive program with four openings with no franchise fee and seven opening with one half of the normal fee. However, only three of the 18 drive-ins opened during the quarter met the criteria for royalty abatement. The deleveraging impact of same store sales declines combined with higher labor costs resulted in lower restaurant level margins in the third quarter and lower overall operating income margins.

Looking at each individual line item, food and packaging costs decreased slightly versus the prior year reflecting approximately a one-half quarter impact of the increased costs from the new Real Ice Cream that was rolled out in advance of the mid-May promotion. Commodity costs were flat year-over-year. As we look forward, most commodities other than beef are locked in for the remainder of the fiscal year. We expect that commodity costs will be higher in the fourth quarter due primarily to higher beef costs. These projections include the higher costs related to our product quality initiatives including the introduction of Real Ice Cream and our new quarter pound footlong Chili Cheese Coney which is being rolled out to our drive-ins this month.

While recent pricing changes will partially offset the improvements in product quality initiatives, the investments that we're making in these initiatives, we believe we will see increased food and paneling costs in the fourth quarter of fiscal 2010 in the range of 50 to 75 basis points. During the third quarter we ran a cumulative menu price increase at partner drive-ins of approximately 2 to 2.5% on a year-over-year basis. At the end of the quarter we lapped approximately 1.5% of that pricing. However, we did take a nominal increase primarily on ice cream products in late May that will put our fourth quarter cumulative increase in the range of 1 to 1.5%.

Our payroll and employee benefits continue to reflect higher labor costs as a result of last summer’s minimum wage increase. This increase was compounded by the deleveraging of same store sales declines. We saw some improvement in this line item as the third quarter progressed. We do expect the combination of lapping over the minimum wage increase during the month of July, and the improved management of this line item will relieve some of the margin pressure in this area of our business.

However, you may recall that I mentioned in our last earnings call that effective April 1st we retooled our partner compensation program to reduce the volatility of our manager's and supervisor's earnings from month to month.

This change adds some incremental costs, estimated at 1 to $1.5 million per quarter, and shifts compensation costs to the labor and benefits line that were formerly reflected as non-controlling interest. We believe this new program is an investment that will provide long term benefits through reduced partner turnover and an improved focus on store level operations. It also retains the spirit of ownership with all managers and supervisors retaining the opportunity for unlimited earnings upside regardless of their status as a legal partner.

Other operating expenses also were hurt by the decline in same store sales as well as some one-time repair expenses preparing for the launch of Real Ice Cream. This caused a 220 basis point deterioration in this line item in the third quarter which was considerably lot better than in the second quarter. While our outlook for same store sales remains negative in the fourth quarter, we expect continued improvement in this trend during the quarter. As I have pointed out previously, change in the accounting rules now requires us to report minority interest and earnings in 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 of earnings during the quarter primarily due to the implementation of our new partner compensation program in April. Several partners have opted to retain their ownership interest so we will continue to have the non-controlling interest line although it will be much smaller going forward.

Our expectations for overall restaurant level margins is for a 150 to 250 basis point deterioration, and is inclusive of the non-controlling interest line for comparative purposes. During the third quarter, SG&A increased by approximately $676,000. This increase was due to an increase in our provision for bad debt as well as one-time costs incurred in connection with the change in the partner compensation program.

As Scott mentioned, the difficult sales and profit environment has created cash flow challenges for some of our franchisees. In recognition of these challenges, we have increased our allowance for uncollectible receivables. In addition, we have engaged a third party to assist some of the more troubled franchisees with financial restructuring.

And our business has improved with warmer weather, our receivables collections have improved correspondingly. We do not expect to have a material bad debt provision in the fourth quarter. I would also add that while we saw significant savings from the refranchising of partner drive-ins last year, we reinvested a good portion of these savings in incremental resources and other areas of our business.

Depreciation and amortization declined by 7.1%, reflecting the refranchising of partner drive-ins and further moderation in partner drive-in development. During the quarter, we saw a $1.5 million increase in other revenues. This increase 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 of earnings from a minority investment that was retained in the operations of 88 of the refranchised drive-ins. This line item should be in the $3 million range in the fourth quarter as well.

We continue to be pleased with our decisions to move to 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. During the third quarter we used a portion of our excess cash to purchase approximately $58 million of our Class A2 senior fixed rate notes.

As Cliff mentioned, this purchase together with our scheduled principal payments will reduce our outstanding debt by more than $100 million this year to less than $600 million by year end. As of the end of the third quarter we had $187.25 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 continue to exceed our debt compliance covenants and we anticipate this compliance will continue into the foreseeable future. We are carrying approximately $40 million in excess cash investments over and above our normal operating needs. We do not anticipate in needing to utilize the significant portion of these funds with ongoing obligations as our free cash flow after planned capital expenditures of approximately 25 to $30 million and approximately $50 million in mandatory principal payment is expected to be only slightly negative. Due to a one-time tax benefit related to our stock option exchange program of approximately $1.8 million, our effective tax rate is well below our typical range of 37.5 to 38.5%.

We expect our rate for the fourth quarter to return to our expected range. However, new developments could impact our rate in any given quarter. As Cliff stated earlier, while we are pleased with the progress and consumer response, we are seeing with our initiatives to drive sales and profits, we continue to see consumers reduce their eating out occasions.

Currently we anticipate that same store sales will decline in the fourth quarter in the range of negative 4 to negative 8%. With that in mind we now expect fiscal 2010 earnings to be in the range of $0.50 to $0.55 per share.

In addition to the sales expectations outlined above, this outlook is based on the following. Deterioration in restaurant level margins of 150 to 250 basis points primarily reflecting the deleveraging impact of lower sales and higher beef costs. This expectation is based on including non-controlling interest, restaurant operating costs on a pro forma basis.

SG&A expenses in the range of 65 to $66 million, depreciation and amortization expense of 42 to $43 million, net interest expense of 36 to $37 million, and capital expenditures of 25 to $30 million.

In summary, while our sales and earnings performance declined in the first nine months of fiscal 2010, the initiatives we have implemented the past few quarters and have planned for the next few quarters provide a solid foundation and position us for earnings growth over the longer term. Improved sales and earnings performance will likely take time but we believe our corporate strategic focus, value defined in a uniquely Sonic way, improved products, highlighted the new product news, service differentiation featuring friendly skating carhops, and innovative approach to media expenditures and moving our business model toward a more predictable and stable cash flow model will increase stockholder value over the longer term.

As evidence of our financial strength we expect our cash flow generated from operations will be sufficient to fund capital expenditures and debt payments with only minor uses of our existing cash. This should provide us with ample flexibility in utilizing our excess cash for shareholder value driving initiatives going forward.

I would now like to turn the call back over to Cliff Hudson for some closing comments.

Cliff Hudson

One of the things that we're pleased to mention today is that next month we'll have a new Chief Marketing Officer joining our company. We have issued a press release today on this and many of you will have been aware of this already as a result of seeing that.

Her name is Danielle Vona and she'll be joining us from PepsiCo where she has just recently resigned her position as Vice President in order to join Sonic. Danielle is – has been living in New York. Living nearby, I should say. In Connecticut, but working out of the purchased New York office and will be here in the immediate future, meaning month of July, begin working with us.

We were impressed with her background and are impressed with her background that involves a variety of areas of our business, including research area, consumer – development of consumer insights, packaging, product development, certainly from a repositioning standpoint.

She was overseeing agency relationships, vendor – excuse me, I should say bottler relationships (inaudible) very much of course to our franchise relationships and we believe from a skill set standpoint, experience standpoint and certainly from a personal and cultural standpoint that she will be a very good fit for our company and help move our marketing activities to another level over time, provide excellent leadership in that area. So we're very pleased to make that announcement today, regarding Danielle. And you all will be able to meet her along the way over time.

But our primary focus when she comes on board as you would expect will be to focus on her staff, also our franchisees and get well integrated into our company, and that will be her chief focus for a number of months.

With that, I'll be happy to open up the call to questions.

Questions-and-Answer-Session

Operator

(Operator Instructions) And we'll go first to Brad Ludington with KeyBanc Capital Markets.

Brad Ludington – KeyBanc Capital Markets

Thank you. I wanted to start off just looking at your fourth quarter and into next year, should we expect share repurchases to come back into the picture at any point?

Cliff Hudson

Well, I think this is something that clearly from use of capital is an option for us and it is one that we will consider over time and the question, at a given point in time will be an issue of what is the best use of capital, whether it's reduction of debt or purchase of stock and we will decide that over time and communicate with you.

I think one of the biggest variables from our standpoint is the performance of the company and the performance of our owned stores and as that progresses we'll look at options that make the most sense for us for the use of that cash.

Brad Ludington – KeyBanc Capital Markets

Okay. Thanks. And Cliff, if you look at the day parts, I mean, I would assume as with most QSR, the breakfast day parts probably get the hit the worst. Has there been any kind of stabilization or improvement in any of the day parts and is that an accurate assessment on breakfast?

Cliff Hudson

Well, one of my comments earlier, if I kind of utilize your question to revisit that a little bit, as we have focused on this buy one shake – buy a shake, get one free, looking for a little guidance from my CFO here, what he has said, what he has not said, but I'll jump out here.

So basically what's happened in terms of a run rate with our – with the shake piece is as we have done buy one, get one free is the sales have tripled. And they didn't start out that way. This was a build. And we're now on the late end of kind of a six week promotion of that. But we are at a point now where it's triple what the ordinary rate of sales of those.

Now, as you would expect, Brad, we don't sell too many of those at breakfast. This is a day part that's more geared towards later in the day and the later you get into the day, the more benefit it's been in terms of kind of improving trends, primarily traffic. So that's – traffic and some of you could check. Anyway, that's the effect of that. The breakfast has been very challenging because of the unemployment circumstance of so many fewer people working and so you got fewer people going out, grabbing something in the morning but also because the competitive challenges we have.

So morning has been a challenging day part and the initiative we have in place so far which are primarily ice cream, is not intended to address breakfast and frankly neither is a Chili Cheese Footlong Quarter Pound Coney but it is intended to affect other day parts like lunch and dinner. So we're slicing this stuff and using different initiatives to try to drive different day parts.

Brad Ludington – KeyBanc Capital Markets

Okay. Thank you. I'll let somebody else jump on at this point.

Operator

And we'll go next to Jeffrey Bernstein with Barclays Capital.

Jeffrey Bernstein – Barclays Capital

Great. Thank you. Just couple of questions, just one in terms of the restaurant margins, you're obviously seeing some significant pressure this quarter, and based on your comp forecast for I guess the fiscal fourth quarter and the beef commentary, I am just wondering if you could talk about the comp or the pricing needed to – whether it be just to protect margins or actually one day expand margins, perhaps maybe the sensitivity to earnings on an incremental comp or any color around the comp needed and the margin outlook would be great. And then I have a follow-up question.

Steve Vaughan

Jeffrey, I'll take a shot at answering that and then Cliff or Scott can jump in. We, in terms of the margins for the fourth quarter, we are at this point projecting a down quarter, negative four to negative eight. We have seen some improvement in our – primarily in our labor line item as the third quarter progressed and we will be lapping over the minimum wage increase.

In terms of when we would expect to get back to flat margins which I think may be where your question is driving, I think if we were able to get to closer to flat sales, that we would have a very good chance of getting back to flat margins, particularly as we roll out some of these new initiatives. We are – we'll have some investments in the product quality side and that we'll need to offset but it – flat to probably slightly positive, same store sales, should get us back to more of a flat margin environment.

Jeffrey Bernstein – Barclays Capital

And the sensitivity to something like that from an incremental comp, and would the cost cutting and whatnot that's going on, how do you size up what incremental comp is worth?

Steve Vaughan

I don't have a reaction for you just off (inaudible), Jeffrey.

Jeffrey Bernstein – Barclays Capital

Okay. And then just separately, you mentioned that April was the best month and May decelerated from there. Just wondering, one, if you could give some thoughts on whether you think that's somewhat Sonic specific, mistakes that you made or marketing you did, Sonic versus quick service in terms of the May deceleration and then as it relates to being 21 days into June, whether there's any color on June or perhaps what you're assuming for that down four to eight comp in terms of, I think you mentioned the price, but versus traffic and mix for the fiscal fourth quarter?

Cliff Hudson

Well, some of it in terms of is it – is it a broader issue or is it Sonic specific; it's probably a combination of the two. We kind of transitioned from the nature of the promotion, kind of value Sonic's way with sandwich and the side and we switched mid-month to the buy one, get one free shake with the new real ice cream.

And so what we have seen is that that, in the case of the second promotion, we have seen the effect of it build progressively over the now four plus weeks we have been doing it. So part of it, a little bit with the hand off from our standpoint in terms of nature of promotion, but we have also seen some broader indicators that May was a pretty difficult month from a retail standpoint.

Steve Vaughan

And also from some of the NPD Crest information that we get that it was a little more challenging for the QSR sector as well. So just echo Cliff's point.

Jeffrey Bernstein – Barclays Capital

And it seems like you guys are going more towards that premium route with the promotions you guys have laid out there. I mean, how do you think of yourselves versus your competitors in that front, whether you believe everyone's going that direction or you're kind of stepping out on a limb when everyone else is pushing more value?

Cliff Hudson

Well, the customer, there's some of the indications, that this case appear to be the customer's really looking for a deal, more than just the, “value menu”, the way the industry has begun to use that term. And so this is why you're seeing us position the improved products and position our differentiated products in that deal fashion, so it's not just an issue we don't want to – we don't care to go to the value menu promotional activity, but rather find other ways to spell value with the customer, both from the standpoint of giving them a better experience, but even as we do talk about price, to do it in the context of our brand, rather than the way one of our competitors might do it.

Jeffrey Bernstein – Barclays Capital

Okay. Thank you very much.

Cliff Hudson

Thank you.

Operator

And we'll go next to Steve West with Stifel Nicolaus.

Matt Van Vliet – Stifel Nicolaus

Yes, hi, Matt Van Vliet on for Steve. I was wondering if you could give us any more color on, on ground beef and sort of where you stand on possibly locking in at least some of it, even if it's at higher price, just to have a little bit of certainty as you go forward and if need be, take price on the ground beef products.

Cliff Hudson

Yeah, on the ground beef front, we are month to month right now. We saw in the month of June I think we were at there about 15% year-over-year, so a significant increase. There is some good news in that during the month of June, the price declined and so in July I think we're probably up year-over-year about 5%.

So we're expecting that to continue to improve as we go through the summer. At this point, we don't believe that it's an appropriate time to lock in. We will – we prefer to be locked in. That's typically our approach.

But when you're at record prices, particularly for the time of year that we're in, we don't feel like it's a good time to do that. But we will continue to evaluate it. Most likely it would be in the fall before we would look at locking that in.

Steve Vaughan

And it isn't our intent to raise prices. We don't believe that pricing, trying to price our way to prosperity is a good strategy to follow on beef as well.

Matt Van Vliet – Stifel Nicolaus

Okay. And then you talked about the higher customer service scores with the units of the skating carhops, is there any real discernible average check difference at those locations or do you see any more I guess profitability on the mix or is that just the customer service that really stands out at this point?

Cliff Hudson

Well, I think what we do see, we do see a sales differentiation and we do see a profit differentiation. And what I think you can – what we're able to derive from that is more one of transactions and almost certainly customer loyalty as a result. So it's higher level of transactions, higher sales, higher profitability.

Matt Van Vliet – Stifel Nicolaus

Okay. Thank you.

Cliff Hudson

Thank you.

Operator

Our next question comes from Greg Ruedy with Stephens.

Greg Ruedy – Stephens, Inc.

Thanks. Good afternoon. I know driving check and traffic is the goal. For the quarter, can you kind of give us an idea of what's meeting your expectation and where is the opportunity or the – is it the loaded burger sales mix? Is it what you were hoping for? And then in the current quarter, can you talk about results of the shake – utilization of the shake promotion versus the test.

Cliff Hudson

Well, in terms of how are we feeling about the nature of those promotions, the shake promotion is the one that we have done so far. We started that mid-May and it will continue to the end of this month and we have been very pleased as we have mentioned, the sales of shakes anyway tripled. So we're getting a lot of customer usage out of it. And it is intended to drive some trials so they would keep coming back to us in the summer and beyond.

So how are we approaching this? As it relates to each of these items, we're not rolling them out simultaneously. The Chili Cheese Footlong Quarter Pound Coney will kick off pretty quickly here. So these things are somewhat sequential.

Now, in terms of impact, we have been pleased in terms of the day parts that ice cream is likely to have an impact on, we have been – I should say relatively pleased. But we would like to have it across more day parts and more complete across all day parts. The answer is always.

However, it has improved traffic trends across the day parts where you expect ice cream to do so. But this is why when we finish talking about buy one shake, get one free, we'll come behind it with – we're already doing this now, but we have come behind it for July and August with a $0.99 sundae after 8 o'clock. So it keeps the news to a secondary national promotion, we get some national cable behind it and it keeps the news behind ice cream and attempts to drive some of those other day parts.

Simultaneously then we'll have the Chili Cheese Footlong Quarter Pound Coney. We have not rolled it out yet. So, if your question is, are we pleased with it, we'll have it in another week and we'll have a sense for that as we get some time for it to develop.

Greg Ruedy – Stephens, Inc.

Yeah, I actually was more asking from the standpoint of the third quarter results, basically consumer behavior, what really changed from April to May? Is it traffic and check? Is it one or the other or both?

Steve Vaughan

Yeah, hey Greg, it was really traffic. One thing, I think Cliff may have mentioned this earlier, we did see our check go positive really starting in February but that continued throughout the third quarter and so we were very pleased with that reaction but the primary challenge that we had during the third quarter was traffic.

Greg Ruedy – Stephens, Inc.

Okay. Can you help me model the ongoing net growth rate? I think on a trailing 12 months basis, the closure rates looks like it peaked in Q1 and it's come down over the last couple quarters. Should we just model an ongoing 1% closure rate?

Steve Vaughan

Yeah, that would be fine. I mean, we'll continue to update if we see some change in that outlook, but we have just been through the toughest winter that we have had in probably 20 years and so I think you can safely model that closure rate right around that area.

Greg Ruedy – Stephens, Inc.

And in terms of development for next year, do you have plans from the franchisees in hand and kind of give us an outlook, what we can expect there?

Steve Vaughan

Well, the answer is we have plans for franchisees in hand but the second part of your question, are we ready to give you an outlook, I think the answer is we're not ready to give you an outlook.

Cliff Hudson

We'll provide that update most likely in early September. We're going through our annual business planning process right now. And so we'll be planning to do that more toward the end of the fiscal year.

Greg Ruedy – Stephens, Inc.

Fair enough. Thank you.

Cliff Hudson

Thank you.

Operator

And we'll go next to Matthew DiFrisco with Oppenheimer & Company.

Matthew DiFrisco – Oppenheimer & Co.

Thank you. Just first, can you clarify your guidance; does that include the $0.03 benefit from the tax benefit?

Steve Vaughan

Yes, Matt, the $0.50 to $0.55 is inclusive of that $0.03.

Matthew DiFrisco – Oppenheimer & Co.

Okay. And then there was a comment made I think it might have been Scott, improvement in new markets with summer, with the summer – return to summer, and does that imply that you're having positive year-over-year same store sales, it was in reference to the 2009 high volume stores that had a drop-off in the winter.

I guess should we conclude that winter was a greater drop-off than you would have marketed – you would have expected and then coming back to summer you are not only getting a sequential improvement which is obvious, but also a year-over-year same store sales gain at those stores?

Steve Vaughan

It implies that summer's better than winter.

Cliff Hudson

Yeah.

Scott McLain

I mean, I think the point I was trying to make was a couple of points. One, we have a number of stores that have been opened for a significant period of time and those stores continue to have volumes that are higher than the system average which is encouraging.

Number two, that new markets, even though we continue to have really high sales volumes on new store openings, did have a tough winter and they're not immune from the economic challenges that we face. But then it's been encouraging to see that sequentially, as the weather's gotten better, we have seen business get better in those markets as well.

Matthew DiFrisco – Oppenheimer & Co.

Right. And my question is when you say business gets better, that's on a year-over-year basis?

Scott McLain

I said what I intended to say. So we're not prepared to go through and quantify, make a kind of quantification that you're asking for. So our business has gotten better in new markets and we continue to be pleased overall with how the brand is performing and being accepted and really throughout the country.

Matthew DiFrisco – Oppenheimer & Co.

Okay. I'm certainly not trying to be combative. I'm just asking a question just to try and better understand. I hope you don't interpret it as that. But –

Steve Vaughan

No, not at all.

Matthew DiFrisco – Oppenheimer & Co.

Okay, I just thought it would be helpful if we understand that if it's getting healthier or not, okay. With reference to the ad spending there was some good time and good analysis shown at the Analyst Day, with respect to that, how there was a sales lift associated with that ad spending.

Are you still seeing those same type of – are you still expecting that same type of benefit even though you're spending less dollars but more targeted, and greater bang for your buck, greater impressions? Are you still going to see that type of lift or do you think that was maybe aggressive, what you saw in the test market?

Steve Vaughan

Yeah, Matt, I think, let me just make sure I'm clarifying your question. When we had the Analyst Day we talked about this new approach that was going to show increased impressions in our trade areas around our drive-ins. I think what we're seeing is, because of some of the sales challenges we have had, we do have less dollars to spend and so what those impressions or what this new strategy to approaching media spending is allowing us to do is to maintain and slightly grow our media impressions, with fewer dollars.

So it's not having probably the same effect that it would have had if we have had flat or even higher dollar spending, so that is certainly a challenge. But we do think that it's helping us avoid what might have been a worse outcome if we hadn't had this new approach. Does that answer your question?

Matthew DiFrisco – Oppenheimer & Co.

Yes, to a degree. Well, I guess you put a number on it like 6% lift, but I totally understand, you have other forces going against you, not just – it's not a closed box here where you're just looking at the ad spend impact, you obviously have the economy moving all over the place.

Steve Vaughan

Right.

Matthew DiFrisco – Oppenheimer & Co.

I know it's probably hard to judge them with that. And then just I guess the last question, have you – I guess if we're getting still negative traffic even though you seem to still be doing some pretty good promotional activity, have you thought of testing or are there franchisees that are testing in any parts of the country pulling back on the happy hour special or is that not something on the table?

Steve Vaughan

That would seem counter to driving more traffic.

Cliff Hudson

The afternoon day part has continued to be our strongest day part and I think that's probably the last thing we would want to do is do anything that would undermine that day part.

Matthew DiFrisco – Oppenheimer & Co.

Okay. Thank you.

Cliff Hudson

Okay. Thank you, Matt.

Matthew DiFrisco – Oppenheimer & Co.

Thanks.

Operator

And we'll go next to John Glass with Morgan Stanley.

John Glass – Morgan Stanley

Hi. Thanks. I'm just still trying to – I'm trying to back into the fourth quarter earnings estimates and I think you're talking about 100 to 150 basis points erosion at the restaurant level margin. I think that's a year-over-year and this quarter you had seen a much more substantial erosion so what makes it–?

Steve Vaughan

John, let me go ahead, before you move on, the guidance was 150 to 250 basis points of margin deterioration year-over-year. So just want to make that clear.

John Glass – Morgan Stanley

Okay. And then this quarter on your basis you experienced how much?

Steve Vaughan

380, I believe.

John Glass – Morgan Stanley

So the difference in your comp estimate is about the same, and it sounds like your food cost is going up and is the variance entirely going to be on the labor line then in your minds?

Steve Vaughan

I walked through what we saw changing. Number one, we are lapping over our minimum wage increase so that pressure will subside. We do have some pricing that will be offsetting some of the investments in quality and then we also had some higher kind of one-time costs in our repair and maintenance line item that goes into other operating expenses, so we would not expect – I think that particular line item was 220 basis points negative year-over-year. We would certainly not expect that same level in the fourth quarter.

John Glass – Morgan Stanley

Got you. Okay. That's helpful. And then this quarter I think you had a slight loss on the debt repurchase. Is that true? And are you no longer able to buy back debt, this 58 million you bought back at a discount. Are those days over now?

Steve Vaughan

No, actually we did buy that back at a discount. However, when we purchase it we have to write off any unamortized loan origination costs and also put up a reserve for insurer premiums that still have to be paid even though we repurchased the debt and so we are buying at a discount. Unfortunately, we're recording an accounting loss but it's not a true cash loss.

John Glass – Morgan Stanley

And the last question is how much flexibility do you have in CapEx for next year? I think Steve you had talked about slightly negative free cash after the cost of development versus CapEx, also your debt repayments will be still negative this year. And I presume you don't want to be in that position next year so how much flexibility do you have on your CapEx? What's required I guess in your minds to run the business well without – in terms of maintenance plus whatever you need to do on a proactive basis?

Steve Vaughan

Yeah, I think the 25 to 30 million we are expecting this year includes four or five new partner drive-ins, so if you back that out you would potentially be in the 15 to $20 million range. So that's probably the level that if we were looking to cut CapEx down to the lowest level we would be comfortable with, I think that's probably a fairly good estimate.

John Glass – Morgan Stanley

Great. Thank you.

Steve Vaughan

Thank you.

Operator

And we'll go next to Nicole Miller with Piper Jaffray.

Nicole Miller – Piper Jaffray

Good afternoon. I just want to understand the guidance of down 4 to 8% in comps. Is that for the fourth quarter or for the year?

Steve Vaughan

That's for the fourth quarter, Nicole.

Nicole Miller – Piper Jaffray

And is that for the company or the system?

Steve Vaughan

Actually, the company and the system were very close in the third quarter. We were at within 0.3% of each other. So we don't expect the fourth quarter there to be a significant difference between those two.

Nicole Miller – Piper Jaffray

Okay. And then I just wanted to circle back on the implementation of the recent partner comp changes, and what percentage of the partners are opting to change over to the new comp structure, and has it increased or decreased turnover?

Steve Vaughan

Yeah, I think about 90% of our partners chose to go to the new compensation structure. So it was very well received. We have only had that in place now for 2.5 months, so it's fairly difficult to gauge has our turnover increased, decreased, but we certainly – we believe that this structure being well received by our store managers and supervisors, that we'll see a decrease going forward. I will tell you, it's probably too early to give you a read on that.

Nicole Miller – Piper Jaffray

Okay. And then can you talk about the trial redemption rates and the feedback on the shift to the Real Ice Cream product?

Steve Vaughan

Can you be a little more specific, when you say the–?

Cliff Hudson

Trial.

Nicole Miller – Piper Jaffray

I guess redemption of the BOGO coupons.

Cliff Hudson

Okay. Well, I think I'll just some very I guess broad numbers, roughly 70% of our customers take both shakes when they come in, so you have about 30% that take the coupon and then about two-thirds of those – and we're still – we're four or five weeks into this promotion but about two-thirds of those at this point are coming back and redeeming the coupon and by the way, I should point out, they're spending more money when they come back with that free coupon than they were spending on the original trip. So that's very encouraging. It's something we had hoped to achieve with this promotion.

Nicole Miller – Piper Jaffray

Thank you.

Cliff Hudson

Thank you.

Operator

And we'll go next to Tom Forte with Telsey Advisory Group.

Tom Forte – Telsey Advisory Group

Hi. Great. Thanks. Can you give us an update on as far as percent of mix from the value menu, where that fit in the fiscal third quarter? Thanks.

Steve Vaughan

It's kind of – I think kind of plateaued at about 6% of sales, so you may recall when we introduced it back in 2009, it was about in between 10% and 12% of sales. We last promoted it in January of this fiscal year and we didn't see it get back to that 10% range. It went up to about 7 to 8 but it's pretty much hanging in that 7% – I think 6% range right now.

Tom Forte – Telsey Advisory Group

Thank you.

Cliff Hudson

Thank you.

Steve Vaughan

Thank you.

Operator

And we'll go next to Robert Derrington with Morgan Keegan.

Robert Derrington – Morgan Keegan

Yes, thank you. Cliff, could you give us a little bit of color on the upcoming hot dog promotion, excuse me, the Coney, excuse me, didn't mean to say hot dog, the Coney promotion in that I think in your Analyst Day you talked about a $2.99 price point. How would that compare year-over-year? What's kind of the check average strategy as you look at the fourth quarter?

Cliff Hudson

Well, you surprised me at the end there as it relates to check year-over-year. Well, the objective in part here, $2.99, as it relates to the pricing of that product, there is a range in the system. Part of the systems are going to be at $2.99.

So as it relates to the product itself, in some cases discounting, in some cases not. The difference in here, the difference here is it's a different product. The meat lot – the meat has improved – increased by almost 50% in size and it is a – well, that's the primary thing. It's a foot long and it's a quarter pound. So you get more for the same money as it relates to the product itself.

Now, in terms of its impact, what we would expect from a check standpoint, and so the question comes up, is the customer going to buy that by itself and a drink. I could promise you it's virtually guaranteed they'll buy a drink. It would be hard to eat a quarter pound foot long Coney without having a drink.

But in the test that we did, we also had a majority of the customers buy a side order as well, tots, rings, et cetera, and so in that case it obviously the side order drives up check considerably. It is a promotion that's intended to focus on lunch and dinner, primarily.

And to the extent that we experience the same thing as we roll it out that we did in our tests, it should have a very nice – it's a very differentiated product, that most people aren't going to be getting anywhere else. It's improved where it's been historically, we have had historical – historically we have had good customer engagement with this promotion. So if we have the same mix in terms of the side orders in the general promotion that we had with the test. It should be pretty positive from a check standpoint.

Steve Vaughan

Because of that dynamic that Cliff described, we also, in the test, saw a positive impact on profit. So not only sales but profits, which is very important, particularly at this time of year.

Robert Derrington – Morgan Keegan

Steve, does the Coney typically mix much? The traditional Coney.

Steve Vaughan

When you say mix–?

Robert Derrington – Morgan Keegan

Is it typically 5% of our sales or 3%?

Steve Vaughan

(inaudible)

Robert Derrington – Morgan Keegan

Go ahead.

Steve Vaughan

The run rate on our Coneys is about 5% of sales.

Robert Derrington – Morgan Keegan

Okay, as opposed to your burger, your hamburger products might be 20%?

Steve Vaughan

Yeah, burgers are about 16% of sales. So it is a smaller mixing item but it has historically responded very well and in the test responded very well to individual promotion.

Robert Derrington – Morgan Keegan

Okay. And then if I could segue for a second, you just hired a new Chief Marketing Officer. Can you give us a little bit of color? Obviously sales aren't as good as you want. You have got a plan with the Coney promotion coming up, the burgers behind that in the fall. Would you anticipate your strategy shifting much with this new person coming on or how do you think about that?

Cliff Hudson

I suspect that what we're going to see is enhancements in various ways over time. The focus on differentiated product and differentiated service is historical brand positioning for our company, so I don't anticipate that changing going forward. Instead, what I would expect is some refinement of it from a nomenclature standpoint, from product development standpoint and I don't mean by that wild new products, I am not trying to bait anyone's thinking there, but perhaps from a media standpoint and leveraging off vendor relationships in different ways. So I think what you should expect is a refinement over time.

She's not on-board yet. So I would not expect impact in the immediate future. But I think she'll be a good addition to our team. She is bright and creative and we'll give her time to have impact.

Robert Derrington – Morgan Keegan

Great. Thank you.

Operator

And we'll go next to Keith Siegner with Credit Suisse.

Keith Siegner – Credit Suisse

Thanks. Just a quick question on the comp, the new compensation structure, so $1 million to $1.5 million of expense per quarter, sounds like roughly 4% increase in the total payroll and employee benefits or 90 to 100 BPs of sales. Do those partners now have the same leverage to the upside that they used to have under the old structure or because there's a higher base is it a reduced level of participation in upside?

Cliff Hudson

Well, they still have unlimited upside in terms of the percentage ownership, in some cases they may have less percent of the upside. It is unlimited. They might have less percentage. In some cases they might have more. But it's structured in a way that we're intending to keep the spirit of the partnership alive and keep their upside unlimited.

Keith Siegner – Credit Suisse

But it sounds like there could be some structurally higher level of compensation that there was under the old compensation structure.

Cliff Hudson

There is definitely a higher base salary with more stability across the entire year.

Keith Siegner – Credit Suisse

Okay. One other question, then, for Scott. I know you didn't want to talk about kind of the outlook for their franchise (inaudible) but can you give us a sense of the outlook for remodels and retrofits maybe over the next couple quarters, maybe what type of pace you expect?

Scott McLain

Yeah, I think we have got basically about 75% of the system retrofitted with about another 25% to go. Over the last – as I mentioned in my commentary, over the last probably two or three years we have incentivized and encouraged our franchisees to invest in their existing assets which they have done quite a bit of in terms of relocating and rebuilding and we have actually either relocated or rebuilt a little over 4% of the system over the last two to three years. So I think they will continue to invest in their businesses where it makes sense but probably not at the same pace that we have seen over the last two to three years, because a lot of that has already occurred.

Keith Siegner – Credit Suisse

And have you considered maybe adding some of that incentive back into, say, finish the program or not?

Scott McLain

Well, I think that we always continue to look for what are ways that we can drive our business. I don't have anything to talk about on the call today but we're always looking for how we can work with our franchisees to drive our business going forward.

And historically, investments that we have made in the physical plant, particularly rebuilding and relocating has had a very strong payoff.

Keith Siegner – Credit Suisse

Okay. Thank you very much.

Cliff Hudson

Thank you.

Operator

(Operator Instructions) We'll go next to Chris O'Cull with SunTrust.

Chris O'Cull – SunTrust

Thanks, good afternoon.

Cliff Hudson

Hi, Chris.

Chris O'Cull – SunTrust

Steve, I wanted to follow up on the restaurant margin guidance for the fourth quarter. Are there any assumptions related to running labor more productively or improved mix that is required to get to that guidance?

Steve Vaughan

We did see improvement as we went through the third quarter and so what we have assumed there is that we will see that improved trend continue into the fourth quarter, so yes, there is some improvement over historical, although we have demonstrated the ability to manage to that level in the month of May.

Chris O'Cull – SunTrust

You're talking labor or menu mix or both?

Steve Vaughan

No, I'm talking labor there. In terms of menu mix, the foot long, Quarter Pound Footlong Chili Cheese Coney promotion will be we think from a profitability standpoint will be a nice promotion for us. It does not involve as Cliff mentioned a lot of discounting, and so again, we would expect particularly as we drive sales as we think it will, to see a positive impact on our margins from that as well relative to last year.

Chris O'Cull – SunTrust

Okay. And then earlier you said the restaurant margin was down 380 basis points this quarter. So I'm assuming you're including the pretax cost of paying minority interest to partners?

Steve Vaughan

Yes, that's correct.

Chris O'Cull – SunTrust

Okay. Does that equate to roughly 220 basis points decline on a pretax basis?

Steve Vaughan

I'm not following you.

Chris O'Cull – SunTrust

On the external P&L when you just look at the restaurant margin with the non-controlling interest below the line, it looks like the restaurant margin fell more than 380 basis points. Is the difference that minority interest?

Steve Vaughan

Well, the non-controlling interest is – even though it's below the line, is a pretax figure. So you should not tax effect that line.

Chris O'Cull – SunTrust

Right. But you're taking that and putting that at the restaurant level to come up with a 380?

Steve Vaughan

Right.

Chris O'Cull – SunTrust

Okay. Okay.

Steve Vaughan

And that – if you look back on page seven of our release, you'll see that on a pro forma basis. That may clarify it for you.

Chris O'Cull – SunTrust

Okay. Great. Then, last question, Cliff, I may have missed this in the presentation, but could you talk a little bit about the performance variation you may have seen from running the ad spots that include the two guys versus the ad spots that include the carhops?

Cliff Hudson

And your question is what is the effect when the two are run?

Chris O'Cull – SunTrust

I know during this quarter you ran both types of commercials and I didn't know if you saw a difference in your same store sales performance or your awareness – or your level of awareness when the carhop ads were run versus when the two guys were run.

Cliff Hudson

No, I don't have a point of feedback for you on that.

Chris O'Cull – SunTrust

Should we continue to see the carhop spots going forward?

Cliff Hudson

What you'll continue to see, either from a parties that are depicted, the products depicted, the description, et cetera, what you'll continue to see is some blend of creative that focuses on both product and service differentiation and so if your question is do we continue to play with that in a variety of ways, the answer is yes.

Chris O'Cull – SunTrust

Okay. Great. Thanks.

Operator

And it appears we have no further questions at this time. I would like to turn it back over to Mr. Cliff Hudson for any additional or closing remarks.

Cliff Hudson

We appreciate your participation today and we will continue to focus on as we have in the past product and service differentiation, build our business and we appreciate your patience in working with us as we continue to do that.

It's a challenging time but I think we have got a number of initiatives under way that should help our brand and help our business at the drive-in level in terms of sales and profitability. So we'll look forward to visiting with you in the future and talk to you along the way. Take care.

Operator

And this concludes today's conference call. Thank you for your participation.

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Source: Sonic Corporation F3Q10 (Qtr End 05/31/10) Earnings Call Transcript
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