Sonic F1Q08 (Qtr End 11/30/07) Earnings Call Transcript

Jan. 4.08 | About: Sonic Corp. (SONC)

Sonic Corporation (NASDAQ:SONC)

F1Q08 Earnings Call

January 4, 2008 10:00 am ET

Executives

Pat Watson - Corporate Communications

J. Clifford Hudson - Chairman of the Board, President, ChiefExecutive Officer

W. Scott McLain - Executive Vice President; President ofSonic Industries Services Inc.

Stephen C. Vaughan - Chief Financial Officer, Vice President

Analysts

Joe Buckley - Bear Stearns

Sharon Zackfia - William Blair & Co.

Steven Rees - JPMorgan

Mitchell J. Speiser - Telsey Advisory Group

Dean Haskell - Morgan Joseph & Co.

Matthew DiFrisco - Thomas Weisel Partners

Rachael Rothman - Merrill Lynch

Nicole Miller - Piper Jaffray

Christopher O’Cull - Suntrust Robinson Humphrey

Howard Penney - Friedman, Billings, Ramsey & Co.

Operator

Good day and welcome to the Sonic first quarter conferencecall. Today’s call is being recorded. At this time for opening remarks andintroductions, I would like to turn the call over to Mr. Pat Watson. Please goahead, sir.

Pat Watson

Thank you and good morning, everyone. This is Pat Watsonwith Corporate Communications. Sonic is pleased to host this conference callregarding results for the company's first quarter of fiscal year 2008, whichended on November 30, 2007. These results were issued yesterday afternoon.

Today's audio and video presentation may be accessed at theinvestor section of the company's Website, www.sonicdrivein.com.

Before we begin, I would like to remind everyone thatmanagement's comments in this conference call that are not based on historicalfacts are forward-looking statements. These statements are made in reliance onthe safe harbor provisions of the Private Securities Litigation Reform Act of 1995and are subject to uncertainties and risks. It should be noted that thecompany's future results might differ materially from those anticipated anddiscussed in the forward-looking statements.

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

Lastly, I would like to point out that management's remarksduring this conference call are based on time-sensitive information which isaccurate only as of today's date, January 4, 2008. For this reason and as amatter of policy, Sonic limits the archive replay of this conference callWebcast 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 theexpress written consent of the company is prohibited.

With those announcements, I’ll turn the call over to CliffHudson, the company's Chairman, Chief Executive Officer, and President. Goodmorning, Cliff.

J. Clifford Hudson

Good morning, Pat and good morning to all of you. Weappreciate your participation in our conference this morning. As in the past,Sonic has consistently earned good quality returns on the assets you haveinvested in our company and this quarter is no exception with our EPS coming inat -- earnings per share coming in at $0.22 a share and as you know, thatexceeds the market’s expectations by a penny a share, with those expectationshaving been at $0.21.

One of the things we’re pleased about on the quarter is thatthe operating income matched that 16% growth rate, and this reflects goodongoing growth in drive-in level profits as well, so we’re very pleased withthe quarter, pleased with the performance, and pleased to talk to you todayabout the things that have driven that historically and will continue to driveit going forward.

For a long period of time, we have talked about ourmulti-layered growth strategy and the trends that you see in our business, topand bottom line growth, really reflect this multi-layered growth strategy.

While many in the restaurant industry have continued toconfront challenges, higher commodity costs, increasing minimum wage rates, aconsumer environment that seems a little cloudy, et cetera, the fact is thatwe’ve been able to continue to achieve top and bottom line growth with thesemulti-layered strategies. And it is those multi-layered strategies that webelieve will be able to keep us growing in that 2% to 4% range that we have forsome time, with an increase in this quarter of 2.1% system wide. Partnerdrive-ins, as you have already seen, continue to outperform the system as theyhave for a number of quarters now with partner drive-ins at 2.9% comp storesales increase for the quarter. And this of course reflects the benefit of avariety of initiatives we have in place that our partnership drive-ins a littlefurther ahead on, like the retrofit and other sales driving initiatives.

Now I’d like to spend a few minutes talking about trafficand how our sales have been growing in the recent past. We typically don’tdiscuss individual monthly sales results and I think I should also say we don’tintend to make a practice of it in the future, just as we haven’t in the past.

But this quarter, there were a number of initiatives andchanges in our business that impacted check and traffic and I believe those areworth discussing with you today. We talked in our last conference call, which Iguess was in October, we talked about the performance for the quarter, thefourth quarter ending August as well as the experience we had the month of Septemberand that we experienced growth in our average check but a decline in traffic.

So to gain a more complete understanding of our sales growthin the quarter, we’ve broken out sales growth between growth in check versustraffic growth for each month in the quarter and you should be able to see howthat performs. This trend shifted dramatically in the month of October. Whileaverage check was positive, it didn’t increase as much as September and moreimportantly, we saw a nice improvement in traffic. These combined to produce asolid sales increase for the month of October with a nice balance betweengrowing check and traffic.

So I think it’s fair to say that the solid performance inOctober was reflected in the success of a number of our sales drivinginitiatives, including the continued rollout of our national coffee program,our emphasis on alternative day parts through new product introductions likeour Spicy Southwest Breakfast Burrito and our Whopper Shake, both of those werefeatured in the month of October, and a continued rollout of our retrofitprogram, which gained considerable momentum during the quarter.

So this solid momentum continued into November with ongoingimplementation of our coffee and retrofit initiatives but it gained an additionalboost from the implementation of our Happy Hour initiative in the month ofNovember. For those of you on the line who aren’t familiar with our Happy Hourprogram, this initiative features half-price drinks from 2:00 p.m. to 4:00 p.m.every day and as you can see from the slide, the impact of Happy Hour furtherenhanced our positive growth in traffic.

Now, at our partner drive-ins, where we have salesinformation broken down by time of day, you’ll see that we experienceddouble-digit traffic growth in the afternoon day part during November alongwith a nice increase in overall sales.

As all of you know, we look at our business as a series ofinitiatives and we began working on Happy Hour initiatives last fiscal year. Westarted working on this because over half of our franchisees, including by theway many of our most successful franchisees, but over half of our franchiseeshave been doing one form or another of a Happy Hour for a long time in manycases, some with very strong results, including sales and profits well ahead ofthe system average in many cases. And given their success and quite frankly atthe urging of many of them, we decided to launch a system-wide version of HappyHour and that’s now being actively promoted for the first time beginning inNovember and it will become, along with of course, all of our other 168,000drink options we offer, it will become another reason that Sonic is the bestplace for folks to stop in and get drinks. So this has had a very nice impacton our business but for the quarter, we achieved an increase in traffic andcheck.

And then looking forward, we plan to continue to buildawareness of the Happy Hour drink initiative and expect that that, combinedwith our other sales driving initiatives, the balance blend of positive growthin traffic and average check will continue to produce strong sales over alonger period of time.

While adverse weather conditions in many of our core marketsduring the month of December have had a negative impact on sales, we continue toexpect same-store sales growth in the 2% to 4% price range -- excuse me, 2% to4% range going forward for the quarter and the year, with partner drive-ins atthe higher end of this range.

Now, one of the things that we also want to review is ourprice increases and the impact of our initiatives on our price increases.You’ll recall that during our last conference call, we told you that ourpartner drive-ins had increased prices 4% in the summer in response to minimumwage, federal minimum wage increases. And that had been on top of a 1% priceincrease taken two different times earlier in the year.

The average menu price increase was somewhat offset themonths of September and October by our focus on our non-traditional day parts,meaning breakfast, afternoon, and evening. Because these non-traditional dayparts have a lower check average than lunch and dinner and because they growdisproportionately during the quarter, they actually offset the average checkgrowth slightly.

The additional discounting and change in mix associated withour Happy Hour drink initiative had the further effect of reducing asignificant portion of our price increase resulting in an average check growthin the range of 2% to 3% for the months of November and December.

So as we look forward related to menu pricing, we expectthat our current pricing strategies, including Happy Hour and this focus we’vetalked about on non-traditional day parts that we talked about for a long timein our business, that those things along with the lapping of our January 2007price increase will yield an average check increase in the range of 1% to 2%for the remainder of the quarter -- that’s the months of January and February-- and we’ll continue to evaluate the appropriateness of our menu and pricingbut currently, we don’t have any plans to take another menu price increase.

We continue to be very optimistic though about our abilityto drive same-store sales and store level sales going forward. Our focus, asyou would expect, will be to continue to drive business in alternative dayparts, like we have for some period of time. This matches our business well andwe think matches where consumers are going.

But we’ll do it by focusing on products like Cheesecake Bitesand a Double Berry Smoothie this month. We’ll do it also by increasing mediaexpenditures, roughly $100 million this year, including almost $100 million onnational cable and the effect of these should be continued positive impact onour business. We’ll do it also through the addition of drive-thru windows inour system. We’ll continue to have a very positive impact as well.

Now, one of the things I should say on the national cable,that the addition of -- and the cable expenditures, expenditures all togetheris a 9% increase over our fiscal spending in 2007. The national cable strategycontinues to be beneficial in raising overall brand awareness in all of ourmarkets, even more so in new markets. And I should say as well while this hashad an enormously positive impact across our system growing sales and profit,it has also had a tremendous impact on attracting new franchisees to our brand,something we’ll talk about more in just a few minutes.

But the ongoing increased media support will also help liftsales the morning, afternoon, and evening, so it will continue to pay off thesenon-traditional day parts that make up more than half of our sales.

So back to the other point, there are other drivers thatcontinue to drive our business. The retrofit is one. Scott’s going to talkabout that more in a few minutes. Electronic signs is another that will helpdrive multiple messages throughout the day at various drive-ins as customersare going past the drive-ins. We have this in about 20 -- a little more than20% of our system now, a great day part initiative.

As I said a moment ago, the addition of drive-thru windowsand the extended hours that this permits. The rollout of a new coffee programis something that’s been hugely positively impactful on our -- I shouldn’t saybut it’s been a very nice impact on our business as we’ve implementedstore-by-store a line of real espresso based drinks, including hot and icelattes, as well as a product that is our own, the Java Chiller, now in -- thewhole program now in over 80% of our drive-ins. By the time we complete fiscalyear ’08, we’ll have that in place throughout the entire system.

So it should be no surprise to you that drive-ins haveimplemented a series of these sales driving initiatives. They are experiencingthe strongest growth in sales and profits in our system, in many cases aboveour targeted range and we expect that the more drive-ins in markets as theyreap, as they implement these programs, they’ll reap a similar benefit in termsof good sales growth market by market.

So as we think about our business going forward we, ourmanagement team, remain very focused on driving sales and development, both newstores and reinvesting in existing stores, not just for the fiscal year but forthe long run and we continue to have a lot of confidence that thismulti-layered growth strategy, being able to pull a number of levers to keepour business growing, this multi-levered growth strategy will continue toproduce good, consistent results for our business and for our shareholders and whilethere will always be a lot of factors which will play a part in futureperformance, including consumer confidence as well as food and labor costs andthings like weather, which we do have to deal with, particularly at this timeof year, that those will be things that will impact us in the short run but wein fact have a number of proven strategies that are in place that will continueto grow our brand, not just over the next few quarters but over the nextseveral years and the positive impact of these strategies is evidence in manymarkets now already and should continue to work for us very well going forward.

So with that, I’d like to turn the meeting over to ScottMcClain to talk about our development and franchising activities.

W. Scott McLain

Thank you, Cliff. We did have an active quarter on thedevelopment front as we opened 36 new drive-ins as well as experienced aconsiderable increase in both retrofits and the relocation and rebuild ofexisting drive-ins. During the first quarter, we completed 240 retrofits,including 202 by franchisees. That was ahead of what we were anticipating andputs us somewhat ahead of our expected pace of 750 to 850 for the year.

Over 30% of our system now has the new look and we should beclose to 50% by the end of the fiscal year. The fact that our franchisees areusing their own money and completing the retrofit faster than expected is astrong testament not only to the returns we’re seeing but also to theircontinued optimism for the Sonic brand and our future.

Relocations to better trade areas and the complete scrapeand rebuild of existing drive-ins are also increasing. Last year, we completed35 of these and that was more than double the average of the last few years.During the first quarter, we completed 15 relocations and rebuilds versus fivein the same period a year ago and more than 50 additional drive-ins havescheduled completion dates.

Now, we don’t count these as new store openings but they dorequire a new drive-in to be built and they are probably our highest return oninvestment activity, routinely generating sales increases of greater than 25%.Were we to count these as new stores, it would add roughly 2% to our overallsystem growth rate.

Now, the fact that many of our existing franchisees aredevoting a considerable amount of their resources to retrofits and relocationsdoes tend to constrain short-term development a bit. However, prospects forincreased new drive-in openings going forward continue to be strong, asevidenced by our growing pipeline.

Our ADA commitment stood at 919 at the end of the firstquarter. That’s a 60% increase from the beginning of fiscal 2007 and typicallyit takes three to five years for all drive-ins under an area developmentagreement to open as a new store. Now, a large portion of the growth in ADAscame from new franchisees and with continued strong interest in new markets, weexpect our ADA commitments to grow to over 1,000 at some point in the nextseveral months.

We also sold 481 development options last summer. Theseoptions gave existing franchisees the right to open under the more favorablenumber six license agreement any time in the next five years.

Now when you consider the development options on top ofrecord area development agreements, the committed portion of our pipeline isindeed significantly stronger than at any time in our history.

Now, the increase in ADA commitments is all well and goodbut we don’t actually start recording revenue until the drive-in opens. Whatwas most encouraging in the first quarter was that we began to see the increasein ADA commitments move further down the pipeline towards increased new storeopenings.

As of the end of November, we had 207 projects undercontract. That’s a 20% increase from the same period a year ago and typicallyit takes 10 to 12 months to go from under contract to a new drive-in opening.

We also began the second quarter with 36 drive-ins underconstruction, which with winter weather always a wildcard positions us well tosurpass the 22 drive-in openings in the second quarter last year and on trackto open 155 to 165 new franchise drive-ins this fiscal year.

Performance of new drive-ins overall continues to be strong,with average opening volumes now approaching $1.3 million, roughly 30% greaterthan what we were seeing just three to four years ago. Volumes in the many newmarkets that we’ve opened over the last 18 months have been even stronger,averaging more than $2 million in sales. In several cases, we’ve also begunopening additional drive-ins in these markets, with no let-up in performancefrom either the initial stores or the newer drive-ins.

Some of you may be interested to know that we opened ourfirst drive-in in New Jersey in the month of November and I’m happy to reportthat the folks in Waretown, New Jersey apparently were anxious for Sonic asthis drive-in did almost $300,000 in sales in its first four weeks.

Our first drive-in in New Jersey marks the sixth new statewe’ve entered since March of 2006 and we now operate a total of 3,374 drive-insin 35 states from coast to coast. We’ve also sold territory in five additionalstates and we are well on our way to becoming a truly national brand withoperations in every state at some point in the next several years.

It’s now my pleasure to turn the call over to Steve Vaughn,our Chief Financial Officer, for his remarks on our financial performance.

Stephen C. Vaughan

Thank you, Scott. We’re very pleased with our multi-layeredgrowth strategy and the ability that it had to drive our consistent earningsgrowth as demonstrated here in the past quarter. As Cliff mentioned earlier,the cornerstones of this strategy are built around low single digit same-storesales growth, our unique ascending royalty rates, additional operating leverageat both the store levels and the bottom part of our income statement, andstrategic use of our balance sheet and strong cash flow for share repurchasesand franchise acquisitions.

We believe the combination of these elements canconsistently produce earnings per share growth in the mid to high teens overthe long term. As Cliff mentioned at the outset of the call, during the firstquarter all of these elements came into play to produce earnings per share of$0.22, an increase of 16% over the comparable quarter last year.

Sales at our partner drive-ins continued to outpace those ofour franchisees during the first quarter, increasing 2.9%. The month ofNovember marked our seventh straight month of higher performance by partnerdrive-ins. We believe this performance is largely the result of a largerpercentage of our package of sales driving initiatives, such as the retrofit,electronic message centers and the implementation of extended hours beingimplemented in our partner drive-ins.

As Cliff mentioned, the rollout of these initiatives isproceeding in more markets and in more franchise drive-ins that we expect anincreasing benefit from these initiatives on the franchise side going forward.

However, in the short-term, inclement weather across anumber of our markets combined with warmer-than-average weather last year hasresulted in same-store sales during the month of December coming in below ourtargeted range. Notwithstanding December’s results, we remain very optimisticabout sales, both in the second quarter and beyond. Not only will we havebroader implementation of our sales driving initiatives going forward, salesduring January a year ago were particularly weak as a result of bad weather andwe will benefit from an extra day of sales in February due to the leap year.

As further evidence of the strong performance we are seeingin our new drive-in openings, average unit volumes for partner drive-insincreased 3.3% during the quarter.

Our franchising income, including franchise fees and royalties,increased $3.7 million during the quarter. This increase reflected the impactof new store development, solid growth of same-store sales, as well as thepositive impact of our ascending royalty rate. During the quarter, our royaltyrate increased by approximately 25 basis points. This increase was driven byour unique ascending rate, which each of our license agreements feature, aswell as approximately $1 million in incremental franchising income from thelicense conversion which we implemented last April. This incrementalfranchising income has relatively less associated costs. It was a major factorin our earnings growth for the quarter.

Looking forward, franchising income should continue to growin future quarters and we expect $13 million to $15 million in incrementalfranchising income this year.

Despite higher prices for several commodity items, as wellas higher labor costs resulting from the July increase in the federal minimumwage, drive-in level margins improved by 50 basis points during the firstquarter. This improvement was largely the result of the price increase takenduring the summer. Looking forward, food inflation and additional minimum wagehikes in several states where we operate will continue to pressure costs.

As Cliff mentioned earlier, the continuation of Happy Hourwill result in higher discounting and in turn, higher costs as a percentage ofsales. While we will continue to receive the benefit of December price increasemitigated by our Happy Hour initiative, we will be [inaudible] over the 1%price increase implemented last January. This lower rate of growth in pricingshould be partially offset by leverage from higher sales volumes but willlikely constrain our ability to continue to improve margins at the restaurantlevel in the next few quarters.

During the first quarter, we also experienced leverage fromthe bottom part of our income statement, particularly in SG&A expenses,which increased by 6%. However, we do expect both SG&A and depreciation andamortization to grow more in the 10% to 12% range for the year.

There were a couple of other items in our first quarterresults that I would like to bring to your attention. First, you will note thatother income decreased by $1.2 million. This decrease was the result of thefavorable resolution of a non-income tax matter settled in the first quarter ayear ago. Also, our income tax rate for the first quarter was 38%, considerablyhigher than the 35% rate from the first quarter of last year. The lower ratelast year was the result of a favorable settlement of state taxes. We expectthe tax rate will be more in the range of 37% to 38% going forward.

Our earnings per share continued to benefit from our tenderoffer last fall, as well as our subsequent share repurchases, including $12.2million that we’ve bought back in the first quarter. We have now repurchasedover $590 million of stock, or more than 30% of the company, over the last fivequarters.

During the first quarter, the accretion from our repurchasesadded roughly $0.01 to our earnings per share growth and should continue to beaccretive, particularly in the latter half of the year.

For the year, we expect our share repurchase activity to add$0.03 to $0.04 per share to our earnings, which will increase our EPS growthrate by approximately three to four percentage points.

In addition, we continue to have the borrowing capacity tomake other strategic investments on an opportunistic basis. As of the end ofthe quarter, we had approximately $57 million available under our revolvingcredit facility. We would expect to continue to access these fundsopportunistically, including acquisitions of franchise drive-ins or additionalshare repurchases under our remaining share repurchase authorization ofapproximately $30 million.

Looking forward, we remain confident that our multi-layeredgrowth strategy should allow us to achieve earnings in the range of $1.10 to$1.12 per share in fiscal year 2008 and we continue to expect that pursuingthis strategy can produce earnings growth in the 18% range over the longerterm.

However, in the short term, I would remind you that thesecond quarter is always our most volatile quarter as a result of the potentialimpact of weather. We benefited a year ago from an unusually low tax rate andwe will likely face some near-term pressure on restaurant level margins.However, we should still be able to show solid growth from our performance of ayear ago, which was $0.13 per share after adjusting for the debt extinguishmentcharges associated with the securitized debt refinancing, which we completed inthe second quarter last year, as well as the retroactive reinstatement of afederal tax credit program.

This concludes our prepared remarks. We would be happy toaccept your questions.

Question-and-AnswerSession

Operator

(Operator Instructions) We’ll go first to Joe Buckley withBear Stearns.

Joe Buckley - BearStearns

Thank you very much. Just a question on the Happy Hourinitiative and the margin impact; I guess what your comments are implying isthat the margin impact is negative. I would as wondering if you could just kindof walk through that a little bit, given that we typically view drinks as veryhigh margin products. I mean, I realize you are doing a half price or a two-for-onesale basically, but just walk us through the dynamics of that, how much impactyou would expect going forward.

Stephen C. Vaughan

Joe, I think from a discounting standpoint, it has added acouple of percentage points to our discount rate. However, as you pointed out,drinks are a higher margin item for us to start out with and so what we haveseen is we have further shifted our mix towards drinks and so while we expectto see some slight impact on our margins, we don’t expect that it will be asdramatic as you might think from a two percentage point increase in ourdiscounting rate.

W. Scott McLain

We also tend, Joe, to sell a lot of snacks during HappyHour. Because we have such a wide menu, we have a lot of snack items and sothose prove to be very popular to consumers as well.

Joe Buckley - BearStearns

I should tell you, at least on my phone, you’re breaking up.This only started with the Q&A, so just to be aware. And just one morefollow-up question, really to Scott; the expansion pipeline continues to builddramatically and all the numbers sound great and the expansion numbers continueto look a little bit light. And I guess -- do the remodels, do the retrofits,the capital spending that -- the spending on that, is that a constraint interms of --

W. Scott McLain

Yeah, I think, Joe -- can you hear me okay?

Joe Buckley - BearStearns

You’re fading pretty badly.

W. Scott McLain

I’m fading. Well, I’m about an inch from the microphone.That’s as close as I can get.

J. Clifford Hudson

Well, I can tell you, Scott, that I’m in a remote location.I can hear you well enough, so I’m not sure if there’s some other issues.

W. Scott McLain

Well, I’ll go ahead and try to answer your question, Joe. Ithink for our existing franchisees, they are actively investing in our brand,probably at a greater rate than they have ever historically. In the firstquarter, they opened 31 stores but they also rebuilt or relocated 15 drive-ins,so their total new unit development in the first quarter was 46 as compared tosomething in the 30s last year.

In addition, they also completed 202 retrofits, which wasahead of our expectations. So while they are busy retrofitting and relocatingas well as opening new drive-ins, that may have somewhat of a temporaryconstraint on new drive-in openings. However, what we are seeing is that thelarge increase in our area development agreements last year, in ourcommitments, most of that came from new franchisees and those new franchisees,once they begin opening stores should more than offset that temporary slowdown,if you will, by existing franchisees. But we probably won’t see that dynamic infull force until the latter part of the year.

Joe Buckley - BearStearns

Scott, do you know offhand, of the 919 commitments, whatpercentage of that or how many stores are from new franchisees?

W. Scott McLain

Well, I don’t know that off the top of my head but one thingI might also point out, Joe, is that our existing franchisees not only havearea development agreements but they also bought 481 development options lastsummer, which gives them the right to open up stores in addition to what theyhave under an area development agreement any time over the next five years.

So I think their appetite for continued growth is strong.It’s just hard to do everything at once -- retrofit, relocate, rebuild adrive-in and build new stores.

Joe Buckley - BearStearns

Okay. Thank you.

Operator

We’ll go next to Sharon Zackfia with William Blair.

Sharon Zackfia -William Blair & Co.

Good morning. I guess given the commentary on Happy Hour andthe impact on margins, excuse me if I missed this because my phone was breakingup too, are you expecting full year restaurant operating margins to be flattishto down at this point? I think when you initially gave guidance, you wereexpecting some improvement there in fiscal ’08.

Stephen C. Vaughan

Yes, I think the guidance, Sharon, is that for the remainderof the year, we expect flat to slightly unfavorable restaurant operatingmargins.

Sharon Zackfia -William Blair & Co.

Okay, and then maybe could you update us on -- I think therewere several initiatives you were working on with theoretical food costs andlabor scheduling. Is anything there likely to be rolled out this year and mightthat help buffer some of the impact from the Happy Hour?

W. Scott McLain

Yes, Sharon, we do have an ideal food cost system that is inuse at a number of our drive-ins, including our company drive-ins and it ismaking a difference and we expect to continue to roll that out to morefranchise stores over the next several months but there are tools available toour operators which should help them deal with some of the food inflation thatwe’ll face over the next several months.

Sharon Zackfia -William Blair & Co.

And then on labor scheduling?

W. Scott McLain

Labor scheduling, we don’t -- we’re not as far along onlabor scheduling as we are on the food cost side but there are some limitedtools available on the labor side as well.

Sharon Zackfia -William Blair & Co.

Okay, and then just so I understand, I mean clearly you areexpecting though for fiscal ’08 that per unit profitability continues toimprove?

W. Scott McLain

Yes.

Sharon Zackfia -William Blair & Co.

Okay. Thank you.

Operator

We’ll go next to Steven Rees with JPMorgan.

Steven Rees -JPMorgan

Thanks. I wanted to ask about credit card payments and howthose trends are holding up. Are they still growing year over year? And I thinkthose transactions used to be higher average check and perhaps why you thinkthat isn’t offsetting some of the impact you are seeing on average check fromthe beverages and focus on other day parts?

Stephen C. Vaughan

Well, Steven, we are continuing to see our credit cardtransactions grow year over year. It isn’t the same level of growth as thefirst year that we had the pace program implemented but I think we continue tosee an average check that is about 40% higher than our cash check and we docontinue to see a nice increase in our average check. It was up roughly -- forthe system, it was up about 1.5% for the quarter.

Steven Rees -JPMorgan

Okay, and then Steve, could you just talk about yourvisibility on commodities as you move throughout the calendar year? How thoseare looking and I guess specifically dairy, if you have any visibility there asyou look forward to the summer months.

Stephen C. Vaughan

Well, we do expect to continue to see some pressures on thecommodity front, dairy in particular. We have locked in some of those costs. Ibelieve it’s about half on the dairy side out several months but it is on afairly significant year-over-year increase.

We will continue to look for opportunities to lock in costswhere we think it makes sense but at this point, I think we’ll continue toexpect that we’ll have an unfavorable year-over-year comparison in terms ofjust overall commodity costs.

Steven Rees -JPMorgan

Okay, and then just finally on the pricing, I know you seempretty reluctant to take additional pricing here in the near term as you lapsome of these smaller ones in the winter but how are you thinking about pricinglonger term? And do you think you still have more room to take pricing,specifically on some dairy or some dessert items in the summer?

Stephen C. Vaughan

Well, I think when the next federal minimum wage increaseoccurs in July, we will certainly reevaluate at that time whether we feel likethat another price increase is necessary. However, at this point in time, wedon’t have a plan in the next six months to take additional pricing.

Steven Rees -JPMorgan

Okay, great. Thank you very much.

Operator

We’ll go next to Mitchell Speiser with Telsey AdvisoryGroup.

Mitchell J. Speiser -Telsey Advisory Group

Thanks very much. Good morning. A few questions; first ondeveloping markets, I saw the comp was down 2.4%, a bit of a decelerationversus the previous couple of quarters. Can you just talk about that -- inparticular, what was going on in developing markets?

W. Scott McLain

Well, one of the things that happens to us, Mitch, indeveloping markets is that we tend to have a more pronounced honeymoon period,so sometimes you can get a better feel for how developing markets areperforming by looking at average unit volumes and I think you’ll note that ouraverage unit volume growth in developing markets was positive during the secondquarter.

The other thing that I think bodes very well for us goingforward, particularly as we expand to additional new markets and additional newstates is that we, as I mentioned, we’ve opened many new markets since March of2006 and six new states and without exception, we’ve gotten tremendous resultsfrom new stores and new markets and as we are opening the second and thirdstores, we’re also seeing similar results from those as well.

Mitchell J. Speiser -Telsey Advisory Group

Okay. Thank you and moving along, did you pay down any debtin the quarter?

Stephen C. Vaughan

Mitch, no, we did not pay down any debt.

Mitchell J. Speiser -Telsey Advisory Group

I’m sorry?

Stephen C. Vaughan

We bought back about $12 million of stock during thequarter, and so we -- our borrowing slightly increased during the quarter.

Mitchell J. Speiser -Telsey Advisory Group

Okay. I thought there was like a monthly or a quarterly debtpay down schedule, or no?

Stephen C. Vaughan

Well, we have a fixed portion that we do actually makemonthly payments on but we also have a variable portion, so we pay down some ofthe fixed portion, drew some on the variable portion.

Mitchell J. Speiser -Telsey Advisory Group

I understand. Thank you. And moving along, it may have beenin the presentation slideshow, but did you tell us what you thought the trafficnumber was in the fiscal first quarter?

Stephen C. Vaughan

Yes, the traffic increased about a half a percent for thequarter.

Mitchell J. Speiser -Telsey Advisory Group

Okay, thank you. And lastly, I think you mentioned that youexpect your long-term earnings growth rate to be 18%. It’s 15% to 17% now. Idon’t think you’ve perhaps thrown out an 18% number in a while. Could you just-- was that the first time that you’ve talked about an 18% number?

Stephen C. Vaughan

No, that’s really consistently been our -- our belief isthat the multi-layered growth strategy can produce that 18% earnings per sharegrowth rate over the long term and that’s consistently been our objective.

Mitchell J. Speiser -Telsey Advisory Group

Great. Thank you very much.

Operator

We’ll go next to Dean Haskell of Morgan Joseph.

Dean Haskell - MorganJoseph & Co.

Thank you. Congratulations on a great first quarter. Scott,you answered some of my questions about under construction for new units, sowhat about remodels for the second quarter? How many are under construction ordo we anticipate getting completed?

W. Scott McLain

Well, we have in the first quarter, Dean, we completed 15.We have more than 50 more that have scheduled completion dates but I’m notexactly sure how many of those will get completed in the second quarter. Butfor the year, we should complete 60 plus relocations or rebuilds, which wouldbe roughly four times what we [did last year]. And as I mentioned before, theseare very positive investments for our franchisees because they routinelygenerate sales increases in excess of 25%.

Dean Haskell - MorganJoseph & Co.

Scott, the question’s on the remodels, not the relocations.

Stephen C. Vaughan

Yeah, retrofit and Scott’s --

W. Scott McLain

Retrofit, I’m sorry. Your question was how many are we goingto complete in the second quarter?

Dean Haskell - MorganJoseph & Co.

Yes, do you anticipate?

W. Scott McLain

I don’t know, Dean. It’s a little hard to predict the secondquarter with weather always an impact. However, we’re ahead of our expectedpace for the year of 750 to 850 and we should continue to stay ahead throughoutthe course of the year. How many are completed in the second quarter versus thethird quarter versus the fourth quarter, I don’t have a really good feel for aswe sit here on the call.

But what I do have a good feel for is that our franchiseesare clearly embracing the retrofit and wanting to get it implemented, so wefeel very good about the 750 to 850 for the year.

Dean Haskell - MorganJoseph & Co.

Okay, good.

Operator

We’ll go next to Matthew DiFrisco with Thomas WeiselPartners.

Matthew DiFrisco -Thomas Weisel Partners

A question with respect to the income statement; looking atthe other operating expense line as a relative percent of sales, it looks likeit’s the first time in a couple of quarters, maybe almost a year-and-a-half,that you got leverage on that. Can you -- is there something in there? I mean,it looks as though that you remodeled more stores. You’re saying credit cardfees have also should have gone up as share moves towards credit cards awayfrom dollars, if that’s correct. Those have been the drivers in the past todeleveraging that. I was curious why or how you are able to lever that in stillsomewhat of a low single digit comp environment.

Stephen C. Vaughan

Well, Matt, I believe a couple of things; one, we had theprice increase that was working in our favor for the entire quarter. Inaddition, the 3% comp that our partner drive-ins put up, 2.9%, was a strongercomp growth than we’ve seen for the last several quarters out of our partnerdrive-ins, so very nice increase there and just got some leverage from thatincremental sales.

Matthew DiFrisco -Thomas Weisel Partners

Okay, and then also, can you just speak about historically,have you ever done a campaign like this before over a prolonged period of time,sort of the Happy Hour? I’m wondering the effect of -- are you concerned withmaybe conditioning consumers to think of you, look for you when you’re on dealand maybe move their buying habits and start going when the Happy Hour is ineffect and moving volume from maybe traditional meal day parts?

J. Clifford Hudson

One reaction to that is the framework we utilized for makingthis decision in the first place. In other words, in looking at doing HappyHour system wide on a sustained basis, we looked to the 45% of our system whichwas all franchisees, but the 45% of the system that have been doing Happy Hourfor a sustained period of time -- and by that, we don’t mean six months. Inmany cases, for years and years. And in analyzing their businesses, what we sawwas that they had above average sales and above average store level income andstore level profit and the -- so we had a case study that showed pretty clearlythat the impact was positive for this business versus those who were not doingHappy Hour on a sustained basis.

And our belief too was that by doing it nationally, it wouldactually help us strengthen their business as well, that is the 45% that arealready doing it because they’ve been doing it for years without marketingsupport. And by bringing that kind of marketing support, it would help theprogram where it had already been implemented as well as where it was not inplace, so this was the basis for overcoming that concern.

Matthew DiFrisco -Thomas Weisel Partners

Okay, and then lastly, what is your comfort or how highcould debt go? I mean, you are around $700 million now in cash, balance wise.I’m curious how -- debt balance wise -- how much higher are you willing to takethat in this environment and also to sustain a certain credit rating that youare comfortable with?

Stephen C. Vaughan

Well, Matt, at this point we have $57 million availableunder our existing credit facility and so we are very comfortable with thatlevel of debt. We will continue to evaluate whether we are comfortable withadditional debt as our business grows but I think at this point, we’re verycomfortable with the current availability.

Matthew DiFrisco -Thomas Weisel Partners

Can you talk about it in capital structure as a percentagethen?

Stephen C. Vaughan

Right now, we’re in the range of about four times debt toEBITDA and I think we are very comfortable with that of debt.

Matthew DiFrisco -Thomas Weisel Partners

Okay. Thank you.

Operator

We’ll go next to Rachael Rothman with Merrill Lynch.

Rachael Rothman -Merrill Lynch

Just a follow-up on the developing markets and kind of thelagging same-store sales growth there; can you talk about what percentage ofyour stores are currently in developing markets and what percentage of yourunit growth has been in those developing markets?

And then maybe when we should see a reversal of that trend,because I guess if you’re -- I’m guessing that if those stores were not losingsame-store sales that your overall blended same-store sales growth would bemuch stronger.

Stephen C. Vaughan

Well, we have between 20% and 25% of our drive-ins are indeveloping markets. I believe that this past year, a little over or roughlyhalf of our development came in developing and new markets, which are includedin that developing market number. And I’m sorry, did you catch the third partof the question? Can you repeat the third part of your question?

Rachael Rothman -Merrill Lynch

Sure, just when do you think that that trend should normalize?I guess in -- does the honeymoon flow in six months after, eight months after,12 months after?

Stephen C. Vaughan

Well, it depends somewhat on whether it’s a brand new marketor a market that we’ve had drive-ins in for a number of years. It tends tonormalize faster in a market that’s a developing market, under-penetrated butwhere we’ve had presence before.

I think that we would expect over time some of these marketswill become core markets as we continue to build drive-ins and so you willalways have a little bit of a potential for your same-store sales being lowerthan your core markets, because you are moving markets over to core as theybecome more penetrated. But we would expect that over time, those marketsstabilize and that’s really what we’ve seen historically.

Rachael Rothman -Merrill Lynch

And can you just remind us where you are with extendedhours, coffee, and the drive-thru as a percentage of the stores, both companyand franchise?

W. Scott McLain

From a drive-thru perspective, we probably have 45% to 50%of our drive-ins that have a drive-thru.

Rachael Rothman -Merrill Lynch

Company and franchise, or is that just company?

W. Scott McLain

Company and franchise. From a coffee implementationstandpoint, we are actively implementing our coffee program across our entiresystem and that will be completed in this calendar year.

And then from an extended hours standpoint, I don’t have a-- Steve, do you have a good feel for how many stores with extended hours?

Stephen C. Vaughan

It’s probably 150 to 200 that are doing extended hours inthe system. And I think just a little more clarification, we have coffee in alittle over 80% of our system now at this point.

Rachael Rothman -Merrill Lynch

And in terms of the planned or targeted penetration ofdrive-thru and extended hours by the end of ’08, do you expect it to increase?I mean, are you rolling out the extended hours in the drive-thru or should weexpect the penetration to stay roughly the same?

J. Clifford Hudson

Well, I’m not sure that the late night initiative in termsof pace within the system or extensiveness is something we’ve communicatedhistorically.

Rachael Rothman -Merrill Lynch

No time like today. How about the drive-thru?

J. Clifford Hudson

Yeah, and it’s not something we anticipate doing todayeither.

Rachael Rothman -Merrill Lynch

Okay, how about the drive-thru?

W. Scott McLain

I think on the drive-thru, Rachael, a couple of points;number one, all of our new stores are being built with a drive-thru, and sojust by virtue of that, the percentage will increase. I think a lot of ourfranchisees, as they are relocating, rebuilding and retrofitting are alsolooking at the potential addition of a drive-thru as a means to increase theirbusiness over time. I don’t have a specific number for you but it is somethingthat is a big part of our business and will probably be a growing part of ourbusiness going forward.

Rachael Rothman -Merrill Lynch

Okay, and then one last question; you guys are pretty far alongin the retrofit to the company operated stores. I guess pretty near term, weshould be hitting the inflection point in terms of the capital spending on theremodels or the retrofits. Can you talk about what the allocation of thatincremental free cash will be post? Are you guys focused at these levels moreon debt reduction or on future buy-backs? And obviously it will depend on thestock price but you are able to repay the debt, is that correct? That’s kind ofyour worst-case alternative?

Stephen C. Vaughan

Yes, we would be able to repay the debt. We have about $140million on our revolving credit facility, so that’s all able to be prepaidwithout penalty. However, I think we will continue to look at the same strategywe’ve pursued for a number of years, which is opportunistically buying backstock and opportunistically reacquiring franchise drive-ins, so those will beour first choices.

Rachael Rothman -Merrill Lynch

And as you go into fiscal ’09 and fiscal 2010, how should wethink about your CapEx trending? What would be a normalized rate, post theretrofit?

Stephen C. Vaughan

Well, some of that will depend upon the level of new storedevelopment that we pursue on the partner drive-in side. However, I think ifyou look at 2009, we will continue to be implementing the retrofit on partnerdrive-ins. In 2010, that might start to tail off somewhat and this year Ibelieve we’ll spend somewhere in the neighborhood of $20 million to $25 millionon retrofits, so that would give you kind of an idea of what amount might startgoing away.

Rachael Rothman -Merrill Lynch

Perfect. Thank you so much.

Operator

We’ll go next to Nicole Miller with Piper Jaffray.

Nicole Miller - PiperJaffray

Good morning. If possible, can you quantify the Decemberweather impact in terms of comps and/or lost days of business?

Stephen C. Vaughan

I guess one comment that we could make, we had one weekwhere we had a significant impact from an ice storm that came across a prettywide swath of our markets in our core markets, and if you exclude that week,our sales for the other three weeks were within the 2% to 4% range. However,for that particular week where we were significantly impacted by weather, oursales were negative so it did drag the month down below the 2% to 4% range.

Nicole Miller - PiperJaffray

And then in terms of the retrofit, you’ve given results inthe past of the stores that have been retrofitted to date. Can you just reviewthat with us and then the stores that were remodeled in this last completed quarter,are you seeing more -- you know, improved results or a decrease or any change?

W. Scott McLain

Nicole, I think what we’ve said in the past is that weexpect the retrofit to add 1.5% to 2% to our system wide sales on an ongoingbasis. I guess probably the best evidence I can give you that the retrofit isworking is the fact that the franchisees are doing it faster than they arerequired to and they are in many cases asking to do it early and when they arewilling to spend their own money to make that investment, that’s a goodindication that it is paying dividends for their business.

Nicole Miller - PiperJaffray

Fair enough. And then in terms of the promotions, inaddition to Happy Hour and coffee, what are the other specific promotions rightnow in January?

Stephen C. Vaughan

We had Cheesecake Bites that we are continuing to promoteand then a Double Berry Smoothie.

J. Clifford Hudson

And a steak, egg, and bacon breakfast burrito.

Nicole Miller - PiperJaffray

And on the Happy Hour, is it just slushy drinks? I mean,it’s not just coming on the coffee side?

Stephen C. Vaughan

It is just our fountain and slushes.

Nicole Miller - PiperJaffray

Thanks. That’s all I had. Thank you.

Operator

We’ll go next to Chris O’Cull with Suntrust.

Christopher O’Cull -Suntrust Robinson Humphrey

Good morning, guys. Steve, it appears the restaurant margincame in a little better than you expected, yet much of the price increases wasnegated by mix shift and the half price Happy Hour promotion. Could you explainor maybe give us a little more explanation on what caused thebetter-than-expected margin?

Stephen C. Vaughan

Well, we did have a little more leverage, particularly incontrolling our labor costs. I think going into the quarter, we probablyexpected a little more deterioration in the labor line item. And I think also,as Scott mentioned, the ideal food cost program, we do feel like we arestarting to see some benefits from that. So probably I would say the number onereason for that is just good controlling of costs.

Christopher O’Cull -Suntrust Robinson Humphrey

Okay. What opportunities are there with labor? I mean, whenyou say labor costs, how do you realize better labor productivity?

Stephen C. Vaughan

Well, I think it’s really just a focus at the store leveland giving our operators tools to try to schedule labor better to meet the rushperiods and then reduce labor when you’re not busy, so it’s really just kind ofbeen an increased focus and I think with the minimum wage increase, that kindof re-emphasized the importance of managing that area and I think our operatorsreally stepped up and did a nice job in that area in the first quarter.

Christopher O’Cull -Suntrust Robinson Humphrey

Okay, and then Scott, when you were -- when you had the badweather in December, was that difficult to manage labor during that week? Imean, did you see some cost issues because of that?

W. Scott McLain

Not really. I mean, I think our operators are fairly skilledat managing their business and when -- first of all, we had a number ofdrive-ins, as Steve mentioned, that were closed in one particular week but Ithink our guys, particularly on the company side where they do have some goodlabor tools from a technology standpoint, they are good at managing theirbusiness and understanding what’s happening to their business.

So it’s not the first time we’ve ever had bad weather, sothey know how to deal with that.

Christopher O’Cull -Suntrust Robinson Humphrey

Okay, and Cliff, I know the company strategy has been tofocus on alternative day parts but at what point does lunch and dinner need tobecome a focus for traffic building, especially in light of what we’re seeingin some of the other fast food chains?

J. Clifford Hudson

Well, it continues to be a focus in ways that we don’tnecessarily talk about from a tactical marketing standpoint. It is on anongoing basis for us.

The difference is and our belief is that the -- two things;one, that the opportunity for growth, breakfast in the industry generally,afternoon with the industry generally but also with the peculiarities or thespecialties of our business and then evening, with ice cream, which theindustry hasn’t shown a big growth in but we have appreciably. These areopportunities for growth that lunch and dinner in the industry and in ourbusiness don’t present the same opportunity.

So in fact, we do continue to focus on lunch and dinner withsome specific marketing tactical initiatives that we simply don’t discuss onthis phone call because it’s too tactical. But it’s not as though we’ve letlunch and dinner go. Our business has grown substantially over time. It’s justthat those alternative day parts have grown disproportionately more stronglyand quite frankly, I think that that’s what sets us apart versus most of ourcompetition. It’s also something most of our competition is trying to mimic.

Christopher O’Cull -Suntrust Robinson Humphrey

Well, that’s right and I know that lunch and dinner has been-- I think you’ve said that the traffic has been negative in those two dayparts. At what point does it become more of a defensive measure in terms ofjust the product, the quality of the product relative to the peers in terms ofjust some of the basic combos?

J. Clifford Hudson

Well, we do over time continue to promote various entreesand new entrees to attempt to attract people with new products, but we also dohave marketing initiatives to drive business to those day parts. And the -- butthe broader point is one of -- the declines in that business or the lack ofgrowth at times in those day parts is not something particular to Sonic. Thatis reflective of what’s happening with the consumer and the shifting in the waythey are spending their money.

And so to some degree, one of the things we are mindful ofis we need to continue to support those traditional day parts but we don’t needto chase them -- we don’t need -- likely a fish swimming upstream whenconsumers are shifting their dollars into other day parts, and particularly otherday parts where we think we have some particular strengths.

Christopher O’Cull -Suntrust Robinson Humphrey

Okay, thanks.

J. Clifford Hudson

That strategy really has for some period of time drivenpretty good same-store sales I think that out-strip most of our competition.

Operator

(Operator Instructions) We’ll go next to Howard Penney withFBR Capital Markets.

Howard Penney -Friedman, Billings, Ramsey & Co.

Thanks very much. Knowing what you know about today aboutthe difficult sales environment, had you not done the Dutch auction a few yearsago, would you make the decision, that same decision to do that today?

J. Clifford Hudson

Well, the Dutch auction is a long-term strategy based one onour historical capital structure and two, where we see the performance of ourbusiness going over time. And with that in mind, long-term strategy based oncapital structure and where we see the business go over time, the answer isyes.

The fact is over an extended period of time, we had boughtback 25% of the company already and you will begin seeing more as we get laterinto the year accretion from an EPS standpoint of the impact of that and we’rein the business for the long term, so two, three, four and five years from now,we’ll look back and we’ll say here is an appreciable pay-off to that strategythat we implemented ’06, ’07.

Howard Penney -Friedman, Billings, Ramsey & Co.

Thanks.

Operator

It appears there are no further questions at this time. Mr.Hudson, would you like for me to turn the call back over to you for closingremarks?

J. Clifford Hudson

That would be fine. We appreciate your listening in todayand your engagement in our business. One of the things you should be able totell from us is as our management team looks at the long run performance of thebusiness is we continue to be very optimistic about it. I think if you look atSonic versus almost any of our competition, there is no one else in the QSRbusiness that I know of that fits this category, and that is we have significantmarket penetration in many states in the United States but enormous virginterritory in which to grow as well. And in spite of that, we’ve had five plusyears of national marketing and the consequence of this is that we are inpeculiar and unique position to be able to grow our business quite handsomelyfor years to come and we hope that all of you continue to have interest in ourbrand, and if you buy the stock and hold on, you’ll see good performance foryears to come.

So thanks for listening in today and we look forward tovisiting with you soon. Take care.

Operator

Once again, this concludes today’s conference. We doappreciate your participation. You may now disconnect.

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