Sonic Corporation F3Q08 (Qtr End 5/31/08) Earnings Call Transcript

Sonic Corporation (SONC)

F3Q08 Earnings Call

June 25, 2008 10:00 am ET

Executives

J. Clifford Hudson - Chairman of the Board, Chief Executive Officer

W. Scott McLain - President of the company and Sonic Industries Services, Inc.

Stephen C. Vaughan - Chief Financial Officer, Vice President

Pat Watson - Corporate Communications

Analysts

Jeffrey Bernstein - Lehman Brothers

Joe Buckley - Bank of America

Sharon Zackfia - William Blair & company, LLC

Steven Rees - J.P. Morgan

Jake Bartlett - Oppenheimer & Co.

Christopher O'Cull - Suntrust Robinson Humphrey

Nicole Miller - Piper Jaffray

Keith Siegner - Credit Suisse

John Glass - Morgan Stanley

[Tom Fortay] - Telsey Advisory Group

Rachael Rothman - Merrill Lynch

Paul Westra - Cowen and company

[Brad Levington] - Keybanc Capital Markets

Lawrence Miller - RBC Capital Markets

Presentation

Pat Watson

Good morning everyone. This is Pat Watson with Corporate Communications. Sonic is pleased to host this conference call regarding results for the third fiscal quarter and nine-month period ended May 31, 2008. These results were issued yesterday afternoon. Today's audio and video presentation may be accessed at the Investor section of the company's web site www.SonicDriveIn.com.

Before we begin I would like to remind everyone that management's comments in this conference that are not based on historical facts are forward-looking statements. These statements are made in reliance on the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to uncertainties and risks. It should be noted that the company's future results might 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 yesterday afternoon and the company's annual report on Form 10K, quarterly reports on Form 10Q, and in other filings with the Securities & 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 which is accurate only as of today's date, June 25, 2008. For this reason and as a matter of policy, Sonic limits the archive replay of this conference call webcast to appear to 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.

J. Clifford Hudson

Good morning to all of you. We appreciate you being with us this morning on the reporting of our third fiscal quarter ending May. It was clearly a difficult quarter with our reporting of $0.28 per share, well below original expectations, not typical of our historical performance nor do we think it's indicative of what the future potential of our brand is, but nonetheless a difficult quarter which we want to talk through this morning. The quarter clearly is a reflection of tougher consumer and operational environments but also the consequences of some of the promotional and operational choices that we as a management team has made in the relatively recent past and so we want to talk through what some of those decisions have been and the strategies have been and how we modify those, already are modifying them, and also looking at the impact of these going forward.

With the talk of the state of the business right now I'd like to talk about that in part in terms of some of the positives that are occurring as well as the challenges about our business because I think this sets a framework for one, how we're looking at the business but also two, how to go about addressing some of the challenges we have. So as you can see here the focus on the core markets, the first area of comment is that our business is really fairly healthy and certain aspects of our business. The system wide same store sales for the core markets for the third quarter were about 1%. This isn't a big number, the 1%, and it is below what we have stated in the past in terms of expecting a 2% to 4% but it's worth pointing out to you that with the exception of March same store sales for these core markets was in fact within that 2% to 4% range that we've talked about historically and to keep in mind that for the first nine months of the year those comps in those markets are about roughly 3%. So a good part of the quarter it really is that kind of March story but as it relates to our core markets where the substantial portion of our sales are we are in fact in the April/May timeframe performing in that range. Now those markets are early beneficiaries of our initiatives like our retrofit along with the earlier implementation of a coffee program and happy hour, our LED signage, as we'd say our 3D program, all of those have been performing well in those markets so the core markets have been beneficiaries of it and represent a majority of the sales of our system. So we continue to feel very good about those core markets and the initiatives we have in place.

Now the next element that I'd like to talk about in terms of things that are going well has to do with new stores in new markets. In the past two years we've entered into doing business in eight new states and our stores in those markets are doing really extremely well. So you probably know, you'll recall that our average sales for new stores is typically about $1.3 million, €the average for the first year sales, but in those new stores in new markets, the ones referred to in the last couple of years, they've consistently been in the range of $2 million and we've really hit some big numbers along the way. The investment in national cable that we've had for a number of years now along with I think the differentiated concept that we obviously continue to promote, they're really playing well in these new markets. These new stores in new markets have experienced a much larger honeymoon period than our other new stores in the system and they've continued to retain sales in the second year that are in line coincidentally with the top 20% of our chain just on average, which is in a $1.6 million to $1.7 million AUV. So good news on an aggregate basis about those openings and they're sustaining good sales.

Just recently we opened our first store in Detroit, Michigan; that was in May; and in St. Paul, Minnesota in June. And coincidentally the drive-in in Detroit, the newly opened, set a record both for opening day sales and also open week sales. The St. Paul drive-in is performing very well, too, but the point is that as we continue to expand in these new markets, in the fall we'll be opening in the Chicago metropolitan area, and as we do so we continue to expect, with very good reason, strong openings and well sustained higher annual unit volumes than we've seen for this system on average. So these are aspects of our business that are going well, that core base and then the new openings representing the future of our system and the sustained sales there good operators, well financed, and a good development program over a sustained period of time.

Now I'd like to shift for a moment and talk about the more challenging aspects of our business right now and walking through this in this way to once again give you a sense of how we're looking at the nature of our business right now and the nature of the challenges we have. Developing markets make up about 25% of our system and are concentrated to a great degree in the Southeastern United States and then also in the more Western part of the Southwestern part of the country. Same store sales for these markets throughout the quarter were negative and facing different kind of challenges more near- to mid-term, a different kind of challenges more near-term we believe, versus those core markets. As an example, as we pointed out in the core markets the rollout of the retrofit is going well but it has minimal application to date in our developing markets so they're not getting the benefit of that. In addition to that there are some other elements, if you look at California and Florida in developing markets kind of some disproportionate effect of our economic environment but in addition to that any of these new stores are going to see a different comp picture. They come into the comp analysis after 15 months. And they're going to see a different course after that and so with these new markets, the developing markets having a disproportionate makeup of that group, it's going to adversely impact their comp base. So a different picture and one which we continue to work with in a variety of ways that I'll talk a little bit more about in a minute, but this is the developing markets, this is one of the challenge areas. We do believe as we continue with retrofits and our 3D messaging and promotional strategy going forward we're going to see some improvement in these markets.

The area that is probably the largest challenge in this third quarter we're reporting and certainly from a financial standpoint and warrants the significant attention is our partner drive-ins. It is the largest factor impacting our earnings performance and when you look at the decline in same store sales, the unfavorable sales gap that has opened up between our franchise and partner drive-ins really kind of widened in the third quarter and it widened as the quarter progressed. There are several things that we're doing; several things we're focusing on to attempt to address this, not the least of which is the intensive refocusing on the customer experience that customers are having when they come to our partner drive-ins. We've done several things in terms of some of the leadership that is there, some of the leadership further into the organization, management placement, management restructuring as it relates to expansive control bringing more talent closer to these stores particularly in the more challenged geographic areas affecting spans of control. In addition to that we're bringing more service assessment tools to our, we'll do this across the system generally but particularly helping with our partner drive-ins to more fully understand the declines in service that are occurring and then over time to ensure that we're using those tools to not only deliver better service but to avoid some of the swings that we've, perhaps avoid some of the swings that we've had in the past.

In addition to that we are also looking at as we go forward some of the pricing initiatives or pricing flexibility we're going to have to be looking at, pursuing that more strategically perhaps than we have in the past. As we've had needs in the past we've addressed them fairly aggressively. I think going forward you'll be seeing us talk about and look at and implement smaller increases on a more frequent basis, then also using pricing even within marketplace. In the past we've probably looked at pricing more as a marketplace issue but prospectively we're looking at pricing much more on a trade area by trade area issue. So utilizing this in a way would be more effective in terms of customer embrace and less disruptive to our business.

I should say also about our partnership drive-ins, one of the things when we're looking at even at margins and some of the deteriorations of margins which Steve will talk about more in a few minutes, the recent initiatives which we are pleased with the outcome on a system basis is the Happy Hour initiative. By definition it involves some significant discounting. A majority of our franchisees already had that in place before we began promoting it nationally but the effect on our partnership drive-ins, because they did not have in in place in any of their drive-ins to speak of, the effect has been disproportionate to them while it has driven that afternoon side of our business nicely and should continue to going forward and as we get people looking at Sonic for their Cherry Limeades and their Vanilla Dr. Peppers and so on and so forth, keep those customers coming back. But the fact is that it has had a slightly disproportionate impact on our partner drive-ins from a discounting standpoint and in the short-term this kind of provides something of a drag on the check growth. But it does continue to be accretive to sales in the afternoon which is what its objective was and continues to separate us nicely from our major competition and really kind of puts us we believe, and there's a reason we did it and we'll stay with it, a strong position to continue to separate us versus our competition on these differentiated drinks.

Now the challenge is that we're talking about here with developing markets and partner drive-ins, particularly the partner drive-ins, is going to take us a while to address these. The developing markets in some ways may be a little bit more of a near-term issue in terms of promotional activity; the partner drive-ins is a little more complex issue and one which we're going to, we're applying significant resources currently but one we're going to clearly be reporting and monitoring over time.

As we look to the nature of these challenges I think this is basically, Mark, let's go ahead and go to the next slide here, As we look to the nature of these challenges in the more recent past, the system wide same store sales being slightly negative to the quarter, as was the case in each of the first two quarters of the fiscal year. The third quarter actually began with negative same store sales in the first month of the quarter. So this happened, we pointed this out in May when we had the release and broadcast of our conference, that each of the last three quarters, first, second and third quarter began their first month began with negative same store sales. In the first couple of quarters sales rebounded more nicely but in this case in the third quarter we had such a negative experience in March the sales rebounding in April and May, though they moved to the range that we previously communicated, in contrast to the first two quarters the improvement in the final two months of this third quarter simply wasn't enough to offset the poor performance of March. But at the same time as we look at this, it's very much a March story as it relates to sales.

The steady improvement over the course of the quarter should reflect to you, it does to us, the positive impact of the refinement of the promotional strategies. In other words, as you look in the fall into the winter the large part of what we were doing was focusing on Happy Hour and we were focusing on coffee, two initiatives that we needed to get into place, we put a disproportionate amount of resources in that direction. There's an opportunity cost to doing so because as you focus so heavily on afternoon, you focus on drinks, coffee, etc. even though some of those coffee drinks are ice cream drinks, etc., you don't get the same meal impact from a promotional standpoint, you don't get the late evening impact from a promotional standpoint. So there was an opportunity cost to doing so, so what we're referring to in terms of the shift in promotional strategy as we move through the quarter we got the benefit then of that shifting strategy where we got back to more ice cream and more meal promotions.

Also in contrast to the first two quarters partner drive-ins which reported same store sales increases that were slightly higher than the system for the first six months of the year, so our partnership drive-ins higher than the system in the first six months of this fiscal year underperformed the system by about 3.5 percentage points in the third quarter and this trend became more evident as the quarter went along. This is a very different picture versus our first two quarters. I'm being a little more forceful about this point but this is a large shift that began occurring in the third quarter and you can see this pictured here as same store sales versus partner drive-in sales, a very different dynamic both as to it being negative versus the system but also as being so negative as it progressed through the quarter. This is a picture that wasn't even altogether apparent about six, seven, eight weeks ago but rather something that had to play out over time to become fully apparent what the effect was.

Now on the traffic and check, as you can see here how this has continued to progress throughout the year despite the tough start in March when traffic was particularly hard hit by poor weather, we really were encouraged by the fact that the system wide traffic ended up positive for the third quarter. And as you can see from the slide our strategies have resulted in positive traffic for the third quarter but lower check for the system. If you break down the traffic and check trends for the months within the quarter, we experienced traffic declines in March but we had positive traffic growth in April and May. So again you can see how the business moves throughout the quarter. The increases in April and to a lesser extent in May were offset by lower average checks. And beginning in May and continuing in June we've geared our promotional strategy to achieve a little bit more of a balance between the day parts, the shifts I was referring to earlier, with the objective of increasing both traffic and check by providing a value offering with one day part or another, and the case currently this month, it's a 99 cent shake promotion, but also offering combo meals or premium sandwiches to drive these other day parts. The promotional change that was made in May continuing into this fourth quarter should have a positive impact to the system and to partner drive-ins as well and this is the trade-off we were referring to earlier about the winter coffee and Happy Hour versus getting back to a somewhat more traditional approach to our promotional activities now.

So while we're facing some more near-term challenges in our developing markets and partner drive-ins, our core and new markets continue to be strong and healthy. So we don't view this as a broad brand issue but rather some managing issues that we need to address in certain aspects of our business. Our view and our expectation is that changes in the promotional strategy combined with the solid performance of our core markets and the continued implementation of things like the retrofit and the 3D signs, as we move those into developing markets, should result in same store sales moving into 2% to 4% range in the fourth quarter, this fourth fiscal quarter. We anticipate also that the partner drive-in performance will continue to be 3% to 4% below the system in the fourth quarter and it's difficult to say how quickly we're going to be able to move partner drive-ins same store sales range back into that 2% to 4% range.

The partner drive-ins performance, the developing markets, the tougher consumer environment, increasing commodity and labor costs continue to have an impact on us in recent, past and coming months. And so the primary thing we can do in that environment is remain focused on improving sales in the fourth quarter and beyond which is exactly what we're doing. Over the long-term we continue to be focused on working to grow same store sales in the range of that 2% to 4% both for the system and for partner drive-ins. So our objective as we continue to look to our business, we've talked in the past about that multi-layered growth strategy, is still very much a part of our strategy today through the development activities that we have, through driving same store sales, through providing good investment for our operators across our system, and ultimately then providing operating leverage both at the store level and for our company. This is the strategy we have developed in the past and we remain on that strategy.

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

W. Scott McLain

We continue to see solid activity on the development front in the third quarter reflected not only by the opening of 41 new drive-ins but also in increased number of relocations, rebuilds and retrofits. During the first nine months of this year we completed 758 retrofits including 630 by franchisees already putting us within the range of 750 to 850 that we expected for the entire year. Approximately 50% of our system now has the new look. Relocations to better trade areas and the complete scrape and rebuild of existing drive-ins are also increasing. Last year our franchisees completed 35 of these more than double the average of the last few years. During the first nine months of this year 45 relocations or rebuilds were completed versus 25 a year ago and we expect our franchisees to complete 60 to 70 this fiscal year. Now we don’t' count these as new drive-ins but they do require a new drive-in to be built and they're probably our highest ROI activity routinely generating sales increases greater than 25%. Were we to count these as new drive-ins it would add roughly 2% to our overall system growth rate.

The increased focus on retrofit activity as well as relocations and rebuilds by our existing franchisees together with some tougher weather in the third quarter has had somewhat of a constraining impact on new drive-in openings which stood at 95 after the end of the third quarter, slightly less than our franchisees opened the prior year. However, when relocations and rebuilds are added to the mix the number of new drive-in openings is actually increased by 16, or 12% for the first nine months. We expect that our existing franchisees will continue to aggressively invest in relocations, rebuilds and retrofits over the next several quarters. After all as I mentioned it is our highest ROI activity. While this will result in a decline in new drive-in openings by existing franchisees from 122 last year to roughly 95 to 100 this year, we do expect that over time their focus will get back toward new drive-in openings. The good news on the new store opening front, however, is that we are seeing a strong pickup in openings from newer franchisees who should more than double their openings from 24 last year to approximately 50 this year and 75+ next year. So in total we expect our development activity this year will produce approximately 215 to 220 new franchise drive-ins consisting of 145 to 155 new store openings and roughly 70 relocations. In the aggregate this should be approximately a 20% increase over the activity of the prior year. We continue to be very optimistic as Cliff mentioned about prospects for increased new drive-in openings going forward based on our growing pipeline.

Our ADA commitment surpassed the 1,000 mark during the third quarter, a 34% increase from the same period a year ago. We also sold 481 development options last summer which gave existing [deeds] the right to open under the more favorable number six license agreement any time in the next five years. When you consider the development options on top of record ADA commitments, the committed portion of our pipeline continues to be at record levels. We're also beginning to see those increased commitments move through the pipeline towards new store openings. Franchisees had roughly 220 pieces of property under contract at the end of the third quarter, a 20% increase from the 179 that were under contract the same period a year ago. Projects under construction at the end of the third quarter were also higher this year.

As Cliff mentioned the performance of new drive-ins overall continues to be strong with average opening volumes now approaching $1.3 million roughly 30% greater than what we were seeing just three to four years ago. Volumes in the eight new states and many new markets that we've opened over the last 18 months have been even stronger averaging more than $2 million in sales during their first year and approximately $1.7 million in their second year. As Cliff mentioned we did open our first drive-ins in Michigan and Minnesota recently with very very strong sales. We ended the third quarter with 3,428 total drive-ins. With the new states we entered this month we're now operating in 37 states. We've also sold territory in several additional states and we're well on our way to becoming a truly national brand.

With that I'll turn the call over to Steve Vaughan our Chief Financial Officer.

Stephen C. Vaughan

For the third quarter ending May 31 our earnings per share declined 10%. For the first nine months of the fiscal year our earnings per share increased 10% from $0.58 to $0.64. The prior year figure includes approximately $0.06 per share in debt refinancing charges. As Cliff discussed the lower than expected sales of partner drive-ins were a major contributing factor to our disappointing third quarter performance.

Same-store sales at our partner drive-ins were challenging during the quarter decreasing 3.9%. Partner drive-ins performance did improve throughout the quarter but was consistently negative and ended up roughly 3.5 percentage points below the system. I would like to expand a little further on Cliff's earlier comments regarding partner drive-in same store sales. As we had discussed previously, March same store sales were significantly negative. For perspective March of 2007 same store sales had increased by approximately 9% as many of our core markets recorded the warmest and driest weather on record last March. In addition the Easter shift from April of 2007 to March of 2008 created a difficult comparison though the core performance in March of 2008 was not totally unexpected. In fact we remain relatively optimistic going into April particularly given the fact that April of 2007 had experienced negative same store sales due at least in part to cold weather last April. Further we expected the Easter shift to positively impact sales this April, however, April 2008 same store sales remained negative at partner drive-ins. This negative sales trend continued into the month of May but improved relative to March and April.

As Cliff mentioned we are addressing a number of challenges specific to our partner drive-ins and believe we are taking the appropriate steps to address the issues. However, it is unclear how immediate the impact will be. As a result of this recent performance looking to the fourth quarter we expect that partner drive-ins will achieve same store sales in the range of 3 to 4 percentage points below that of the system.

From an acquisition standpoint effective March 1 we acquired 11 drive-ins from a franchisee. These drive-ins have average unit volumes slightly higher than our partner drive-in average and we expect that they will add roughly 1 percentage point to our overall revenue growth over the next three quarters.

Our franchising income including franchise fees and royalties increased $2 million during the quarter. This increase reflected continued new store development, slightly positive growth in same store sales at franchise drive-ins, as well as the positive impact of a slightly higher royalty rate. Our royalty rate increased by approximately 7 basis points during the quarter. This increase was driven by our new drive-ins opening under the new form of license agreement that has a higher average rate as well as incremental franchising income from the license conversion which we implemented last April. Looking forward we expect franchising income for 2008 to grow by $12 million to $14 million versus the prior year.

Higher prices for several commodity items as well as higher labor costs resulting from the July increase in the federal minimum wage exacerbated by a decline in the same store sales resulted in drive-in level margins deteriorating by 138 basis points during the third quarter. The deterioration and other operating expenses a result of deleveraging from negative same store sales had the largest impact on third quarter margins. However higher commodity and wage costs as well as increased discounting associated with Happy Hour were also contributing factors. A decline in our minority partner share of earnings partially offset these items. Looking forward persistent increases in commodity costs coupled with the discounting impact of Happy Hour will continue to result in higher food and packaging costs. Next month we will [be back] to the December 2007 price increase which will be replaced with a much smaller price increase to partially offset another minimum wage hike effective July 24. Further, higher discounting associated with our Happy Hour program will likely result in a decline in our average check. The combination of cost pressures and higher discounting along with our weak sales trends are expected to result in significant year-over-year margin deterioration in the fourth quarter.

Looking to the bottom half of our income statement overhead costs including both SG&A and depreciation and amortization increased approximately 9% during the quarter. We anticipate these line items will continue to grow in the 8% to 10% range during the remainder of the fiscal year. I would also like to point out a couple of other items that impacted our results this quarter relative to last year. Other revenue declined $2.2 million versus the same quarter last year. You may recall that last year's results included a gain on the sale of real estate to a franchisee whom we had previously sold the operations of several partner drive-ins. The lack of a similar gain in the current year had a negative impact to earnings per share from a comparison standpoint of roughly $0.02 per share. As expected our income tax rate was 37.9% considerably higher than the 36.3% rate from the third quarter of last year. The higher rate this year had a negative impact to earnings of approximately $0.01 per share versus last year's rate. We continue to expect the tax rate will be in the range of 37.5% to 38.5% going forward but may vary from quarter to quarter as individual tax matters change.

While we are disappointed with our recent stock price performance, we continue to believe that the share repurchases we have made over the last two years will prove to be a good long-term investment.

As of the end of the quarter we had $37 million available under our revolving credit facility and expect our positive cash flow in the fourth quarter will provide additional available capital. We would continue to expect to use our existing credit availability and future cash flows opportunistically including acquisitions of additional franchise drive-ins or further share repurchases under our remaining share repurchase authorization of approximately $10.4 million.

Looking forward we believe the sales and [inaudible] challenges we have discussed on this call will constrain our earnings growth at least in the short term. For the year we now expect our earnings per share to be in the range of $1.00 and $1.02 per share. We are currently working through our annual business planning process and anticipate providing our fiscal year 2009 outlook in early September.

This concludes our prepared remarks and we'd be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Jeffrey Bernstein - Lehman Brothers.

Jeffrey Bernstein - Lehman Brothers

A couple of questions first, you talked about the gap of the company operated versus the franchise comp and it sounds like it did widen throughout the quarter. I know in your release you talked about that it could widen further from here. I'm just wondering why not assume further widening? What gives you comfort that it won't widen further? And forward why wouldn't you provide more conservative guidance for the rest of the year just based on the trends throughout the quarter?

J. Clifford Hudson

We may have a couple of reactions to that but one of them is the level of attention being given to these operators in their immediate past. Changes in some management even at supervisory level meaning when I use the term supervisory I'm talking about local market level, so some change outs in personnel decreasing spans of control, a higher energy focus at the market level, change in some leadership at the top, and the consequence of all these renewed focus on customer service, and performance of what's occurring at the store level, so you can look at and you can have the perspective that dynamics that set this in place six and nine months ago are still in place and to a limited degree that's true that it's kind of a shift that takes a little while tot urn. But with the personnel issues we're talking about the change and the level of focus at the unit level we should start seeing some impact in a relatively quick fashion to one degree or another. This is probably what gives us some optimism and there are signs already of some positive impact so we'll continue to measure that and report on it over time, but the fact is we're realizing positive impact.

Jeffrey Bernstein - Lehman Brothers

And then kind of a follow up to that, I know back in early to mid-May you offered 9% to 12% guidance for the full year. It seems like trends remained relatively strong in May as compared to the prior month. I'm just wondering in terms of visibility when you mention the company operated can seem to under-perform, was that really the primary driver I guess of the significant further reduction in guidance now to the 4% to 6% range? If so, if you could just talk about kind of broadly thoughts on visibility for yourself and some of your competitors looking out to next year with such short-term swings.

J. Clifford Hudson

One of the things that did transition in the last, we made reference to this earlier, in the last six or seven weeks, I want to give you a reaction that I think Steve Vaughan's going to, too, and that is that when we talked to you early in May the focus of our feedback to you and our own focus was in terms of what had occurred in our business intra-quarter, third quarter, was that March was a lousy month. And March was a lousy month I think for everybody in the industry. But it was a lousy month throughout our system both franchise and partnership drive-ins. What had not become apparent at that point even as the system was sort of going through some correction was that the partnership drive-ins basically went the opposite direction and that pattern that developed throughout the quarter and particularly then from a margin standpoint with the deleveraging, with the negative comps, was not the picture we were focusing on in early May because we didn't have that complete picture. So your question, are the partnership drive-ins more the focus of the story than they were the first of May? The answer's yes.

Stephen C. Vaughan

I would just add that really the difference, Jeff, was partner drive-ins and the deleveraging that occurred as their sales remained negative in the month of May. I think our view had been that we would see more relative improvement than we saw.

Jeffrey Bernstein - Lehman Brothers

And then just one last question on commodity quests, I was just wondering if you can give any thoughts on your outlook but more specifically can you talk about any recent changes to either the length of the term of the contracts that you're getting or perhaps the shift to more floating contracts versus fixed as you renegotiate with suppliers? There seems to be a lot of discussion from the supplier side of perhaps shortening the terms of the contracts and maybe looking to not lock in, getting a more floating price or having some escalator components.

J. Clifford Hudson

I don't know how specific we can answer your question other than to say that the commodity environment continues to be challenging really one very front and it has been our practice historically and we hope to have this occur prospectively as well to try to lock in costs to the extent we can, to remove some of the volatility that we had. However, as you point out it is more difficult to do that in this environment but we have successfully locked in some of our contracts, like chicken for example, but there are others that we're still looking for the right opportunity to do that.

Operator

Our next question comes from Joe Buckley - Bank of America.

Joe Buckley - Bank of America

I think you mentioned that the July 08 price increase will be less than the 4% you took last year. Can you go into more detail on what type of price increase you're planning and then in connection with that, is there any way to mitigate some of the national minimum wage changes?

J. Clifford Hudson

[Inaudible] a price increase that will probably be in the 1% to 2% range. We're going about it a little bit differently so it's a little more challenging to quantify but it will probably be in that range. We are continuing to look at options from a labor standpoint and how to address the continuing challenges there but we don't have anything at this point to discuss with you.

Joe Buckley - Bank of America

A question just on the partner drive-ins, I think the release mentions the service levels being an issue and I know we talked about this at the main meeting and it was sort of a perception that maybe service issues existed but it didn't sound like you were able to measure them at that point. Has that changed subsequent to the meeting?

J. Clifford Hudson

We have had methods of measurement historically but what we have been doing since that time is expanding some information that we already had but aggregating that and segmenting it in a way we had not historically. So we're not expanding the amount of data available to our operators and we're also in the process of expanding further still the depth and richness of potential data for what's occurring at the store level that will both provide data to the store level manager but also on a store level macro basis for us here at the company. So it's an ongoing process but one in which we attend to address more fully in the very immediate future.

Joe Buckley - Bank of America

And one last question on average check, I guess I was a little bit surprised that the average check deteriorated as the quarter progressed. Wasn't part of the issue in March that you were doing specialty coffee and Happy Hour and perhaps brought the check down and maybe talk about your thoughts on average check going forward? Have you proceeded with the Angus burger, for example, or any other higher check items?

W. Scott McLain

Well, Joe, I think the shift in the promotional strategy in May was to focus on the 99 cent regular cheese coney and then once we got people on the lot to up sell them to a bundle package of items. What happened is in March with the colder weather we don't sell as many drinks and so I think that's really why you would see in March, we saw a slight increase in our check. In April and May as the weather became more of a normal year-over-year comparison, the Happy Hour promotion had a disproportionate impact as I think it will continue to have in the fourth quarter and afternoon business which typically is a lower check time of day.

Stephen C. Vaughan

But we will have on lot, Joe, items such as the Angus burger and higher priced items that are attempted to drive check once the traffic gets online.

Operator

Our next question comes from Sharon Zackfia - William Blair & company, LLC.

Sharon Zackfia - William Blair & company, LLC

I guess I'm surprised this question hasn't been asked already, but is it fair to assume you're within your guidance so far in June?

J. Clifford Hudson

We haven't commented on June sales, Sharon.

Sharon Zackfia - William Blair & company, LLC

Steve, do you have the developing market comps if you excluded Florida and California?

Stephen C. Vaughan

I don't have that in front of me. We have looked at that and they do not, they look quite a bit better. They would not be positive but they would be relatively quite a bit stronger.

Sharon Zackfia - William Blair & company, LLC

And then I guess I'm still somewhat confused as to why partner drive-ins weakened so much as the quarter progressed. I listened to the whole call and I've heard what you said but it's not really clicking for me. And Cliff you're mentioning personnel changes and I'm not sure if you're talking about upper management or store level management or what's going on and how you're combating this and if it's something regional or broadly based that you're seeing at partner drive-ins?

J. Clifford Hudson

Well, I'll kind of do those in reverse order. It is regionally disproportionate in the much as we talked about developing versus core. In developing markets which would primarily be the Southeastern United States the poor performance is far greater than it is in our core markets so part of what we're seeing is being driven by broader environmental elements but I think that coincided with some operational challenges that we had there, some people challenges that we perhaps should have moved on earlier correcting. In some ways, Sharon, you could look at that as something that was unfolding over time and perhaps getting some momentum. As you look at the comps there is some element of that but the pace that it [inaudible] so you don't get it for the third quarter. I mean, I'm not being cute when I say to you my reactions to our folks is "I don't get it either." So earlier in the year we've got comps stronger than the system; we've invested quite a bit there and the result is not acceptable. So it's not a positive result to say that come unwound so quickly but the fact is that's the performance of the third quarter versus the first in particular and even the second.

In terms of your questions about at what levels, there are some changes from top to bottom. And I'm not saying by that all across the board. I'm saying that the guy who is overseeing that for us now is a guy who's been with us a dozen years or more and has probably 30 years restaurant operating experience in the industry, highly thought of in the industry, and highly thought of in our business, and he is now, he came to us years ago in our owned operations, our partnership drive-ins, for a number of years he's been on the franchise side in a leadership position, and he's now running our partnership drive-ins. That's Eddie Saroch. So you have some changes at the top but you're also talking about some changes in some of these weaker markets literally at the supervisory level and undoubtedly then continue on down to the store level, but specific changes that I have seen and he is making at the six unit supervisor level. So that's more detail maybe than you're asking for but it's a top to bottom review and it is a shift in expectations, but it is something that started coming unwound in a significant way in this third fiscal quarter.

Sharon Zackfia - William Blair & company, LLC

I know you have some things going on that are quicker or can get results faster than others, at least that's what it sounded like on the call, and there are some that are going to have more of a lag time. Are you starting to see any kind of stabilization in trends at company-owned units or is it really still kind of a crapshoot?

J. Clifford Hudson

I wouldn't call it a crapshoot but I would say making changes with Eddie and others in the last 45 days, it would be a little irresponsible of me to say we're seeing trends that you should bank on 60, 90 and 180 days from now. We have to give him more time to solidify these things, working on refining compensation structures [citivising] both the people at the unit and supervisory level, and these things have to be worked to where they make sense by market and then they have to be given time to work. So the guy's been on board I guess 45 to 60 days and I'm going to give him at least another 45 to 60 days to create a trend. And I'm not trying to be cute when I say that; it's just that this will take time.

Operator

Our next question comes from Steven Rees - J.P. Morgan.

Steven Rees - J.P. Morgan

I understand the negative mix impact from happy hour, but can you just talk about how traffic is trending at your partner stores or how it trended throughout the quarter at lunch and dinner and then if you're also seeing a negative mix impact at those day parts that you know maybe customers trade down to more, some other value that you're offering?

J. Clifford Hudson

Well, we have the traffic at our partner drive-ins did improve as the quarter progressed; however, it was negative. I think it started out significantly negative in March, still negative in April and was almost flat in the month of May. So we are seeing challenges there. Obviously we are growing our traffic in the afternoon which tells you that traffic in the other day parts is really dragging down our growth, lunch and dinner being the two most challenging day parts for us right now. And again I think we're doing some things, the 99 cent regular cheese coney, our recent promotion the Island Fire Burger, that will help us with those day parts but it will take some time.

Steven Rees - J.P. Morgan

And then are you seeing your average check pressure also at lunch and dinner?

J. Clifford Hudson

You know, I don't think that that's been a big issue for us at lunch and dinner.

Steven Rees - J.P. Morgan

To what extent do you think the Happy Hour occasion is replacing lunch and dinner sales? I mean do you think traffic would be weak at lunch and dinner if you weren't promoting Happy Hour?

J. Clifford Hudson

Well, the issues about lunch and dinner are broader industry issues. Those are not just Sonic issues. Those are issues that we've seen over time. In addition to that, what we have seen is we do best as we promote different product and kind of break through from a product standpoint, breakthrough meaning in the advertising area, and so the idea of simply promoting lunch and dinner by itself is something historically we've not seen drive our business.

Steven Rees - J.P. Morgan

And then my last question is on unit development going forward on the partner side. It sounds like the new markets are performing quite well but given some of the challenges you've seen in your developing markets from a same store sales and margin perspective, how should we be thinking of unit growth going forward? Are you still planning the 5% to 6% range for now or is a temporary reduction possible?

J. Clifford Hudson

Your question's about partner drive-ins?

Steven Rees - J.P. Morgan

Yes. Partner drive-in unit growth, specifically in fiscal 09.

W. Scott McLain

Well, historically we've kept partner drive-ins at what, about 30 to 35 new units a year and I don't see that changing significantly.

Operator

Our next question comes from Jake Bartlett - Oppenheimer & Co.

Jake Bartlett - Oppenheimer & Co.

We had just a quick question on what can be explained by the year ago comparisons? It looked like the partner same store sales were better than the franchise same store sales in the fourth quarter, so looking back I think some of that's due to pricing and maybe more retrofits on a comparable basis, but was there anything else going on a year ago last and going into the fourth quarter that can explain some of this widening gap?

J. Clifford Hudson

You hit on the things from a year ago. The capital investments that were being made really sustained our partnership drive-ins for a good period of time.

W. Scott McLain

I think the one other piece that may be occurring is our franchisees didn't take a significant price increase in the summer, as significant as we had taken, but they have gradually taken additional price where with the service issues that we've encountered on the partner drive-in side we've not taken any price since last July.

J. Clifford Hudson

The other dynamic you'll see at play now and it will grow is that our franchisees have started more widely implementing the retrofit program. And we had announced previously that by year-end we'd have 700?

W. Scott McLain

Yes.

J. Clifford Hudson

And we're easily on target for that one which is to say our franchisees are embracing the retrofit and we'll do every bit of 700 this year and so with that rolls, franchise stores will be getting today's benefit of it whereas our partnership drive-ins probably started that with some [inaudible] as much as two years ago. So we're not finished with our partnership drive-ins but they've got the earlier benefit from that.

Jake Bartlett - Oppenheimer & Co.

And you mentioned that the ROI units doing the retrofits were superior ROI to other uses of cash, so I guess that implies a pretty good lift for same store sales for retrofitted stores. Could you give us any indication on what the size of that lift is and maybe whether that lift is changing over time on a retrofitted store?

J. Clifford Hudson

I think what we said historically is the retrofit does best when you do it with other initiatives. This whole concept of momentum in our business and this kind of fly-wheel concept that there are a whole series of things that can help drive it, but the retrofit, the LED signage or as we say with the driving day part dollars the advertising due to that signing unit level, with that type of coffee, that type of Happy Hour, and so on and so forth, service initiatives, so all of these things are keeping that momentum going. As a matter of fact I think what we've not tried to say is that the retrofit alone is the key deal. As a matter of fact we tell our operators the reverse, do the retrofit and other initiatives to keep their business rolling. But those markets with the retrofit and the other initiatives continue to significantly outperform markets without those initiatives.

Jake Bartlett - Oppenheimer & Co.

And just lastly real quick, could you give us what same store sales were in the Florida market?

Scott McLain

No we don't break that out specifically.

Operator

Our next question comes from Christopher O'Cull - Suntrust Robinson Humphrey.

Christopher O'Cull - Suntrust Robinson Humphrey

Just starting out with the price increase, Steve, you said the 1% to 2% price increase you're planning next month. Can you maybe elaborate on how the increase will be different from the prior increase or maybe explain the lessons you've learned from the last increase and how that's going to be applied to next month's increase?

Stephen C. Vaughan

Well the biggest difference is just the percentage, Chris. We took 4% last July so we'll be taking less than half of that. But the way we're going about it is really looking at service levels, service scores at our partner drive-ins and those that have better service scores are really what we would use that as almost a qualifier to take a price increase and that's becoming kind of the main cut in terms of where we will take price. And we're continuing to go about it, to look at competitor pricing as well. But it will be much more drive-in level focused as opposed to market focused.

Christopher O'Cull - Suntrust Robinson Humphrey

Will the increases be targeted more towards the combo transactions or the beverages or desserts or - ?

Stephen C. Vaughan

I don't have that specific information for you.

Christopher O'Cull - Suntrust Robinson Humphrey

Okay. And then, Steve, would you describe your exposure to changes in boneless beef prices.

Stephen C. Vaughan

Well we are on a month-to-month contract right now for our beef supply and that is a significant challenge for us currently. We're seeing double digit year-over-year increases that looking out again we feel like in the fall that will come down but it will be a major challenge for this summer.

Christopher O'Cull - Suntrust Robinson Humphrey

Is that something you're trying to hedge or contract longer term right now or will you always be floating month-to-month?

Stephen C. Vaughan

Well historically we have been able to lock that in. Unfortunately we have not been able to, the premium that our suppliers wanted to charge us for that did not allow us to lock it in at a price we felt like was viable. We'll continue to explore that option. We would prefer to be locked in but it has to make sense economically.

Christopher O'Cull - Suntrust Robinson Humphrey

And then one last question just related to improving the service. Could you elaborate on what financial investments are required to improve service? Are we talking about additional labor hours in the restaurant?

Stephen C. Vaughan

The service fees - What's going to happen from a labor standpoint is to a considerable degree going to be a unit by unit assessment. The analytical tools that we're talking about are really quite moderate from an investment standpoint, so to the extent that you're talking about unit level margin impact, it's really more of a leadership sort of thing of how we get data, the varying nature of the data we get, how we slice and dice that, how we pull that together and put it in a form that is of benefit to our six or seven unit supervisor and store level managers. So that expense, while there is some expense to doing that on a system basis, is not a significant unit level expense.

Christopher O'Cull - Suntrust Robinson Humphrey

I was thinking more in terms of just have you cut back in the number of hours that are deployed at the restaurant level when you may need to increase the number of hourly employees or at least the number of hours that they're on staff at the restaurant level?

Stephen C. Vaughan

Chris, there may be some of that but I think we feel like the bigger payback will be making the incentive programs we have in place now and really narrowing the focus to be about the customer. So customer service as opposed to, our programs have become fairly defused and are looking at a number of different things that we're managing against, and I think what Eddie and his team are looking to do is really narrow that to the customer service. That may require some extra hours in some drive-ins but I don't think we necessarily see that as a system wide "we're going to go out and add 100 hours to every store across our system."

Operator

Our next call comes from Nicole Miller - Piper Jaffray.

Nicole Miller - Piper Jaffray

I was just looking back at store level margins like early on in the decade around 27% and since that time there's been a number of different macro cycles and you know inflationary environments, and I'm just trying to figure out sort of what would be a target store level margin over an extended period of time? I mean, is 22 going lower or can it go higher and what should it be and why?

W. Scott McLain

Well one thing I think to keep in mind as you look at some of those numbers from several years ago is minority interest is now included in our store level operating margins though it may be a little bit of apples-to-apples, Nicole, if you're looking at several years of apples-to-oranges looking at several years ago. So you need to include that minority interest number. And from just a run rate standpoint you know I think we are in a very difficult time from both a commodity and a minimum wage standpoint but these things tend to go in cycles and as we look out we should see some improvement. Is that 12 months from now or you know 18 months out? I think it's hard to see that far out at this point.

Nicole Miller - Piper Jaffray

And just king of thinking about I guess the operating margin as well, this gap between the partner and franchise same store sales. I think I understand that part of that's natural due to the remodel cycle and that the franchisees are accelerating that, but then I'm also thinking as those comps go up, shouldn't you see more leverage there and a higher, well more flow through and more leverage on that flow through? So at the operating margin, is it just not enough to offset the store level inflation?

W. Scott McLain

I'm not sure I understand your question. Can you - ?

Nicole Miller - Piper Jaffray

The franchise as the comps go up. It's more sales to you and those sales dollars have a higher flow through. So I'm just sitting here thinking, maybe there shouldn't be as much deterioration at the operating line as we see at the store level, if there really is a continued gap between the franchise and partner AUVs, or comps, excuse me. Maybe it's not all that bad. I mean, can you leverage the royalty on those dollars?

W. Scott McLain

Well we do think we continue to get a nice flow through from our incremental franchising income was $2 million and we did get some flow through from that. I think the challenge was again our partner drive-ins with a negative same store sales and the deleveraging that it more than offset that flow through from our incremental franchising income.

Operator

Our next question comes from Keith Siegner - Credit Suisse.

Keith Siegner - Credit Suisse

Just one quick follow up, I just wanted to circle back to what you were talking about with the pricing for July and the focus on the service scores as a way to maybe base the price. Is this distinct and/or different from the longer-term initiative to get to more of a store level pricing? In other words is that pricing tool going to be in place for July and is the service basis a major part of that or are these two different things?

W. Scott McLain

No these are two different things. We are in the process of testing a pricing tool that would be more of a proprietary kind of trade area demographic elasticity tool. But that is not going to be in place for this July price increase.

Keith Siegner - Credit Suisse

Is there even a tentative rollout schedule for that pricing tool yet or is it still too early because of where it is with testing?

W. Scott McLain

We have not discussed publicly a rollout plan at this point.

Operator

Our next question comes from John Glass - Morgan Stanley.

John Glass - Morgan Stanley

A couple questions, first Steve, what's your current view on the free cash generation of the business this year? How much free cash can you generate this year?

Stephen C. Vaughan

John, I think we will be, if you exclude acquisitions, we will probably generate somewhere around $10 million in free cash for the year.

John Glass - Morgan Stanley

And that includes, that's after cap ex but it's also including after some debt repayment? Is that correct?

Stephen C. Vaughan

That is correct.

John Glass - Morgan Stanley

And then how do you think about that next year? What I'm trying to get at is how much stock can you really buy back given those constraints? How much if you add your free cash next year plus your debt capacity, how much stock could you really buy back?

Stephen C. Vaughan

Well we're in the process of going through our FY09 business plan so until we ever nail down our cap ex requirements, I think that would be premature to give you an answer on that at this point.

John Glass - Morgan Stanley

Do you think cap ex falls next year though or stays about where it is in rough terms?

Stephen C. Vaughan

Well I think it will actually come down because the retrofit on the partner drive-in side is beginning to wind down so you should see a decline in cap ex in 09.

John Glass - Morgan Stanley

And then just going back to the developing markets, I know you don't want to talk about specific markets that are weak, but is there anything from the top line you can do? For example, are you able to do local marketing or accelerate that in those markets? Are you able to do different pricing in those markets or maybe different promotions in those markets that help sales? Is there anything that you can do from that side of the business?

W. Scott McLain

Well I think John there are certain things that we can do and are trying to do to impact sales both from the way we promote from a system fund marketing basis, the items that we promote, and at the local level all the way down to the store level in terms of promotional activity to drive traffic. So those are things that our marketing team is actively working on.

John Glass - Morgan Stanley

And then, Steve, could you just recap the commodity, you talked about beef being month-to-month and that's challenging. Can you maybe just run through a couple of the other key items, dairy, for example, chicken, whatever else that you've got that's currently either on contract and coming off or not on contract?

Stephen C. Vaughan

Well our largest remains are our syrups for our fountain drinks. Those are locked in on the long-term contract. That's about 16% of our cost of goods. Then we talked about beef which is about 12%. Dairy is about 12%. We do have some of our cheese costs locked in. I think it's roughly half through the, actually I think through the end of the calendar year, so 50% of that is on a floating rate. That will be up year-over-year based on the locked in prices but not to the extent that it has been. It's probably more high single digits. It will depend upon what the cash price is though for the blended average. And then our ice cream mix continues to be, we buy that on a monthly contract and it's actually roughly flat year-over-year but maybe slightly down. And then Scott mentioned chicken. 10% of our costs are locked in through calendar 2009. And we have several smaller items that are creating some pressure for us, bread, for example, is about 6% of our costs and it is a double digits year-over-year and continues to be a challenge.

John Glass - Morgan Stanley

If you rolled those all together, what would you say the rate of inflation is for your commodities for this fiscal year, 08?

Stephen C. Vaughan

For the fiscal year we're probably in the 5% to 6% range.

Operator

Our next question comes from Tom Fortay - Telsey Advisory Group.

Tom Fortay - Telsey Advisory Group

I had two broad questions. The first was I wanted to know, it seems like a lot of your QSR competitors are rolling out bigger beverage initiatives and I wanted to know if you were seeing any impact from that?

Stephen C. Vaughan

Well our beverage business continues to be extremely strong. We talked a lot about the Happy Hour initiative and we see just incredibly positive consumer reaction to the Happy Hour initiative so I don't think we're really seeing any impact to our beverage business.

Tom Fortay - Telsey Advisory Group

And the second question was I want to know if you saw any lift in May or if you attributed any improvement in May from a comp standpoint on the stimulus checks?

Stephen C. Vaughan

Well May was our best month of the quarter. Some of that may have been due to the tax rebates. It's very difficult to know you know what drove that. We think our promotional strategy changes also helped but it's very possible that the tax rebate checks were a help as well.

Tom Fortay - Telsey Advisory Group

And then last question if I may. I wanted to know if there was something you felt like with being a drive-in concept if higher gas prices had a greater impact on your business than maybe other QSR operators who didn't have that focus?

W. Scott McLain

Well in terms of just the format itself I can see why you would ask the question. However, I would also say that QSR predominantly throughout the country, QSR being located at primary intersections, shopping center parking lots, so on and so forth, QSR to a very very great degree is built around automobile traffic across the country. It's possible sitting in the core of an urban area that's less apparent but by and large in the country that is the case. So while on its surface there would be some, maybe some sense of that, I think that this is something to the extent that we're seeing the impact of increasing automobile fuel prices, as an example, sort of started spiking in March, that was felt on a widespread basis including by our competitors as well as us.

The other thing that actually might help in that regard is that our concept is not a highway based concept. We're very much a neighborhood based concept and so we are very convenient to a lot of customers. And it could well be that where our concept is located; we're actually more amenable to folks who may want to walk from a neighborhood to our shop versus most of our competition.

Operator

Our next question comes from Rachael Rothman - Merrill Lynch.

Rachael Rothman - Merrill Lynch

Can you talk a little bit about what initiative you have in place on the franchise side to ensure that we don't see the same ramp down in the franchise same store sales that we've seen in the company-operated as you guys lacked the introduction in some of the initiatives?

J. Clifford Hudson

A whole series of things, we're going to have the next one, two and three years of retrofit applications with the LED signage that we've talked about, we have growing marketing promotions with refined, we've now got the Happy Hour and coffee in place system wide so the refinement back to more of the day part strategy not leaving coffee and the Happy Hour, instead of using those as tags to other commercials. So the very initiatives that would be in place for our partnership drive-ins will be there for franchise drive-ins as well. And I'd also say that the initiatives that we're developing that are more customer service focused that our partnership drive-ins will have access to will be readily available on a system basis. So this is not something in terms of feedback from customers, etc., not something to be isolated to our partner drive-ins.

Rachael Rothman - Merrill Lynch

And has there ever been a time in your history where the escalating royalty rate has actually declined, where it actually works against you because comps are averaging at volume growth?

J. Clifford Hudson

No not in my 24 years.

Rachael Rothman - Merrill Lynch

And then can you talk a little bit about why the franchise unit growth is lower than the initial expectation that you guys had set for the 155 to 165 units. Is it because they're ramping up the remodels and relocations or is it because of margin headwinds or increases in construction costs or - ?

W. Scott McLain

Well I think, Rachael, what's happening is our existing franchisees are investing faster than we expected in the retrofit as well as doing significantly more relocations and rebuilds than they were a year ago. So the number of new store openings from them is lower this year. But if you take the number of new stores opening plus the number of relocations plus the number of rebuilds, their total activity is actually up. Our new franchisees are making up that gap to some degree and that should continue going forward. So I guess as we look at development overall our activity, while it may take a slightly different form, is actually quite healthy over the last year.

J. Clifford Hudson

I want to piggy back onto Scott's comments and particularly with the suggestion of some margin deterioration or performance being these guys are pulling away. Scott showed us why in his presentation. There was a stacked bar chart that showed what would traditionally just be new store development and it also showed relocations and rebuilds, which is going to be existing franchisees building a new drive-in either on the spot where their old drive-in existed or in that same trade radius maybe down the block. And then showing new franchisees so there were three segments stacked in that bar chart.

W. Scott McLain

What I showed for 08 is when you stack those three, there is a spiking of development activity with new and existing franchisees, not a decline. So if anyone gets the impression that our franchisees, okay you can see up on the screen there now, if anybody gets the impression that our franchisees aren't investing in the brand either through new store development or through rebuilding existing stores or through the retrofits, which will be over 700 drive-ins this year retrofitted, you've got the wrong impression. So in fact there is an enormous amount of investment going on in the brand and as you can then see, with new franchisees a lot of new attraction to the system. And it's paying off for them as they open these new markets.

Rachael Rothman - Merrill Lynch

And at what point should we expect the building backlog to translate into an acceleration in the new unit growth?

W. Scott McLain

As Steve mentioned we're going to give you our outlook for 09 in September but we are seeing some things that are encouraging, Rachael. For example, at the end of the third quarter as I mentioned in the comments we had, our franchisees had 220 pieces of property under contract. That's a 20% increase from the number of pieces of property we had under contract at that point a year ago. So we are seeing those ADA commitments move through the pipeline and that should translate into greater new store openings, particularly when our existing franchisees get further along in the retrofit and their relocations and rebuilds and kind of turn their focus back towards new store development.

Operator

Our next question comes from Paul Westra - Cowen and Company.

Paul Westra - Cowen and Company

Just two quick ones I guess for this time here, you didn't comment so much on the breakfast. You talked about lunch, dinner and the afternoon but could you talk a little bit about how breakfast is performing in the mix, holding up or not throughout the quarter?

W. Scott McLain

Well over time breakfast has been a very good growing day part for us. As we in the kind of winter into spring as we focused more on coffee and Happy Hour we had some slow growth in breakfast. I don't have figures for you but as we shift these dollars back, I mentioned earlier it's clear by focusing on coffee so intensely, drinks so intensely, there is an opportunity to [cost] for ice cream as an opportunity to [cost] for breakfast. So shifting, in fact we are shifting those dollars back at that point, excuse me, back now, and we should see some kind of renewed emphasis on breakfast from a promotional standpoint and I believe with results also. Breakfast does seem to be the day part that really is helped from just sustained reminder to the consumer, even if it's not new product news, just sustained reminder. It behaves a little differently from some of the other day parts.

Paul Westra - Cowen and Company

So on a year-over-year basis is it expected to [inaudible] down as a percentage of the mix?

W. Scott McLain

No. That's not a fair statement.

Paul Westra - Cowen and Company

But it's still okay.

W. Scott McLain

Breakfast is a multi-dynamic part of our business and there's a lot of opportunity for growth.

Paul Westra - Cowen and Company

And my last question for you, you actually referred to a little bit. What percentage of the media mix did, or weight or dollars, did the Happy Hour sort of take up the last three to four months and how much is going to be the ongoing percentage on a rough term?

W. Scott McLain

Well really if you look at happy hour it was a primary promotion in the month of March. We have now shifted to making it a tag so we'll be promoting another item and putting happy hour as a tagline at the end of the commercial. So that's really the main shift that we've made there.

Paul Westra - Cowen and Company

Is it primary, does that mean primary like over 50% of the budget.

W. Scott McLain

Typically it means at least 50%.

J. Clifford Hudson

In a given month, if it's the primary promotion it's getting most of the bucks. Don't over-react to that because there's a lot of ways national versus local and secondary and so on, so there's never a month where there's one thing going on only.

Operator

Our next question comes from [Brad Levington] - Keybanc Capital Markets.

[Brad Levington] - Keybanc Capital Markets

I just have a couple of quick questions, mostly on promotions. I apologize, I don't remember. Did you do half-price shakes last year and if not, comparing fourth quarter to fourth quarter could that have a negative impact on cost of sales?

W. Scott McLain

We did not do 99 cent shakes last year. We did do 99 cent root beer floats.

[Brad Levington] - Keybanc Capital Markets

Okay. And then have you commented on when the next promo change is? I know the Angus burger will probably pick up frequency a little bit.

W. Scott McLain

Well let us know what store you're going to and we'll do it right now. The promo changes generally occur on a monthly basis but that has variations, breakfast versus other day parts. But there is going to be new promotional activity every month.

[Brad Levington] - Keybanc Capital Markets

And then I apologize if I missed this, did you mention what the cap ex spend was in the third quarter?

Stephen C. Vaughan

No we did not mention that and I don't have that in front of me. We'll publish that when we file our 10Q, Brad. A couple more questions it sounds like?

Operator

Our next question comes from Larry Miller - RBC Capital Markets.

Larry Miller - RBC Capital Markets

I just had a couple of quick questions. Can you guys comment on the turnover and the morale in the partner side of the business? They're probably earning less money today. Is that contributing to the service issues, do you think?

W. Scott McLain

That's a little bit of a chicken and egg thing in terms of the quarter finished, did they make less money versus a year ago. The answer to that is absolutely. And is that a dynamic we like to see in place? The answer is no. Does that have a potential impact if it's sustained, does that have an impact on morale? The answer's got to be yes. Now the question about does it have an impact on service. Well it can but it's just going to depend on the individual circumstance. If we've got a circumstance where we've got some sustained lack of performance, having a change in management may improve service. So it's going to differ from one circumstance to the next but our objective for our operators, whether a franchise or a partner, is to have growth and profitability. So it's a dynamic that's not healthy for us or for them when that occurs.

Larry Miller - RBC Capital Markets

And then I know you have the unit pipeline to do that kind of long-term growth rate that I think you guys were targeting 18% or so, but is that still the right rate of growth for you guys given you know the trends out there?

W. Scott McLain

Well Larry I think we're working through our 09 planning process and we'll give you guidance for 09 beyond that.

Stephen C. Vaughan

In September.

Larry Miller - RBC Capital Markets

And I just had a thought and I wasn't sure if there was any seasonality in some of these new developing markets that we don't know about on sales?

W. Scott McLain

Well I think the further south we go they may have a little more of a kind of flat seasonality where the north may have a little more higher summers and little lower winters, but it's fairly comparable to the system overall.

W. Scott McLain

We appreciate the brevity of that last question and we appreciate all of you participating today. It was a difficult quarter and one that we would obviously prefer not to repeat, but in spite of the challenges of the quarter our perspective as we hopefully made clear today our perspectives when you look at our core markets, when you look at the new developing markets, a lot of good upside for this brand, a lot of base strength to the brand. So clearly challenges that we need to confront in our company operations, our owned operations, as well as in some of these less well developed markets. But we're highly mindful of that and attacking it as a management team. So we appreciate your engagement today. We appreciate your support prospectively. And we wish you all the best of luck. Thanks a lot.

Operator

This does conclude today's conference call. We appreciate your participation. You may disconnect at this time.

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