Jack in the Box Inc (JACK) 2010 Q2 法說會逐字稿

Good day, everyone, and welcome to the Jack in the Box, Inc. second-quarter fiscal 2010 earnings conference call. Today's call is being broadcast live over the internet. (Operator Instructions). At this time for opening remarks and introductions I would like to turn the call over to Carol DiRaimo, Vice President of investor relations and corporate communications for Jack in the Box. Please go ahead.

Thank you, Debbie, and good morning everyone. Joining me on our call today are our Chairman, CEO and President, Linda Lang; our Executive Vice President and CFO, Jerry Rebel; and Senior Vice President and COO, Lenny Comma. During this morning's session we we'll review the Company's operating results for the second quarter of fiscal 2010 and update guidance for the remainder of the year. Following today's presentation we'll take questions from the financial community.

Please be advised that during the course of our presentation and our question-and-answer session today we may make forward-looking statements that reflect managements' expectations for the future, which are based on current information. Actual results may differ materially from these expectations based on risks to the business. The Safe Harbor statement in yesterday's news release and the cautionary statement in the Company's Form 10-Q that will be filed later this week are considered part of this conference call. Material risk factors, as well as information relating to Company operations, are detailed in our most-recent 10-K, 10-Q, and other public documents filed with the SEC. These documents are available on the investor section of our website at www.jackinthebox.com.

A few calendar items to note. Jack in the Box management will be presenting at RBC Capital Markets consumer and retail conference in New York on June the 3rd and at Oppenheimer's consumer gaming lodging and leisure conference in Boston on June the 29th. Our Third Quarter ends on July the 4th and we tentatively expect to announce results the week of August the 2nd.

And with that I'll turn the call over to Linda.

Thank you, Carol, and good morning. Our performance for the second quarter was generally in line with our overall expectations, excluding lower gains from refranchising due to the timing of a transaction that closed in the third quarter rather than in the second. Jerry will address that transaction and refranchising gains in his remarks this morning. Also, Qdoba sales were better than our expectations and in a few moments I'll discuss what drove that improvement. Same-store sales at Jack in the Box Company restaurants decreased 8.6% compared with a year ago increase of 0.4%. The decrease was in line with the guidance we provided in February. We saw a sequential improvement in both one and two-year same-store sales trends in the second quarter, driven by improvement in transactions in average check. The average check in the quarter was lower than last year, which we attribute, in part, to several value promotions, including the continuation of our $3.49 Jumbo Deal through February and two breakfast promotions; two croissant sandwiches for $3 and two breakfast biscuits for $3.

While we've seen an improvement in our California and Texas Markets we don't expect significant improvement in underlying fundamentals at Jack in the Box until high unemployment rates in these major Markets for our key customer demographics begin to improve. Looking at our footprint, 44% of our restaurants are located in the 10 states with the highest unemployment, while only 2% are in the states with the lowest unemployment. In this environment we continue to believe the best way for us to drive traffic is by targeting our advertising to reach multiple consumer segments with concurrent messages focusing on both value promotions and premium products. To continue our ad reach we plan to increase our ad spend in the back half of the year.

Throughout the economic slowdown we've continued to reinforce our position as a premium brand with one of the most varied and innovative menus in QSR. An excellent example of this is the new product platform we debuted in the second quarter, our grilled sandwiches. To drive trial of our new grilled sandwiches, on February 23rd Jack in the Box offered a free grilled sandwich with the purchase of any large drink. Guest response was very good and there was a high attach rate. Our grilled sandwiches continued to sell well after the promotion and sustained a higher -- a high percentage of our product sales mix. In March, we introduced a new higher-quality french fry, which are crispier and maintain their temperature longer. These fries have the operational benefit of a shorter cook time and longer hold time.

We continue to maintain a robust pipeline of new products in various stages of development and test. Early in the third quarter Jack in the Box launched a grilled breakfast sandwich that leveraged the popularity of our new grilled sandwiches. In April, we upgraded our coffee by introducing a new Kona blend for hot and iced coffee drinks. Kona has considerable brand equity among coffee drinkers and is consistent with our premium positioning. Near the end of April Jack in the Box launched a Pick 3 for $3 promotion that leverages the variety of our menu and features hamburgers, fries, and some of our distinctive products like onion rings, mini churros and egg rolls. Guests can mix and match any three of eight menu items for just $3 plus tax. This margin-friendly promotion is a great value proposition for our guests and an opportunity for us to drive traffic. And this week, to keep our extensive line of beverages top-of-mind with consumers, Jack in the Box added a raspberry flavor to our smoothie and real ice cream shakes.

Moving on to Qdoba, we're very pleased with our 3.1% increase in system same-store sales during the quarter. We attribute this increase to higher consumer confidence and spending patterns of fast casual customers, as well as several effective marketing initiatives, including a new menu option called "Craft 2," which allows guests to mix and match smaller portions of some of Qdoba's most popular items; enhancements to our kids meals; an effective viral marketing campaign; and catering promotion. At both Jack in the Box and Qdoba our focus on training is favorably impacting service execution and guest satisfaction scores at our restaurants. We saw continued improvement in guest satisfaction scores in the second quarter compared to both the first quarter and a year-ago period.

We remain on track with our growth plans including continued expansion of the Jack in the Box brand into new markets. In early April we opened our first restaurant in Tulsa, Oklahoma, and this week we opened our first restaurant in Oklahoma City. We also recently broke ground on our first location in the Kansas City area. As we've seen when other new markets open, sales volumes in our new markets exceed our overall system average. In fact opening week sales in Tulsa topped $100,000. Throughout the extended economic downturn we have been effective in continuing to execute the key initiatives of our long-term strategic plan and reducing our cost structure. As a result, we believe we'll be significantly -- a significantly stronger organization when the economy does turn around and well positioned to achieve our goals.

And now I'll turn the call over to Jerry for a look at the financial side of our business. Jerry?

Thank you, Linda, and good morning. Second quarter earnings were $0.32 per diluted share compared to $0.51 last year. Refranchising gains were lower than last year by approximately $0.15 and below our internal expectation due to a delay in closing one transaction involving 21 restaurants with a new franchisee. That transaction has now closed with estimated gains of approximately $0.10 per share. The restaurants sold during the quarter had lower-than-average sales volumes and cash flows; however we expect these transactions to be $0.01 to $0.02 accretive to annual operating earnings in addition to generating the $7.5 million in cash proceeds. We did not provide any financing for the two deals at closed during the quarter, as our franchisees ability to access to the credit markets to purchase existing stores continues to ease. As of the end of the second quarter notes receivable from franchisees related to refranchising activities totaled $7.2 million, as we collected $3.3 million during the quarter related to previous transactions.

We currently expect third-quarter 2010 gains to be higher than third-quarter 2009 due to the timing of refranchising transactions. We expect full-year gains from the sale of approximately 200 Jack in the Box restaurants to total between $60 million to $70 million with total proceeds of $85 million to $95 million. The increase in the number of restaurants we expect to be franchised for the year is due primarily to transactions such as those that have already closed that have lower-than-average cash flows and gains. The rest of our P&L was in line with our expectations. Restaurant operating margin was 15.2% of sales compared to 16.5% last year. Our focus on cost control helped to mitigate the sales deleverage, which we estimate negatively impacted the second quarter margins by approximately 190-basis points. Food and packaging costs improved by 70-basis points, as year-over-year commodity costs were approximately 1% lower in the quarter. Despite a rise in the beef market, our beef costs were modestly favorable for the quarter as we had 100% of our import 90s covered through April.

We continue to demonstrate control over labor costs, as payroll and employee benefit costs were up only 20-basis points despite the 8.6% decline in same-store sales and we also continue to benefit from lower turnover. As we saw in the third quarter, franchise margins were lower than last year due primarily to franchise sales deleverage. We control the leases on a majority of our franchise locations and charge franchisees rent based upon the greater of a percentage of sales or a fixed minimum rent. As our underlying rent expense is fixed, lower franchise sales comprise -- compress the markets.

SG&A decreased by $8.7 million versus last year if we continue to take costs out of the business. Our refranchising strategy and planned overhead reductions resulted in about $5.2 million of the decrease for the quarter and $8.8 million year to date. In addition, roughly half of the $3.7 million decrease in advertising costs in the quarter and $9.2 million year to date was due to refranchising. The savings related to refranchising should continue. However, as Linda mentioned, we believe it is important to maintain our advertising weight, particularly in a tough sales environment. This weighting in Q3 and Q4 will result in $5 million to $6 million of incremental spending collectively, which is reflected in our SG&A guidance. Facility charges declined by $1.7 million and these may fluctuate quarter to quarter depending largely on capital spending and impairment charges taken in each period. We expect these non-cash charges to be higher in the back half of the year due to the timing of our reimage schedule and again, as reflected in our SG&A guidance.

We expect our incentive compensation to continue to be lower than last year in the third and fourth quarters; however, that benefit is expected to be offset by continued higher pension expense, which is non-cash. We repurchased 464,000 shares of our stock in the quarter at an average price of $21.54 per share. Through the first two quarters of the year we have repurchased approximately 2.6 million shares of stock at an average price of $19.44 per share and have approximately $47 million left to repurchases under the terms of our current credit facility and authorized by our Board. We also repaid approximately $21 million under our term loan during the quarter, as required. Our distribution sales were up 35% in the quarter versus last year as compared to 14% increase in Q1. The increase was driven by two factors; the number of stores that had been refranchised and an additional 114 locations that are now -- franchise locations that are now being supplied by our distribution centers, so we do expect this line to be higher for the balance of the year.

Before I review our guidance for the third quarter and fiscal 2010, I'd like to provide an update to our commodity cost outlook for the remainder of the year. Overall we expect commodity costs for the full year to decrease by approximately 1%, reflecting approximate 4.5% increase -- or decrease, excuse me, experienced during the first two quarters of the year. Commodity costs are expected to increase by approximately 2% in the third quarter and 3% in the fourth quarter as compared to prior year. The increase in the third and fourth quarters is being driven by higher beef costs, which accounts for approximately 20% of our spend. For the full year we are anticipating beef costs to be flat, with increases in the low double digits in the third and fourth quarters. And we have 40% of our import 90s covered through May at $1.44 per pound versus current market prices in the $1.75 to $1.78 per pound range. The increase in beef costs will be partially offset by lower chicken and bakery costs, which combined also account for 20% of our spend and are expected to be about 6% lower for the balance of the year.

Let's move on to the gui -- to our guidance for the balance of the year. For the third quarter we expect same-store sales for Jack in the Box Company restaurants to decrease 7% to 9% and systemwide same-store sales for Qdoba to increase from 2% to 4%. For the full year same-store sales at Jack in the Box Company restaurants are expected to decrease 6.5% to 8.5%. And based on stronger performance we've seen at Qdoba we are raising our full-year same-store sales guidance to an increase of 1% to 3%. And diluted earnings per share remains unchanged in the range of $1.85 to $2.05 per share.

Lastly I want to provide a quick update on the restaurants in Sacramento that were involved in the bankruptcy of one of our former franchisees. I am pleased to report that the process to market and sell the restaurants has been successfully completed by the trustee. Of the 70 restaurants involved, 56 have been transferred to five acquiring franchisees to date, one restaurant was reacquired by the Company and three were closed. 10 restaurants remain to be transferred to one of the acquiring franchisees and these transfers are scheduled to be completed by the end of the month.

And that concludes our prepared remarks. I'd now like to turn the call over to the operator to open it up for questions.

Thank you. (Operator Instructions). Our first question is from Joe Buckley. Your line is open.

Hi, thank you. Can I ask you a question about the competitive discounting environment in QSR. From our perspective it looks like it's easing a little bit, I guess I'm curious what you're seeing? And maybe in conjunction with that talk a little bit more about the incremental advertising spend you're planning in the back half of the year and where that'll be targeted?

Sure, hi, Joe. Competitive discounting is still -- I would still call it a very competitive environment, not only from the QSR players but also the casual dining players. As you know Chili's just announced bringing back their 3 for $20 deal in a couple of the targeted markets that are challenged and those are big markets, California and Texas. So we are seeing a lot of couponing. We are seeing some discounting -- heavier discounting, I would say, in California. And then, of course, Burger King has come off of the $1 double cheeseburger but they've moved on to the $1 Buck Double I believe it's called, so that's still a pretty discounted product. But maybe versus a couple of quarters ago a little less competitive, however still competitive. Breakfast was a very competitive daypart with McDonald's rolling out the value menu. However I can say our breakfast actually held up pretty well. It was the best performing daypart that we had and we actually increased our sales mix at the breakfast daypart.

And then regarding the ad spend, we had made some shifts in our media buys that allowed us to increase, or at least not reduce our media weights in the first and second quarter. However, those shifts have been made and so really the only way to maintain our media weights in the back half of the year is to spend incrementally, so we'll continue with the marketing strategy in terms of the spending in three areas. Premium top-tier product introductions, so you'll see the grilled sandwich and potential extensions on the grilled sandwiches. Value messaging, and those messages will be around bundled meals again. We have the three for three -- "Pick 3 for $3" and then of course breakfast bundled meals, as well. And then we also have introduced the new Kona coffee, which would have some media behind that, as well.

Okay, thank you.

Our next question is from Jeff Omohundro of Wachovia. Your line is open.

Thanks. Just first a little bit more on the refranchising gains. In the press release there was mention of $0.15 decrease impact related to timing of such transactions and then I think if I caught it right, I think Jerry said there would be a $0.10 addition from the 21 unit sale in Q3. I'm just, I guess, first curious about the difference between those numbers?

Yes, Jeff. The $0.15 is really referring to the delta from last-year's second quarter. The $0.10 was a deal that we closed in the third quarter that we had originally anticipated closing in the second quarter that was a new franchisee. Sometimes the new franchisee deals take a little longer with a little extra due diligence on the part of the lender and that was the case here and that's what shifted that from a Q2 deal into an early Q3 deal. That deal has, in fact, closed, though, and reported $0.10 a share.

So the $0.10 number would be comparable for Q2 I guess?

Exactly.

Okay. And then I guess a high-level question. I'm just curious how satisfied you are with the balance of value across the menu -- balance of value with premium given current sales mix? Thanks.

Yes. We know that we have to offer value but we are careful not to significantly erode margins, so when we have put our bundle meals together, for example the "Pick 3 for $3," we're seeing early -- nice early results in terms of the mix and it's also pretty margin friendly because we've added in the side items, which are -- have the higher margins, So we want -- we know we have to offer value but we don't want to significantly erode margins and we don't want to do anything that will damage the brand long term. Very good, thank you.

Our next question is from Chris O'Cull of SunTrust. Your line is open. Thanks, good morning.

Thanks, good morning.

Good morning.

Linda, McDonald's mentioned recently that they do not expect to see much commodity pressure the balance of the year so no need to really get aggressive with pricing, how do smaller chains that are experiencing commodity cost pressure respond when you've got the 800-pound gorilla not raising prices?

Right. We take a pretty cautious approach on pricing increases but we will be working with our outside consultants to analyze whether or not there is an opportunity to take price at some point, so that will be work done with our outside consultants.

Any read yet from the tests that you may have done?

Nothing that we want to share.

Okay, fair enough. And then, Jerry, boneless beef prices they've spiked in recent weeks but appear to be coming down. What comfort can you give investors when you see weekly spikes in beef prices? For example, how many days or weeks can you be out of the market -- and specifically talking about the beef 50's -- before you have succumb to paying the higher prices?

Yes, it takes -- Chris, it takes about three to four weeks of the current spot market to work itself into our systems. We have some flexibility there but because the 50s are, in fact, fresh there's not nearly as much flexibility with the 50s as there is with the 90s.

Can you help follow up -- as just a follow up can you tell us what your expectation is for the beef 50s in the back half?

Yes, we are looking at beef 50s plus or minus about $1 a pound.

Okay, great. Thanks.

Our next question is from Matt DiFrisco of Oppenheimer. Your line is open.

Thank you very much, just two questions. I think when you look back at 3Q from a year ago you mentioned something, I think there was an insurance settlement with respect to investments that you had. How much was that in the G&A did that benefit?

In the third quarter or second quarter last year?

It was in the third quarter of last year. I'm just trying to figure out when we look at fiscal 3Q modeling purposes your G&A has been favorable last two quarters, you mentioned advertising being one source of something to consider in the back half a little higher but I also saw you had a market performance of insurance. You phrased it as attributable to market performance of insurance investment products that came out and helped to offset pressures in G&A last year?

Yes, the mark-to-market on the insurance product in the third quarter. We'll have to get that for you, it's not right at the top of my head but we can get that for you after the call.

Okay, but I would assume that's also another source of something that you didn't have in 1Q and 2Q so also looking at how 3Q, as far as in absolute dollar terms, is not as easy to be controlled, I would guess, or contract on a year-over-year basis?

Yes, we were actually -- if you look at the total mark-to-market differences, say, in the second quarter, we were actually unfavorable by $1.2 million in the quarter and we still delivered nice reductions in our SG&A costs.

Okay, that's good to know.

And again the advertising, while a piece of it was less than the pure cost reductions related to refranchising in our overhead cost reductions (inaudible) late last year.

Okay. And then just to understand your same-store sales comments with respect to unemployment, Texas is obviously one of those states that has below national levels of unemployment. Are you inferring then that Texas would be -- is doing stronger than California or I think in the prior calls you were saying California, actually you were calling out in the last call, was getting -- was outperforming your overall markets?

Yes, California is outperforming the Texas markets. Both improved in the second quarter but Texas is a more challenged market for us. I think you'd have to look at unemployment among our consumer, among our demographics, so it's the younger male and Hispanic.

Okay. And I guess you're also looking at when does -- the Texas comparable same-store sales must be more challenging also from a year ago, is that correct to assume and when does that normalize for your internal model? When Texas looks and feels more like the rest of the country other than being one of the better performers from a year ago?

Texas was positive up until Q4 of last year.

Our next question is from Jeffrey Bernstein of Barclays. Your line is open.

Great, thank you. A couple of questions, one just on the follow up to the premium versus value discussion. Being that you are a smaller player relative to some of your peers, how do you measure whether you're spread too thin. When you split between the premium and the value, perhaps how do you measure that success? And would you expect would the increased spend in the second half, is there potential to raise the contribution you're getting from your Company and/or franchise stores?

Yes, the incremental spend is coming from the Company, not from the franchisees, so it is an incremental spend from the Company. We look at -- we have -- we do analysis every time we have a product or a promotion or a value message that gets communicated so we are able to analyze the impact in terms of sales, traffic, and margin related to that particular promotion, so that's really how we know whether or not it's successful.

In terms of the idea of being maybe spread too thin, how do you get comfortable that it wouldn't be better to go all value or premium at a point in time rather than trying to be all things to all people?

Really, we have done several different scenarios and tested different scenarios and we believe that you need to see the message so it's important to have enough weight behind the message to generate the traffic if it's a value message or new product introduction. But over time after a couple of weeks of seeding then we're able to put weight behind both of those messages effectively.

Okay. And then just separately, could you give us an update on where we stand on the restaurant reimage program, perhaps the cost and the comp lift and how much more time we think until that will be fully completed?

Yes, we are a little better than 50% complete on the full remodel. All of them have been completed on the exterior and we continue to roll through the remainder of the interiors and we expect to be through with those by the end of fiscal 2012. We've -- what we've said without providing a lot of detail is that the remodeled locations, their sales are holding up better than the locations that have not been fully reimaged so we feel it's important to continue with that reimage program. And we're currently -- in terms of the (inaudible) we're about two-thirds of the Company-operated locations are completely reimaged as of now.

Our next question is from Robert Derrington of Morgan Keegan. Your line is open.

Thank you. A question if I could on your be -- your commodity outlook. We've listened to some hand ringing over higher beef prices but Linda, one thing that I think typically your purchasing has done pretty well is contract and do it pretty well, so I'm just curious. When we look at the overall +2% for Q3 and +3% in Q4, your product mix generally are margin-favorable products, how much of those higher commodities can you offset with your mix typically?

Well, we do factor in the commodity costs and we have done a really good job in designing and reciping products and putting together value promotions that are, as I said earlier, margin friendly and actually have a lower food cost so I think there is some benefits to that, especially something like the grilled sandwiches that is not a beef product. But if -- Jerry, if you want to talk specifically on the offsetting of the commodities, the purchasing?

Yes, Bob, you're right in that we don't have a lot of deep discounts on our beef-related products and that certainly helps the process for us, and that will lessen the impact of the significantly-higher beef costs going forward for the balance of the year. But I will tell you, though, because of some of the promotions have focused on some value -- breakfast as an example with the "2 for $3" biscuits, the "2 for $3" croissants, and the big deal promotion that we -- or the "Jumbo Deal" promotion that we had, those are a little lower margin. They aren't substantially lower but the mix is actually hurt us a little bit on the margin line in the first and second quarters, but of course, it would have been a lot worse had we been deep discounting on the burger product.

Okay, and then a quick follow up, if I may. On the guidance you provide, which we appreciate, the G&A typically you provide it to us as a percent. The percent is based on revenue, revenue which includes distribution sales, which vary dramatically, I think, from what probably most of us have expected.

Right.

Have you considered giving that to us on an absolute basis a range of number that's a little bit easier to understand and model?

That's a fair point. I'm not going to give it to you today but we'll certainly consider that going forward.

Okay, thanks for that.

That's a fair point.

Okay, thanks, Jerry.

Our next question is from Keith Siegner of Credit Suisse. Your line is open.

Thanks. I just had a question about breakfast. So, despite McDonald's launching the dollar menu at breakfast, you did have a couple other initiatives like the breakfast specials you mentioned and talked about how breakfast was the strongest of the dayparts. I just want to clarify that that was dayparts and not product mix for breakfast products? And assuming that it was daypart, how were breakfast products mixing across the whole day because I would imagine that the promotions have to sell pretty well at lunch and dinner, as well, and could that have had any impact, say, on check if you got trade down to discounted breakfast products at lunch or dinner from otherwise higher products?

Yes, I don't have the specifics on the top of my head but generally we don't see a lot of breakfast outside of the breakfast daypart, up until noon or so.

Even with an aggressive promotion?

Can you repeat that question?

I just said, even with an aggressive promotion it still doesn't mix that high at lunch and dinner?

No. Generally what you see at lunch and dinner is the core breakfast products that people are hooked on and are buying at different dayparts, they continue to sell during those dayparts but the new products and the advertising behind it really draws people into the breakfast dayparts.

Okay and then one last question, if I may. Just an update on the long-term averages we should be using when thinking about the refranchising program because I don't think we've gotten an update since you changed the program to be five years. We're getting a lot of volatility quarter to quarter and that's fine, especially when we get margin-accretive nature immediately even if the proceeds are lower, but how should we be thinking about those averages for the last three years of the program? If you can give an update that would be great.

Yes, let me -- I'll get you part of the way there. If you look at the full fiscal year and the mid point, say, of the proceeds and the gains that we're forecasting, they're certainly lower than what our historical average has been. The proceeds will average about 450 this year and average gains about 3.25 based upon the mid point again. But if you look at -- there's really two factors there. One are the 30 restaurants that we sold in the second quarter that had the gains and the proceeds that we talked about and we have visibility of one additional larger deal either in the third or the fourth quarter that will also have lower-than-average proceeds and gains, although not nearly as low as that second quarter deal was. So when you look at the balance of the year, absent those two transactions, we're going to see the balance of the year with respect to proceeds and gains look a lot like what our historical average does, and so I hope that helps. And a current preliminary view of 2011 would also suggest a return to more normal proceeds in gains that, but I will caution you that that is very preliminary at this point and of course, things do ebb and flow.

That's very helpful, thank you.

Our next question is from Tom Forte of Telsey Advisory Group. Your line is open.

Great, thank you. On refranchising in the second quarter and the one that took place early in the third quarter was there a geographic concentration? I know in the past you talked about refranchising the whole Santa Barbara market, for example, so there was something specific to the geography of the refranchised locations?

Yes, there was. The deals that closed in the second quarter, Pacific Northwest, and the early third quarter deal was in Central California.

Great. And then any thoughts on quantifying? There was a lot of locations in Texas and California, Texas in particular, the bad weather in the March quarter, any thoughts on quantifying the drag on comps from bad weather?

Yes, it's really difficult to do so we tend not to really look at the weather impact.

We know it's a common excuse, we hate to use it though, because you also lap it the next year.

Yes, and the weather's getting better now.

Right.

Okay, thank you.

Thank you.

Our next question is from Bart Glenn of D.A. Davidson. Your line is open.

Thank you. You talked a little bit about the improving environment for financing for the refranchising process. I was just curious, you're now looking at 200 units that you anticipate you'll refranchise this year, should we think about it as a faster run rate in terms of number of units that you might be able to refranchise per year going forward? Thank you.

I think our expectations of being 70% to 80% franchised by the end of 2013 gets you pretty close to a high of 100 to a 200 restaurant run rate anyway, so we're not anticipating anything faster than that going forward.

Okay, thank you.

Our next question is from [Matt Vendley] of Stifel Nicolaus

Yes, hi, I'm on for Steve West today. I guess just a little more detail on the refranchising expectations. You increased the number of stores expected but didn't change the gains, is this primarily from the deal that you were just talking about that's expected third or fourth quarter that's not going to have very high average gain?

Yes, it's actually more related to the deal that we just -- the two deals that we closed in the second quarter totaling 30 restaurants because some 30 restaurants have an average gain of $100,000 a unit doesn't move the average -- or it doesn't move the total gains numbers that much. As I mentioned, the third or fourth quarter deal, which is also expected to have lower average gains and proceeds, that will be higher, though -- substantially higher than what the 30 restaurants were that we sold in the second quarter.

Okay, and then just a follow up to that. Have there been any changes or can you give us any more update on what the proceeds are expected to be used for or is it just continue to be between share repurchases and debt paydowns?

Yes, it's the -- I'll give you the standard response, which is we continue to reinvest in the business, both through new restaurant growth and through reimaging our restaurants, and then we'll have the required debt paydown although I wouldn't expect to pay down debt beyond what's required. And then we still have $47 million worth of share repurchases left and that authorization expires in November of this year.

Okay, thank you.

Our next question is from Larry Miller of RBC. Your line is open.

Yes, thanks. I just wanted to follow up on the beef pricing right now. Jerry, what's your thought about extending those beef 90s or increasing the percent of coverage and just your thought on the market trend into the second half. Is it your expectation you're going to wait and then contract or can you give us some color on that? Thanks?

Yes, Larry, if -- our coverage right now through May is at $1.44 for import 90s if we could extend that coverage trust me we would have already done so. We haven't been able to get that coverage to date. We continue to monitor, though. We have our commodity guys looking at that information daily and several times a day so if we have a chance to jump back in and get some favorable rates on the beef we will absolutely take that coverage. What our current guidance has going forward, though, is that the coverage expires in May when we would have no coverage going forward, which is what's included in our guidance right now.

Okay, great, that's very helpful. And then can you just explain to me the negative margin on the distribution, why that might be and then should we be planning for that to continue?

You probably should plan on that to continue modestly until the overall sales volume picks up. It's really sales volume against fixed cost, so with the franchisee sales also trending lower on a same-store sales basis that's what's causing the drag on the margin there.

Okay, thank you very much.

Our next question is from Conrad Lyon of Global Hunter Securities. Your line is open.

Yes, hey, a quick question on the refranchising maybe geared towards Jerry. Have you seen the structure or has the structure of the deals changed, especially with some of the bigger buyers, in that maybe we see a change in the royalty structure at all going forward compared to historical levels?

No. What we do is there are from time to time when we will be able to negotiate a little higher royalty rate from time to time but we aren't planning -- other than one off location by location and negotiation we are not planning any reduction in our royalty rates.

Okay, thank you.

Our next question is from Joe Buckley of Banc of America. Your line is open.

Thank you. I wanted to follow up on a couple of things. First on the marketing again, so the first half of the year did you say you were able to maintain the media weights, approximately spending a little bit less money or spending the same amount of money year over year?

Yes. No, we did maintain the rates and we spent -- yes, we maintained the media weights because we did some shifting from national to local.

Okay. And in the back half of the year the incremental $5 million to $6 million is that because rates are starting to rise to maintain the same weights?

No, it's just because of the sales situation, Joe, that we're --

Oh, okay.

-- we're having to -- yes, to spend.

Okay, and then a follow up on the food. Jerry, you talked about the 50s thinking plus or minus a dollar. I think the latest data point I saw that was trading at about $1.15. I'm not going to say I understand the spikes and peaks and valleys of the hamburger meat market but does it have to come down quite a bit for that number would imply for your food guidance to hang together?

Joe, yes, you're right, it is at about $1.15 now. Remember, again, that's going to work itself into our system in about three to four weeks so we do have limited flexibility with that. But overall for the entire quarter we are expecting about a dollar and some of that will be due to seasonality but that's where our current thinking is. Clearly if it stays at $1.15 for the balance of the fiscal year we're going to have under forecasted beef costs.

Okay, and --

I don't think it's going to stay there.

And then last question on the commodities. You shared the chicken plus baked items, roughly the same 20% composition as beef and being down about 6%. Talk about some of the other maybe big areas what you're seeing, like on dairy or soft drink prices, things like that where you stand?

Sure. Let me tell you some of the other key items. Cheese is probably the other item. You're looking at cheese and pork that are each about 5% of the total purchase. They're going to be up in the mid double digits, like in the 14%, 15% range in that area. And then what you're going to see on the downside is you're going to see shortening, which is going to be down low double digits and you're going to see potatoes, which is actually 8% spend, that's also down low single digits. So when you do the weighting on all of that, Joe, and you also look at beverages, which are basically flat and that's about 10% of our spend, that's how we get comfortable with this 2% and 3% increase respect every third and fourth Quarter.

Okay. Okay, thank you.

Yes.

Our next question is from Chris O'Cull of SunTrust. Your line is open.

Thanks, I just had one follow up. Jerry, if my memory is correct last year in the third quarter sales started out pretty strong because of the launch of the mini platform but then they really started to fall off about half way through that quarter. Is that correct? Is that a correct trend?

You have a tremendous memory.

Yes, that's very true, Chris.

Okay, great. Okay, and then one last thing. On the beef 90s, after the coverage expires in May, what does your guidance assume for beef 90s? And I apologize if you mentioned this.

Yes, let me -- I'll tell you that. We are in -- after that we're in the, call it, mid $1.70 range, $1.75, $1.78 in that range.

Great, thanks.

Our next question is from Jonathan Waite. Your line is open.

Did you disclose your franchisee comps in the quarter?

We did not.

And what were they?

We do not disclose them.

And why is that, why is the reason? I'm wondering if they're seeing same trends you are?

Yes, it's not -- if you look market by market it's very much aligned with the Company.

Yes, they aren't materially different.

Yes.

Okay, okay.

We've always just -- we had Company because we were a majority Company so at some point we'll consider shifting.

Yes, we're at 50% -- almost 50% here.

Right.

Yes, exactly.

Okay. On the -- you made the comment in 2011 you expect to return to more normal gains in proceeds. What exactly would you term as normal gains?

Well, if you look historically, the gain, call it in the 450 range plus or minus and the total proceeds $600,000, again, plus or minus what I would consider to be normal and I say where we have the better visibility is in the back half of 2010 and that's what we're seeing for the back half of 2010 absent that one additional larger market deal that I just described earlier.

Okay, all right, thank you. Appreciate it.

Operator let's take one more question because I know that some folks have to jump on another call here shortly.

Thank you. Our last question is from Michael Wolleben of Sidoti & Company. Your line is open.

Good afternoon. I was wondering if you guys could just touch on here your confidence in hitting that -- your restaurant operating margins between 15% and 16% since we're looking at the back half of the year was commodity costs up 2% and 3% and then these comps continuing decline. Should we be leaning more towards the low end of that 15% operating margin?

At the mid point of our EPS guidance we're right about the mid point of that range, so as you get down towards the $1.85 level, if we hit that God forbid, we'd be more in that 15% range and if you get north of $2 on our EPS you'd be more in the 16% range. But yes, we feel pretty good about that given where our expense control has been thus far this year. And while beef costs are up, yes, let's also remember that we have the commodity complex, which is trending down 6% until the back half of the year. And of course we did 15.2% this quarter on a down 8.6% comp.

Right. Okay, great. Thanks.

Great, excellent.

I think that's all the time we have for today. Thanks for joining us and we look forward to speaking to you next time.

Thank you.

Thank you. This concludes today's presentation. You may disconnect at this time.