Jack in the Box Inc (JACK) 2018 Q2 法說會逐字稿

Good day, everyone, and welcome to Jack in the Box Inc. Second Quarter Fiscal 2018 Earnings Conference Call. Today's call is being broadcast live over the Internet. A replay of the call will be available on the Jack in the Box corporate website starting today. (Operator Instructions) At this time --

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Please go ahead.

Thank you, Chris, and good morning, everyone. Joining me on the call today are: Chairman and CEO, Lenny Comma; and Executive Vice President and CFO, Lance Tucker.

In our comments this morning, per share amounts refer to diluted earnings per share, and operating earnings per share is defined as diluted earnings per share from continuing operations on a GAAP basis, excluding gains or losses on the sale of company-operated restaurants; restructuring charges; and the impact of tax reform on the company's deferred tax assets as well as the excess tax benefits from share-based compensation arrangements, which are now recorded as a component of income tax expense versus equity previously.

Adjusted EBITDA represents net earnings on a GAAP basis, excluding discontinued operations, income taxes, interest expense, gains or losses from the sale of company-operated restaurants; impairment and other charges; depreciation and amortization and the amortization of franchise tenant improvement allowances. Our comments may also include other non-GAAP measures such as restaurant operating margin, restaurant-level EBITDA, franchise margin and franchise EBITDA. Please refer to the non-GAAP reconciliations included in the earnings release.

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 management's expectations for the future, which are based on current information. Actual results may differ materially from these expectations based on the risks to the business. The safe harbor statement in yesterday's news release and the cautionary statement in the company's most recent Form 10-K are considered a 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 Investors section of our website at www.jackinthebox.com.

A few calendar items to note. Jack in the Box's management plans to attend Baird's Global Consumer Technology and Services Conference in New York on June 6, Oppenheimer's Annual Consumer Conference in Boston on June 19 and Jefferies Consumer Conference in Nantucket on June 20. Our third quarter ends on July 8, and we tentatively plan to announce results on Wednesday, August 8, after market close. Our conference call is tentatively scheduled to be held at 8:30 a.m. Pacific time on Thursday, August 9.

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

Thank you, Carol, and good morning. As we reported yesterday, our second quarter results were in line with our expectations, and we made significant progress toward creating an asset-light business model that is less capital intensive. During the quarter, we completed the sale of our Qdoba business and began shifting our strategic focus solely to the Jack in the Box brand.

Among reported other notable highlights, our restaurant system surpassed the 90% mark for franchise ownership; we amended our credit facility to increase our borrowing capacity; and we resumed our stock buyback program, which got a boost last week, and our Board reaffirmed its commitment to return cash to shareholders by authorizing additional $200 million for stock repurchases. In addition, we added 2 key executives to my leadership team in Q2, including: Chief Operating Officer, Marcus Tom; and Chief Financial Officer, Lance Tucker, who you'll hear from in a few minutes. It was a very productive quarter, which should position us well for the future.

This morning, I'd like to review our top line performance during the quarter and what we're doing to drive traffic and sales in the back half of the year. I'd also like to share our priorities for the remainder of the year, including some opportunities, markets we've identified to strengthen our restaurant operations.

Q2 system same-store sales decreased slightly while company same-store sales grew nearly 1%. A greater emphasis on value contributed to a sequential improvement in traffic during the quarter and an incremental improvement in under $5 transactions. The incremental improvement in those transactions was driven by 2 promotions in the quarter. The first was a second iteration of our value Jack's Way LTL, that featured 4 items at the $1 through $4 price points. Late in the quarter, we shifted to a $3 bundle featuring 3 tacos and a drink that will continue -- we're continuing to promote in Q3.

We continue to see the impact of the value wars, which have been negatively impacting margins at many of our major competitors. Instead of increasing the level of discounting, we chose to spend an incremental $1.5 million for additional advertising in Q2. This protected our company and franchise restaurant level margin while avoiding the potential long-term consequences of training our customers to only come to us when we are offering an aggressive deal.

We were also able to protect margin in the quarter by balancing our value offers with premium products, including a new Food Truck Series of sandwiches and our current LTL, the Cholula Buttery Jack, a line extension of our Buttery Jack burgers.

Looking ahead, over the back half of the year, we have a couple of innovative products planned for the menu, including a new offering that we've tested with great results. It's a snack item that will come in at a lower price point, but deliver a lot of food for the money. We will follow this up by promoting some of the differentiated items that we believe only Jack in the Box, which is a unique QSR player, has a license to promote.

Major priorities for the remainder of the year include remodels, completing our refranchising initiatives, expanding delivery in our mobile app, improving the consistency of restaurant operations and updating our long-term strategic plan.

As for delivery, it continues to generate an incremental lift in sales that will continue to expand that part of our business. We're now offering delivery in all of our major markets with 2/3 of our system being served by one or more delivery companies, including DoorDash, Grubhub and as of the second quarter, Postmates. We expect to continue to grow our footprint as our delivery partners expand their coverage into other markets, including more rural areas.

Moving on to our mobile app. We're expanding the test, as it's been performing well. On average, we're seeing a higher ticket with mobile orders, and we continue to believe we'll be in a position to begin rolling it out by the end of the year.

One of our long-term initiatives is elevating the brand's image through restaurant remodel. The investments required will largely be tiered depending on sales levels, meaning locations with lower AUVs will get less investment than those with higher AUVs. We believe these investments are critical to maintaining and improving our brand relevance. You'll see us in partnership with our franchisees implemented over the next 4 years.

Moving on to refranchising. We're rapidly nearing completion of this important initiative. We sold 53 Jack in the Box restaurants to franchisees in the second quarter and 29 thus far in Q3. Our franchise mix now stands at 93%, and we currently have signed nonbinding letters of intent with franchisees to sell 17 additional restaurants, which should bring the Jack in the Box franchise mix to approximately 94%.

Now I'd like to share some observations and opportunities identified by our new Chief Operating Officer, Marcus Tom. Although he's only been with us for about 90 days, he has spent his time not only gaining an understanding of our operation, but evaluating the opportunities that could accelerate performance going forward.

Looking at the positives, he's been most impressed by our strong culture, the pride that employees display throughout all levels of the organization, our ability to deliver a very extensive menu and our commitment to food safety. As for key opportunities, he's identified means to elevate and improve the consistency of training and brand standards and an even simplified kitchen operation. He believes we can achieve simplification through the rationalization of redundant SKUs, replacing single-use equipment with faster, more versatile equipment and by modifying or eliminating certain prep steps. The net effect of simplification will be a faster and more consistent guest experience.

As we sought out our new COO, we were looking for someone with great leadership and operational experience, combined with an owner's mentality. I believe we found this in Marcus, and I'm very excited to see him hit the ground running.

Lastly, we recognize the need to update you on our long-term guidance, including the cadence of G&A reductions as well as EBITDA, CapEx and free cash flow targets.

Let me start by shedding some light on how we plan to address G&A. Our desire to get our company in line with more asset-light companies, and we expect to move quickly to this position as we roll off the transition services agreements we currently have in place with Qdoba.

While in sale of Qdoba, Apollo had begun compensating us for the shared services that we're providing. So you'll begin to see a reduction in G&A in the back half of the year, which is reflected in our lower G&A guidance. We understand that some functions are expected to transition within the next few months while others could extend through the next year. As that happens, we'll begin putting our go-forward structure in place. To assist us in building the right structure to support our long-term strategic plans, we have engaged an outside consulting firm. We tasked them with finding significant cost savings and efficiencies, while also maintaining support necessary to drive growth. We're also in negotiations to sell one of our corporate support centers and consolidate our corporate offices in San Diego from 2 buildings into 1, resulting in a reduction in utilities and upkeep costs.

We expect to be in a position to share our long-term guidance with you in connection with our earnings release in August.

Before turning the call over to Lance, I'd like to take this opportunity to introduce him to you and share what I was really looking for in a CFO. I wanted someone who would come in with a franchise mindset, curious about the ways that we could drive growth through our franchisees, both in same-store sales and in new units. From my conversations with Lance, I really felt like he was the type of person who will approach the business with that level of curiosity. He was also the Chief Administrative Officer of a major public pizza chain, so he had a lot of experience beyond finance. And I wanted a person who can break those folks from various departments and have a great perspective on their part of the business. I think he's a great addition to the team, and I'm happy he chose to join us.

With that, I'll turn the call over to Lance for a more detailed look at the second quarter and an update on guidance for the year. Lance?

Thank you, Lenny, and good morning, everyone. Let me start by expressing how very excited and grateful I am for the opportunity to work alongside such a strong management team to help grow the Jack in the Box brand for many years to come.

Now moving on to our operating results for the second quarter. Operating EPS was $0.80 as compared to $0.86 last year. The decrease was driven primarily by the impact of refranchising, higher impairment charges and SG&A costs as well as higher interest expense. These were partially offset by a lower tax rate and a reduction in the share count.

Jack in the Box systemwide comparable sales declined 10 basis points in the second quarter. The 90 basis point increase in company comparable sales was comprised of pricing of approximately 2.5%, slightly positive mix of 10 basis points and the decline in transactions of 1.7%. Franchise comparable sales declined to 20 basis points in the quarter.

Company restaurant level EBITDA margins increased by 250 basis points to 26.4%. The increase was due primarily to the benefit of refranchising, which was partially offset by wage and commodity inflation in the quarter as well as higher maintenance and repair expense. Restaurant level EBITDA margin for the 138 stores we currently intend to keep after the refranchising initiative is complete was 28.3% in the quarter.

Franchise EBITDA increased by 9.4% to $57.3 million, due primarily to the refranchising. G&A increased to approximately 2.5% of systemwide sales as compared to 2.1% last year. The increase was due primarily to a negative mark-to-market adjustment and higher incident compensation.

Qdoba results are shown as discontinued operations for all periods presented, including the Qdoba direct level G&A. Our shared service G&A, which supports both the Jack in the Box brand and the Qdoba brand, remained in continuing operations until the transaction closed on March 21. Following the close, we have a transition services agreement in place with the buyer, under which we are now being reimbursed for the cost related to Qdoba.

In addition, SG&A as a percent of revenue was higher by or due primarily to $1.5 million of incremental spending for advertising as Lenny has already discussed.

Tax Act reduced our federal statutory rate from 35% to 21% effective January 1, resulting in a blended statutory federal rate of 24.5% for the fiscal year. Including state taxes, our adjusted Q2 effective tax rate was 29.8%, which excludes the $0.02 impact from onetime adjustments related to the Tax Act.

Our estimated tax rate for the full fiscal year will be approximately 29%, again excluding the impact of the onetime adjustments from the Tax Act.

We repurchased 1.1 million shares of stock for $100 million to end the quarter, and weighted average shares outstanding decreased by nearly 6% versus last year. With the additional $200 million authorization approved by our Board last week, we now have approximately $280 million available for share repurchases.

In March, we announced an amendment to our credit facility, which extended the maturity date by 1 year to March of 2020. The amendment permits an extra half turn of leverage to 4.5x. We view this as an interim step while we work with our advisers to evaluate longer term financing alternatives following the completion of our long-term strategic point out.

Our leverage ratio was approximately 3.4x at the end of the quarter. I'd like to reiterate that we are comfortable taking the leverage up to 5x EBITDA. And once we wrap the critical steps of completing the long-term strategic plan and evaluating the various financing alternatives with our advisers, we do expect to move quickly towards this new capital structure.

In the second quarter, we refranchised 63 units, bringing our full year number to 85. The year-to-date proceeds are $48.3 million, which does include $31.5 million of short-term notes receivable of which we've already collected $9 million. As of today, we are now 93% franchised.

Moving on to guidance. As Lenny mentioned, we will provide updated long-term guidance along with our Q3 earnings release in early August. Our systemwide comparable sales guidance range for the third quarter is flat to up 1%. Through the first 4 weeks of the third quarter, we are tracking within this range. Our fiscal year guidance in the press release is unchanged, except for the following items which I'll point out.

Based on our results to the first 2 quarters and taking our Q3 guidance into account, we lowered our system full year comparable sales expectations for flat to up 1%. We expect G&A for the year to now be in the range of 2.3% to 2.5% of system sales, with a lower run rate in the back half of the year due primarily to the reimbursement of Qdoba-related support costs under the transition services agreements, and partially offsetting our lower G&A expectations is incremental advertising spend in the last 2 quarters of the year, resulting in expected SG&A of 12% to 12.5% of revenues.

That concludes our prepared remarks, and I'd now like to turn the call over to the operator to open it up for questions. Chris?

(Operator Instructions) Our first question comes from Brian Bittner from Oppenheimer.

I understand you don't want to rush the long-term financial guidance. I get that. But it seems like you kind of have by this time a pretty good handle on the really important moving pieces that ultimately drive how you do think about the long-term earnings and free cash flow goals. So can you just first just help us understand what maybe holding you back at this point from giving us those targets sooner as opposed to waiting another 3 months?

Brian, this is Lenny. Keep in mind, the pace at which we roll off the TSAs will largely impact our ability to put the G&A and the structure in place that we believe will drive the strategy going forward. So we don't want to jump the gun on that. We also want to be in a position where we are finished with the refranchising and also have an updated fighter financial plan before we go out to look at debt going forward and how we would service that. So there's some pretty big moving pieces that we're not going to rush because we're not going to put ranges out there, targets that, at this point in time, we're not able to narrow it to the point that really would makes sense to the investment community. I think as folks are looking at their models, they certainly have an idea of some of wide ranges, as do we. But we're going to be really responsible about putting the pieces together for the strategic plan before we go out with those details. So look, we've got an outside adviser that we're bringing in to look at our structure. I will say that our company has been very good at reducing G&A in the past, and I'm confident we can do that going forward. I just want to be in a place where, as we look to our business as compared to other asset-light businesses, that we don't miss opportunities to find efficiencies because we're caught in all paradigms. So I'd like to hear what they have to say before we move forward. And then my 2 new executives, both my COO and CFO, really have just come out of training here in the last 30 days. I want them to influence this plan. I don't want to hand them a plan that they could have improved upon, had they been part of the process. So it's -- we're talking about 1 quarter that could set the stage for the long-term liability of the company. And although I know folks are anxious for that, I'm not going to be irresponsible enough to have 2 new recruits, an outside partner to tell us about G&A, refranchising to complete and the rolling off TSAs. All of that will be largely settled or at least well understood over the next 90 days and put us in a much better position to give you better targets for the long term, I think is the right thing to do.

No, it's very clear. And with the new repurchase authorization that you announced yesterday, can we expect an ASO [ratable]? Or just in general, the more aggressive way to return this cash due to repurchases more in the near term, just particularly in terms of where the stock price is today?

And this is Lance, so I'll take that one. For right now, we're likely to stick with open market repurchases here. Again, less to what Lenny just talked about, we need to work through what the new financing structure is going to look like. We're working with advisers on that. We want to make sure we're in a good place with the plan overall, which again, it's just about a 90-day delay here. So we will be in the market, and I won't go any deeper into it than that, but we will certainly be in the market by (inaudible)

Yes. Brian, I will just add. You look in the 10-Q when it comes out. You can see that we bought the entire $100 million worth in a 4-week span here in this last quarter. So we can sort of be in the market in different ways other than perhaps going through an ASR.

Okay. And then last one and I'll get out. Just on the comp, I guess, it sounds based in your commentary counts to be positive here in this quarter. But it seems as though you are still kind of at this negative gap to the industry. What do you think is continuing to drive the underperformance versus the industry? And where do we go from here as far as -- I know you've talked about innovation, a good lineup for the back half of the year, but what really is going to drive a sustained mobility back to kind of this 2% range where you're used to you guys comping, historically?

Yes. I think the simple answer that really tells us, or at least explains the gap to the industry is value. I mean, at the end of the day, what's out in the marketplace today is very aggressive. We've chosen not to be as aggressive, but we've chosen to participate. We even like to protect margins over the long term. We see other folks take a pretty sizable hit to their margins right now. And I've been saying for a long time, it's not sustainable and it simply isn't. I mean, if you look at the fact that these are all asset-like businesses primarily that have large franchise base, you've seen lots of commentary recently on franchise margin, you've seen a lot of commentary on franchise health. I just don't think that businesses are being responsible for the strategy in place that essentially, in the short term, makes the corporation look strong, but in the long term isn't sustainable as the franchisees can also be strong alongside you. So we're just trying to take a balanced approach to that. We've been using more advertising dollars to drive the sales at this point in time than discounting, but I think it's the better move to retain our equities. Because at the end of the day, the consumer is choosing us for more than just value today, and I don't want to train them to believe that the only way to use us is value. So -- look, it's a balancing act. We can turn on the juice, but I just don't think that at the end of the day, it's worth the squeeze.

Our next question comes from Chris O'Cull from Stifel.

On the last call, you indicated quite a bit of confidence in the comps still accelerating in the back half of the year, with the introduction of some of these new products, some you mentioned, I think in the script. But so I'm wondering if your expectation for these products has changed? This may be why the guidance was lowered for the full year?

Yes. Really, the confidence in the back half of the year hasn't really changed very much. It's the results in the second quarter that came in lower than I would have liked to see. At the end of the day, the early performance, for example, of the Buttery Jack, Jewel Buttery Jack, although it did bolster sales of the overall Buttery Jack line, we didn't see enough of that -- out of that individual product. Although we had some pretty good hits on the value side, again not enough to essentially be on a place where the map will work out. I mean, at the end of the day, if we're a little stronger in Q2, I'd feel -- felt just fine keeping guidance where it was for the year. But it's a little bit too much ground to make up. And although we're confident how we'll perform in the back half of the year, I don't want to feel like we're throwing Hail Marys.

Yes, fair enough. And then, I believe the company invested in a mystery shopper program for the system. Are there any initial reads from the data that you've collected from that program?

Yes. We -- so a couple of things. The program, first of all, was put in place to really help the franchisees identify the inconsistencies in their business, and we're seeing them. I mean, essentially what we see is our weekend business, our late-night business and when it comes to the guest experience, are the weaker parts of our business. So there's an extreme amount of focus that needs to be there. We think some of that's related to management scheduling, the restaurant managers and other leadership being available during the highest dayparts and/or days of the week. And so we'll be working with our operations to make sure there's an extreme focus on that. But our operators have also given us some feedback as they started to see and can turn to the detail that they'd like to see us really try to simplify the operation. And so as I stated in my prepared remarks, Marcus has identified a handful of things that although they wouldn't change the quality of the food, they could potentially improve the consistency of the guest experience quite a bit. So that's really what the mystery guest was put in place to do, was to identify the opportunities. We'll keep it in place until we start to see improvement. And then we also have VOG and other guest monitoring programs we can use to make sure that we're sustaining that improvement. But this gives us a little more of a micro focus then we would have had otherwise.

Okay, great. And then just lastly, Lance, from the past, the company's provided what the AUVs were for the stores it plans to continue to own. Could you update us on the AUVs for those stores, maybe like the last 12 months average?

Yes, Chris, I sure will. Good to hear from you, by the way. They are kind of in the mid-2s, so 2 4, 2 5, in that range.

Our next question comes from Greg Francfort from Bank of America Merrill Lynch.

It's actually JonMichael on for Greg. I just wanted to ask on the cadence of refranchising in the back half. You mentioned 29 sold so far this quarter, with 17 commitments. Should we assume sort of like last year, where you had an even split between 3Q and 4Q?

Well, it looks like 3Q, we'll have more to focus. Obviously, we got to close on the deals, but we're getting close enough to these things now to feel like it'll be skewed towards 3Q.

Got you. And then on the commodity side. I'm just wondering where you're seeing inflation or deflation. Is that impacting how you're approaching value?

Well we think a piece of that and the other folks want to take some of what we're looking at as far as commodity, the commodities outlook, we can add some color there. But it's really not. What's driving our decision, more than anything else is, the desire to balance our need to be competitive with our need to keep the consumers having a relatively high take rate on the premium items on our menu. So we're going to guard against trimming them to buy down, while at the same time, we have to have enough promotional activity in the form of discounts to stay competitive and at least keep the competition within our sight.

Yes, and I'll just add to that. In Q1, you remember, we had inflation of over 5%. It was 3.6% this quarter. So the inflation in the back half of the year will be lower than it was in Q1 and Q2. And I think like most companies, one of the biggest inflationary items has been potatoes for the entire year, and that continues for most of our competitors, as well as of ourselves.

Our next question comes from Alex Slagle from Jefferies.

So the question is, how we should think about the advertising strategy going forward, both in terms of the creative, that it looks like more about the brand and personality, less on the food? And also if you could elaborate on the strategy to put more price points out there in front of consumers.

Yes. So first, let me say, we really are still emphasizing the products, but what we're -- what we've done essentially is brought back some of the humor of Jack woven into the ads. I think we had tapered that back maybe a little too much, but the emphasis will still be on the food, and you'll see that going forward. And then as far as the multiple price points, the multiple price points is really just -- it relates to what I answered in the previous question. We want to keep the competition in our sights. We will periodically, when we see what's going on in the marketplace, whether it be $4 and $5 bundles or multiple price points, we will add to the noise and hopefully mute some of the effect that competitors get and also draft off of some of those deals, but that's not our core strategy. Our core strategy is going generally going to be bundling of what we believe to be items unique to the Jack in the Box menu like tacos with other items in our menu, and/or LTOs, that are typically in the form if either new, completely new items or line extensions for example like the Cholula Buttery Jack. So hopefully that gives you a picture of what you can see from us going forward. And as I stated in the prepared remarks, one of the things we really want to focus on in the back half of the year is more around new news. So we've got at least one item that will be a line extension to a product that's unique to Jack in the Box. It's not a sandwich. And we think that's going to be, going to garner a lot of attention from the consumer. We've actually improved the product by adding even more protein to it, and we think the consumer's going to respond very favorably to it. And then the snack item is just a decadent item that is a lot of food for the money and sort of fits right into the price point that the consumers are attracted to right now, but we're doing it again more like Jack would, where they're unique, they're uniquely packaged, the price point is competitive, the quantity of food is significant and it'll -- it's features sort of a late-night item, but available throughout the entire day.

Our next question comes from Andrew Charles from Cowen.

Lenny, the implied guidance for 4Q same-store sales, the midpoint's around 2%, which is pretty much in line with what the Street was thinking prior to today. So I'm curious what gives you confidence that 4Q same-store sales improve from 3Q on a 2-year basis. You mentioned that 4Q is going to include a line extension of an item unique to Jack. Is this showing signs of stress in test markets and thinking a little bit more outside the box here, no pun intended, while balancing obviously, to guys do balancing, what could be transient headwinds from SKU rationalization.

Yes. So I don't think the SKU rationalization is going to have a little impact fiscal '18. I think that's -- even if we do decide to rationalize some of the SKUs, they will be largely not even noticed by the consumer. I mean, it's -- at the end of the day, when you have a fresh set of eyes on the business, one of the examples Marcus talks about is, the number of cheese sauces we have, or the number of bread SKUs that we have. When you look at how many various bakery funds or cheese sauces we have, and at the end of the day, we can consolidate some of those without drastically changing any of the products that we make, it's easier for the restaurants to operate. So we're going to focus in on the (inaudible). We'll do some taste testing make sure we don't ruin anything, but at the end of the day, it makes sense to. That will take a little bit of time, I don't think it will have a significant impact this year. But as far as the confidence in Q4 and any type of acceleration here, we -- the product that we'll be extending, the last time we promoted this we did get a fairly high take rate on this product. And it's been quite some time since we've promoted it. And then again, not only promoting the existing product, but with the line extension as well, so really confident we'll perform well. And then also, we've got a little bit of a rollover effect associated with the hurricane last year that should also bolster the conference to be able to read the (inaudible)

Got it, okay. And then, just around the new food, beneath the new equipment. Can you give us a sense for how expansive of a kitchen refresh is needed? And what level of investment will be required from the franchisees? And is this something that you plan to partner with them? Or is this something that they'll be funding themselves?

Yes, so the franchisees actually were the ones who initiated the conversation. Some of our franchisees run multiple franchise offerings from competitors that are not necessarily near in the QSR states but certainly are in the fast casual and casual dining space. And some of the equipment efficiencies that they found in their other operations, they're asking us to implement at Jack in the Box. So we actually have, I want to say, close to 20 pieces of equipment in franchise stores today. They're being vetted through our franchisees. Our supply chain is looking at several alternatives to those pieces of equipment to see what works the best. We generally don't contribute to equipment when we're looking to make changes in the restaurant operation. So in the facility in general, with the remodel, there's typically a contribution. For equipment, we may help with some type of lending facility or something, if folks want a little bit of help in that way, but we typically don't have a direct investment on equipment.

Our next question comes from Mary McNellis from Robert W. Baird.

One just on the model. On the franchise expense side, as you near the completion of the refranchising strategy, how are you thinking about how that franchise expense ratio should look for fiscal 2018 and longer term?

Yes, this is Lance. I think we would probably cover that all once we get to the refranchising and give our guidance, in conjunction with the fourth quarter release.

Fair enough. And on the console look for the second half, you talked about a couple of internal factors that are giving you confidence in that outlook. But does the guidance for that second half contemplate any expectations for the environment to improve as well, maybe behind some of the tax cuts that are implemented earlier in the year?

No, we haven't contemplated that, although I would absolutely love to see it.

Our next question comes from Robert Derrington from Telsey Advisory Group.

Lance, along the line of the last question around the franchise margin, sort of the EBITDA margin. Is the mystery guest program, was that the principal reason why the margins were lower year-over-year? Or was there something else?

Bob, in fact, it was. It was a little bit over half of the variance and then the remainder was just kind of flat-to-down a little bit franchise sales just a small amount of deleverage. But really, this big driver was, in fact, the mystery shopper program.

Is that a program that we should be expecting that you will continue on an ongoing quarterly basis?

Yes, this is Lenny. We will continue to have some type of guest tracking system in place. We've always had a guest tracking system in place, but we'll continue to have something in place really for the foreseeable future. It may not be this specific program. And as we look at bringing down our G&A, we would largely offset these types of investments with reductions in other places.

Got you. And Lenny, if I may one, one last. As you look at the refranchising program, I think you talked about you're roughly 94% after you complete the upcoming refranchising with the LOIs. Should we expect that, that essentially will kind of bring the formal program kind of to a close and there may be some onesies, twosies as we go forward?

I believe the answer to that question is yes.

I'll just say, Bob, if you -- Lance's remarks, we commented about the 138 stores that we intend to keep, that's really what we've been saying all year long. So that will get you right around 94%. The onesies, twosies can change that as well as fully franchised openings over the next several years.

Our next question comes from Jeff Farmer from Wells Fargo.

Just following up on an earlier question. How effective has incremental advertising been for you guys in the past? And I think that's my understanding that you either just recently used incremental advertising or you plan to over the balance of the year?

We have used incremental advertising already, and we will continue to use, not as much as we did in Q2. And I would say that this time, I would have liked it to be more effective than in actually was. But I think it was the better decision, because we essentially contemplated doubling down on some additional discounting or beefing up the advertising and trying to bring more attention to the broad range of products, and we chose path number 2. That generally works for us, and it did certainly help in Q2. But obviously, if I were -- gotten a little more out of it in Q2, it would've helped me to keep long -- keep the annual sales guidance in place and we did have to bring that down a little bit. So I would've liked a little bit more out of it. Still believe it was the right decision. We won't be as aggressive with it, don't believe we will need to be in the last 2 quarters of the year.

All right. Then unrelated, you did touch on it, but in terms of I think roughly 1/3 of the system's been working with DoorDash for I think a little bit more than a year. What can you share with us in terms of sales lift, incrementality, demographics, daypart trends? Any of that information? You have one of the longest views into delivery for a quick service company versus your peers out there, and it would be very interesting to hear how you guys are seeing this business evolve?

Yes. So I'll say a few comments on that. It's something Carol's also been very curious and interested in, so she may have a view.

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tidbits as well. But in general, we do see that delivery is largely incremental. And in order for this to make sense for us, it needs to be largely incremental. The contracts with the third-party providers really only work financially if these are incremental sales. So I think we can check the box on that so far, and we feel pretty good about it. Second thing, the consumer in all of our research is essentially not just in restaurants but also, as you can see us in retail, they are redefining convenience and delivery is -- I think it's here to stay I think for the foreseeable future. One way or another, whether it be in the future, drones or driverless vehicles, we will find a way for folks to get the convenience that they need through some type of delivery mechanism. And so, I would like to see the financial situation improve so that you don't necessarily need all these transactions at the incremental in order for them to make sense. But right now, I certainly wouldn't want to give this additional sale away, and so we're going to participate in this. For us specifically, the 2 things that we really like is that we're getting a lot of activity at late-night, which is something that our brand is known for, and we also see that the average check is higher. I think those are similar things that our competitors have said. So as you look at where the customer trend is, it's sort of late night, it's sort of a bigger meal purchase and it's attached to this need for convenience or this higher take rate on the availability of convenience that's in the marketplace today.

And Jeff, I would just say, I think none of our competitors has shed specifics on what the sales lift is, but it was a contributor to our sales in the quarter. I would also say that because of the uniqueness of our menu, that we serve anything on the menu, anytime of the day. I talked to someone yesterday who had ordered a Breakfast Burrito at 9:00 at night. So I think that sort of menu variety and availability also plays into where Jack could differentiate ourselves when everybody is doing delivery.

And just final question on delivery. Across the 3 different platforms, DoorDash, Postmates, GrubHub, at this point, I know you're working on it. But how many of those orders are placed through either Jack in the Box site or app? Or are the majority of those orders is still being placed through the third parties, site or app?

Majority's still through the third party.

Our next question comes from Jake Bartlett from Suntrust.

Lenny or maybe Lance, the question is around the G&A and the shared services or the services you're performing for Qdoba. You mentioned that there are some of those that were going to last through, through '19, and that affects your ability to cut costs. So I'm wondering I believe your prior guidance had been under 2%, but does that change the math? Or would that prevent you from cutting costs more materially in '19?

This is Lance. I'll start with that, and I'll let Lenny or Carol jump in if needed. So a couple of our bigger groups that are providing a lot of the services are the ones that are expected to last longer on the TSA. They're just going to take longer. So things like your finance group, which obviously is intimately (inaudible) or at least getting there. From a cost standpoint, we're being, largely being reimbursed. In fact, being pretty much fully reimbursed by Qdoba for those costs. And so from a P&L standpoint, I think you'll start to see, and this is reflected in our second half guidance. I think you'll start to see some costs coming down. What really changes the pounding of is, it's more of this -- if there's personal changes that need to happen. Those would come down the load. So Lenny, I'll let you jump in with anything else.

Yes. We didn't give timing on the 2% or lower as a percent of systemwide sales, but what we did say is we expect somewhat very aggressively toward that number. I would say that, look, at the end of the day, my desire is to get the company in its go-forward state as soon as possible, so that everyone's focused on Jack and we're operating sort of in the new normal. So we're not going to wait too long to move on these critical steps, and I do not think that the TSAs necessarily hold us back. It's just a matter of managing through to make sure that we are providing to Qdoba, as the contracts spells out the services that they require along the way.

Got it. So I was under the impression that the TSA, if that's what we're calling them, that, that was preventing you from cutting G&A this year more than you would have otherwise. And I'm just wondering whether the fact that those continue in '19 means that you're going to get less than you would have otherwise?

Got it. I understand your question. The only thing that's held us back from cutting this year is we really want to get an outside perspective on where some of the biggest efficiencies can be gained. But if you look at the back of the year guidance, I think what really reflects is that anything we can and should be doing now, we're taking advantage of.

Got it. And then, a quick question on just the competitive environment and what's working out there, I mean, one message that we've heard some of your larger competitors is that the balanced menu approach, the kind of the high end, the low are both working. So other large competitors have talked about actually the more premium sandwiches doing a little bit better than they had before. I'm trying to square that just with your experience, and I'm wondering whether with the Buttery Jack, whether it's just a promotion that hasn't resonated and has maybe less to do with the consumer. I mean, how do you -- please square what we're hearing in terms of a high-low working at large competitors versus what you're experiencing?

Yes. So we're still getting a pretty high take rate on our premium product. So that doesn't seems to be -- any evidence that consumers are having a lower take rate of those products for us isn't there. Where we see the lower take rates is in transactions under $5, which is really where most of our most of our traffic has been lost. So I guess the question I would have is, how do you -- how do the competitors square with significant deteriorations in their margins, if they're getting a much higher take rate on premium products? That really doesn't -- it just doesn't add up.

Got it. And then last question. The remodeled program with the 600, just looking beyond that. It's been, what, 7, 8 years since your last kind of refresh. And that was not a really full refresh, was kind of a little more limited. So I'm wondering, does the system need a larger refresh aside from the 600 that you're doing that are in kind of most need? Should we expect this 600 to be the beginning and then you're just kind of going into a -- what would be a normal cycle refresh going forward?

Got it. Yes, I think when we look at the 600 we're addressing, there are significant issues with those facilities. And so, not only is the investment much higher, but the urgency is much higher as well. When we look at the remainder of the sites, we certainly can't leave them untouched, but we have a fair number of newer buildings within the remaining mix that may not need a significant investment. And certainly we're not needed, we won't do it. And so we will address that in our long-term plan. And certainly, the way that we'll look to do is to make decisions that are both productive for the franchisees, but also productive for the shareholder and the customer, too.

Operator, can we poll to see if there are any additional questions in the queue?

We're showing no questions at this time. (Operator Instructions) We do have 1 additional question, coming from Pratik Patel from Barclays.

Maybe one tactical question and one strategic question. Maybe first, Lenny, it appears at least on the company side, pricing is at the highest level in 4 quarters. Just wondering if the franchisees were taking similar levels of pricing? And going forward, how do you achieve the right balance, given the dog fight for traffic right now and the need to protect margins against labor inflation?

Yes, we typically, on an annual basis are showing price increases in the mid-2 percentile. We have not exceeded that for company ops, so we don't have any type of accelerated pricing activity or increased pricing activity for company ops this year. And with the sensitivity from the consumer, we don't plan to do anything that would be more aggressive than we already or typically do. And then for the franchisees, a lot of what we're seeing there is also regionally based. So West is much stronger right now than the East. The East is almost 100% franchised and so a little bit of it is just the mix of the stores that are driving the difference in comps as well, the geographic difference in stores.

Got it. That makes sense. And Lance, congrats on the new role. Any perspective you can share with us in your brief time with the company? It seems like one of the biggest initiatives to become more heavily franchised, more heavily levered were already quite well underway before you got here. Just want to get your perspective on what you see is the biggest remaining opportunities for value creation.

I think it's been a relatively short stint so far, so I'll hedge my bets a little bit by leading that way. But I think creating value in QSR, almost regardless of the brand around it is about driving costs without driving the unit. So I think what we need to do is make sure that we've got a good economics model out there that works. Certainly, Marcus and his team are going to be driving that along with the rest of the team. And then getting ourselves in a position to grow a bit. That is the biggest single opportunity that I see. We're in 21 or 22 states. I'd say we need to turn around and be in 45 states tomorrow, but it would be nice to get this thing over the right amount of time as the model has proven out as we get through some of this planning to get (inaudible) going again. So that would be the biggest single opportunity that I see.

Our next question comes from Chris O'Cull from Stiefel.

I've just got a couple of follow-ups. One, Lenny, we've seen some other chains have some success with franchisees consolidating the store base, so that you have a larger operation with more scale, resources to invest in the stores. Is this an opportunity or an area of focus for you, for the Jack system?

So we talked a little bit about our franchisee base, and I'll start with the answer. It's not a focus for us, but let me talk about why. Although we have some very large franchisees today with 100-plus locations and lots in the 50-plus locations range as well, our franchisees largely come from a prior Jack in the Box employee base, and have been with us for 20, 30, 40 years. And so although they might be smaller, they are in a position where these are essentially cash cows. They're not carrying any debt. They're making a lot of money on relatively high AUV location, and they're able to invest in the location. Obviously, when you have a bigger operator, they're able to -- they have a little bit more financial wherewithal. We just don't see weakness associated with size in our brands. If we see weakness, it's typically associated with the either operational execution or potentially geographic or competitor threats in that area, but isn't necessarily related to size.

That's great. That's very helpful. And then is the company able to track the franchisees guest transaction changes? If so, how does it compare with the company's transaction performance?

Yes, we are able to track it, and I don't know if we've shared details on the differences between the 2. Let me just talk about what would be safe to share at this point in time, just because I hadn't thought about getting that granular, and I don't want to jump the gun. But essentially, when we track the guest experiences, we can see the things that drive consumer loyalty. We can also see the things that drive transactions as a result. Inaccurate orders, slow speed of service and rude treatment or not being friendly, are really big drivers of dissatisfaction. And I would say that, look, whether it's company or franchise, we see a similar percentage of restaurants that underperform in those areas that I mentioned. So on the flip side, we do see that where we get the better, the higher levels of guest performance, consistency of the treatment of the guest and also speed of service and service times being lower, we do see higher transactions. But I would say in general, when I relate transactions, the single largest impact on transaction has been the decisions that either we or franchisees have made related to price. And that's really what has been a bigger driver of any disparity across our chain in transactions.

Operator, these are all the questions that we have in the queue, so we look forward to speaking to you all here on the road in June or on our upcoming call in August.

And that concludes today's conference. Thanks for your participation. You may now all disconnect.