Jack in the Box Inc. (JACK) Q2 2011 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the Jack in the Box Inc. Second Quarter Fiscal 2011 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, 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, Kathy, and good morning, everyone. Joining me on the call today are our Chairman, CEO and President, Linda Lang; Executive Vice President and CFO, Jerry Rebel; and Executive Vice President and Chief Operating Officer, Lenny Comma. During this morning's session, we'll review the company's operating results for the second quarter of fiscal 2011 and update our guidance for 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 management's 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 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 management will be participating in the Wells Fargo Consumer Gaming and Lodging Conference in Las Vegas on May 24 and the Jefferies 2011 Global Consumer Conference on June 22 in Nantucket. Our third quarter ends on July 10, and we tentatively expect to announce results the week of August 8. With that, I'll turn the call over to Linda.

Thank you, Carol, and good morning. As you saw in yesterday's news release, same-store sales for Jack in the Box company restaurants increased 0.8% in the second quarter. Sales exceeded our guidance despite severe weather that impacted many of our major markets in the first 4 weeks of the quarter. As the weather improved, so did traffic and sales. And on a 2-year basis, we've seen a sequential improvement in same-store sales for 3 consecutive quarters, and that trend has continued in the first 4 weeks of the third quarter. Restaurant margins in the quarter were impacted by rapidly rising commodity costs, which Jerry will discuss in a minute. To offset some of these inflationary pressures, last week we implemented an approximate 1.5% price increase in company Jack in the Box restaurants. We continue to be cautious on taking price in this environment and consider both the competitive landscape, as well as grocery store inflation in our pricing decision. California and Texas both continue to have positive same-store sales, and California was our best performing market on a 2-year basis. It's also worth noting that same-store sales in Arizona remain positive for the second consecutive quarter. As we've said previously, our #1 priority this year is to drive sales and traffic in Jack in the Box. As we did with the February launch of a new mid-tier product, the All-American Jack burger, which we featured as a $4.99 combo meal. This promotion was extremely popular and represented a significant mix of our sales. Even at a higher price point than our typical bundled value meal, our guests saw this as a good value. In addition to new products and promotional events, we've been making noticeable quality improvements to several of our core products over the past year to reengage lapsed customers and create an even broader appeal for these guest favorites. We've talked about the improvements we've made over the last several months to our coffee, French fries, bacon and tacos, and order incidents have increased on all of these core items since the improvements were made. We'll continue to invest in improving other core products, as well as developing compelling new menu items for our guests, such as the recently introduced Bourbon BBQ Steak Grilled Sandwich. We're also investing in new menu boards, which will be installed throughout the system in June. The new menu boards will enable guests to more easily navigate our menu while showcasing our variety, highlighting average check builders and encouraging trial sales of higher-margin products. Concurrent with the new menu boards will be the deletion of several less popular menu items. We believe the investments we've made to improve the overall guest experience at our restaurants are resonating with our guests. The improvement we've seen in our results coincides with the systemwide program we launched in the fourth quarter of last year to deliver a more consistent guest experience. Since we began this program, we've seen improvement in our Voice of Guest and brand loyalty surveys, especially in the areas of order accuracy and cleanliness. We recognize that we have opportunities for improvement in other areas, especially speed of service, reducing variability and more consistently delivering faster service will build trust with our guests, foster loyalty and lead to additional guest visits. We continue to make substantial progress on reimaging the Jack in the Box system. We remain on pace to substantially complete our restaurant re-image program systemwide by the end of the calendar year. At quarter-end, 82% of company restaurants and more than 68% of the Jack in the Box system featured all interior and exterior elements of the re-image program. Moving on to Qdoba. We're very pleased on how the brand is performing. System same-store sales in the second quarter exceeded our guidance and increased 6%. This improvement was driven largely by transaction growth, as well as higher Catering sales. We continue to drive Qdoba sales by leveraging its points of differentiation, such as its broader menu with innovative and unique flavor profiles. Based on the results we've seen year-to-date, we've increased our full year same-store sales guidance for both brands. Before turning the call over to Jerry, I'd like to reiterate that our #1 priority this year is to drive sales and traffic at Jack in the Box through investments we're making to enhance our food, service and facilities. We recognize that these investments may depress margins in the near term but should build sales and brand loyalty over the longer term. To recap the steps we're taking, we're investing resources to improve many of our top-selling core products and continuing to emphasize both premium products and value promotions in our marketing calendar. We're investing resources to improve guest service by delivering a more consistent dining experience. Phase 2 of this systemwide plan is focusing on improving speed of service and other key drivers of guest satisfaction. We're on track to substantially complete our restaurant re-image program systemwide by the end of the calendar year, and we're ahead of our timeline to increase franchise ownership to 70% to 80% of the Jack in the Box system. And now I'll turn the call over to Jerry. Jerry?

Thank you, Linda, and good morning. All of my comments this morning regarding per share amounts refer to diluted earnings per share. Second quarter earnings were $0.13 per share compared to $0.32 last year, with lower refranchising gains responsible for $0.03 of decrease. Operating earnings per share, which we define as EPS on a GAAP basis less gains from refranchising, were $0.12 compared to $0.28 last year. Restaurants operating margin decreased 290 basis points to 12.3% of sales for the quarter. As we said on our February call, we expect the Q2 restaurants operating margin to be similar to Q1, which was 12.6%. Food and packaging costs were up 190 basis points as compared to 80 basis points in Q1, driven by commodity inflation of approximately 5% compared to approximately 2.3% in Q1 and 1% deflation in last year's second quarter. Rising beef cost was the biggest contributor, up over 13% versus our expectations of 10% inflation. We also saw significant increases for produce, cheese, pork, dairy and shortening. These increases were partially offset by lower costs for bakery and poultry and the benefit of pricing, which was about 1.3% higher in the quarter, similar to Q1. In addition to commodity inflation, food costs were impacted by product mix, particularly the popularity of the All-American Jack, which drove a substantially higher mix of burgers. Labor costs were up 30 basis points, the same as Q1, reflecting higher levels of staffing designed to improve the guest experience, as well as increases in unemployment taxes in several states. Occupancy and other costs increased 70 basis points in the second quarter as compared to 60 basis points in Q1. Guest service initiatives accounted for the majority of the increase. As in Q1, rent expense as a percentage of sales was higher, resulting from a greater proportion of company-operated Qdoba restaurants versus the prior year. As of the end of the second quarter, Qdoba represented nearly 21% of our company-operated store base as compared to 12% last year. The average age of a Qdoba restaurant is much lower than a Jack in the Box restaurant. Rents are typically higher as a percentage of sales as Jack in the Box has many legacy leases with below current market rents. Lower utilities partially offset these higher costs. As in Q1, consolidated restaurant operating margins benefited by about 50 basis points in the quarter from the 40 restaurants and we closed last September. However, this benefit was more than offset by higher commodity costs and the improvements that we've made to some of our core products and guest service initiatives. We repurchased over 1.1 million shares of our stock in the quarter at an average price of $22.23 per share and year-to-date have repurchased nearly 3.5 million shares at an average price of $21.58 per share. We have $25 million available for repurchases under a board authorization, which expires in November of this year. And lastly, our board authorized an additional $100 million repurchase program, which expires in November 2012. Before I review our guidance for the third quarter and full year, I'd like to provide an update to our commodity cost outlook for the remainder of the year. Commodity costs for most items have continued to move higher in the past several months. In February, we were forecasting commodity costs for the full year to increase by 3% to 4%. Based on the increases we've seen in most commodities since that time, we now expect full year commodity inflation to be 4.5% to 5.5%. Beef accounts for more than 20% of our spend and is the biggest factor driving the change in our guidance. For the full year, we are now anticipating beef costs to be up nearly 14% versus our previous expectation of 9% inflation. We expect beef costs to be up approximately 14% to 15% in the third quarter. Our third quarter forecast for beef 90s, in the low $2 per pound range, and for beef 50s, we expect prices to average in the $0.95 to $1.05 per pound range in Q3. Pork accounts for about 6% of our spend. We expect it to increase 4% for the full year. Cheese also accounts for about 6% of our spend, and we continue to expect a 13% increase for the year. We now have 100% coverage on cheese through the remainder of the fiscal year. Dairy costs, which are over 3% of our spend, continue to be impacted by higher butter prices and are now forecasted to be up 6.5% for the full year versus our prior forecast of up 5%. Bakery accounts for about 9% of our spend, and we continue to expect a 1.5% decline for the year. We now have 90% of our bakery needs covered through December of 2011. There has been no change in our outlook for chicken, which is about 9% to 10% of our spend as we have fixed-price contracts that run through March of 2012. Produce represents about 5% of our spend, and Q3 and Q4 costs are expected to normalize after the weather-related inflation we experienced in Q2. We have fixed-price contracts in place for potatoes, which accounts for approximately 8% of our spend, with 100% of our potato needs for the full year contracted with prices essentially flat versus last year. Now let's move on to the rest of 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 increase from 2% to 4% and systemwide same-store sales for Qdoba to increase 4% to 6%. Our guidance reflects the sales trends we've seen thus far in the quarter. Commodity costs for the quarter are currently expected to increase by approximately 6% to 7%, driven by recent increases for several items, including significantly higher beef costs. Q3 restaurants operating margins are expected to be similar to our full year guidance. Refranchising gains are expected to be lower than the third quarter 2010, with remaining gains for the fiscal year expected to be split approximately equally between Q3 and Q4. And I won't repeat all of the full year guidance included in the press release, but here's our current thinking on some of the line items that we have changed since our February guidance. As Linda mentioned, we've raised our full year same-store sales guidance for both brands. Same-store sales are now expected to increase approximately 1% to 3% at Jack in the Box company restaurants versus our prior guidance of down 2% -- up 2%. At Qdoba, we now expect systemwide same-store sales to increase 4% to 6% versus our prior guidance of a 3% to 5% increase. Overall commodity costs are now expected to increase 4.5% to 5.5% for the full year, with Q3 inflation expected in the 6% to 7% range. Restaurant operating margin for the full year is now expected to range from 12.5% to 13.5%, with better sales versus our prior guidance largely offsetting higher commodity inflation. We've increased our guidance for Qdoba unit growth this year and now expect 60 to 70 restaurants to open systemwide as franchisees are now expected to open 35 to 45 restaurants. We have not changed our full year guidance for diluted earnings per share of $1.40 to $1.65. Gains from refranchising are expected to contribute $0.70 to $0.83 to EPS, with $0.01 increase on the upper end due to the lower expected tax rate for the full year. Operating earnings per share, which we define as diluted EPS on a GAAP basis less gains from refranchising, are expected to range from $0.70 to $0.82 per share. EPS includes approximately $0.10 to $0.12 of incremental re-image incentive payments to franchisees in fiscal 2011 as compared to fiscal 2010. The incremental re-image incentive payments for Q2 were $0.02 higher and year-to-date, $0.03 higher than in fiscal 2010, although re-image incentive payments were $2.7 million year-to-date versus $650,000 in Q2 of 2010. And lastly, as we approach completion of our refranchising strategy, I'd like to provide some perspective on our longer-term outlook for some of the key drivers of our performance. Our goal is to drive higher AUVs for both the investments we have made in the business as well as refranchise, which should result in a higher-margin, higher-AUV company-operated footprint. We would expect that our restaurant operating margins, at the conclusion of our refranchising strategy, will be above 16% in a normalized inflationary environment. In addition, we have said previously that we expect G&A, excluding advertising, as a percentage of consolidated systemwide sales to be in the 3% to 4% range, and Q2 year-to-date, we were at approximately 4.3% of systemwide sales. And capital expenditures are expected to be $110 million or less, with the majority of that spend going towards new unit growth for both brands versus maintenance and remodel capital. In addition, the change in our business model should result in growing royalty and rental income, be less capital intensive, improved returns on invested capital and EBIT margins and generate higher free cash flow. We would expect to continue to use the proceeds from refranchising, as well as cash from operations, to return cash to shareholders and maintain reasonable leverage while investing and growing both of our brands. That concludes our prepared remarks. I'd now like to turn the call over to the operator to open it up for questions. Kathy?

[Operator Instructions] Our first question is from Joe Buckley, Bank of America.

Can I just get a little bit of clarification on some of the sales comments? I know you've talked about taking 1.5% pricing in the company stores last week. Where would that put you on a year-over-year basis in terms of pricing? And then could you fill out a little bit more on the performance that you saw towards the end of the quarter, in the beginning of the third quarter, in terms of day part? And I think you mentioned California and Texas, both positive, California, the best on a 2-year basis. Will it also be the best on a one-year basis? Just kind of give us a little bit more color around it.

Sure. Joe, we don't disclose what our pricing is, what we're rolling off and what our cumulative pricing is, but we did disclose that we have taken approximately 1.5% price increase. Let me give you a little bit of color on day part. Breakfast continued to be strong. We had gains in breakfast, and we had gains and dinner day part as well. In terms of regional performance, on a one-year basis, all the major markets, with the exception of one that was really impacted by weather, were positive. And on a 2-year basis, the strongest were, let's see, Texas market, California and Arizona were the strongest on a 2-year cum basis. And almost all the major markets were up on a 2-year cumulative basis. And most of those gains were driven by traffic gains on a 2-year cum. Did I answer all the parts of your question?

Yes, I think so. That's good.

Our next question comes from Jeff Bernstein from Barclays.

Actually, just first, a clarification on a comment you made earlier, Jerry, in terms of the longer-term outlook. I think you mentioned that the restaurant operating margins for the system would be above 16%. I know now we're kind of targeting this year in a 13% range. I'm just wondering, what's the time frame, or how would you get back to that kind of normalized level, or how far off of it are you now just due to commodity? I'm just trying to figure out the pacing to get back to something in that 16% range. And then just separately, you mentioned kind of the refranchising. Moving along, do you think we're going to be done now? Is it possible to be done in fiscal '12 versus the initial target for fiscal '13?

Sure. Let me take the first part of that question first. This is going to be the longest part of the answer, Jeff, so bear with me here for a moment. Let's take a look at a couple of things that are impacting our earnings this year. Now they're not impacting restaurant operating margin, but they are impacting earnings this year that I would argue we would not expect to continue to occur or not continue to occur at the level which they are occurring this year. Just to remind everyone, we included in our operating EPS guidance, we have 2 fairly significant cost items in there. One is our re-image contribution payments to franchisees, which incrementally is $0.10 to $0.12 a share. In total, though, it's about $0.12 to $0.14 a share impact for fiscal 2011. Also, we've talked about impairment and other charges, which includes a fairly significant cost of accelerated depreciation for our re-image program, and we said that's 70 to 80 basis points. That 70 to 80 basis points represent roughly $0.20 worth of EPS decline in the year or of impact in the year. And while we wouldn't expect all of that to go away, we would expect a good portion of that to go away going forward. Then getting back into more of your question on the restaurant operating margin, we can go back to what our initial outlook was for the full year. Back in November, we were talking about flattish comp down 2% to plus 2%. We talked about commodity inflation of 1% to 2%, and that was going to drive restaurant operating margin expectations in the 14% range. And now the decline from that 14% is the midpoint of our range right now. 13% is largely driven by the commodity inflation, which we're now expecting to be 4.5% to 5.5%. So how we grow our restaurant operating margin from the normalized commodity inflation level, we'll call it 14%, is really due to -- it's going to be driven by improving average unit volumes, which will drive the restaurant operating margin up. Now we know that prior to 2010, we were at above 16% both in 2008 and 2009. In 2008, we had modest same-store sales. 2009, we were actually down, I think, 1.2%. And before that, we were about 17% restaurant operating margin. So we think we have a pretty clear pathway of getting back to those historical margin levels. Let's talk about driving the AUV, one of which is going to be due to refranchising activities. And we know exactly which restaurants and which markets we are in process of refranchising, and we know that by and large, they're not in California. California would drive the higher AUVs. And so we would expect to get some AUV growth as a result of the refranchising activity because of the markets that we intend to sell. Secondly, we and our franchisees are having significant investments in our respective locations this year, and those investments are intended to drive average unit volumes. And we're seeing some impact on that so far this year with our raised guidance, now plus 1%, plus 3% for the full year. And those investments include labor, speed of service, which Linda talked about, our re-image program, the core products that we have improved and others that we plan to improve and just an overall significantly better, more consistent guest experience. Also driving restaurant operating margins will be the fact that Qdoba is now a greater proportion of our company restaurants, which is now 21% versus 12% last year. And as we continue to grow Qdoba and continue to refranchise, we would expect that percentage to continue to grow. And we know that strictly in the back half of the year, we expect Qdoba restaurant to have a positive impact on the overall company margin for Q3 and Q4. Also, when you look at just the Jack in the Box brand, Jeff, we know that we have, currently, a significant number of our existing company restaurants that have AUVs of $1.4 million or higher. And even in Q2, with commodity inflation of 5%, these restaurants were delivering north of the 16% restaurant operating margin. So that gives us a great deal of confidence as we complete our refranchising program that we should be able to return to those levels. Timing is difficult to forecast. If some of the refranchising activity were ahead of our current schedule, probably about a year ahead, it could be possible to get at the low end of that 70% range this year, although I don't think that we're forecasting that but it could be possible. If not, we should be there sometime next year. But just because we get to the 70% threshold doesn't mean that we're complete with that strategy. The other thing is we will need to have some level of improved job growth. We're seeing some today, but we know that we have significant correlation between job growth and same-store sales growth. And if that continues to improve, assuming that it does, we should see some improvements to our same-store sales. And also, it would be quite helpful to have commodity be less of a headwind than what they are right now.

Our next question comes from John Glass of Morgan Stanley.

First, just on the refranchising, you sold some, I think, some pretty low volume units this quarter. So maybe, what was the -- was there an impact to this quarter to margins, benefit to margins, or what do you think the benefit of that sale could have to margins going forward?

Yes, I think, John, if you go back to our comments last quarter about what was going to drive restaurant operating margin improvement in the back half of the year versus the front half of the year, part of that was improved restaurant operating margin based upon the restaurant that we had planned to sell. And I think we would see that, and that's included in our 12.5% to 13.5% guidance for the full year. Unfortunately, when we spoke a quarter ago, we were anticipating commodity inflation of 3% to 4% versus 4.5% to 5.5%. So that's going to give way, that is as well as much of the improved sales growth that we're anticipating.

Okay. But is there any way to parse out what those restaurants that have lower sales volume that may have been a drag on the margins to sort of understand that dynamic?

Well, there were only -- first of all, there were only 22 -- we only sold 26 restaurants in the quarter, and 22 of them were in that market where we had the lower-than-average AUV. So the 22 particularly sold in the quarter is not going to have a significant impact to margins during that quarter. So a lot of these things happened mid quarter till late in the quarter, and so it really didn't have any impact to Q2, John.

And then you highlighted the fact that Qdoba is becoming a more meaningful part of your company's store base, over 20%, and would probably get much higher next year if this progression continues on refranchising one brand and building out another one. Can you talk about where their margins are now or in the last couple of quarters? Have Qdoba's margins have been improving, even as the underlying business, the Jack business, has deteriorated? Or have they experienced the same kind of food cost pressures so their margins have back-slipped this year as well?

Yes, let me -- we're not really disclosing their exact restaurant operating margin, but let me give you a little bit of perspective there. So what we've said is that Qdoba tends to be, and this is kind of broadly defined, but in Q1 tends to be their lowest restaurant operating margin. They are a bit more seasonal than what Jack is. So kind of Q1 tends to be their lowest sales and lowest restaurant operating margin. They tend to be a little dilutive to the overall company restaurant operating margin. Second quarter becomes kind of a push, and third and fourth quarter, it becomes accretive. So when you look at the third and fourth quarter sales guidance that we have in there for Qdoba, along with the recent acquisition of the Indianapolis market, which we said earlier were higher than Qdoba system AUV and higher than Qdoba system average restaurant operating margins, we're anticipating Qdoba margins to be about 50 to 60 basis points accretive to our back half margins for the full year.

I'm sorry, for the full year, so...

Excuse me. I'm sorry, for Q3 and 4 versus what they were in the first half of the year.

Our next question comes from Larry Miller of RBC.

Just a quick follow-up on one question, and then I want to ask a question about commodity inflation. Jerry, when you were talking about getting back to that 16% margin, is it fair to assume that some of the stores that you're selling, or generally the portfolio of stores that you're selling, is a lower-margin so that there's natural rise to the base that you have left? And then for commodity inflation, you normally give us some sense how long you may be contracted on those 90s. And can you give us a sense on what you're baking in for the 90s and 50s, specifically in that 4% to 5% guidance for the fourth quarter, 4% to 5% for the full year, for the fourth quarter if that's said correctly?

Okay, let me talk about the commodity piece first. So I think beef for the year-to-date so far is up about 12%. We said we're forecasting 14% for the third quarter, 14% for the full year, so that would imply something a little north of 14% in Q4. We have little of our 90s contracted at this point. We do have some protection if it were to go up, but we didn't feel it appropriate to take. It's a significant amount of protection given where the prices are. So by and large, we're going to be on the open market for a significant amount of those purchases, particularly in the fourth quarter, although we do have some -- a greater degree of coverage through June on the import 90s in Q3.

And then just on the basis stores that you'll be maintaining, is that also a higher-volume and a higher-margin base?

Yes, exactly. On those restaurants that we have left to sell, because of the markets in which they are, they'll have lower than system average AUV, we generally would drive lower-than-system-average restaurant operating margins.

Our next question comes from Bob Derrington of Morgan Keegan. Robert Derrington - Morgan Keegan & Company, Inc.: If you could just clarify something for me, help me with math. I think you'd mentioned that, and in your release, you talked about the 70 to 80 basis points of impairment and other costs. Is there anything other than just impairment, essentially, that flows through that line?

Yes, you're going to see -- well, just from a technical standpoint, impairment is difficult to predict as you're running on impairment each and every quarter. So impairments in there if you have a restaurant that just isn't profitable or isn't profitable enough for the underlying assets in that. It's very difficult to predict. If I could predict them I'd have to take charge right now. So those just kind of come and go, and you could expect to see some of those in any business at any point in time. The biggest piece of the increase, however, is the accelerated depreciation associated with our re-image program, and that's driving the biggest part of the 70% to 80% worth of expense. Robert Derrington - Morgan Keegan & Company, Inc.: And that essentially comes to, in general, almost a close by the end of the year. Is that the implication here?

Exactly right. So if you know when you're going to retire that asset, you have to then accelerate that depreciation timeframe between that decision point and when you're going to actually retire that asset. Robert Derrington - Morgan Keegan & Company, Inc.: So if you assume the midpoint approximately, that's on about little over $2 billion in projected revenue, maybe roughly $18 million and maybe franchise image incentive payments of roughly $9 million more. So all in, it's approximately depressing your earnings this year by $0.30 to $0.35? I think that's pretty close to the math that I worked through earlier in my answer to Jeff. But I also -- I would just caution you that the impairment of the charges will not go completely away, although they should be significantly lower. We'll always have some of those activities going on. They shouldn't be to the extent that we currently have them. Robert Derrington - Morgan Keegan & Company, Inc.: Got it, great.

Our next question comes from Jeff Omohundro from Wells Fargo.

It's Jason Belcher for Jeff. I was wondering if you could talk a little more about what you're seeing in terms of the competitive discounting environment in your core markets and how you're responding to that. And then also, if you could give us a little more color on the new menu boards set to roll out in June. Maybe tell us which of those items are being deleted and any other notable changes you can share.

Sure. In terms of the competitive marketplace, it's about where it has been in terms of the number of promotions and coupons and so forth. And we've talked for several months now about the kind of promotions that we will be doing and that continue to work for us in our positioning. And that's those bundled meal deals. So we're talking about the All-American Jack combo, which was a $4.99 price point, a full meal, very compelling price point and a great product. So you'll continue to see those types of bundled value meals that have worked for us. And because they are bundled with a fry and a drink, their food cost is not significantly higher than the overall food cost. So that's a positive for us. So you'll continue to see those as well. And then in terms of deletions, I won't give you the exact products because we haven't yet deleted them. But we have a very extensive analysis that we do to review all of the products that are on our menu to determine which one makes the most sense to delete from the menu. And we look at product performance in terms of the mix and the margin. We look at our fit -- the fit with the business strategy, is it a niche product, is it something that could easily be substituted. And then, of course, we look at operational considerations, labor, the number of unique ingredients. So last year, we actually did delete several products. We then, this year, are planning on doing a deletion concurrent with the new menu board rollout. When we tested the menu board, we did the deletions and putting in the menu board helped to offset the impact of those deletions. That's kind of how we work through the deletions. We would expect every year to have some level of deletions to continue to help with operational complexity.

Our next question comes from David Tarantino from Baird. David Tarantino - Robert W. Baird & Co. Incorporated: Jerry, I wanted to come back to the question on the long-term restaurant margin outlook and ask how much of the progress towards that goal would simply be the mechanics of refranchising the units that you have left to refranchise. In other words, if you were to complete that process today, what would the margins look like without any further AUV progress?

Yes, let me answer the question this way. So driving the AUVs in all of the system restaurants is going to be important. So if you look back at when we had the restaurant operating margin that I spoke about earlier, at 16%, and then one year, as high as -- they were over 17%. That was with the averaging of volumes, about 1.440 million. If you look at where our average unit volumes are, annualized, based upon current year performance, about 1.375 million. So we need to get those average unit volumes up. I think that's going to be a significant piece. We need to continue to grow same-store sales. I don't think it would be as simple as just refranchising all of those units. However, that is going to be a significant portion of this. I'm not sure exactly how I would describe, how I would weight that, but I would say that they are, call it, equally important. We need to do both in the system. David Tarantino - Robert W. Baird & Co. Incorporated: Okay, that's helpful. And if I could squeeze one more in, if you could maybe just give a real high-level view of the second half year-over-year earnings growth that you're projecting versus the first half, where you saw your core earnings decline, if you could just talk at a real high-level as what are the puts and takes there that gives you confidence that you'll be able to grow earnings in the second half relative to the first half, that'd be helpful.

Yes, I think the key piece of driving the earnings is going to be same-store sales. So we're looking at improving -- if you look at our guidance, we're looking at improving one-year and 2-year same-store sales trends rather significantly over the back half of the year versus what we saw in the first half of the year. I'd say that's the biggest piece of it. In fact, it would be probably be higher with those sales were it not for the significant drain on commodities. I really think it's as simple as those 2 items.

Our next question comes from Keith Siegner from Credit Suisse. Karen Holthouse - Crédit Suisse AG: This is actually Karen Holthouse today for Keith. Just a question. It looks like with the $0.12 for the year, that the remodel incentives are going to be ramping in Q3 and Q4 versus the first half of the year. And do you have any kind of sense on the timing or the split between those 2 quarters?

No. Well, the first part of that question is yes, they will be ramping. As to exactly when they're going to be split over the balance of the year, we have an estimate. I'm not going to tell you what that is because I'm not sure that it's all that important to split that between Q3 and Q4, and I really don't have any significant way to estimate exactly when the franchisees are going to get these things done.

Next question comes from Conrad Lyon of B. Riley. Conrad Lyon - B. Riley & Co., LLC: A question, though, regarding -- going back to the menu boards coming up here. Conceptual, how should we look at it? With any deleted items, will you replace those items or will we see the menu boards kind of spatially or look to seem, I don't know, larger fonts, or how do you think about that going forward?

Right. Actually, the deletions really helped improve the visual appeal of the menu boards. So it did allow more space to highlight the flagship products, to highlight those average check builders. So you will see a big improvement, and it's really designed to help facilitate the navigation or the ordering process, especially at the drive-thru. Conrad Lyon - B. Riley & Co., LLC: Got you.

So the deletions do help with that. Conrad Lyon - B. Riley & Co., LLC: Got you. Just a question with the prototypes. I know that you have some out there with glass walls near the queue-up area for the drive-thru, and I think that it's a nice strategy, especially given that it seems like a lot of folks like more transparency and see what they're getting into. Have you noticed a better sales production with those prototypes than other prototypes?

Generally, we do because they are newer prototypes and new trade areas for us that create a lot of demand, and they're in all of new our markets. And Lenny, I don't know if you want to add anything to that.

This is Lenny. Let me add to it also that the new prototypes outside just the glass and the visuals from drive-thru, the kitchens are very efficient because we're able to implement new layouts, more efficient placement of the equipment and new equipment is actually faster. So yes, in general, those models are way more productive than the older one. Conrad Lyon - B. Riley & Co., LLC: Got you, okay.

Our next question comes from Larry Miller of RBC.

Jerry, I was wondering if you might be able to help us on this remodeling thing. You said roughly equal amount of gains from store sales in the third and fourth quarter. Roughly, you'd have about $30 million of gains you have to record to get to your guidance. Can you give us a sense of is it a function of more stores at -- and then this may be the case, more number of stores historically at lower-than-historical prices, or is it more of a historical price and a similar amount of stores?

Well, if you look at the guidance, Larry, I think the guidance would suggest about $300,000 a copy in average gains, roughly, for the full year. So it will -- what we've guided is based upon what we think we have in the pipeline. Anything that we'd modify with that would be changes in anticipated deals, either deals moving in or out that may have different average unit volumes and different restaurant operating margins. Those larger deals is what we're doing now. Remember, we're no longer selling, by and large, 3 and 4 restaurant deals. We're selling 50 and 60 restaurant deals on occasion, and they've become much harder to predict exactly when they fall.

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

Beginning the September fiscal year-end, do you have any visibility in the food cost outlook for fiscal '12?

Boy, Joe, if we did, we could make a ton of money. It's just...

More than we're already making.

More than we're making, exactly. But the commodity is bigger. But we are not currently anticipating any significant decline in food cost. We're just not seeing anything that would indicate that. We could be way more on that, and we'll provide more perspective on the next call. But as you all know, this is an extraordinary difficult time to predict where the commodities are going.

Okay. And then a question on the quarter. The franchisee expense level seems a little high. Is there anything unusual there? Or are you hitting some inflection point in the franchise mix where that might be higher?

I think what you're seeing is as we continue -- first of all, that's where the re-image incentive payments are. That's $2.7 million this year versus $650,000 last year on a yearly basis. And then the other piece is if we continue to sell restaurants, remember, we're getting about a 3.5% rent spread on those. So we'll continue to get the 5% royalties, but then you'll get the rental income going into the rental revenue line, and you'll see -- the underlying rent expense going into the franchise cost line. And since there's a 3.5% spread there, you'll tend to see the overall margin rate depress a little bit even though the franchise dollars should be going up significantly. But I'm looking at this much more as a franchise contributions to earnings than I would a percentage margin because of the rent spread that we're getting.

That's helpful. And then one last question. The menu board rollout, is there significant capital investment behind that? And maybe if you would just describe it a little bit, how high-tech is it, what advantage do you expect to get from it.

This is Lenny. Let me first describe that. The menu boards that we're rolling out is not a hardware thing where we're putting in all-new framing and lights and backlights and what have you. It's really just the panels themselves that are being replaced, so that's not a significant investment there. But the panels themselves are way easier to navigate, and that's really what the benefit of the new menu boards are. Did that answer the question, or was there more color you want on that?

When you say easier to navigate, just easier to read or easier to update as the day goes on or...

I think what you'll see in the new menu boards is the imagery that's on there of the food is way more directed to the consumer, so it's far easier for the consumer to identify what they want and quickly make that choice. So we think it'll be very efficient in the drive-thru line.

Okay.

And Joe, also, next week at a conference, we will show the before-and-after pictures, so you'll be able to see them on the website next week.

Sounds good.

Our next question comes from Jake Bartlett of Susquehanna.

I had a follow-up and then a quick question. The follow-up is just in talking about the incentive, the program for guest satisfaction and such, could you quantify the impact on margins and maybe EPS just so we can try to see what goes away after -- if you start to lap that? And then I also have a question on uses of cash and just where you expect debt to land. What can we expect from cash use?

Jake, can you -- you broke up about midway through your question. Can you ask that again, please, at least the first part of that question?

Okay, so first half, I'm asking you to quantify the impact of the guest satisfaction initiatives. I know you've talked about hitting some of labor and some of occupancy. I don't have a great sense as to how many basis points that's affecting 2011 margins. As we go to 2012, what the boost could be as you anniversary those.

Right. Let me just -- let me take the second part first here. So in terms of how we're going to deploy the cash, I think our capital deployment strategy will remain. First, it's investing in the business, and then we'll maintain reasonable leverage. And we believe that we have reasonable leverage now, and that our credit facility, even if we ramp that up on the revolver, we'll still provide there reasonable leverage then beyond that, we'd return cash to shareholders. And I think we remain committed to doing that, and our board remains committed to doing that. I think it's evidenced by the additional $100 million worth of share repurchases that they authorized last week. In terms of the impact of the guest service initiatives, I would say not all of them will continue at the same rate going forward. But if you look at the labor deployment that we're using now and the restaurant inspections, we believe that they are a significant driver to the AUV improvement that we're seeing. It's also going to help drive speed of service for us. And so while you may not get the leverage that you may normally see in production labor, as we drive AUVs, we'll get significant leverage on things such as management comp, normal occupancy depreciation and amortization. So what we're seeing right now is that this is a worthwhile investment, and it's a significant impact to driving AUV. I don't know what I would think about this all of a sudden being a cliff where all that stuff just drops off at some point in time because it is driving volume.

Maybe it will be helpful if you can describe some of the items that are hitting the occupancy line. Aside from just kind of putting more labor towards getting through-put? What's hitting the occupancy and the other restaurant expenses?

Yes, I think it's occupancy and others. So if you look at the occupancy side, what's really driving that is what we talked about on Qdoba. And so currently, the Qdoba impact on just the pure occupancy side, about 20 basis points. So the 50 basis points in addition to that or the same, it's the inspectors that we have out in the field, and that is hitting restaurant operating margins. And it's also items related to maintenance and repairs. We're making sure that the restaurants are in good repair and make a good impression on our guests. So our restaurant managers are being coached to be more diligent on that and take a look at their restaurant from a guest perspective, making sure that it makes a good impression when the guests walk in. We've been improving our guest satisfaction scores, and we want to continue to do that and not just have that be a onetime item for the guests.

So the inspection in the field right now, that's going to be an ongoing thing. You're not doing inspections to learn things to make changes that are going to be implemented. It's more of an ongoing program?

Jake, this is Lenny. I just wanted to describe that. The inspections are really just the beginnings of where we're going, and it's sort of a catalyst for us to drive the service where we need it. We expect that we'll continue to invest in that way, but we may evolve the specifics of the program. So today, it's in the form of inspections, and we have a system that provides immediate feedback. We'll probably always have some mechanism along those lines, but I would suggest to you that we will also see that evolve over time into other methods of providing that feedback. Potentially finding more efficient ways to do it, but I wouldn't say that as a result of those efficiencies, we would decrease the spend. We'll probably just reallocate it to other places where we thought we could use it to drive AUVs.

Okay, great.

Our next question, our final question then comes from Peter Saleh of Telsey Group.

Just wondering if the restaurants that you've refranchised over the past couple of quarters, was there any kind of royalty abatement or deferment of the royalty? Or have the franchisees been paying the royalty since day one?

The restaurants that we have -- no, there has not been royalty abatement, so they pay royalties from day one.

Thanks for joining us, and we will talk to you next quarter.

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