CKE Restaurants Q1 Earnings Call Transcript

123jump.com Staff
06 Jul, 2009
New York City

CKE Restaurant earnings dropped 6% to $446.8 million while net income dropped 18% to $14.4 million on same-store sales drop of 1.8%. Earnings per share were 26 cents as against 31 cents a year ago.

CKE Restaurants, Inc ((CKR))
Q1 2010 Earnings Call Transcript
June 25, 2009 9:00 a.m. ET

Executives

Lisa Riordan - Vice President, Investor Relations
Andrew F. Puzder - President, and Chief Executive Officer
Theodore Abajian - Chief Financial Officer and Executive Vice President
Mike Murphy – President Franchising, General Counsel
John Dunion -- Executive Vice President, Supply Chain Management.

Analysts

Gregory Rudy (ph) – Stevens Inc
Sean Dodge -- SunTrust Robinson Humphrey
Tony Brenner – Roth Capital Partners
Mark Smith -- Feltl & Co
Michael Wolleben – Sidoti & Co
Howard Penney – Research Edge

Presentation

Operator

Ladies and gentlemen thank you for standing by and welcome to the CKE Restaurant’s fiscal year 2010 first quarter earnings conference call. (Operator Instructions) For the conference all participants are in a listen-only mode. However there will be an opportunity for your questions and instructions will be given at that time. If you need any assistance please press * then 0. As a reminder today’s call is being recorded. Now with that being said, I’ll turn the conference now to Ms Lisa Riordan. Please go ahead.

Lisa Riordan – Vice president of Investor Relations

Thank you, John. As you know we issued our press release yesterday announcing our financial results for our fiscal 2010 first quarter ended May 18th 2009 as well as our period five same store sales press release. These releases are available on our website, www.ckr.com. CKE has also filed its Form 10-Q with the SEC. This call will reflect items discussed within these press releases and Form 10-Q. CKE management will make reference to them several times this morning. To assist investors we also prepared a slide presentation which can also be found on our website, click on investors and then on presentations. We will be referring to the presentation during the call.

We are speaking to you this morning from St Louis where our Hardee’s headquarters is located. After the call concludes we’ll be holding our annual stockholder’s meeting which will also be webcast today. Speaking on today''s call are Andy Puzder, Chief Executive Officer, and Ted Abajian, Executive Vice President, Chief Financial Officer. Also available are, Mike Murphy President and John Dunion our Executive Vice President, Supply Chain Management. Andy will begin today''s presentation with a few comments regarding our first quarter and then Ted will review some of the financials in more detail. Andy will conclude with comments on the strategic direction of the company. Following the prepared remarks we’ll open it up for Q&A.

Turning to slide two of the presentation, I''d like to remind you of our disclosure regarding forward-looking statements contained in our Form 10Q and earnings release. Our disclosure regarding forward-looking statements can be found within our Form 10Q under Item 2 of MD&A. Matters discussed during our conference call today may include forward-looking statements relating to future plans and developments, financial goals and operating performance, and are based on management''s current beliefs and assumptions. Such statements are subject to risks and uncertainties and actual results may differ materially from those projected in the forward-looking statements.

I’d now like to turn the call over to Andy Puzder.

Andrew F. Puzder – Chief Executive Officer

Thank you, Lisa and good morning to everyone. Because we report our company operated same store sales every period, it is no surprise to you that this economy and the extremely competitive environment have taken a toll on our same-store sales especially at Carl’s Jr, where you heard me talk for many months about our conquest on brand image and profitability rather than sales at any cost. And while profitability remains a high priority for us I want to assure you that we’re not sitting idly and waiting for the economy to turn the corner. We are diligently analyzing the testing initiatives to turn our same-store sales positive and I’ll share some of those with you later in the presentation. So let us take a look at first quarter results in more detail on slide number four which discusses operating income. Operating income was $29.7 million in the first quarter, up slightly from last year’s $29.6 million. Operating income margin was 6.6 this year versus 6.4 last year an improvement of 20 basis points. A reduction in general administration expenses primarily consisting of $2.1 million reduction in share-based compensation expense and $1.3 million decline in all other G&A expenses drove this year’s year-over-year improvement.

As you can see, we held our first quarter operating income relatively steady over the last three years despite commodity cost increases, increases in labor costs due to the higher minimum wage and our recent same-store sales challenges. This is the result of our management team’s ability to adjust to a rapidly changing economic environment and focus on our company’s economic strength.

Turning to slide five, you can see our consolidated restaurant level margins for our company operated stores. At 19.9% for first quarter, we were even with last year and were pleased with this result given the fiercely competitive pricing environment we faced. The resulting 1.8% same-store sales decline and the increase in depreciation we absorbed as a result of our on-going remodel program at both brands. As this slide depicts, in fiscal 2007 when we experienced the perfect convergence of strong same-store sales and favorable labor and commodity prices, we enjoyed restaurant level margins of 21.4%. Given a negative differential of 7.4% in same-store sales, and restaurant level margin slippage of 1.5% from the peak margins in the first quarter of fiscal 2007, when all factors were in our favor, we did extremely well this quarter. This is particularly true as our depreciation expense has increased 150 basis points since 2007, due to the remodel program at both brands. At 19.9% our restaurant level margins are among the highest in the hamburger focused QSR sector.

Turning to slide six, you can see the average unit volumes of our company operated restaurants for the trailing 13 period for our two brands, Carl’s Jr and Hardee’s. For the first quarter AUVs for company operated restaurants were $1,005,700 at Carl’s Jr and $1,010,000 at Hardee’s. For franchise operated restaurants not shown on this slide, average unit volumes were $1,163,000 at Carl’s Jr and $979,000 at Hardee’s. While AUVs were down $7000 year-over-year at Carl’s Jr company operated restaurants they were up 5% at Hardee’s for company operated restaurants. Since 2001 when our management took over, average unit volumes for both brands have improved 40%. Average check at both brands was relatively steady. The average check at Carl’s Jr was $6.93 in the first quarter which compares to $6.92 cents last year. At Hardee’s the average check was $5.04 which compares to $5.07 for the first quarter last year. Hardee’s has a lower average check because 45% of its business is at breakfast versus 15% at Carl’s Jr. Breakfast is a lower food cost and hence a lower average check pay part.

As you can see on slide seven, quarterly net income declined by $2.2 million to $14.4 million. This decrease resulted primarily from increases in interest and income tax expenses. Interest expense increased by $1.8 million due to charges related to our interest rate swap agreements partially offset by a reduction in interest expense related to our credit facility. Now mark-to-market adjustments and our interest rate swap agreements increased interest expense by $2.4 million this quarter as opposed to the prior year quarter when the swap agreement adjustments reduced interest expense by $2.4 million. As expected lower outstanding debt balances and lower interest rates have caused our cash obligations for interest to decrease during the first quarter as compared to the prior year quarter. Quarterly income tax expense increased by 4/10th of a million to $9.8 million and our effective income tax rate increased to 40.5% from 36.2% in the prior year quarter. The increase in our effective income tax rate resulted from favorable tax law changes we recognized in the prior year quarter that did not recur this year. This 4.3% point increase in our effective tax rate equates to $1 million negative impact to net income based on our $24.2 million pre tax income.

On slide eight you can see our diluted earnings per share. Excluding the impact of the mark-to-market charge, it was $0.29 which is ahead of last year. And when comparing to the first quarter of fiscal 2007 when we had the perfect convergence again of same-store sales increases and low commodity and labor costs as I mentioned earlier, our diluted earnings per share were $0.23, so we are up $0.26 from that time period. Our actual diluted earnings per share as reported on our income statement was $0.26 for the first quarter of fiscal 2010 which compares to $0.31 for the same period last year. The decline is due to the mark-to-market adjustments on our interest rate swap agreement and the impact of the increase on our effective tax rate for the first quarter.

On slide nine, we can see our five year trend for adjusted EBITDA. For the first quarter of this year, we increased adjusted EBITDA to $54.7 million. This improvement is noteworthy because we achieved it despite re-franchising 102 Hardee’s and 3 Carl’s Jr restaurants since January 31, 2008, which reduced adjusted EBITDA by $2.7 million from last year. In addition 1.8% blended same-store sales decline had a net impact of reducing EBITDA by $1.6 million. Ted will provide more detail on adjusted EBITDA a little later on in the presentation.

While it is a mistake to place too much emphasis on any one period’s results, I do want to briefly discuss period five results on slide 10. We announced our same-store sales results for period five on Wednesday. The troubled economy and the extremely competitive landscape continued to put pressure on same-store sales during period five. In addition Hardee’s resulting over stronger same-store sales in the prior year than was the case during the first quarter. Blended same-store sales declined by 5.2% during period five after having increased by 2.6% during period five of last year. As a result on a two year basis blended same-store sales for period five were negative 2.6%. Consolidated company restaurant revenues were $85.2 million in period five of this year which compares to $88.6 million in the year ago period. Company operated trailing 13 period average unit volumes were $1,499, 000 for Carl’s Jr and $1,008,000 for Hardee’s. While both brands were rolling over positive same-store sales in the prior year, we are determined to bring them back to positive sales territory but to do so without demeaning our brand image, our consumer perceptions, with respect to the taste and quality of our products. Initiatives designed to improve same-store sales at both brands while preserving our brand image remain our management team’s primary focus. We will become increasingly aggressive in conveying our great value for the money positioning through both traditional and digital media outlets in the coming months. I’ll explain some of what we are doing a little later on and now I’d like to turn the call over to Ted.

Theodore Abajian - Chief Financial Officer

Thank you Andy and good morning everyone. I know you are all anxious to get to the Q&A session, so I’ll keep this as brief as possible. As Andy spoke about earlier, we held our consolidated restaurant level margins flat with last year at 19.9%. For Carl’s Jr restaurant level margin was 21.9% down 60 basis points from last year’s first quarter. This decrease was primarily due to a 70 basis point increase in depreciation expense as a result of our ongoing remodel program. Given the increase in depreciation expense we are quite pleased with our 21.9% restaurant level margin which would have actually exceeded the prior year but for this increase. In addition rent expense increased about 40 basis points as a result of the de-leveraging impact of our same-store sales decline. Workers comp expense increased 30 basis points as a result of favorable claims adjustment last year which did not recur to the same extent this year. These increases were partially offset by 70 basis point decline in food and packaging costs resulting from more favorable pricing for cheese, produce, oil and beef products as well as reduced fuel prices which aided our distribution food costs.

On slide 13 we can see that Hardee’s increased it’s restaurant level margins by 60 basis points over last year to 17.5% for the first quarter of fiscal 2010. An interesting point here is our margins are down just 50 basis points from the first quarter of fiscal 2007, that perfect convergence quarter Andy spoke of earlier when same-store sales at Hardee’s were more than double what they were for this quarter. This is despite our increase in depreciation expense of 140 basis points over that period due to our remodel program. Driving the margin improvement this quarter was a 160 basis point reduction in labor costs, a 40 basis point reduction in food and packaging costs and a 30 basis point reduction in costs for repair and maintenance. Labor was lower due to labor efficiency programs implemented in the second quarter last year while food and packaging was lower due to lower commodity prices and reduced fuel sales which have a higher associated cost of goods sold than our food products in the sole gas stations that we operate. Repairs and maintenance costs declined because our cost control efforts this year as well as unusually high costs last year that resulted from the acquisition of some facilities from a franchisee. These cost reductions more than offset the 130 basis point increase in occupancy and other costs which increased mainly due to increased depreciation expense that resulted from our ongoing remodel program and new restaurant openings.

In looking at the adjusted EBITDA grid on slide 14, you can see that we grew adjusted EBITDA by $121,000 despite a number of items that materially reduced adjusted EBITDA during the quarter. The biggest year-over-year negative impact resulted from our re-franchising program that occurred in fiscal 2009. As you may recall we re-franchised 102 Hardee’s units and 3 Carl’s Jr unit since January 31, 2008. The net result was a reduction to adjusted EBITDA of $2.7 million. The 1.8% decline in blended same-store sales reduced adjusted EBITDA by $1.6 million and our net franchise contribution was $575,000 below the prior year mostly a result of the same-store sales decrease at our franchised Carl’s Jr restaurants. On the plus side, our opening of 24 new Carl’s Jr and 8 Hardee’s company operated restaurants since January 31, 2008 generated a $2.1 million increase in adjusted EBITDA and we reduced G&A and all other costs by $2.1 million for the quarter. Finally same store operating costs decreased $722,000 or 16 basis points which was driven primarily by lower commodity costs. Overall given the negative impact of re-franchising 105 restaurants we are very pleased with the modest increase in adjusted EBITDA this quarter.

Looking a little closer at G&A expense on slide 15, it is important to note that we not only reduced G&A expense by $3.4 million on an absolute dollar basis but we also reduced G&A costs by 30 basis points as a percentage of sales., which was quite remarkable given the 4% decline in total revenues which was primarily due to the Hardee’s re-franchising program and our 1.8% blended same-store sales decline. As Andy mentioned earlier this $3.4 million decrease in G&A costs was comprised of a $2.1 million reduction in share-based compensation and a $1.3 million decrease in all other G&A costs.

On slide 16, you can see our restaurant operating cost mix not to be confused with costs as percentage of sales. The biggest cost item is food and packaging at 36% of total cost. Not far behind is our labor expense at 35% of total restaurant operating costs. On the right side of the slide we broke out for you our consolidated systems food costs mix for the first quarter. Beef remained our biggest cost item. We purchased our U.S fed and graded Black Angus Beef in the spot market. However we do forward purchase approximately 25% of the total burger products we buy and we typically forward purchase 60 to 90 days in advance. During the quarter our food costs were rated by reduced cost for cheese, produce, oil and beef products at Carl’s Jr. As we said in our press release we are forecasting a 2% to 3%food cost inflation for fiscal 2010.

Moving on lets take a look at our balance sheet on slide 17. At May 18, 2009 we had a $54.5 million outstanding balance on our $200 million revolving line, down from $62 million at the end of fiscal 2009. The interest rate on this facility is LIBOR plus 150 basis points or approximately 1.9%. The revolver also has a letter of credit prep facility primarily to support our casual insurance program of which 35.4 million was outstanding as of May 18, 2009 leaving us with approximately $110 million of available borrowings on the revolving portion of our credit facility. Under our term loan facility we had $249.4 million outstanding as of the end of the quarter. This loan bears interest at a rate of LIBOR plus 1.38%. We have an interest rate locked on $200 million for term loan debt which fixes our cash interest payments on this debt at 6.12%. During the 16 weeks ended May 18, 2009 we made aggregate plus full payments of $2.3 million on the term loan of which $1.6 million was based on excess cash flows for fiscal 2009 as required by the terms of our facility. Finally, our leverage ratio was 2.27 at the end of the quarter comfortably below our 2.75 plus maximum leverage ratio.

Slide 18 covers our capital plans for fiscal years 2010 and 2011 and this plan hasn’t changed since the end of fiscal 2009. We are still planning to spend between $100 million and $110 million for fiscal 2010 down from the $117 million we spent last year. Of course w can adjust our spending levels relatively easily if needed. As we near the end of our remodel program we expect capital expenditures to drop unless we decide to increase spending on new unit development. At present we are forecasting capital expenditures for 2011 to be between $83 million and $93 million. We are often asked about the availability of additional financing for us as well as the financing available for our franchisees. As it relates to us we have approximately $110 million of liquidity available on our credit facility which expires in early 2012. In the present time we are very comfortable with our current credit facility but we do keep appraised of current developments in the credit markets in order to make sure we are thinking far enough ahead at all times. As we have been stating for quite sometime now, we do not intend to borrow money for our capital plans. As far as franchisees the credit markets remain tight but our franchisees do have access to capital. Many of our franchisees work with local banks which in many cases have been less impacted by the financial crisis than many of the very large banks.

In slide 19, you’ll find a brief recap of our restaurant portfolio and the changes that have occurred since the end of first quarter last year and the end of fiscal 2009. We have had a net addition of 17 restaurants since the end of fiscal 2009 and a net addition of 32 restaurants since the end of the first quarter last year.

As Andy mentioned period five same-store sales results were also released yesterday. On slide 20 we depict these results for Carl’s Jr. For period five, same-store sales were down 7.1% and on a two year basis same-store sales were down 4.6%. Andy will discuss with you some of our initiative to try to turn sales positive so I wanted to focus my discussion on a few items we have been asked as of late. Here are some metrics to help you ascertain the impact the economy is having on our sales. The Californian unemployment rate was 11.5% at the end of May 2009 which compares to 11.1% for April, 6.8% for May of 2008. The national unemployment rate was 9.4% for May 2009, 8.9% for April 2009 and was 5.5% for May 2008. At the end of first quarter fiscal 2010 we had 367 company operated restaurants located in California and 361 franchise restaurants operated in California.

And now turning to Hardee’s on slide 21, you can see that the same-store sales were off to a positive trend at the beginning of the year but have now turned negative with period five down 2.7%. On a two year basis same-store sales were positive 0.1%. Hardee’s negative same-store sales for this period is partially due to tough prior year comparisons although with the national unemployment rate creeping upwards it is very likely this is having effect as well. Our biggest states of concentration for Hardee’s restaurants are South Carolina with 106 restaurants, Tennessee with 87 restaurants and North Carolina with 66 restaurants. The unemployment rates for May 2009 for these states were 12.1%, 10.7% and 11.1% respectively which compares to 11.4, 9.9, and 10.7 respectively for April and 6.3%, 6.2% and 5.9% for May 2008. There has also been some speculation of the rollover of government stimulus checks that were issued in May of last year could also be impacting same-store sales. I’ll now turn the call back to Andy who will discuss in more detail what we are doing to turn the sales situation around.

Andrew F. Puzder

Thanks Ted. Let’s turn into slide 23, one of the more pleasant looking slides, and I’ll briefly review our product initiative for the first quarter. At Carl’s Jr we rolled out the Green Burritos, Crisp Burritos, the Kentucky Bourbon Burger, and the Jumbo Chili Dog. The Kentucky Bourbon Burger was supported by a comical television ad campaign where we featured a doctor who had to have his Bourbon everyday. At Hardee’s we featured the chicken parmesan sandwich also supported by a comical television ad campaign and then later in the quarter we introduced the Western Bacon Thickburger supported by a very provocative commercial starring top chef Padma Lakshmi who is pictured on this slide. During the quarter we also introduced Beer-Battered Onion Rings and Texas Toast breakfast sandwiches at Hardee’s. Despite these efforts our sales are not meeting expectations. As I mentioned the competitive environment has been fierce and while we have not been participating in the discount wars, the fact is we do have value items. Value and affordability are in our view two different concepts. Value involves getting a lot for which you pay either in terms of quantity, taste or quality regardless of the price. Affordability is about paying very little. The $6 dollar Burger for only $3.99 is a good example of our value concept for a relatively high priced product. However in the current economy, affordability is increasingly important as people have fewer and fewer discretionary dollars. The $0.99 items we sell are good examples of affordable items. However $0.99 customers are the least profitable customers. This is why you see our margins holding up at a high level despite negative same-store sales in the first quarter. While certain of our competitor’s with slightly positive same-store sales have lower margins and have sacrificed margins. The key is to drive sales without significant margin erosion. So, how do you drive sales without eroding margins?

Slide 24 outlines some of the action steps we are taking to try and turn sales positive. We recognize the need to improve our value affordability perceptions but we need to do so in ways that are consistent with our positioning and brand image. We will continue our premium product strategy and use cutting edge commercials to promote our big juicy burgers to young hungry guys. However we will also begin to launch initiatives that increase the awareness of our value items. The reality is that we also have very good affordable items. For example our big burger for $0.99 in some restaurants and $1.29 in others is a great value and a great burger. I think it’s the best $0.99 burger out there. Our spicy chicken sandwich for $0.99 is another good example of a great tasting, very affordable product. Last week at Carl’s Jr we began running a two for $4 Western Bacon Cheeseburger promotion supported by the Padma commercial. We are also bringing back our Teriyaki burger starting at $2.89. This product will be supported by a TV commercial featuring Audrina Patridge from the Hills. And at Hardee’s we introduced the delicious and low priced breakfast item known as Biscuit Holes at the very end of period five.

Biscuit Holes made with our famous butter milk biscuit dough are rolled in cinnamon sugar and served with a cup of icing for dipping. We will support this product on air during period six by utilizing humorous ads that feature actual consumers coming up with alternative names for this product. Hardee’s also has we believe the best and most popular breakfast menu in the business anchored by its ‘Made from Scratch Biscuits.’ We are testing the full Hardee’s breakfast menu branded as Hardee’s and at Carl’s Jr in Orange County. To date the test has been encouraging. However we have to make sure operationally we can cook this product without over complicating our operations. The other test we will be conducting involves a snack menu and a reduced combo up chart. For competitive reasons I don’t want to talk about the snack menu but the combo up charge initiative involves replacing our 20 ounce spring cup with a 16 ounce cup and reducing the cost of a combo up charge from approximately $2.50 to $ 2. I’ll talk to the last two points noted on the slide, Digital Media and diversification outside of California in the slides to follow.

For me some of the most exciting initiative we have involved digital media. Pictured here on slide 25 is a screen shot from our new upgraded YouTube channel at Carl’s Jr. We just launched a very innovative partnership with YouTube whereby we are utilizing some of their most popular video stars to produce short videos promoting our burgers. With the combined following of 3.2 million subscribers these video burgers are helping us target our customers where they already are. We also just retained a digital agency known as 72andSunny whose other clients include Nike and 2K Sports. Our young hungry guy demographics spend a lot of time in the digital world and we need to be there with sales driving initiatives.

Another priority for us is to expand our presence both domestically and internationally. Our strategy in this regard is laid out on slide 26. While this is certainly a much longer term plan than the other initiatives mentioned it is nevertheless important. For Carl’s Jr we intend to lessen our exposure to California. As such we are targeting a large percentage of our growth in Texas, a state that is named to be more business friendly. In fact in the May 2009 edition of Fiscal Notes, a monthly report issued by Susan Combs the Texas Comptroller of Public Accounts, it states, “Downturn or upturn Texas leaders want our state to be the most attractive in the country for business.” And according to Newgeography.com five Texas metropolitan areas dominated the list of the top large cities for job growth.

For the Hardee’s brand we plan to fill in some of the southern states, doing so with the aid of our media buyers as it will enable us to have more media purchasing power in certain regions. We also have plans for international expansion as I have discussed in the past. International expansion is currently proposed to be primarily franchise-driven. We have 325 international stores at the end of the first quarter and currently expect to have 375 additional units by 2014 for a total of about 700 units. System wise by the end of fiscal 2014, we expect to have 3848 units versus 3133 today. That’s a 23% unit growth rate over five years. We expect that approximately 75% of our system will be franchised and licensed versus 71% today. We expect franchisees will represent about 90% of all new units and we currently expect our international units to reach 18% of total versus 10% today.

And now before the summary I want to relate you with a mouth watering visual, that’s on slide 27, where we have Audrina Patridge from the Hills television channel and our latest commercial star featured wearing a compelling gold bikini. In the commercial she professes her love for our Teriyaki Burger with grilled Dole pineapple rings. By the way you can find this at YouTube. I think it is /Carl’s Jr at the Carl’s Jr site in YouTube. This ad will be paired with a spot called ‘Through the grill’ featuring a young hungry guy devouring a burger and focusing on value, so everybody hungry now?

Finally on page 29, we will wrap up. While we are running our company for long-term growth not short-term pops, we are launching initiatives that aim to turn sales positive. We will continue to utilize provocative advertising to enhance our brand awareness and we’ll begin some innovative digital programs. We are expanding domestically and internationally to accelerate our growth over the longer term. The bottom line is we are designing strategies that deliver long-term shareholder value while keeping our enterprise value intact. I’d now like to open up the call to Q&A.

Question-and-answer session

Operator

(Operator instructions) Ladies and gentlemen if you’d like to ask a question today please press the * and then 1 on your touchtone phone. You’ll hear a tone indicating that you’ve been placed in queue. If your question gets answered or you wish to remove yourself from the queue please press the pound key. Once again if you have a question *1 and we will first go to the line of Greg Rudy with Stevens. Please go ahead.

Gregory Rudy – Stevens Inc

Thanks good morning.

Andrew F. Puzder

Hey Greg.

Gregory Rudy – Stevens Inc

On the stock media I can understand why you don’t want to discuss maybe some of your tests and describe it a little bit. Are you at test with it currently or can you tell us when you plan to roll that out if test is successful and I have a follow up there?

Andrew F. Puzder

We are in test with it. And we do have some preliminary results but I am not sure I am going to tell what they are. They are encouraging. They are strong enough to make us want to continue. We’ve got a few things we need to determine in the test. One thing you’d like to know when you do something like this is whether the less expensive products are improving the number of people coming into your restaurant, increasing it or are we merely taking the bit that are already coming into your restaurants and they are just trading down from a more expensive product to these less expensive products. And so that’s something that takes a little while longer to figure out than you might say but that’s sort of the state we are in now.

Gregory Rudy – Stevens Inc

Okay and I guess that covered the follow up, shifting to your discussion of Texas, you have got plans for 70 company-owned and you have had that for years? What percentage of those are Texas and then maybe a question for Ted, can you discuss AUVs on those early units there and the ROIC variance versus an average company owned Carl’s Jr?

Theodore Abajian

Well on both questions Greg and of these 70 units I mean roughly 75% approximately of our growth, company corporate stores, is focused in Texas. We will occasionally build a store in California to fill in or just to commence an opportunity but it needs to be a grade A or maybe AA site in California. We are experiencing similar rebuilds essentially in Texas that we are experiencing elsewhere and that we expect from in general. So, we are excited about that market. And there is Andy mentioned tremendous growth opportunity and very business friendly environment and franchisees are very excited about that market.

Andrew F. Puzder

Yeah once again to keep in mind Greg, in Texas we don’t have enough restaurants to be on TV. So, if we are doing comparably well that’s really good.

Gregory Rudy – Stevens Inc

Right, I appreciate that. Last one and then I’ll pass it along. You are looking at options on combo meals. Do you think that will allow you to recover your average check without taking price and Ted how do you view your ability to take price in this macro? Thanks.

Theodore Abajian

We feel we haven’t lost anything on average check. Actually Carl’s was up a penny and Hardee’s was down $0.02 which really is no change at all in either direction. The problem right now we are having in sales actually isn’t, when we introduce a new burger we are not selling less new burgers that when we did the Bourbon Burger. We didn’t sell fewer new Bourbon burgers than we did other products that we introduced and we didn’t sell fewer than we expected. We actually did better than we expected with that product but people are getting combos like they used to. I think one of our competitors who has released day before yesterday made the same comment. It is really a problem that you’ve got guys who used to come in and say “I’ll take a Western Bacon Cheese Burger and a combo and not say I’ll take a Western Bacon and Cheese Burger and a glass of water.” So, getting that combo incidence back up I think will go a long way towards addressing some of these sales issues and I think the way to do that is to make our combo pricing more attractive. Our small soda used to be $1.29 at 20 ounce soda. It is a little tough for a guy to come in and spend a buck 29 on a burger and a buck 29 on the soda. So, this 16 ounce prices go down to a dollar on the soda which becomes a much more attractive offer and we can offer a smaller fry maybe with our kids meal bag so you don’t have that big bag of fries but you have some fries and for two bucks you can have a combo. So, it is something that we are working on and testing and we are hoping that will make a difference.

Gregory Rudy – Stevens Inc

And the ability to take price in this environment?

Theodore Abajian

I think we can take price when people perceive that prices have increased. In other words we took a lot of pricing when commodities went up and now they’ve come down some and as you know nobody has lowered their prices. So, we have got some room right now with the decline in commodity prices in our pricing. And we’ve also done some adjustment. You try a chicken for example which doesn’t happen to be a low cost item at the moment becomes a low cost item and you try new chicken products. There are things you can do in the short-term that also addresses this issue. I think that there is sort of a broader question but you will think with all the money we are printing, we are kind of printing it like newspaper, and the debt that the country is assuming like a bunch of drunken soldiers or sailors you’d think that inflation would be coming but I think with unemployment as high as it is, actual employment as low as it is, and with credit as tight as it is, it is a little tough to see where that inflation, those inflationary dollars would come from if prices went up. So, I think the slow economy, high unemployment and credit will probably keep inflation under control for a while. So, I am not envisioning that in the near-term we are going to need to raise our prices.

Gregory Rudy – Stevens Inc

Fair enough. I’ll jump back in the queue. Thank you.

Operator

Next we’ll go to the line of Sean Dodge with SunTrust. Please go ahead.

Andrew F. Puzder

Good morning, Sean.

Sean Dodge -- SunTrust Robinson Humphrey

Yeah, good morning, concerning your guidance for the food cost inflation, 2% to 3% I was wondering what level of inflation are you seeing for the bonus 50 for the 90s if it was included in that?

Andrew F. Puzder

That number comes from John Dunion who is head of Supp Chain Management and John just happens to be here to answer that question.

Sean Dodge -- SunTrust Robinson Humphrey

That’s fine.

John Dunion

I think the beginning of the favorable trend began in Q3 and Q4 and so year-over-year it was favorable. But going forward if you look at commodity prices year-over-year they are down substantially from last year. So, second and third quarter should be beneficial from a spot pricing perspective.

Sean Dodge -- SunTrust Robinson Humphrey

Okay what are the food cost inflation do you guys see during the first quarter?

John Dunion

Market basket that, we were 3.4% on our first quarter market basket year-over-year.

Sean Dodge -- SunTrust Robinson Humphrey

Okay. Again based on your guidance it looks like you guys are going to need to take five or six day 90 basis points of price at both concepts to offset that. I just wanted to know if that’s the plan right now to take at least that much pricing during the year.

John Dunion

I think right now we are not factoring in is the fact that commodities were down from when we took pricing last time.

Sean Dodge -- SunTrust Robinson Humphrey

Okay.

Andrew F. Puzder

We do have some flexibility here and we can take because we don’t lock ourselves into a price point. We don’t lock ourselves in the $0.99 to a $1.29 or a $1.49. So, we can take a nickel or a dime here and there and it doesn’t seem to hurt as much. Now with sales the way they are we would be disinclined to increase prices until we saw more positive trend but we still have some flexibility to do that. I think in the short-term, like I said it is still a little early. I don’t really see us getting hit by inflation. I just don’t think inflation is going to hit the economy like people are predicting until job, until unemployment declines or until credit becomes available and when those things happen you should be seeing a positive trend in our sales anyway. So, it is not, I am not viewing this as a real difficult issue at the moment. It certainly isn’t currently.

All right. Thank you very much.

Operator

And the line of Tony Brenner with Roth Capital Partners, please go ahead.

Theodore Abajian

Good morning Tony.

Andrew F. Puzder

Good morning Tony.

Tony Brenner – Roth Capital Partners

Good morning. I have a question regarding your remodeling program. First what percentage of your stores, which you intend to remodel have already been remodeled and what remaining length of that program is there?

Andrew F. Puzder

Tony at Carl’s we are getting very close in terms of…and all of this is company operated restaurants in response to your question. At Carl’s we are getting very close to being complete with the remodel program. We are down to the stores that…this year we will finish the stores that are easily remodeled and what we will have left will be just the ones with where we have to determine the lease or we may need other issue to work with the city but in our investor presentation you can see that we are going to be about 79% of our company operated stores remodeled by the end of the year and at Hardee’s we’ll be about 63%. So, at Hardee’s we’ll have another year, next year until we get to that same position as at Carl’s.

Tony Brenner – Roth Capital Partners

Right. So, depreciation costs continue to rise through early fiscal 2011 basically and then will the little flutter after that other than expansion?

Andrew F. Puzder

I think as I said our new units impact will not be an unreasonable way to think about it.

Tony Brenner – Roth Capital Partners

Okay and could you comment on the difference if there is one in sales comparisons in the remodeled stores versus stores in the same market areas that have not been remodeled?

Theodore Abajian

Tony the way we do that is we take a group of comparable stores and with Carl’s we have run out. We don’t have to work out comparable stores. It is really hard to do that comparison. When we were doing the comparison the remodeled stores were performing both on ROI and same-store sales basis better than the non-remodeled stores and the ROI was ranging from single digits to the teens up to the higher teens based upon the extent of the remodels that you did. There were a number of different remodels. There were interior only where they won’ let you do anything outside. There is an interior where they will let you change the signs and paints but they won’t let you do anything outside. There is an interior with green or red burrito and those two scenarios and then there were the ones where we can do what we call an exterior remodel and full interior remodel and had a green or red burrito. And although the ones where we added the green or red burrito did the exterior and the interior were the most expensive they were also the highest ROI and the best same-store sales conversions and the ones where we did the least were the lowest ROI and the lowest same-store sales conversion but all of them were positive. And so really we had to do it even if they were flat but even if they were negative we needed to remodel these stores. But they were all on the positive side just kind of a broad range.

Tony Brenner – Roth Capital Partners

Similarly for Hardee’s where the red burritos were right.

Andrew F. Puzder

Yes the red burritos.

Tony Brenner – Roth Capital Partners

That was across the system.

Andrew F. Puzder

Yeah I was referring to both and I was giving current information.

Tony Brenner – Roth Capital Partners

Okay thank you.

Andrew F. Puzder

Thanks Tony.

Theodore Abajian

Thanks Tony.

Operator

And to the line of Mark Smith with Feltl, please go ahead.

Mark Smith with Feltl & Co

Hi guys. Can you tell us if you found a significant impact from your Mexican restaurants, restaurants in Mexico due to swine flu in the quarter?

Andrew F. Puzder

Yeah we did, we did see. There were periods of time when restaurants could only have their dry foods open. I think that was a week or a little longer than a week and that was a significant impact and for the quarter our same-store sales in that region I think were down between 20% or 25% which you can imagine, if you don’t have your dining room open for quite a number of, I think a number of weeks and just the general issues that accompany having a health problem of that nature, it was a significant impact to those restaurants. That has not, fortunately it is not that big of a overall impact to us on a corporate basis but it did have an impact in that specific region.

Theodore Abajian

First quarter numbers were affected also.

Mark Smith with Feltl & Co

And then last question, all of the Texas restaurants that you are looking to building on the company operated side all of these are going to be dual branded? Is that correct?

Andrew F. Puzder

No. We’ll dual brand them where we think that dual branding is…it is much like we did in the rest of the country, where we think dual branding is going to be effective. It is something like, I don’t know, 15 different things to look at to make this call. But where we think it will work, we are going to do it and where we don’t think it is, we won’t.

Mark Smith with Feltl & Co

Okay. That does it. Thanks.

Theodore Abajian

Thank you.

Operator

And we have the line of Michael Wolleben with Sidoti. Please go ahead.

Michael Wolleben – Sidoti & Co

Good morning guys.

Andrew F. Puzder

Hi Michael.

Michael Wolleben – Sidoti & Co

Just had a quick question here, I wondered if you guys can give your call on uses of cash as it relates to paying down debt here? Is that a big priority for you guys? Is there a targeted amount of free cash flow that you’d use to pay down that debt?

Andrew F. Puzder

I don’t really have a target. Debt pay down for me is always I mean for anybody who has been following the company for the last nine years, knows that we have been very focused on paying down debt. I don’t like debt. I am more focused on making sure our restaurants are in good shape. So we have been doing our remodels and I want to continue to do that absolutely and get it down but really any excess cash or cash above that and the dividends that we pay goes to reduce debt and as long as the debt continues to come down as it did, I think totally about $10 million, close to 10 million, as long as it continues to come down on quarter-by-quarter basis I’m okay. If it stops coming down or it start to go up then we are going to slow our capital expenditures to put more focus on debt repayments.

Theodore Abajian

I must add that we are comfortable with our current leverage but with current market environment I think all things considered it is still prudent to use excess cash flow to reduce debt. We have held our leverage ratios essentially flat for the quarter versus the year end and that’s something that we do manage and as Andy mentioned we do adjust our capital spending to make sure that we are not incurring debt to fund that program.

Michael Wolleben – Sidoti & Co

Great, thanks guys.

Operator

And just a quick reminder, if you do have a question press “*1” and then we have the line of Howard Penney with Research Edge. Please go ahead.

Howard Penney – Research Edge

Good morning, thanks very much. Do you have any thought about the California law that goes into effect on July 1st?

Andrew F. Puzder

Well number 1, we actually have. I think it was in Washington, we have an area where we have to put that information on the menu board already. And it does not seem to be impacting sales at all. I will say we maybe in a little bit of a different position than some of our competitors although some of them are in the same position as we are. They are smart guys in all these brands. But we already posed all these information in the restaurants. There are two big posters. I think we give as much or more information than is required by this law to be available at the counter. So, we have got a poster where we can go to our website and you can build any product we have or check any product we have to see what the fat and calorie content is and you can make up a product of your own. You can hold the mail or hold the cheese and this program will tell you the fat and core content and we generally put the calories and fat in our press releases, as a sort of and as a young hungry guys we kind of brag about it and so it is not something we expect to impact us. I think it is a hassle. I think it is kind of a nanny state law that tries to protect people from themselves but it is not the kind of thing that I think is productive or helpful or meaningful. I think it is a kind of thing that politicians pretend they are doing something but we will comply. And there is actually a law at the federal level, two laws that are being considered at the federal level and we are talking to the politicians who are addressing those laws. The Californian law really was a bad law. It is not a good law but again we’ll comply. I don’t expect it to have much of an impact on sales around people’s eating habits.

Howard Penney – Research Edge

I appreciate it. Secondly how many stores in different markets that you are going to be testing the value initiative in?

Andrew F. Puzder

The value initiative which is what value? We have got a lot of value products. We are doing two for $4 in restaurants now.

Howard Penney – Research Edge

The ones that you talked about this morning.

Andrew F. Puzder

There is a snap menu but it is not a value, it does have some more affordable products on it but it is sort of like a late night menu. We have been actually talking about this for years and that will be probably in, I’m not sure how many stores they are in now? My recollection is three or four and we’ll be taking it out to broader tests to see what kind of impact it has on overall sales. Whether people are trading down too much to make it effective and we are testing the Hardee’s biscuit. We have got a number of tests going on to try and see what we need to do to adapt to the new consumer environment.

Howard Penney – Research Edge

Thank you.

Operator

And please listeners there are no further questions. Thank you.

Andrew F. Puzder

Well, thanks everybody and we look forward to speaking to you at the end of second quarter.

Operator

Ladies and Gentlemen that does conclude your conference for today. Thank you for your participation. You may now disconnect.