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Edited Transcript of JACK earnings conference call or presentation 8-Aug-19 3:30pm GMT

Q3 2019 Jack in the Box Inc Earnings Call

SAN DIEGO Oct 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Jack in the Box Inc earnings conference call or presentation Thursday, August 8, 2019 at 3:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Carol A. DiRaimo

Jack in the Box Inc. - Former VP, Chief IR & Corporate Communications Officer

* Lance F. Tucker

Jack in the Box Inc. - Executive VP & CFO

* Leonard A. Comma

Jack in the Box Inc. - Interim Chairman & CEO

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Conference Call Participants

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* Andrew Michael Charles

Cowen and Company, LLC, Research Division - Director

* Brian John Bittner

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* Christopher Thomas O'Cull

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst

* David E. Tarantino

Robert W. Baird & Co. Incorporated, Research Division - Co-Director of Research and Senior Research Analyst

* Dennis Geiger

UBS Investment Bank, Research Division - Director and Equity Research Analyst of Restaurants

* Gregory Ryan Francfort

BofA Merrill Lynch, Research Division - Associate

* Jeffrey Daniel Farmer

Gordon Haskett Research Advisors - MD & Senior Analyst of Restaurants

* John Stephenson Glass

Morgan Stanley, Research Division - MD

* Jon Michael Tower

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Lauren Danielle Silberman

Crédit Suisse AG, Research Division - Senior Analyst

* Matthew James DiFrisco

Guggenheim Securities, LLC, Research Division - Director and Senior Equity Analyst

* Nerses Setyan

Wedbush Securities Inc., Research Division - Senior VP of Equity Research & Senior Equity Analyst

* Robert Marshall Derrington

Telsey Advisory Group LLC - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good day, everyone, and welcome to the Jack in the Box Inc. Third Quarter Fiscal 2019 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 introduction, I would like to turn the call over to Carol DiRaimo, Chief Investor Relations and Corporate Communications Officer for Jack in the Box. Please go ahead.

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Carol A. DiRaimo, Jack in the Box Inc. - Former VP, Chief IR & Corporate Communications Officer [2]

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

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

Adjusted EBITDA represents net earnings on a GAAP basis, excluding discontinued operations, income taxes, interest expense, gains or losses on the sale of company-operated restaurants, impairment and other charges, depreciation and amortization and the amortization of franchise tenant improvement allowances.

Our comments may also include other non-GAAP measures such as restaurant-level margin and franchise-level margins. Please refer to the non-GAAP reconciliations included in the earnings release as well as the prior year results recast for the adoption of the revenue recognition accounting standard.

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 as 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 in the Investors Section of our website at www.jackinthebox.com.

A few calendar items to note this morning. Our fourth quarter and fiscal 2019 ends on Sunday, September 29, and we tentatively plan to announce results on Wednesday, November the 20th, after market close. Our conference call is tentatively scheduled to be held at 8:30 a.m. Pacific Time on Thursday, November the 21st.

And on a personal note, after more than 30 years in the restaurant industry, including 11 wonderful years with Jack in the Box, this will be my last earnings call before I retire this month. You're in great hands with Rachel, Lance and Lenny.

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

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [3]

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Carol, let me just take a moment to congratulate you on your retirement. There really is no one more deserving than you. I view you to be one of the most talented professionals I've ever had the pleasure and honor to work with. Your code of ethics, care for people and commitment to business has been second to none. You truly are a role model. But please accept my heartfelt thank-you and know that we all (technical difficulty).

Moving on to the business, I'm going to start by sharing a little bit about what fueled our third quarter results and why I'm so bullish about the future. System same-store sales for the quarter increased to their highest level since Q1 of 2017, with all day parts positively contributing to the sales growth, and year-over-year transactions were the strongest we've seen in nearly 4 years. This sales and traffic momentum has accelerated into Q4. With more than 3 quarters of fiscal 2019 now on the books, we're on track to achieve our ninth consecutive year of system same-store sales growth. Driving the sales growth in Q3 was the right mix of product innovation, value and operational execution.

In the quarter we targeted our marketing spend towards 3 bundle deals that offered a little something for everyone at compelling price points. Our primary promotion for most of Q3 was a $4.99 combo featuring Jack's new Spicy Chicken Strips, which is on trend and a great example of culinary innovation. Most markets also featured a $4.99 Triple Bonus Jack Combo, including our signature curly fries. And we brought back a guest favorite with our 2-for-$4 breakfast croissants.

Emphasis on value is not adversely affecting our average check. In fact, the average check for value-priced combos in Q3 was significantly higher than other orders due to upsell and add-ons. It's important to note that our approach to value is not negatively impacting restaurant-level profitability. Our margins remain among the highest in the industry. We generally refrain from deep discounting tactics, especially on our core products, which we believe would not be in the best interests of the long-term health of our brand. Many of our value-oriented promotions, like Jack's Spicy Chicken Strips, are either new menu items or limited-time offers, which minimizes the risk of diluting the equity of core products that our loyal customers crave. We also strategically build in upsell opportunities with these promotions that can generate a higher check while preserving margins.

Looking ahead, it's important that we continue evolving in all areas of our business to meet the ever-changing needs of consumers and drive sustainable sales growth. Let me share some of the initiatives that are underway to do that.

First, we will simplify the Jack in the Box restaurant operations so that guest experience will be more consistent and about a minute faster on average. Phase 1 of this initiative rolled out across the system in July. But this phase really just scratches the surface when it comes to making meaningful improvements to benefit speed of service and increase throughput. To do that, we need to change the way we operate in back of the house, and that's exactly what we'll be targeting in the next phase of the program. As changes are implemented, we expect to provide faster and more consistent service for our guests and ultimately deliver more sales and profit for our operators.

Second, Jack in the Box has a rebellious personality that differentiates us from other brands. This appeals to our loyal fan base who live online and in a world dominated by Instagram memes, gaming and social media influence. We plan to capitalize on the strength of our brand to build relationships with our fans and promote our craveable products at competitive prices. Social and digital space allows us to meet consumers where they are, so we'll continue to build up our app user base and expand in other digital avenues to further fuel our sales.

Next, we'll work with our third-party delivery providers, who now cover more than 90% of our system, to further expand coverage while also making the purchase more seamless for our guests and restaurant teams.

Another area of focus will be enhancing the drive-through experience. We're currently testing different amenities intended to do just that, including digital menu boards, new branding elements, canopies and designated parking for pickup and delivery. We plan to finalize the elements of this upgraded experience and to begin rolling out the program in 2020.

Now I'd like to switch gears and address some of the structural components of our business. With our securitization completed, we're planning to resume share repurchases this quarter. Including the $150 million we returned to shareholders in Q4 last year, we continue to expect to return more than $1 billion to shareholders through 2022 in the form of share repurchases and dividends. In addition, we will soon complete our transition to an asset-light, single-brand entity when we roll off the last of the transition service agreements we have with Qdoba.

With our refranchising initiative concluded, we're seeing higher and more predictable levels of franchise revenues and increasing free cash flows. It's certainly taken a lot of effort to get to this place, and I'd like to thank my team for their loyalty and contributions as well as our key stakeholders for their participation and patience. With that behind us, I am extremely bullish on JACK's future, and I am pleased to see that we're already starting to experience some early wins.

Now I'll turn the call over to Lance for a more detailed look at the third quarter and our expectations for the full fiscal year. Lance?

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Lance F. Tucker, Jack in the Box Inc. - Executive VP & CFO [4]

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Thank you, Lenny. And Carol, I, too, want to reiterate how much we appreciate the time and energy you've devoted to Jack in the Box in the investment community at large. It's been an honor to have one of the industry's experts here at Jack in the Box, and I've enjoyed the relatively short time we've worked together, but wish you all best in retirement.

Now I'll review third quarter operating results and provide an update on where we're tracking so far in the fourth quarter. Operating EPS for the third quarter was $1.07 as compared to $1.00 last year. The $0.07 increase was driven primarily by our good comparable sales performance, a gain on sale of a restaurant property, favorable tax rate and fewer shares outstanding, all of which more than offset higher G&A and dilution from last year's refranchising.

Adjusted EBITDA for the quarter was nearly $58 million as compared with approximately $64 million last year. Adjusted EBITDA includes the negative $7.1 million impact of an unfavorable jury verdict, which is in the G&A line. And I want to note that the gain generated by the sale of the restaurant property that I just mentioned is not included in adjusted EBITDA. Rather, the gain is included in the impairment and other line.

System-wide comparable sales increased 2.7% in the quarter. Company-owned comp sales increased to 2.8% as transactions improved to flat, which is our best transaction performance in several years. As Lenny mentioned, strategically designing these compelling value bundles in a way that also enables upsells allows us to capitalize on incremental transactions while positively impacting check averages.

Check increased 2.8% in the third quarter, comprised of approximately 2.3% of pricing, with mix increasing 50 basis points. Franchise comparable sales increased 2.7% in the quarter. Company restaurant-level margin remained strong at 27% for the quarter. This is 50 basis points lower than the prior year, due primarily to increases in labor and food and packaging costs. Most of the labor increases were due to hourly wage inflation, which approximated 6.5% for the quarter. As we anticipated, commodity inflation increased in the third quarter by approximately 3%. Given our more favorable commodity inflation in the first half of the year, we remain on track for our full year inflation guidance of approximately 2%. As noted in the release, we are keeping our full year guidance for the company restaurant-level margin at 26% to 27%.

Franchise-level margin increased by $2.8 million in the quarter or about 5% when compared with last year's recast figures, due primarily to strong sales performance and refranchising.

Advertising costs, which are included in SG&A, decreased $1.9 million versus the prior year due to refranchising and an incremental $1.5 million in spending last year. The company did not provide any incremental contributions in the quarter. While we still expect G&A for the full year to come in at the 1.8% to 2% of system sales that we've guided to, G&A in the third quarter increased to approximately 2.5% of system-wide sales. The major components of the increase versus the prior year are listed in yesterday's press release, with the most notable increases coming from the unfavorable jury verdict discussed earlier and an increase in incentive compensation, offset by a significant favorable adjustment to our worker's comp and general liability insurance reserves.

5 new restaurants opened in the quarter, bringing our year-to-date total to 16, all of which are franchise restaurants. We remain on track to achieve our full year guidance of 25 to 35 new restaurants in 2019.

Now let's speak a little bit about our refinancing on July 8. We completed our securitization, bringing our leverage ratio to approximately 5x EBITDA, in line with our stated target. As we've discussed, there are numerous benefits to the securitization structure, including flexible covenants and amortization, a good fixed interest rate and the ability to increase our leverage above what we could borrow with bank debt. The details of the securitization can be found in our filings, so I won't go into more details here. But as you can imagine, we're excited to have this refranchising behind us so we could focus fully on driving the business day-to-day.

We've received numerous questions about how the model interest expense moving forward. While this interest rate on the $1.3 billion of senior secured notes is just over 4.4%, interest expense will also include an additional $8 million to $10 million in 2020 for the amortization of transaction fees as well as fees for letter of credit, rating agency fees and other miscellaneous items.

On a related note, our Board has authorized an additional $200 million in share repurchases, bringing our total share repurchase authorization to roughly $300 million. We did not repurchase any shares of common stock in the third quarter, but as Lenny mentioned, we do intend to resume share repurchases in the fourth.

In anticipation of the securitization closing, we terminated our existing interest rate swaps in the third quarter, which resulted in a pretax charge of $23.6 million. This is reflected in interest expense. The termination of these swaps also impacted our tax rate, which was a benefit of 17.9% for the quarter -- a first in my career, anyway. Excluding this impact, our tax rate was approximately 20% in the third quarter. For the year we now expect our tax rate to approximate 20%, including the termination of the interest rate swaps, or 23% to 24% excluding the swaps or the impact of the swaps.

Moving on to our performance so far in the fourth quarter, for the first 4 weeks of the fourth quarter, system same-store sales have accelerated from Q3 results, and we currently have positive system traffic growth. Given this strong performance so far in Q4 and our good Q3 comps, we have increased our full year system same-store sales guidance to up at least 1%. We've also updated our guidance for tenant improvement allowances to $15 million to $20 million for 2019. This change is mainly due to the timing of the projects.

To wrap up our remarks, our operating performance in the third quarter was strong, driven by good sales and business fundamentals. Q4 is starting out even better. We also completed our securitization and have now achieved our target leverage ratio of approximately 5x EBITDA, a significant milestone that's been a long time coming.

We look forward to 2019 being our ninth straight year of system same-store sales growth and to continuing the momentum into 2020.

With that, I'd now like to turn the call over to the operator to open up the call for questions. Ann? Operator, we're ready for questions, please.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Brian Bittner.

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Brian John Bittner, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [2]

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Wow, Carol, congratulations on your retirement. You're just a true professional, full of accomplishments that I think are all very well known. Just an incredible human being, true friend. I'm personally going to miss you in this industry, but I'm sure our paths will continue to cross in the future, but you'll obviously be missed.

Lenny, you saw a clear inflection in traffic this quarter from what you've been running at for several quarters now, a clear traffic inflection relative to your peer set. Can you just dive a little deeper into what really drove this now? Why did this happen now? What shifted in your business or in the environment that really drove this improved performance?

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [3]

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Yes, so what I'll share a little bit about is what's fueling it today and how I see that progressing into tomorrow. So if you look at today, it's really a couple of things. One is new product introductions that have been placed into the market in the form of these bundles, and very strategically placed in a way that allows for the add-ons and upsells. That price point is very attractive at the below-$5.00 mark, but the ability to either add proteins or additional add-ons aside from snacks has worked very well for our operation. So I think we have essentially found our way to compete in the QSR space effectively on value. And I think that we were missing that for quite some time. But I do anticipate that we will continue to do that into the future.

But what's also fueling the sales is that our operations have been making ongoing improvements in service. It's been able to reduce the number of customer complaints and the types of complaints that essentially have people walk away from the Jack in the Box business. As we have looked at it in the past, those disappointments are very strongly correlated to our sales and transactions growth and/or decline. So happy to see that we're making improvements there. And these are just the early phases now that we're experiencing. So at this point, it's really those 2 basic things that are driving it.

As we look at what will fuel it for tomorrow, we'll continue with the limited-time offer bundle deals at competitive prices and we'll continue with a strategy that allows for the upsell of an add-on.

But the second thing that we'll do is we'll have a permanent new menu item that will be intended to restore some of the everyday value that we lost when we increased our taco pricing. So there will be some permanent additions coming in the future as well.

And then we'll be focusing on faster and more consistent service, simplifying our operation. We believe that's a decent-sized sales layer. We do have a new Vice President of Operation Services who has worked in this area for other major brands and has been very successful, and he's already identified what we believe to be pretty big opportunities for us to simplify the operation for our crew and do it in a way that really does drive more consistency and speed.

We'll have an all-new...

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Brian John Bittner, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [4]

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Okay. As just a follow-up, you talked about accelerating trends in the fourth quarter. It's happening at the same time that a very large player is doing $1.00 tacos. Can you just confirm -- I guess you're not seeing a negative impact from that. And can you also confirm that comparisons for the quarter get easier for the next 2 months?

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Carol A. DiRaimo, Jack in the Box Inc. - Former VP, Chief IR & Corporate Communications Officer [5]

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Yes, so Brian, the last period of our quarter, as we talked about last year, was the softest. If you remember, we started out in a 1% to 2% range a year ago, and we wound up the quarter at a 0.5%. So the comparison is actually easier in the last month of the quarter.

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [6]

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And as far as the taco sales from our competitor, I can't really speak to how they're doing, but our taco sales are currently up, so I don't know that there's any correlation between what they're doing and how we're currently performing. But certainly, we're happy to see our taco sales increasing.

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Operator [7]

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The next question is from Gregory Francfort.

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Gregory Ryan Francfort, BofA Merrill Lynch, Research Division - Associate [8]

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Just going back to maybe the proceeds from the refinancing and how you thought about the uses of that cash, 2 questions. The first is how should we think about the timing of which you're maybe going to deploy that cash to shareholders? And then as you went through the process of evaluating best uses for the cash, did you consider maybe making a bigger investment in the business than you're making today? And how did you go through that process of evaluating that and maybe possible uses of it rather than share returns?

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Lance F. Tucker, Jack in the Box Inc. - Executive VP & CFO [9]

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Greg, this is Lance. I'll take that one. So first of all -- without getting into the exact timing, obviously -- we can get into the market pretty quickly once all the information is out there, which yesterday's release and all were designed to do. So we'll be in the market quickly.

Relative to the use of proceeds, our free cash flow more than funds what we need in order to be able to fund the growth and reinvest back in the business. So from a standpoint of how we intend to use the securitization funds, we do expect that, that will be all used pretty much for returning to shareholders because we've got plenty of cash otherwise to make the investments we need to make.

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Operator [10]

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The next question is from John Glass.

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John Stephenson Glass, Morgan Stanley, Research Division - MD [11]

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Wow, Carol, we're going to miss you. From the early days at Applebee's to the present, it's been a real pleasure.

And my question is first on comps. Lenny, you talked about the bundled value and some of the things you've done to stimulate growth. But you've been at that for a while, so maybe what's more recently changed? And specifically, do you think the competitive environment has really played a role in that? I think when deep discounting was more prevalent, you had been hurt by that. So this a signal you're seeing less of that, or has that not changed, and what's really changed has been what you've been doing?

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [12]

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We're still seeing a significant amount of value in the marketplace, so we don't necessarily see it as waning. We do see that at least one of our competitors is focusing some of their advertising dollars on some other positioning of products. But the deals that are in the marketplace are still aggressive and pretty prevalent. So we feel that it's still a competitive environment and likely remains a competitive environment in the QSR space going forward.

As far as what we did in the past, we would typically take core items and discount them and we bundled them, but unfortunately, what that would lead to is trade-downs, and that would not fuel the sales. In addition, we didn't create the type of products that allow more protein add-ons and/or sides and snacks, nor did we innovate sides and snacks that were compelling add-ons to these LTOs. But today the bundles that we're putting out there are primarily LTOs, typically a new item or line extension that also are coupled with a complementary add-on or upsell. So it's very different from what we've done in the past. It's easy to execute for the crews, both on the upsell side and also back of house. And I think that the combination of the positioning of that as well as the execution through the operation is what's driving it.

And I'd say on the advertising front, I think we're doing a much better job of directing our advertising, particularly through the social and digital space, and we're also making sure that that advertising is being spread across multiple day parts and/or offerings that we can balance out things like breakfast versus a dinner or lunch offering. And I think that that's a more balanced approach as well.

So lots of tweaks that have happened since we started this. I think much more effective today than we have been in the past.

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John Stephenson Glass, Morgan Stanley, Research Division - MD [13]

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That's helpful. And then just my follow-up is on unit development. This quarter's results were notable in that you had flat growth year-on-year and you had seen modest declines in prior quarters. How do you think the development pipeline is shaping up when we look in 2020? I know the long-term plans for getting back to unit development has the combination of labor in market and some of the franchise frictions in the recent past. Have they taken a toll on that pipeline? Or how do you think about unit development over the next 12 to 18 months as you see it today?

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Lance F. Tucker, Jack in the Box Inc. - Executive VP & CFO [14]

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John, it's Lance. I'll start with that one. Obviously, we'll be giving our 2020 unit guidance in November, so I'm not going to go into a lot of detail. But what I can tell you is the pipeline right now is as strong as we've seen in some time. 2019, we will be in our 25 to 35 new restaurant guidance, as we've said, and that will result in a net number of unit openings, and I would expect 2020 to look at least like this year without getting too far ahead of my skis and, frankly, should be better next year. I just don't want to get too far out on numbers.

So I think from a looking-forward standpoint, particularly now that we have some of these other things behind us as well, we're going to really be focused on growth, and we think the pipeline sets us up nicely to get off to a good start with that next year. It's the last thing I'll say, and then Lenny can add anything if he'd like to, is that good results tend to fuel unit growth. And so some of the other frictions aside, as we continue to have a sustainable plan for comps and growth business, that should naturally lead to more interest in opening units.

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Operator [15]

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The next question is from Dennis Geiger.

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Dennis Geiger, UBS Investment Bank, Research Division - Director and Equity Research Analyst of Restaurants [16]

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And Carol, congratulations. Thanks, as always, for all your help and assistance, and best of luck for sure in the future.

Lenny, I wanted to just ask another on value and just how you're thinking about the go-forward. A couple of parts to it. Just is it fair to assume, given the success that you've had with the 3 value messages simultaneously, that that generally is going to be how you're thinking about it going forward versus doing 2 at times in the past? And the other piece or two there is just franchisee adoption on the value promos, how generally high is that now? If you could speak to that, and do you have good visibility that it's going to remain high, given the results that you've seen? And then maybe -- you touched on it just now -- but the last point on the value. Variety of price points, day parts, menu items -- just based on the learnings you've seen so far, that's going to continue to be the strategy? Is that fair?

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [17]

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So a lot there. I'll try not to miss any of that. But as far as the 3 versus 2 messages, I think that really comes down to how big we're going on any particular thing. So if we have the launch of something that we think is pretty major, we may do only 2 messages at that time, that we can create more media weight for the area of focus. But outside of that, we're likely to have significantly more windows, marketing windows where we'll have 3 items marketed.

We do have a pretty high participation rate from our franchisees, but I think that that is conditioned on performance. So at the end of the day, if we're putting the right stuff into the marketplace that allows franchisees to grow their sales or profitability, then I would anticipate that that participation rate would stay high, and certainly would respect it reducing if we weren't able to do so.

So I do think that what you're seeing from us today will be a part of our strategy going forward, but I do think that it's important that we don't just believe that we can live on LTOs and marketing promotions. I think we have to also restore some of the equity that's lost in everyday value, and so you'll see us do that. And I think that that creates more of a permanent sales layer or restoration of a lost sales layer that allows us to bring back or bring up the base of sales altogether, and then everything else will ladder on top of that.

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Operator [18]

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The next question is from Chris O'Cull.

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Christopher Thomas O'Cull, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [19]

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I have learned a lot from you over the past 20 years.

So I just want to follow up on unit development. Lenny, could you talk a little bit about whether you're testing a new prototype? If so, how has it performed? And when franchisees might be able to use it for development?

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [20]

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Not too much to say on that at this time. What I will say is that some of our franchisees who have been very strong developers throughout the years have actually contributed to the ideas around prototypes and the next generation of prototypes. And our Chief Development Officer is currently working on what a new prototype would look like. It's designed to be more cost-efficient still. And it is also designed to target the investments toward what the consumer's going to appreciate the most. Our convenience is growing. It's growing through both delivery and order ahead and pick up. Also a huge focus throughout the industry on drive-through consistency and speed. But you can anticipate that whatever we do with a prototype would really try to address those basic needs.

We're not far enough along to comment beyond that, but just know that it's an area of focus and one that we do appreciate the contributions that our franchisees...

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Christopher Thomas O'Cull, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [21]

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Okay. And then could you provide some more detail on what you hope to accomplish with the digital menu boards? Obviously, we've heard a lot of competitors talk about the different levels of technology that they plan to use in digital menu boards through the drive-through. Can you help us understand what JACK's expecting from those?

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [22]

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So what I would say about digital menu boards is a couple of things. One, it's a great platform that is more dynamic than our static menu boards today. We have a pretty complex menu. In order to essentially advertise and present to the consumer all of the day parts that are available to them 24/7, it means that the menu board is pretty cluttered throughout each day part. If we can go to digital menu boards, then what we could potentially do is flex what is presented to the consumer so that what they're more likely to buy during that day part takes up more of the space. That would be a huge thing for our consumers in simplifying what they're reading on those menu boards, and it would be potentially a contributor to not only our sales but also our throughput, as it eases the ordering for the consumer.

The other thing that you can do with a menu board is advertise directly to that consumer the products that you're trying to sell, the promotional items that you're trying to sell. So there's an opportunity to do that.

And then also, as you start to have a relationship with those consumers into the future, you could evolve that platform to a place where you're communicating with consumers on a one-to-one basis based on their history of purchases with the brand.

We're not 100% sure that the investment in the digital menu boards is going to pay off in all of the areas that I mentioned, but we do believe that it's worth testing along with the other components. And if we see a return on the investment, then we'll go for it. But we also would note that there are other brands in the industry that have decided not to use digital menu boards, and they are growing the highest AUVs that we see in the industry today. So I think it's really just a matter of how we can capitalize on this for our individual brand. We're going to attempt to do so, but we're not going to work with it if it doesn't pay off.

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Operator [23]

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The next question is from David Tarantino.

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David E. Tarantino, Robert W. Baird & Co. Incorporated, Research Division - Co-Director of Research and Senior Research Analyst [24]

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Lenny, just a question. I think you referenced on the operations improvement there, and I was wondering if you could elaborate on what you're doing there in addition to this phased line you just rolled out by way of the simplification. And then secondly, if you look back at the last couple of years, there's been a lot of change inside the company that likely has led to some level of distraction. And I'm wondering your thoughts on whether that has been the case. And as you've exited that period of uncertainty, do you think maybe a little bit more operational focus is what's helping drive some of the recent sales momentum you've had?

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [25]

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Yes, so on the operations side, a couple of things are happening. First, at the end of Q3 we rolled out the first phases of an op simplification test that was successfully completed earlier in the year, and it essentially removes some SKUs and simplifies some procedures in back of house. The feedback that we received from the operations that it made it easier for the crews to be trained, and it also reduced some of the food waste and it's had a marginal improvement in speed of service. So all good things, and none of those things negatively impacted the guests. So we felt like it was the right thing to get moving with some of those early wins.

What we have seen now is that when we study our hold times for our proteins and we start to figure out what are the biggest detractors from consistency and speed of service, our new VP of Operations Services has identified a handful of products that are essentially causing our bottlenecks. And we do think that if we can change some of the procedures in back of the house specific to these items, we'll be able to make it a lot easier for our crews to meet the speed objectives that we have. So there's some testing going on in that area today, and we're pretty encouraged by what we've discovered and pretty encouraged by what we think the size of the opportunity is. So more to come on that, but we're going to allow our new VP to do his job and to solidify a plan before I say too much about it.

As far as the changes that we've experienced as a company, yes, they've certainly been distracting. And although we'd all like to imagine that we can drive above-average results during a period of significant change, that's difficult to do. So I can say that look, despite those changes, I'm happy that we're tracking to have our ninth straight year of same-store sales growth, so certainly the distractions haven't taken the company down. But at the same time, I think there's way more upside, and maybe what the additional focus will give us is that additional upside that we've been wanting.

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David E. Tarantino, Robert W. Baird & Co. Incorporated, Research Division - Co-Director of Research and Senior Research Analyst [26]

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Great. And Carol, my congratulations to your terrific career. We'll certainly miss you.

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Operator [27]

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The next question is from Jeff Farmer.

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Jeffrey Daniel Farmer, Gordon Haskett Research Advisors - MD & Senior Analyst of Restaurants [28]

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Just to echo some of the earlier comments, we will miss you, Carol. I think I've worked with you for almost 20 years, which will stricken that out, and you are definitely the best.

So moving on to my questions, you guys touched on it, but what is the franchise appetite to pursue the drive-through remodels? And can you provide an updated time line on when you expect that remodel initiative to more aggressively begin or get started?

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [29]

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Yes, I'll answer the second part of your question first. We have essentially finished Phase 1 of this test, which was really just testing the stability of the various components. So we put some new branding elements out there. Some of those things are internally lit. We also have some digital components out there, as you know, some canopies. All of those things, we just needed to make sure that the hardware and software actually worked properly and held up to the elements. So we're testing it in some of the most extreme weather, whether it be rain and/or significantly high temperatures. And we're discovering a lot about what components will hold up and which ones have not needed to be adjusted. So that was really the intent to Phase 1.

What now we will do is put it in the hands of the marketers and operators. And those individuals will take those platforms and essentially present them to the guests in a compelling way that we believe has an opportunity to drive sales. We are only at the beginning phases of that. In fact, I think the team had its first meeting this past week. So we've had to give them a little bit of time to get everything lined up and to officially kick off that Phase 2 part of the test. And then once we can get a read on that, we can start to hone in on timing.

And then lastly, as far as franchise participation or franchisees, it's very simple. If there is a return on the investment and you can help me grow my sales or profitability at a reasonable investment size, then I'm all in. And if you can't do that, I'm probably not all in. So from our standpoint, we will keep the size of the investment very reasonable for our franchise operators, and we will also target a reasonable return so that franchisees will be encouraged. That's really all I can say about it at this time. We think it can really enhance the overall guest experience, but we do need to do a little bit more work before I can start to really share specifics.

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Jeffrey Daniel Farmer, Gordon Haskett Research Advisors - MD & Senior Analyst of Restaurants [30]

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All right, that's helpful. And as a follow-up, you mentioned the add-ons with the $4.99 combo meals, but where are you seeing the average check move to for those combo meal orders? And have you been surprised by the customer response in terms of pushing that average check higher than potentially you thought it might go?

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [31]

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Yes, so I wouldn't say that we're surprised. Our marketers actually designed the promotions to generate this result, so I would say we're pleased that we actually generated the result that we were able to. One of the things that we've said consistently -- you've heard me say this many times -- we do not want to erode our brand in the process of trying to drive value or to compete quarter-by-quarter. And I think we've done a good job of preserving our brand equity around craveable food, and what we then try to do is with that in mind, present some craveable options to the consumer so that they can come in at a reasonable price point if all they're looking for is value. But if they are one of our tried-and-true, loyal customers that's looking for those craveable items, they're going to typically bundle more than what we presented to them within that bundle deal, and that's exactly what we're seeing.

So for example, the doughnut holes that we currently have out in the marketplace for $1.00, it's a convenient add-on for the consumer, it's an easy upsell for the crew, it's a reasonable price. It's also a very craveable item. They're really high-quality doughnut holes. And we sell them throughout the day, not just at breakfast. So again, I think all this is by design because we know that we can't take an a la carte, single item, price it low, and go into the marketplace and beat some of the national competitors who can compete in that space. So for us, you've got to find that sweet spot with combos and craveable items that attracts a guest that maybe isn't just looking for value, while at the same time we're presenting something at value price for those who are.

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Operator [32]

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The next question is from Jon Tower.

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Jon Michael Tower, Wells Fargo Securities, LLC, Research Division - Senior Analyst [33]

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And to echo a sentiment earlier on the call, Carol, it's been great working with you. I learned a lot from you, and best of luck on future endeavors.

Now just to turn to the questions. First, on the digital side of the equation, can you provide some insights into either customer adoption of delivery, maybe as a percentage of mix, or perhaps some numbers around the mobile app ordering and registered users and where you sit today?

And then the next question is just on the permanent menu item on the value side for everyday value, Lenny, that you mentioned earlier. Can you give us some color as to what you're thinking here? Would it be something new to JACK with respect to innovation, or would it be something within JACK's consistent, or JACK's current menu, just perhaps presented a little bit differently to consumers?

And then, sorry, last piece. I'm curious on the quarter-to-date trends. Any discrepancies in the different markets that you're present in? We heard one of your casual dining competitors talk about California starting off the quarter on some weaker footing, so thank you.

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [34]

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Yes, maybe I'll take your last question first. So when we look at our quarter-to-date performance, we're really seeing improvements across all markets. There are always the individual operator anomalies, but we do not see any specific market weakness to note. So I would just tell you that we're looking pretty good across our business right now.

As far as permanent value, I'm not going to really share any details around that. All I can say is that we've tested some things that are working really well. We're excited to roll them out next year.

And then about the digital space, we haven't really shared percentage mix on digital. The app is still a relatively small percentage of our business, but adoption continues to grow. And on the delivery side, our sales per store more than doubled in Q3 versus last year.

So the way I would just look at digital and delivery for Jack in the Box is that we don't see this as the main delivery point or connection point to the consumer today, but it is an area that we believe will grow significantly, so we want to make sure that we're presenting this opportunity to the consumer. Still, 70% of our consumers are going to the drive-through, and of the remaining guests that go inside, half of those are take-outs. So from our standpoint, over time, because we're mostly a convenience-oriented purchase, we think digital and delivery are going to make sense for us to play in. But again, a relatively small part of our business at this point in time.

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Jon Michael Tower, Wells Fargo Securities, LLC, Research Division - Senior Analyst [35]

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And just on that last point on the digital piece, have you done any exclusive offers so far only through the digital to get some uptake from consumers?

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [36]

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Yes, we have. We've done a good number of those things, especially to drive up adoption and have people opt into the app.

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Operator [37]

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The next question is from Robert Derrington.

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Robert Marshall Derrington, Telsey Advisory Group LLC - MD & Senior Research Analyst [38]

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Carol, 27 years, it's been a long time, and I just know that I want to be invited to the heck of a party that I'm sure you're going to have. (Laughter) So I'm going to miss you.

Specifically, Lenny, during this past quarter, this was the first quarter that I remember you guys ever using a, quote, “celebrity spokesman” beyond Jack to market a product. Can you give us a little bit of color around that and whether that's something that JACK, whether you might use again in the future?

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [39]

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Yes, so we used Lele Pons, who has got a huge Internet following, social media following. We chose to do that because we thought that it would create a sort of connectivity with that set of consumers, and it's the first time that we reversed the way that we approach this. Typically, we'll start with a mass media play and then we will extend it into social media. We actually started with social media in mind and then built that up into a mass media play. And so that's why it made sense for us to use her in the campaign. She was wonderful to work with and extremely professional, a very talent individual who seemed to have a passion not only for what she does but also for the brand. And so we'd love to work with people like that in the future to continue to connect to our consumer base.

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Robert Marshall Derrington, Telsey Advisory Group LLC - MD & Senior Research Analyst [40]

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Got you. That's helpful. One last, one follow-up, if I could. On the outlook for JACK, Lenny, do you believe JACK needs a plant-based protein in its future? Or is that counter to what JACK's all about?

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [41]

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I think it would be counter to what JACK's all about to simply copy the way everybody else is doing plant-based proteins. I don't think that it would be counter to JACK to have either a plant-based protein and/or some other sort of protein substitute, but we pride ourselves on bringing things into the marketplace in an interesting way. As we like to say, “In a world of French fries, we'll be the curly ones.” So I would look forward to my marketing teams, who have been known to play with some ideas. I've seen some of them. I think they're pretty exciting. But at the same time, they're going to need to make sure that it is authentic to the Jack in the Box way of doing things.

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Robert Marshall Derrington, Telsey Advisory Group LLC - MD & Senior Research Analyst [42]

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Terrific. And congrats, Carol, we'll miss you.

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Operator [43]

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The next question is from Andrew Charles.

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Andrew Michael Charles, Cowen and Company, LLC, Research Division - Director [44]

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And Carol, it can't be said enough. Best wishes and thank you for all your help, support and partnership. We're going to miss you. And Rachel, of course, congratulations to you in your new role.

Can you guys talk about franchisee gross margins amid the value bundle strategy? I realize the company-operated gross margins were only down 90 basis points amid almost 3% inflation, but because these are higher-volume stores that presumably have higher ticket sizes and perhaps higher order counts in the franchise base, is it fair to think that franchisees might be having a different gross margin experience with the value bundles, especially if 3Q commodity inflation stepped up?

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Lance F. Tucker, Jack in the Box Inc. - Executive VP & CFO [45]

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Andrew, this is Lance. I'll take that one. You're right in that we do have a higher sales base and higher AUVs. With that said, from a dollar margin standpoint, we think the franchisees were really able to benefit from the way we've gone about introducing value back into the market. So granted, we're working on a higher margin than a lot of those guys are from a percentage standpoint, but we really feel like this is going to be a benefit to franchisees and this is the right way for us to approach value in a way that the franchisees' dollar margins are going to grow as well.

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Andrew Michael Charles, Cowen and Company, LLC, Research Division - Director [46]

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That's helpful. And one more just clarification: have the quarter day trends been helped by an increase in the mix of taco sales amid news in the quick-service hamburger category around tacos?

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [47]

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I can't say that's I've looked at it that way, so I won't answer that question. But I would say that we're happy to see our taco sales up, and if there's anything anyone else is doing to contribute to that, hallelujah.

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Operator [48]

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The next question is from Matthew DiFrisco.

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Matthew James DiFrisco, Guggenheim Securities, LLC, Research Division - Director and Senior Equity Analyst [49]

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I just wanted to clarify on the comp. It sounds like you guys are saying that it's pretty broad-based, so I just want to make sure. I know you have 2 pretty big markets in Texas and California, and they're relatively different as far as consumer bases. If there's anything you wanted to mention about a difference in those -- are they both accelerating? And then, Lance, just a point of -- I just want to clarify. I think you said on the call earlier, the prepared remarks, that you recommitted or you restated again or reaffirmed the $1 billion return by 2022? Does that also infer, then, that the $175 million target for free cash flow by 2022 remains intact? I know you had something in there about TI for 2019, and I wonder if that factors into the longer-term free cash flow as well. Thank you.

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Lance F. Tucker, Jack in the Box Inc. - Executive VP & CFO [50]

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So I'll go on and take your second question there, Matt. So absolutely, we're going to be on track to return the $1 billion or more. We'll -- any changes to the long-term guidance, we certainly would let you guys know about, and we reaffirmed as recently as a quarter ago all of our long-term guidance. So we do expect to return the cash, as we've talked about. We reaffirmed the $175 million last quarter, and no changes or we would have spoken to that.

And then as it relates to the TIs, most of the reduction of the TI guidance for this year is really related to timing. As we have updates to TIs or the money that we're putting in and contributing to franchise remodels, we'll update you on that. What I can say -- I said this on the last call and I'll reiterate right now -- you would not expect to see that number go up from what we have already committed to in our long-term plan. And as we get more through the strategic process, we'll see if there's any opportunity to bring it down a little bit.

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [51]

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And just to confirm, yes, California and Texas are both trending up, as are most of our markets. So just to reiterate. I know those are -- California and Texas account for 79-plus percent of our total business, and I know that there has been some news that other brands were experiencing some softness in either of those markets. But we are seeing both of those markets with sales growth.

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Operator [52]

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The next question is from Nick Setyan.

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Nerses Setyan, Wedbush Securities Inc., Research Division - Senior VP of Equity Research & Senior Equity Analyst [53]

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Carol, congratulations and thank you for all of the help throughout the years.

In terms of G&A, obviously within the long-term framework, I know that you guys just now reiterated. We're already in that 1.8% to 2% range in terms of system sales. How are you thinking about that over the next year, 2 years, 3 years within the long-term framework?

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Lance F. Tucker, Jack in the Box Inc. - Executive VP & CFO [54]

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Nick, it's Lance. What we've guided to in the long-term plan is we'd ultimately be targeting around 1.7%, so there's still just a little bit of work to do there. But as you noted, we're getting pretty close to that range now, and that's what you would expect given, as Lenny mentioned, the Qdoba transition services agreement's coming to an end and most of the restructuring we expected to do has been done, so a few pieces left. So we're thinking that 1.7% of system sales.

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Nerses Setyan, Wedbush Securities Inc., Research Division - Senior VP of Equity Research & Senior Equity Analyst [55]

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Got it. In terms of the remodels and the drive-through enhancements, anything that you would share on the drive-through sides in terms of what you're seeing in the tests in terms of sales lifts? And then any update on the sales lifts that you're seeing from the remodels?

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Lance F. Tucker, Jack in the Box Inc. - Executive VP & CFO [56]

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This is Lance. I'll take that one as well. So as Lenny mentioned, right now the phase we're in with the drive-throughs has really been about equipment testing -- making sure the equipment works, it will hold up to the elements and all those things. We have not really introduced what we would expect to be the major sales-driving components, so more to come on that once we've got some of the digital menu boards in place and really doing some upselling of some other things that we would expect to more drive sales.

Relative to the remodels, we're making good progress on the remodels, just to reiterate what we said on the last call. Our plan is to move forward with the 150 or so, some of the oldest units in the system that need some structural work as well. We're well over 50% of those now. And we have seen good lifts on those of mid to high single digits. Sales lifts is what I'm referring to there.

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Operator [57]

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The next question is from Lauren Silberman.

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Lauren Danielle Silberman, Crédit Suisse AG, Research Division - Senior Analyst [58]

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I just wanted to go back to delivery. Did it meaningfully contribute to comps in the quarter? And then what kind of modifications are you making in the restaurant, whether that be packaging, store layout, integration in the POS just as delivery becomes a bigger part of the mix? And both Carol and Rachel, congratulations.

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Leonard A. Comma, Jack in the Box Inc. - Interim Chairman & CEO [59]

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Lauren, I don't think we have shared the specifics on delivery's contribution to comps. Although delivery is growing and growing fast, it's still a relatively small part of our overall business, so I would say that really what I had mentioned about the new product introductions and the improvements to operations or guest service is the biggest driver.

And then I would say as far as what we're doing to integrate, our IT group is currently working with some of the major delivery, third-party delivery partners, to integrate their system into our POS networks so we're not having to use separate tablets to bring those sales in as well as our marketing department is working with the third-party providers to negotiate down the fees. And so a lot of work being done to make it just more palatable going forward for both the crews, the guests, and also our profitability. So more work to be done there, but we have taken the time to meet face-to-face with the leaders of all of those major third-party delivery companies, and they seem very open to working with us towards what would be service as well as to continue to work with us to grow the business.

We'll see where it goes from here, and that will be largely dependent on what contribution it's making to our bottom line. So more to come on that. But we do believe it makes sense strategically to play in this space since the consumers seem to be going here. But we will remain cautiously optimistic about how to get it done the right way.

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Carol A. DiRaimo, Jack in the Box Inc. - Former VP, Chief IR & Corporate Communications Officer [60]

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Thanks, everyone, for joining us on the call today. It's been a pleasure to work with all of you over the many years, and I look forward to listening from the outside in on the next call. So enjoy the rest of your day.