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Sonic reported earnings after the close yesterday and beat expectations for both revenues and earnings.  The focus of the call was on sales trends that slowed in May and June.  Is the slowdown temporary or will hot dogs save the day?

Management went through a very detailed explanation as to why sales trends slowed in May and June but stopped short of saying what the magnitude was.  All they said was that the slowdown was limited to guests coming in after 8pm.  In May and June 2011 the company is lapping a buy-one-get-one-free shake promotion, which generated significant traffic; expectations are for low single same-store sales for 4Q11. 

For the balance of the quarter the “hope and expectation” is that the BAJA hotdog (along with a new line of shakes) at $1.99 will bring back some incremental traffic.  The irony in all this is that despite the SONC customer having been so responsive to the company’s value initiatives, management apparently feel comfortable raising menu prices.  

Sonic reported EPS of $0.21 excluding extraordinary items on the back of strong same-store sales growth and improved margin that management attributed to labor efficiencies that were offset by increased commodity costs and investment in product quality.

Company-operated same-store sales came in at +6.5%, beating expectations of +6.1%, which implied a two year average trend of +0.1% or 650 basis points higher than the two-year average trend in 2QFY11.  Management stated that the premium six-inch hot dog promotion which is driving traffic across all day parts.  The company had an effective year-over-year price increase of +1.5% on the menu in April and May which was then increased at the beginning of this month as an additional 0.5% price increase was implemented with the new menu.  The 2% price currently on the menu is not expected to begin rolling off until April of next year.

SONC: SOLID BEAT, BUT... - sonc pod1

The improvement in the company’s performance is reflected by the marked improvement in customer satisfaction scores at company and franchise stores versus the satisfaction scores that the company was reporting in fall 2008.  Over that period, company and franchise customer satisfaction scores have improved from 59% to 78% and 69% to 77%, respectively. 

Restaurant level operating margins expanded for the first time since 2009.  The improved top-line performance helped margins as food and packaging costs were better than expected due to less discounting and more aggressive price increases than originally planned.  Other operating expenses were favorable reflecting leverage from the company-owned same-store sales trends.

SONC: SOLID BEAT, BUT... - sonc pod2

Sonic is launching a new Baja hotdog in July that it hopes will, in combination with the loaded burger promotion, drive traffic and check.  In addition a new line of Real Ice Cream Shakes will be released which, in conjunction with the other products and promotions on offer, management is expecting to drive positive sales in the fourth quarter. 

One area management is focusing on going forward is the after 8pm day part which was slower in the third quarter than one year prior and has been a primary contributor to the slowing of SONC’s business over the last few weeks.  With respect to margins, labor costs are expected to be favorable in the fourth quarter and the other operating expense line is expected to improve again.

Food cost inflation in the third quarter came in lower than expected, between 5 and 6%, and management expects fourth quarter food inflation to come in below that range.

Howard Penney

Managing Director