SEPTEMBER 18, 2009





  • A conversation with Dick’s Sporting Goods management suggested that Under Armour’s launch of running shoes in their stores was inline with plans and overall DKS was pleased with the product. This is particularly noteworthy because the general perception across the marketplace and the Street is that the launch did not live up to expectations. Clearly there were some disappointments. However, with DKS being one of UA’s largest partners we think the vote of confidence bodes well for future product proliferation.


  • With the back to school chatter officially dwindling, we can’t ignore the trend of consumers buying closer to need. Footwear sales posted a substantial increase last week, increasing by 17%. The measurable improvement  in sales takes the trailing 3 week performance to only down 1.8%, the best performance we have seen for the category since late April. ASP’s while still positive at 1.2%, decelerated from 4.9% in the prior week. This was the first deceleration in ASP growth in seven weeks. While most brands posted a strong week of growth, Reebok, Adidas, and New Balance all showed sales declines.  Converse and Under Armour were top performers for the week, with increases of 59% and 53% respectively.


  • A visit to a Dick’s Sporting Goods store revealed prime product placement for K-Swiss’ recently launched running shoes. The $75 “Tubes Run 100” were prominently positioned with a brand specific display on an end-cap located near the center-core of the footwear department. While this shoe represents the entry level product in KSWS’ recently launched performance running line, we’re encouraged to see the “classics” image being complimented by the new “performance” offering. The running line currently ranges for $75 to $125 at retail.


  • At an investor conference yesterday, Kenneth Cole management expressed the company is embracing the trade-down environment from luxury to lower priced shoes.  Admittedly, the brand lost on the way up when the consumer migrated above KCP’s price range. Now, with luck and a changed macro backdrop the company believes they are poised to take advantage of the consumer trade down.  I guess if you wait long enough, eventually the market dynamics will revert back into favor.


  • Timberland increased the discounts on its own e-commerce site for the beginning of September from 30% last year to 40% this year.  In looking at NPD data, sales across all channels for the brand have been deteriorating at a rapid pace. Over the last three months June sales declined by 11.7%, July by 13.5%, and August by 20%. Interestingly as sales momentum has deteriorated, ASPs have increased from flat in June to up 14% in August.  While increased ASP’s may suggest an attempt to preserve margins, the heavy discounting is likely an attempt to clear inventory as we near the key boot selling season. With the departure of two high level executives (CFO and co-President) recently, the direction of the brand and strategy still appears to be unclear.


  • As Pier 1 continues its turnaround efforts, the company has successfully negotiated rent reductions on 30% of its store base. These reductions which will reduce rental expense by $37 million with 75% of the cash savings expected to flow through over the next 3 years. PIR remains one of the most aggressive retailers on the rental reduction effort. On the sales front, the company indicated that same store sales have turned positive in September.





-Positive trends are beginning to emerge in specialty retail mergers and acquisitions activity - A report by investment banking firm Tully & Holland cites a rebound in retail valuations and a more than 50% rise in the S&P Retail Index since March as key elements in the shift. A dozen transactions were announced in the second quarter of this year, double the volume during the first quarter and at about the same level as the second quarter last year, the study said. About two-thirds of the activity this year has involved distressed sales, and most acquirers were strategic buyers. Transactions in the second quarter include: New Deal buying Against All Odds; Levi Strauss & Co. acquiring Levi’s Docker’s outlets; Golden Gate Capital getting J. Jill Group Inc.; Jimmy Khezrie purchasing Man Alive; Syms Inc. buying Filene’s Basement and Dress Barn acquiring Tween Brands Inc. Third-quarter activity includes: purchasing; a consortium led by Diamond Capital buying 16-door general merchandise retailer Baskins Department Stores; Golden Gate Capital acquiring Eddie Bauer Holdings Inc.; Tresalia Capital’s taking a minority stake in Tory Burch and Advent International getting Charlotte Russe Holding Inc. The study cited two other positive signs in August: the initial public offering filing by Dollar General Corp., owned by private equity firm KKR, and the receipt of $11 million in private placement funding by online apparel retailer MyShape. Tully & Holland noted valuations for three recent transactions were within historical retail valuation norms: Tween Brands Inc. sold at 5.6 times earnings before interest, taxes, depreciation and amortization; Eddie Bauer at 5.9 times EBITDA and Charlotte Russe at 6.6 times EBITDA. <>


-Department stores are continuing to struggle as Japan inches its way out of a recession - Department store sales in August dropped 8.8%. This is the 18th straight month of decline for the retailers, which have been suffering for about a decade in the wake of increased competition from shopping malls and specialty stores. Apparel sales at Japan's 271 department stores fell 11.3% during the month.  Men’s wear sales shed 11.7%, while women’s wear sales declined 11.4% against a year ago.  The country's harsh economic condition, coupled with an unusually cool summer bit into business,  the association said. <>


-K-Swiss Racing for Success in the Long Run - While Under Armour received overwhelming attention from the media and Wall Street for its running shoe “launch” this past year, another iconic athletic brand is making inroads into the running shoe market while flying under the screen. The primary difference in the way the two brands entered the running has to do with the slow, measured approach taken by K-Swiss Chief Executive Steven Nichols as he works to build on a performance platform for future growth. <>


-Hanesbrands Inc. said Thursday that it will exit the yarn business by selling three of its plants and closing a fourth - The Winston-Salem, N.C.-based basics maker said it will stop production immediately at its yarn facility in Sanford, N.C., which has 150 employees. In addition, by yearend Hanesbrands will close two warehouses in North Carolina that have a total of 25 employees. Gastonia, N.C.-based yarn manufacturer Parkdale will take over Hanesbrands’ yarn plants in Rabun Gap, Ga., Mountain City, Tenn., and Galax, Va. Those facilities have a combined head count of 780 employees, the company said. Hanesbrands declined to disclose the sale price. The firm said it will use Parkdale as a yarn supplier after the deal is completed. “Producing our own yarn, when more than adequate large-scale supplies exist, serves no strategic purpose,” said Richard Noll, Hanesbrands chairman and chief executive officer. “Outsourcing yarn is a logical evolutionary step to drive value and improve the use of our assets.” The company said it expects to realize $100 million in balance sheet benefits within six months of the sale due to working capital improvement and reductions in raw material requirements and inventory. It anticipates the sale to close in the fourth quarter of its fiscal 2009. <>


-Diadora's sale of the founder of footwear firm Geox SpA has been put on hold until next month by an Italian bankruptcy court - As reported, the Italian-based Diadora SpA in June agreed to to sell its business to Geox SpA's founder and chairman Mario Moretti Polegato through his family's investment arm.  <>


-Adidas and Puma are gearing up for what they're calling “a historic handshake" in support of a non-violence initiative - On Monday, dubbed Peace One Day 2009, employees from the two German firms will play football together and then watch “The Day After Peace,” a film by Peace One Day's initiator, Jeremy Gilly. This will be the first time the two Herzogenaurach-based companies have been involved in a joint activity since their founders Rudolf and Adi Dassler left their shared sport shoe firm and established Adidas and Puma 60 years ago. The goal, both companies say, is to raise awareness for Peace One Day, a project initiated by Gilly in 2001 to establish an annual day of ceasefire and non-violence. Adidas and Puma said they would also bring the message of peaceful cohabitation to Munich and Stuttgart's football stadiums on Saturday during the halftime of the German premier league games being played there. As Adidas chief executive Herbert Hainer proclaimed, “We firmly believe that sport can bring the world together.”  <>


-Labelux Group, a Vienna-based luxury goods holding company, has acquired a stake in high-end Italian accessories maker Zagliani - Though the terms of the deal were not disclosed, Berndt Hauptkorn, chief executive officer of Labelux, said the investment is in line with the company’s “buy to build” strategy. “We continue to believe that the luxury goods market will remain on a long-term growth trajectory for those brands and designers who manage to occupy a unique territory and deliver on design, quality and craftsmanship,” he said. Mauro Orietti-Carella, Zagliani’s owner and creative director since 2002, said the new setup will allow Zagliani to reach its potential and support long term growth. “We chose Labelux because we share a philosophy of uncompromised quality in every aspect of the brand,” he said. “We have always believed that brands with strong integrity and focused DNA will continue to have a future in today and tomorrow’s luxury market.” <>


-Italy’s Sixty SpA has signed an agreement with Aldo Group to oversee its retail division in the U.S - “They’ve hired us to run their stores in the U.S. as their retail store portfolio managers,” said David Bensaboun, a vice president at the Montreal-based footwear and accessories firm. The move will reduce infrastructure and operations expenses for Sixty, a premium denim and contemporary sportswear maker. Word of job reductions at the New York headquarters has been circulating this week among employees of Sixty USA, and some of them already have begun sending out résumés. However, management has not made any announcements about operational changes to the U.S. business. A spokeswoman for Sixty USA, which distributes the Miss Sixty, Energie, Sixty, Killah, RefrigiWear and Murphy & Nye labels, declined to comment. <>


-E-bay takes brand fight to EU - E-bay has taken a petition signed by 750,000 of its users to the European Union to ask it to amend EU competition law to stop brands from restricting the sale of their products on the internet. <>


-NFL Apparel lawsuit Needles the unions - As American Needle, Inc. files papers with the Supreme Court Friday in its dispute with the NFL over licensed apparel, the sports unions remain hopeful that any ruling in the case is as narrow as possible. American Needle sued the NFL after the league's exclusive apparel deal with Reebok barred it from selling clothes with NFL logos, and the sports unions fear that the court may issue a ruling that provides antitrust exemption for the leagues that goes beyond licensing and marketing. <>


-Target is ready to walk on the wild side with Jean Paul Gaultier - Sources told WWD that Gaultier is next up in the discounter’s Designer Collaboration series, a relatively new concept geared to bolster the chain’s cheap-chic status. A Gaultier collection wouldn’t appear in the stores for some time, but Target, said sources, has the ball in motion. “We don’t have anything to share other than we admire his work and incredible design aesthetic,” a Target spokesman said Thursday. A spokeswoman for Gaultier declined comment. Target’s DC series entails recruiting established designers with strong reputations to create collections based on their muses or other creative inspirations. The series made its debut with Alexander McQueen in March with McQ Alexander McQueen for Target, inspired by Leila Moss, lead singer of The Duke Spirit. Anna Sui followed this month by channeling the TV program “Gossip Girl.” She’s a fan of the show. The collections were rolled out to hundreds of Target stores and also are sold on and stay available for four months or so.  <>


-Sears recruits merchants to sell on - Not to be outdone by, Sears Holdings is expanding its online marketplace to attract more merchants that want to sell their merchandise on <>


-Timberland Co. last week hired Carrie Teffner as its new CFO, effective Sept. 28 - Teffner, 43, comes from Sara Lee Corp., where she served in executive financial positions since 1998, including SVP and CFO of the international household and body care division, and SVP and CFO of the foodservice division. Crimmins joined the Stratham, N.H.-based company in 2002 and served as its CFO since March 2007. He will depart on Sept. 30. <>


-The Consumer Product Safety Commission recalled approximately 2,000 pairs of Clarks children’s shoes on Thursday - The shoes were manufactured by C&J Clark America Inc., which does business as the Clarks Companies N.A. According to the agency, there is a risk that molded rubber pieces on the sole of the shoe could detach, posing a risk of choking to infants and young children. The shoes were sold at Clarks stores nationwide for between $35 and $40 beginning in February 2009 and ending in July 2009. The recall covers shoes sold in infant sizes under the “crawlers” style name and children’s sizes under the “hazy daze” style name. <>


-MBT appoints CEO - Nearly a year after naming Ken Pucker as interim global CEO, MBT has made a permanent hire for the top spot. The Swiss footwear company this week named Jan Stig Andersen, an ex-Ecco CEO, as its new chief executive. He will officially join the company next month, when Pucker departs. <>


-The Real Housewives announces an apparel line - Television merchandising juggernaut Bravo Media, which has already moved into the apparel and accessories business with high-end handbags ("NYC Prep") and designer clothes ("The Fashion Show") -- which the Image section discussed in this article on the future of fashion on TV -- is set to announce its latest apparel adventure later today: a line of clothing and accessories inspired by the fashion and style of "The Real Housewives" reality franchise. Bravo has struck a licensing deal with a company called Royal Plush to develop a co-branded the Real Housewives-Royal Plush line, which will consist of premium denim, loungewear, activewear, handbags and accessories. Bravo is also expected to announce the start of production on the third season of  "The Real Housewives of New York City," with Countess LuAnn de Lesseps, Bethenny Frankel, Kelly Killoren Bensimon, Alex McCord, Ramona Singer and Jill Zarin (a few of whom have been spotted at New York Fashion Week, which wraps up here today).  <>




RESEARCH EDGE PORTFOLIO: (Comments by Keith McCullough): KSWS


09/17/2009 10:57 AM


Dogs that are illiquid? Not what the risk manager wants me to be owning with the market up here. Sorry Brian; I'm out... for now... KM





Ciaran Carruthers is moving on from his role as StarWorld COO.  The timing of Carruthers’ departure is not believed to have anything to do with Galaxy’s results announcement this week.  DM speculates that the company, guided by the Lui family, is looking to go in a different direction than it had been under Carruthers’ leadership: a more “Vegas-like” direction.  Mike Mecca, a very experienced industry veteran, has been brought in as President/COO and will likely change the corporate culture. 


Some issues confront Mecca almost immediately, such as how to keep the company running smoothly in the absence of Carruthers and the former VP of StarWorld’s casino operations Justin Casey, who also recently ended his time at StarWorld.  Where Mecca will really play a valuable role is in the capital markets; Galaxy needs go to the capital markets in order to fund its Cotai project, according to DM.




SJM has been doing well in September, according to DM. Having seen numbers for the first 13 days of the month, DM writes that SJM’s hold percentages seem to have turned around after two weak months. This turnaround has resulted in a gross gaming revenue figure of MOP1.46 billion for the first 13 days – more than MOP100 million per day.  This news comes following the first-half results this week which reported a profit of HK$338 million from HK$571 million in 1H08.  There is still no reliable news on Stanley Ho’s current condition.





Pansy Ho’s Shun Tak Holdings announced this week that its net profit before exceptional gains was up 43% compared to the first half of 2008.  Shun Tak also announced it is raising HK$1.4 billion in convertible debt. The company states that it “will be used for general working capital and to finance new investment opportunities”.  DM speculates that the company may look at buying a bigger stake in STDM.





The declaration of Hengqin island as China’s third state-level strategic development zone should be sufficient to convince skeptics that Zhuhai’s time has finally come.  This is good news for Cotai; while infrastructure development is needed on Hengqin, the Chinese will certainly satisfy that need rapidly.  Hengqin’s population is likely to rocket to more than 120,000 by 2015, from just a few thousand at present.  The Lotus Bridge will have a feeder network and will probably go to the same operating hours as Gongbei.






Following their IPO gaining approval from the Hong Kong stock exchange, Wynn Resorts is under the spotlight in Macau these days.  The Wynn Macau had 8.9% of the table games in Macau but captured 15.4% of the table revenues during the first six months of the year.  The statistics are even more dramatic in slot machines, where the Wynn Macau had 9.7% of the machines, but 23.9% of the revenues. 


The company hasn’t indicated what it plans to do with capital raised from its IPO.  There are tentative plans to develop a 21 hectare site on Cotai but no construction timeline has been outlined.  The company expects strong demand for its offering.  Wynn is hiring 1,000 new staff in Macau for its US$650 million Encore project, which is funded and due to open next spring.







“Whenever I felt happy about having discovered something, the first encounter, not only with the public, with other musicians, with specialists, etc, was that they rejected it.”
-Karlheinz Stockhausen
Like our Chief of everything German here at Research Edge (Michael Blum), Karlheinz Stockhausen lived on the Edge of Chaos. Stockhausen passed away at the end of the US Economic Leverage Cycle (December 2007) and left this world as one of the most controversial, yet acclaimed, composers of the last century.
Whether it was Stockhausen’s musical theories of the 1950’s and 1960’s (electronic music), or those that we are defining in the 21st century of real-time finance – to me, it’s all the same thing. It’s about discovering and evolving. Every day, our profession’s challenge is to unlearn and re-learn.
How does Chaos Theory apply to financial Risk Management? How did Stockhausen’s Spatialization Theory apply to the proceeding 60 years of music? The answer to the 2nd question is much clearer. Looking backwards is always crystal clear, indeed…
After the SP500 closed down for it’s first day this week (down -0.31%, on decelerating volume, to 1065), I don’t think Stockhausen himself could have a more linear composition for Stockperformance. If you think that lyrical play on words was cute, you should see an ex-hockey player dance…
Perfectly linear performance? Here’s the score:
1.      Bears: October 2007-March 2009 = -57%

2.      Bulls : March 2009-September 2009 = +57%

So, lets dance.
Peter Schiff, Nouriel Roubini, and David Rosenberg. I am calling you all out on the dance floor. Let’s do it – in New Haven, CT, Stockhausen style.
Having done a reasonable job from the Top, to the Bottom, and Back Again, Research Edge is now taking ownership of this investment strategy debate. Someone has to be the auditor of this Gong Show. In 2009, all 3 of you gentleman have proven to be demonstrably reckless with the volume of your storytelling. Your timing in particular has been way off pitch. So let’s grease up those squeaky Depressionista wheels and have a little accountability session. I’ll host it. Nouriel, I’ll get you back onto Yale’s campus again, don’t worry…
Stockhausen said, “what is important is neither linearity or non-linearity, but the change, the degree of change from something that doesn't move to other events with different tempos in particular.” So, that’s going to be debate topic #1 – how do you, the other musicians of CNBC and the like, Wall Street “specialists” if you will, think about changes on the margin? Do they matter? When? Why? Let’s take the validity of this profession up a notch and debate the basic answers that anyone with a repeatable investment process should have.
Then, for debate topic #2, we can dig in maybe to Stockhausen’s thoughts about style and duration: “there is a personal sense of style for a given work - I don't like a general style, but every work has its own style, and I want to create a style for every work.”
Finally, I’d love to submit topic #3, which is more of a Stockperformance idea I have… which is simply how we should hold ourselves – you know, the “specialists” of calling markets, accountable for what comes out of our mouths and fingers. As Stockhausen said, “I'm always interested when other musicians are trying to discover new worlds of sound.”
Throw me some dates boys. My dance card is wide open. I already have a few major media sponsors lined up for the event.
My immediate term TRADE support/resistance levels for the SP500 this morning are now 1044 and 1076, respectively. Yesterdays intraday selloff in US Equities was inspired by an intraday bid for the bombed out US Dollar. If the Buck stops Burning, most things priced in Bucks will stop going up. This we know. What we don’t know remains – and if we think we discover something, we should embrace that “first encounter, not only with the public, with other musicians, with specialists, etc.”, especially if they reject it.
Have a solid weekend with your families,



CAF – Morgan Stanley China Fund A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the more volatile domestic equity market instead of the shares listed in Hong Kong. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth. Although this process will inevitably come at a steep cost, we still see this as the best catalyst for economic growth globally and are long going into the celebration of the 60th Anniversary of the People’s Republic.

We bought back our long standing bullish position on gold on a down day on 9/14 with the threat of US centric stagflation heightening.   


XLV – SPDR Healthcare We’re finally getting the correction we’ve been calling for in Healthcare. It’s a good one to buy into. Our Healthcare sector head Tom Tobin remains bullish on fading the “public plan” at a price.

EWH – iShares Hong Kong The current lower volatility in the Hang Seng (versus the Shanghai composite) creates a more tolerable trading range in the intermediate term and a greater degree of tactical confidence.  

CYB – WisdomTree Dreyfus Chinese Yuan The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.
TIP – iShares TIPS The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.


LQD – iShares Corporate Bonds Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates that bonds will give some of that move back. Shorting ahead of Q4 cost of capital heightening as access to capital tightens.

EWU – iShares UK We’re bearish on the UK’s leadership and monetary policy to weather its economic downturn. Although we’re seeing improved fundamentals within the country and across Europe we continue to see the country’s financial leverage as a headwind and increasingly the data suggests that inflation is getting ahead of growth. We shorted EWU on 9/9.

DIA  – Diamonds Trust We shorted the Dow on 9/3.  In the US, we want to be long the Nasdaq (liquidity) and short the Dow (financial leverage).

EWJ – iShares Japan While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

SHY – iShares 1-3 Year Treasury Bonds  If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.

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A top media story this afternoon was the first quarterly increase in household net worth since 2007, with US personal wealth increased by $2 trillion in Q2 according to Federal Reserve estimates. Clearly as the value of IRAs and 401Ks and (eventually) real estate holdings regain some of the value lost it only stands to reason that consumer spending should increase. Indeed, retail August sales released earlier this week showed an improvement of 2.7%  over July.




If you read our recent posts on the long term view for US consumers you will recall we touched on overlapping negative trends in employment, demographics and credit.  Today’s data suggests another factor: psychology. In the chart below we have illustrated the wild swings in household net worth experienced by the American Consumer over the past 15 years.  As the 45-54 age group becomes the largest component of the US labor force (see our post “TIDAL” from Sept .11), what will the psychological impact of this volatility be on spending as this critical group races to build a big enough nest egg before retirement begins? 




Andrew Barber


It’s no secret that Australia is one of our favorite economies. With sober monetary policy as well as commodity resources and a strategic geographical location in the Asian supply chain that provide competitive advantages in meeting Chinese demand, the land down under has managed to sidestep recession. Although, at 5.8% SA, unemployment remains historically high and the construction and financial sectors continue to face challenges; in comparison with the rest of Developed Asia (or the Developed economies globally for that matter) Australia appears to be enviably positioned –a fact reflected in consumer confidence measures that have rebounded to levels not seen since 2007 in recent months.  


This relative strength has been reflected in the markets. After a Q2 reporting season that was without major surprises the ASX All Ordinaries has continued to outperform US equities with YTD performance of almost 29% VS.  18% while, in the wake of Governor Stevens tightening  signals, the Australian Dollar has continued to outpace the greenback with the Aussie now up 25% YTD (making the USD investment performance for the ASX  over +60%).


On an absolute AUD basis, the trend in exports continues to improve across the commodity spectrum as Chinese demand has remained resilient in the months since the Beijing stimulus program was initiated (see first chart below). This picture is clouded by the relative late ABS reporting schedule and the impact of currency strength on a relative basis versus the competition (see second chart), but all unofficial data sources and channel checks continue to support the trend.  Regardless of the positive impact of demand from “The Client”, the year-over-year compare will continue to be brutal until October –last year’s high water mark for shipments (see third chart).








We will continue to follow Australia closely and will look for opportunities to resume long exposure to either equities or the currency as dictated by price action.


Andrew Barber
Director or


In our power rankings of stocks in the QSR restaurant universe, SONC is the most under loved name next to SNS, a name which hardly anybody cares about.  


SONC, MCD, JACK and BKC are the only QSR names that are down on a year-to-date basis.  The rest of the group is up over 50%.  Of these four names, I’m more favorably disposed to JACK and now warming up to SONC.  




SONC reported fiscal 4Q09 system same-store sales growth of -4.5% with partner drive-ins down 5.4%.  Sales trends at the partner drive-ins have been significantly underperforming the franchise drive-ins for the last 5 quarters and although partner drive-ins improved 230 bps sequentially from 3Q09 on a 1-year basis, the 2-year average trends continued to decline slightly (though they appear to be stabilizing).  The reported flat traffic result is somewhat impressive relative to the current environment, but average check declined 4.5% YOY, similar to the 4.9% decline in 3Q09. 






SONC attributed its flat traffic number to the success of the company’s Everyday Value Menu, which was implemented in 2Q09.  The Everyday Value Menu is also accountable for the decline in average check.  Restaurant level margins started to decline prior to the introduction of this value menu to the tune of about 400 bps in both 4Q08 and 1Q09.  The value menu already accounts for 10% of sales but its negative impact on margins was somewhat offset in 3Q09 as a result of the company’s refranchising efforts.  Restaurant level margins most likely declined again in 4Q09, though to a much lesser degree than the 200 bp decline in 3Q09, as a result of the July minimum wage increase and the expected increase in food costs as a percent of sales.  This increase in food costs as a percent of sales is being driven by the lower margin Everyday Value Menu because commodity costs were expected to be down YOY in the fourth quarter (lapping the 4Q08 180 bp increase in food costs as a percent of sales).




SONC guided to improved restaurant level margins in fiscal 2010, which would be encouraging after five reported quarters of rather significant declines.   This guidance also assumes flat partner drive-in same-store sales, which implies an acceleration in sales trends on a 2-year average basis.  Although the company is relying on the full-year benefit of it 2009 refranchising activity and lower commodity costs to drive restaurant level margins higher, we have yet to see any recovery in SONC’s 2-year average partner drive-in comparable sales trends (though they are not getting worse).  And, if the value menu continues to grow as a percent of sales, it will continue to put pressure on average check and food costs as a percent of sales, offsetting some of the YOY commodity cost favorability. 


From an operating margin perspective, the company’s expectations for significantly lower YOY SG&A and D&A expense as a result of refranchising efforts should lead to better operating margins in fiscal 2010 even if restaurant margins don’t prove as favorable as expected.


On a separate topic, SONC also announced that it has implemented a program intended to encourage franchise openings in fiscal 2010.  Part of this program is likely to include lower required average franchise fees per new franchise opening.  The company is still guiding to 100-110 franchise openings in 2010, but this type of change signals a decrease in franchise interest.

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