Sonics management noted that part of the declining performance at partner drive-ins was due to the consumer rejecting the aggressive price increases taken last year. On top of that, management reduced labor in the stores as they were trying to manage margins. Trying to manage to Wall Street's expectations is extremely difficult, and sometimes, decisions are made that can have severe repercussions on the business model.
- Here are two things we know from the quarter SONC just reported. (1) It can't raise prices, so with inflation rampant, margins are coming down. (2) SONC needs to add labor to the stores to improve service levels, putting further pressure on margins. Things continue to deteriorate for SONC. - Here is a quick look at the guidance time line: after its 2Q, the company forecasted 15%-17% FY08 EPS growth (but still 18% long-term growth). On May 9, when the company preannounced its 3Q results, management lowered its FY08 EPS expectations to 9%-12% growth. Today the company is looking for 4-6% growth. The science of guidance!
- SONC also slightly lowered its development schedule from 2Q when they were saying they would open 180-200 drive-ins system-wide in FY08. The company is now expecting to open 175-185. To help improve the trend in same-store sales, the company increased the number of franchise retrofits it expects to complete by fiscal year end to more than 700 (versus its prior expectation of 600-700). A phrase used often at Research Edge is when a company pulls the goalie to make the quarter. In short, this means that the company cuts SG&A so it can make the number. For SONC, the company has been pulling the goalies for years and there is nothing left. In 2001, SONC's SG&A as percentage of sales was just over 9%, today it's hovering around 7%. SONC is the model of efficiency when you compare its level of SG&A spending relative to sales to that of its competition. Given what we have learned about management's quest to maintain margins in the current quarter by cutting labor at the expense of customer service, I'm thinking that maybe the company has gone too far.