• It's Here!

    Etf Pro

    Get the big financial market moves right, bullish or bearish with Hedgeye’s ETF Pro.

  • It's Here


    Identify global risks and opportunities with essential macro intel using Hedgeye’s Market Edges.

Given that SONC just preannounced its 2Q sales trends two weeks ago, the company did not say anything too incremental on its earnings call today.  Management would not comment on quarter-to-date trends but said it is comfortable with its 2H10 system same-store sales guidance of flat to -5%.  During 2Q, SONC estimates that its same-store sales came in -4% to -5%, excluding weather. 

Management stated that average check turned slightly positive during the quarter, which seemed somewhat expected given that the company lapped the implementation of its Everyday Value menu.  Management went on to clarify that the improvement in check did not come in January when it lapped the Everyday Value menu but instead, check turned slightly positive in February, which it attributed to the new promotion of free add-on onion rings with the purchase of the Steak Melt Toaster.  The company is running a similar promotion in March and thinks it should continue to drive average check higher going forward.

Sonic also commented on a change in compensation structure for its partner drive-in managers, which will cost an additional $1-$1.5M per quarter in labor expense.  As of April, most partner managers will transition to a more normal, stable compensation structure that includes a higher, more competitive base salary along with an incentivized bonus based on individual sales and profit performance.  Management explained that this provides more stable income for managers, which helps with retention, while still allowing for unlimited upside earnings potential.  When asked on the call, if this new compensation structure could cost more to the company when same-store stores growth and profits move higher, management joked that it would welcome that problem and discussion when it happens.

Notes from the call:


  • Difficult quarter for the average drive-in
  • Inclement weather in core markets
  • Recession taking hold much more intensely in core markets (lagging balance of country)
  • 1/3 of system in Texas and Oklahoma
  • Double-digit declines in state and local sales tax collections
  • Weather impact: analytical firm examined results, temperature, snowfall and concluded that 2/3 of decline in winter quarter was due to the harsh weather
    • SSS, ex weather, would have been -4% to -5%
    • Despite challenging environment, check turned positive for the first time in a good while
    • A year ago, everyday value menu was rolled out which impacted traffic
  • New promotions should lead to positive check going forward


Sales and profit growth

  • Value equation was previously focused on price
  • Going forward in FY10, more focus on the customer while maintaining achievements in price
    • Brand and business will be the better for it

4 components of strategy

  • High quality customer service experience at each drive in
    • Customer feedback has been sought out
  • Focus on product improvements in core menu items
    • LTO’s, core menu improvement, unique entrees and desserts et cetera
  • Marketing to drive home points of differentiation
    • Skating car hops etc.
  • New media reallocation of marketing dollars to maximize media impressions in trade areas of every store in the system (slight shift from national to local)
    • National spend will be $70m (one ad per hour)
    • Reallocation will be determined based on penetration and other metrics

Development growth has been challenged

  • Weather
  • Credit market
  • Franchisees uncertain
    • But continuing to reinvest in their assets
    • Remodels are high ROI opportunities
    • License incentive agreement for relocations or rebuilds expired, but investment continues
      • 150 or 4% of chain over the last two years
  • Sales and profit environment will lead to fewer than expected
    • 80 to 90 openings for FY10
  • First year sales continue to be strong
    • Opening volumes of 1.5m
    • 84 drive ins in new markets open for 1 yr
      • 1.4m average volumes
  • Continue to see construction prices fall and interest rates are low
    • Franchisees taking more time than usual to negotiate best deal so near term openings will continue to be constrained
  • Rate of closings remains low
  • Franchisees remain healthy


Sales deleveraging had impact on margins

Opened 17 drive-ins

Food improved slightly, commodities should be slightly lower in 3Q, higher in 4Q – flat 2H10

  • Higher costs with real ice cream and improved foot long chili cheese cone

Pricing: 2.5% price increase through 3Q (lapping 1.5%) may take pricing driving a 4Q cumulative increase of 1-1.5%

Higher labor costs

Other operating expenses were impacted because a large portion of them are fixed

  • Expecting improvement in 2H10

2010 Guidance:

  • EPS of $0.55 to $0.60
  • Restaurant level margins deteriorate slightly
  • SG&A $65-66m
  • DA $42-43M
  • Interest expense of $37-38m
  • FY10 positive operating cash flow of $25-30m, $52-53m in principal payments
  • Capex $25-30M
  • $100m in excess cash on hand
  • FCF flat to slightly positive


Q: Refranchised sales, were they in specific markets and what was the timing of those sales

A: Atlanta markets and a handful in Dallas. Lower performing and better performing drive-ins

Q: Change in partner compensation again? 1.5m on incremental labor expense? The upside is unlimited?

A: Sales and profit deterioration in partner drive in, disproportionate. Met with managers and supervisors and have given them chance to take different compensation structure. More predictable. Partner during summer months earn more in summer than winter. The idea is to provide stable compensation while retaining the upside that comes with driving the profits of the business.

1.5m in additional costs per quarter, health insurance, FICA, more stable based salary. We’d hope that this will result in a decrease turnover experience. Historically base comp has been on the lower end of market

Q: dollar amount received for refranchised stores?

A: slight loss on those transactions, lower performing and a small number of better performing drive ins. Partly why 2Q other revs came down. It’s also seasonal.

Q: G&A bad debt?

A: 1m increase attributable to bad debt. 3Q expectations for bad debt are built into 65-66m SGA annual guidance

Q:  Improvement in back half…where are we today? Within range of 0 to -5% to give that guidance?

A: When the weather has been comparable to the prior year (2Q and 3QTD) we are within that range.

Q: Bad debt expense…uncollectibles from franchisees? What’s that like yoy?

A: Some increase in delinquencies, small number of franchisees…not significant.  Majority of franchisees are in good shape

Q: Cash build, future uses. Talk about the decision not to buy back stock this quarter

A: Continue to evaluate that on a regular basis.

Q: Competitors with beverage innovation – big piece of your business – talk about % of sales from beverages vs 2 yrs ago…strategy?

A: Beverages are the best part of our business and beverage sales have held on better than other parts of the business.

Q: Ex-weather implying business improved, where is check, traffic?

A: As quarter progressed, lapped happy hour, we saw check turn positive. Not up by a huge amount but it is positive.

Q: Long term EPS growth target?

A: Key to growth is SSS turning positive. That’s our focus. Long term target is more contingent on SSS.

Q: Bad debt. What options do you have? Is it tacked on to rate you can charge franchisee over time? You write it off in entirety, future cash flows from that franchisee?

A: Through Feb 28th, we have recorded an appropriate amount. If business improves, it will decline. It is a larger amount than is typical. Suspect all franchisors have bad debt over time. This is a large amount attributable to terrible winter. Working out things with a franchisee on a case by case basis

Q: Given the new initiatives, how did you test the programs, which will be most meaningful?

A: Not possible to test some strategies (dollar marketing shift). The most important of the initiatives is improving product and service. People have to have a good experience and they have to enjoy the product.  Those are high priority and have to be steadfast. Creative and allocation of dollars are somewhat more transitory.  Those can change in a couple of quarters depending on market demands.

Q: Any impact from MCD dollar menu at breakfast?

A: No

Q: More color on COGs flat yoy in 2H. Product quality improvement, free tater tots in March, commodities flat? How do you get to flat?

A: Cost of goods being down in 3Q and up in 4Q include quality improvement. We did some discounting and promotions last year.  Some promotions are replacing promotions from last year

Q: Given more tip dependency on part of car hops, how are they dealing with SSS decline?

A: Don’t have exact figure but more skating gets more tips. Probably has been some offset but difficult to quantify.

Q: Turnover for car hops?

A: Declined slightly.

Q: Promotions with onion rings and tater tots, has this cannibalized combo meal sales?

A: there has been some trade-off but these promotions go out with a full price drink so penny profit isn’t diminished.

Q: How much of sales guidance in back half incorporates employment stabilization? Holding current rates steady?

A: Second quarter ex weather was at low end of range. Initiatives give us confidence that we should be able to offset or improve on current sales trend.

Q: New bundling with the free side, is there any trade away from value menu into that promotion?

A: Not sure. Value menu as % of sales has declined. Not promoting it this year vs last year. A year ago, customers wanted to know if we had a value menu. Now they seem to want a deal on regular items.

Q: Tweak value menu in light of moves by BKC and MCD?

A: We’d like to play on playing field where we have advantage – ice cream, conies, tater tots, onion rings. Not battling competitors on everyday value

Q: Do I have to request free attachments or is it automatically offered?

A: Offered if you order sonic cheeseburger

Q: What is the change in average check with change in promotion?

A: went slightly positive from negative.

Q: How important is it to broaden drink platform from happy hour and diversify away from high fructose corn syrup?

A: Drink sales are strong at breakfast…very big throughout day. Breadth of product offering is constantly being examined. Including types of drinks offered and times of day they are promoted.

Q: Store closures…would have expected more on franchisees, is there consolidation between franchisee base?

A: Historically that’s happened. Franchisees buying from company and each other. When a store gets in trouble it’s usually sold. That’s partly why closures are lower than one might expect.

Q: Average check now vs mid-07?

A: Running ~$5. Was around $5.35, $5.40.

Howard Penney

Managing Director