Sonic (NASDAQ:SONC) had a nice finish to fiscal 2006, and began FY 2007 with an equally savory performance. During the company's first-quarter earnings conference call, management discussed some of the initiatives that will drive growth in the second quarter and for the remainder of the year. Last week, at Cowen and Company's fifth annual Consumer Conference, two Sonic executives addressed analysts and further fleshed out the company's strategy for success.
Differentiation
Sonic President Scott McLain focused on how the company differentiates itself from the competition. With so many quick-serve restaurant concepts out there, including McDonald's (NYSE:MCD), Wendy's (NYSE:WEN), and Steak n Shake (NYSE:SNS), among others, any way that a concept can distinguish itself from the pack is extremely useful in attracting new customer traffic.
One of the best examples that come to mind on the importance of differentiation is Ruby Tuesday (NYSE:RI). For years, the restaurant chain was lost in the shuffle among other casual offerings like Applebee's (NASDAQ:APPB). To distinguish itself, Ruby Tuesday recently implemented a burger-centric menu, to positive results thus far.
Sonic's hardly lacking in its ability to stand out from the quick-serve crowd. McLain pointed to Sonic's format, which emphasizes customization, as one of the qualities unique to the brand. "Only at Sonic can you get a Cherry Vanilla Dr. Pepper, if that is what you want," McLain explained.
By making available numerous add-in flavors that customers can choose for their fountain drinks, the company is able to distinguish itself from other fast-food concepts that might be sitting directly across the street. Any way a brand can do different well is good business.
Sonic also distinguishes itself in its food. Unlike many quick-serve operations, where certain menu items are only available at certain times of the day, at Sonic the entire menu is available throughout the day. McLain pointed out that this is made possible because "everything at Sonic is made after you order."
Whether it's food, drinks, or frozen treats, expect Sonic to continue its emphasis on maintaining a fresh menu. Nearly every month, Sonic introduces something new to the menu, and it will continue this approach in 2007, having already introduced a Raspberry-Banana Smoothie for January.
One of the most obvious differences about the Sonic concept is noticeable when you first pull into one of the restaurant's 24 to 36 drive-in bays. Most drive-ins disappeared in the 1950s and '60s, but Sonic has kept the concept alive in style. Sonic is in the process of once again retrofitting existing drive-ins, as it did in the '80s and '90s. McLain indicated that the company benefited nicely from the prior two retrofits, and management expects success this time as well.
Advertising
Beyond differentiation, McLain pointed out that advertising, particularly national cable advertising, has increased in relevance for the company as it has continued to grow in size. As Sonic penetrates developing markets, cable serves as the best way to spread the word about the brand.
As the company grows, so do its advertising expenditures. Sonic is planning to spend roughly $160 million on advertising in FY 2007, with $80 million designated for national cable. "As we spend more money on advertising," McLain argued, "we tend to see a very positive correlation to sales and profits."
Expansion
Speaking of development, McLain indicated that in just the past few months, Sonic has established a beachhead in five new markets. Sonic already has more than 3,200 units in operation, but McLain believes the concept has "lots of opportunity to grow."
In fact, the company has accelerated development in recent months, after achieving "sustained momentum" in store-level profitability. In top-line performance alone, Sonic has seen steady progress over the years.
For instance, a look at its last annual 10-K filing indicates that Sonic's average sales per franchise increased from $929,000 in 2003, to $983,000 in 2004, to $1.04 million in 2005, to almost $1.1 million in 2006. The top 20% of its stores are operating at the $1.5 to $1.6 million level. As the brand improves its profitability and proves that it is a sustainable concept, franchisees are increasingly willing to invest.
We know from the 10-K filing that the company expects to open 150 to 160 franchised drive-ins in fiscal 2007. I'm sure it has many more planned for opening, but given the tricky real estate market, many plans will doubtlessly fall through.
One of the most significant changes to Sonic's franchising biz over the years has been its average royalty rate. Ten years ago, it was 2.7% of sales; today it stands at 3.6% of sales. CFO Steve Vaughan confirmed that this upward trend will continue over the next three years as the company works toward an average royalty rate of 4.2%. These increases are justified again by Sonic's proven concept, and the average $1.1 million in sales generated per franchised site.
Concluding thoughts
That wraps up a few of the key highlights from the conference. From my analysis of the company's last quarterly earnings conference call, you'll know that I have a very favorable view of Sonic's operation. Nothing from this conference has altered my opinion.
I see a company with a sound strategy to maintain its success, through both a highly differentiated product and its ability to increase profitability. Sonic has 20 consecutive years of positive same-store sales, with comps increasing by an average of 5% per year over the past 10 years. This remarkable track record establishes a solid foundation for the next 10 years, as well.
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Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Motley Fool has a disclosure policy.
