Sonic Corp. ( SONC - Snapshot Report ) reported third quarter fiscal 2012 adjusted earnings of 24 cents per share, surpassing the Zacks Consensus Estimate and year-ago earnings by 2 and 3 cents respectively. On a GAAP basis, quarterly earnings were 24 cents per share, compared with a loss of 8 cents in the year-earlier quarter.

Total revenue in the reported quarter dipped 1.8% year over year to $149.4 million, but was in line with the Zacks Consensus Estimate. Comparable store sales (comps) for the quarter grew 2.8%, mainly on a 2.7% uptick at franchise drive-ins and a 3.7% rise in company drive-ins. The comps growth, however, deteriorated from the 3.9% increase recorded in the year-earlier period.

Sonic registered a modest decline in its cost structure. Food and packaging expense fell 30 basis points (bps) to 27.8%, as a percentage of revenue. Payroll and employee benefits and other operating expenses declined 60 bps and 50 bps to 35% and 20.2%, respectively. Restaurant level margins improved 140 basis points to 17.0% on the back of improved same-store sales growth and abating commodity inflation.

Store Update

Oklahoma-based Sonic opened seven, acquired one from company-owned unit and closed five franchised drive-ins in the third quarter. Sonic also closed two company-owned drive-ins. The drive-in fast food chain operator presently has 3,550 drive-in restaurants and remains on track to open 30–40 new franchise drive-ins in 2012.

Financial Position

At the end of the quarter, current assets were $41.6 million, long-term debt due after one year was $470.6 million and shareholders’ equity was $48.9 million. Sonic completed its $30 million share buyback program in early June.

Outlook

For fourth quarter 2012, Sonic expects positive comps in the low single digits. Improvement in restaurant level margin will be a function of same store sales growth. Selling, general and administrative expenses are expected in the range of $17–$18 million and depreciation and amortization between $10.5 million and $11.0 million.

Sonic also expects to generate $50 million to $55 million in free cash flow in 2012.

Our Take

Sonic is gradually moving in a positive direction. The takeaways from the third quarter earnings were modest comps improvement and margin expansion. Slightly benign food and packaging cost environment will also bode well for the quarter ahead.

Sonic also tapped the important day part of sales, i.e., breakfast, to drive sales. Providing impetus on this day-part as well as implementation of a 2% to 3% pricing in the beginning of May will likely position Sonic’s fourth quarter in a brighter light.

Other initiatives that the company is taking are shutting down underperforming units, focusing on smaller prototypes to improve return on investment and cost containment. Execution of a point-of-sale system over the next few years is also on Sonic’s long-term wish list. The program will be launched this fall and spread across all the company drive-ins within the end of calendar year 2013.

However, stiff competition in the marketplace and waning consumer confidence remain concerns for the company. Additionally, fourth quarter generally sees sequentially lower restaurant-level margins due to higher utility costs related to summer.

Sonic, which competes with the likes of BJ’s Restaurants Inc. ( BJRI - Analyst Report ) , currently retains a Zacks #2 Rank, that translates into a short-term ‘Buy’ rating. We also maintain our long-term Neutral recommendation on the stock.