Quarterly Report


Table of Contents


 
 
 
 
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________
FORM 10-Q
_____________________

SONCLOGOA07.JPG
(Mark One)
[ X ]     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended May 31, 2018

OR

[  ]     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______________  to ________________

Commission File Number 0-18859
_____________________
SONIC CORP.
(Exact name of registrant as specified in its charter)
_____________________

Delaware
(State or other jurisdiction of
incorporation or organization)
 
73-1371046
(I.R.S.   Employer Identification No.)
 
 
 
300 Johnny Bench Drive
Oklahoma City, Oklahoma
(Address of   principal   executive   offices)
 
73104
(Zip Code)
໿
(405) 225-5000
(Registrant’s telephone number, including area code)
_____________________



Table of Contents


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ☒  No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  ☒  No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
    
Large accelerated filer ☒
Accelerated filer                  ☐
Non-accelerated filer   ☐ (Do not check if a smaller reporting company)
Smaller reporting company ☐
 
Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ☐  No  ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of June 27, 2018 , approximately 36,085,715  shares of the registrant’s common stock, par value $0.01 per share, were outstanding.
 
 
 
 
 


Table of Contents


SONIC CORP.
Index


໿

 
Page
Number
 

 
 
Item 1.
 

 
 
 

 
 


 
 


 
 


 
 
Item 2.

 
 
Item 3.

 
 
Item 4.

 
 
 

 
 
Item 1.

 
 
Item 1A.

 
 
Item 2.

 
 
Item 6.
໿



Table of Contents


PART I – FINANCIAL INFORMATION
Item 1.  Financial Statements
SONIC CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
(Unaudited)

 
May 31,
2018
 
August 31,
2017
ASSETS
 
 
 
 
Current assets:
 
 

 
 
Cash and cash equivalents
 
$
44,869

 
$
22,340

Restricted cash
 
15,017

 
19,736

Accounts and notes receivable, net
 
37,571

 
33,758

Prepaid expenses and other current assets
 
6,678

 
13,350

Total current assets
 
104,135

 
89,184

Noncurrent restricted cash
 
13,457

 
42,120

Notes receivable, net
 
18,238

 
9,801

Property, equipment and capital leases
 
605,594

 
616,001

Less accumulated depreciation and amortization
 
(304,724
)
 
(303,621
)
Property, equipment and capital leases, net
 
300,870

 
312,380


 
 

 
 

Goodwill
 
75,344

 
75,756

Debt origination costs, net
 
1,299

 
2,439

Other assets, net
 
32,203

 
30,064

Total assets
 
$
545,546

 
$
561,744


 
 

 
 

LIABILITIES AND STOCKHOLDERS’ DEFICIT
 
 

 
 

Current liabilities:
 
 

 
 

Accounts payable
 
$
11,649

 
$
9,213

Franchisee deposits
 
530

 
1,093

Accrued liabilities
 
38,375

 
44,846

Income taxes payable
 
197

 

Current maturities of long-term debt and capital leases
 
7,761

 
3,464

Total current liabilities
 
58,512

 
58,616

Obligations under capital leases due after one year
 
13,632

 
16,167

Long-term debt, net
 
701,853

 
628,116

Deferred income taxes
 
25,737

 
40,101

Other non-current liabilities
 
19,072

 
20,502

Total non-current liabilities
 
760,294

 
704,886

Stockholders’ deficit:
 
 

 
 

Preferred stock, par value $.01;  1,000 shares authorized; none outstanding
 

 

Common stock, par value $.01;  245,000 shares authorized; 118,309 shares issued (118,309 shares issued at August 31, 2017)
 
1,183

 
1,183

Paid-in capital
 
236,380

 
236,895

Retained earnings
 
968,405

 
934,017

Treasury stock, at cost; 82,120 shares (78,081 shares at August 31, 2017)
 
(1,479,228
)
 
(1,373,853
)
Total stockholders’ deficit
 
(273,260
)
 
(201,758
)
Total liabilities and stockholders’ deficit
 
$
545,546

 
$
561,744


The accompanying notes are an integral part of the consolidated financial statements.

4



SONIC CORP.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)

 
Three months ended
May 31,
 
Nine months ended
May 31,

 
2018
 
2017
 
2018
 
2017
Revenues:
 
 

 
 

 
 

 
 

Company Drive-In sales
 
$
66,587

 
$
72,062

 
$
182,217

 
$
223,500

Franchise Drive-Ins:
 
 

 
 

 
 

 
 

Franchise royalties and fees
 
48,251

 
48,220

 
122,766

 
122,687

Lease revenue
 
2,203

 
2,418

 
5,288

 
5,474

Other
 
1,265

 
1,290

 
1,565

 
2,038

Total revenues
 
118,306

 
123,990

 
311,836

 
353,699


 
 

 
 

 
 

 
 

Costs and expenses:
 
 

 
 

 
 

 
 

Company Drive-Ins:
 
 

 
 

 
 

 
 

Food and packaging
 
18,549

 
19,380

 
50,863

 
61,112

Payroll and other employee benefits
 
23,468

 
25,590

 
67,325

 
82,688

Other operating expenses, exclusive of depreciation and amortization included below
 
12,354

 
13,836

 
37,303

 
47,540

Total cost of Company Drive-In sales
 
54,371

 
58,806

 
155,491

 
191,340


 
 

 
 

 
 

 
 

Selling, general and administrative
 
21,118

 
20,763

 
57,733

 
58,813

Depreciation and amortization
 
9,566

 
9,520

 
28,492

 
29,531

Other operating income, net
 
(4,010
)
 
(540
)
 
(4,503
)
 
(11,105
)
Total costs and expenses
 
81,045

 
88,549

 
237,213

 
268,579

Income from operations
 
37,261

 
35,441

 
74,623

 
85,120


 
 

 
 

 
 

 
 

Interest expense
 
8,598

 
7,318

 
24,411

 
21,734

Interest income
 
(524
)
 
(291
)
 
(1,361
)
 
(1,047
)
Loss from debt transactions
 

 

 
1,310

 

Net interest expense
 
8,074

 
7,027

 
24,360

 
20,687

 
 
 
 
 
 
 
 
 
Income before income taxes
 
29,187

 
28,414

 
50,263

 
64,433

Provision for income taxes
 
7,611

 
9,663

 
(2,350
)
 
21,601

Net income
 
$
21,576

 
$
18,751

 
$
52,613

 
$
42,832


 
 

 
 

 
 

 
 

Basic income per share
 
$
0.58

 
$
0.44

 
$
1.38

 
$
0.97

Diluted income per share
 
$
0.58

 
$
0.44

 
$
1.36

 
$
0.96


 
 

 
 

 
 

 
 

Cash dividends declared per common share
 
$
0.16

 
$
0.14

 
$
0.48

 
$
0.42


The accompanying notes are an integral part of the consolidated financial statements.



5



SONIC CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

 
Nine months ended
May 31,

 
2018
 
2017
Cash flows from operating activities:
 
 

 
 

Net income
 
$
52,613

 
$
42,832

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
28,492

 
29,531

Stock-based compensation expense
 
3,318

 
2,906

Loss from debt transactions
 
1,310

 

Benefit from deferred income taxes
 
(14,279
)
 
(1,354
)
Gain on disposition of assets, net
 
(4,989
)
 
(12,097
)
Other
 
1,821

 
1,388

Change in operating assets and liabilities:
 
 

 
 

(Increase) decrease in restricted cash
 
5,088

 
4,549

(Increase) decrease in accounts receivable and other assets
 
(5,749
)
 
(2,124
)
Increase (decrease) in accounts payable
 
(705
)
 
(2,894
)
Increase (decrease) in accrued and other liabilities
 
(3,998
)
 
(12,701
)
Increase (decrease) in income taxes
 
1,910

 
44

Total adjustments
 
12,219

 
7,248

Net cash provided by operating activities
 
64,832

 
50,080


 
 

 
 

Cash flows from investing activities:
 
 

 
 

Purchases of property and equipment  
 
(24,523
)
 
(37,146
)
Proceeds from sale of assets
 
16,278

 
62,393

Proceeds from sale of investment in refranchised drive-in operations
 

 
8,354

Issuance of notes receivable
 
(14,158
)
 
(1,214
)
Collections on notes receivable
 
6,232

 
10,114

Other
 
659

 
1,674

Net cash provided by (used in) investing activities
 
(15,512
)
 
44,175


 
 

 
 

Cash flows from financing activities:
 
 

 
 

Purchases of treasury stock
 
(110,621
)
 
(128,180
)
Payment of dividends
 
(18,184
)
 
(18,485
)
Payments on debt
 
(171,000
)
 
(10,417
)
Proceeds from borrowings
 
253,000

 
43,000

Restricted cash for securitization obligations
 
28,294

 
203

Debt issuance costs and prepayment premiums
 
(5,121
)
 
(10
)
Proceeds from exercise of stock options
 
1,635

 
2,528

Other
 
(4,794
)
 
(2,936
)
Net cash used in financing activities
 
(26,791
)
 
(114,297
)

 
 

 
 

Net increase (decrease) in cash and cash equivalents
 
22,529

 
(20,042
)
Cash and cash equivalents at beginning of period
 
22,340

 
72,092

Cash and cash equivalents at end of period
 
$
44,869

 
$
52,050


 
 

 
 

Supplemental cash flow information
 
 

 
 

Cash paid during the period for:
 
 

 
 

Interest
 
$
22,626

 
$
20,210

Income taxes (net of refunds)
 
10,175

 
22,985

Non-cash investing and financing activities:
 
 

 
 

Net additions to capital lease obligations
 
$
97

 
$
1,433

Change in obligation to acquire treasury stock
 
(1,521
)
 
(516
)
Stock options exercised by swap
 
2,697

 

The accompanying notes are an integral part of the consolidated financial statements.

6



SONIC CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)
1.
Basis   of   Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) and with the rules and regulations of the Securities and Exchange Commission (“SEC”).  Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements of Sonic Corp. (the “Company”).  In the opinion of management, these financial statements reflect all adjustments of a normal recurring nature, including recurring accruals, necessary for the fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods presented in conformity with GAAP.  In certain situations, recurring accruals, including franchise royalties, are based on more limited information at interim reporting dates than at the Company’s fiscal year end due to the abbreviated reporting period.  Actual results may differ from these estimates.  These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the fiscal year ended August 31, 2017 , included in the Company’s Annual Report on Form 10-K.  Interim results are not necessarily indicative of the results that may be expected for a full year or any other interim period.

Principles of Consolidation

The accompanying financial statements include the accounts of the Company, its wholly owned subsidiaries and a number of Company Drive-Ins in which a subsidiary has a controlling ownership interest.  All intercompany accounts and transactions have been eliminated.

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers,” which requires an entity to recognize revenue in an amount that reflects the consideration to which the entity expects to be entitled for the transfer of promised goods or services to customers.  The standard also requires additional disclosure regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.  The ASU will replace most of the existing revenue recognition requirements in U.S. GAAP when it becomes effective.  Further, the FASB has issued clarifying guidance with ASU No. 2016-08, “Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net),” ASU No. 2016-10, “Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing,” and ASU No. 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers.” ASU No. 2016-08 provides guidance for evaluating when another party, along with the entity, is involved in providing a good or service to a customer.  ASU No. 2016-10 clarifies assessing whether promises to transfer goods or services are distinct, and whether an entity's promise to grant a license provides a customer with a right to use or right to access the entity's intellectual property. ASU No. 2016-20 provides corrections or improvements to issues that affect narrow aspects of the guidance.
The Company plans to adopt the standards in the first quarter of fiscal year 2019 using the cumulative effect transition method.  The Company does not believe the new revenue recognition standard will impact the recognition of sales from Company Drive-Ins or the recognition of royalty fees from franchisees, nor will it have a material impact to the recognition of gift card breakage. The Company expects the pronouncement will impact the recognition of the initial franchise fee, which is currently recognized upon the opening of a Franchise Drive-In. The impact on these fees is not expected to be material to total revenue. The Company is finalizing the impact of the required cumulative effect adjustment to be recorded to the balance sheet on the date of initial application and continues to evaluate the effect this pronouncement will have on principal versus agent considerations, other transactions, the financial statements and related disclosures.
In February 2016, the FASB issued ASU No. 2016-02, “Leases.”  The new standard, which replaces existing lease guidance, requires lessees to recognize on the balance sheet a liability to make lease payments and a corresponding right-of-use asset. The guidance also requires certain qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. Accounting guidance for lessors is largely unchanged. In January 2018, the FASB issued ASU No. 2018-01. ASU 2018-01 permits an entity to elect an optional transition practical expedient to forgo the evaluation of land easements that existed or expired before the entity’s adoption of 2016-02 and that were not accounted for as leases under previous lease guidance. The standard is effective for fiscal year 2020, with early application permitted. This standard requires adoption based upon a modified retrospective transition approach for leases existing at, or entered into after,

7

SONIC CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)

the beginning of the earliest comparative period presented in the financial statements, with optional practical expedients. Based on a preliminary assessment, the Company expects that most of its operating lease commitments will be subject to the new guidance and recognized as operating lease liabilities and right-of-use assets upon adoption, resulting in a significant increase in the assets and liabilities on the consolidated balance sheet. The Company is continuing its assessment, which may identify additional impacts this standard will have on its consolidated financial statements and related disclosures.
In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses.” The update was issued to provide more decision-useful information about the expected credit losses on financial instruments. The update replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The update is effective for fiscal year 2021, with early adoption permitted for fiscal years beginning after December 15, 2018. The update should be adopted using a modified-retrospective approach. The Company is currently evaluating the effect this update will have on its financial statements and related disclosures.
In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments.” The update is intended to reduce diversity in practice in how certain transactions are classified and will make eight targeted changes to how cash receipts and cash payments are presented in the statement of cash flows. The update is effective for fiscal year 2019. The new standard will require adoption on a retrospective basis unless it is impracticable to apply, in which case the amendments will apply prospectively as of the earliest date practicable. The Company is currently evaluating the effect of this update but does not believe it will have a material impact on its financial statements and related disclosures.
In October 2016, the FASB issued ASU No. 2016-16, “Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory,” as part of its simplification initiatives. The update requires that an entity recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than deferring the recognition until the asset has been sold to an outside party as is required under current GAAP. The update is effective for fiscal year 2019. The new standard will require adoption on a modified retrospective basis through a cumulative-effect adjustment to retained earnings, and early adoption is permitted. The Company is currently evaluating the effect of this update but does not believe it will have a material impact on its financial statements and related disclosures.
In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows - Restricted Cash.” The update requires that restricted cash balances be included in the beginning and ending cash balance within the statement of cash flows. The update is effective for fiscal year 2019. The amendments should be adopted on a retrospective basis for each period presented, and early adoption is permitted. The adoption will increase the beginning and ending cash balance within the Company's statement of cash flows by its restricted cash balances and will require a new disclosure to reconcile the cash balances within the statement of cash flows to the balance sheets. The Company does not expect any other material impacts to its financial statements.
In May 2017, the FASB issued ASU No. 2017-09, “Compensation - Stock Compensation: Scope of Modification Accounting,” which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. An entity will account for the effects of a modification unless the fair value of the modified award is the same as the original award, the vesting conditions of the modified award are the same as the original award and the classification of the modified award as an equity instrument or liability instrument is the same as the original award. The update is effective for fiscal year 2019. The update is to be adopted prospectively to an award modified on or after the adoption date. Early adoption is permitted. The Company is currently evaluating the effect of this update but does not believe it will have a material impact on its financial statements and related disclosures.
The Company has reviewed all other recently issued accounting pronouncements and concluded they are not applicable or not expected to be significant to our operations.

8

SONIC CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)

2.
Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share:

 
Three months ended
May 31,
 
Nine months ended
May 31,

 
2018
 
2017
 
2018
 
2017
Numerator:
 
 
 
 
 
 
 
 
Net income
 
$
21,576

 
$
18,751

 
$
52,613

 
$
42,832


 
 

 
 

 
 

 
 

Denominator:
 
 

 
 

 
 

 
 

Weighted average common shares outstanding– basic
 
36,924

 
42,402

 
38,178

 
43,972

Effect of dilutive employee stock options and unvested restricted stock units
 
392

 
691

 
455

 
757

Weighted average common shares outstanding – diluted
 
37,316

 
43,093

 
38,633

 
44,729


 
 

 
 

 
 

 
 

Net income per common share – basic
 
$
0.58

 
$
0.44

 
$
1.38

 
$
0.97

Net income per common share – diluted
 
$
0.58

 
$
0.44

 
$
1.36

 
$
0.96


 
 

 
 

 
 

 
 

Anti-dilutive securities excluded (1)
 
1,898

 
1,362

 
1,534

 
1,095

__________________
(1)
Anti-dilutive securities consist of stock options and unvested restricted stock units that were not included in the computation of diluted earnings per share because either the exercise price of the options was greater than the average market price of the common stock or the total assumed proceeds under the treasury stock method resulted in negative incremental shares and thus the inclusion would have been anti-dilutive.
3.
Share Repurchase Program

During fiscal year 2017 , approximately 6.7 million shares were repurchased under the Company's share repurchase program for a total cost of $172.9 million , resulting in an average price per share of $25.71 .  In August 2017, the Board of Directors approved an incremental $160.0 million share repurchase authorization of the Company's outstanding shares of common stock through August 31, 2018.

During the first nine months of fiscal year 2018 , approximately 4.3 million shares were repurchased for a total cost of $109.1 million , resulting in an average price per share of $25.23 . The total remaining authorized under the share repurchase program as of May 31, 2018 was $50.9 million .

Subsequent to the end of the quarter, the Board of Directors authorized a $500.0 million share repurchase program through August 31, 2021, replacing the Company’s previous fiscal year 2018 authorization. Including amounts purchased during the first nine months of the fiscal year, the total remaining authorized under the share repurchase program is $390.9 million .

Share repurchases may be made from time to time in the open market or otherwise, including through an accelerated share repurchase program, under terms of a Rule 10b5-1 plan, in privately negotiated transactions or in round lot or block transactions.  The share repurchase program may be extended, modified, suspended or discontinued at any time.

9

SONIC CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)

4.     Income Taxes

The following table presents the Company’s provision for income taxes and effective income tax rate for the periods below:

 
Three months ended
May 31,
 
Nine months ended
May 31,

 
2018
 
2017
 
2018
 
2017
Provision for income taxes
 
$
7,611

 
$
9,663

 
$
(2,350
)
 
$
21,601

Effective income tax rate
 
26.1
%
 
34.0
%
 
(4.7
)%
 
33.5
%

The lower effective income tax rate during the third quarter and first nine months of fiscal year 2018 was due primarily to the recognition of the impacts of the Tax Cuts and Jobs Act (“TCJA”) discussed below.

On December 22, 2017, the TCJA was signed into law, significantly impacting several sections of the Internal Revenue Code. The most significant impacts on the Company for fiscal year 2018 include:

Effective January 1, 2018, the U.S. corporate federal statutory income tax rate was reduced from 35% to 21% . Because of our fiscal year end, the Company's statutory federal tax rate is 25.7% for fiscal year 2018 and 21% for fiscal year 2019 and thereafter.
The Company remeasured its existing deferred tax assets and liabilities at the rate the Company expects to be in effect when those deferred taxes will be realized (either 25.7% if in 2018 or 21% thereafter). The Company recognized a discrete benefit from the deferred tax remeasurement of approximately $14.1 million in the second quarter of fiscal year 2018.
    
In December 2017, the SEC provided guidance allowing registrants to record provisional amounts, during a specified measurement period, when the necessary information is not available, prepared or analyzed in reasonable detail to account for the impact of the TCJA. Accordingly, we have reported the revaluation of our deferred tax assets and liabilities based on provisional amounts. In the three months ended May 31, 2018, no material changes to the provisional amounts occurred.
    
Among the factors that could affect the accuracy of our provisional amounts is uncertainty about the statutory tax rate applicable to our deferred income tax assets and liabilities, since the actual rate will be dependent on the timing of realization or settlement of such assets and liabilities. At May 31, 2018, we estimated the dates when such realization or settlement would occur. The actual dates when such realization or settlement occurs may be significantly different from our estimates, which could result in the ultimate revaluation of our deferred income taxes to be different from our provisional amounts. In addition, there is uncertainty about the impact of expected Internal Revenue Service guidance intended to interpret the most complex provisions of the TCJA.
We are currently assessing the potential additional impact of the TCJA on our consolidated financial statements and expect to complete such assessment on or before August 31, 2018.

The difference between our U.S. federal statutory income tax rate and our effective income tax rate for the nine months ended May 31, 2018 and 2017 is summarized below:
 
Nine months ended
May 31, 2018
 
Nine months ended
May 31, 2017
U.S. federal statutory income tax rate
25.7
 %
 
35.0
 %
State income taxes, net of federal tax benefit
3.4
 %
 
2.6
 %
Federal tax benefit of statutory tax deduction
(1.3
)%
 
(1.4
)%
Employment related and other tax credits, net
(1.5
)%
 
(1.7
)%
Stock option excess tax benefit
(2.8
)%
 
(1.4
)%
Deferred tax revaluation
(28.1
)%
 
 %
Other
(0.1
)%
 
0.4
 %
Effective tax rate
(4.7
)%
 
33.5
 %

10

SONIC CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)

5.
Accounts and Notes Receivable

Accounts and notes receivable consist of the following:

 
May 31,
2018
 
August 31,
2017
Current accounts and notes receivable:
 
 
 
 
Royalties and other trade receivables
 
$
21,046

 
$
19,571

Notes receivable from franchisees
 
1,311

 
1,441

Receivables from system funds
 
6,540

 
6,360

Other
 
9,775

 
7,475

Accounts and notes receivable, gross
 
38,672

 
34,847

Allowance for doubtful accounts and notes receivable
 
(1,101
)
 
(1,089
)
Current accounts and notes receivable, net
 
$
37,571

 
$
33,758


 
 

 
 

Noncurrent notes receivable:
 
 

 
 

Receivables from franchisees
 
$
8,562

 
$
6,810

Receivables from system funds
 
10,113

 
3,033

Allowance for doubtful notes receivable
 
(437
)
 
(42
)
Noncurrent notes receivable, net
 
$
18,238

 
$
9,801


The Company’s receivables are primarily due from franchisees, all of whom are in the restaurant business.  Substantially all of the notes receivable from franchisees are collateralized by real estate or equipment. The receivables from system funds represent transactions in the normal course of business. 
6.
Contingencies

Litigation

As reported in the Annual Report on Form 10-K for the year ended August 31, 2017, the Company was named as a defendant in five purported class action complaints related to a payment card breach at certain Sonic Drive-Ins. The Company has since been named as a defendant in four additional purported class action complaints filed on October 9, 2017, in the United States District Court for the Northern District of Ohio, on November 3, 2017, in the United States District Court for the Northern District of Texas, on November 13, 2017, in the United States District Court for the District of Arizona, and on December 17, 2017, in the Northern District of Illinois. Each of these complaints asserted various claims related to the Company’s alleged failure to safeguard customer credit card information, and the plaintiffs sought monetary damages, injunctive and declaratory relief and attorneys’ fees and costs. The cases were centralized in the Northern District of Ohio for coordinated or consolidated pretrial proceedings, and a consolidated complaint was filed. The Company believes it has meritorious defenses to the litigation and intends to vigorously oppose the claims asserted in the complaint. We cannot reasonably estimate the range of potential losses that may be associated with the litigation because of the early stage of the lawsuit. We also cannot provide assurance we will not become subject to other inquiries or claims relating to the payment card breach in the future. Although we maintain cyber liability insurance, we currently believe it is possible the ultimate amount paid by us, if we are unsuccessful in defending the litigation, will be in excess of our cyber liability insurance coverage applicable to claims of this nature. We are unable to estimate the amount of any such excess.

The Company is involved in various other legal proceedings and has certain unresolved claims pending.  Based on the information currently available, management believes all such other claims currently pending are either covered by insurance or would not have a material adverse effect on the Company’s business or financial condition.


11

SONIC CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)

Note Repurchase Agreement

On December 20, 2013, the Company extended a note purchase agreement to a bank that serves to guarantee the repayment of a franchisee loan, with a term through 2018 .  In the event of default by the franchisee, the Company would purchase the franchisee loan from the bank, thereby becoming the note holder and providing an avenue of recourse with the franchisee.  The Company recorded a liability for this guarantee which was based on the Company’s estimate of fair value.  As of May 31, 2018 , the balance of the franchisee’s loan was $5.2 million .

Lease Commitments

The Company has obligations under various operating lease agreements with third-party lessors related to the real estate for certain Company Drive-In operations that were sold to franchisees.  Under these agreements, which expire through 2029 , the Company remains secondarily liable for the lease payments for which it was responsible as the original lessee.  As of May 31, 2018 , the amount remaining under these guaranteed lease obligations totaled $15.4 million .  At this time, the Company does not anticipate any material defaults under the foregoing leases; therefore, zero liability has been provided.
7.
Fair Value of Financial Instruments

The fair value of financial instruments is the amount at which the instrument could be exchanged in a current transaction between willing parties.  The Company has no financial liabilities that are required to be measured at fair value on a recurring basis.

The Company categorizes its assets and liabilities recorded at fair value based on the following fair value hierarchy established by the FASB:

Level 1 valuations use quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date.  An active market is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2 valuations use inputs other than actively quoted market prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.  Level 2 inputs include: (a) quoted prices for similar assets or liabilities in active markets, (b) quoted prices for identical or similar assets or liabilities in markets that are not active, (c) inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves observable at commonly quoted intervals and (d) inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3 valuations use unobservable inputs for the asset or liability.  Unobservable inputs are used to the extent observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.

The Company’s cash equivalents, some of which are included in restricted cash, are carried at cost which approximates fair value and totaled $63.8 million at May 31, 2018 and $73.9 million at August 31, 2017 .  This fair value is estimated using Level 1 inputs.

At May 31, 2018 , the fair value of the Company’s Series 2018-1 Senior Secured Fixed Rate Notes, Class A-2 (the “2018 Fixed Rate Notes”), the Series 2016-1 Senior Secured Fixed Rate Notes, Class A-2 (the “2016 Fixed Rate Notes”) and the Series 2013-1 Senior Secured Fixed Rate Notes, Class A-2 (the “2013 Fixed Rate Notes” and together with the 2018 Fixed Rate Notes and 2016 Fixed Rate Notes, the “Fixed Rate Notes”) approximated the carrying value, including accrued interest, of $720.4 million . At August 31, 2017 , the fair value of the Company's 2016 Fixed Rate Notes and 2013 Fixed Rate Notes approximated the carrying value, including accrued interest, of $578.2 million .  At May 31, 2018 , there was no balance on the Company's Series 2016-1 Senior Secured Variable Funding Notes, Class A-1 (the “2016 Variable Funding Notes” and, together with the Fixed Rate Notes, the “Notes”). At August 31, 2017 the fair value of the 2016 Variable Funding Notes approximated the carrying value of $60.1 million , including accrued interest. The fair value of the Notes is estimated using Level 2 inputs from market information available for public debt transactions for companies with ratings that are similar to the Company’s ratings and from information gathered from brokers who trade in the Company’s notes.

12

SONIC CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)

8.
Debt

During the second quarter of fiscal year 2018, the Company made a pro rata prepayment of $28.0 million on its 2013 Fixed Rate Notes and 2016 Fixed Rate Notes. The prepayment was made at par, as allowed under the note terms.

On February 1, 2018 , various subsidiaries of the Company (the “Co-Issuers”) issued $170.0 million of 2018 Fixed Rate Notes in a private transaction which bears interest at 4.03% per annum.  The 2018 Fixed Rate Notes have an expected life of seven years with an anticipated repayment date in February 2025 .  At May 31, 2018 , the balance outstanding under the 2018 Fixed Rate Notes including accrued interest totaled $170.2 million and carried a weighted-average interest cost of 4.40% , including the effect of the loan origination costs described below.

Sonic used a portion of the net proceeds from the issuance of the 2018 Fixed Rate Notes to pay down the outstanding portion of the 2016 Variable Funding Notes and to pay the costs associated with the securitized financing transaction. In conjunction with the issuance of the 2018 Fixed Rate Notes, the commitments under the 2016 Variable Funding Notes were reduced to $100.0 million .

Loan origination costs associated with the Company’s 2018 Fixed Rate Notes totaled $5.0 million .  Loan costs are amortized over each note’s expected life, and the unamortized balance related to the 2016 Variable Funding Notes and the Fixed Rate Notes is included in debt origination costs, net and long-term debt, net, respectively, on the condensed consolidated balance sheets.

In connection with the 2018 transactions described above, the Company recognized a $1.3 million loss during the second quarter of fiscal year 2018 . The loss consisted of a $0.7 million write-off of unamortized deferred debt origination costs related to the reduction of the 2016 Variable Funding Notes commitments, as well as a $0.4 million write-off of unamortized deferred debt origination costs related to the prepayment on its 2013 Fixed Rate Notes and 2016 Fixed Rate Notes. Additionally, as required by the terms of the 2016 Fixed Rate Notes, the Company paid a $0.2 million prepayment premium.

While the 2018 Fixed Rate Notes have an expected life of seven years, they have a legal final maturity date of February 2048 .  The Company intends to repay or refinance the 2018 Fixed Rate Notes on or before the end of their respective expected life.  In the event the 2018 Fixed Rate Notes are not paid in full by the end of their expected life, the Notes are subject to an upward adjustment in the annual interest rate of at least 5% .  In addition, principal payments will accelerate by applying all of the royalties, lease revenues and other fees securing the debt, after deducting certain expenses, until the debt is paid in full. Also, any unfunded amount under the 2016 Variable Funding Notes will become unavailable.

The Co-Issuers and Sonic Franchising LLC (the “Guarantor”) are existing special purpose, bankruptcy remote, indirect subsidiaries of Sonic Corp. that hold substantially all of Sonic’s franchising assets and real estate.  As of May 31, 2018 , assets for these combined indirect subsidiaries totaled $255.2 million , including receivables for royalties, certain Company and Franchise Drive-In real estate, intangible assets and restricted cash balances of $28.5 million .  The Notes are secured by franchise fees, royalty payments and lease payments, and the repayment of the Notes is expected to be made solely from the income derived from the Co-Issuer’s assets.  In addition, the Guarantor, a Sonic Corp. subsidiary that acts as a franchisor, has guaranteed the obligations of the Co-Issuers under the Notes and pledged substantially all of its assets to secure those obligations.

Neither Sonic Corp., the ultimate parent of the Co-Issuers and the Guarantor, nor any other subsidiary of Sonic, guarantees or in any way is liable for the obligations of the Co-Issuers under the 2018 Fixed Rate Notes.  The Company has, however, agreed to cause the performance of certain obligations of its subsidiaries, principally related to managing the assets included as collateral for the 2018 Fixed Rate Notes and certain indemnity obligations relating to the transfer of the collateral assets to the Co-Issuers.

The 2018 Fixed Rate Notes are subject to a series of covenants and restrictions similar to the Company’s 2016 Fixed Rate Notes and customary for transactions of this type.  If certain covenants or restrictions are not met, the Notes are subject to customary accelerated repayment events and events of default.  Although management does not anticipate an event of default or

13

SONIC CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)

any other event of noncompliance with the provisions of the debt, if such event occurred, the unpaid amounts outstanding could become immediately due and payable.
9.
Other Operating Income

During the first quarter of fiscal year 2017, the Company recorded a gain of $3.8 million on the sale of minority investments in franchise operations retained as part of a refranchising transaction that occurred in fiscal year 2009. The gain is reflected in other operating income, net, on the condensed consolidated statement of income.
10.
Refranchising

During the third quarter of fiscal year 2018, the Company recognized a net gain of $3.2 million related to the refranchised operations of 41 drive-ins and retained a non-controlling minority investment in the franchise operations. These transactions represent additional markets identified after completion of the refranchising initiative in fiscal year 2017 and bring the Company to a 95% franchised system.

The Company completed a previously announced refranchising initiative in fiscal year 2017. During the first six months of fiscal year 2017, 110 Company Drive-Ins were refranchised, and the Company retained a non-controlling minority investment in most of the franchise operations.

The gains and losses related to refranchised drive-ins are recorded in other operating income, net, on the condensed consolidated statement of income. Income from minority investments is included in other revenue on the condensed consolidated statements of income.

In addition to the refranchised drive-ins discussed above in which the Company retained a non-controlling minority investment in the operations, the Company also refranchised the operations of two drive-ins during the third quarter and eight drive-ins during the first nine months of fiscal year 2018, respectively, compared to five drive-ins refranchised during the third quarter and first nine months of fiscal year 2017. These refranchising transactions all occurred in the normal course of business and did not result in any retained interests.


14

SONIC CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
(Unaudited)

The following is a summary of the pretax activity recorded as a result of the refranchising initiative transactions in fiscal year 2017 (in thousands, except number of refranchised Company Drive-Ins):
 
Three months ended
May 31, 2017
 
Nine months ended
May 31, 2017
Number of refranchised Company Drive-Ins

 
110

 
 
 
 
Proceeds from sales of Company Drive-Ins
$

 
$
20,036

Proceeds from sale of real estate (1)
4,749

 
4,749

Proceeds receivable from sale of real estate (1)
6,977

 
6,977

 
 
 
 
Real estate assets sold (1)
(12,095
)
 
(12,095
)
Assets sold, net of retained minority investment (2)
847

 
(7,891
)
Initial and subsequent lease payments for real estate option (1)
195

 
(3,201
)
Goodwill related to sales of Company Drive-Ins

 
(966
)
Deferred gain for real estate option (3)
141

 
(899
)
Gain (loss) on assets held for sale

 
(65
)
Refranchising initiative gains, net
$
814

 
$
6,645

_______________
(1)
During the first quarter of fiscal year 2017, as part of a 53 drive-in refranchising transaction, a portion of the proceeds was applied as the initial payment for an option to purchase the real estate within the next 24 months. The franchisee initiated exercise of the option during the third fiscal quarter and a portion of the proceeds was received after the quarter ended. Until the option was fully exercised, the franchisee made monthly lease payments which were included in other operating income, net of sub-lease expense.
(2)
Net assets sold consisted primarily of equipment. During the third quarter of fiscal year 2017, the Company made an adjustment to retained minority investment.
(3)
The deferred gain of $0.9 million is recorded in other non-current liabilities as a result of a real estate purchase option extended to the franchisee in the second quarter of fiscal year 2017. The deferred gain will continue to be amortized into income through January 2020 when the option becomes exercisable.


15


Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

In the Quarterly Report on Form 10-Q, unless the context otherwise requires, the terms “Sonic Corp.,” “the Company,” “we,” “us” and “our” refer to Sonic Corp. and its subsidiaries.
Overview

System same-store sales decreased 0.2% during the third quarter and 1.5% for the first nine months of fiscal year 2018 as compared to a decrease of 1.2% and 3.3% , respectively, for the same periods last year. Same-store sales at Company Drive-Ins increased 0.2% during the third quarter and decreased 2.1% for the first nine months of fiscal year 2018 as compared to a decrease of 3.2% and 4.7% , respectively, for the same periods last year.  The same-store sales decreases reflect a decline in traffic, which was impacted by adverse weather and aggressive competitive activity in the first half of the fiscal year, partially offset by positive momentum from Company initiatives seen during the third fiscal quarter. We continue to execute on our long-term strategies, including new technology, product innovation, personalized service, brand-appropriate value promotions and our fully integrated media strategy.  All of these initiatives fuel Sonic’s strategy to drive growth through improvement in same-store sales and new drive-in development, and to enhance returns through the deployment of cash to shareholders.  Same-store sales growth is the most important component to driving brand value as it generates operating leverage, increased operating cash flows and improved return on investment.

Revenues decreased to $118.3 million for the third  quarter and $311.8 million for the first nine months of fiscal year 2018 from  $124.0 million and $353.7 million , respectively, for the same periods last year, due to a decrease in Company Drive-In sales. The decrease in Company Drive-In sales was a result of refranchising certain Company Drive-Ins during fiscal year 2017 as part of our initiative to move toward an approximately 95%-franchised system. To a lesser degree, the decline in revenues is also attributed to decreased same-store sales. Restaurant margins at Company Drive-Ins were unfavorable by 10 basis points during the third  quarter and favorable by 30 basis points for the first nine months of fiscal year 2018 as compared to the same periods last year, reflecting the impact of refranchising underperforming drive-ins, commodity cost inflation and the de-leveraging impact of same-stores sales decreases.

Third quarter results for fiscal year 2018 reflected net income of $21.6 million or  $0.58 per diluted share as compared to net income of $18.8 million or $0.44 per diluted share for the same period last year.  Net income and diluted earnings per share for the first nine months of fiscal year 2018 were $52.6 million and $1.36 , respectively, as compared to net income of $42.8 million and diluted earnings per share of $0.96 for the same period last year. Adjustments to net income are detailed below in Results of Operations.

In December 2017, Congress enacted comprehensive amendments to the Internal Revenue Code of 1986 with the passage of the Tax Cuts and Jobs Act (“TCJA”). Based on the amendments, our U.S. federal statutory tax rate decreased to 25.7% for fiscal year 2018, and we recorded a discrete net provisional benefit of approximately $14.1 million for the revaluation of deferred tax assets and liabilities in the second quarter of fiscal year 2018.

During the third quarter of fiscal year 2018, we recognized a net gain of $3.2 million related to the refranchised operations of 41 drive-ins and retained a non-controlling minority investment in the franchise operations. These transactions represent additional markets identified after completion of the refranchising initiative in fiscal year 2017 and bring the Company to a 95% franchised system.

We completed a previously announced refranchising initiative in fiscal year 2017. During the first six months of fiscal year 2017, 110 Company Drive-Ins were refranchised, and we retained a non-controlling minority investment in most of the franchise operations. The Company recorded a gain of $6.6 million on these transactions.

In addition to the refranchised drive-ins discussed above in which we retained a non-controlling minority investment in the operations, we also refranchised the operations of two drive-ins during the third quarter and eight drive-ins during the first nine months of fiscal year 2018, respectively, compared to five drive-ins refranchised during the third quarter and first nine months of fiscal year 2017. These refranchising transactions all occurred in the normal course of business and did not result in any retained interests.

The gains and losses related to refranchised drive-ins are recorded in other operating income, net, on the condensed consolidated statement of income. Income from minority investments is included in other revenue on the condensed consolidated statements of income. For additional information on transactions associated with the refranchising initiative, see Note 10 - Refranchising, included in Part I, Item 1, “Financial Statements,” in this Quarterly Report on Form 10-Q for more information.

16





໿


The following table provides information regarding the number of Company Drive-Ins and Franchise Drive-Ins operating as of the end of the periods indicated as well as the system change in sales and average unit volume.  System information includes both Company Drive-In and Franchise Drive-In information, which we believe is useful in analyzing the growth of the brand as well as the Company’s revenues since franchisees pay royalties based on a percentage of sales.
System Performance
($ in thousands)

 
 
 
 

 
Three months ended
May 31,
 
Nine months ended
May 31,
 
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
Increase (decrease) in total sales
 
1.1
 %
 
(0.5
)%
 
(0.1
)%
 
(2.5
)%

 
 

 
 

 
 

 
 

System drive-ins in operation (1) :
 
 

 
 

 
 

 
 
Total at beginning of period
 
3,587

 
3,562

 
3,593

 
3,557

Opened
 
5

 
15

 
18

 
39

Closed (net of re-openings)
 
(3
)
 
(6
)
 
(22
)
 
(25
)
Total at end of period
 
3,589

 
3,571

 
3,589

 
3,571


 
 

 
 

 
 

 
 
Average sales per drive-in
 
$
347

 
$
346

 
$
901

 
$
907


 
 

 
 

 
 

 
 

Change in same-store sales (2)
 
(0.2
)%
 
(1.2
)%
 
(1.5
)%
 
(3.3
)%
__________________
(1)
Drive-ins that are temporarily closed for various reasons (repairs, remodeling, relocations, etc.) are not considered closed unless the Company determines they are unlikely to reopen within a reasonable time.
(2)
Represents percentage change for drive-ins open for a minimum of 15 months.
Results of Operations

Revenues .  The following table sets forth the components of revenue for the reported periods and the relative change between the comparable periods.
Revenues
($ in thousands)

 
 
 
 
 
 

 
Three months ended
May 31,
 
Increase
(Decrease)
 
Percent
Increase
(Decrease)

 
2018
 
2017
 
 
Company Drive-In sales
 
$
66,587

 
$
72,062

 
$
(5,475
)
 
(7.6
)%
Franchise Drive-Ins:
 
 

 
 

 
 

 
 

Franchise royalties
 
48,063

 
47,890

 
173

 
0.4
 %
Franchise fees
 
188

 
330

 
(142
)
 
(43.0
)%
Lease revenue
 
2,203

 
2,418

 
(215
)
 
(8.9
)%
Other
 
1,265

 
1,290

 
(25
)
 
(1.9
)%
Total revenues
 
$
118,306

 
$
123,990

 
$
(5,684
)
 
(4.6
)%
໿

17



 
Nine months ended
May 31,
 
Increase
(Decrease)
 
Percent
Increase
(Decrease)

 
2018
 
2017
 
 
Company Drive-In sales
 
$
182,217

 
$
223,500

 
$
(41,283
)
 
(18.5
)%
Franchise Drive-Ins:
 
 

 
 

 
 

 
 
Franchise royalties
 
122,285

 
121,910

 
375

 
0.3
 %
Franchise fees
 
481

 
777

 
(296
)
 
(38.1
)%
Lease revenue
 
5,288

 
5,474

 
(186
)
 
(3.4
)%
Other
 
1,565

 
2,038

 
(473
)
 
(23.2
)%
Total revenues
 
$
311,836

 
$
353,699

 
$
(41,863
)
 
(11.8
)%

The following table reflects the changes in sales and same-store sales at Company Drive-Ins.  It also presents information about average unit volumes and the number of Company Drive-Ins, which is useful in analyzing the change in Company Drive-In sales.
Company Drive-In Sales
($ in thousands)

 
 
 
 
 
 
 
 

 
Three months ended
May 31,
 
Nine months ended
May 31,

 
2018
 
2017
 
2018
 
2017
Company Drive-In sales
 
$
66,587

 
$
72,062

 
$
182,217

 
$
223,500

Percentage decrease
 
(7.6
)%
 
(37.4
)%
 
(18.5
)%
 
(28.9
)%

 
 
 
 
 
 
 
 
Company Drive-Ins in operation (1) :
 
 
 
 
 
 
 
 
Total at beginning of period
 
222

 
233

 
228

 
345

Opened
 

 
2

 

 
3

Sold to franchisees
 
(43
)
 
(5
)
 
(49
)
 
(115
)
Closed (net of re-openings)
 

 

 

 
(3
)
Total at end of period
 
179

 
230

 
179

 
230


 
 
 
 
 
 
 
 
Average sales per Company Drive-In
 
$
318

 
$
312

 
$
826

 
$
818


 
 
 
 
 
 
 
 
Change in same-store sales (2)
 
0.2
 %
 
(3.2
)%
 
(2.1
)%
 
(4.7
)%
__________________
(1)
Drive-ins that are temporarily closed for various reasons (repairs, remodeling, relocations, etc.) are not considered closed unless the Company determines they are unlikely to reopen within a reasonable time.
(2)
Represents percentage change for drive-ins open for a minimum of 15 months.

Same-store sales for Company Drive-Ins increased 0.2% for the third quarter and decreased 2.1% for the first nine months of fiscal year 2018 , as compared to a decrease of 3.2% and 4.7% for the same periods last year, reflecting adverse weather as well as aggressive competitive activity in the first half of the fiscal year, partially offset by positive momentum from Company initiatives in the third fiscal quarter. We continue to focus on our innovative product pipeline, multi-day-part promotions and increased media effectiveness.  Company Drive-In sales decreased $5.5 million during the third  quarter and $41.3 million during the first nine months of fiscal year 2018 as compared to the same periods last year. The decrease in Company Drive-In sales in the third quarter and first nine months of fiscal year 2018 is primarily due to the sale of certain Company Drive-Ins to franchisees. Associated sales declines related to those divestitures were $5.3 million and $38.8 million for the third quarter and first nine months of fiscal year 2018, respectively.




18


The following table reflects the change in franchise sales, the number of Franchise Drive-Ins, average unit volumes and franchising revenues.  While we do not record Franchise Drive-In sales as revenues, we believe this information is important in understanding our financial performance since these sales are the basis on which we calculate and record franchise royalties.  This information is also indicative of the financial health of our franchisees.

Franchise Information
($ in thousands)

 
 
 
 
 
 
 
 

 
Three months ended
May 31,
 
Nine months ended
May 31,

 
2018
 
2017
 
2018
 
2017
Franchise Drive-In sales
 
$
1,163,863

 
$
1,145,042

 
$
3,010,081

 
$
2,971,775

Percentage increase
 
1.6
 %
 
3.4
 %
 
1.3
 %
 
0.3
 %

 
 
 
 
 
 
 
 
Franchise Drive-Ins in operation (1) :
 
 
 
 
 
 
 
 
Total at beginning of period
 
3,365

 
3,329

 
3,365

 
3,212

Opened
 
5

 
13

 
18

 
36

Acquired from the Company
 
43

 
5

 
49

 
115

Closed (net of re-openings)
 
(3
)
 
(6
)
 
(22
)
 
(22
)
Total at end of period
 
3,410

 
3,341

 
3,410

 
3,341


 
 
 
 
 
 
 
 
Average sales per Franchise Drive-In
 
349

 
348

 
906

 
915


 
 
 
 
 
 
 
 
Change in same-store sales (2)
 
(0.2
)%
 
(1.1
)%
 
(1.4
)%
 
(3.2
)%

 
 
 
 
 
 
 
 
Franchising revenues (3)
 
$
50,454

 
$
50,638

 
$
128,054

 
$
128,161

Percentage increase (decrease)
 
(0.4
)%
 
3.7
 %
 
(0.1
)%
 
0.3
 %

 
 
 
 
 
 
 
 
Effective royalty rate (4)
 
4.13
 %
 
4.18
 %
 
4.06
 %
 
4.10
 %
__________________
(1)
Drive-ins that are temporarily closed for various reasons (repairs, remodeling, relocations, etc.) are not considered closed unless the Company determines they are unlikely to reopen within a reasonable time.
(2)
Represents percentage change for drive-ins open for a minimum of 15 months.
(3)
Consists of revenues derived from franchising activities, including royalties, franchise fees and lease revenues.  See Revenue Recognition Related to Franchise Fees and Royalties in the Critical Accounting Policies and Estimates section of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended August 31, 2017 .
(4)
Represents franchise royalties as a percentage of Franchise Drive-In sales.

Same-store sales for Franchise Drive-Ins decreased 0.2% for the third quarter and 1.4% for the first nine months of fiscal year 2018 as compared to a decrease of 1.1% and 3.2% , respectively, for the same periods last year, reflecting adverse weather as well as aggressive competitive activity in the first half of the fiscal year, partially offset by positive momentum from Company initiatives in the third fiscal quarter. We continue to focus on our innovative product pipeline, multi-day-part promotions and increased media effectiveness. Franchising revenues decreased $0.2 million , or 0.4% , for the third  quarter of fiscal year 2018 and $0.1 million , or 0.1% , for the first nine months of fiscal year 2018 compared to the same period last year.  For the third quarter and first nine months of fiscal year 2018, franchise royalties were positively impacted by franchisee acquisitions of Company Drive-ins and net new unit growth, partially offset by incentives offered to franchisees and the impact of the decrease in same-store sales.


19


Operating Expenses .  The following table presents the overall costs of drive-in operations as a percentage of Company Drive-In sales.  Other operating expenses include direct operating costs such as marketing, telephone and utilities, repair and maintenance, rent, property tax and other controllable expenses.
Company Drive-In Margins

 
 
 
 

 
Three months ended
May 31,
 
Percentage Points
Increase (Decrease)

 
2018
 
2017
 
Costs and expenses
 
 
 
 

 
 
Company Drive-Ins:
 
 

 
 

 
 
Food and packaging
 
27.9
%
 
26.9
%
 
1.0
Payroll and other employee benefits
 
35.2

 
35.5

 
(0.3)
Other operating expenses
 
18.6

 
19.2

 
(0.6)
Cost of Company Drive-In sales
 
81.7
%
 
81.6
%
 
0.1

 
Nine months ended
May 31,
 
Percentage Points
Increase (Decrease)

 
2018
 
2017
 
Costs and expenses
 
 
 
 

 
 
Company Drive-Ins:
 
 

 
 

 
 
Food and packaging
 
27.9
%
 
27.3
%
 
0.6
Payroll and other employee benefits
 
36.9

 
37.0

 
(0.1)
Other operating expenses
 
20.5

 
21.3

 
(0.8)
Cost of Company Drive-In sales
 
85.3
%
 
85.6
%
 
(0.3)
    
Drive-in level margins at Company Drive-Ins were unfavorable by 10 basis points during the third quarter and were favorable by 30 basis points during the first nine months of fiscal year 2018 .  Sequentially improving sales in the later portion of the quarter resulted in less de-leveraging on overall drive-in level margins. Food and packaging costs were unfavorable by 100  basis points during the  third  quarter of fiscal year 2018 and by 60 basis points during the first nine months of fiscal year 2018 as a result of commodity cost inflation and a higher level of discounting as compared to the prior-year period.  Payroll and other employee benefits were favorable by 30 basis points for the third quarter of fiscal year 2018 and by 10 basis points during the first nine months of fiscal year 2018, reflecting more effective management of labor expenses and the impact of refranchising underperforming drive-ins and drive-ins in higher-cost labor markets. Other operating expenses were favorable by 60 basis points during the third quarter of fiscal year 2018 and by 80 basis points during the first nine months of fiscal year 2018, driven by the impact of refranchising underperforming drive-ins and more effective management of operating expenses.
  
Selling, General and Administrative (“SG&A”) .   SG&A expenses increased $0.4 million , or 1.7% , to $21.1 million for the third  quarter and decreased $1.1 million , or 1.8% , to $57.7 million for the first nine months of fiscal year 2018 , as compared to the same periods last year. The year-to-date decrease reflects expense reduction initiatives taken at the end of the prior fiscal year and general cost control during the periods.

Depreciation and Amortization .  Depreciation and amortization was flat at $9.6 million in the third quarter and decreased $1.0 million , or 3.5% , to $28.5 million for the first nine months of fiscal year 2018 , as compared to the same periods last year.  This is primarily attributable to a decrease in Company assets related to the refranchising of certain Company Drive-Ins in the first half of fiscal year 2017 and the third quarter of fiscal year 2018, disposition of real estate in the last quarter of fiscal year 2017 and assets that fully depreciated in the prior fiscal year, partially offset by an increase in technology assets.

Net Interest Expense .  Net interest expense increased $1.0 million , or 14.9% , to $8.1 million for the third quarter and $3.7 million , or 17.8% , to $24.4 million for the first nine months of fiscal year 2018 , as compared to the same periods last year. The increase reflects additional interest expense related to the increase in the long-term debt balance. Additionally, the net interest expense includes the $1.3 million loss on debt transactions related to the commitment reduction of the Series 2016-1 Senior Secured Variable Funding Notes, Class A-1 (the “2016 Variable Funding Notes”), as well as the pro rata prepayment on the Series 2016-1 Senior Secured Fixed Rate Notes, Class A-2 (the “2016 Fixed Rate Notes”) and Series 2013-1 Senior Secured Fixed Rate Notes, Class A-2 (the “2013 Fixed Rate Notes”). The increase was also impacted by the net borrowings on the 2016 Variable Funding Notes during the first nine months of fiscal year 2018, as compared to less borrowings on the 2016 Variable

20


Funding Notes in the same periods last year. See “Liquidity and Sources of Capital” and “Item 3. Quantitative and Qualitative Disclosures About Market Risk” below for additional information on our debt financing transactions and factors that could impact interest expense.

Income Taxes .  The provision for income taxes reflects an effective tax rate of 26.1% for the third quarter of fiscal year 2018 compared to 34.0% for the same period in 2017. The provision for income taxes reflects an effective tax rate of (4.7)% for the first nine months of fiscal 2018 compared to 33.5% for the same period in 2017. The lower effective income tax rate during the third quarter and first nine months of fiscal year 2018 was due primarily to the impacts of the TCJA. Specifically, the lower effective income tax rate during the third quarter of fiscal year 2018 was due primarily to the reduction of the U.S. corporate federal income tax rate from 35% in fiscal year 2017 to a blended statutory rate of 25.7% in fiscal year 2018. The lower effective income tax rate during the first nine months of fiscal year 2018 was due primarily to the lower U.S. corporate federal statutory income tax rate and the recognition of a provisional income tax benefit of $14.1 million in the second quarter of fiscal year 2018 resulting from the revaluation of our deferred income tax assets and liabilities. Please refer to Note 4 - Income Taxes, included in Part I, Item 1, "Financial Statements," in this Quarterly Report on Form 10-Q for a discussion of the impacts of the TCJA. Our tax rate may continue to vary from quarter to quarter depending on the timing of stock option dispositions by option holders and as circumstances on other tax matters change.
 
Non-GAAP Adjustments. Excluding the non-GAAP adjustments further described below, net income for the third quarter of fiscal year 2018 increased 7% and diluted earnings per share for the quarter increased 21% to $0.52 . Net income and diluted earnings per share for the first nine months of fiscal year 2018 would have increased 5% and 21% , respectively. The lower tax rate resulting from the federal tax reform benefited adjusted earnings per share by approximately $0.06 for the third quarter and $0.10 for the first nine months of fiscal year 2018. Excluding the total impact of federal tax reform, adjusted net income per diluted share improved 7% to $0.46 in the third quarter and 9% to $0.88 in the first nine months of fiscal year 2018.

The following analysis of non-GAAP adjustments is intended to supplement the presentation of the Company’s financial results in accordance with GAAP.  We believe the exclusion of these items in evaluating the change in net income and diluted earnings per share for the periods below provides useful information to investors and management regarding the underlying business trends and the performance of our ongoing operations and is helpful for period-to-period and company-to-company comparisons, which management believes will assist investors in analyzing the financial results for the Company and predicting future performance.

(In thousands, except per share amounts)

 
Three months ended
May 31, 2018
 
Three months ended
May 31, 2017

 
Net
Income
 
Diluted
EPS
 
Net
Income
 
Diluted
EPS
Reported – GAAP
 
$
21,576

 
$
0.58

 
$
18,751

 
$
0.44

Payment card breach expense (1)
 
338

 
0.01

 

 

Tax impact on payment card breach expense (2)
 
(99
)
 
0.00

 

 

Net gain on refranchising transactions (3)
 
(3,153
)
 
(0.08
)
 
(814
)
 
(0.02
)
Tax impact on refranchising transactions (4)
 
924

 
0.02

 
396

 
0.01

Adjusted - Non-GAAP (5)
 
$
19,586

 
$
0.52

 
$
18,333

 
$
0.43

________________
(1)
Costs include legal fees.
(2)
Tax impact during the period at a consolidated blended statutory tax rate of 29.3%.
(3)
During the third quarter of fiscal year 2018, we completed transactions to refranchise the operations of 41 Company Drive-Ins. During the first and second quarters of fiscal year 2017, we completed transactions to refranchise the operations of 110 Company Drive-Ins. Refer to Note 10 - Refranchising Initiative, included in Part I, Item 1, “Financial Statements,” in this Quarterly Report on Form 10-Q for more information.
(4)
Tax impact at a consolidated blended statutory tax rate of 29.3% during fiscal year 2018 and at an adjusted effective tax rate of 48.7% during fiscal year 2017.
(5)
Sum of per share data may not agree to the total amounts due to rounding.

໿

21



 
Nine months ended
May 31, 2018
 
Nine months ended
May 31, 2017

 
Net
Income
 
Diluted
EPS
 
Net
Income
 
Diluted
EPS
Reported – GAAP
 
$
52,613

 
$
1.36

 
$
42,832

 
$
0.96

Payment card breach expense (1)
 
1,209

 
0.03

 

 

Tax impact on payment card breach expense (2)
 
(411
)
 
(0.01
)
 

 

Loss from debt transactions (3)
 
1,310

 
0.03

 

 

Tax impact on debt transactions (4)
 
(384
)
 
(0.01
)
 

 

Discrete impact of the Tax Cuts and Jobs Act
 
(14,120
)
 
(0.37
)
 

 

Net gain on refranchising transactions (5)
 
(3,153
)
 
(0.08
)
 
(6,645
)
 
(0.15
)
Tax impact on refranchising transactions (6)
 
924

 
0.02

 
2,501

 
0.05

Gain on sale of investment in refranchised drive-in operations (7)
 

 

 
(3,795
)
 
(0.08
)
Tax impact on sale of investment in refranchised drive-in operations (8)
 

 

 
1,350

 
0.03

Adjusted - Non-GAAP (9)
 
$
37,988

 
$
0.98

 
$
36,243

 
$
0.81

________________
(1)
Costs include legal fees, investigative fees and costs related to customer response.
(2)
Combined tax impact at consolidated blended statutory tax rates of 38.2% during the first quarter of fiscal year 2018 and 29.3% during the second and third quarters of fiscal year 2018.
(3)
Includes a $0.7 million write-off of unamortized deferred loan fees related to the reduction of the Company's variable funding note commitments, as well as a $0.4 million write-off of unamortized deferred loan fees related to the prepayment on its 2013 Fixed Rate Notes and 2016 Fixed Rate Notes. Additionally, as required by the terms of the 2016 Fixed Rate Notes, we paid a $0.2 million prepayment premium.
(4)
Tax impact during the period at a consolidated blended statutory tax rate of 29.3%.
(5)
During the third quarter of fiscal year 2018, we completed transactions to refranchise the operations of 41 Company Drive-Ins. During the first and second quarters of fiscal year 2017, we completed transactions to refranchise the operations of 110 Company Drive-Ins. Refer to Note 10 - Refranchising Initiative, included in Part I, Item 1, “Financial Statements,” in this Quarterly Report on Form 10-Q for more information.
(6)
Tax impact at a consolidated blended statutory tax rate of 29.3% during fiscal year 2018; a combined tax impact at an effective tax rate of 35.6% during the first quarter of fiscal year 2017 and at adjusted effective tax rates of 36.0% and 48.7% during the second and third quarters of fiscal year 2017, respectively.
(7)
Gain on sale of investment in refranchised drive-ins is related to minority investments in franchise operations retained as part of a refranchising transaction that occurred in fiscal year 2009.
(8)
Tax impact during the period at an adjusted effective tax rate of 35.6%.
(9)
Sum of per share data may not agree to the total amounts due to rounding.
Financial Position

Total assets decreased $16.2 million , or 2.9% , to $545.5 million during the first nine months of fiscal year 2018 from $561.7 million at the end of fiscal year 2017 .  The decrease in total assets was driven by a decrease in property, equipment and capital leases primarily driven by refranchising transactions, as well as depreciation, partially offset by capital expenditures and a decrease in assets held for sale. Additionally, there was an increase in notes receivable, primarily related to notes extended to the system marketing funds and franchisees and an increase in royalties and other trade receivables reflective of higher total sales compared to sales at the end of the prior fiscal year.

Total liabilities increased $55.3 million , or 7.2% , to $818.8 million during the first nine months of fiscal year 2018 from $763.5 million at the end of fiscal year 2017 .  The increase was primarily attributable to an increase in long-term debt of $79.1 million related to the 2018 debt transactions, detailed below in “Liquidity and Sources of Capital.” This was partially offset by a decrease of $14.4 million in deferred income taxes as a result of the TCJA and of $6.5 million in accrued liabilities, which is mainly related to payment of wages and incentive compensation and other tax liabilities that were accrued as of August 31, 2017.

Total stockholders’ deficit increased $71.5 million , or 35.4% , to a deficit of $273.3 million during the first nine months of fiscal year 2018 from a deficit of $201.8 million at the end of fiscal year 2017 .  This increase was primarily attributable to $109.1 million in purchases of common stock during the first  nine months of the fiscal year and the payment of $18.2 million in dividends, partially offset by current-year earnings of $52.6 million .


22


Liquidity and Sources of Capital

Operating Cash Flows .  Net cash provided by operating activities increased $14.8 million to $64.8 million for the first nine months of fiscal year 2018 as compared to $50.1 million for the same period in fiscal year 2017 .  The increase was mainly due to changes in working capital, primarily related to higher incentive compensation paid in the prior fiscal year period, as well as the timing of payments for operational, payroll and tax transactions. Operating cash flow was also impacted by an increase of $4.0 million in net income, excluding the non-cash items for gain on disposition of assets and the benefit from deferred income taxes.

Investing Cash Flows .  Net cash used in investing activities was $15.5 million for the first nine months of fiscal year 2018 as compared to net cash provided by investing activities of $44.2 million for the same period in fiscal year 2017 .  Proceeds declined $54.5 million from the $70.7 million received during the first nine months of fiscal year 2017. The increased activity in fiscal year 2017 resulted from the sale of assets related to stores sold to franchisees as part of the refranchising initiative and the sale of investment in refranchised drive-in operations. Additionally, we had decreased investments in property and equipment of $12.6 million, mainly due to an $18.9 million decrease related to the timing of rebuilds, relocations and remodels of existing drive-ins and newly constructed drive-ins for the Company and franchisees. This was partially offset by an increase of $7.6 million in acquisition of real estate.

The table below outlines our use of cash in millions for investments in property and equipment for the first nine months of fiscal year 2018 :
Brand technology investments
$
9.1

Acquisition of real estate
7.6

Purchase and replacement of equipment and technology
4.5

Rebuilds, relocations and remodels of existing drive-ins
2.5

Newly constructed drive-ins leased or sold to franchisees
0.8

Total investments in property and equipment
$
24.5


Financing Cash Flows .  Net cash used by financing activities decreased  $87.5 million to $26.8 million for the first nine months of fiscal year 2018 , as compared to cash used in financing activities of $114.3 million for the same period in fiscal year 2017 . In February of fiscal year 2018 we completed a debt financing transaction as described below, which is the primary driver of the increase. Additionally, there was a decrease in purchases of treasury stock of $17.6 million compared to the prior-year period.

During the second quarter of fiscal year 2018, we used a portion of the restricted funds from the proceeds of the sale of securitized assets during fiscal year 2017 to make a pro rata prepayment of $28.0 million on our 2013 Fixed Rate Notes and 2016 Fixed Rate Notes. The prepayment was made at par, as allowed under the note terms.

On February 1, 2018 , various subsidiaries (the “Co-Issuers”) issued $170.0 million of Series 2018-1 Senior Secured Fixed Rate Notes, Class A-2 (the “2018 Fixed Rate Notes”) in a private transaction which bears interest at 4.03% per annum.  The 2018 Fixed Rate Notes have an expected life of seven years with an anticipated repayment date in February 2025 .  At May 31, 2018 , the balance outstanding under the 2018 Fixed Rate Notes including accrued interest totaled $170.2 million and carried a weighted-average interest cost of 4.40% , including the effect of the loan origination costs described below.

We used a portion of the net proceeds from the issuance of the 2018 Fixed Rate Notes to pay down the outstanding portion of the 2016 Variable Funding Notes and to pay the costs associated with the securitized financing transaction. In conjunction with the issuance of the 2018 Fixed Rate Notes, the commitments under the 2016 Variable Funding Notes were reduced to $100.0 million .

Loan origination costs associated with the 2018 Fixed Rate Notes totaled $5.0 million .  Loan costs are amortized over each note’s expected life, and the unamortized balance related to the 2016 Variable Funding Notes and the Fixed Rate Notes is included in debt origination costs, net and long-term debt, net, respectively, on the condensed consolidated balance sheets.

In connection with the 2018 transactions described above, we recognized a $1.3 million loss during the second quarter of fiscal year 2018 . The loss consisted of a $0.7 million write-off of unamortized deferred debt origination costs related to the reduction of the 2016 Variable Funding Notes commitments, as well as a $0.4 million write-off of unamortized deferred debt origination costs related to the prepayment on our 2013 Fixed Rate Notes and 2016 Fixed Rate Notes. Additionally, as required by the terms of the 2016 Fixed Rate Notes, we paid a $0.2 million prepayment premium.

23


 
While the 2018 Fixed Rate Notes have an expected life of seven years, they have a legal final maturity date of February 2048 .  We intend to repay or refinance the 2018 Fixed Rate Notes on or before the end of their respective expected life.  In the event the 2018 Fixed Rate Notes are not paid in full by the end of their expected life, the Notes are subject to an upward adjustment in the annual interest rate of at least 5% .  In addition, principal payments will accelerate by applying all of the royalties, lease revenues and other fees securing the debt, after deducting certain expenses, until the debt is paid in full. Also, any unfunded amount under the 2016 Variable Funding Notes will become unavailable.

We anticipate fiscal year 2018 interest expense from the 2018 Fixed Rate Notes, the 2016 Fixed Rate Notes and the 2013 Fixed Rate Notes (collectively, the “Fixed Rate Notes”), including the amortization of loan origination costs, to be approximately $30.8 million annually. As a result of an amortization requirement based on a leverage ratio calculation, we will be making principal payments of $5.3 million over the next twelve months on the 2016 Fixed Rate Notes. For additional information on our 2018 transactions see note 8 – Debt, included in Part I, Item 1, “Financial Statements” in this Quarterly Report on Form 10-Q. See note 10 - Long-Term Debt in the Notes to Consolidated Financial Statements in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 2017 for additional information regarding our long-term debt.

During fiscal year 2017 , approximately 6.7 million shares were repurchased under our share repurchase program for a total cost of $172.9 million , resulting in an average price per share of $25.71 .  In August 2017, the Board of Directors approved an incremental $160.0 million share repurchase authorization of the Company's outstanding shares of common stock through August 31, 2018.

During the first nine months of fiscal year 2018 , approximately 4.3 million shares were repurchased for a total cost of $109.1 million , resulting in an average price per share of $25.23 . The total remaining authorized under the share repurchase program as of May 31, 2018 was $50.9 million .

Subsequent to the end of the quarter, the Board of Directors authorized a $500.0 million share repurchase program through August 31, 2021, replacing the Company’s previous fiscal year 2018 authorization. Including amounts purchased during the first nine months of the fiscal year, the total remaining authorized under the share repurchase program is $390.9 million .

As of May 31, 2018 , our total cash balance of $73.3 million ( $44.9 million of unrestricted and $28.5 million of restricted cash balances) reflected the impact of the cash generated from operating activities, net proceeds from the 2018 debt transactions and cash used for share repurchases, dividends and capital expenditures mentioned above.  We believe that existing cash, funds generated from operations and the amount available under our 2016 Variable Funding Notes will meet our needs for the foreseeable future.
Critical Accounting Policies and Estimates

Critical accounting policies are those the Company believes are most important to portraying its financial condition and results of operations and also require the greatest amount of subjective or complex judgments by management.  Judgments and uncertainties regarding the application of these policies may result in materially different amounts being reported under various conditions or using different assumptions.  There have been no material changes to the critical accounting policies previously disclosed in our Annual Report on Form 10-K for the fiscal year ended August 31, 2017 .

New Accounting Pronouncements

For a description of new accounting pronouncements, see note 1 - Basis of Presentation, included in Part I, Item 1, “Financial Statements,” in this Quarterly Report on Form 10-Q.  
Item 3.  Quantitative and Qualitative Disclosures About Market Risk

There has been no material change in the quantitative and qualitative market risks set forth in Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K for the year ended August 31, 2017 .

24


Item 4.  Controls and Procedures

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-14 under the Securities Exchange Act of 1934).  Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives.  Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level.

There were no significant changes in the Company’s internal control over financial reporting during the quarter ended May 31, 2018 , that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II – OTHER INFORMATION
Item 1. Legal Proceedings

On October 4, 2017, the Company issued a public statement notifying guests that it had discovered that credit and debit card numbers may have been acquired without authorization as part of a malware attack experienced at certain Sonic Drive-In locations. As we reported in our Annual Report on Form 10-K for the year ended August 31, 2017, the Company was named as a defendant in five purported class action complaints. The Company has since been named as a defendant in four additional purported class action complaints filed on October 9, 2017, in the United States District Court for the Northern District of Ohio, on November 3, 2017, in the United States District Court for the Northern District of Texas, on November 13, 2017, in the United States District Court for the District of Arizona, and on December 17, 2017, in the Northern District of Illinois. Each of these complaints asserted various claims related to the Company’s alleged failure to safeguard customer credit card information, and the plaintiffs sought monetary damages, injunctive and declaratory relief and attorneys’ fees and costs. The cases were centralized in the Northern District of Ohio for coordinated or consolidated pretrial proceedings, and a consolidated complaint was filed. The Company believes it has meritorious defenses to the litigation and intends to vigorously oppose the claims asserted in the complaint. We cannot reasonably estimate the range of potential losses that may be associated with the litigation because of the early stage of the lawsuit. We also cannot provide assurance that we will not become subject to other inquiries or claims relating to the payment card breach in the future. Although we maintain cyber liability insurance, we currently believe it is possible that the ultimate amount paid by us, if we are unsuccessful in defending the litigation, will be in excess of our cyber liability insurance coverage applicable to claims of this nature. We are unable to estimate the amount of any such excess.

The Company is involved in various legal proceedings and has certain unresolved claims pending.  Based on the information currently available, management believes that all claims currently pending are either covered by insurance or would not have a material adverse effect on the Company’s business, operating results or financial condition.
Item 1A. Risk Factors

There has been no material change in the risk factors set forth in Part I, Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended August 31, 2017 .

25



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(c) Issuer Purchases of Equity Securities

Shares repurchased during the third quarter of fiscal year 2018 are as follows (in thousands, except per share amounts):
Period
 
Total
Number of
Shares
Purchased
 
Average
Price
Paid per
Share
 
Total Number
of Shares
Purchased as
Part of Publicly
Announced
Plans or
Programs
 
Maximum Dollar
Value that May
Yet Be
Purchased
Under the
Program
(1)
March 1, 2018 through March 31,2018
 
544

 
$
24.95

 
544

 
$
74,938

April 1, 2018 through April 30, 2018
 
372

 
26.35

 
372

 
65,144

May 1, 2018 through May 31, 2018
 
572

 
24.90

 
572

 
50,899

Total
 
1,488

 
 

 
1,488

 
 

__________________
(1)
In August 2017, the Company’s Board of Directors extended the Company’s share repurchase program, authorizing the Company to purchase up to $160.0 million of its outstanding shares of common stock through August 31, 2018.  In June 2018, the Board of Directors authorized a $500.0 million share repurchase program through August 31, 2021, replacing the Company’s previous fiscal year 2018 authorization.
(2)
Share repurchases may be made from time to time in the open market or otherwise, including through an accelerated share repurchase program, under terms of a Rule 10b5-1 plan, in privately negotiated transactions or in round lot or block transactions.  The share repurchase program may be extended, modified, suspended or discontinued at any time.  Please refer to note 3 – Share Repurchase Program included in Part I, Item 1, “Financial Statements” in this Quarterly Report on Form 10-Q for additional information.

26



Item 6.  Exhibits

 
Exhibits.
 
Certification of Chief Executive Officer Pursuant to SEC Rule 13a-14
Certification of Chief Financial Officer Pursuant to SEC Rule 13a-14
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document


27



SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
SONIC CORP.
 
 
 
 
 
 
 
By:
/s/ Corey R. Horsch
 
 
Corey R. Horsch
Vice President, Chief Financial Officer
and Treasurer

Date:  July 3, 2018

28

Table of Contents


EXHIBIT INDEX
Exhibit Number and Description


 
31.01
Certification of Chief Executive Officer Pursuant to SEC Rule 13a-14
31.02
Certification of Chief Financial Officer Pursuant to SEC Rule 13a-14
32.01
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
32.02
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document


29


Exhibit 31.01
CERTIFICATION PURSUANT TO
SEC RULE 13a-14
I, Clifford Hudson, certify that:
1.
I have reviewed this quarterly report on Form 10-Q of Sonic Corp.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a)
designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)
designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)
evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d)
disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a)
all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b)
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: July 3, 2018


 
By: /s/ Clifford Hudson
Clifford Hudson
Chief Executive Officer






Exhibit 31.02
CERTIFICATION PURSUANT TO
SEC RULE 13a-14

I, Corey R. Horsch, certify that:
1.
I have reviewed this quarterly report on Form 10-Q of Sonic Corp.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a)
designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)
designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)
evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d)
disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a)
all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b)
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: July 3, 2018

 
By: /s/ Corey R. Horsch
Corey R. Horsch
Chief Financial Officer






Exhibit 32.01
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
The undersigned hereby certifies that to his knowledge the quarterly report of Sonic Corp. (the “Company”) filed with the Securities and Exchange Commission on the date hereof fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in such report fairly represents, in all material respects, the financial condition and results of operations of the Company.
Date: July 3, 2018  


By: /s/ Clifford Hudson
Clifford Hudson
Chief Executive Officer






Exhibit 32.02
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
The undersigned hereby certifies that to his knowledge the quarterly report of Sonic Corp. (the “Company”) filed with the Securities and Exchange Commission on the date hereof fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in such report fairly represents, in all material respects, the financial condition and results of operations of the Company.
Date: July 3, 2018 


By: /s/ Corey R. Horsch
Corey R. Horsch
Chief Financial Officer