Quarterly Report
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
Indicate
by check mark whether the registrant (1) has filed all reports required 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
the reports), and (2) has been subject to such filing requirements for the
past
90 days.
Yes
X
.
No
.
Indicate
by check mark whether the Registrant is an accelerated filer (as defined in
Rule
12b-2 of the Exchange Act).
Yes
X
.
No
.
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act. Yes
.
No
X
.
As
of
February 28, 2006, the Registrant had 57,210,984 shares of common stock issued
and outstanding (excluding 19,032,812 shares of common stock held as treasury
stock).
SONIC
CORP.
Index
|
Page
Number
|
||
|
PART
I. FINANCIAL INFORMATION
|
||
|
|
||
|
PART
II. OTHER INFORMATION
|
||
|
CONDENSED
CONSOLIDATED BALANCE SHEETS
(In
thousands, except share data)
|
|||||||
|
(Unaudited)
|
|||||||
|
ASSETS
|
February
28,
2006
|
|
|
August
31,
2005*
|
|||
|
Current
assets:
|
|||||||
|
Cash
and cash equivalents
|
$
|
27,327
|
$
|
6,431
|
|||
|
Accounts
and notes receivable, net
|
16,726
|
18,801
|
|||||
|
Other
current assets
|
8,437
|
10,017
|
|||||
|
Total
current assets
|
52,490
|
35,249
|
|||||
|
Property,
equipment and capital leases
|
621,764
|
587,558
|
|||||
|
Less
accumulated depreciation and amortization
|
(182,061
|
)
|
(164,733
|
)
|
|||
|
Property,
equipment and capital leases, net
|
439,703
|
422,825
|
|||||
|
Goodwill,
net
|
101,361
|
88,471
|
|||||
|
Trademarks,
trade names and other intangible assets, net
|
6,795
|
6,434
|
|||||
|
Investment
in direct financing leases and noncurrent portion of
|
|||||||
|
notes
receivable
|
7,809
|
8,171
|
|||||
|
Other
assets, net
|
1,924
|
2,166
|
|||||
|
Intangibles
and other assets, net
|
117,889
|
105,242
|
|||||
|
Total
assets
|
$
|
610,082
|
$
|
563,316
|
|||
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|||||||
|
Current
liabilities:
|
|||||||
|
Accounts
payable
|
$
|
12,837
|
$
|
14,117
|
|||
|
Deposits
from franchisees
|
2,051
|
3,157
|
|||||
|
Accrued
liabilities
|
32,763
|
26,367
|
|||||
|
Income
taxes payable
|
1,923
|
15,174
|
|||||
|
Obligations
under capital leases and long-term debt
|
|||||||
|
due
within one year
|
6,002
|
6,527
|
|||||
|
Total
current liabilities
|
55,576
|
65,342
|
|||||
|
Obligations
under capital leases due after one year
|
39,482
|
36,259
|
|||||
|
Long-term
debt due after one year
|
144,050
|
55,934
|
|||||
|
Other
noncurrent liabilities
|
18,114
|
17,864
|
|||||
|
Stockholders’
equity:
|
|||||||
|
Preferred
stock, par value $.01; 1,000,000 shares
|
|||||||
|
authorized;
none outstanding
|
–
|
–
|
|||||
|
Common
stock, par value $.01; 100,000,000 shares
|
|||||||
|
authorized;
76,243,796 shares issued (75,766,006 shares
|
|||||||
|
issued
at August 31, 2005)
|
762
|
758
|
|||||
|
Paid-in
capital
|
163,811
|
154,154
|
|||||
|
Retained
earnings
|
427,323
|
397,989
|
|||||
|
Accumulated
other comprehensive income (loss)
|
(160
|
)
|
–
|
||||
|
591,736
|
552,901
|
||||||
|
Treasury
stock, at cost; 19,032,812 common shares
|
|||||||
|
(16,450,920
shares at August 31, 2005)
|
(238,876
|
)
|
(164,984
|
)
|
|||
|
Total
stockholders’ equity
|
352,860
|
387,917
|
|||||
|
Total
liabilities and stockholders’ equity
|
$
|
610,082
|
$
|
563,316
|
|||
*
Adjusted to include the impact of stock-based compensation expense; see Note
5
for additional information.
See
accompanying notes.
|
CONDENSED
CONSOLIDATED STATEMENTS OF INCOME
(In
thousands, except per share data)
|
|||||||||||||
|
(Unaudited)
Three
months ended
|
(Unaudited)
Six
months ended
|
||||||||||||
|
February
28,
|
February
28,
|
||||||||||||
|
2006
|
2005*
|
2006
|
2005*
|
||||||||||
|
Revenues:
|
|||||||||||||
|
Partner
Drive-In sales
|
$
|
126,376
|
$
|
112,655
|
$
|
261,798
|
$
|
232,866
|
|||||
|
Franchise
Drive-Ins:
|
|||||||||||||
|
Franchise
royalties
|
20,745
|
18,169
|
42,998
|
38,275
|
|||||||||
|
Franchise
fees
|
879
|
874
|
1,820
|
1,809
|
|||||||||
|
Other
|
948
|
915
|
2,132
|
1,890
|
|||||||||
|
148,948
|
132,613
|
308,748
|
274,840
|
||||||||||
|
Costs
and expenses:
|
|||||||||||||
|
Partner
Drive-Ins:
|
|||||||||||||
|
Food
and packaging
|
33,160
|
29,415
|
69,267
|
61,988
|
|||||||||
|
Payroll
and other employee benefits
|
38,938
|
34,910
|
79,940
|
71,875
|
|||||||||
|
Minority
interest in earnings
|
|||||||||||||
|
of
Partner Drive-Ins
|
4,490
|
4,048
|
9,321
|
8,627
|
|||||||||
|
Other
operating expenses
|
26,027
|
23,309
|
54,212
|
46,976
|
|||||||||
|
102,615
|
91,682
|
212,740
|
189,466
|
||||||||||
|
Selling,
general and administrative
|
13,214
|
11,785
|
25,410
|
22,618
|
|||||||||
|
Depreciation
and amortization
|
9,997
|
8,870
|
19,894
|
17,276
|
|||||||||
|
Provision
for impairment of long-lived
|
|||||||||||||
|
assets
|
–
|
387
|
–
|
387
|
|||||||||
|
125,826
|
112,724
|
258,044
|
229,747
|
||||||||||
|
Income
from operations
|
23,122
|
19,889
|
50,704
|
45,093
|
|||||||||
|
Interest
expense
|
2,271
|
1,712
|
4,118
|
3,491
|
|||||||||
|
Interest
income
|
(175
|
)
|
(180
|
)
|
(715
|
)
|
(354
|
)
|
|||||
|
Net
interest expense
|
2,096
|
1,532
|
3,403
|
3,137
|
|||||||||
|
Income
before income taxes
|
21,026
|
18,357
|
47,301
|
41,956
|
|||||||||
|
Provision
for income taxes
|
8,122
|
7,084
|
17,967
|
15,569
|
|||||||||
|
Net
income
|
$
|
12,904
|
$
|
11,273
|
$
|
29,334
|
$
|
26,387
|
|||||
|
Net
income per share - basic
|
$
|
.22
|
$
|
.19
|
$
|
.51
|
$
|
.44
|
|||||
|
Net
income per share - diluted
|
$
|
.22
|
$
|
.18
|
$
|
.49
|
$
|
.42
|
|||||
*
Adjusted to include the impact of stock-based compensation expense; see Note
5
for additional information.
See
accompanying notes.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In
thousands, except per share data)
Note
1
The
unaudited Condensed Consolidated Financial Statements include all adjustments,
consisting of normal, recurring accruals, which Sonic Corp. (the “Company”)
considers necessary for a fair presentation of the financial position and the
results of operations for the indicated periods. In certain situations, these
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.
The notes to the condensed consolidated financial statements should be read
in
conjunction with the notes to the consolidated financial statements contained
in
the Company’s Form 10-K for the fiscal year ended August 31, 2005. The results
of operations for the six months ended February 28, 2006, are not necessarily
indicative of the results to be expected for the full year ending August 31,
2006.
Note
2
Certain
amounts have been reclassified on the condensed consolidated financial
statements to conform to the fiscal year 2006 presentation.
Note
3
The
following table sets forth the computation of basic and diluted earnings per
share:
|
Three
months ended
|
Six
months ended
|
||||||||||||
|
February
28,
|
February
28,
|
||||||||||||
|
2006
|
2005*
|
2006
|
2005*
|
||||||||||
|
Numerator:
|
|||||||||||||
|
Net
income
|
$
|
12,904
|
$
|
11,273
|
$
|
29,334
|
$
|
26,387
|
|||||
|
Denominator:
|
|||||||||||||
|
Weighted
average shares outstanding - basic
|
57,484
|
60,263
|
57,881
|
60,136
|
|||||||||
|
Effect
of dilutive employee stock options
|
2,023
|
2,525
|
2,046
|
2,451
|
|||||||||
|
Weighted
average shares - diluted
|
59,507
|
62,788
|
59,927
|
62,587
|
|||||||||
|
Net
income per share - basic
|
$
|
.22
|
$
|
.19
|
$
|
.51
|
$
|
.44
|
|||||
|
Net
income per share - diluted
|
$
|
.22
|
$
|
.18
|
$
|
.49
|
$
|
.42
|
|||||
*
Adjusted to include the impact of stock-based compensation expense; see Note
5
for additional information.
Note
4
The
Company has entered into agreements with various lenders and an agreement with
GE Capital Franchise Finance Corporation (“GEC”), pursuant to which GEC made
loans to existing Sonic franchisees who met certain underwriting criteria set
by
GEC. Under the terms of the agreement with GEC, the Company provided a guarantee
of 10% of the outstanding balance of loans from GEC to the Sonic franchisees,
limited to a maximum amount of $5,000. As of February 28, 2006, the total amount
guaranteed under the GEC agreement was $3,216. The Company ceased guaranteeing
new loans under the program during fiscal year 2002 and has not been required
to
make any payments under its agreement with GEC. Existing loans under guarantee
will expire through 2012. In the event of default by a franchisee, the Company
has the option to fulfill the franchisee’s obligations under the note or to
become the note holder, which would provide an avenue of recourse with the
franchisee under the notes.
The
Company has obligations under various lease agreements with third party lessors
related to the real estate for Partner Drive-Ins that were sold to franchisees.
Under these agreements, the Company remains secondarily liable for the lease
payments for which it was responsible as the original lessee. As of February
28,
2006, the amount remaining under the guaranteed lease obligations totaled
$5,126.
Effective
November 30, 2005, the Company extended a note purchase agreement to a bank
that
serves to guarantee the repayment of a franchisee loan and also benefits the
franchisee with a lower financing rate. 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. As of February 28, 2006, the balance of the loan was
$3,007.
The
Company has not recorded a liability for its obligations under the guarantees,
other than an immaterial amount related to the fair value of the guarantee
associated with the note purchase agreement, and none of the notes or leases
related to the guarantees were in default as of February 28, 2006.
Note
5
Effective
September 1, 2005, the Company adopted the provisions of Statement of Financial
Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS
123R”). Under the provisions of SFAS 123R, stock-based compensation is measured
at the grant date, based on the calculated fair value of the award, and is
recognized as an expense over the requisite employee service period (generally
the vesting period of the grant). The Company adopted SFAS 123R using the
modified retrospective application method and, as a result, financial statement
amounts for the prior periods presented in this Form 10-Q have been adjusted
to
reflect the fair value method of expensing prescribed by SFAS 123R. The Company
believes that the modified retrospective application of this standard achieves
the highest level of clarity and comparability among the presented
periods.
The
following table shows total stock-based compensation expense and the tax benefit
included in the Condensed Consolidated Statements of Income and the effect
on
basic and diluted earnings per share:
|
Three
months ended
|
Six
months ended
|
||||||||||||
|
February
28,
|
February
28,
|
||||||||||||
|
2006
|
2005
|
2006
|
2005
|
||||||||||
|
Selling,
general and administrative
|
$
|
1,810
|
$
|
1,725
|
$
|
3,447
|
$
|
3,065
|
|||||
|
Income
tax benefit
|
(403
|
)
|
(403
|
)
|
(878
|
)
|
(857
|
)
|
|||||
|
Net
stock-based compensation expense
|
$
|
1,407
|
$
|
1,322
|
$
|
2,569
|
$
|
2,208
|
|||||
|
Impact
on net income per share:
|
|||||||||||||
|
Basic
|
$
|
.02
|
$
|
.02
|
$
|
.04
|
$
|
.04
|
|||||
|
Diluted
|
$
|
.02
|
$
|
.02
|
$
|
.04
|
$
|
.04
|
|||||
Many
of
the options granted by Sonic are incentive stock options, for which a tax
benefit only results if the option holder has a disqualifying disposition.
For
grants of non-qualified stock options, the Company expects to recognize a tax
benefit on exercise of the option, so the full tax benefit is recognized on
the
related stock-based compensation expense. As a result of the limitation on
the
tax benefit for incentive stock options, the tax benefit for stock-based
compensation will generally be less than the Company’s overall tax rate, and
will vary depending on the timing of employees’ exercise and sale of
stock.
As
a
result of adopting SFAS 123R retrospectively, financial statements for the
prior
periods presented in this Form 10-Q have been adjusted to reflect the fair
value
method of expensing stock options. The following table details the impact of
retrospective application on previously reported results:
|
Three
months ended
|
Six
months ended
|
||||||||||||
|
February
28, 2005
|
February
28, 2005
|
||||||||||||
|
Adjusted
|
As
Previously Reported
|
Adjusted
|
As
Previously Reported
|
||||||||||
|
Income
Statement items
:
|
|
|
|||||||||||
|
Income
before income taxes
|
$
|
18,357
|
$
|
20,082
|
$
|
41,956
|
$
|
45,021
|
|||||
|
Net
income
|
11,273
|
12,595
|
26,387
|
28,595
|
|||||||||
|
Net
income per share - basic
|
$
|
.19
|
$
|
.21
|
$
|
.44
|
$
|
.48
|
|||||
|
Net
income per share - diluted
|
.18
|
.20
|
.42
|
.46
|
|||||||||
|
Cash
Flow items
:
|
|||||||||||||
|
Net
cash provided by operating activities
|
$
|
45,518
|
$
|
48,563
|
|||||||||
|
Net
cash used in financing activities
|
(4,632
|
)
|
(7,677
|
)
|
|||||||||
|
Year
ended
August
31, 2005
|
|||||||
|
Adjusted
|
As
Previously Reported
|
||||||
|
Balance
Sheet items
:
|
|||||||
|
Other
noncurrent liabilities
|
$
|
17,864
|
$
|
21,242
|
|||
|
Paid-in
capital
|
154,154
|
121,982
|
|||||
|
Retained
earnings
|
397,989
|
426,783
|
|||||
|
Total
stockholders’ equity
|
387,917
|
384,539
|
|||||
|
Total
liabilities and stockholders’ equity
|
563,316
|
563,316
|
|||||
At
Sonic’s annual meeting of stockholders on January 31, 2006, the stockholders
approved the Sonic Corp. 2006 Long-Term Incentive Plan and the authorization
of
4,500,000 shares for awards to employees and non-employee directors. This
omnibus plan provides flexibility to award various forms of equity compensation,
such as stock options, stock appreciation rights, performance shares, restricted
stock and other stock-based awards. Prior to approval of this plan, the Company
had two share-based compensation plans for employees and non-employee directors,
which authorized the granting of stock options (see Note 12 of Notes to
Consolidated Financial Statements in the Company’s form 10-K for the fiscal year
ended August 31, 2005 for more information). No further awards will be granted
under the previous plans now that the 2006 Long-Term Incentive Plan has been
approved. The number of shares authorized for issuance under the Company’s
existing plans as of February 28, 2006 totals 4,500,000, all of which were
available for future issuance. Stock options historically granted under the
Company’s plans were granted with an exercise price equal to the market price of
the Company’s stock at the date of grant, a contractual term of ten years, and
generally a vesting period of three years. The Company’s policy is to recognize
compensation cost for these options on a straight-line basis over the requisite
service period for the entire award. Additionally, the Company’s policy is to
issue new shares of common stock to satisfy stock option exercises.
The
Company measures the compensation cost associated with share-based payments
by
estimating the fair value of stock options as of the grant date using the
Black-Scholes option pricing model. The Company believes that the valuation
technique and the approach utilized to develop the underlying assumptions are
appropriate in calculating the fair values of the Company’s stock options
granted during the six months ended February 28, 2006 and 2005. Estimates of
fair value are not intended to predict actual future events or the value
ultimately realized by the employees who receive equity awards.
The
per
share weighted average fair value of stock options granted during the six months
ended February 28, 2006 and 2005 was $10.67 and $13.30, respectively. In
addition to the exercise and grant date prices of the awards, certain weighted
average assumptions that were used to estimate the fair value of stock option
grants in the respective periods are listed in the table below:
|
Six
months ended
February
28,
|
||
|
2006
|
2005
|
|
|
Expected
term (years)
|
4.7
|
5.3
|
|
Expected
volatility
|
34%
|
43%
|
|
Risk-free
interest rate
|
4.5%
|
3.7%
|
|
Expected
dividend yield
|
0%
|
0%
|
The
Company estimates expected volatility based on historical daily price changes
of
the Company’s common stock for a period equal to the current expected term of
the options. The risk-free interest rate is based on the United States treasury
yields in effect at the time of grant corresponding with the expected term
of
the options. The expected option term is the number of years the Company
estimates that options will be outstanding prior to exercise considering vesting
schedules and our historical exercise patterns.
SFAS
123R
requires the cash flows resulting from the tax benefits for tax deductions
in
excess of the compensation expense recorded for those options (excess tax
benefits) to be classified as financing cash flows. These excess tax benefits
were $2,880 for the six months ended February 28, 2006 and are classified as
a
financing cash inflow in the Company’s Condensed Consolidated Statements of Cash
Flows.
A
summary
of stock option activity under the Company’s share-based compensation plans for
the six months ended February 28, 2006 is presented in the following
table:
|
Options
|
Weighted
Average Exercise Price |
Weighted
Average Remaining Contractual Life (Yrs.) |
Aggregate
Intrinsic Value (in thousands) |
||||||||||
|
Outstanding-beginning
of year
|
5,216,919
|
$
|
14.87
|
||||||||||
|
Granted
|
158,648
|
28.96
|
|||||||||||
|
Exercised
|
(477,790
|
)
|
6.77
|
||||||||||
|
Forfeited
or expired
|
(40,604
|
)
|
26.51
|
||||||||||
|
Outstanding
February 28, 2006
|
4,857,173
|
$
|
16.02
|
5.70
|
$
|
76,053
|
|||||||
|
Exercisable
February 28, 2006
|
3,463,593
|
$
|
11.83
|
4.53
|
$
|
68,495
|
|||||||
The
total
intrinsic value of options exercised during the six months ended February 28,
2006 and 2005 was $10,495 and $14,298, respectively. At February 28, 2006,
total
remaining unrecognized compensation cost related to unvested stock-based
arrangements was $10,605 and is expected to be recognized over a weighted
average period of 1.4 years.
Note
6
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 or financial
condition.
Note
7
Pursuant
to the Company’s Board-approved share repurchase program, 2.6 million shares
were acquired at an average price of $28.62 per share for a total cost of
$73,095 during the first half of fiscal year 2006. The total remaining amount
authorized for repurchase as of February 28, 2006 was $34,581. Largely as a
result of this share repurchase activity, the Company took additional advances
on its available line of credit. The balance outstanding under the Company’s
line of credit as of February 28, 2006 was $118,000, an increase of $87,850
from
the balance outstanding as of August 31, 2005.
Note
8
In
February 2006, the Company entered into an interest rate swap agreement to
modify a portion of the variable rate line of credit to a fixed rate obligation,
thereby reducing the exposure to market rate fluctuations. The interest rate
swap agreement has been designated as a cash flow hedge, and effectiveness
is
determined by matching the principal balance and terms with that specific
obligation. The effective portions of changes in fair value are recognized
in
accumulated other comprehensive income (loss) in the accompanying Condensed
Consolidated Balance Sheets. Ineffective portions of changes in fair value
are
recognized as a charge or credit to earnings. The agreement expires in May
2010
and settles quarterly until expiration. Under the terms of the interest rate
swap agreement, the Company makes payments based on a fixed rate of 5.66% and
receives interest payments based on 3-month LIBOR on a notional amount of $60
million. The differences to be paid or received under the interest rate swap
agreement are recognized as an adjustment to interest expense. The agreement
is
with a major financial institution, which is expected to fully perform under
the
terms of the agreement. This interest rate swap is the only item reflected
in
accumulated other comprehensive income (loss) as of February 28,
2006.
Note
9
On
April
6, 2006, the Company’s board of directors approved a three-for-two stock split
in the form of a stock dividend. Holders of record of the Company’s common
stock, par value $.01 per share, at the close of business on April 17, 2006
will
receive one additional share of common stock for every two shares held on
that
date. The stock dividend will be distributed April 28, 2006 and the Company’s
stock will begin trading ex-dividend on May 1, 2006. The stock split will
increase the number of shares of common stock outstanding from approximately
57.2 million shares to approximately 85.8 shares (exclusive of treasury shares).
The pro forma earnings per share, giving retroactive effect to the stock
split,
are as follows:
|
Three
months ended
|
Six
months ended
|
||||||||||||
|
February
28,
|
February
28,
|
||||||||||||
|
2006
|
2005
|
2006
|
2005
|
||||||||||
|
Basic
earnings per share - as reported
|
$
|
.22
|
$
|
.19
|
$
|
.51
|
$
|
.44
|
|||||
|
Basic
earnings per share - after stock split
|
$
|
.15
|
$
|
.12
|
$
|
.34
|
$
|
.29
|
|||||
|
Diluted
earnings per share - as reported
|
$
|
.22
|
$
|
.18
|
$
|
.49
|
$
|
.42
|
|||||
|
Diluted
earnings per share - after stock split
|
$
|
.14
|
$
|
.12
|
$
|
.33
|
$
|
.28
|
|||||
Also
on
April 6, 2006, the board of directors increased the amount available under
the
Company’s stock repurchase authorization from $34.6 million to a total of $110
million. In addition, the term for the repurchase of the newly authorized
amount
was extended to August 31, 2007. Share repurchases are authorized to be made
from time-to-time in the open market depending on market
conditions.
Overview
Description
of the Business
.
Sonic
operates and franchises the largest chain of drive-ins in the United States.
As
of February 28, 2006, the Sonic system was comprised of 3,089 drive-ins, of
which 19% or 599 were Partner Drive-Ins and 81% or 2,490 were Franchise
Drive-Ins. Sonic Drive-Ins feature Sonic signature items such as specialty
soft
drinks including cherry limeades and slushes, and frozen desserts, made-to-order
sandwiches and hamburgers, extra-long chili-cheese coneys, hand-battered onion
rings, tater tots, salads and wraps. Sonic Drive-Ins also offer a breakfast
menu. Items on the breakfast menu include Breakfast Toaster and Bistro
sandwiches and breakfast burritos with sausage, egg and cheese, and specialty
breakfast drinks. We derive our revenues primarily from Partner Drive-In sales
and royalties from franchisees. We also receive revenues from initial franchise
fees. To a lesser extent, we also receive income from the selling and leasing
of
signs and real estate, as well as from minority ownership interests in a few
Franchise Drive-Ins.
Costs
of
Partner Drive-In sales, including minority interest in earnings of drive-ins,
relate directly to Partner Drive-In sales. Other expenses, such as depreciation,
amortization, and general and administrative expenses, relate to the Company’s
franchising operations, as well as our Partner Drive-In operations. Our revenues
and expenses are directly affected by the number and sales volumes of Partner
Drive-Ins. Our revenues and, to a lesser extent, expenses also are affected
by
the number and sales volumes of Franchise Drive-Ins. Initial franchise fees
and
franchise royalties are directly affected by the number of Franchise Drive-In
openings.
Overview
of Business Performance
.
Our
strong business performance continued during our second fiscal quarter ended
in
February 2006. Net income increased 14.5% and earnings per share increased
22.2%
to $.22 per diluted share from $.18 in the year earlier period, which is
adjusted for the retrospective adoption of SFAS 123R for expensing stock-based
compensation. For the first half of fiscal 2006, net income increased 11.2%
and
earnings per share increased 16.7% to $.49 per diluted share from $.42 in the
year earlier period, also adjusted for SFAS 123R. Second quarter and first
half
results for both 2006 and 2005 reflect a decrease of $.02 and $.04 per diluted
share, respectively, for stock-based compensation, net of related income tax
benefits. We believe these results reflect our multi-layered growth strategy
that features the following components:
| · |
Solid
same-store sales growth;
|
| · |
Expansion
of the Sonic brand through new unit growth, particularly by franchisees;
|
| · |
Increased
franchising income stemming from franchisee new unit growth, solid
same-store sales growth and our unique ascending royalty rate;
|
| · |
Operating
leverage at both the drive-in level and the corporate level;
and
|
| · |
The
use of excess operating cash flow for franchise acquisitions and
share
repurchases.
|
The
following table provides information regarding the number of Partner Drive-Ins
and Franchise Drive-Ins in operation as of the end of the periods indicated
as
well as the system-wide growth in sales and average unit volume. System-wide
information includes both Partner and Franchise Drive-In information, which
we
believe is useful in analyzing the growth of the brand as well as the Company’s
revenues since franchisees pay royalties based on a percentage of
sales.
|
System-Wide
Performance
($
in thousands)
|
|||||||||||||
|
Three
months ended
|
Six
months ended
|
||||||||||||
|
February
28,
|
February
28,
|
||||||||||||
|
2006
|
2005
|
2006
|
2005
|
||||||||||
|
Percentage
increase in sales
|
12.2
|
%
|
13.3
|
%
|
11.2
|
%
|
14.2
|
%
|
|||||
|
System-wide
drive-ins in operation
(1)
:
|
|||||||||||||
|
Total
at beginning of period
|
3,065
|
2,917
|
3,039
|
2,885
|
|||||||||
|
Opened
|
33
|
32
|
66
|
66
|
|||||||||
|
Closed
(net of re-openings)
|
(9
|
)
|
(15
|
)
|
(16
|
)
|
(17
|
)
|
|||||
|
Total
at end of period
|
3,089
|
2,934
|
3,089
|
2,934
|
|||||||||
|
Core
markets
(2)
|
2,372
|
2,094
|
2,372
|
2,094
|
|||||||||
|
Developing
markets
(2)
|
717
|
840
|
717
|
840
|
|||||||||
|
All
markets
|
3,089
|
2,934
|
3,089
|
2,934
|
|||||||||
11
System-wide
same-store sales increased 5.5% during the second quarter of fiscal year 2006,
primarily as a result of growth in average check. This increase was a result
of
price increases, as well as the success of the PAYS program that has increased
credit and debit card transactions that, on average, exceed the average cash
transaction. We believe this solid sales performance resulted from our specific
sales driving initiatives including:
| · |
Use
of technology to reach customers and improve the customer
experience;
|
| · |
Strong
promotions and new product news focused on quality and expanded choice
for
our customers;
|
| · |
Continued
growth of our business in non-traditional day parts including the
morning,
afternoon, and evening day parts;
and
|
| · |
Growth
in brand awareness through increased media spending and greater use
of
network cable advertising;
|
Looking
forward, due to the solid performance we have experienced, as well as the sales
driving initiatives planned, we are increasing our targeted system-wide
same-store sales growth to a range of 3% to 5% for the remainder of fiscal
year
2006. Estimated system-wide same store sales for March 2006 were within this
revised target growth rate range. We expect this solid increase in same-store
sales to translate to revenue growth in the 12% to 14% range in the second
half
of fiscal year 2006.
Implementation
of the PAYS program, which began in Partner Drive-Ins in the fall of 2003,
was
completed in the remainder of our Partner Drive-Ins during the second quarter
of
fiscal 2005. Under the PAYS program, a credit card terminal is added to each
drive-in stall to facilitate credit and debit card transactions. Rollout to
Franchise Drive-Ins began in February 2005 and is expected to be completed
system-wide by the end of the calendar year 2006. Over 60% of Franchise
Drive-Ins and almost 70% of drive-ins system-wide now have the PAYS system
in
place.
We
continue to use our monthly promotions to highlight our distinctive food
offerings and to feature new products.
We
also
use our promotions and product news to create a strong emotional link with
consumers and to align closely with consumer trends for fresh ingredients,
customization, menu variety and choice. During the second quarter, our new
product offerings included a Mushroom Swiss Double Cheeseburger, Gingerbread
Blast, new yogurt-based fresh fruit Smoothies and a Sweetheart Brownie Blast.
We
will continue to have new product news in the coming months, all designed to
meet customers’ evolving taste preferences including the growing desire for
fresh, quality product offerings and healthier alternatives.
We
continue to promote expansion of business in our non-traditional day parts
(morning, afternoon, and evening). Through the second quarter of fiscal year
2006, we saw continued growth in sales in our non-traditional day parts, and
we
believe we have continued opportunity to grow these day parts throughout fiscal
year 2006.
During
fiscal year 2006, our total system-wide media expenditures are expected to
be
approximately $145 million as compared to approximately $125 million in fiscal
year 2005, which we believe will continue to increase overall brand awareness
and strengthen our share of voice relative to our competitors. We will also
continue to refine our system-wide marketing fund efforts, which comprise
approximately one-half of our media expenditures and are largely used for
network cable television advertising. Our national cable strategy has proven
to
be beneficial in raising overall brand awareness in all markets and particularly
as we develop in newer markets.
We
opened
33 drive-ins during the second quarter, consisting of seven Partner Drive-Ins
and 26 Franchise Drive-Ins, which was one more than the total number of drive-in
openings during the second quarter a year ago. For the first six months, we
have
opened 66 drive-ins which was consistent with the total number of drive-in
openings during the first six months of last year. Despite continuing cost
pressures as a result of the increasing demand for construction materials and
labor, we are maintaining our projected system openings for the year at 180
to
190 drive-ins, including 45 to 50 during the third quarter of 2006.
Results
of Operations
Revenues
.
Total
revenues increased 12.3% to $148.9 million in the second fiscal quarter of
2006
and 12.3% to $308.7 million for the first six months of fiscal 2006. The
increase in revenues primarily relates to solid sales growth for Partner
Drive-Ins and, to a lesser extent, a rise in franchising income.
|
Revenues
|
|||||||||||||
|
(In
thousands)
|
|||||||||||||
|
Percent
|
|||||||||||||
|
February
28,
|
Increase/
|
Increase/
|
|||||||||||
|
2006
|
2005
|
(Decrease)
|
(Decrease)
|
||||||||||
|
Three
months ended
|
|||||||||||||
|
Revenues:
|
|||||||||||||
|
Partner
Drive-In sales
|
$
|
126,376
|
$
|
112,655
|
$
|
13,721
|
12.2
|
%
|
|||||
|
Franchise
revenues:
|
|||||||||||||
|
Franchise
royalties
|
20,745
|
18,169
|
2,576
|
14.2
|
|||||||||
|
Franchise
fees
|
879
|
874
|
5
|
0.6
|
|||||||||
|
Other
|
948
|
915
|
33
|
3.6
|
|||||||||
|
Total
revenues
|
$
|
148,948
|
$
|
132,613
|
$
|
16,335
|
12.3
|
%
|
|||||
|
Six
months ended
|
|||||||||||||
|
Revenues:
|
|||||||||||||
|
Partner
Drive-In sales
|
$
|
261,798
|
$
|
232,866
|
$
|
28,932
|
12.4
|
%
|
|||||
|
Franchise
revenues:
|
42,998
|
38,275
|
4,723
|
12.3
|
|||||||||
|
Franchise
royalties
|
|||||||||||||
|
Franchise
fees
|
1,820
|
1,809
|
11
|
0.6
|
|||||||||
|
Other
|
2,132
|
1,890
|
242
|
12.8
|
|||||||||
|
Total
revenues
|
$
|
308,748
|
$
|
274,840
|
$
|
33,908
|
12.3
|
%
|
|||||
The
following table reflects the growth in Partner Drive-In sales and changes in
comparable drive-in sales for Partner Drive-Ins. It also presents information
about average unit volumes and the number of Partner Drive-Ins, which is useful
in analyzing the growth of Partner Drive-In sales.
The
increases in Partner Drive-In sales result from newly constructed and acquired
drive-ins and same-store sales increases in existing drive-ins, offset by the
loss of sales for sold and closed drive-ins.
Effective
September 1, 2005, we acquired 15 Franchise Drive-Ins located in the Tennessee
and Kentucky markets. We expect this acquisition to add approximately 2.5%
to
our revenue growth during fiscal year 2006. Over the past several years, we
have
completed the acquisition of several Franchise Drive-Ins in various markets.
These acquisitions have added and are expected to continue to add to revenue
growth and are expected to continue to be accretive to earnings over time.
Our
acquisitions are typically focused on higher volume stores with strong
store-level management already in place. In addition, the selling franchisee
usually retains a significant drive-in base and continues growing with us in
other areas. We view these types of acquisitions of drive-ins with proven track
records as a very good, lower-risk use of our capital and they remain a very
viable potential use of our excess cash flow in future years.
The
following table reflects the growth in franchising income (franchise royalties
and franchise fees) as well as franchise sales, average unit volumes and the
number of Franchise Drive-Ins. 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
income, which consists of franchise royalties and franchise fees, increased
13.6% to $21.6 million in the second fiscal quarter of 2006 and 11.8% to
$44.8
million for the first six months of fiscal year 2006.
Franchise
royalties increased 14.2% to $20.7 million in the second quarter of 2006,
compared to $18.2 million in the second fiscal quarter of 2005. Of the $2.5
million increase, approximately $1.7 million resulted from franchise same-store
sales growth of 6.5% in the second fiscal quarter of 2006, combined with an
increase in the effective royalty rate to 3.46% during the second fiscal quarter
of 2006 compared to 3.40% during the same period in fiscal year 2005. Each
of
our license agreements contains an ascending royalty rate whereby royalties,
as
a percentage of sales, increase as sales increase. The balance of the increase
was primarily attributable to growth in the number of franchise units over
the
prior period.
Franchise
royalties increased 12.3% to $43.0 million in the first two fiscal quarters
of
2006, compared to $38.3 million during the same period of the prior year. Of
the
$4.7 million increase, approximately $2.9 million resulted from Franchise
Drive-Ins’ same-store sales growth of 5.7% in the first six months of fiscal
year 2006, combined with an increase in the effective royalty rate to 3.48%
during the first two fiscal quarters of 2006 compared to 3.43% during the same
period in fiscal year 2005. The balance of the increase was primarily
attributable to growth in the number of franchise units over the prior
period.
Franchise
fees were virtually unchanged as franchisees opened 26 new drive-ins in the
second quarter and 56 new drive-ins for the first six months of both fiscal
years 2006 and 2005. Our franchise development pipeline continues to strengthen
and we continue to anticipate 150 to 160 drive-in openings by franchisees
this
fiscal year as compared to 138 openings during the previous year. We do continue
to experience significantly increased
development costs, including
increased demand for construction supplies and labor, that could constrain
future drive-in openings. As a result of new Franchise Drive-In openings,
same-store sales increases expected to be in the 3% to 5% range, and the
continued benefit of the ascending royalty rate, we expect incremental
franchising income of $3.0 million to $3.5 million in the third
quarter.
Operating
Expenses
.
Overall,
drive-in cost of operations, as a percentage of Partner Drive-In sales,
decreased to 81.2% in the second fiscal quarter of 2006 compared to 81.4% in
the
same period of fiscal year 2005, and decreased to 81.3% for the first six months
of 2006 compared to 81.4% for the same period of fiscal year 2005. Minority
interest in earnings of drive-ins is included as a part of cost of sales, in
the
table below, since it is directly related to Partner Drive-In operations.
Food
and
packaging costs increased by 0.1 percentage points during the second quarter
of
fiscal year 2006 and decreased by 0.1 percentage points during the first six
months of fiscal year 2006 compared to the same periods of fiscal year 2005.
These results are being impacted by higher beef costs, as well as higher
distribution costs, offset by favorable dairy costs. Looking forward, we expect
that lower costs for dairy and other items will at least partially offset higher
beef and distribution costs and produce flat to slightly higher year-over-year
food and packaging costs for the next several months.
Labor
costs decreased by 0.2 percentage points during the second quarter of fiscal
year 2006 and decreased by 0.4 percentage points for the first six months of
fiscal year 2006 compared to the same periods of fiscal year 2005. These
favorable variances resulted from the leverage of sales growth. Looking forward,
we expect the leverage from sales growth to keep labor costs, as a percentage
of
Partner Drive-In sales, favorable on a year-over-year basis.
Minority
interest, which reflects our store-level partners’ pro-rata share of earnings
through our partnership program, increased by $0.4 million during the second
fiscal quarter of 2006 and by $0.7 million during the first six months of fiscal
year 2006 compared to the same periods of fiscal year 2005, reflecting the
increase in average profit per store. We continue to view the partnership
program as an integral part of our culture at Sonic and a large factor in the
success of our business, and we are pleased that profit distributions to our
partners increased during the quarter. Looking forward, because we expect our
store level profits to continue to grow, we would likewise expect minority
interest to increase in dollar terms but to be relatively flat versus the prior
year as a percentage of Partner Drive-In sales.
Other
operating expenses decreased by 0.1 percentage points during the second quarter
of fiscal year 2006 and increased by 0.5 percentage points in the first six
months of 2006 compared to the same periods in fiscal year 2005. The increase
for the year-to-date period is related primarily to increases in utility costs
as a result of higher energy prices. Due to the mild weather experienced this
winter, combined with the more recent easing of energy prices (particularly
natural gas), we did not experience the level of deterioration in our utility
costs that we had expected going into the second quarter. A secondary
contributor to the increase for the year-to-date period is increasing credit
card charges resulting from the success of the PAYS program. We continue to
expect some pressure on energy prices and slightly higher credit card fees.
Collectively, other operating expenses are expected to be approximately 0.25
percentage points higher in the third quarter versus the same period last
year.
To
summarize, we believe the higher food and packaging costs, as well as other
operating expenses will be largely offset by leverage from sales growth. As
a
result, overall restaurant-level margins for the third quarter of 2006 are
expected to be flat to slightly unfavorable on a year-over-year
basis.
Selling,
General and Administrative
.
Selling,
general and administrative expenses increased 12.1% to $13.2 million during
the
second fiscal quarter of 2006 compared to the same period of fiscal year 2005,
and increased 12.3% to $25.4 million for the first six months of 2006 versus
the
same period of 2005. Sonic adopted SFAS 123R effective with the beginning of
the
first quarter of this fiscal year, therefore, we are now expensing the estimated
fair value of stock options over their vesting period. We have chosen to adopt
the new standard using the modified retrospective application method, as
provided for in the standard. This method of adoption requires us to adjust
all
prior periods to reflect expense for the fair value of stock options that was
previously only disclosed in the footnotes to the financial statements. As
it
relates to the ongoing effect of stock-based compensation under SFAS 123R,
we
estimate total stock compensation expense for fiscal year 2006 will be
approximately $8 million. As of February 28, 2006, total remaining unrecognized
compensation cost related to unvested stock-based arrangements was $10.6 million
and is expected to be recognized over a weighted average period of 1.4 years.
See Note 5 of the Notes to Condensed Consolidated Financial Statements included
in this Form 10-Q for additional information regarding our stock-based
compensation. Excluding stock-based compensation expense, we anticipate that
these costs will increase in the range of 10% to 12% for fiscal year 2006 as
compared to the prior year primarily as a result of increased headcount
additions to support continued growth in our business.
Depreciation
and Amortization
.
Depreciation and amortization expense increased 12.7% to $10.0 million in the
second quarter of fiscal year 2006, and increased 15.2% to $19.9 million for
the
first six months of 2006. These increases were due in part to additional
depreciation stemming from the Tennessee and Kentucky acquisitions, which will
continue through August 2006, as well as the reduction in remaining useful
life
for certain assets related to the retrofit of Partner Drive-Ins in the late
1990s. This reduction in life resulted from a re-evaluation of the remaining
life of such assets. Capital expenditures during the first six months of fiscal
year 2006 were $46.5 million, including $14.6 million related to the acquisition
of drive-ins. Looking forward, planned capital expenditures for fiscal year
2006
of approximately $75 million, along with the items discussed above, are expected
to result in depreciation growth of 13% to 15% for the third quarter of 2006
over the same period of the prior year.
Provision
for Impairment of Long-Lived Assets
.
During
the second quarter of fiscal year 2005, one mall location became impaired under
the guidelines of FAS 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets.” As a result, a provision for impairment of $0.4 million was
recorded for the drive-in’s carrying cost in excess of its estimated fair value.
While it is impossible to predict if future write-downs will occur, we do not
believe that future write-downs will impede our ability to continue growing
earnings at a solid rate.
Interest
Expense
.
Net
interest expense increased 36.8% to $2.1 million for the second quarter of
2006
and increased 8.5% to $3.4 million for the first six months of fiscal year
2006
compared to the same periods in fiscal year 2005. These increases result from
approximately $115 million in share repurchases over the last 12 months. Going
forward, we expect higher interest expense in future quarters depending on
our
level of repurchase activity and potential franchise acquisitions.
Income
Taxes
.
Our
income tax rate during the second quarter was approximately 38.6%, roughly
equivalent to the tax rate last year after adjusting for the adoption of SFAS
123R. The effective rate for the first half of fiscal year 2006 was 38.0%
compared to a rate of 37.1% for the same period of 2005. The adoption of SFAS
123R related to the expensing of stock options will create differences in book
and taxable income on both a permanent and temporary basis. Many of the options
granted by Sonic are incentive stock options for which a tax benefit results
only if the option holder has a disqualifying disposition. Accordingly, the
expected tax benefit of stock options will be less than our overall tax rate
and
is estimated at 25%, but may vary significantly depending upon the timing of
employees’ exercise and sale of stock. In addition, the expiration of the Work
Opportunity Tax Credit on January 1
st
will
impact our tax rate going forward. We expect that Congress will reinstate the
tax credit retroactively, as they have done in the past. However, we are not
allowed to record the benefit of this credit until the legislation becomes
enacted law. We expect our tax rate to be in the range of 37% to 38% in the
third quarter. However, depending upon the timing of the renewal of the Work
Opportunity Tax Credit program and based upon the timing of option exercises
and
dispositions by option-holders, the rate will continue to vary from quarter
to
quarter, as circumstances on individual tax matters change.
Financial
Position
During
the first six months of fiscal year 2006, current assets increased 48.9% to
$52.5 million compared to $35.2 million as of the prior fiscal year end as
a
result of strong cash flow from operations and line of credit advances which
remained unspent. Net property and equipment increased by $16.9 million as
a
result of drive-in construction, relocations, remodels and retrofits, along
with
the Tennessee and Kentucky acquisition. Goodwill increased by $12.9 million
as a
result of the Tennessee and Kentucky acquisition. These increases combined
with
the increase in current assets resulted in an 8.3% increase in total assets
to
$610.1 million as of the end of the second quarter of fiscal year
2006.
Total
current liabilities decreased $9.8 million or 14.9% during the first six months
of fiscal year 2006 primarily as a result of tax payments during the second
fiscal quarter of 2006. Long-term debt increased $91.6 million or 83.2% as
a
result of advances on the Company’s line of credit to fund portions of the share
repurchases, capital expenditures and the Tennessee and Kentucky acquisition.
Overall, total liabilities increased $81.8 million or 46.6% as a result of
the
items discussed above.
Shareholders’
equity decreased $35.1 million or 9.0% during the first six months of fiscal
year 2006 primarily resulting from stock repurchases of $73.1 million, offset
by
earnings during the period of $29.3 million, stock-based compensation and the
proceeds and related tax benefits from the exercise of stock options. At the
end
of the second fiscal quarter of 2006, our debt-to-total capital ratio was 34.9%,
up from 20.3% at the end of fiscal year 2005. For the twelve months ended
February 28, 2006, return on average stockholders’ equity was 20.1% and return
on average assets was 12.8%.
Liquidity
and Sources of Capital
Net
cash
provided by operating activities increased $2.5 million or 5.5% to $48.0 million
in the first six months of fiscal year 2006 as compared to $45.5 million in
the
same period of fiscal year 2005, primarily as a result of an increase in
operating profit before depreciation and amortization, offset by decreases
in
operating liabilities associated with the timing of tax payments. We also
anticipate continuing to generate increasing positive free cash flow going
forward. We believe free cash flow, which we define as net income plus
depreciation and amortization and stock compensation expense less capital
expenditures, is useful in evaluating the liquidity of the Company by assessing
the level of funds available for share repurchases, acquisitions of Franchise
Drive-Ins, and repayment of debt. This year we expect free cash flow to approach
$50 million.
Under
the
share repurchase program authorized by the Board of Directors, the Company
acquired 2.6 million shares at an average price of $28.62 per share for a total
of $73.1 million during the first six months of fiscal year 2006. As of February
28, 2006, we had approximately $34.6 million available under the program, which
we anticipate fully utilizing over the remainder of the fiscal year. See
Subsequent Events
discussion on page 19. We expect to fund these share
repurchases through cash flow from operations and borrowings under our existing
line of credit.
We
opened
ten newly constructed Partner Drive-Ins and acquired 15 drive-ins from
franchisees during the first two fiscal quarters of 2006. During the first
six
months of this fiscal year, we used cash generated by operating activities
and
borrowings under our line of credit to fund capital additions totaling $46.5
million, which included the cost of newly opened drive-ins, new equipment for
existing drive-ins, drive-ins under construction, the acquisition of Franchise
Drive-Ins, and other capital expenditures. During the six months ended February
28, 2006, we purchased the real estate for ten of the 25 newly constructed
and
acquired drive-ins.
We
plan
capital expenditures of approximately $75 million in fiscal year 2006, excluding
acquisitions. These capital expenditures primarily relate to the development
of
additional Partner Drive-Ins, stall additions, remodels and relocations of
older
drive-ins and store equipment. We expect to fund these capital expenditures
through cash flow from operations and borrowings under our existing line of
credit.
We
have
an agreement with a group of banks that provides us with a $150.0 million
line
of credit expiring in July 2010. As of February 28, 2006, our outstanding
borrowings under the line of credit were $118.0 million at an effective
borrowing rate of 5.26%, as well as $0.7 million in outstanding letters of
credit. The amount available under the line of credit as of February 28,
2006,
was $31.3 million. We have long-term debt maturing in fiscal years 2006 and
2007
of $8.1 million and $4.7 million, respectively. Of the $8.1 million maturing
in
fiscal 2006, $4.6 million relates to our senior unsecured notes that will
be
maturing in August 2006, and is classified as long-term because we intend
to
utilize amounts available under our line of credit to fund this obligation.
We
believe that free cash flow will be adequate for repayment of any long-term
debt
that does not get refinanced or extended. We plan to use the line of credit
to
finance the opening of newly constructed drive-ins, acquisitions of existing
drive-ins, purchases of the Company’s common stock and for other general
corporate purposes, as needed. See Note 9 of the Notes to Consolidated Financial
Statements in the Company’s Form 10-K for the fiscal year ended August 31, 2005
for additional information regarding our long-term debt.
As
of
February 28, 2006, our total cash balance of $27.3 million reflected the impact
of the cash generated from operating activities, borrowing activity, and capital
expenditures mentioned above. We believe that existing cash and funds generated
from operations, as well as borrowings under the line of credit, will meet
our
needs for the foreseeable future.
Subsequent
Events
On
April
6, 2006, the Company’s board of directors approved a three-for-two stock split
in the form of a stock dividend. Holders of record of the Company’s common
stock, par value $.01 per share, at the close of business on April 17, 2006
will
receive one additional share of common stock for every two shares held on
that
date. The stock dividend will be distributed April 28, 2006 and the Company’s
stock will begin trading ex-dividend on May 1, 2006. The stock split will
increase the number of shares of common stock outstanding from approximately
57.2 million shares to approximately 85.8 million shares (exclusive of treasury
shares).
Also
on
April 6, 2006, the board of directors increased the amount available under
the
Company’s stock repurchase authorization from $34.6 million to a total of $110
million. In addition, the term for the repurchase of the newly authorized
amount
was extended to August 31, 2007. Share repurchases are authorized to be made
from time-to-time in the open market depending on market
conditions.
I
mpact
of Inflation
Though
increases in labor, food or other operating costs could adversely affect our
operations, we do not believe that inflation has had a material effect on income
during the past several years.
Seasonality
We
do not
expect seasonality to affect our operations in a materially adverse manner.
Our
results during the second fiscal quarter (the months of December, January and
February) generally are lower than other quarters because of the climate of
the
locations of a number of Partner and Franchise Drive-Ins.
Critical
Accounting Policies and Estimates
The
Consolidated Financial Statements and Notes to Consolidated Financial Statements
included in this document contain information that is pertinent to management's
discussion and analysis. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to use its
judgment to make estimates and assumptions that affect the reported amounts
of
assets and liabilities and disclosure of contingent assets and liabilities.
These assumptions and estimates could have a material effect on our financial
statements. We evaluate our assumptions and estimates on an ongoing basis using
historical experience and various other factors that are believed to be relevant
under the circumstances. Actual results may differ from these estimates under
different assumptions or conditions.
We
annually review our financial reporting and disclosure practices and accounting
policies to ensure that our financial reporting and disclosures provide accurate
and transparent information relative to the current economic and business
environment. We believe that of our significant accounting policies (see Note
1
of Notes to Consolidated Financial Statements in the Company’s Form 10-K for the
fiscal year ending August 31, 2005), the following policies involve a higher
degree of risk, judgment and/or complexity.
Impairment
of Long-Lived Assets
.
We
review
each Partner Drive-In for impairment when events or circumstances indicate
it
might be impaired. We test for impairment using historical cash flows and
other
relevant facts and circumstances as the primary basis for our estimates of
future cash flows. This process requires the use of
estimates
and assumptions, which are subject to a high degree of judgment. In addition,
at
least annually, we assess the recoverability of goodwill and other intangible
assets related to our brand and drive-ins. These impairment tests require
us to
estimate fair values of our brand and our drive-ins by making assumptions
regarding future cash flows and other factors. If these assumptions change
in
the future, we may be required to record impairment charges for these
assets.
Ownership
Program
.
Our
drive-in philosophy stresses an ownership relationship with supervisors and
drive-in managers. Most supervisors and managers of Partner Drive-Ins purchase
and own an equity interest in the drive-in, which is typically financed by
a
third-party bank. Supervisors and managers are neither employees of Sonic nor
of
the drive-in in which they have an ownership interest.
The
investments made by managers and supervisors in each partnership or limited
liability company are accounted for as minority interests in the financial
statements. The ownership agreements contain provisions, which give Sonic the
right, but not the obligation, to purchase the minority interest of the
supervisor or manager in a drive-in. The amount of the investment made by a
partner and the amount of the buy-out are based on a number of factors,
primarily upon the drive-in’s financial performance for the preceding 12 months,
and are intended to approximate the fair value of a minority interest in the
drive-in.
The
net
book value of a minority interest acquired by the Company in a Partner Drive-In
is recorded as an investment in partnership, which results in a reduction in
the
minority interest liability on the Consolidated Balance Sheet. If the purchase
price exceeds the net book value of the assets underlying the partnership
interest, the excess is recorded as goodwill. The acquisition of a minority
interest for less than book value results in a decrease in purchased goodwill.
Any subsequent sale of the minority interest to another minority partner is
recorded as a pro-rata reduction of goodwill and investment, and no gain or
loss
is recognized on the sale of the minority ownership interest. Goodwill created
as a result of the acquisition of minority interests in Partner Drive-Ins is
not
amortized but is tested annually for impairment under the provisions of FAS
142,
“Goodwill and Other Intangible Assets.”
Revenue
Recognition Related to Franchise Fees and Royalties
.
Initial
franchise fees are nonrefundable and are recognized in income when we have
substantially performed or satisfied all material services or conditions
relating to the sale of the franchise. Area development fees are nonrefundable
and are recognized in income on a pro-rata basis when the conditions for revenue
recognition under the individual development agreements are met. Both initial
franchise fees and area development fees are generally recognized upon the
opening of a Franchise Drive-In or upon termination of the agreement between
Sonic and the franchisee.
Our
franchisees are required under the provisions of the license agreements to
pay
royalties to Sonic each month based on a percentage of actual net sales.
However, the royalty payments and supporting financial statements are not due
until the 20
th
of the
following month. As a result, we accrue royalty revenue in the month earned
based on estimates of Franchise Drive-Ins sales. These estimates are based
on
actual sales at Partner Drive-Ins and projections of average unit volume growth
at Franchise Drive-Ins.
Accounting
for Stock-Based Compensation
.
As
discussed further in Note 5 of Notes to Condensed Consolidated Financial
Statements in this Form 10-Q, we adopted Statement of Financial Accounting
Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) effective
September 1, 2005 using the modified retrospective application method. As a
result, financial statement amounts for prior periods presented in this Form
10-Q have been adjusted to reflect the fair value method of expensing prescribed
by SFAS 123R.
We
estimate the fair value of options granted using the Black-Scholes option
pricing model along with the assumptions shown in Note 5 to the financial
statements. The assumptions used in computing the fair value of share-based
payments reflect our best estimates, but involve uncertainties relating to
market and other conditions, many of which are outside of our control. We
estimate expected volatility based on historical daily price changes of the
Company’s stock for a period equal to the current expected term of the options.
The expected option term is the number of years the Company estimates that
options will be outstanding prior to exercise considering vesting schedules
and
our historical exercise patterns. If other assumptions or estimates had been
used, the stock-based compensation expense that was recorded for the first
six
months of 2006 could have been materially different. Furthermore, if different
assumptions are used in future periods, stock-based compensation expense could
be materially impacted in the future.
Income
Taxes
.
We
estimate certain components of our provision for income taxes. These estimates
include, among other items, depreciation and amortization expense allowable
for
tax purposes, allowable tax credits for items such as wages paid to certain
employees, effective rates for state and local income taxes and the tax
deductibility of certain other items.
Our
estimates are based on the best available information at the time that
we
prepare the provision, including legislative and judicial developments.
We
generally file our annual income tax returns several months after our fiscal
year end. Income tax returns are subject to audit by federal, state and
local
governments, typically several years after the returns are filed. These
returns
could be subject to material adjustments or differing interpretations of
the tax
laws. Adjustments to these estimates or returns can result in significant
variability in the tax rate from period to period.
Forward-looking Statements
This
annual report contains various "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of
the
Securities Exchange Act of 1934, as amended. Forward-looking statements
represent our expectations or beliefs concerning future events, including the
following: any statements regarding future sales or expenses, any statements
regarding the continuation of historical trends, and any statements regarding
the sufficiency of our working capital and cash generated from operating and
financing activities for our future liquidity and capital resource needs.
Without limiting the foregoing, the words "believes," "anticipates," "plans,"
"expects," and similar expressions are intended to identify forward-looking
statements. We caution that the following important economic and competitive
factors, among others, could cause the actual results to differ materially
from
those in the forward-looking statements made in this report and from time to
time in news releases, reports, proxy statements, registration statements,
and
other written or electronic communication, as well as verbal forward-looking
statements made from time to time by representatives of the Company. Factors
that may cause actual results to differ materially from forward-looking
statements include, without limitation, risks of the restaurant industry,
including risks of and publicity surrounding food-borne illnesses, a highly
competitive industry and the impact of changes in consumer spending patterns,
consumer tastes, local, regional, and national economic conditions, weather,
demographic trends, traffic patterns, employee availability, increases in
utility costs, and cost increases or shortages in raw food products. In
addition, the opening and success of new drive-ins will depend on various
factors, including the cost of construction, weather, strikes, the availability
of suitable sites for new drive-ins, the negotiation of acceptable lease or
purchase terms for new locations, local permitting and regulatory compliance,
our ability to manage the anticipated expansion and hire and train personnel,
the financial viability of our franchisees, particularly multi-unit operators,
and general economic and business conditions. Accordingly, such forward-looking
statements do not purport to be predictions of future events or circumstances
and may not be realized. For these reasons, you should not place undue reliance
on forward-looking statements. We undertake no obligation to publicly update
or
revise them.
There
were no material changes in the Company’s exposure to market risk for the
quarter ended February 28, 2006.
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). Based upon that evaluation, the Chief Executive Officer and the
Chief Financial Officer concluded that the Company’s disclosure controls and
procedures were effective. There were no significant changes in the Company’s
internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation.
On
September 13, 2005, Sonic Industries Inc. (“Sonic Industries), a subsidiary of
the Company, filed a declaratory judgment action against
AeroComm, Inc., in the United States District Court for the
Western District of Oklahoma in Oklahoma City, Oklahoma, in a case
titled,
Sonic
Industries Inc. v. AeroComm, Inc.
(Case
No.: CIV-05-1065-R). Sonic Industries seeks the Court's
declaration that Sonic Industries has not violated antitrust laws and that
AeroComm has no protected rights in Sonic Industries’ pay-at-your-stall
(PAYS) credit card system. AeroComm was the primary supplier of PAYS
radio components until AeroComm unilaterally terminated its relationship
with Sonic Industries. On October 24, 2005, AeroComm filed counterclaims
against
Sonic Industries alleging that Sonic Industries interfered with AeroComm’s
business relationships and opportunities with another PAYS supplier, provided
proprietary information to the company that replaced AeroComm, and violated
antitrust laws by restricting the ability of another PAYS supplier to use
AeroComm for non-Sonic applications. The counterclaim seeks
unspecified compensatory and other damages and injunctive relief. On February
27, 2006, AeroComm notified Sonic Industries that it was specifically
seeking compensatory damages for lost profits and lost valuation. The Company
believes that AeroComm's claims are without merit and will vigorously defend
against them. While acknowledging the uncertainties of litigation, the
Company does not believe that AeroComm’s claims will have a material adverse
effect on the Company’s business or financial condition.
During
the fiscal quarter ended February 28, 2006, Sonic Corp. (the “Company”) did not
have any other material legal proceedings brought against it, its subsidiaries
or their properties. In addition, no material developments occurred in
connection with any previously reported legal proceedings against the Company,
its subsidiaries or their properties during the last fiscal
quarter.
(c)
Issuer Purchases of Equity Securities
Shares
repurchased during the second quarter of fiscal 2006 are as follows (in
thousands, except share and per share amounts):
|
Period
|
Total
Number of Shares Purchased (1) |
Average
Price
Paid
per
Share
|
Total
Number of
Shares Purchased as Part of Publicly Announced Plans or Programs (2) |
Maximum
Dollar Value that May Yet Be Purchased Under the Program |
|||||||||
|
December
1, 2005 through December 31, 2005
|
150,953
|
$
|
29.87
|
150,953
|
$
|
55,483
|
|||||||
|
January
1, 2006 through January 31, 2006
|
579,752
|
$
|
27.84
|
556,956
|
$
|
39,993
|
|||||||
|
February
1, 2006 through February 28, 2006
|
184,934
|
$
|
29.48
|
183,700
|
$
|
34,581
|
|||||||
|
Total
|
915,639
|
$
|
28.50
|
891,609
|
|||||||||
(1)
During the second quarter of fiscal 2006, 24,030 shares were tendered to
the
Company as payment for the exercise price of options in connection with the
Company’s share-based compensation plans. There is no maximum amount of shares
that the Company may repurchase under these plans.
(2)
The
Company’s share repurchase program was first publicly announced on April 14,
1997. In April 2005, the Company’s Board of Directors approved an increase in
the share repurchase authorization from $60,000 to $150,000 and extended the
program to August 31, 2006. See
Subsequent Events
discussion on page
19.
None.
On
January 31, 2006, the Company held its annual meeting of stockholders, at which
the stockholders re-elected Michael J. Maples and Frank E. Richardson and
elected Kathryn L. Taylor as directors for three-year terms expiring at the
annual meeting to be held in 2009. The following table sets forth the voting
results for the directors:
|
Director
|
Votes
For
|
Votes
Withheld
|
|
Michael
J. Maples
|
54,120,048
|
1,346,328
|
|
Frank
E. Richardson
|
50,941,986
|
4,524,390
|
|
Kathryn
L. Taylor
|
54,787,061
|
679,315
|
Other
directors of the Company whose terms continued after the meeting are Leonard
Lieberman, H.E. “Gene” Rainbolt, J. Clifford Hudson, Federico F. Peña and Robert
M. Rosenberg.
Voting
results for the other matters voted upon at the meeting are set forth in the
following table:
|
Votes
For
|
Votes
Against
|
Votes
Abstained
|
|
|
Approval
of Amendment to Certificate of Incorporation
|
43,481,946
|
11,961,671
|
22,759
|
|
Approval
of the Sonic Corp. 2006 Long-term Incentive Plan
|
31,163,511
|
17,944,295
|
61,912
|
|
Approval
of Independent Registered Public Accounting Firm
|
51,288,658
|
4,150,916
|
26,802
|
None.
Exhibits
.
|
|
||
SIGNATURES
Pursuant
to the requirements of the Securities Act of 1934, the Company has caused the
undersigned, duly authorized, to sign this report on behalf of the
Company.
|
|
|
SONIC
CORP.
|
|
|
|
|
|
|
|
|
|
|
By:
|
/s/
Stephen C. Vaughan
|
|
|
|
Stephen
C. Vaughan, Vice President
|
|
|
|
and
Chief Financial Officer
|
Date:
April 7, 2006
EXHIBIT
31.01
CERTIFICATION
PURSUANT TO
SEC
RULE
13a-14
I,
J.
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:
April 7, 2006
|
|
|
|
|
|
|
/s/
J. Clifford Hudson
|
|
|
|
J.
Clifford Hudson
|
|
|
|
Chief
Executive Officer
|
EXHIBIT
31.02
CERTIFICATION
PURSUANT TO
SEC
RULE
13a-14
I,
Stephen C. Vaughan, 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:
April 7, 2006
|
|
|
|
|
|
|
/s/
Stephen C. Vaughan
|
|
|
|
Stephen
C. Vaughan
|
|
|
|
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:
April 7, 2006
|
|
|
|
|
|
|
/s/
J. Clifford Hudson
|
|
|
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J.
Clifford Hudson
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Chief
Executive Officer
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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:
April 7, 2006
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/s/
Stephen C. Vaughan
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Stephen
C. Vaughan
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Chief Financial
Officer
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