Annual Report
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
Securities
registered pursuant to section 12(b) of the Act:
None
Securities
registered pursuant to section 12(g) of the Act:
Common
Stock, Par Value $.01 (Title of class)
Rights
to
Purchase Series A Junior Preferred Stock, Par Value $.01 (Title of
class)
Indicate
by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act. Yes
X
. No
.
(Facing
Sheet Continued)
Indicate
by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section
15(d) of the
Act. Yes
. No
X
.
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 the reports),
and
(2) has been subject to the filing requirements for the past 90
days. Yes
X
. No
.
Indicate
by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part
III
of this Form 10-K or any amendment to this Form
10-K.
[
X
]
.
Indicate
by check mark whether the
registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of “accelerated filer and
large accelerated filer” in Rule 12b-2 of the Exchange
Act.
(Check
one):
Large
accelerated filer
X
. Accelerated
filer
___. Non-accelerated
filer __.
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, 2007, the aggregate
market value of the 62,780,894
shares of common stock of
the Company held by non-affiliates of the Company equaled $1,360,461,973 based
on the closing sales price for the common stock as reported for that
date.
As
of October 16
,
2007, the Registrant had
60,780,414
shares of common stock issued and outstanding.
Documents
Incorporated by Reference
Part
III of this report incorporates by
reference certain portions of the definitive proxy statement which the
Registrant
will
file
with the Securities and Exchange Commission no later than 120 days after August
31, 2007.
FORM
10-K OF SONIC CORP.
TABLE
OF CONTENTS
|
PART
I
|
||
|
|
|
|
|
Business
|
1
|
|
|
|
|
|
|
Risk
Factors
|
9
|
|
|
Unresolved
Staff Comments
|
14
|
|
|
Properties
|
14
|
|
|
|
|
|
|
Legal
Proceedings
|
14
|
|
|
|
|
|
|
Submission
of Matters to a Vote of Security Holders
|
14
|
|
|
|
|
|
|
Executive
Officers of the Company
|
15
|
|
|
|
|
|
|
PART
II
|
||
|
|
|
|
|
Market
for the Company’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
|
16
|
|
|
|
|
|
|
Selected
Financial Data
|
18
|
|
|
|
|
|
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
20
|
|
|
|
|
|
|
Quantitative
and Qualitative Disclosures About Market Risk
|
31
|
|
|
|
|
|
|
Financial
Statements and Supplementary Data
|
32
|
|
|
|
|
|
|
Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
|
32
|
|
|
|
|
|
|
Controls
and Procedures
|
32
|
|
|
|
|
|
|
Other
Information
|
34
|
|
|
|
|
|
|
PART
III
|
||
|
|
|
|
|
Directors
and Executive Officers of the Company and Corporate
Governance
|
34
|
|
|
|
|
|
|
Executive
Compensation
|
34
|
|
|
|
|
|
|
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
|
34
|
|
|
|
|
|
|
Certain
Relationships and Related Transactions, and Director
Independence
|
34
|
|
|
|
|
|
|
Principal
Accounting Fees and Services
|
34
|
|
|
|
|
|
|
PART
IV
|
||
|
|
|
|
|
Exhibits
and Financial Statement Schedules
|
35
|
|
FORM
10-K
SONIC
CORP.
PART
I
General
Sonic
Corp. (the “Company”) operates
and franchises the largest chain of drive-in restaurants (“Sonic Drive-Ins”) in
the United States. As of August 31, 2007, the Company had 3,343 Sonic
Drive-Ins in operation from coast to coast, consisting of 654 Partner Drive-Ins
and 2,689 Franchise Drive-Ins. We own a majority interest, typically
at least 60%, and the supervisor and manager of the drive-in own a minority
interest in each Partner Drive-In. Franchise Drive-Ins are owned and
operated by our franchisees. At a typical Sonic Drive-In, a customer
drives into one of 24 to 36 covered drive-in spaces, orders through an intercom
speaker system, and has the food delivered by a carhop within an average of
four
minutes. Many Sonic Drive-Ins also include a drive-through lane and
patio seating.
Our
objective is to maintain our
position as, or to become, a leading operator within each of our core and
developing markets. We have developed and are implementing a strategy
designed to build the Sonic brand and to maintain high levels of customer
satisfaction and repeat business. The key elements of that strategy
are: (1) a unique drive-in concept focusing on a distinctive menu of
quality made-to-order food products including several signature items; (2)
a
commitment to customer service featuring the quick delivery of food by carhops;
(3) the expansion of Partner Drive-Ins and Franchise Drive-Ins within the
continental United States; (4) an owner/operator philosophy, in which managers
have an equity interest in their restaurants, thereby providing an incentive
for
managers to operate restaurants profitably and efficiently; and (5) a commitment
to strong franchisee relationships.
The
Sonic Drive-In restaurant chain was
begun in the early 1950’s. Sonic Corp. was incorporated in the State
of Delaware in 1990 in connection with its 1991 public offering of common
stock. Our principal executive offices are located at 300 Johnny
Bench Drive, Oklahoma City, Oklahoma 73104. Our telephone number is
(405) 225-5000.
Menu
Sonic
Drive-Ins feature Sonic signature items, such as specialty soft drinks including
cherry limeades and slushes, frozen desserts, made-to-order sandwiches and
hamburgers, extra-long cheese coneys, hand-battered onion rings, tater tots,
salads, and wraps. Sonic Drive-Ins also offer breakfast items that
include sausage, ham, or bacon with egg and cheese Breakfast Toaster
®
or Bistro
sandwiches, sausage and egg burritos, and specialty breakfast
drinks. Sonic Drive-Ins serve the full menu all day.
Restaurant
Locations
We
identify markets based on television
viewing areas and further classify markets as either core or
developing. We define our core television markets as those markets
where the penetration of Sonic Drive-Ins (as measured by population per
restaurant, advertising levels, and share of restaurant spending) has reached
a
certain level of market maturity established by management. All other
television markets where Sonic Drive-Ins are located are referred to as
developing markets. Our core markets contain approximately 75% of all
Sonic Drive-Ins as of August 31, 2007. The following table sets forth
the number of Partner Drive-Ins and Franchise Drive-Ins by core and developing
markets as of August 31, 2007:
|
|
Core
Markets
|
Developing
Markets
|
Total
|
||||
|
States
|
Partner
|
Franchise
|
Total
|
Partner
|
Franchise
|
Total
|
|
|
Alabama
|
33
|
72
|
105
|
6
|
6
|
111
|
|
|
Arizona
|
97
|
97
|
97
|
||||
|
Arkansas
|
29
|
161
|
190
|
190
|
|||
|
California
|
36
|
36
|
36
|
||||
|
Colorado
|
14
|
8
|
22
|
21
|
38
|
59
|
81
|
|
Delaware
|
2
|
2
|
2
|
||||
|
Florida
|
16
|
10
|
26
|
20
|
76
|
96
|
122
|
|
Georgia
|
5
|
16
|
21
|
4
|
100
|
104
|
125
|
|
Idaho
|
18
|
18
|
18
|
||||
|
Illinois
|
29
|
29
|
29
|
||||
|
Indiana
|
17
|
17
|
17
|
||||
|
Iowa
|
1
|
16
|
17
|
17
|
|||
|
Kansas
|
41
|
95
|
136
|
136
|
|||
|
Kentucky
|
4
|
31
|
35
|
39
|
39
|
74
|
|
|
Louisiana
|
23
|
139
|
162
|
162
|
|||
|
Mississippi
|
123
|
123
|
123
|
||||
|
Missouri
|
44
|
164
|
208
|
208
|
|||
|
Nebraska
|
8
|
17
|
25
|
25
|
|||
|
Nevada
|
20
|
20
|
20
|
||||
|
New
Mexico
|
73
|
73
|
73
|
||||
|
North
Carolina
|
93
|
93
|
93
|
||||
|
Ohio
|
4
|
11
|
15
|
15
|
|||
|
Oklahoma
|
94
|
175
|
269
|
269
|
|||
|
Oregon
|
3
|
3
|
3
|
||||
|
Pennsylvania
|
3
|
3
|
3
|
||||
|
South
Carolina
|
19
|
19
|
53
|
53
|
72
|
||
|
South
Dakota
|
2
|
2
|
2
|
||||
|
Tennessee
|
42
|
168
|
210
|
10
|
10
|
220
|
|
|
Texas
|
216
|
685
|
901
|
12
|
12
|
913
|
|
|
Utah
|
28
|
28
|
28
|
||||
|
Virginia
|
25
|
25
|
50
|
50
|
|||
|
Washington
|
1
|
1
|
1
|
||||
|
West
Virginia
|
2
|
2
|
2
|
||||
|
Wyoming
|
5
|
5
|
5
|
||||
|
|
|||||||
|
Mexico
|
1
|
1
|
1
|
||||
|
Total
|
561
|
1,939
|
2,500
|
93
|
750
|
843
|
3,343
|
Expansion
During
fiscal year
2007
, we opened 175 Sonic Drive-Ins, which consisted of 29 Partner
Drive-Ins and 146 Franchise Drive-Ins. During fiscal year 2008, we
anticipate approximately 180 to 200 new Sonic Drive-In openings, including
155
to 165 openings by our franchisees. That expansion plan involves the
opening of new Sonic Drive-Ins predominantly by franchisees under existing
area
development agreements, single-store development by existing franchisees, and
development by new franchisees. We believe that our existing core and developing
markets, as well as newly-opened markets, offer significant growth opportunities
for both Partner Drive-In and Franchise Drive-In expansion. The
ability of Sonic and its franchisees to open the anticipated number of Sonic
Drive-Ins during fiscal year 2008 necessarily will depend on various factors,
including those discussed under
Item 1A. Risk Factors – Failure
to successfully implement our growth strategy could reduce, or reduce the growth
of, our revenue and net income,
of this Form 10-K.
Our
expansion strategy for Sonic
Drive-Ins involves three principal components: (1) the building-out
of existing core markets, (2) the further penetration of developing markets,
and
(3) the expansion into new markets. In addition, we may consider the
acquisition of other similar local or regional brands for conversion to Sonic
Drive-Ins.
Restaurant
Design and Construction
General.
The
typical Sonic Drive-In consists of a kitchen housed in a one-story building
flanked by canopy-covered rows of 24 to 36 parking spaces, with each space
having its own intercom speaker system and menu board. In addition,
since 1995, most new Sonic Drive-Ins have incorporated a drive-through service
and patio seating area. We have
191
Sonic
Drive-Ins that provide an indoor seating area,
49
of which
are located in non-traditional areas such as shopping mall food courts,
airports, and universities, and
21
of which
are located adjacent to convenience stores.
Retrofit
.
In
fiscal 2006, we began implementing a program to retrofit all Sonic Drive-Ins
over the next several years. The retrofit is a remodeling program which includes
significant trade dress modifications to the drive-ins. We completed
the retrofit of over 100 Partner Drive-Ins in fiscal 2006. In fiscal
2007, we completed the retrofit of an additional 173 Partner Drive-Ins and
326
Franchise Drive-Ins. In fiscal 2008, we expect to retrofit
approximately 150 additional Partner Drive-Ins and 600 to 700 Franchise
Drive-Ins. Franchisees pay the costs of the retrofit for their
drive-ins. We currently estimate the cost to complete a standard
retrofit at approximately $125,000 to $150,000 per drive-in, which may be higher
or lower depending on the configuration of the drive-in. All new
Sonic Drive-Ins being built now feature the new retrofit changes.
Marketing
We
have designed our marketing program
to differentiate Sonic Drive-Ins from our competitors by emphasizing five key
areas of customer satisfaction: (1) wide variety of distinctive
made-to-order menu items, (2) personal delivery of service by carhops, (3)
speed
of service, (4) quality, and (5) value. The marketing plan includes
promotions for use throughout the Sonic chain. We support those
promotions with television, radio, interactive media, point-of-sale materials,
and other media as appropriate. Those promotions generally center on
products which highlight limited time new product introductions or signature
menu items of Sonic Drive-Ins.
Each
year Sonic develops a marketing
plan with the involvement of the Sonic Franchise Advisory
Council. (Information concerning the Sonic Franchise Advisory Council
is set forth on page 7 under Franchise Program -
Franchise Advisory
Council
.) Funding for our marketing plan has three
components: (1) the System Marketing Fund (2) local advertising
expenditures, and (3) the Sonic Brand Fund (formerly known as the Sonic
Advertising Fund).
Depending
on the type of license
agreement, each Sonic Drive-In must spend 1.125% to 5.0% of the drive-in’s gross
revenues on local advertising, either directly or through participation in
the
local advertising cooperative. Advertising cooperatives among drive-in owners
are formed to pool and direct advertising expenditures in local markets. The
members of each local advertising cooperative may elect and frequently do elect
by majority vote to require the cooperative’s member drive-ins to contribute
more than the minimum percentage of gross revenues to the advertising
cooperative’s funds. For fiscal year 2007, drive-ins participating in
cooperatives contributed an average of 4.15% of their Sonic Drive-Ins’ gross
revenues to Sonic advertising cooperatives. As of August 31, 2007,
3,236 Sonic Drive-Ins (97% of the chain) participated in advertising
cooperatives.
The
System Marketing Fund is funded out
of the required local advertising funds by either redistributing 2.0% of each
Sonic Drive-In’s gross revenues from the local advertising cooperatives to the
System Marketing Fund or, if no advertising cooperative has been formed,
requiring the Sonic Drive-In to pay directly 2.0% of its gross revenues to
the
System Marketing Fund with a corresponding deduction in the amount the drive-in
is required to spend on local advertising. The System Marketing Fund complements
local advertising efforts in attracting customers to Sonic Drive-Ins by
promoting the Sonic brand and restaurant to an expanded audience. The
primary focus of the System Marketing Fund is to purchase advertising on
national cable and broadcast networks and other national media and sponsorship
opportunities.
The
Sonic Brand Fund is Sonic’s
national media production fund. Each Sonic Drive-In must contribute
0.375% to 0.90% of their gross revenues, depending on the type of license
agreement, to the Sonic Brand
Fund.
The
total amount spent on media
(principally television) was approximately $175 million for fiscal year 2007
and
we expect media expenditures of approximately $190 million for fiscal year
2008.
Purchasing
We
negotiate with suppliers for our
primary food products (hamburger patties, dairy products, chicken products,
hot
dogs, french fries, tater tots, cooking oil, fountain syrup, produce, and other
items) and packaging supplies to ensure adequate quantities of food and supplies
and to obtain competitive prices. We seek competitive bids from
suppliers on many of our food products. We approve suppliers of those
products and require them to adhere to our established product and food safety
specifications. Suppliers manufacture several key products for Sonic under
private label and sell them to authorized distributors for resale to Partner
Drive-Ins and Franchise Drive-Ins.
We
require our Partner Drive-Ins and
Franchise Drive-Ins to purchase from approved distribution
centers. By purchasing as a group, we have achieved cost savings,
improved food quality and consistency, and helped decrease the volatility of
food and supply costs for Sonic Drive-Ins. For fiscal year 2007, the
average cost of food and packaging for a Sonic Drive-In, as reported to us
by
our Partner Drive-Ins and Franchise Drive-Ins, equaled approximately
27
%
of
revenues.
Food
Safety and Quality Assurance
To
ensure
the consistent delivery of safe, high-quality food, we created a food safety
and
quality assurance program. Sonic’s food safety program promotes the
quality and safety of all products and procedures utilized by all Sonic
Drive-Ins, and provides certain requirements that must be adhered to by all
suppliers, distributors, and Sonic Drive-Ins. We also have a
comprehensive, restaurant-based food safety program called Sonic
Safe. Sonic Safe is a risk-based system that utilizes Hazard Analysis
& Critical Control Points (HACCP) principles for managing food safety and
quality. Our food safety system includes employee training, supplier
product testing, unannounced drive-in food safety auditing by independent
third-parties, and other detailed components that monitor the safety and quality
of Sonic’s products and procedures at every stage of the food preparation and
production cycle. Employee food safety training is covered under our
Sonic Drive-In training program, referred to as the STAR Training
Program. This program includes specific training information and
requirements for every station in the drive-in. We also require our
drive-in managers and assistant managers to pass the ServSafe training
program. ServSafe is the most recognized food safety training
certification in the restaurant industry.
General
Operations
Management
Information
Systems
. We utilize point-of-sale equipment in each of our
Partner Drive-Ins and Franchise Drive-Ins. Certain financial and
other information is polled on a daily basis from most drive-ins. We
are continuing to develop software and hardware enhancements to our management
information systems to facilitate improved communication and the exchange of
information among the corporate office and Partner Drive-Ins and Franchise
Drive-Ins. These enhancements primarily utilize an intranet designed
for that purpose, which we refer to as PartnerNet.
Reporting
. The
new
form of license agreement (Number 7) requires all Sonic Drive-Ins to submit
a
profit and loss statement on or before the 10
th
of each
month,
while all prior forms of license agreements require submission on or before
the
20
th
of each
month. All Partner Drive-Ins and
66
%
of
Franchise Drive-Ins submit their data electronically. We expect to
add more Franchise Drive-Ins to electronic reporting which will reduce resources
needed for manual processing of restaurant level data.
Hours
of Operation
. Sonic Drive-Ins typically operate seven days a
week and are open from at least 6:00 a.m. to 11:00 p.m. Some
Sonic Drive-Ins are open 24 hours a day.
Company
Operations
Restaurant
Personnel
. A typical Partner Drive-In is operated by a manager,
two to four assistant managers, and approximately 25 hourly employees, many
of
whom work part-time. The manager has responsibility for the
day-to-day operations of the Partner Drive-In. Each supervisor has
the responsibility of overseeing an average of four to seven Partner
Drive-Ins. Sonic Restaurants, Inc. (“SRI”), Sonic’s operating
subsidiary, oversees the operations and development of and provides
administrative services to all Partner Drive-Ins. SRI employs
directors of operations who oversee an average of four to seven supervisors
within their respective regions and report to either a regional vice president
or a vice president of SRI.
Ownership
Program.
The Sonic Drive-In philosophy stresses an ownership
relationship with supervisors and managers. As part of the ownership
program, either a limited liability company or a general partnership is formed
to own and operate each individual Partner Drive-In. SRI owns a majority
interest, typically at least 60%, in each of these limited liability companies
and partnerships. Generally, the supervisors and managers own a minority
interest in the limited liability company or partnership. The amount of
ownership percentage is separately negotiated for each Partner Drive-In.
Supervisors and managers are not employees of Sonic or of the limited liability
companies or partnerships in which they have an ownership interest. As
owners, they share in the cash flow and are responsible for their share of
any
losses incurred by their Partner Drive-Ins. We believe that our ownership
structure provides a substantial incentive for Partner Drive-In supervisors
and
managers to operate their restaurants profitably and efficiently.
Additional information regarding our ownership program can be found under
Ownership Program, in Part II, Item 7, at page 30 of this Form 10-K.
Sonic
records the interests of supervisors and managers
as “minority interest in earnings of Partner Drive-Ins” under costs and expenses
on its financial statements. We estimate that the average percentage
interest of a supervisor was 16% and the average percentage interest of a
manager in a Partner Drive-In was 19% in fiscal year 2007. Each Partner
Drive-In distributes its available cash flow to its supervisors and managers
and
to Sonic on a monthly basis pursuant to the terms of the operating agreement
or
partnership agreement for that restaurant. Sonic has the right, but not
the obligation, to purchase the minority interest of the supervisor or manager
in the restaurant. The amounts of the buy-in and the buy-out are generally
based on the Partner Drive-In’s sales during the preceding 12 months and
approximate the fair market value of a minority interest in that
restaurant. Most supervisors and managers finance the buy-in with a loan
from a third-party financial institution.
Each
Partner Drive-In usually purchases equipment with funds borrowed from Sonic
at
competitive rates. In most cases, Sonic also owns or leases the land and
building and guarantees any third-party lease entered into for the
site.
Partner
Drive-In Data.
The following table provides certain financial
information relating to Partner Drive-Ins and the number of Partner Drive-Ins
opened and closed during the past five fiscal years.
|
2007
|
2006
|
2005
|
2004
|
2003
|
|||||||||||
|
Average
Sales Per Partner Drive In
|
|||||||||||||||
|
(
in
thousands
)
|
$
|
1,017
|
$
|
980
|
$
|
957
|
$
|
886
|
$
|
799
|
|||||
|
Number
of Franchise Drive-Ins:
|
|||||||||||||||
|
Total
Open at Beginning of Year
|
623
|
574
|
539
|
497
|
452
|
||||||||||
|
Newly
Opened and Re-opened
|
29
|
35
|
37
|
21
|
35
|
||||||||||
|
Purchased
from Franchisees*
|
(15
|
)
|
(15
|
)
|
(4
|
)
|
24
|
|
52
|
||||||
|
Sold
to Franchisees*
|
10
|
--
|
5
|
(3
|
) |
(41
|
) | ||||||||
|
Closed
|
(3
|
) |
(1
|
) |
(1
|
) |
0
|
(1
|
) | ||||||
|
Total
Open at Year End
|
654
|
623
|
574
|
539
|
497
|
||||||||||
*The
relatively large number of drive-ins sold to
franchisees in fiscal year 2003 and purchased from franchisees in fiscal
years
2003 and 2004 represent transactions where a majority of Sonic Drive-Ins
in a
certain market were sold to or purchased from a multi-unit franchisee
group. In most instances where we purchased Sonic Drive-Ins, the selling
multi-unit franchisee groups continued to own and operate multiple Franchise
Drive-Ins.
Franchise
Program
General.
As of August 31, 2007, we had 2,689 Franchise Drive-Ins in operation.
A large number of successful multi-unit franchisee groups have developed
during
the Sonic system’s 54 years of operation. Those franchisees continue to develop
new Franchise Drive-Ins in their franchise territories either through area
development agreements or single site development. Our franchisees opened
146 Franchise Drive-Ins during fiscal year 2007 and we expect our franchisees
to
open approximately 155 to 165 Franchise Drive-Ins in fiscal 2008. We
consider our franchisees a vital part of our continued growth and believe
our
relationship with our franchisees is good.
Franchise
Agreements
. Each Sonic Drive-In, including each Partner
Drive-In, operates under a franchise agreement that provides for payments to
Sonic of an initial franchise fee and a royalty fee based on a graduated
percentage of the gross revenues of the drive-in. We began offering a
new form of license agreement (Number 7) in July 2007 which provides
for an initial franchise fee of $45,000 and an ascending royalty rate beginning
at 2% of gross revenues and increasing to 5% as the level of gross revenues
increases. For non-traditional drive-ins, which are those Sonic
Drive-Ins located in venues such as shopping mall food courts, airports, and
universities, the new form of license agreement (Number 7NT) provides for a
franchise fee of $22,500 and a graduated royalty rate from 2% to 5% of gross
revenues. The most recent prior form of license agreement (Number 6A)
has a $30,000 initial license fee and a graduated royalty rate of 1% to 5%
of
gross revenues. Also in fiscal 2007, existing franchisees of
approximately 790 drive-ins with older forms of license agreement opted to
convert to a newer form of license agreement (Number 5.5) which contains a
20-year term and provides for the payment of a higher royalty rate than under
the franchisee’s previous agreement.
All
Sonic Drive-Ins opening in fiscal
year 2008 are expected to open under the Number 6A license agreement. These
drive-ins will be opening under previously entered area development agreements
which provide for the use of a Number 6A license agreement. We
have the right to terminate any franchise agreement for a variety of reasons,
including a franchisee’s failure to make payments when due or failure to adhere
to our policies and standards. Many state franchise laws affect our
ability to terminate or refuse to renew a franchise.
As
of August 31, 2007,
51
%
of all
Sonic Drive-Ins were subject to the 1% to 5% graduated royalty
rate. For fiscal year 2007, Sonic’s average royalty rate equaled
3.75
%.
Area
Development
Agreements
. We use area development agreements to facilitate the
planned expansion of the Sonic Drive-In restaurant chain through multiple unit
development. While many existing franchisees continue to expand on a
single drive-in basis, approximately
73
%
of the
new Franchise Drive-Ins opened during fiscal year 2007 occurred as a result
of
then-existing area development agreements. Each area development
agreement gives a developer the exclusive right to construct, own, and operate
Sonic Drive-Ins within a defined area. In exchange, each developer
agrees to open a minimum number of Sonic Drive-Ins in the area within a
prescribed time period. If the developer does not meet the minimum
opening requirements, we have the right to terminate the area development
agreement and grant a new area development agreement to other franchisees for
the area previously covered by the terminated area development
agreement.
During
fiscal year 2007, we entered
into 71 new area development agreements calling for the opening of
441 Franchise Drive-Ins and amended 19 existing area development agreements
calling for the opening of an additional 68 Franchise Drive-Ins, all during
the
next seven years. As of August 31, 2007, we had a total of 173 area
development agreements in effect and in compliance, calling for the development
of 908 Sonic Drive-Ins during the next seven years. We cannot give any assurance
that our franchisees will achieve that number of new Franchise Drive-Ins during
the next seven years. Of the 167 Franchise Drive-Ins scheduled to
open during fiscal year 2007 under area development agreements in place at
the
beginning of that fiscal year, 107 or 64% opened during the
period. During fiscal year 2007, we terminated 25 of the 152
area development agreements existing at the beginning of the fiscal
year. The terminated area development agreements called for the
opening of 35 Franchise Drive-Ins in fiscal year 2007 and an
additional ten Franchise Drive-Ins in the next three fiscal
years. All of these terminations were as a result of the franchisee
failing to meet the development schedule under the area development
agreement.
In
addition to the area development agreement commitments, during fiscal 2007,
existing franchisees purchased options to develop approximately 400 drive-ins,
which allow them to open new drive-ins under the more favorable Number 6A
license agreement, rather than the new Number 7 license agreement. The
development options and area development agreements together reflect a
development pipeline of over 1,300 drive-ins.
Franchise
Drive-In
Development
. We assist each franchisee in selecting sites and
developing Sonic Drive-Ins. Each franchisee has responsibility for selecting
the
franchisee’s drive-in location, but must obtain our approval of each Sonic
Drive-In design and each location based on accessibility and visibility of
the
site and targeted demographic factors, including population density, income,
age, and traffic. We provide our franchisees with the physical
specifications for the typical Sonic Drive-In.
Franchisee
Financing
. Other than the agreements described below, we do not
generally provide financing to franchisees or guarantee loans to franchisees
made by third-parties.
We
had 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, Sonic provided a
guaranty of 10% of the outstanding balance of a loan from GEC to the Sonic
franchisee. The portions of loans made by GEC to Sonic franchisees
that are guaranteed by the Company total $2.2 million as of August 31, 2007.
We
ceased guaranteeing new loans made under the program during fiscal year 2003
and
have not been required to make any payments under our agreement with
GEC.
We
have an agreement with Irwin
Franchise Capital Corporation (“IFCC”) pursuant to which IFCC has agreed to make
loans to existing Sonic franchisees who meet certain underwriting criteria
set
by IFCC to finance the equipment and improvements for our retrofit program
as
described under
Restaurant Design and Construction – Retrofit
of Item 1
of this Form 10-K. Under the terms of the agreement with IFCC, we will
provide a guaranty to IFCC of the greater of (i) 5% of the outstanding balance
of a loan from IFCC to the Sonic franchisee or (ii) $250,000, provided that
in
no event will our maximum liability to IFCC exceed $2,500,000 in the
aggregate. As of August 31, 2007, the total amount guaranteed under
the IFCC agreement was $
250,000.
Franchisee
Training
. Each franchisee must have at least one full-time
employee at the Sonic Drive-In who has completed the Sonic Management
Development Program before opening or operating the Sonic
Drive-In. The program consists of a minimum of 12 weeks of on-the-job
training and one week of classroom development. The program
emphasizes food safety, quality food preparation, speed of service, cleanliness
of Sonic Drive-Ins, management techniques and consistency of
service. We also require our management teams to pass the ServSafe
training program. ServSafe is the most recognized food safety training
certification in the restaurant industry.
Franchisee
Support
. In addition to training, advertising and food
purchasing as a system, and marketing programs, we provide various other
services to our franchisees. Those services include assistance with
quality control through area field representatives, to ensure that each
franchisee consistently delivers high quality food and service. Our field
service consultants provide operational services and support for our
franchisees, and our field marketing representatives assist the franchisees
with
the development of advertising cooperative and local market promotional
activities. We also provide new franchise consultants and new
franchisee trainers to franchisees to support the successful integration of
new
franchisees into the Sonic system from training through the first months
following the opening of each of the franchisee’s first three Sonic
Drive-Ins. We provide training to franchisees in such areas as shift
management, customer service, time management, supervisory skills, and financial
controls. We additionally assist franchisees with the identification
of trade areas for new Franchise Drive-Ins and the franchisees’ selection of
sites for their Franchise Drive-Ins using demographic data and studies of
traffic patterns. Our architect and engineering personnel design,
plan, and permit new stores. Our construction personnel also assist
in the construction of new drive-ins.
Franchise
Operations
. Sonic’s franchisees operate all Franchise Drive-Ins
in accordance with uniform operating standards and
specifications. These standards pertain to the quality and
preparation of menu items, selection of menu items, maintenance and cleanliness
of premises, and employee responsibilities. We develop all standards
and specifications with input from franchisees, and they are applied on a
system-wide basis. Each franchisee has certain discretion to
determine the prices charged to its customers.
Franchise
Advisory
Council
. Our Franchise Advisory Council provides advice,
counsel, and input to Sonic on important issues impacting the business, such
as
marketing and promotions, operations, purchasing, building design, human
resources, technology, and new products. The Franchise Advisory
Council currently consists of 19 members selected by Sonic.
Currently,
we have six executive committee members who are selected at large, 12 regional
members representing four defined regions of the country, and one at large
member representing new franchisees and smaller operators.
We
have five Franchise Advisory Council task groups comprised of
48
total members who serve two-year terms and lend support
on individual key priorities.
Franchise
Drive-In
Data
. The following table provides certain financial information
relating to Franchise Drive-Ins and the number of Franchise Drive-Ins opened,
purchased from or sold to Sonic, and closed during Sonic’s last five fiscal
years.
|
2007
|
2006
|
2005
|
2004
|
2003
|
|||||||||||
|
Average
Sales Per Franchise
|
|||||||||||||||
|
Drive-In (
in
thousands
)
|
$ |
1,132
|
$ |
1,092
|
$ |
1,039
|
$ |
983
|
$ |
929
|
|||||
|
Number
of Franchise Drive-Ins:
|
|||||||||||||||
|
Total
Open at Beginning of Year
|
2,565
|
2,465
|
2,346
|
2,209
|
2,081
|
||||||||||
|
New
Franchise Drive-Ins
|
146
|
138
|
138
|
167
|
159
|
||||||||||
|
Sold
to the Company*
|
(15 | ) | (15 | ) | (4 | ) | (24 | ) | (52 | ) | |||||
|
Purchased
from the Company*
|
10
|
--
|
5
|
3
|
41
|
||||||||||
|
Closed
and Terminated,
|
|||||||||||||||
|
Net
of Re-openings
|
(17 | ) | (23 | ) | (20 | ) | (9 | ) | (20 | ) | |||||
|
Total
Open at Year End
|
2,689
|
2,565
|
2,465
|
2,346
|
2,209
|
||||||||||
*
The
relatively large number of drive-ins purchased from Sonic in fiscal year 2003
and sold to Sonic in fiscal years 2003 and 2004 represent transactions where
a
majority of Sonic Drive-Ins in a certain market were sold to or purchased from
a
multi-unit franchisee group. In most instances where Sonic purchased
Sonic Drive-Ins, the selling multi-unit franchisee groups continued to own
and
operate multiple Franchise Drive-Ins.
Competition
We
compete in the restaurant industry,
a highly competitive industry in terms of price, service, restaurant location,
and food quality. The restaurant industry is often affected by
changes in consumer trends, economic conditions, demographics, traffic patterns,
and concerns about the nutritional content of quick-service foods. We
compete on the basis of speed and quality of service, method of food preparation
(made-to-order), food quality and variety, signature food items, and monthly
promotions. The quality of service, featuring Sonic carhops,
constitutes one of our primary marketable points of difference from the
competition. There are many well-established competitors with
substantially greater financial and other resources. These
competitors include a large number of national, regional, and local food
services, including quick-service restaurants and casual dining
restaurants. A significant change in pricing or other marketing
strategies by one or more of those competitors could have an adverse impact
on
Sonic’s sales, earnings, and growth. In selling franchises, we also
compete with many franchisors of quick-service and other restaurants and other
business opportunities.
Seasonality
Our
results during Sonic’s second
fiscal quarter (the months of December, January and February) generally are
lower than other quarters because of the lower temperatures in the locations
of
a number of Partner Drive-Ins and Franchise Drive-Ins, which tends to reduce
customer visits to our drive-ins.
Employees
As
of August 31, 2007, we had
357
full-time
corporate employees. This number does not include the approximately
19,000 full-time and part-time employees employed by separate partnerships
and
limited liability companies that operate our Partner Drive-Ins or the
supervisors or managers of the Partner Drive-Ins who own a minority interest
in
the separate partnerships or limited liability companies.
None
of our employees is subject to a
collective bargaining agreement. We believe that we have good labor
relations with our employees.
Trademarks
and Service Marks
Sonic
owns numerous trademarks and service marks. We have registered many
of those marks, including the “Sonic” logo and trademark, with the United States
Patent and Trademark Office. Trademarks and service marks generally
are valid as long as they are used or registered. We believe that our
trademarks and service marks have significant value and play an important role
in our marketing efforts.
Government
Regulations
We
must comply with regulations adopted
by the Federal Trade Commission (the “FTC”) and with several state laws that
regulate the offer and sale of franchises. We also must comply with a
number of state laws that regulate certain substantive aspects of the
franchisor-franchisee relationship. The FTC’s Trade Regulation Rule
on Franchising (the “FTC Rule”) requires that we furnish prospective franchisees
with a franchise disclosure document containing information prescribed by the
FTC Rule.
State
laws that regulate the
franchisor-franchisee relationship presently exist in a substantial number
of
states. Those laws regulate the franchise relationship, for example, by
requiring the franchisor to deal with its franchisees in good faith, by
prohibiting interference with the right of free association among franchisees,
by regulating discrimination among franchisees with regard to charges,
royalties, or fees, and by restricting the development of other restaurants
within certain prescribed distances from existing franchised
restaurants. Those laws also restrict a franchisor’s rights with
regard to the termination of a franchise agreement (for example, by requiring
“good cause” to exist as a basis for the termination), by requiring the
franchisor to give advance notice and the opportunity to cure the default to
the
franchisee, and by requiring the franchisor to repurchase the franchisee’s
inventory or provide other compensation upon termination. To date,
those laws have not precluded us from seeking franchisees in any given area
and
have not had a significant effect on our operations.
Each
Sonic Drive-In must comply with
regulations adopted by federal agencies and with licensing and other regulations
enforced by state and local health, sanitation, safety, fire, and other
departments. Difficulties or failures in obtaining the required
licenses or approvals can delay and sometimes prevent the opening of a new
Sonic
Drive-In.
Sonic
Drive-Ins must comply with
federal and state environmental regulations, but those regulations have not
had
a material effect on their operations. More stringent and varied
requirements of local governmental bodies with respect to zoning, land use,
and
environmental factors can delay and sometimes prevent development of new Sonic
Drive-Ins in particular locations.
Sonic
and its franchisees must comply
with laws and regulations governing immigration, labor, employment and wage
and
hour issues, such as employment eligibility verification, minimum wage,
overtime, family and medical leave, discrimination, and other working
conditions. Many of the food service personnel in Sonic Drive-Ins
receive compensation at rates related to federal, state, and local minimum
wage
laws and, accordingly, increases in applicable minimum wage laws will increase
labor costs at those locations.
Available
Information
We
maintain an internet website with
the address of
http://www.sonicdrivein.com
. Copies of the
Company’s reports filed with, or furnished to, the Securities and Exchange
Commission on Forms 10-K, 10-Q, and 8-K and any amendments to such reports
are
available for viewing and copying at such internet website, free of charge,
as
soon as reasonably practicable after filing such material with, or furnishing
it
to, the Securities and Exchange Commission. In addition, copies of
Sonic’s corporate governance materials, including the Corporate Governance
Guidelines, Audit Committee Charter, Compensation Committee Charter, Nominating
and Corporate Governance Committee Charter, Code of Ethics for Financial
Officers, and Code of Business Conduct and Ethics are available for viewing
and
copying at the website, free of charge.
Events
reported in the media, such as incidents involving food-borne illnesses or
food
tampering, whether or not accurate, can cause damage to our reputation and
rapidly affect sales and profitability.
Reports,
whether true or not, of food-borne illnesses, such as e-coli, avian flu, bovine
spongiform encephalopathy (commonly known as mad cow disease), hepatitis A
or
salmonella, and injuries caused by food tampering have in the past severely
injured the reputations of participants in the restaurant industry and could
in
the future affect us. The potential for terrorism of our nation’s
food supply also exists and, if such an event occurs, it could have a negative
impact on our brand’s reputation and could severely hurt sales, revenues, and
profits.
Our
brand’s reputation is an important asset to the business; as a result, anything
that damages our brand’s reputation could immediately and severely hurt sales,
revenues, and profits. If customers become ill from food-borne
illnesses or food tampering, we could also be forced to temporarily close some,
or all, Sonic Drive-Ins. In addition, instances of food-borne
illnesses or food tampering occurring at the restaurants of competitors, could,
by resulting in negative publicity about the restaurant industry, adversely
affect our sales on a local, regional, or national basis. A decrease
in customer traffic as a result of these health concerns or negative publicity,
or as a result of a temporary closure of any Sonic Drive-Ins, could materially
harm our brand, sales, and profitability.
The
restaurant industry is highly competitive, and that competition could lower
our
revenues, margins, and market share.
The
restaurant industry is intensely competitive as to price, service, location,
personnel, dietary trends, and quality of food, and is often affected by changes
in consumer tastes, economic conditions, population, and traffic patterns.
We
compete with international, regional and local restaurants, some of which
operate more restaurants and have greater financial resources. We
compete primarily through the quality, price, variety, and value of food
products offered. Other key competitive factors include the number and location
of restaurants, quality and speed of service, attractiveness of facilities,
effectiveness of advertising and marketing programs, and new product development
by us and our competitors. Some of our competitors have substantially
larger marketing budgets, which may provide them with a competitive
advantage. In addition, our system competes within the quick-service
restaurant industry not only for customers but also for management and hourly
employees, suitable real estate sites, and qualified franchisees.
Changing
dietary preferences may cause consumers to avoid our products in favor of
alternative foods.
The
restaurant industry is affected by consumer preferences and
perceptions. Although we will monitor these changing preferences and
strive to adapt to meet changing consumer needs, growth of our brand, and
ultimately system-wide sales, depend on the sustained demand for our
products. If dietary preferences and perceptions cause consumers to
avoid certain products offered by Sonic Drive-Ins in favor of alternative foods,
demand for our products may be reduced, and our business could be
harmed.
Our
earnings and business growth strategy depends in large part on the success
of
our franchisees, who exercise independent control of their
businesses.
A
portion
of our earnings comes from royalties, rents and other amounts paid by our
franchisees. Franchisees are independent contractors, and their employees are
not our employees. We provide training and support to, and monitor
the operations of, our franchisees, but the quality of their drive-in operations
may be diminished by any number of factors beyond our
control. Franchisees may not successfully operate drive-ins in a
manner consistent with our high standards and requirements, and franchisees
may
not hire and train qualified managers and other restaurant
personnel. Any operational shortcoming of a Franchise Drive-In is
likely to be attributed by consumers to the entire Sonic brand, thus damaging
our reputation and potentially affecting revenues and
profitability.
Changes
in economic, market and other conditions could adversely affect Sonic and its
franchisees, and thereby Sonic’s operating results.
The
quick-service restaurant industry
is affected by changes in economic conditions, consumer preferences and spending
patterns, demographic trends, consumer perceptions of food safety, weather,
traffic patterns, the type, number and location of competing restaurants, and
the effects of war or terrorist activities and any governmental responses
thereto. Factors such as interest rates, inflation, gasoline prices,
food costs, labor and benefit costs, legal claims, and the availability of
management and hourly employees also affect restaurant operations and
administrative expenses. Economic conditions, including interest
rates and other government policies impacting land and construction costs and
the cost and availability of borrowed funds, affect our ability and our
franchisees’ ability to finance new restaurant development, improvements and
additions to existing restaurants, and the acquisition of restaurants from,
and
sale of restaurants to, franchisees. Inflation can cause increased
food, labor and benefits costs and can increase our operating
expenses. As operating expenses increase, we recover increased costs
by increasing menu prices, to the extent permitted by competition, or by
implementing alternative products or cost reduction procedures. We
cannot ensure, however, that we will be able to recover increases in operating
expenses due to inflation in this manner.
Our
financial results may fluctuate depending on various factors, many of which
are
beyond our control.
Our
sales
and operating results can vary from quarter to quarter and year to year
depending on various factors, many of which are beyond our
control. Certain events and factors may directly and immediately
decrease demand for our products. If customer demand decreases
rapidly, our results of operations would also decline
precipitously. These events and factors include:
|
|
•
|
|
variations
in the timing and volume of Sonic Drive-Ins’
sales;
|
|
|
•
|
|
sales
promotions by Sonic and its
competitors;
|
|
|
•
|
|
changes
in average same-store sales and customer
visits;
|
|
|
•
|
|
variations
in the price, availability and shipping costs of
supplies;
|
|
|
•
|
|
seasonal
effects on demand for Sonic’s
products;
|
|
|
•
|
|
unexpected
slowdowns in new drive-in development
efforts;
|
|
|
•
|
|
changes
in competitive and economic conditions
generally;
|
|
|
•
|
|
changes
in the cost or availability of ingredients or
labor;
|
|
|
•
|
|
weather
and other acts of God; and
|
|
|
•
|
|
changes
in the number of franchise agreement
renewals.
|
Our profitability may be adversely affected by increases in energy costs.
Our
success depends in part on our ability to absorb increases in energy
costs. Various regions of the United States in which we operate
multiple drive-ins have experienced significant increases in energy
prices. If these increases continue to occur, it would have an
adverse effect on our profitability.
Shortages
or interruptions in the supply or delivery of perishable food products or rapid
price increases could adversely affect our operating
results.
We
are
dependent on frequent deliveries of perishable food products that meet certain
specifications. Shortages or interruptions in the supply of
perishable food products may be caused by unanticipated demand, problems in
production or distribution, financial or other difficulties of suppliers,
disease or food-borne illnesses, inclement weather or other
conditions. We purchase large quantities of food and supplies, which
can be subject to significant price fluctuations due to seasonal shifts, climate
conditions, industry demand, energy costs, changes in international commodity
markets and other factors. These shortages or rapid price increases
could adversely affect the availability, quality and cost of ingredients, which
would likely lower revenues and reduce our profitability.
Failure
to successfully implement our growth strategy could reduce, or reduce the growth
of, our revenue and net income.
We
plan
to increase the number of Sonic Drive-Ins, but may not be able to achieve our
growth objectives, and any new drive-ins may not be profitable. The
opening and success of drive-ins depends on various factors,
including:
|
|
•
|
|
competition
from other restaurants in current and future
markets;
|
|
|
•
|
|
the
degree of saturation in existing
markets;
|
|
•
|
consumer
interest in the Sonic Brand in new and developing
markets;
|
||
|
|
•
|
|
the
identification and availability of suitable and economically viable
locations;
|
|
|
•
|
|
sales
levels at existing drive-ins;
|
|
|
•
|
|
the
negotiation of acceptable lease or purchase terms for new
locations;
|
|
|
•
|
|
permitting
and regulatory compliance;
|
|
•
|
the
cost and availability of construction
resources;
|
|
|
•
|
|
the
ability to meet construction
schedules;
|
|
|
•
|
|
the
availability of qualified franchisees and their financial and other
development capabilities;
|
|
|
•
|
|
the
ability to hire and train qualified management
personnel;
|
|
•
|
weather;
and
|
|
|
•
|
|
general
economic and business conditions.
|
If
we are
unable to open as many new drive-ins as planned, if the drive-ins are less
profitable than anticipated or if we are otherwise unable to successfully
implement our growth strategy, revenue and profitability may grow more slowly
or
even decrease.
Our
outstanding and future leverage could have an effect on our
operations.
On
December 20, 2006, the Company closed on a securitized financing facility,
comprised of a $600 million fixed rate term loan and a $200 million variable
rate revolving credit facility. As of August 31, 2007, we had
$593.4 million in outstanding debt under the fixed rate note at an interest
rate
of 5.7% and $116 million outstanding under the variable rate note at an interest
rate of 6.4%.
Our
increased leverage could have the
following consequences:
|
|
•
|
|
We
may be more vulnerable in the event of deterioration in our business,
in
the restaurant industry or in the economy generally. In
addition, we may be limited in our flexibility in planning for
or reacting
to changes in our business and the industry in which we
operate.
|
|
|
•
|
|
We
may be required to dedicate a substantial portion of our cash
flow to the
payment of interest on our indebtedness, which could reduce the
amount of
funds available for operations or development of new Partner
Drive-Ins and
thus place us at a competitive disadvantage as compared with
competitors
that are less highly leveraged.
|
|
•
|
From
time to time, we may engage in various capital markets, bank
credit and
other financing activities to meet our cash requirements. We
may have difficulty obtaining additional financing at economically
acceptable interest rates.
|
||
|
|
•
|
|
Our
existing and future debt obligations may contain certain negative
covenants including limitations on liens, consolidations and
mergers,
indebtedness, capital expenditures, asset dispositions, sale-leaseback
transactions, stock repurchases and transactions with affiliates,
which
may reduce our flexibility in responding to changing business
and economic
conditions.
|
|
|
•
|
|
Our
debt obligations are subject to customary rapid amortization
events and
events of default. Although management does not anticipate an
event of default or any other event of noncompliance with the
provisions
of the Notes, if such an event occurred, the unpaid amounts outstanding
could become immediately due and payable.
|
Sonic
Drive-Ins are subject to health, employment, environmental and other government
regulations, and failure to comply with existing or future government
regulations could expose us to litigation, damage to our reputation and lower
profits.
Sonic
and
its franchisees are subject to various federal, state and local laws affecting
their businesses. The successful development and operation of
restaurants depend to a significant extent on the selection and acquisition
of
suitable sites, which are subject to zoning, land use (including the placement
of drive-thru windows), environmental (including litter), traffic and other
regulations. Restaurant operations are also subject to licensing and
regulation by state and local departments relating to health, food preparation,
sanitation and safety standards, federal and state labor and immigration laws,
(including applicable minimum wage requirements, overtime, working and safety
conditions and citizenship requirements), federal and state laws prohibiting
discrimination and other laws regulating the design and operation of facilities,
such as the Americans with Disabilities Act of 1990. If we fail to
comply with any of these laws, we may be subject to governmental action or
litigation, and our reputation could be accordingly harmed. Injury to
our reputation would, in turn, likely reduce revenues and profits.
In
recent
years, there has been an increased legislative, regulatory and consumer focus
on
nutrition and advertising practices in the food industry, particularly among
restaurants. As a result, we may become subject to regulatory
initiatives in the area of nutrition disclosure or advertising, such as
requirements to provide information about the nutritional content of our food
products, which could increase expenses. The operation of our
franchise system is also subject to franchise laws and regulations enacted
by a
number of states and rules promulgated by the U.S. Federal Trade
Commission. Any future legislation regulating franchise relationships
may negatively affect our operations, particularly our relationship with our
franchisees. Failure to comply with new or existing franchise laws
and regulations in any jurisdiction or to obtain required government approvals
could result in a ban or temporary suspension on future franchise
sales. Changes in applicable accounting rules imposed by governmental
regulators or private governing bodies could also affect our reported results
of
operations.
We
are
subject to the Fair Labor Standards Act, which governs such matters as minimum
wage, overtime and other working conditions, along with the Americans with
Disabilities Act, various family leave mandates and a variety of other laws
enacted, or rules and regulations promulgated, by federal, state and local
governmental authorities that govern these and other employment
matters. We have experienced and expect further increases in payroll
expenses as a result of federal and state mandated increases in the minimum
wage, and although such increases are not expected to be material, there may
be
material increases in the future. In addition, our vendors may be affected
by
higher minimum wage standards, which may increase the price of goods and
services they supply to us.
Litigation
from customers, franchisees, employees and others could harm our reputation
and
impact operating results.
Claims
of
illness or injury relating to food quality or food handling are common in the
quick-service restaurant industry. In addition, class action lawsuits
have been filed, and may continue to be filed, against various quick-service
restaurants alleging, among other things, that quick-service restaurants have
failed to disclose the health risks associated with high-fat foods and that
quick-service restaurants’ marketing practices have encouraged
obesity. In addition to decreasing our sales and profitability and
diverting management resources, adverse publicity or a substantial judgment
against us could negatively impact our reputation, hindering the ability to
attract and retain qualified franchisees, and grow the business.
Further,
we may be subject to employee, franchisee and other claims in the future based
on, among other things, discrimination, harassment, wrongful termination and
wage, rest break and meal break issues, including those relating to overtime
compensation.
We
may not be able to adequately protect our intellectual property, which could
decrease the value of our brand and products.
The
success of our business depends on
the continued ability to use existing trademarks, service marks and other
components of our brand in order to increase brand awareness and further develop
branded products. All of the steps we have taken to protect our
intellectual property may not be adequate.
Ownership
and leasing of significant amounts of real estate exposes us to possible
liabilities and losses.
We
own or
lease the land and building for all Partner Drive-Ins. Accordingly,
we are subject to all of the risks associated with owning and leasing real
estate. In particular, the value of our assets could decrease and our
costs could increase because of changes in the investment climate for real
estate, demographic trends and supply or demand for the use of our drive-ins,
which may result from competition from similar restaurants in the area, as
well
as liability for environmental conditions. We generally cannot cancel
the leases, so if an existing or future Sonic Drive-In is not profitable, and
we
decide to close it, we may nonetheless be committed to perform our obligations
under the applicable lease including, among other things, paying the base rent
for the balance of the lease term. In addition, as each of the leases
expires, we may fail to negotiate renewals, either on commercially acceptable
terms or at all, which could cause us to close drive-ins in desirable
locations.
Catastrophic
events may disrupt our business.
Unforeseen
events, including war, terrorism and other international conflicts, public
health issues, and natural disasters such as hurricanes, earthquakes, or other
adverse weather and climate conditions, whether occurring in the United States
or abroad, could disrupt our operations, disrupt the operations of franchisees,
suppliers or customers, or result in political or economic
instability. These events could reduce demand for our products or
make it difficult or impossible to receive products from suppliers.
None.
Of
the
654
Partner
Drive-Ins operating as of August 31, 2007, we operated
273
of them on property
leased from third-parties and
381 of them on property we
own. The leases expire on dates ranging from 2007 to 2027, with the
majority of the leases providing for renewal options. All leases
provide for specified monthly rental payments, and some of the leases call
for
additional rentals based on sales volume. All leases require Sonic to
maintain the property and pay the cost of insurance and taxes.
Our
corporate headquarters are located
in the Bricktown district of downtown Oklahoma City. We have a
15-year lease to occupy approximately 78,000 square feet. The lease
expires in November 2018 and has two five-year renewal options. Sonic
believes its properties are suitable for the purposes for which they are being
used.
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.
Sonic
did not submit any matter during
the fourth quarter of the Company’s last fiscal year to a vote of Sonic’s
stockholders, through the solicitation of proxies or otherwise.
Identification
of Executive Officers
The
following table identifies the
executive officers of the Company:
|
Name
|
Age
|
Position
|
Executive
Officer
Since
|
|
J.
Clifford Hudson
|
52
|
Chairman
of the Board of Directors, Chief Executive Officer and
President
|
June
1985
|
|
W.
Scott McLain
|
45
|
Executive
Vice President of Sonic Corp. and President of Sonic Industries Services
Inc.
|
April
1996
|
|
Michael
A. Perry
|
49
|
President
of Sonic Restaurants, Inc.
|
August
2003
|
|
Stephen
C. Vaughan
|
41
|
Vice
President and Chief Financial Officer
|
January
1996
|
|
V.
Todd Townsend
|
43
|
Vice
President and Chief Marketing Officer
|
August
2005
|
|
Paige
S. Bass
|
38
|
Vice
President and General Counsel
|
January
2007
|
|
Carolyn
C. Cummins
|
49
|
Vice
President of Compliance and Corporate Secretary
|
April
2004
|
|
Claudia
San Pedro
|
38
|
Vice
President of Investor Relations and Treasurer
|
January
2007
|
|
Terry
D. Harryman
|
42
|
Controller
|
January
1999
|
Business
Experience
The
following sets forth the business
experience of the executive officers of the Company for at least the past five
years:
J.
Clifford Hudson has served as the
Company’s Chairman of the Board since January 2000 and Chief Executive Officer
since April 1995. Mr. Hudson served as President of the Company from
April 1995 to January 2000 and reassumed that position in November
2004. He has served in various other offices with the Company since
1984. Mr. Hudson has served as a Director of the Company since 1993.
Mr. Hudson has served on the Board of Trustees of the Ford Foundation since
January 2006 and on the Board of Trustees of the National Trust for Historic
Preservation since January 2001, where he now serves as Chairman of the
Board. He served as Chairman of the Board of Securities Investor
Protection Corporation, the federally-chartered organization which serves as
the
insurer of customer accounts with brokerage firms, from 1994 to
2001.
W.
Scott McLain has served as Executive
Vice President of the Company and President and Director of Sonic Industries
Services Inc. since September 2004. He served as the Company’s
Executive Vice President and Chief Financial Officer from January 2004 until
November 2004 and as the Company’s Senior Vice President and Chief Financial
Officer from January 2000 until January 2004. Mr. McLain served as
the Company’s Vice President of Finance and Chief Financial Officer from August
1997 until January 2000.
Michael
A. Perry has served as
President and Director of Sonic Restaurants, Inc. since September
2004. He served as Senior Vice President of Operations and Director
of Sonic Restaurants, Inc. from August 2003 until September 2004. Mr.
Perry served as Vice President of Franchise Services of Sonic Industries
Services Inc. from September 1998 until August 2003.
Stephen
C. Vaughan has served as Vice
President and Chief Financial Officer of the Company since November
2004. Mr. Vaughan also served as Treasurer of the Company from
November 2004 until April 2005. Mr. Vaughan served as Vice President
of Planning and Analysis and Treasurer from November 2001 until November 2004
and served as Vice President of Planning and Analysis from January 1999 until
November 2001. He joined the Company in 1992.
V.
Todd Townsend has served as Vice
President and Chief Marketing Officer of the Company since joining the Company
in August 2005. Mr. Townsend served as Vice President of Marketing for Yahoo!
Inc. from 2004 until joining the Company in 2005. Mr. Townsend served
as Assistant Vice President of Marketing for Sprint Corp. from 2001 until 2003
and as
Senior Director
of
Marketing for Sprint Corp.
from 2000 until 2001.
Paige
S. Bass has served as Vice
President and General Counsel of the Company since January 2007. Ms.
Bass joined the Company as Associate General Counsel in April
2004. Prior to joining the Company, Ms. Bass was employed
seven
years
as an associate with the law firm of Crowe & Dunlevy in Oklahoma City,
Oklahoma.
Carolyn
C. Cummins has served as the
Company’s Corporate Secretary since January 2007 and as the Company’s Vice
President of Compliance since April 2004. Ms. Cummins has also served
as Assistant General Counsel since joining the Company in January
1999.
Claudia
San Pedro has served as Vice
President of Investor Relations and Treasurer of the Company since January
2007
and as Treasurer of Sonic Industries Services Inc. since November
2006. She served as the Director of the Oklahoma Office of State
Finance from June 2005 through November 2006. From July 2003 to May
2005, Ms. San Pedro served as the Budget Division Director for the Office of
State Finance. From September 2000 until June 2003, Ms. San Pedro
served as the Assistant Fiscal Staff Director and Education Fiscal Analyst
for
the Oklahoma State Senate.
Terry
D. Harryman has served as the
Company’s Controller since January 1999. Mr. Harryman has also served
as the Controller of Sonic Restaurants, Inc. and Sonic Industries Services
Inc.
since January 2002. He served as Assistant Treasurer of Sonic
Restaurants, Inc. and Sonic Industries Services Inc. from October 1996 until
January 2002. Mr. Harryman joined the Company in 1996.
PART
II
Market
Information
The
Company’s common stock trades on
the Nasdaq National Market (“Nasdaq”) under the symbol “SONC.” The following
table sets forth the high and low closing bids for the Company’s common stock
during each fiscal quarter within the two most recent fiscal years as reported
on Nasdaq. Share amounts set forth below and elsewhere in this report
have been adjusted to reflect the results of the April 2006 three-for-two stock
split.
|
Fiscal
Year Ended August 31, 2007
|
High
|
Low
|
Fiscal
Year Ended August 31, 2006
|
High
|
Low
|
|
First
Quarter
|
$24.02
|
$21.63
|
First
Quarter
|
$19.94
|
$17.99
|
|
Second
Quarter
|
$
24.35
|
$21.50
|
Second
Quarter
|
$
21.73
|
$18.33
|
|
Third
Quarter
|
$24.96
|
$20.60
|
Third
Quarter
|
$23.48
|
$20.83
|
|
Fourth
Quarter
|
$24.71
|
$20.29
|
Fourth
Quarter
|
$22.40
|
$19.07
|
Stockholders
As
of October 16, 2007, the Company had
629 record holders of its common stock.
Dividends
The
Company did not pay any cash
dividends on its common stock during its two most recent fiscal years and does
not intend to pay any dividends in the foreseeable future as profits are
reinvested in the Company to fund expansion of its business, acquisition of
Franchise Drive-Ins, repurchases of the Company’s common stock, and payments
under the Company’s financing arrangements. As in the past, future
payment of dividends will be considered after reviewing, among other factors,
returns to stockholders, profitability expectations and financing
needs.
Issuer
Purchases of Equity Securities
Shares
repurchased during the fourth quarter of fiscal 2007 are as follows (in
thousands, except per share amounts):
|
Period
|
Total
Number of Shares
Purchased
(a)
|
Average
Price Paid per
Share
(b)
|
Total
Number of Shares Purchased as Part of Publicly Announced Plans
or Programs
(1)
(c)
|
Maximum
Dollar Value that May Yet Be Purchased Under the
Program
(d)
|
|
June
1, 2007 through June 30, 2007
|
890
|
$21.36
|
890
|
$20,425
|
|
July
1, 2007 through July 31, 2007
|
942
|
$21.68
|
942
|
$2
|
|
August
1, 2007 through August 31, 2007
|
1,481
|
$21.90
|
1,481
|
$42,571
|
|
Total
|
3,313
|
$21.89
|
3,313
|
(1) All
of the shares purchased during the fourth quarter of fiscal 2007 were purchased
as part of the Company’s share repurchase program which was first publicly
announced on April 14, 1997. In August 2007, the Company’s Board of
Directors approved an additional $75 million under the Company’s stock
repurchase authorization and extended the program to August 31,
2008.
The
following table sets forth selected
financial data regarding the Company’s financial condition and operating
results. One should read the following information in conjunction
with “Management’s Discussion and Analysis of Financial Condition and Results of
Operations,” below, and the Company’s Consolidated Financial Statements included
elsewhere in this report.
[The
Remainder of this Page Intentionally Left Blank]
Selected
Financial Data
(In
thousands, except per share data)
|
Year
ended August 31,
|
||||||||||||||||||||
|
2007
|
2006
|
2005
(1)
|
2004
(1)
|
2003
(1)
|
||||||||||||||||
|
Income
Statement Data:
|
||||||||||||||||||||
|
Partner
Drive-In sales
|
$ |
646,915
|
$ |
585,832
|
$ |
525,988
|
$ |
449,585
|
$ |
371,518
|
||||||||||
|
Franchise
Drive-Ins:
|
||||||||||||||||||||
|
Franchise
royalties
|
111,052
|
98,163
|
88,027
|
77,518
|
66,431
|
|||||||||||||||
|
Franchise
fees
|
4,574
|
4,747
|
4,311
|
4,958
|
4,674
|
|||||||||||||||
|
Other
|
7,928
|
4,520
|
4,740
|
4,385
|
4,017
|
|||||||||||||||
|
Total
revenues
|
770,469
|
693,262
|
623,066
|
536,446
|
446,640
|
|||||||||||||||
|
Cost
of Partner Drive-In sales
|
520,176
|
468,627
|
421,906
|
358,859
|
291,764
|
|||||||||||||||
|
Selling,
general and administrative
|
58,736
|
52,048
|
47,503
|
44,765
|
41,061
|
|||||||||||||||
|
Depreciation
and amortization
|
45,103
|
40,696
|
35,821
|
32,528
|
29,223
|
|||||||||||||||
|
Provision
for impairment of long-lived
|
||||||||||||||||||||
|
assets
|
1,165
|
264
|
387
|
675
|
727
|
|||||||||||||||
|
Total
expenses
|
625,180
|
561,635
|
505,617
|
436,827
|
362,775
|
|||||||||||||||
|
Income
from operations
|
145,289
|
131,627
|
117,449
|
99,619
|
83,865
|
|||||||||||||||
|
Debt
extinguishment and other costs
|
6,076
|
─
|
─
|
─
|
─
|
|||||||||||||||
|
Interest
expense, net
|
38,330
|
7,578
|
5,785
|
6,378
|
6,216
|
|||||||||||||||
|
Income
before income taxes
|
$ |
100,883
|
$ |
124,049
|
$ |
111,664
|
$ |
93,241
|
$ |
77,649
|
||||||||||
|
Net
income
|
$ |
64,192
|
$ |
78,705
|
$ |
70,443
|
$ |
58,031
|
$ |
47,801
|
||||||||||
|
Income
per share
(2)
:
|
||||||||||||||||||||
|
Basic
|
$ |
0.94
|
$ |
0.91
|
$ |
0.78
|
$ |
0.65
|
$ |
0.55
|
||||||||||
|
Diluted
|
$ |
0.91
|
$ |
0.88
|
$ |
0.75
|
$ |
0.63
|
$ |
0.52
|
||||||||||
|
Weighted
average shares used in calculation
(2)
:
|
||||||||||||||||||||
|
Basic
|
68,019
|
86,260
|
89,992
|
88,970
|
87,698
|
|||||||||||||||
|
Diluted
|
70,592
|
89,239
|
93,647
|
92,481
|
91,365
|
|||||||||||||||
|
Balance
Sheet Data:
|
||||||||||||||||||||
|
Working
capital (deficit)
|
$ | (40,784 | ) | $ | (35,585 | ) | $ | (30,093 | ) | $ | (14,537 | ) | $ | (2,875 | ) | |||||
|
Property,
equipment and capital leases, net
|
529,993
|
477,054
|
422,825
|
376,315
|
345,551
|
|||||||||||||||
|
Total
assets
|
758,520
|
638,018
|
563,316
|
518,633
|
486,119
|
|||||||||||||||
|
Obligations
under capital leases (including current portion)
|
39,318
|
36,625
|
38,525
|
40,531
|
27,929
|
|||||||||||||||
|
Long-term
debt (including current portion)
|
710,743
|
122,399
|
60,195
|
82,169
|
139,587
|
|||||||||||||||
|
Stockholders’
equity (deficit)
|
(106,802 | ) |
391,693
|
387,917
|
337,900
|
267,733
|
||||||||||||||
|
Cash
dividends declared per common share
|
─
|
─
|
─
|
─
|
─
|
|||||||||||||||
(1) Previously
reported prior-year results have been adjusted to implement SFAS 123R on a
modified retrospective basis.
(2) Adjusted
for three-for-two stock splits in 2006 and 2004.
Overview
Description
of the Business
.
Sonic operates and franchises the
largest chain of drive-ins in the United States. As of August 31,
2007, the Sonic system was comprised of 3,343 drive-ins, of which 20% or 654
were Partner Drive-Ins and 80% or 2,689 were Franchise
Drive-Ins. Sonic Drive-Ins feature signature menu items such as
specialty soft drinks and frozen desserts, made-to-order sandwiches and a unique
breakfast menu. 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 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
.
Business fundamentals at the drive-in
level continued to be strong during fiscal year 2007. Cumulative
results for the year, however, were impacted by costs associated with the
financing of the Company’s tender offer and other share repurchase activities
which have collectively resulted in the repurchase of approximately 30% of
the
Company’s outstanding stock during the year ended August 31,
2007. While the tender offer was dilutive to earnings per share in
the first two quarters of fiscal 2007, it was accretive to third and fourth
quarter earnings per share and is expected to continue to be accretive in the
future. Net income for the year decreased 18.4%, while earnings per share
increased 3.4% to $0.91 per diluted share from $0.88 in the previous
year. The Company’s earnings were reduced by debt extinguishment
charges related primarily to Sonic’s tender offer and financing activities
during fiscal year 2007, which totaled $0.05 per diluted share for the
year. Excluding these special charges, net income per diluted share
was $0.96 for fiscal year 2007, reflecting a 9.1% increase versus the prior
year. The Company believes this non-GAAP measure of net income per
diluted share before special items provides for comparability to prior year
net
income per diluted share, and is useful in assessing ongoing operations
performance.
We
continue to experience considerable momentum in our business fueled by solid
growth in same-store sales that led to an increase in system-wide drive-in
level
average profits. In turn, the rise in store-level profits, which have
grown handsomely over the last four years, helped produce an increase in the
number of new drive-in openings by franchisees. We believe these
results reflect our multi-layered growth strategy that features the following
components:
|
·
|
Solid
same-store sales growth;
|
|
·
|
Expansion
of the Sonic brand through new unit growth, particularly by
franchisees;
|
|
·
|
Increased
franchising income stemming from franchisee new unit growth, solid
same-store sales growth and our unique ascending royalty
rate;
|
|
·
|
Operating
leverage at both the drive-in level and the corporate level;
and
|
|
·
|
The
use of excess operating cash flow and issuance of new debt for share
repurchases and franchise
acquisitions.
|
The
following table provides information regarding the number of Partner Drive-Ins
and Franchise Drive-Ins in operation as of the end of the periods indicated
as
well as the system-wide growth in sales and average unit volume. System-wide
information includes both Partner Drive-In and Franchise Drive-In information,
which we believe is useful in analyzing the growth of the brand as well as
the
Company’s revenues since franchisees pay royalties based on a percentage of
sales.
|
System-Wide
Performance
($
in thousands)
|
||||||||||||
|
Year
Ended August 31,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
Percentage
increase in sales
|
8.6 | % | 10.7 | % | 12.4 | % | ||||||
|
System-wide
drive-ins in operation
(1)
:
|
||||||||||||
|
Total
at beginning of
period
|
3,188
|
3,039
|
2,885
|
|||||||||
|
Opened
|
175
|
173
|
175
|
|||||||||
|
Closed
(net of
re-openings)
|
(20 | ) | (24 | ) | (21 | ) | ||||||
|
Total
at end of
period
|
3,343
|
3,188
|
3,039
|
|||||||||
|
Core
markets
(2)
|
2,500
|
2,435
|
2,165
|
|||||||||
|
Developing
markets
(2)
|
843
|
753
|
874
|
|||||||||
|
All markets
|
3,343
|
3,188
|
3,039
|
|||||||||
|
Average
sales per drive-in:
|
||||||||||||
|
Core
markets
|
$ |
1,145
|
$ |
1,105
|
$ |
1,059
|
||||||
|
Developing
markets
|
998
|
954
|
934
|
|||||||||
|
All markets
|
1,109
|
1,070
|
1,023
|
|||||||||
|
Change
in same-store sales
(3)
:
|
||||||||||||
|
Core
markets
|
3.6 | % | 5.3 | % | 5.6 | % | ||||||
|
Developing
markets
|
1.2
|
1.5
|
7.4
|
|||||||||
|
All markets
|
3.1
|
4.5
|
6.0
|
|||||||||
|
(1)
Drive-ins that are temporarily closed for various reasons (repairs,
remodeling, relocations, etc.) are not considered closed unless the
Company determines that they are unlikely to reopen within a reasonable
time.
(2)
Markets are identified based on television viewing areas and further
classified as core or developing markets based upon number of drive-ins
in
a market and the level of advertising support. Market classifications
are updated periodically.
(3)
Represents percentage change for drive-ins open for a minimum of
15
months.
|
||||||||||||
System-wide
same-store sales increased 3.1% during fiscal year 2007 as a result of growth
in
average check, offset somewhat by a slight decrease in traffic (number of
transactions per drive-in). The increase in average check was the result of
price increases, as well as the success of the pay-at-your-stall (PAYS) program,
which has increased credit and debit card transactions that, on average, exceed
the average cash transaction. We believe our strong sales performance
is a direct result of our specific sales-driving initiatives including, but
not
limited to:
|
·
|
Continued
growth of our business in non-traditional day parts including the
morning,
afternoon, and evening day parts;
|
|
·
|
Use
of technology to reach customers and improve the customer
experience;
|
|
·
|
Monthly
promotions and new product news focused on quality and expanded choice
for
our customers;
|
|
·
|
Growth
in brand awareness through increased media spending and greater use
of
network cable advertising; and
|
|
·
|
The
ongoing physical retrofit of drive-ins with a new
look.
|
Looking
forward, these strategies are expected to continue to positively impact our
business. We expect revenue growth of between 10% and 12% for fiscal
year 2008, based upon targeted same-store sales growth in the range of 2% to
4%,
with Partner Drive-In sales growth expected to be slightly ahead of this
range.
We
continue to use our monthly promotions to highlight our distinctive food
offerings and to feature new products.
We also use our promotions
and new 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 past year, our new product offerings
showcased the breadth of our menu and emphasized the opportunity for choice
at
Sonic. 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.
During
fiscal year 2007, our system-wide media expenditures were approximately $175
million as compared to $145 million in fiscal year 2006, which we believe
continues to increase overall brand awareness. We also continued to
spend approximately one-half of our marketing dollars on system-wide marketing
fund efforts, which are largely used for network cable television advertising,
growing this area of our advertising from approximately $72 million in fiscal
year 2006 to approximately $90 million in fiscal year 2007. We
believe increased network cable advertising provides several benefits including
the ability to more effectively target and better reach the cable audience,
which has now surpassed broadcast networks in terms of viewership. In
addition, national cable advertising also allows us to bring additional depth
to
our media and expand our message beyond our traditional emphasis on a single
monthly promotion. Looking forward, we expect system-wide media
expenditures to be approximately $190 million in fiscal 2008, with the
system-wide marketing fund representing approximately one-half of total media
expenditures.
We
continue to make investments to upgrade the exterior look of our drive-ins
including a retrofit and the use of new electronic signage. The new
retrofit features several new elements including an upgraded building exterior,
new more energy-efficient lighting, a significantly enhanced patio area, and
improved menu housings. We completed the retrofit of over 100 Partner
Drive-Ins before fiscal year 2007. During fiscal year 2007, the
retrofit was completed at 326 Franchise Drive-Ins and 173 Partner
Drive-Ins. The retrofit of the entire Sonic system is expected to
occur over the next three to four years, with an additional 600 to 700 Franchise
Drive-Ins and 150 Partner Drive-Ins expected to be retrofitted during fiscal
year 2008.
Sonic
opened 175 new drive-ins during fiscal year 2007, consisting of 29 Partner
Drive-Ins and 146 Franchise Drive-Ins, a slight increase overall from 173
drive-in openings during fiscal year 2006 (35 Partner Drive-Ins and 138
Franchise Drive-Ins). Looking forward, the Company expects to open
180 to 200 new drive-ins during fiscal year 2008, including 155 to 165 by
franchisees.
Results
of Operations
Revenues
.
Total
revenues increased 11.1% to $770.5 million in fiscal year 2007 from $693.3
million during fiscal year 2006. The increase in revenues primarily
relates to solid sales growth for Partner Drive-Ins and a rise in franchise
royalties.
|
Revenues
|
||||||||||||||||
|
($
in thousands)
|
||||||||||||||||
|
Percent
|
||||||||||||||||
|
Increase/
|
Increase/
|
|||||||||||||||
|
Year
Ended August 31,
|
2007
|
2006
|
(Decrease)
|
(Decrease)
|
||||||||||||
|
Revenues:
Partner
Drive-In sales
|
$ |
646,915
|
$ |
585,832
|
$ |
61,083
|
10.4 | % | ||||||||
|
Franchise
revenues:
Franchise
royalties
|
111,052
|
98,163
|
12,889
|
13.1
|
||||||||||||
|
Franchise fees
|
4,574
|
4,747
|
(173 | ) | (3.6 | ) | ||||||||||
|
Other
|
7,928
|
4,520
|
3,408
|
75.4
|
||||||||||||
|
Total revenues
|
$ |
770,469
|
$ |
693,262
|
$ |
77,207
|
11.1
|
|||||||||
|
Percent
|
||||||||||||||||
|
Increase/
|
Increase/
|
|||||||||||||||
|
Year
Ended August 31,
|
2006
|
2005
|
(Decrease)
|
(Decrease)
|
||||||||||||
|
Revenues:
Partner
Drive-In sales
|
$ |
585,832
|
$ |
525,988
|
$ |
59,844
|
11.4 | % | ||||||||
|
Franchise
revenues:
Franchise
royalties
|
98,163
|
88,027
|
10,136
|
11.5
|
||||||||||||
|
Franchise fees
|
4,747
|
4,311
|
436
|
10.1
|
||||||||||||
|
Other
|
4,520
|
4,740
|
(220 | ) | (4.6 | ) | ||||||||||
|
Total revenues
|
$ |
693,262
|
$ |
623,066
|
$ |
70,196
|
11.3
|
|||||||||
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
following table reflects the increase in Partner Drive-In sales by type of
activity for fiscal year 2007 and 2006:
The
increase in Partner Drive-In sales for both fiscal year 2007 and 2006 was
primarily driven by the opening of newly constructed
drive-ins. Looking forward, we anticipate opening approximately 25 to
35 Partner Drive-Ins during fiscal year 2008. Same-store sales at
Partner Drive-Ins increased 2.5% in fiscal year 2007 and 1.9% in fiscal year
2006, which also contributed to the increase in total Partner Drive-In
sales. These increases also reflect the positive impact of increasing
average sales per drive-in of 3.8% for 2007 and 2.4% for 2006.
The
following table reflects the growth in franchise 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
royalties increased 13.1% to $111.1 million in fiscal year 2007, compared
to
$98.2 million in fiscal year 2006. Of the $12.9 million increase,
approximately $8.0 million resulted from Franchise Drive-Ins’ same-store sales
growth of 3.3% in fiscal year 2007, combined with an increase in the effective
royalty rate to 3.75% during fiscal year 2007 compared to 3.59% during fiscal
year 2006. 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 attributable to growth in
the number of Franchise Drive-Ins over the prior period.
Franchise
royalties were positively impacted during the latter half of fiscal year
2007
when franchisees opted to convert approximately 790 older license agreements
to
a newer form of license agreement. The conversion license provides a
20 year term and for payment of a higher royalty rate than in the previous
agreement. The rate for the converted licenses was effective April 1,
2007, and we estimate the total benefit for the last half of the fiscal
year was between $1.5 to $2.0 million. Looking forward,
franchise royalties will continue to be impacted positively by this
conversion. The benefit to the first half of fiscal year 2008 is
expected to be approximately $1.5 million in additional royalties.
Franchise
royalties increased 11.5% to $98.1 million in fiscal year 2006, compared
to
$88.0 million in fiscal year 2005. Of the $10.1 million increase,
approximately $6.1 million resulted from Franchise Drive-Ins’ same-store sales
growth of 5.1% in fiscal year 2006, combined with an increase in the effective
royalty rate to 3.59% during fiscal year 2006 compared to 3.56% during fiscal
year 2005. The balance of the increase was attributable to growth in
the number of Franchise Drive-Ins over the prior period.
Franchisees
opened 146 new drive-ins in fiscal year 2007, up from 138 new drive-ins in
fiscal year 2006. Despite the increase in new drive-in openings,
franchise fees decreased 3.6% to $4.6 million as a result of approximately
$0.3
million more in fees recognized in fiscal year 2006 from terminations of
area
development agreements. These terminations were due to an initiative
to strengthen the franchise development pipeline by terminating non-performing
agreements and were the primary reason for the 10.1% increase in franchise
fees
to $4.7 million in fiscal year 2006, when franchisees opened 138 new drive-ins
in both fiscal years 2006 and 2005.
As
of
August 31, 2007, we had 173 area development agreements representing 908
planned
Franchise Drive-In openings over the next few years, compared to 152 such
agreements at August 31, 2006 which represented approximately 576 planned
Franchise Drive-In openings. We anticipate 155 to 165 store openings
by franchisees during fiscal year 2008. As a result of these new
Franchise Drive-In openings, the impact of the conversion of older license
agreements, and the continued benefit of the ascending royalty rate contained
in
all license agreements, we expect approximately $13 to $15 million in
incremental franchise fees and royalties in fiscal year 2008.
Other
income increased 75.4% to $7.9 million in fiscal year 2007 from $4.5 million
in
fiscal year 2006. The increase relates primarily to the net favorable
impact of non-income tax matters and an approximately $2.0 million gain on
the
sale of real estate to a franchisee. Looking forward, other income is
anticipated in the range of $0.8 million to $1.0 million per quarter during
fiscal year 2008.
Operating
Expenses
.
Overall, drive-in cost of operations, as
a percentage of Partner Drive-In sales, increased to 80.3% in fiscal year
2007
from 80.0% in fiscal year 2006. 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 decreased by 0.2 percentage points during fiscal year 2007
compared to fiscal year 2006 following a decrease of 0.3 percentage points
during fiscal year 2006 compared to fiscal year 2005. The
decrease for fiscal year 2007 relates primarily to price increases that more
than offset generally higher commodity pricing, particularly for dairy, soybean
oil and packaging. The improvement for fiscal year 2006 relates
primarily to lower dairy costs and a favorable shift in product mix to drinks
and ice cream, which have more favorable margins than other menu
items. Looking forward, commodity pressures are expected to ease in
the second half of fiscal year 2008.
Labor
costs increased by 0.4 percentage points during fiscal year 2007 compared
to
fiscal year 2006 after a decrease of 0.3 percentage points during fiscal
year
2006 compared to fiscal year 2005. The increase for fiscal year 2007
was a result of federal and state minimum wage increases, which was partially
offset by price increases. The improvement for fiscal year 2006 was
primarily a result of leverage from higher sales volumes. Looking
forward, wage rates are expected to continue to increase as a result of federal
and state minimum wage legislation. While the Company expects to
mitigate some of the increase with menu price increases, it is likely that
labor
costs, as a percentage of sales, will rise during fiscal year 2008.
Minority
interest, which reflects our store-level partners’ pro-rata share of earnings
through our partnership program, increased by $1.4 million during fiscal
year
2007. While these costs increased in real terms during fiscal year
2007, they declined as a percentage of Partner Drive-In sales reflecting
our
partners’ share of the increased operating costs experienced during the
period. During fiscal year 2006, minority interest increased $3.7
million, 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 fiscal year
2007. Since we expect our average store level profits to continue to
grow in fiscal year 2008, we expect minority interest to continue to increase
in
dollar terms.
Other
operating expenses increased by 0.3 percentage points during fiscal year
2007
after an increase of 0.2 percentage points during fiscal year
2006. The increase in fiscal year 2007 relates to a number of items,
including higher credit card fees due to increasing credit card sales and
higher
repair and maintenance costs. Leverage from higher sales partially
offset increased utility costs resulting from higher energy prices in fiscal
year 2006. Looking forward, we expect increases in credit card fees
to continue, which is expected to be offset by leverage from higher sales
to
result in flat to slightly favorable other operating expenses, as a percentage
of sales, on a year-over-year basis, in fiscal year 2008.
To
summarize, we are expecting leverage from higher sales and operations
initiatives to result in slightly favorable overall restaurant-level margins
during fiscal year 2008 on a year-over-year basis, primarily in the second
half
of the year.
Selling,
General and Administrative (“SG&A”)
.
SG&A
expenses increased 12.8% to $58.7 million during fiscal year 2007 and 9.6%
to
$52.0 million during fiscal year 2006. The increases in these fiscal
years relate to the addition of headcount and other infrastructure to support
the continued growth of our business. As a percentage of total
revenues, SG&A expenses increased to 7.6% in fiscal year 2007, compared with
7.5% in fiscal year 2006 and 7.6% in fiscal year 2005. Stock-based
compensation is included in SG&A, and, as of August 31, 2007, total
remaining unrecognized compensation cost related to unvested stock-based
arrangements was $12.9 million and is expected to be recognized over a weighted
average period of 1.6 years. See Note 1 and Note 12 of the Notes to
the Consolidated Financial Statements included in this Form 10-K for additional
information regarding our stock-based compensation. We anticipate
that SG&A costs will increase approximately 10% to 12% in fiscal year 2008
and decline slightly, as a percentage of sales.
Depreciation
and Amortization
.
Depreciation and amortization
expense increased 10.8% to $45.1 million in fiscal year 2007 as a result
of
additional capital expenditures. Depreciation and amortization
expense increased 13.6% to $40.7 million in fiscal year 2006 due, in part,
to
additional depreciation stemming from the Tennessee and Kentucky acquisitions,
as well as the reduction in remaining useful life for certain assets related
to
the retrofit of Partner Drive-Ins in the late 1990s. Capital expenditures
during
fiscal year 2007 for new drive-in construction and continued investment in
existing drive-ins, including retrofit and, in some cases, upgraded signage
were
$110.9 million. An additional $10.8 million was spent for the
acquisition of drive-ins from franchisees. Looking forward, with
approximately $75 to $85 million in capital expenditures planned for the
year, normal depreciation and amortization is expected to increase by
approximately 11% to 13% for the year.
Provision
for Impairment of Long-Lived Assets
.
We assess
drive-in assets for impairment on a quarterly basis under the guidelines
of FAS
144 – “Accounting for the Impairment or Disposal of Long-Lived
Assets.” During fiscal year 2007, three surplus or leased properties
were impaired which resulted in a charge of $0.8 million to reduce the carrying
cost of the properties to estimated fair value. In addition, during
fiscal year 2007, two operating Partner Drive-Ins were impaired resulting
in a
$0.4 million charge for carrying cost in excess of estimated fair value for
the
related assets. The total of these provisions for fiscal year
2007 was $1.2 million. During fiscal year 2006, three surplus
properties became impaired which resulted in a provision for impairment of
$0.3
million for carrying cost in excess of estimated fair value for the
assets. During fiscal year 2005, one operating Partner Drive-In and
one surplus property became impaired which resulted in provision for impairment
of $0.4 million for carrying cost in excess of estimated fair value for the
assets. We continue to perform quarterly analyses of certain
underperforming drive-ins. It is reasonably possible that the estimate of
future
cash flows associated with these drive-ins may change in the near future
resulting in the need to write-down assets associated with one or more of
these
drive-ins to 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
million to $44.4 million in fiscal year 2007 and increased $1.8 million to
$7.6
million in fiscal year 2006. The increase in fiscal year 2007 is the
result of interest on increased borrowings used to fund the purchase of shares
in the Company’s tender offer and subsequent repurchases, as well as $6.1
million in debt extinguishment charges related to financing the Company’s tender
offer and other share repurchase activities. The smaller increase in
net interest expense in fiscal year 2006 resulted from increased borrowings
that
were used largely to fund share repurchases and capital
expenditures. During fiscal year 2008, we expect net interest expense
of approximately $45 to $50 million, but may vary based upon the level
of share repurchases and acquisitions of Franchise Drive-Ins during the
year.
Income
taxes
. The provision for income taxes remained relatively
constant for fiscal year 2007 with an effective federal and state tax rate
of
36.4% compared with 36.6% in fiscal year 2006 and 36.9% in fiscal year 2005.
The
decrease in rate in fiscal year 2007 related to the favorable resolution
of
state tax matters and the retroactive extension of the Work Opportunity Tax
Credit. We expect our tax rate to be in the range of 36.5% to 37.5%
in fiscal year 2008. However, our tax rate may continue to vary
significantly from quarter-to-quarter depending on the timing of option
exercises and dispositions by option-holders and as circumstances on individual
tax matters change.
Financial
Position
During
fiscal year 2007, current assets increased 73.4% to $73.7 million compared
to
$42.5 million as of the end of fiscal year 2006. Cash balances
increased by $29.3 million primarily due to changes in cash processing for
the
securitized cash flows, including consideration of the current portion of
restricted cash of $13.5 million. In addition, the noncurrent portion
of restricted cash of $11.4 million was an increase associated with the
securitized cash flows. Net property, equipment and capital leases
increased by $52.9 million primarily as a result of capital expenditures
of
$112.0 million, capital lease additions of $5.2 million and $10.8 million
for
the acquisition of drive-ins from franchisees. Goodwill increased by
$5.7 million primarily as a result of the acquisition of drive-ins from
franchisees. Debt origination costs increased by $19.8 million as a
result of the costs associated with the securitized debt
transaction. These increases combined with the increase in current
assets resulted in an 18.9% increase in total assets to $758.5 million as
of the
end of fiscal year 2007.
Total
current liabilities increased $36.4 million or 46.6% during fiscal year 2007
primarily as a result of a $15.3 million increase in the current obligations
for
capital leases and debt related to the securitized debt transaction, a $14.4
million accrual for share repurchase obligations that settled in September
and a
$1.6 million increase in gift program liabilities. The noncurrent
portion of long-term debt increased $573.3 million as a result of the debt
used
to fund the repurchase of stock. Overall, total liabilities increased
$619.0 million or 251.3% as a result of the items discussed above.
Stockholders’
equity decreased $498.5 million during fiscal year 2007 primarily resulting
from
the stock repurchase activity during the year. The Company completed
a “modified Dutch auction” tender offer in October 2006, repurchasing 15.9
million shares at a purchase price of $23.00 per share for a total of $366.1
million, and incurred costs related to the transaction totaling $1.2 million
that are included in stockholders’ equity. Subsequent to the tender
offer, additional share repurchases totaling approximately $211.1 million
were
completed under Board-authorized share repurchase initiatives. The
stock repurchase activity was partially offset by earnings during the year
of
$64.2 million and proceeds and the related tax benefits from the exercise
of
stock options.
The
Company considers the non-GAAP measure of debt-to-EBITDA to be a significant
indication of the Company’s financial performance and available capital
resources. This is not a measure of financial performance or
liquidity under generally accepted accounting principles
(“GAAP”). EBITDA is a non-GAAP measure of income and does not include
the effects of interest and taxes, and excludes the “non-cash” effects of all
depreciation and amortization. While management considers EBITDA
useful in analyzing our results, it is not intended to replace any presentation
included in our consolidated financial statements. As of August 31,
2007, our debt-to-EBITDA ratio was 3.9. The following table
reconciles EBITDA to net income as of August 31, 2007 and provides the
components to calculate this ratio:
|
Net
Income
|
$ |
64,192
|
||
|
Provision
for income taxes
|
36,691
|
|||
|
Depreciation
and amortization
|
45,103
|
|||
|
Net
interest expense
|
44,406
|
|||
|
EBITDA
|
$ |
190,392
|
||
|
Obligations
under capital leases (including current portion)
|
$ |
39,318
|
||
|
Long-term
debt (including current portion)
|
710,743
|
|||
|
Total
debt
|
$ |
750,061
|
||
|
Debt-to-EBITDA
|
3.9
|
Liquidity
and Sources of Capital
Operating
Cash Flows
.
Net cash provided by operating
activities decreased $6.5 million or 5.1% to $121.0 million in fiscal year
2007
as compared to $127.5 million in fiscal year 2006. This decrease
results from lower net income excluding non-cash items as a result of increased
interest expense associated with the Company’s increased debt, the segregation
of $9.0 million of operating cash flows at year-end as restricted cash as
a
result of debt requirements, and $5.6 million from termination of a hedge
instrument. These decreases were offset by a significant increase in
operating liabilities related to the amount and timing of tax and other
liability payments, including the effect of an increase in franchise deposits
from franchise development activities.
Investing
Cash Flows.
During fiscal year 2007, we opened 29 newly
constructed Partner Drive-Ins, acquired 15 drive-ins from franchisees and
sold
ten drive-ins to franchisees. For the same period, we used cash
generated from operating activities and borrowings to fund capital additions
of
$110.9 million, which included the cost of newly opened drive-ins, retrofits
of
existing drive-ins, new equipment for existing drive-ins, drive-ins under
construction and other capital expenditures, from cash generated by operating
activities and borrowings. We purchased the real estate for 21 of the
29 newly constructed drive-ins. In addition, the acquisition of 15
drive-ins during fiscal year 2007 resulted in cash outlays of $10.8
million. We also entered into a sale-leaseback agreement during the
first fiscal quarter and disposed of the real estate underlying drive-ins
that
were acquired in the fourth quarter of fiscal year 2006 for proceeds of
approximately $12.6 million. Proceeds from dispositions of assets for the
year
of $13.7 million primarily resulted from sales of other real estate relating
to
drive-ins previously sold to franchisees.
Financing
Cash Flows.
In December 2006, the Company closed on a
securitized financing facility of Variable Rate Series 2006-1 Senior Variable
Funding Notes, Class A-1, which provides for the issuance of up to $200 million
of Variable Funding Notes and certain other credit instruments, including
letters of credit. As of August 31, 2007, our outstanding Variable Funding
Notes
totaled $116.0 million at an effective borrowing rate of 6.4%, as well as
$0.3
million in outstanding letters of credit. The amount available under the
Variable Funding Notes as of August 31, 2007, was $83.7 million. In
addition to the Class A-1 notes, the Company issued $600 million of Fixed
Rate
Series 2006-1 Senior Notes, Class A-2, in a private transaction in December
2006. This new debt has an effective borrowing rate of 6.8%, including debt
issuance costs totaling $24.3 million which were incurred in conjunction
with
the securitized debt transactions closed in December 2006. We believe that
cash
flows from operations will be adequate for repayment of any long-term debt
that
does not get refinanced or extended. We plan to use our Class A-1
notes 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 for additional information regarding our long-term
debt.
The
Class
A-1 and Class A-2 notes are subject to a series of covenants and restrictions
customary for transactions of this type, including (i) required actions to
better secure collateral upon the occurrence of certain performance-related
events, (ii) application of certain disposition proceeds as note prepayments
after a set time is allowed for reinvestment, (iii) maintenance of specified
reserve accounts, (iv) maintenance of certain debt service coverage ratios,
(v)
optional and mandatory prepayments upon change in control, (vi) indemnification
payments for defective or ineffective collateral, and (vii) covenants relating
to recordkeeping, access to information and similar matters. The
Notes are also subject to customary rapid amortization events and events
of
default. Although management does not anticipate an event of default
or any other event of noncompliance with the provisions of the debt, if such
an
event occurred, the unpaid amounts outstanding could become immediately due
and
payable. See Note 1 –
Restricted Cash
of the Notes to
Consolidated Financial Statements for additional information regarding
restrictions on cash.
The
Company’s tender offer in October 2006 resulted in total cash outflow of $366.1
million, along with related costs totaling $1.2 million. In addition to the
shares purchased through the tender offer, the Company has acquired 9.6 million
shares for a total cost of $211.1 million under the share repurchase program
authorized by our Board of Directors. In August 2007, the Board of
Directors authorized an additional $75.0 million under the Company’s share
repurchase program and extended the program through August 31,
2008. As of August 31, 2007, $42.6 million remained available under
the program.
We
plan
capital expenditures of approximately $75 to $85 million in fiscal year 2008,
excluding potential acquisitions and share repurchases. These capital
expenditures primarily relate to the development of additional Partner
Drive-Ins, retrofit of existing Partner Drive-Ins and other drive-in level
expenditures. We expect to fund these capital expenditures through
cash flow from operations and borrowings under the Variable Funding
Notes.
As
of
August 31, 2007, our total cash balance of $50.3 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 Variable Funding
Notes, will meet our needs for the foreseeable future.
Off-Balance
Sheet Arrangements
The
Company has obligations for
guarantees on certain franchisee loans and lease agreements. See Note 15
of the
Notes to Consolidated Financial Statements for additional information about
these guarantees. The Company has no other material off-balance sheet
arrangements.
Contractual
Obligations and Commitments
In
the
normal course of business, Sonic enters into purchase contracts, lease
agreements and borrowing arrangements. Our commitments and
obligations as of August 31, 2007 are summarized in the following
table:
|
Payments
Due by Period
|
||||||||||||||||||||
|
(In
Thousands)
|
||||||||||||||||||||
|
Total
|
Less
than
|
1 – 3 | 3 – 5 |
More
than
|
||||||||||||||||
|
1
Year
|
Years
|
Years
|
5
Years
|
|||||||||||||||||
|
Contractual
Obligations
|
||||||||||||||||||||
|
Long-term
debt
(1)
|
$ |
857,836
|
$ |
54,079
|
$ |
155,041
|
$ |
213,579
|
$ |
435,137
|
||||||||||
|
Capital
leases
|
57,332
|
4,385
|
10,774
|
10,143
|
32,030
|
|||||||||||||||
|
Operating
leases
|
190,174
|
11,948
|
23,606
|
22,661
|
131,959
|
|||||||||||||||
|
Total
|
$ |
1,105,342
|
$ |
70,412
|
$ |
189,421
|
$ |
246,383
|
$ |
599,126
|
||||||||||
(1)
The
fixed-rate interest payments included in the table above assume that all
the
Class A-2 notes will be outstanding for the expected six-year term, and all
other fixed-rate notes will be held to maturity. Interest
payments
associated
with variable-rate debt have not been included in the table. Assuming
that the amounts outstanding under the Class A-1 notes as of August 31, 2007
are
held to maturity, and utilizing interest rates in effect at August 31, 2007,
the
interest payments will be in the range of $7 to $8 million for at least the
next
five years.
Impact
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), the following policies involve a higher degree of risk, judgment and/or complexity.
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), the following policies involve a higher degree of risk, judgment and/or complexity.
Impairment
of Long-Lived Assets
.
We
review Partner Drive-In and other long-lived assets for impairment when events
or circumstances indicate they 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. During fiscal year 2007, we reviewed Partner Drive-ins and
other long-lived assets with combined carrying amounts of $12.5 million in
property, equipment and capital leases for possible impairment, and, our
cash
flow assumptions resulted in impairment charges totaling $1.2 million to
write-down certain assets to their estimated fair value. During the
fourth quarter of fiscal year 2007, we performed our annual assessment of
recoverability of goodwill and other intangible assets and determined that
no
impairment was indicated. As of August 31, 2007, goodwill and
intangible assets totaled $114.0 million. 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 own an
equity interest in the drive-in, which is financed by third
parties. Supervisors and managers are neither employees of Sonic nor
of the drive-in in which they have an ownership interest.
The
minority ownership interests in Partner Drive-Ins of the managers and
supervisors are recorded as a minority interest liability on the Consolidated
Balance Sheets, and their share of the drive-in earnings is reflected as
Minority interest in earnings of Partner Drive-Ins in the Costs and expenses
section of the Consolidated Statements of Income. 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
Company acquires and sells minority interests in Partner Drive-Ins from time
to
time as managers and supervisors buy-out and buy-in to the partnerships or
limited liability companies. If the purchase price of a minority
interest that we acquire 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 is recorded as
a
reduction in purchased goodwill. Any subsequent sale of the minority
interest to another minority partner is recorded as a pro-rata reduction
of
goodwill, 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 recognized in income when we have substantially performed
or
satisfied all material services or conditions relating to the sale of the
franchise and the fees are nonrefundable. 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 10
th
of the
following
month for the new form of license agreement (Number 7) and the 20
th
of the
following
month for all prior forms of license agreement. As a result, we
accrue royalty revenue in the month earned based on estimates of Franchise
Drive-Ins sales. These estimates are based on projections of average
unit volume growth at Franchise Drive-Ins collected from a majority of Franchise
Drive-Ins.
Accounting
for Stock-Based Compensation
.
We account for
stock-based compensation in accordance with Statement of Financial Accounting
Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS
123R”). We estimate the fair value of options granted using the
Black-Scholes option pricing model along with the assumptions shown in Note
12
of Notes to the Consolidated Financial Statements in this Form
10-K. 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 during fiscal year 2007
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.
Leases
.
Certain
Partner Drive-Ins lease land and buildings from third parties. Rent
expense for operating leases is recognized on a straight-line basis over
the
expected lease term, including cancelable option periods when it is deemed
to be
reasonably assured that we would incur an economic penalty for not exercising
the options. Judgment is required to determine options expected to be
exercised. Within the provisions of certain of our leases, there are
rent holidays and/or escalations in payments over the base lease term, as
well
as renewal periods. The effects of the rent holidays and escalations
are reflected in rent expense on a straight-line basis over the expected
lease
term, including cancelable option periods when appropriate. The lease
term commences on the date when we have the right to control the use of lease
property, which can occur before rent payments are due under the terms of
the
lease. Contingent rent is generally based on sales levels and is
accrued at the point in time we determine that it is probable that such sales
levels will be achieved.
Sonic’s
use of debt directly exposes the Company to interest rate
risk. Floating rate debt, where the interest rate fluctuates
periodically, exposes the Company to short-term changes in market interest
rates. Fixed rate debt, where the interest rate is fixed over the
life of the instrument, exposes the Company to changes in market interest
rates
reflected in the fair value of the debt and to the risk that the Company
may
need to refinance maturing debt with new debt at a higher rate. Sonic
is also exposed to market risk from changes in commodity
prices. Sonic does not utilize financial instruments for trading
purposes. Sonic manages its debt portfolio to achieve an overall
desired position of fixed and floating rates and may employ interest rate
swaps
as a tool to achieve that goal in the future.
Interest
Rate Risk.
At the time the Company filed its Form 10-K for
the year ended August 31, 2006, the Company had refinanced the debt outstanding
as of year-end with variable rate debt and had borrowed additional amounts
for
the tender offer. The market risk disclosure for the prior year
therefore addressed interest rate risk based upon $486 million of variable
rate
debt. Our exposure to interest rate risk at August 31, 2007 is
primarily based on the fixed rate Class A-2 notes with an effective rate
of
5.7%, before amortization of debt-related costs. At August 31, 2007,
the fair value of the Class A-2 notes was estimated at $591.7 million versus
carrying value of $594.4 million (including accrued
interest). Differences between fair value versus carrying value are
attributable to interest rate increases subsequent to when the debt was
originally issued. Should interest rates increase or decrease by one
percentage point, the estimated fair value of the Class A-2 notes would decrease
by approximately $21.9 million or increase by approximately $22.9 million,
respectively. The Class A-1 notes outstanding at August 31, 2007
totaled $116.0 million, with a variable rate of 6.4%. The annual
impact on our results of operations of a one-point interest rate change for
the
balance outstanding at year-end would be approximately $1.2 million before
tax. We have made certain loans to our franchisees totaling $6.2
million as of August 31, 2007. The interest rates on these notes are
generally between 5.0% and 10.5%. We believe the fair market value of
these notes approximates their carrying amount.
Commodity
Price Risk
.
The Company and its franchisees
purchase certain commodities such as beef, potatoes, chicken and dairy
products. These commodities are generally purchased based upon market
prices established with vendors. These purchase arrangements may contain
contractual features that limit the price paid by establishing price floors
or
caps; however, we have not made any long-term commitments to purchase any
minimum quantities under these arrangements. We do not use financial instruments
to hedge commodity prices because these purchase agreements help control
the
ultimate cost.
This
market risk discussion contains forward-looking statements. Actual
results may differ materially from this discussion based upon general market
conditions and changes in financial markets.
The
Company has included the financial
statements and supplementary financial information required by this item
immediately following Part IV of this report and hereby incorporates by
reference the relevant portions of those statements and information into
this
Item 8.
None.
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 the 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.
Management's
Report on Internal Control over Financial Reporting
The
management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting. The Company’s internal
control system was designed to provide reasonable assurance to the Company’s
management and Board of Directors regarding the preparation and fair
presentation of published financial statements. All internal control systems,
no
matter how well designed, have inherent limitations. Therefore, even those
systems determined to be effective can provide only reasonable assurance
with
respect to financial statement preparation and presentation.
The
Company’s management assessed the effectiveness of the Company’s internal
control over financial reporting as of August 31, 2007. In making this
assessment, it used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission in Internal Control—Integrated
Framework. Based on our assessment, we believe that, as of August 31,
2007, the Company’s internal control over financial reporting is effective based
on those criteria.
Report
of Independent Registered Public Accounting Firm
The
Board
of Directors and Stockholders of
Sonic
Corp.
We
have audited Sonic Corp.’s internal control over financial reporting as of
August 31, 2007, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (the COSO criteria). Sonic Corp.’s management is
responsible for maintaining effective internal control over financial reporting,
and for its assessment of the effectiveness of internal control over financial
reporting included in the accompanying Management’s Report on Internal Control
Over Financial Reporting. Our responsibility is to express an opinion
on the effectiveness of the company’s internal control over financial reporting
based on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of
internal control over financial reporting, assessing the risk that a
material weakness exists, testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk, and performing
such other procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our opinion.
A
company’s internal control over financial reporting is a process designed 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. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain
to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary
to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company
are
being made only in accordance with authorizations of management and directors
of
the company; and (3) provide reasonable assurance regarding prevention or
timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls
may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In
our opinion, Sonic Corp. maintained, in all material respects, effective
internal control over financial reporting as of August 31, 2007, based on
the
COSO criteria.
We
also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets
of
Sonic Corp. as of August 31, 2007 and 2006, and the related consolidated
statements of income, retained earnings, and cash flows for each of the three
years in the period ended August 31, 2007 of Sonic Corp. and our report dated
October 17, 2007 expressed an unqualified opinion thereon.
|
|
ERNST
& YOUNG LLP
|
|
|
Oklahoma
City, Oklahoma
October
17, 2007
No
information was required to be
disclosed in a Form 8-K during the Company’s fourth quarter of its 2007 fiscal
year which was not reported.
PART
III
Sonic
has adopted a Code of Ethics for
Financial Officers and a Code of Business Conduct and Ethics that applies
to all
directors, officers and employees. Sonic has posted copies of these codes
on the investor section of its internet website at the internet address:
http://www.sonicdrivein.com.
Information
regarding Sonic’s executive
officers is set forth under Item 4A of Part I of this report. The
other information required by this item is incorporated by reference from
the
definitive proxy statement which Sonic will file with the Securities and
Exchange Commission no later than 120 days after August 31, 2007 (the “Proxy
Statement”), under the captions “Election of Directors” and “Section 16(a)
Beneficial Ownership Reporting Compliance.”
The
information required by this item
is incorporated by reference from the Proxy Statement under the caption
“Executive Compensation – Compensation Discussion and Analysis.”
The
information required by this item
is incorporated by reference from the Proxy Statement under the captions
“Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters” and “Equity Compensation Plan Information
The
information required by this item
is incorporated by reference from the Proxy Statement under the captions
“Certain Relationships and Related Transactions,” “Director Independence,”
“Committees, Compensation, and Meetings of the Board of Directors,” and
“Compensation Committee Interlock and Insider Participation.”
PART
IV
Financial
Statements
The
following consolidated financial
statements of the Company appear immediately following this Item
15:
|
Page
s
|
||
|
Report
of Independent Registered Public Accounting Firm
|
F-1
|
|
|
Consolidated
Balance Sheets at August 31, 2007 and 2006
|
F-2
|
|
|
Consolidated
Statements of Income for each of the three years
|
||
|
in
the period ended August 31, 2007
|
F-4
|
|
|
Consolidated
Statements of Stockholders’ Equity (Deficit) for each
|
||
|
of
the three years in the period ended August 31, 2007
|
F-5
|
|
|
Consolidated
Statements of Cash Flows for each of the three years
|
||
|
in
the period ended August 31, 2007
|
F-6
|
|
|
Notes
to Consolidated Financial Statements
|
F-8
|
Financial
Statement Schedules
The
Company has included the following
schedule immediately following this Item 15:
| Page | ||||||||
|
Schedule
II
|
-
|
Valuation
and Qualifying Accounts
|
F-30 |
The
Company has omitted all other
schedules because the conditions requiring their filing do not exist or
because
the required information appears in Sonic’s Consolidated Financial Statements,
including the notes to those statements.
Exhibits
The
Company has filed the exhibits
listed below with this report. The Company has marked all management
contracts and compensatory plans or arrangements with an asterisk
(*).
3.01.
Certificate of Incorporation of the Company, which the Company hereby
incorporates by reference from Exhibit 3.1 to the Company’s Form S-1
Registration Statement No. 33-37158 filed on October 3, 1990.
3.02.
Certificate of Amendment of Certificate of Incorporation of the Company,
March
4, 1996, which the Company hereby incorporates by reference from Exhibit
3.05 to
the Company’s Form 10-K for the fiscal year ended August 31, 2000.
3.03.
Certificate of Amendment of Certificate of Incorporation of the Company,
January
22, 2002, which the Company hereby incorporates by reference from Exhibit
3.06
to the Company’s Form 10-K for the fiscal year ended August 31,
2002.
3.04.
Certificate
of
Amendment of Certificate of Incorporation of the Company, January 31,
2006
, which the Company hereby incorporates by reference from Exhibit
3.04 to the Company’s Form 10-K for the fiscal year ended August 31, 2006
.
3.05.
Bylaws of the Company, which the Company hereby incorporates by reference
from
Exhibit 3.2 to the Company’s Form S-1 Registration Statement No. 33-37158 filed
on October 3, 1990.
3.06.
Certificate of Designations of Series A Junior Preferred Stock, which the
Company hereby incorporates by reference from Exhibit 99.1 to the Company’s Form
8-K filed on June 17, 1997.
4.01. Specimen
Certificate for Common Stock, which the Company hereby incorporates by
reference
from Exhibit 4.01 to the Company’s Form 10-K for the fiscal year ended August
31, 1999.
10.01. Form
of Sonic Industries Franchising LLC, successor to Sonic Industries Inc.,
License
Agreement (the Number 4 License Agreement), which the Company hereby
incorporates by reference from Exhibit 10.1 to the Company’s Form S-1
Registration Statement No. 33-37158 filed on October 3, 1990.
10.02. Form
of Sonic Industries Franchising LLC, successor to Sonic Industries Inc.,
License
Agreement (the Number 5 License Agreement), which the Company hereby
incorporates by reference from Exhibit 10.2 to the Company’s Form S-1
Registration Statement No. 33-37158 filed on October 3, 1990.
10.03. Form
of Sonic Industries Franchising LLC, successor to Sonic Industries Inc.,
License
Agreement (the Number 4.2 License Agreement and Number 5.1 License Agreement),
which the Company hereby incorporates by reference from Exhibit 10.03 to
the
Company’s Form 10-K for the fiscal year ended August 31, 1994.
10.04. Form
of Sonic Industries Franchising LLC, successor to Sonic Industries Inc.,
License
Agreement (the Number 6 License Agreement), which the Company hereby
incorporates by reference from Exhibit 10.04 to the Company’s Form 10-K for the
fiscal year ended August 31, 1994.
10.05. Form
of Sonic Industries LLC, successor to Sonic Industries Inc., License Agreement
(the Number 6A License Agreement), which the Company hereby incorporates
by
reference from Exhibit 10.05 to the Company’s Form 10-K for the fiscal year
ended August 31, 1998.
10.06. Form
of Sonic Industries Franchising LLC, successor to Sonic Industries Inc.,
License
Agreement (the Number 5.2 License Agreement), which the Company hereby
incorporates by reference from Exhibit 10.06 to the Company’s Form 10-K for the
fiscal year ended August 31, 1998.
10.07. Form
of Sonic Industries Franchising LLC, successor to Sonic Industries Inc.,
License
Agreement (the Number 6NT License Agreement), which the Company hereby
incorporates by reference from Exhibit 10.07 to the Company’s Form 10-K for the
fiscal year ended August 31, 2004.
10.08. Form
of Sonic Industries LLC License Agreement (the Number 4.4/5.4 License
Agreement).
10.09. Form
of Sonic Industries LLC License Agreement (the Number 5.5 License
Agreement).
10.10. Form
of Sonic Industries LLC License Agreement (the Number 7 License
Agreement).
10.11. Form
of Sonic Industries LLC License Agreement (the Number 7NT License
Agreement).
10.12. Form
of Sonic Industries Franchising LLC, successor to Sonic Industries Inc.,
Area
Development Agreement (the Number 6A Area Development Agreement), which
the
Company hereby incorporates by reference from Exhibit 10.05 to the Company’s
Form 10-K for the fiscal year ended August 31, 1995.
10.13. Form
of Sonic Industries LLC Area Development Agreement (the Number 7 Area
Development Agreement).
10.14. Form
of Sonic Industries Services Inc. Sign Lease Agreement, which the Company
hereby
incorporates by reference from Exhibit 10.4 to the Company’s Form S-1
Registration Statement No. 33-37158.
10.15. Form
of General Partnership Agreement, Limited Liability Company Operating Agreement
and Master Agreement, which the Company hereby incorporates by reference
from
Exhibit 10.09 to the Company’s Form 10-K for fiscal year ended August 31,
2003.
10.16. 1991
Sonic Corp. Stock Option Plan, which the Company hereby incorporates by
reference from Exhibit 10.5 to the Company’s Form S-1 Registration Statement No.
33-37158.
*
10.17. 1991
Sonic Corp. Stock Purchase Plan, which the Company hereby incorporates
by
reference from Exhibit 10.6 to the Company’s Form S-1 Registration Statement No.
33-37158.
*
10.18. 1991
Sonic Corp. Directors’ Stock Option Plan, which the Company hereby incorporates
by reference from Exhibit 10.08 to the Company’s Form 10-K for the fiscal year
ended August 31, 1991.
*
10.19. Sonic
Corp. Savings and Profit Sharing Plan, which the Company hereby incorporates
by
reference from Exhibit 10.8 to the Company’s Form S-1 Registration Statement No.
33-37158.
*
10.20. Net
Revenue Incentive Plan, which the Company hereby incorporates by reference
from
Exhibit 10.19 to the Company’s Form S-1 Registration Statement No.
33-37158.
*
10.21. Form
of Indemnification Agreement for Directors, which the Company hereby
incorporates by reference from Exhibit 10.7 to the Company’s Form S-1
Registration Statement No. 33-37158.
*
10.22. Form
of Indemnification Agreement for Officers, which the Company hereby incorporates
by reference from Exhibit 10.14 to the Company’s Form 10-K for the fiscal year
ended August 31, 1995.
*
10.23. Employment
Agreement with J. Clifford Hudson dated August 20, 1996, which the Company
hereby incorporates by reference from Exhibit 10.18 to the Company’s Form 10-K
for the fiscal year ended August 31, 2002.
*
10.24. Employment
Agreement with W. Scott McLain dated January 27, 1998, which the Company
hereby
incorporates by reference from Exhibit 10.21 to the Company’s Form 10-K for the
fiscal year ended August 31, 2002.
*
10.25.
Employment Agreement with Michael A. Perry dated August 20, 2003, which
the
Company hereby incorporates by reference from Exhibit 10.22 to the Company’s
Form 10-K for the fiscal year ended August 31, 2003.
*
10.26. Employment
Agreement with Stephen C. Vaughan dated August 20, 1996, which the Company
hereby incorporates by reference from Exhibit 10.23 to the Company’s Form 10-K
for the fiscal year ended August 31, 2002.
*
10.27.
Employment Agreement with Terry D. Harryman dated January 19, 2000, which
the
Company hereby incorporates by reference from Exhibit 10.24 to the Company’s
Form 10-K for the fiscal year ended August 31, 2002.
*
10.28. Employment
Agreement with Carolyn C. Cummins dated April 29, 2004, which the Company
hereby
incorporates by reference from Exhibit 10.25 to the Company’s Form 10-K for the
fiscal year ended August 31, 2004.
*
10.29. Employment
Agreement with V. Todd Townsend dated August 18, 2005 which the Company
hereby
incorporates by reference from Exhibit 10.26 to the Company’s Form 10-K for the
fiscal year ended August 31, 2005.
*
10.30.
Employment
Agreement
with Paige S. Bass dated January 31, 2007
,which the Company hereby
incorporates by reference from Exhibit 10.01 to the Company’s Form 10-Q for the
quarterly period ended February 28, 2007.
*
10.31.
Employment
Agreement
with Claudia San Pedro dated January 31, 2007
,which the Company hereby
incorporates by reference from Exhibit 10.02 to the Company’s Form 10-Q for the
quarterly period ended February 28, 2007.
*
10.32. 2001
Sonic Corp. Stock Option Plan, which the Company hereby incorporates by
reference from Exhibit No. 10.32 to the Company’s Form 10-K for the fiscal year
ended August 31, 2001.
*
10.33. 2001
Sonic Corp. Directors’ Stock Option Plan, which the Company hereby incorporates
by reference from Exhibit No. 10.33 to the Company’s Form 10-K for the fiscal
year ended August 31, 2001.
*
10.34. Sonic
Corp. 2006 Long Term Incentive Plan which the Company hereby incorporates
by
reference from Exhibit No. 10.31 to the Company’s Form 10-K for the fiscal year
ended August 31, 2006.
*
21.01. Subsidiaries
of the Company.
23.01. Consent
of Independent Registered Public Accounting Firm.
31.01. Certification
of Chief Executive Officer pursuant to S.E.C. Rule 13a-14.
31.02. Certification
of Chief Financial Officer pursuant to S.E.C. 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.
99.01 Base
Indenture dated December 20, 2006 among Sonic Capital LLC and certain other
indirect subsidiaries of the Company, and Citibank, N.A. as Trustee and
Securities Intermediary, which the Company hereby incorporates by reference
from
Exhibit 99.1 to the Company’s Form 8-K filed on December 27, 2006.
99.02 Supplemental
Indenture dated December 20, 2006 among Sonic Capital LLC and certain other
indirect subsidiaries of the Company, and Citibank, N.A. as Trustee and
the
Series 2006-1 Securities Intermediary, which the Company hereby incorporates
by
reference from Exhibit 99.2 to the Company’s Form 8-K filed on December 27,
2006.
99.03 Class
A-1 Note Purchase Agreement dated December 20, 2006 among Sonic Capital
LLC and
certain other indirect subsidiaries of the Company, certain private conduit
investors, financial institutions and funding agents, Bank of America,
N.A. as
provider of letters of credit, and Lehman Commercial Paper Inc., as a swing
line
lender and as Administrative Agent, which the Company hereby incorporates
by
reference from Exhibit 99.3 to the Company’s Form 8-K filed on December 27,
2006.
99.04 Guarantee
and Collateral Support Agreement dated December 20, 2006 made by Sonic
Industries LLC, as Guarantor in favor of Citibank N.A. as Trustee, which
the
Company hereby incorporates by reference from Exhibit 99.4 to the Company’s Form
8-K filed on December 27, 2006.
99.05 Parent
Company Support Agreement dated December 20, 2006 made by Sonic Corp. in
favor
of Citibank N.A., as Trustee, which the Company hereby incorporates by
reference
from Exhibit 99.5 to the Company’s Form 8-K filed on December 27,
2006.
The
Board
of Directors and Stockholders of
Sonic
Corp.
We
have
audited the accompanying consolidated balance sheets of Sonic Corp. as of
August
31, 2007 and 2006, and the related consolidated statements of income,
stockholders’ equity (deficit), and cash flows for each of the three years in
the period ended August 31, 2007. Our audits also included the financial
statement schedule listed in the Index at Item 15. These financial statements
and schedule are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In
our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Sonic Corp. at
August
31, 2007 and 2006, and the consolidated results of their operations and their
cash flows for each of the three years in the period ended August 31, 2007,
in
conformity with U.S. generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Sonic Corp.’s internal control over financial reporting as of August 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated October 17, 2007, expressed an unqualified opinion thereon.
ERNST
&
YOUNG
LLP
Oklahoma
City, Oklahoma
October
17, 2007
Sonic
Corp.
Consolidated
Balance Sheets
|
August
31,
|
||||||||
|
2007
|
2006
|
|||||||
|
(In
Thousands)
|
||||||||
|
Assets
|
||||||||
|
Current
assets:
|
||||||||
|
Cash
and cash equivalents
|
$ |
25,425
|
$ |
9,597
|
||||
|
Restricted
cash
|
13,521
|
─
|
||||||
|
Accounts
and notes receivable, net
|
23,084
|
21,271
|
||||||
|
Net
investment in direct financing leases
|
1,267
|
1,287
|
||||||
|
Inventories
|
4,444
|
4,200
|
||||||
|
Deferred
income taxes
|
517
|
307
|
||||||
|
Prepaid
expenses and other
|
5,445
|
5,848
|
||||||
|
Total
current assets
|
73,703
|
42,510
|
||||||
|
Noncurrent
restricted cash
|
11,354
|
─
|
||||||
|
Notes
receivable, net
|
5,532
|
5,182
|
||||||
|
Net
investment in direct financing leases
|
2,593
|
3,815
|
||||||
|
Property,
equipment and capital leases, net
|
529,993
|
477,054
|
||||||
|
Goodwill,
net
|
102,628
|
96,949
|
||||||
|
Trademarks,
trade names and other intangibles, net
|
11,361
|
10,746
|
||||||
|
Debt
origination costs, net
|
20,914
|
1,083
|
||||||
|
Other
assets, net
|
442
|
679
|
||||||
|
Total
assets
|
$ |
758,520
|
$ |
638,018
|
||||
Sonic
Corp.
Consolidated
Balance Sheets (continued)
|
August
31,
|
||||||||
|
2007
|
2006
|
|||||||
|
(In
Thousands)
|
||||||||
|
Liabilities
and stockholders’ equity (deficit)
|
||||||||
|
Current
liabilities:
|
||||||||
|
Accounts
payable
|
$ |
25,283
|
$ |
23,438
|
||||
|
Deposits
from franchisees
|
2,783
|
2,553
|
||||||
|
Accrued
liabilities
|
55,707
|
33,874
|
||||||
|
Income
taxes payable
|
7,863
|
10,673
|
||||||
|
Obligations
under capital leases and long-term debt due within one
year
|
22,851
|
7,557
|
||||||
|
Total
current liabilities
|
114,487
|
78,095
|
||||||
|
Obligations
under capital leases due after one year
|
36,773
|
34,295
|
||||||
|
Long-term
debt due after one year
|
690,437
|
117,172
|
||||||
|
Other
noncurrent liabilities
|
17,212
|
12,504
|
||||||
|
Deferred
income taxes
|
6,413
|
4,259
|
||||||
|
Commitments
and contingencies
(Notes 6, 7, 14, and 15)
|
||||||||
|
Stockholders’
equity (deficit):
|
||||||||
|
Preferred
stock, par value $.01; 1,000,000 shares authorized; none
outstanding
|
─
|
─
|
||||||
|
Common
stock, par value $.01; 245,000,000 shares authorized; shares issued
116,222,839 in 2007 and 114,988,369 in 2006
|
1,162
|
1,150
|
||||||
|
Paid-in
capital
|
193,682
|
173,802
|
||||||
|
Retained
earnings
|
540,886
|
476,694
|
||||||
|
Accumulated
other comprehensive income
|
(2,848 | ) | (484 | ) | ||||