UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT |
| OF 1934 |
For the fiscal year ended:August 31, 2006 |
For the fiscal year ended: August 31, 2005
OR
| |
OR |
| |
[ ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE |
| ACT OF 1934 |
For the transition period from _______________ to _________________ |
| |
Commission File Number 0-18859 |
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| SONIC CORP. | |
For the transition period from ________ to ________
Commission File Number 0-18859
SONIC CORP.
(Exact name of registrant as specified in its charter)
Delaware(Exact name of registrant as specified in its charter) |
| | |
Delaware | | 73-1371046 |
(State of incorporation) | | (I.R.S. Employer |
incorporation) | | Identification No.) |
| | 300 Johnny Bench Drive | | |
| | Oklahoma City, Oklahoma | | 73104 |
| | (Address of principal executive offices) | | Zip Code |
| | |
Registrant’s telephone number, including area code: (405) 225-5000 |
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 the 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, (as definedor a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.) (Check one):
YesLarge accelerated filer X . No Accelerated filer ___. . Non-accelerated filer __.
IndicteIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.)
Act). Yes __.. No X .
As of February 28, 2005,2006, the aggregate market value of the 57,680,867 81,870,537shares of common stock of the Company held by non-affiliates of the Company equaled $1,943,268,409,$1,725,285,116 based on the closing sales price for the common stock as reported for that date.
As of October 31, 2005,16, 2006, the Registrant had 57,995,684 69,581,790shares 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, 2005.2006.
FORM 10-K OF SONIC CORP.
TABLE OF CONTENTS
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PART I |
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| Business | 1 |
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| Risk Factors | 10 |
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| Unresolved Staff Comments | 14 |
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| Properties | 1014 |
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| Legal Proceedings | 1014 |
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| Submission of Matters to a Vote of Security Holders | 1015 |
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| Executive Officers of the Company | 1115 |
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PART II |
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| Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | 1216 |
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| Selected Financial Data | 1418 |
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| Management’s Discussion and Analysis of Financial Condition and Results of Operations | 1620 |
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| Quantitative and Qualitative Disclosures About Market Risks | 2832 |
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| Financial Statements and Supplementary Data | 2933 |
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| Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | 2933 |
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| Controls and Procedures | 2933 |
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| Other Information | 3135 |
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PART III |
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| Directors and Executive Officers of the Company | 31 |
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| Executive Compensation | 31 |
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| Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | 31 |
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| Certain Relationships and Related Transactions | 31 |
| | |
| Principal Accounting Fees and Services | 31 |
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PART IV |
| | |
| Exhibits and Financial Statement Schedules | 32 |
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, 2005,2006, the Company had 3,0393,188 Sonic Drive-Ins in operation, consisting of 574623 Partner Drive-Ins and 2,4652,565 Franchise Drive-Ins, principally in the southern two-thirds of the United States. Partner Drive-Ins are those Sonic Drive-Ins owned and operated by either a limited liability company or a general partnership. 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, which are owned and operated as either a limited liability company or general partnership. 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. Most Sonic Drive-Ins also include a drive-through lane and patio seating.
The Company has two operating subsidiaries, Sonic Industries Inc. and Sonic Restaurants, Inc. Sonic Industries Inc. serves as the franchisor of the Sonic Drive-In chain, as well as the administrative services center for the Company. Sonic Restaurants, Inc. develops and operates the Partner Drive-Ins. References to “Sonic,” the “Company,”“we, “we,”“us, “us,” and “our” in this report are references to Sonic Corp. and its subsidiaries and predecessors, unless the context indicates otherwise.
Our objective is to maintain our position as, or to become, a leading operator in terms of the number of quick-service restaurants within each of our core and developing markets. We have developed and are implementing a strategy designed to build the Sonic brand and to continue to achieve 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 Sonic’s core and developing markets; (4) an owner/operator philosophy, in which managers have an equity interest in their restaurant,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.
All Sonic Drive-Ins also offer a breakfast menu. Items on the breakfast menuitems that include sausage, ham, or bacon with egg and cheese Breakfast Toaster®Bistro sandwiches, sausage and egg burritos, and specialty breakfast drinks. Sonic Drive-Ins typically are open from 7at least 7:00 a.m. to 11:00 p.m. and serve the full menu all day.
Restaurant Locations
As of August 31, 2005, 3,0392006, 3,188 Sonic Drive-Ins were in operation and located in 2933 states, principally in the southern two-thirds of the United States, and in Mexico. 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. A market may be located where it extends into more than one state, causing some states to have both core and developing markets. Our core markets contain approximately 71%76% of all Sonic Drive-Ins as of August 31, 2005.2006. Developing markets are located in the states indicated below and Mexico. The following table sets forth the number of Partner Drive-Ins and Franchise Drive-Ins by core and developing markets as of August 31, 2005:2006:
| Core Markets | Developing Markets | Total |
States | Partner | Franchise | Total | Partner | Franchise | Total | |
Alabama | 32 | 71 | 103 | | 5 | 5 | 108 |
Arizona | | | | | 93 | 93 | 93 |
Arkansas | 29 | 157 | 186 | | | | 186 |
California | | | | | 34 | 34 | 34 |
Colorado | 14 | 10 | 24 | 20 | 31 | 51 | 75 |
Delaware | | | | | 1 | 1 | 1 |
Florida | 18 | 4 | 22 | 11 | 72 | 83 | 105 |
Georgia | 9 | 20 | 29 | | 86 | 86 | 115 |
Idaho | | | | | 16 | 16 | 16 |
Illinois | | 8 | 8 | | 19 | 19 | 27 |
Indiana | | | | | 14 | 14 | 14 |
Iowa | | | | | 12 | 12 | 12 |
Kansas | 40 | 95 | 135 | | | | 135 |
Kentucky | 4 | 42 | 46 | | 23 | 23 | 69 |
Louisiana | 23 | 132 | 155 | | | | 155 |
Mississippi | | 123 | 123 | | | | 123 |
Missouri | 32 | 126 | 158 | 13 | 29 | 42 | 200 |
Nebraska | | | | 8 | 18 | 26 | 26 |
Nevada | | | | | 18 | 18 | 18 |
New Mexico | | 71 | 71 | | | | 71 |
North Carolina | | 1 | 1 | | 88 | 88 | 89 |
Ohio | | | | | 6 | 6 | 6 |
Oklahoma | 79 | 186 | 265 | | | | 265 |
Oregon | | | | | 1 | 1 | 1 |
Pennsylvania | | | | | 1 | 1 | 1 |
South Carolina | 42 | 22 | 64 | | 46 | 46 | 110 |
Tennessee | | 161 | 161 | 10 | | 10 | 171 |
Texas | 211 | 673 | 884 | | 2 | 2 | 886 |
Utah | | | | 7 | 19 | 26 | 26 |
Virginia | | | | 21 | 20 | 41 | 41 |
Washington | | | | | 1 | 1 | 1 |
West Virginia | | | | | 1 | 1 | 1 |
Wyoming | | | | | 5 | 5 | 5 |
| | | | | | | |
Mexico | | | | | 2 | 2 | 2 |
Total | 533 | 1,902 | 2,435 | 90 | 663 | 753 | 3,188 |
| Core Markets | Developing Markets | Total |
States | Partner | Franchise | Total | Partner | Franchise | Total | |
Alabama | 16 | 14 | 30 | 14 | 60 | 74 | 104 |
Arizona | | | | | 87 | 87 | 87 |
Arkansas | 30 | 150 | 180 | | | | 180 |
California | | | | | 28 | 28 | 28 |
Colorado | | | | 33 | 37 | 70 | 70 |
Florida | | | | 23 | 68 | 91 | 91 |
Georgia | | | | 9 | 95 | 104 | 104 |
Idaho | | | | | 15 | 15 | 15 |
Illinois | | 8 | 8 | 3 | 19 | 22 | 30 |
Indiana | | | | | 12 | 12 | 12 |
Iowa | | | | | 12 | 12 | 12 |
Kansas | 38 | 93 | 131 | | | | 131 |
Kentucky | | 8 | 8 | | 56 | 56 | 64 |
Louisiana | 22 | 130 | 152 | | | | 152 |
Mississippi | | 117 | 117 | | | | 117 |
Missouri | 41 | 134 | 175 | | 19 | 19 | 194 |
Nebraska | | | | 6 | 17 | 23 | 23 |
Nevada | | | | | 17 | 17 | 17 |
New Mexico | | 69 | 69 | | | | 69 |
North Carolina | | | | | 81 | 81 | 81 |
Ohio | | | | | 6 | 6 | 6 |
Oklahoma | 77 | 182 | 259 | | | | 259 |
South Carolina | | | | | 69 | 69 | 69 |
Tennessee | 30 | 168 | 198 | 10 | | 10 | 208 |
Texas | 195 | 643 | 838 | | | | 838 |
Utah | | | | 7 | 18 | 25 | 25 |
Virginia | | | | 20 | 19 | 39 | 39 |
West Virginia | | | | | 1 | 1 | 1 |
Wyoming | | | | | 5 | 5 | 5 |
| | | | | | | |
Mexico | | | | | 8 | 8 | 8 |
Total | 449 | 1,716 | 2,165 | 125 | 749 | 874 | 3,039 |
2
Expansion
During fiscal year 2005,2006, we opened 175173 Sonic Drive-Ins, which consisted of 3735 Partner Drive-Ins and 138 Franchise Drive-Ins. During fiscal year 2006,2007, we anticipate approximately 180 to 190200 new Sonic Drive-In openings, including 150 to 160 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 a significant growth opportunityopportunities 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 20062007 necessarily will depend on various factors. Those factors, include (among others)including those discussed under Item 1A. Risk Factors - Failure to successfully implement our growth strategy could reduce, or reduce the availabilitygrowth of, suitable sites, the costour revenue and availabilitynet income, of construction resources, the negotiation of acceptable lease or purchase terms for new locations, local permitting and regulatory compliance, the financial resources of Sonic and its franchisees, and the general economic and business conditions to be faced in fiscal year 2006.this Form 10-K.
Our expansion strategy for PartnerSonic Drive-Ins involves two principal components: (1) the building-out of existing core markets and (2) the further penetration of current developing markets. The Company isWe are always in the process of identifying new developing markets for the opening of both Partner Drive-Ins and Franchise Drive-Ins. In addition, we may consider the acquisition of other similar conceptslocal 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 151174 Sonic Drive-Ins that provide an indoor seating area, 4644 of which are located in non-traditional areas such as shopping mall food courts, airports, and universities, and 1119 of which are located inadjacent to convenience stores.
Retrofit.In fiscal 2006, we completed the retrofit of over 100 Partner Drive-Ins and 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. In fiscal 2007, we expect to roll-out the retrofit program to approximately 150 additional Partner Drive-Ins and, in January 2007, will begin to extend the program to Franchise Drive-Ins. Franchisees will pay the cost of the retrofit for their drive-ins. We currently estimate the cost to make a standard retrofit at approximately $125,000 to $135,000 per drive-in. All new Sonic Drive-Ins being built in all markets will 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) the personal mannerdelivery 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, commercials, 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 8 under Company Operations-Franchise Program -Franchise Advisory Council.) Funding for our marketing plan has three components: (1) local advertising expenditures, (2) the System Marketing Fund, and (3) the Sonic Advertising Fund, (2)Fund. Depending on the type of license agreement, each Sonic Drive-In must spend 2% to 3.25% of the drive-in’s gross revenues on local advertising, expenditures,either directly or through participation in the local advertising cooperative. The members of each local advertising cooperative may elect and (3)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 2006, drive-ins participating in cooperatives contributed an average of 4.09% of their Sonic Drive-In’s gross revenues to Sonic advertising cooperatives. As of August 31, 2006, 3,077 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.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 message of the Sonic brand 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 Advertising Fund is a national media production fund that we administer. Each Sonic Drive-In must contribute 0.375% to 0.75%, depending on the type of license agreement, of the Sonic Drive-In’s gross revenues to the Sonic Advertising Fund. Once a sufficient number of Sonic Drive-Ins have been opened in a market, we require the formation of advertising cooperatives among drive-in owners to pool and direct advertising expenditures in local markets. Each Sonic Drive-In must spend 2% to 3.25%, depending on the type of license agreement, of the drive-in’s gross revenues on local advertising, either directly (if the advertising cooperative for the drive-in’s market is not yet formed) or through participation in the local advertising cooperative. 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 2005, drive-ins participating in cooperatives contributed an average of 4.1% of their Sonic Drive-In’s gross revenues to Sonic advertising cooperatives. As of August 31, 2005, 2,931 Sonic Drive-Ins (96% of the chain) participated in advertising cooperatives. The System Marketing Fund is funded out of the required local advertising expenditures by either redistributing 2.0% (1.0% prior to September 2004) 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 message of the Sonic brand 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 total amount spent on media (principally television) was approximately $125$145 million for fiscal year 20052006 and we expect media expenditures of approximately $140$160 million for fiscal year 2006.2007.
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 specifications that we establish.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 2005,2006, 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 28%27% of net 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 training in 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 providerequire our drive-in managers and assistant managers to pass ServSafe training in ServSafe to drive-in managers.programs. 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 Partner Drive-Ins and many Franchise 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 license agreement requires all Sonic Drive-Ins to submit a profit and loss statement on or before the 20th of each month. All Partner Drive-Ins and 1,1821,772 or 48%70% of Franchise Drive-Ins submit their data electronically. We expect to add more SonicFranchise 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 7:00 a.m. to 11:00 p.m.
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 fivefour to sixseven supervisors within their respective regions and report to either a regional vice president or a vice president of SRI. SRI’s three regional vice presidents and three vice presidents report to the 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 profitscash 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 is incorporated herein by reference tocan be found under Ownership Program, in Part II, Item 7, at page 2631 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%17% and the average percentage interest of a manager in a Partner Drive-In was 19% in fiscal year 2005.2006. 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 alone 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.
| | 2005 | | 2004 | | 2003 | | 2002 | | 2001 | | | 2006 | | 2005 | | 2004 | | 2003 | | 2002 | |
Average Sales per Partner Drive-In | | | | | | | | | | | | | | | | | | | | | | | | |
(in thousands) | | $ | 957 | | $ | 886 | | $ | 799 | | $ | 791 | | $ | 772 | | | $ | 980 | | $ | 957 | | $ | 886 | | $ | 799 | | $ | 791 | |
Number of Partner Drive-Ins: | | | | | | | | | | | | | | | | | | | | | | | | |
Total Open at Beginning of Year | | | 539 | | 497 | | 452 | | 393 | | 312 | | | | 574 | | 539 | | 497 | | 452 | | 393 | |
Newly-Opened and Re-Opened | | | 37 | | 21 | | 35 | | 40 | | 34 | | | | 35 | | 37 | | 21 | | 35 | | 40 | |
Purchased from Franchisees* | | | 4 | | 24 | | 52 | | 25 | | 50 | | | | 15 | | 4 | | 24 | | 52 | | 25 | |
Sold to Franchisees* | | | (5 | ) | | (3 | ) | | (41 | ) | | (5 | ) | | (2 | ) | | | -- | | (5 | ) | | (3 | ) | | (41 | ) | | (5 | ) |
Closed | | | (1 | ) | | 0 | | | (1 | ) | | (1 | ) | | (1 | ) | | | (1 | ) | | (1 | ) | | 0 | | | (1 | ) | | (1 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total Open at Year End | | | 574 | | | 539 | | | 497 | | | 452 | | | 393 | | | | 623 | | | 574 | | | 539 | | | 497 | | | 452 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
_________________
*The relatively large number of drive-ins sold to franchisees in fiscal year 2003 and purchased from franchisees in fiscal years 2001 through2002, 2003, 2004 and 2006 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, 2005,2006, we had 2,4652,565 Franchise Drive-Ins operating in 2933 states and in Mexico. A large number of successful multi-unit franchisee groups have developed during the Sonic system’s 5253 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 138 Franchise Drive-Ins during fiscal year 20052006 and we expect our franchisees to open approximately 150 to 160 Franchise Drive-Ins in fiscal 2006.2007. 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. Our current standard license agreement provides for aan initial franchise fee of $30,000 and an ascending royalty rate beginning at 1% 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 license agreement provides for a franchise fee of $15,000 and a graduated royalty rate from 1% to 5% of gross revenues. Approximately 97%96% of all Sonic Drive-Ins opening in fiscal year 20062007 are expected to open under the current standard license agreement, with the remaining 3%4% expected to open in venues that would be included under the non-traditional license agreement. The current standard license agreement provides for a term of 20 years, with one 10-year renewal option. The term for a non-traditional Sonic Drive-In is typically 10 years, with two five-year renewal options. 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, 2005, 44%2006, 48% of all Sonic Drive-Ins were subject to the 1% to 5% graduated royalty rate, 49% were subject to a former version of the license agreement (no longer being issued) providing for a 1% to 4% graduated royalty rate, and 7% were subject to a former version of the license agreement (also no longer being issued) providing for a 1% to 3% graduated royalty rate. For fiscal year 2005,2006, Sonic’s average royalty rate equaled 3.56%3.59%. The license agreements for those Franchise Drive-Ins which currently operate under the 1% to 4% or 1% to 3% graduated royalty rate begin expiring in fiscal year 2006 and will continue to expire through fiscal year 2023.at various times over the next 16 years. We expect that almost all the Franchise Drive-Ins currently operating under those expiring license agreements will renew their licenses pursuant to the terms of the then current license agreement. Those renewals of the expiring license agreements to the current form of the license agreement with the 1% to 5% graduated royalty rate will contribute to an increase in our royalty revenues.
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 64%51% of the new Franchise Drive-Ins opened during fiscal year 20052006 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 2005,2006, we entered into 5036 new area development agreements calling for the opening of 212128 Franchise Drive-Ins and amended 1410 existing area development agreements calling for the opening of an additional 4013 Franchise Drive-Ins, all during the next sevenfive years. As of August 31, 2005,2006, we had a total of 163152 area development agreements in effect, calling for the development of 635576 additional Sonic Drive-Ins during the next sevensix years. We cannot give any assurance that our franchisees will achieve that number of new Franchise Drive-Ins for fiscal year 20062007 or during the next sevensix years. Of the 205183 Franchise Drive-Ins scheduled to open during fiscal year 20052006 under area development
agreements in place at the beginning of that fiscal year, 8894 or 43%51% opened during the period. During fiscal year 2005,2006, we terminated 2628 of the 157163 area development agreements existing at the beginning of the fiscal year. The terminated area development agreements called for the opening of 3228 Franchise Drive-Ins in fiscal year 20052006 and an additional 3073 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.
Our realization of the expected benefits under various existing and future area development agreements currently depends and will continue to depend upon the ability of the developers to open the minimum number of Sonic Drive-Ins within the time periods required by the agreements. The financial resources of the developers, as well as their experience in managing quick-service restaurant franchises, represent critical factors in the success of area development agreements. Although we grant area development agreements only to those developers whom we believe possess those qualities, we cannot give any assurances that the future performance by developers will result in the opening of the minimum number of Sonic Drive-Ins contemplated by the area development agreements or reach the compliance rate we have previously experienced.
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 $3.8$2.7 million as of August 31, 2005.2006. 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. Since franchisees are not scheduled to begin the retrofit program until January 2007, they have not yet entered into any loan agreements with IFCC.
Franchisee Training. Each franchisee must have at least one individual working 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, quickspeed of service, cleanliness of Sonic Drive-Ins, management techniques and consistency of service. Furthermore,We also require our management teams receiveto pass ServSafe training in ServSafe,programs. ServeSafe 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: (1) assistance with quality control through area field representatives, to ensure that each franchisee consistently delivers high quality food and service; (2) support of new franchisees with guidance and training in the opening of their first three Sonic Drive-Ins; and (3) assistance in selecting sites for new Sonic Drive-Ins using demographic data and studies of traffic patterns. Our field services organization consists of 17 field service consultants, 14 field marketing representatives, four regional marketing directors, one marketing manager, onetwo senior marketing director,directors, twoconsultants for new franchise consultants,franchises, fiveregional vice presidents, all with responsibility for defined geographic areas, a onedirector of new franchise services, and twovice presidents of franchise finance. The field service consultants provide operational services and support for our franchisees, while the field marketing representatives assist the franchisees with the development of advertising cooperative and local market promotional activities. New franchise consultants 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. One director, nine field trainers and four training consultants provide training to franchisees in such areas as shift management, customer service, time management, supervisory skills, and financial controls. We also have a vice president of franchise real estate and six real estate directors who assist the franchisees with the identification of trade areas for new Franchise Drive-Ins and the franchisees’ selection of sites for their Franchise Drive-Ins, subject to Sonic’s final approval of those sites. Ten field trainersWe also have a staff of six architect and four training consultants provide trainingengineering personnel to franchiseesdesign, plan and permit new stores. A senior director of construction with two construction managers also assists in such areas as shift management, customer service, time management, supervisory skills, and financial controls.
constructing 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 full discretion to determine the prices charged to its customers.
Franchise Advisory Council. We have established a Franchise Advisory Council which 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 18 members selected by Sonic. Currently we have six executive committee members who are selected at large. The remaining 12 members are regional members who represent four defined regions of the country and serve three-year terms. We have five Franchise Advisory Council task groups comprised of 5346 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.
| | 2005 | | 2004 | | 2003 | | 2002 | | 2001 | | | 2006 | | 2005 | | 2004 | | 2003 | | 2002 | |
Average Sales Per Franchise Drive-In (in thousands) | | $ | 1,039 | | $ | 983 | | $ | 929 | | $ | 935 | | $ | 899 | | |
Average Sales Per Franchise | | | | | | | | | | | | | |
Drive-In (in thousands) | | | $ | 1,092 | | $ | 1,039 | | $ | 983 | | $ | 929 | | $ | 935 | |
Number of Franchise Drive-Ins: | | | | | | | | | | | | | | | | | | | | | | | | |
Total Open at Beginning of Year | | | 2,346 | | 2,209 | | 2,081 | | 1,966 | | 1,863 | | | | 2,465 | | 2,346 | | 2,209 | | 2,081 | | 1,966 | |
New Franchise Drive-Ins | | | 138 | | 167 | | 159 | | 142 | | 157 | | | | 138 | | 138 | | 167 | | 159 | | 142 | |
Sold to the Company* | | | (4 | ) | | (24 | ) | | (52 | ) | | (25 | ) | | (50 | ) | | | (15 | ) | | (4 | ) | | (24 | ) | | (52 | ) | | (25 | ) |
Purchased from the Company* | | | 5 | | 3 | | 41 | | 5 | | 2 | | | | -- | | 5 | | 3 | | 41 | | 5 | |
Closed and Terminated, | | | | | | | | | | | | | | | | | | | | | | | | |
Net of Re-openings | | | (20 | ) | | (9 | ) | | (20 | ) | | (7 | ) | | (6 | ) | | | (23 | ) | | (20 | ) | | (9 | ) | | (20 | ) | | (7 | ) |
Total Open at Year End | | | 2,465 | | | 2,346 | | | 2,209 | | | 2,081 | | | 1,966 | | | | 2,565 | | | 2,465 | | | 2,346 | | | 2,209 | | | 2,081 | |
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* The relatively large number of drive-ins purchased from Sonic in fiscal year 2003 and sold to Sonic in fiscal years 2001 through2002, 2003, 2004 and 2006 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 quick-service restaurant industry, a highly competitive industry in terms of price, service, restaurant location, and food quality. The quick-service 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 climate oflower temperatures in the locations of a number of Partner Drive-Ins and Franchise Drive-Ins.Drive-Ins, which reduces customer visits to our drive-ins.
Employees
As of August 31, 2005,2006, we had 330332 full-time corporate employees. This number does not include the approximately 19,00020,000 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 isare 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 and the Mexican Institute of Industrial Property. 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 offering circular 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 labor, employment and wage and hour issues, such as 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, trichinosis or salmonella, and injuries caused by food tampering have in the past severely injured the reputations of participants in the restaurant segment and could in the future affect us. 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, we could also be forced to temporarily close some 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 reputation, 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. We anticipate intense competition will continue to focus on pricing. 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 health or dietary preferences may cause consumers to avoid our products in favor of alternative foods.
The food service industry is affected by consumer preferences and perceptions. If prevailing health or dietary preferences and perceptions cause consumers to avoid these products offered by Sonic Drive-Ins in favor of alternative or healthier 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, whose actions are outside of our control.
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; |
| • | | 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 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 October 13, 2006, we completed a previously announced tender offer and repurchased 15,918,131 shares, or approximately 19%, of our outstanding common stock, for a total cost of $366.1 million. The shares were repurchased with borrowings under a new term loan facility. As of October 13, 2006, we had approximately $486 million of total long-term debt, comprised entirely of a balance outstandingonour term loan facility. We may in the future repurchase shares of our common stock, which may be funded by additional debt. Our increased leverage and debt service obligations 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 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 new revolving credit facility contains, and any 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.
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 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 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 wages, 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 expect 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, we cannot assure you that there will not 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 food service 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 574623 Partner Drive-Ins operating as of August 31, 2005,2006, we operated 237249 of them on property leased from third-parties and 337374 of them on property we own. The leases expire on dates ranging from 2006 to 2024,2025, 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.
We moved our corporate headquarters to a new building in the Bricktown district of downtown Oklahoma City in November 2003 and have a 15-year lease to occupy approximately 78,000 square feet in the new building. 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.
On September 13, 2005, Sonic Industries Inc. (“Sonic Industries”) filed a declaratory judgment action against AeroComm, Inc., in the United States District Court for the Western District of Oklahoma in Oklahoma City, Oklahoma, in a case titled, Sonic Industries Inc. v. AeroComm, Inc. (Case No.: CIV-05-1065-R). Sonic Industries seeks the Court's declaration that Sonic Industries has not violated antitrust laws and that AeroComm has no protected rights in Sonic Industries’ pay-at-your-stall (PAYS) credit card system. AeroComm was the primary supplier of PAYS radio components until AeroComm unilaterally terminated its relationship with Sonic Industries. On October 24, 2005, AeroComm filed counterclaims against Sonic Industries alleging that Sonic Industries interfered with AeroComm’s business relationships and opportunities with another PAYS supplier, provided proprietary information to the company that replaced AeroComm, and violated antitrust laws by restricting the ability of another PAYS supplier to use AeroComm for non-Sonic applications. The counterclaim seeks unspecified compensatory and other damages and injunctive relief. On February 27, 2006, AeroComm notified Sonic Industries that it was specifically seeking compensatory damages for lost profits and lost valuation. The Company believes that AeroComm's claims are without merit and will vigorously defend against them. While acknowledging the uncertainties of litigation, the Company does not believe that AeroComm’s claims will have a material adverse effect on the Company’s business or financial condition.
The Company is involved in various other 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.Company:
Name | Age | Position | Executive
Officer Since |
| | | |
J. Clifford Hudson | 5051 | Chairman of the Board of Directors, Chief Executive Officer and President | June 1985 |
| | | |
W. Scott McLain | 4344 | Executive Vice President of Sonic Corp. and President of Sonic Industries Inc. | April 1996 |
| | | |
Michael A. Perry | 4748 | President of Sonic Restaurants, Inc. | August 2003 |
| | | |
Ronald L. Matlock | 5455 | Senior Vice President, General Counsel and Secretary | April 1996 |
| | | |
Stephen C. Vaughan | 3940 | Vice President, and Chief Financial Officer and Treasurer | January 1996 |
| | | |
V. Todd Townsend | 4142 | Vice President and Chief Marketing Officer | August 2005 |
| | | |
Carolyn C. Cummins | 4748 | Vice President of Compliance | April 2004 |
| | | |
Terry D. Harryman | 4041 | Controller | January 1999 |
| | | |
Renee G. Shaffer | 44 | Treasurer | April 2005 |
Business Experience
The following sets forth the business experience of the executive officers of the Company for at least the past five years.years:
J. Clifford Hudson has served as the Company’s Chairman of the Board and Chief Executive Officer since January 2000. Mr. Hudson served as Chief Executive Officer and President of the Company from April 1995 to January 2000 and reassumed the position of President 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. 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 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 Inc. from September 1998 until August 2003.
Ronald L. Matlock has served as the Company’s Senior Vice President, General Counsel and Secretary since January 2000. Mr. Matlock served as the Company’s Vice President, General Counsel and Secretary from April 1996 until January
2000. Mr. Matlock has also served as a Director of Sonic Restaurants, Inc. and as a Director of Sonic Industries Inc. since April 1996.
Stephen C. Vaughan has served as Vice President and Chief Financial Officer of the Company since November 2004.2004 and as Treasurer of the Company since September 2006. 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.
Carolyn C. Cummins has served as the Company’s Vice President of Compliance since April 2004. Ms. Cummins has also served as Assistant General Counsel and Assistant Secretary since joining the Company in January 1999.
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 Inc. since January 2002. He served as Assistant Treasurer of Sonic Restaurants, Inc. and Sonic Industries Inc. from October 1996 until January 2002.
Renee G. Shaffer has served as the Treasurer of the Company since joining the Company in April 2005. Ms. Shaffer served as an Assistant Vice President of Information Systems of Hobby Lobby Stores, Inc. from December 2003 until December 2004 and the Director of Information Systems of Hobby Lobby Stores, Inc. from January 2001 until December 2003. She worked as a certified public accountant providing financial and accounting services from 1998 until January 2001.
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 May 2004April 2006 three-for-two stock split.
Fiscal Year Ended August 31, 2006 | High | Low | Fiscal Year Ended August 31, 2005 | High | Low |
First Quarter | $19.940 | $17.987 | First Quarter | $19.987 | $14.934 |
Second Quarter | $21.727 | $18.327 | Second Quarter | $22.580 | $19.447 |
Third Quarter | $23.480 | $20.827 | Third Quarter | $23.647 | $20.534 |
Fourth Quarter | $22.400 | $19.070 | Fourth Quarter | $22.547 | $19.447 |
Quarter Ended | High | Low | | Quarter Ended | High | Low |
November 30, 2004 | $29.980 | $22.400 | | November 30, 2003 | $20.587 | $16.260 |
February 28, 2005 | $33.870 | $29.170 | | February 29, 2004 | $23.247 | $19.673 |
May 31, 2005 | $35.470 | $30.800 | | May 31, 2004 | $24.313 | $20.233 |
August 31, 2005 | $33.970 | $29.170 | | August 31, 2004 | $23.500 | $21.100 |
Stockholders
As of October 31, 2005,16, 2006, the Company had 601624 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, and repurchases of the Company’s common stock.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.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information about the Company’s equity compensation plans as of August 31, 2005.2006.
Equity Compensation Plan Information
| Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) |
Plan category | (a) | (b) | (c) | (a) | (b) | (c) |
| | |
Equity compensation plans approved by security holders | 5,216,919 | $14.87 | 918,058 | |
Equity compensation plans not approved by security holders | -0- | -0- | -0- | 7,230,188 | $11.98 | 6,051,382 |
Equity compensation plans not approved by security holders | | -0- | -0- | -0- |
Issuer Purchases of Equity Securities
Shares repurchased during the fourth quarter of fiscal 20052006 are as follows (in thousands, except share and per share amounts):follows:
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, 2005 through June 30, 2005 | 228,700 | | $31.49 | | 228,700 | | $122,800 |
July 1, 2005 through July 31, 2005 | 498,900 | | $30.31 | | 498,900 | | $107,676 |
August 1, 2005 through August 31, 2005 | -0- | | $ 0.00 | | -0- | | $107,676 |
Total | 727,600 | | $30.68 | | 727,600 | | |
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, 2006 through June 30, 2006 | 132,800 | $21.36 | 132,800 | $89,412,723 |
July 1, 2006 through July 31, 2006 | -- | -- | -- | $89,412,723 |
August 1, 2006 through August 31, 2006 | -- | -- | -- | $89,412,723 |
Total | 132,800 | $21.36 | 132,800 | |
(1) All of the shares purchased during the fourth quarter of fiscal 20052006 were purchased as part of the Company’s share repurchase program which was first publicly announced on April 14, 1997. In April 2005,2006, the Company’s Board of Directors approved an increase in the share repurchase authorization from $60,000$34,581,097 to $150,000$110,000,000 and extended the program to August 31, 2006.2007.
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, | |
| | 2005 | | 2004 | | 2003 | | 2002 | | 2001 | |
| | | | | | | | | | | |
Income Statement Data: | | | | | | | | | | | | | | | | |
Partner Drive-In sales | | $ | 525,988 | | $ | 449,585 | | $ | 371,518 | | $ | 330,707 | | $ | 267,463 | |
Franchise Drive-Ins: | | | | | | | | | | | | | | | | |
Franchise royalties | | | 88,027 | | | 77,518 | | | 66,431 | | | 61,392 | | | 54,220 | |
Franchise fees | | | 4,311 | | | 4,958 | | | 4,674 | | | 4,020 | | | 4,408 | |
Other | | | 4,740 | | | 4,385 | | | 4,017 | | | 4,043 | | | 4,547 | |
Total revenues | | | 623,066 | | | 536,446 | | | 446,640 | | | 400,162 | | | 330,638 | |
Cost of Partner Drive-In sales | | | 421,906 | | | 358,859 | | | 291,764 | | | 257,057 | | | 207,782 | |
Selling, general and administrative | | | 40,746 | | | 38,270 | | | 35,426 | | | 33,444 | | | 30,602 | |
Depreciation and amortization | | | 35,821 | | | 32,528 | | | 29,223 | | | 26,078 | | | 23,855 | |
Provision for impairment of long-lived assets | | | 387 | | | 675 | | | 727 | | | 1,261 | | | 792 | |
Total expenses | | | 498,860 | | | 430,332 | | | 357,140 | | | 317,840 | | | 263,031 | |
Income from operations | | | 124,206 | | | 106,114 | | | 89,500 | | | 82,322 | | | 67,607 | |
Net interest expense | | | 5,785 | | | 6,378 | | | 6,216 | | | 6,319 | | | 5,525 | |
Income before income taxes | | $ | 118,421 | | $ | 99,736 | | $ | 83,284 | | $ | 76,003 | | $ | 62,082 | |
Net income | | $ | 75,381 | | $ | 63,015 | | $ | 52,261 | | $ | 47,692 | | $ | 38,956 | |
| | | | | | | | | | | | | | | | |
Income per share (1): | | | | | | | | | | | | | | | | |
Basic | | $ | 1.26 | | $ | 1.06 | | $ | 0.89 | | $ | 0.79 | | $ | 0.65 | |
Diluted | | $ | 1.21 | | $ | 1.02 | | $ | 0.86 | | $ | 0.75 | | $ | 0.62 | |
Weighted average shares used in calculation (1): | | | | | | | | | | | | | | | | |
Basic | | | 59,995 | | | 59,314 | | | 58,465 | | | 60,234 | | | 59,774 | |
Diluted | | | 62,431 | | | 61,654 | | | 60,910 | | | 63,310 | | | 62,598 | |
Balance Sheet Data: | | | | | | | | | | | | | | | | |
Working capital (deficit) | | $ | (30,093 | ) | $ | (14,537 | ) | $ | (2,875 | ) | $ | (12,942 | ) | $ | (3,335 | ) |
Property, equipment and capital leases, net | | | 422,825 | | | 376,315 | | | 345,551 | | | 305,286 | | | 273,198 | |
Total assets | | �� | 563,316 | | | 518,633 | | | 486,119 | | | 405,356 | | | 358,000 | |
Obligations under capital leases (including current portion) | | | 38,525 | | | 40,531 | | | 27,929 | | | 12,938 | | | 13,688 | |
Long-term debt (including current portion) | | | 60,195 | | | 82,169 | | | 139,587 | | | 109,375 | | | 109,168 | |
Stockholders’ equity | | | 384,539 | | | 334,762 | | | 265,398 | | | 230,670 | | | 200,719 | |
Cash dividends declared per common share | | | – | | | | | | | | | | | | | |
| | Year ended August 31, | |
| | 2006 | | 2005(1) | | 2004(1) | | 2003(1) | | 2002(1) | |
| | | | | | | | | | | |
Income Statement Data: | | | | | | | | | | | | | | | | |
Partner Drive-In sales | | $ | 585,832 | | $ | 525,988 | | $ | 449,585 | | $ | 371,518 | | $ | 330,707 | |
Franchise Drive-Ins: | | | | | | | | | | | | | | | | |
Franchise royalties | | | 98,163 | | | 88,027 | | | 77,518 | | | 66,431 | | | 61,392 | |
Franchise fees | | | 4,747 | | | 4,311 | | | 4,958 | | | 4,674 | | | 4,020 | |
Other | | | 4,520 | | | 4,740 | | | 4,385 | | | 4,017 | | | 4,043 | |
Total revenues | | | 693,262 | | | 623,066 | | | 536,446 | | | 446,640 | | | 400,162 | |
Cost of Partner Drive-In sales | | | 468,627 | | | 421,906 | | | 358,859 | | | 291,764 | | | 257,057 | |
Selling, general and administrative | | | 52,048 | | | 47,503 | | | 44,765 | | | 41,061 | | | 38,246 | |
Depreciation and amortization | | | 40,696 | | | 35,821 | | | 32,528 | | | 29,223 | | | 26,078 | |
Provision for impairment of long-lived assets | | | 264 | | | 387 | | | 675 | | | 727 | | | 1,261 | |
Total expenses | | | 561,635 | | | 505,617 | | | 436,827 | | | 362,775 | | | 322,642 | |
Income from operations | | | 131,627 | | | 117,449 | | | 99,619 | | | 83,865 | | | 77,520 | |
Net interest expense | | | 7,578 | | | 5,785 | | | 6,378 | | | 6,216 | | | 6,319 | |
Income before income taxes | | $ | 124,049 | | $ | 111,664 | | $ | 93,241 | | $ | 77,649 | | $ | 71,201 | |
Net income | | $ | 78,705 | | $ | 70,443 | | $ | 58,031 | | $ | 47,801 | | $ | 43,864 | |
| | | | | | | | | | | | | | | | |
Income per share (2): | | | | | | | | | | | | | | | | |
Basic | | $ | 0.91 | | $ | 0.78 | | $ | 0.65 | | $ | 0.55 | | $ | 0.49 | |
Diluted | | $ | 0.88 | | $ | 0.75 | | $ | 0.63 | | $ | 0.52 | | $ | 0.46 | |
Weighted average shares used in calculation (2): | | | | | | | | | | | | | | | | |
Basic | | | 86,260 | | | 89,992 | | | 88,970 | | | 87,698 | | | 90,350 | |
Diluted | | | 89,239 | | | 93,647 | | | 92,481 | | | 91,365 | | | 94,965 | |
Balance Sheet Data: | | | | | | | | | | | |
Working capital (deficit) | | $ | (35,585 | ) | $ | (30,093 | ) | $ | (14,537 | ) | $ | (2,875 | ) | $ | (12,942 | ) |
Property, equipment and capital leases, net | | | 477,054 | | | 422,825 | | | 376,315 | | | 345,551 | | | 305,286 | |
Total assets | | | 638,018 | | | 563,316 | | | 518,633 | | | 486,119 | | | 405,356 | |
Obligations under capital leases (including current portion) | | | 36,625 | | | 38,525 | | | 40,531 | | | 27,929 | | | 12,938 | |
Long-term debt (including current portion) | | | 122,399 | | | 60,195 | | | 82,169 | | | 139,587 | | | 109,375 | |
Stockholders’ equity | | | 391,693 | | | 387,917 | | | 337,900 | | | 267,733 | | | 232,236 | |
Cash dividends declared per common share | | | ─ | | | ─ | | | ─ | | | ─ | | | ─ | |
(1) Previously reported prior-year results have been adjusted to implement SFAS 123R on a modified retrospective basis.
(1)(2) Adjusted for a 3-for-2three-for-two stock splitsplits in 2006, 2004 and 20022002.
Overview
Description of the Business. Sonic operates and franchises the largest chain of drive-ins in the United States. As of August 31, 2005,2006, the Sonic system was comprised of 3,0393,188 drive-ins, of which 19%20% or 574623 were Partner Drive-Ins and 81%80% or 2,4652,565 were Franchise Drive-Ins. Sonic Drive-Ins feature Sonic signature menu 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.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 performance was strong during fiscal year 20052006 as net income increased 19.6%11.7% and earnings per share increased 18.6%17.3% to $1.21$0.88 per diluted share.share from $0.75 per diluted share in the year-earlier period, which is adjusted for the retrospective adoption of SFAS 123R for expensing stock-based compensation.
The Sonic brand achieved several milestones during fiscal year 2005, including:
· | Surpassing the $1.0 million mark in system-wide average unit volumes; |
· | Opening of the 3,000th Sonic Drive-In; and
|
· | Our 19th consecutive year of higher system-wide same-store sales.
|
We continue to experience considerable momentum in our business fueled by strong growth in same-store sales that despite some pressure on store-level operating costs during the year, led to a significantstrong increase in system-wide drive-in level average profit per store. Theprofits. In turn, the rise in store-level profits, in turn,which have grown handsomely over the last three years, helped produce a solid 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; |
· | Increased franchising income stemming from solid same-store sales growth and our unique ascending royalty rate; |
· • | | 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 franchise acquisitions and share repurchases. |
Looking forward, these strategies are expected to continue to positively impact our business. We expect revenue growth of between 13% and 15% for fiscal year 2006, based upon same-store sales growth in the target range of 2% to 4%. This increase in revenues includes the expected benefit from 15 Franchise Drive-Ins which were acquired by the Company effective September 1, 2005.
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, | |
| | 2006 | | 2005 | | 2004 | |
Percentage increase in sales | | | 10.7 | % | | 12.4 | % | | 13.1 | % |
| | | | | | | | | | |
System-wide drive-ins in operation (1): | | | | | | | | | | |
Total at beginning of period | | | 3,039 | | | 2,885 | | | 2,706 | |
Opened | | | 173 | | | 175 | | | 188 | |
Closed (net of re-openings) | | | (24 | ) | | (21 | ) | | (9 | ) |
Total at end of period | | | 3,188 | | | 3,039 | | | 2,885 | |
| | | | | | | | | | |
Core markets (2) | | | 2,435 | | | 2,165 | | | 2,059 | |
Developing markets (2) | | | 753 | | | 874 | | | 826 | |
All markets | | | 3,188 | | | 3,039 | | | 2,885 | |
System-Wide Performance ($ in thousands) | | |
System-Wide Performance (cont’d) ($ in thousands) | | System-Wide Performance (cont’d) ($ in thousands) | |
| | | | | | | | | |
| | Year Ended August 31, | | | Year Ended August 31, | |
| | 2005 | | 2004 | | 2003 | | |
| | | | | | | | |
Percentage increase in sales | | | 12.4 | % | | 13.1 | % | | 7.0 | % | |
| | | | | | | | | | | |
System-wide drive-ins in operation: | | | | | | | | | | | |
Total at beginning of period | | | 2,885 | | | 2,706 | | | 2,533 | | |
Opened | | | 175 | | | 188 | | | 194 | | |
Closed (net of re-openings) | | | (21 | ) | | (9 | ) | | (21 | ) | |
Total at end of period | | | 3,039 | | | 2,885 | | | 2,706 | | |
| | | | | | | | | | | |
Core markets | | | 2,165 | | | 2,059 | | | 1,977 | | |
Developing markets | | | 874 | | | 826 | | | 729 | | |
All markets | | | 3,039 | | | 2,885 | | | 2,706 | | |
| | | | | | | | | | | | 2006 | | 2005 | | 2004 | |
Average sales per drive-in: | | | | | | | | | | | | | | | | | | | | |
Core markets | | $ | 1,059 | | $ | 1,004 | | $ | 947 | | | $ | 1,105 | | $ | 1,059 | | $ | 1,004 | |
Developing markets | | | 934 | | | 861 | | | 802 | | | | 954 | | | 934 | | | 861 | |
All markets | | | 1,023 | | | 964 | | | 907 | | | | 1,070 | | | 1,023 | | | 964 | |
| | | | | | | | | | | | | | | | | | | | |
Change in same-store sales (1): | | | | | | | | | | | |
Change in same-store sales (3): | | | | | | | | | | | |
Core markets | | | 5.6 | % | | 6.4 | % | | 0.5 | % | | | 5.3 | % | | 5.6 | % | | 6.4 | % |
Developing markets | | | 7.4 | | | 6.8 | | | (1.2 | ) | | | 1.5 | | | 7.4 | | | 6.8 | |
All markets | | | 6.0 | | | 6.5 | | | 0.3 | | | | 4.5 | | | 6.0 | | | 6.5 | |
| | | | | | | | | | | | | | | | | | | | |
(1) Represents percentage change for drive-ins open for a minimum of 15 months. | |
(1) Drive-ins that are temporarily closed for various reasons (repairs, remodeling, management changes, 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. | | (1) Drive-ins that are temporarily closed for various reasons (repairs, remodeling, management changes, 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 6.0%4.5% during fiscal year 2005, largely as a result2006, with growth for the year in all of traffic growth (an increase in the number of transactions) across allour non-traditional day parts (e.g. morning, lunch,(morning, afternoon dinner, and evening). Additionally,The average check amount (average amount spent per transaction) represented a lesserlarger portion of the overall sales increase than traffic growth came from an increase in the average check (the average amount spent per transaction)(number of transactions). This marked our 1920th consecutive year of positive same-store sales.sales growth. We believe our strong sales performance is a direct consequence of our specific sales-driving initiatives including, but not limited to:
· | Growth in brand awareness through increased media spending and greater use of network cable advertising; |
· • | Strong promotions and new product news focused on quality and expanded choices for our customers; |
· | Continued growth of our business in non-traditional day parts including the morning, afternoon, and evening day parts, which saw solid increases in sales; andparts; |
· | • | | Use of technology to reach customers and improve the customer experience.experience; |
| • | | Monthly promotions and new product news focused on quality and expanded choice for our customers; and |
| • | | Growth in brand awareness through increased media spending and greater use of network cable advertising. |
DuringLooking forward, these strategies are expected to continue to positively impact our business. We expect revenue growth of between 11% and 13% for fiscal year 2007, based upon targeted same-store sales growth in the range of 2% to 4%.
We continue to promote the expansion of our business in non-traditional day parts (morning, afternoon, and evening), which resulted in positive growth during fiscal year 2006 compared to fiscal year 2005 our total system-wide media expenditures were approximately $125 million as comparedfor each of these non-traditional day parts. We believe we have continuing opportunity to $110 million ingrow these day parts throughout fiscal year 2004,2007.
Implementation of the PAYS program, which we believe continues to increase overall brand awareness and strengthen our sharebegan in the fall of voice relative to our competitors. We have also shifted more2003, was completed in the remainder of our marketing dollars to our system-wide marketing fund efforts, which are largely used for network cable television advertising, growing this areaPartner Drive-Ins during the second quarter of our advertising from approximately $32 million in fiscal year 2004 to approximately $60 million in fiscal year 2005. We believe increased network cable advertising provides several benefits includingUnder the abilityPAYS program, a credit card terminal is added to more effectively targeteach drive-in stall to facilitate credit and better reach the cable audience, which has now surpassed broadcast networksdebit card transactions. Rollout to Franchise Drive-Ins began in terms of viewership. In addition, national cable advertising also allows us to bring additional depth to our mediaFebruary 2005 and expand our message beyond our traditional emphasis on a single monthly promotion. Looking forward, we expect system-wide media expendituresis expected to be approximately $140 millionsubstantially complete system-wide by the end of calendar year 2006. Approximately 80% of Franchise Drive-Ins and over 83% of drive-ins system-wide now have the PAYS system in fiscal 2006. The system-wide marketing fund portion will again represent approximately one-half of total media expenditures for fiscal 2006.
We continue to use our monthly promotions to highlight our distinctive food offerings and to feature new products. We also use our promotions and product news to create a strong emotional link with consumers and to align closely with consumer trends for fresh ingredients, customization, menu variety and choice. During the 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.
We continue to promote the expansion of our business in non-traditional day parts (morning, afternoon, and evening). The momentum in our evening business, which rose significantly with the return of our Sonic Nights initiative in the summer ofDuring fiscal year 2004, continued through fiscal year 2005. Every day part, including lunch and dinner, showed positive growth during2006, our total system-wide media expenditures were approximately $145 million as compared to $125 million in fiscal year 2005, compared to fiscal year 2004, andwhich we believe we have continuing opportunitycontinues to growincrease overall brand awareness and strengthen our non-traditional day parts like afternoon and evening throughout fiscal year 2006.
Implementationshare of the PAYS program, which began in the fall of 2003, was completed in the remaindervoice relative to our competitors. We also continued to spend approximately one-half of our Partner Drive-Ins during the second quartermarketing dollars on our system-wide marketing fund efforts, which are largely used for network cable television advertising, growing this area of fiscal year 2005. Under the PAYS program, a credit card terminal is added to each drive-in stall to facilitate credit and debit card transactions. Rollout to Franchise Drive-Ins beganour advertising from approximately $60 million in February 2005 and is expected to be completed system-wide by the end of calendar year 2006. The average investment to install PAYS in a typical Sonic Drive-In is approximately $25 thousand. In evaluating this initiative, we have targeted an “increased sales to investment ratio” of 1 to 1, and it has been our experience that the installation of the PAYS program has generally met and often exceeds this target.
A highlight of fiscal year 2005 was reaching the $1.0to approximately $72 million mark for system-wide average unit volumes. Another positive trend that has continued for seven consecutive quarters is the performance of developing markets relative to core markets. System-wide same-store sales in developing markets outpaced same-store sales in core markets, increasing 7.4% during fiscal year 2005 on top of a 6.8% increase in fiscal year 2004.2006. We believe this increase was primarily dueincreased network cable advertising provides several benefits including the ability to additional spending onmore effectively target and better reach the cable audience, which has now surpassed broadcast networks in terms of viewership. In addition, national cable which has benefited alladvertising 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 $160 million in fiscal 2007. The system-wide marketing fund portion will again represent approximately one-half of our markets, and particularly our developing markets. From an average unit volume standpoint, developing markets, which represent roughly 29% of the store base, increased 8.5% continuing the positive trend of the last year and well ahead of the average unit volume increase in core markets which increased 5.5%.total media expenditures for fiscal 2007.
Another milestone reached during fiscal year 2005 was the opening of Sonic’s 3,000th drive-in. WeSonic opened 175173 new drive-ins during fiscal year 2005,2006, consisting of 3735 Partner Drive-Ins and 138 Franchise Drive-Ins, down slightly from 188175 drive-in openings during fiscal year 2004 (212005 (37 Partner Drive-Ins and 167138 Franchise Drive-Ins). Looking forward, the Company expects to open 180 to 190200 new drive-ins during fiscal year 2006,2007, including 150 to 160 by franchisees.
Overview of Tender Offer and Financing Transactions. On October 13, 2006, we repurchased 15.9 million shares of our common stock that were properly tendered and not withdrawn, at a purchase price of $23.00 per share for a total purchase price of $366.1 million. We funded the repurchase of the shares of our common stock with the proceeds from new senior secured credit facilities with a syndicate of financial institutions led by Banc of America Securities LLC and Lehman Brothers Inc. The new senior secured credit facilities consist of a $100 million, five-year revolving credit facility and a $486 million, seven-year term loan facility.
Results of Operations
Revenues. Total revenues increased 16.1%11.3% to $623.1$693.3 million in fiscal year 20052006 from $536.4$623.1 million during fiscal year 2004.2005. The increase in revenues primarily relates to strongsolid sales growth for Partner Drive-Ins and to a lesser extent, a rise in franchising income.
Revenues | |
(in thousands) | |
| | | | | | 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 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | Percent | |
| | | | | | Increase/ | | Increase/ | |
Year Ended August 31, | | 2005 | | 2004 | | (Decrease) | | (Decrease) | |
Revenues: | | | | | | | | | | | | | |
Partner Drive-In sales | | $ | 525,988 | | $ | 449,585 | | $ | 76,403 | | | 17.0 | % |
Franchise revenues: | | | | | | | | | | | | | |
Franchise royalties | | | 88,027 | | | 77,518 | | | 10,509 | | | 13.6 | |
Franchise fees | | | 4,311 | | | 4,958 | | | (647 | ) | | (13.0 | ) |
Other | | | 4,740 | | | 4,385 | | | 355 | | | 8.1 | |
Total revenues | | $ | 623,066 | | $ | 536,446 | | $ | 86,620 | | | 16.1 | |
Revenues | |
(in thousands) | |
| | | | | | Percent | |
| | | | | | Increase/ | | Increase/ | |
Year Ended August 31, | | 2005 | | 2004 | | (Decrease) | | (Decrease) | |
Revenues: | | | | | | | | | | | | | |
Partner Drive-In sales | | $ | 525,988 | | $ | 449,585 | | $ | 76,403 | | | 17.0 | % |
Franchise revenues: | | | | | | | | | | | | | |
Franchise royalties | | | 88,027 | | | 77,518 | | | 10,509 | | | 13.6 | |
Franchise fees | | | 4,311 | | | 4,958 | | | (647 | ) | | (13.0 | ) |
Other | | | 4,740 | | | 4,385 | | | 355 | | | 8.1 | |
Total revenues | | $ | 623,066 | | $ | 536,446 | | $ | 86,620 | | | 16.1 | |
| | | | | | | | | | | | | |
| | | | | | | | | |
| | | | | | | | Percent | |
| | | | | | Increase/ | | Increase/ | |
Year Ended August 31, | | 2004 | | 2003 | | (Decrease) | | (Decrease) | |
Revenues: | | | | | | | | | | | | | |
Partner Drive-In sales | | $ | 449,585 | | $ | 371,518 | | $ | 78,067 | | | 21.0 | % |
Franchise revenues: | | | | | | | | | | | | | |
Franchise royalties | | | 77,518 | | | 66,431 | | | 11,087 | | | 16.7 | |
Franchise fees | | | 4,958 | | | 4,674 | | | 284 | | | 6.1 | |
Other | | | 4,385 | | | 4,017 | | | 368 | | | 9.2 | |
Total revenues | | $ | 536,446 | | $ | 446,640 | | $ | 89,806 | | | 20.1 | |
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.
Partner Drive-In Sales ($ in thousands) | Partner Drive-In Sales ($ in thousands) | | Partner Drive-In Sales ($ in thousands) | |
| | | | |
| | Year Ended August 31, | | | Year Ended August 31, | |
| | 2005 | | 2004 | | 2003 | | | 2006 | | 2005 | | 2004 | |
Partner Drive-In sales | | $ | 525,988 | | $ | 449,585 | | $ | 371,518 | | | $ | 585,832 | | $ | 525,988 | | $ | 449,585 | |
Percentage increase | | | 17.0 | % | | 21.0 | % | | 12.3 | % | | | 11.4 | % | | 17.0 | % | | 21.0 | % |
| | | | | | | | | | | | | | | | | | | | |
Partner Drive-Ins in operation: | | | | | | | | | | | |
Partner Drive-Ins in operation (1): | | | | | | | | | | | |
Total at beginning of period | | | 539 | | | 497 | | | 452 | | | | 574 | | | 539 | | | 497 | |
Opened | | | 37 | | | 21 | | | 35 | | | | 35 | | | 37 | | | 21 | |
Acquired from (sold to) franchisees, net | | | (1 | ) | | 21 | | | 11 | | | | 15 | | | (1 | ) | | 21 | |
Closed | | | (1 | ) | | - | | | (1 | ) | | | (1 | ) | | (1 | ) | | - | |
Total at end of period | | | 574 | | | 539 | | | 497 | | | | 623 | | | 574 | | | 539 | |
| | | | | | | | | | | | | | | | | | | | |
Average sales per Partner Drive-In | | $ | 957 | | $ | 886 | | $ | 799 | | | $ | 980 | | $ | 957 | | $ | 886 | |
Percentage increase | | | 8.0 | % | | 10.9 | % | | 1.0 | % | | | 2.4 | % | | 8.0 | % | | 10.9 | % |
| | | | | | | | | | | | | | | | | | | | |
Change in same-store sales (1)(2) | | | 7.4 | % | | 7.8 | % | | (0.3 | %) | | | 1.9 | % | | 7.4 | % | | 7.8 | % |
| | | | | | | | | | | | | | | | | | | | |
(1) Represents percentage change for drive-ins open for a minimum of 15 months. | |
(1) Drive-ins that are temporarily closed for various reasons (repairs, remodeling, management changes, etc.) are not considered closed unless the Company determines that they are unlikely to reopen within a reasonable time. (2) Represents percentage change for drive-ins open for a minimum of 15 months. | | (1) Drive-ins that are temporarily closed for various reasons (repairs, remodeling, management changes, etc.) are not considered closed unless the Company determines that they are unlikely to reopen within a reasonable time. (2) Represents percentage change for drive-ins open for a minimum of 15 months. |
The increases in Partner Drive-In sales result from newly constructed and acquired drive-ins and same-store sales increases in existing drive-ins, offset by the loss of sales for sold and closed drive-ins.
Change in Partner Drive-In Sales ($ in thousands) | Change in Partner Drive-In Sales ($ in thousands) | | Change in Partner Drive-In Sales ($ in thousands) | |
| | | | |
| | Year Ended August 31, | | | Year Ended August 31, | |
| | 2005 | | 2004 | | | 2006 | | 2005 | |
Increase from addition of newly constructed drive-ins (1) | | $ | 28,184 | | $ | 23,099 | | | $ | 33,332 | | $ | 28,184 | |
Increase from acquisition of drive-ins (2) | | | 19,831 | | | 38,378 | | | | 19,549 | | | 19,831 | |
Increase from same-store sales | | | 31,109 | | | 28,561 | | | | 9,754 | | | 31,109 | |
Decrease from drive-ins sold or closed (3) | | | (2,721 | ) | | (11,971 | ) | | | (2,791 | ) | | (2,721 | ) |
Net increase in Partner Drive-In sales | | $ | 76,403 | | $ | 78,067 | | | $ | 59,844 | | $ | 76,403 | |
| | | | | | | | |
(1) Represents the increase for 72 and 58 drive-ins opened since the beginning of the prior fiscal year as of August 31, 2006 and 2005, respectively. | | (1) Represents the increase for 72 and 58 drive-ins opened since the beginning of the prior fiscal year as of August 31, 2006 and 2005, respectively. |
(2) Represents the increase for 19 and 28 drive-ins acquired since the beginning of the prior fiscal year as of August 31, 2006 and 2005, respectively. | | (2) Represents the increase for 19 and 28 drive-ins acquired since the beginning of the prior fiscal year as of August 31, 2006 and 2005, respectively. |
(3) Represents the decrease for 7 and 9 drive-ins sold or closed since the beginning of the prior fiscal year as of August 31, 2006 and 2005, respectively. | | (3) Represents the decrease for 7 and 9 drive-ins sold or closed since the beginning of the prior fiscal year as of August 31, 2006 and 2005, respectively. |
| | |
(1) Represents the increase for 58 and 55 drive-ins opened since the beginning of the prior fiscal year as of August 31, 2005 and 2004, respectively. |
(2) Represents the increase for 28 and 77 drive-ins acquired since the beginning of the prior fiscal year as of August 31, 2005 and 2004, respectively. |
(3) Represents the decrease for 9 and 45 drive-ins sold or closed since the beginning of the prior fiscal year as of August 31, 2005 and 2004, respectively. |
During fiscal year 2005, same-store sales at Partner Drive-Ins again exceeded the same-store sales performance of our franchisees. The increase in average unit volume was also strong - growing 8.0% during the year as a result of the acquisition of higher volume drive-ins in Colorado in July 2004 as well as strong performance from new stores. Effective JulySeptember 1, 2005, we rolled overacquired 15 Franchise Drive-Ins located in the Tennessee and Kentucky markets. This acquisition of the Colorado drive-ins which accounted foradded approximately three percentage points of the3% to our revenue growth in Partner Drive-In sales during fiscal year 2005.
Beginning in fiscal year 2004, we implemented initiatives designed to close the approximately $130 thousand sales gap in annual average unit volumes between Partner Drive-Ins and Franchise Drive-Ins. To a large degree, this effort is modeled on the best practices of our top-volume Partner and Franchise Drive-Ins. Our intent is to complement the strong profit motive created through our partnership program with strong incentives focused on top-line growth. During fiscal year 2004, this gap narrowed by 25% or approximately $30 thousand per drive-in. During fiscal year 2005, the trend continued as same-store sales growth at Partner Drive-Ins outpaced same-store sales of Franchise Drive-Ins, closing the gap by another $15 thousand.
2006. Over the past several years, we have completed the acquisition of several Franchise Drive-Ins in various markets including the acquisition of 51 drive-ins located in the San Antonio, Texas market in May 2003 and the acquisition of 22 drive-ins located in the Denver and Colorado Springs, Colorado markets in July 2004. Effective September 1, 2005, we acquired 15 franchise drive-ins located in the Tennessee and Kentucky markets. These acquisitions have added and are expected to continue to add to revenue growth and are expected to continue to be accretive to earnings over time.earnings. Our acquisitions are typically focused on higher volume stores with strong store-level management already in place. In addition, the selling franchisee usually retains a significant drive-in base and continues growing with us in other areas. We view these types of acquisitions of drive-ins with proven track records as a very good, lower-risk use of our capital and they remain a very viable potential use of our excess cash flow in future years.
The following table reflects the growth in franchise revenuesincome (franchise royalties and franchise fees) as well as franchise sales, average unit volumes and the number of Franchise Drive-Ins. While we do not record Franchise Drive-In sales as revenues, we believe this information is important in understanding our financial performance since these sales are the basis on which we calculate and record franchise royalties. This information is also indicative of the financial performancehealth of our Franchise Drive-Ins.franchisees.
Franchise Information ($ in thousands) | Franchise Information ($ in thousands) | | Franchise Information ($ in thousands) | |
| | |
| | Year Ended August 31, | | | Year Ended August 31, | |
| | 2005 | | 2004 | | 2003 | | | 2006 | | 2005 | | 2004 | |
Franchise fees and royalties (1) | | $ | 92,338 | | $ | 82,476 | | $ | 71,105 | | | $ | 102,910 | | $ | 92,338 | | $ | 82,476 | |
Percentage increase | | | 12.0 | % | | 16.0 | % | | 8.7 | % | | | 11.4 | % | | 12.0 | % | | 16.0 | % |
| | | | | | | | | | | | | | | | | | | | |
Franchise Drive-Ins in operation: | | | | | | | | | | | |
Franchise Drive-Ins in operation (2): | | | | | | | | | | | |
Total at beginning of period | | | 2,346 | | | 2,209 | | | 2,081 | | | | 2,465 | | | 2,346 | | | 2,209 | |
Opened | | | 138 | | | 167 | | | 159 | | | | 138 | | | 138 | | | 167 | |
Acquired from (sold to) Company, net | | | 1 | | | (21 | ) | | (11 | ) | | | (15 | ) | | 1 | | | (21 | ) |
Closed | | | (20 | ) | | (9 | ) | | (20 | ) | | | (23 | ) | | (20 | ) | | (9 | ) |
Total at end of period | | | 2,465 | | | 2,346 | | | 2,209 | | | | 2,565 | | | 2,465 | | | 2,346 | |
| | | | | | | | | | | | | | | | | | | | |
Franchise Drive-In sales | | $ | 2,474,133 | | $ | 2,219,340 | | $ | 1,988,842 | | | $ | 2,735,802 | | $ | 2,474,133 | | $ | 2,219,340 | |
Percentage increase | | | 11.5 | % | | 11.6 | % | | 6.1 | % | | | 10.6 | % | | 11.5 | % | | 11.6 | % |
| | | | | | | | | | | | | | | | | | | | |
Effective royalty rate | | | 3.56 | % | | 3.49 | % | | 3.34 | % | | | 3.59 | % | | 3.56 | % | | 3.49 | % |
| | | | | | | | | | | | | | | | | | | | |
Average sales per Franchise Drive-In | | $ | 1,039 | | $ | 983 | | $ | 929 | | | $ | 1,092 | | $ | 1,039 | | $ | 983 | |
| | | | | | | | | | | | | | | | | | | | |
Change in same-store sales (2) | | | 5.8 | % | | 6.2 | % | | 0.4 | % | |
Change in same-store sales (3) | | | | 5.1 | % | | 5.8 | % | | 6.2 | % |
| | | | | | | | | | | |
(1) See Revenue Recognition Related to Franchise Fees and Royalties in the Critical Accounting Policies and Estimates section of MD&A. | (1) See Revenue Recognition Related to Franchise Fees and Royalties in the Critical Accounting Policies and Estimates section of MD&A. | (1) See Revenue Recognition Related to Franchise Fees and Royalties in the Critical Accounting Policies and Estimates section of MD&A. |
(2) Represents percentage change for drive-ins open for a minimum of 15 months. | |
(2) Drive-ins that are temporarily closed for various reasons (repairs, remodeling, management changes, etc.) are not considered closed unless the Company determines that they are unlikely to reopen within a reasonable time. (3) Represents percentage change for drive-ins open for a minimum of 15 months. | | (2) Drive-ins that are temporarily closed for various reasons (repairs, remodeling, management changes, etc.) are not considered closed unless the Company determines that they are unlikely to reopen within a reasonable time. (3) Represents percentage change for drive-ins open for a minimum of 15 months. |
Franchise income, which consists of franchise royalties and franchise fees, increased 12.0%11.5% to $92.3$98.2 million in fiscal year 2006, compared to $88.0 million in fiscal year 2005. Of the $10.2 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. 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 increased 13.6% to $88.0 million in fiscal year 2005, compared to $77.5 million in fiscal year 2004. Of the $10.5 million increase, approximately $6.3 million resulted from Franchise Drive-Ins’ same-store sales growth of 5.8% in fiscal year 2005, combined with an increase in the effective royalty rate to 3.56% during fiscal year 2005 compared to 3.49% during fiscal year 2004. 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 royaltiesfees increased 16.7%10.1% to $77.5 million in fiscal year 2004, compared to $66.4 million in fiscal year 2003. Of the $11.1 million increase, approximately $6.7 million resulted from Franchise Drive-Ins’ same-store sales growth of 6.2% in fiscal year 2004, combined with an increase in the effective royalty rate to 3.49% during fiscal year 2004 compared to 3.34% during fiscal year 2003. The balance of the increase was attributable to growth in the number of Franchise Drive-Ins over the prior period.
Franchise fees decreased 13.0% to $4.3$4.7 million as franchisees opened 138 new drive-ins in both fiscal year 2005 as compared to 167 openings in2006 and fiscal year 2004.2005. The increase in franchise fee revenue resulted from the termination of area development agreements related to an initiative to strengthen the franchise development pipeline by terminating non-performing agreements. Franchise fees increased 6.1%decreased 13.0% to $5.0$4.3 million during fiscal 20042005 as 167138 Franchise Drive-Ins opened compared to 159167 during the previous year.
During fiscal year 2005, development on the franchise side was negatively impacted by a number of factors. We had numerous projects affected by various delays caused by zoning and permitting difficulties as well as site specific location and construction issues. We believe this is a direct by-product of a more challenging development environment as much of our development is occurring in harder-to-develop markets, including Florida and California. In addition, since the development cycle tends to be 18 to 24 months long, we are, to some degree, feeling the impact of a slowdown in store profitability during 2003 that tends to create a more cautious approach to development from franchisees.
Looking forward, there has been a strong riseincrease in per store profits over the last 24 months thatthree years. Historically, strong growth in sales and profits has positively impactedbeen a good indicator of increased franchise openings in the pipeline for future franchise development. This is evidenced by 163following years. As of August 31, 2006, we had 152 area development agreements at the end of fiscal year 2005 representing approximately 635576 planned Franchise Drive-In openings over the next few years, compared to 157163 such agreements at August 31, 20042005 which represented approximately 570635 planned Franchise Drive-In openings. While the number of agreements and commitments has declined, we believe that the termination of several non-performing agreements over the past year has improved the quality of our franchise
pipeline. Another step that has contributed to growth of our confidence in the franchise pipeline is the recent planned expansion into a number of new markets, primarily located along the east and west coasts. In the past, our market expansion has been limited to a fewer number of markets at one time; we believe the brand awareness provided by our national cable advertising efforts will support this planned expansion to a greater number of markets.
TwentyTwenty-three Franchise Drive-Ins were closed during fiscal year 2005,2006, which was an increase from the nine20 Franchise Drive-Ins closed during fiscal year 2004.2005. Most of the closings in fiscal year 2006 were the result of low sales and were spread across a broad range of markets and franchise groups. Fifteen of the fiscal year 2005 closings occurred during the second quarter and related primarily to two weaker franchise operators in two different markets. We do not believe that these drive-in closings are indicative of the Sonic brand’s success. We have taken steps to require stronger financial qualifications of new franchisees, which we believe will significantly mitigate this type of risk. In addition, we expect that some of these drive-ins may re-open under new franchisee ownership.
We anticipate 150 to 160 store openings by franchisees during fiscal year 2006.2007. Substantially all of these new drive-ins will open under our newest form of license agreement, which contains a higher average royalty rate and initial opening fee. As a result of these new Franchise Drive-In openings and the continued benefit of the ascending royalty rate, we expect approximately $9 to $10 million in incremental franchise fees and royalties in fiscal year 2006.2007.
Operating Expenses. Overall, drive-in cost of operations, as a percentage of Partner Drive-In sales, increaseddecreased to 80.0% in fiscal year 2006 from 80.2% in fiscal year 2005 from 79.8% in fiscal year 2004.2005. Minority interest in earnings of drive-ins is included as a part of cost of sales, in the table below, since it is directly related to Partner Drive-In operations.
Operating Margins | Operating Margins | | Operating Margins | |
| | | |
| | Year Ended August 31, | | | Year Ended August 31, | |
| | 2005 | | 2004 | | 2003 | | | 2006 | | 2005 | | 2004 | |
Costs and Expenses (1): | | | | | | | | | | | | | | | | | |
Partner Drive-Ins: | | | | | | | | | | | | | | | | | | | | |
Food and packaging | | | 26.2 | % | | 26.3 | % | | 26.0 | % | | | 25.9 | % | | 26.2 | % | | 26.3 | % |
Payroll and other employee benefits | | | 30.3 | | | 30.2 | | | 29.6 | | | | 30.0 | | | 30.3 | | | 30.2 | |
Minority interest in earnings of Partner Drive-Ins | | | 4.1 | | | 4.4 | | | 3.9 | | | | 4.3 | | | 4.1 | | | 4.4 | |
Other operating expenses | | | 19.6 | | | 18.9 | | | 19.0 | | | | 19.8 | | | 19.6 | | | 18.9 | |
Total Partner Drive-In cost of operations | | | 80.2 | % | | 79.8 | % | | 78.5 | % | | | 80.0 | % | | 80.2 | % | | 79.8 | % |
| | | | | | | | | | | | | | | | | | | | |
(1) As a percentage of Partner Drive-In sales. |
Food and packaging costs decreased by 0.3 percentage points during fiscal year 2006 compared to fiscal year 2005 following a decrease of 0.1 percentage points during fiscal year 2005 compared to fiscal year 2004 following an increase of 0.3 percentage points during2004. The improvement for fiscal year 2004 compared2006 relates primarily to fiscal year 2003. In the early part of the year, we experienced significant, year-over-year increaseslower dairy costs and a favorable shift in several commodities including beef, dairy,product mix to drinks and tomatoes. They were offset byice cream, which have more favorable margins than other menu price increases of approximately 1% in December 2004 and 1.5% in May 2005, as well as abatement of price pressures for these items, particularly dairy, in the latter part of the year.items. Looking forward, we anticipate that slightly lower year-over-year costs for beef, as well as lower costs for other itemsa benign commodity cost environment will result in lowerflat to slightly favorable food and packaging costs, as a percentage of sales, on a year-over-year basis in fiscal year 2006. This favorable outlook may be negatively impacted if energy prices remain high throughout the year.2007.
Labor costs increaseddecreased by 0.3 percentage points during fiscal year 2006 compared to fiscal year 2005 after an increase of 0.1 percentage points during fiscal year 2005 compared to fiscal year 2004 after an increase of 0.6 percentage points during2004. The improvement for fiscal year 2004 compared to fiscal year 2003.2006 is primarily a result of leverage from higher sales volumes. The slight increase for fiscal year 2005 resulted from staffing increases at the assistant manager level, as well as higher labor costs related to opening newly constructed stores as higher staffing levels were required for pre-opening training and through the initial opening period. The 2004 increase was primarily a result of significant payments made under the sales-based incentive program for drive-
in management as well as higher staffing levels reflecting successful ongoing efforts to reduce turnover at Partner Drive-Ins.
Looking forward, theThe average wage rate has increased only slightly inover the last two quarters of fiscal year 2005, although the increase has not been significantpast year. Looking forward, wage increases are expected to date. We plan to continue making significant payments under our sales incentive program, as we believe it has been a major driver of strong sales performance at Partner Drive-Ins. These increases, however, should be leveraged by higher volumes. As a result, we expect labor costs to be flat to slightly favorable, as a percentage of sales, on a year-over-year basis, in fiscal year 2006.2007.
Minority interest, which reflects our store-level partners’ pro-rata share of earnings fromthrough our partnership program, increased by $1.6$3.7 million during fiscal year 2005,2006, reflecting the increase in average profit per store.store-level profits. During fiscal year 2004,2005, minority interest increased $5.5$1.6 million, also reflecting the increase in average
profit per store. Overall, weWe 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 2005.2006. Since we expect our average store level profits to continue to grow in fiscal year 2006,2007, we would expect minority interest to continue to increase in dollar terms but stay relatively flat as a percentage of sales.terms.
Other operating expenses increased by 0.2 percentage points during fiscal year 2006 after an increase of 0.7 percentage points during fiscal year 2005. CostsLeverage from higher sales partially offset increased utility costs resulting from higher energy prices in fiscal year 2006. The increase in fiscal year 2005 resulted primarily as a result offrom credit card charges associated with the increase in credit card transactions stemming from the success of the PAYS program, as well as increased repairs and maintenance expenses resulting from a greater focus on the physical appearance of our drive-ins, both inside and outside. Utility costs also increased toward the end of fiscal year 2005 as a result of increased energy prices. During fiscal year 2004, other operating expenses decreased by 0.1 percentage points as the leverage of operating at higher unit volumes more than offset increased costs.drive-ins. Looking forward, we expect cost increases in many of the items listed above, particularly utility costs, to carry over into fiscal year 2006. Our expectations for other operating costs will continue to depend upon future swings in energy costs, but we generally expect that the cost increases will result in other operating expenses increasing 0.25 to 0.50 percentage points,be flat to slightly favorable in fiscal year 2006.2007, as we lap over the higher costs from a year ago.
To summarize, we are expecting overall restaurant-level margins to be relatively flatslightly favorable during fiscal year 20062007 on a year-over-year basis, depending upon the variability in energy costs.basis.
Selling, General and Administrative. Selling, general and administrative expenses increased 6.5%9.6% to $40.7$52.0 million during fiscal year 20052006 and 8.0%6.1% to $38.3$47.5 million during fiscal year 2004. We continue to see leverage as the growth in these expenses was considerably less than the growth in revenues.2005. As a percentage of total revenues, selling, general and administrative expenses decreased to 6.5%7.5% in fiscal year 2006, compared with 7.6% in fiscal year 2005 compared with 7.1%and 8.3% in fiscal year 2004 and 7.9% in fiscal year 2003. Beginning in2004. Sonic adopted SFAS 123R at the first quarterbeginning of fiscal year 2006, therefore, we are now expensing the Company willestimated fair value of stock options over their vesting period. We chose to adopt FAS 123R whichthe new standard using the modified retrospective application method, as provided for in the standard. This method of adoption requires us to adjust all prior periods to reflect expense for the fair value of stock options be chargedthat was previously only disclosed in the footnotes to expense. The projected impactthe financial statements. As of adopting this standard is estimatedAugust 31, 2006, total remaining unrecognized compensation cost related to be additional expense of approximately $8 to $9unvested stock-based arrangements was $12.4 million during fiscal year 2006. This expenseand is expected to be incurred pro-ratarecognized 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. Excluding stock-based compensation expense, these costs increased 10.1% during fiscal year with the amount increasing slightly in the third2006 and fourth quarters due6.5% during fiscal year 2005, both increases related primarily to the annual grantincreased headcount additions to support continued growth of options that typically occurs at Sonic’s spring board meeting. Excluding the impact of FAS 123R, weour business. We anticipate that theseselling, general and administrative costs will increase in the range of 10% to 12% in fiscal year 20062007 and to decline slightly, as a percentage of sales. This rate of increase is higher than prior years primarily because of increased headcount additions which management believes is necessary to support continued growth in our business.
Depreciation and Amortization. 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. This reduction in life resulted from a re-evaluation of the remaining life of such assets in the fourth quarter of fiscal year 2005. Depreciation and amortization expense increased 10.1% to $35.8 million in fiscal year 2005 due, in part, to additional depreciation stemming from the Colorado acquisition in July 2004. Similarly, depreciation and amortization expense increased 11.3% to $32.5 million inCapital expenditures during fiscal year 2004 as a result2006 were $113.6 million, including $14.6 million related to the acquisition of drive-ins, and $12.1 million related to the San Antonio and Colorado acquisitions, as well aspurchase of real estate in the capital lease on our corporate office space. Capital expenditures, excluding acquisitions, were $85.9 million in fiscal year 2005.fourth quarter. Looking forward, with approximately $75 to $80 million in capital expenditures planned for the year, normal depreciation and amortization is expected to increase by approximately 9%8% to 11%10% for the year. However, the Company re-evaluated the remaining asset life of certain assets related to the retrofit of Partner Drive-Ins in the late 1990s and has determined that the remaining useful life should be reduced. This reduction will cause an incremental increase in depreciation and amortization over the next four quarters of approximately 7% over the prior year, resulting in an overall expectation that depreciation and amortization will increase in the range of 16% to 18% for the year.
Provision for Impairment of Long-lived Assets. One Partner Drive-In and one property held for disposalThree surplus properties became impaired during fiscal year 20052006 under the guidelines of FAS 144 - “Accounting for the Impairment or Disposal of Long-Lived Assets.” As a result, a total provision for impairment of long-lived assets of $0.4$0.3 million was recorded for the carrying costs of these assets in excess of their estimated fair values. One Partner Drive-In and one surplus property became impaired during fiscal year 20042005 which resulted in a provision for impairment of $0.7$0.4 million to reduce the drive-in’sfor carrying cost to itsin excess of estimated fair value. During fiscal year 2003, two Partner Drive-Ins became impaired which resulted in a provisionvalue for impairment totaling $0.7 million to reduce the drive-ins’ carrying cost to their estimated fair value.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 decreased 9.3%increased 31.0% in fiscal year 20052006 compared to a 2.6%9.3% decrease in fiscal year 2005. The increase in fiscal year 2004 as2006 resulted from increased borrowings which have been used largely to fund approximately $93.7 million in share repurchases during the year and capital expenditures. The reduction in interest expense for fiscal year 2005 was a result of strong cash flow from operations. Theoperations that limited borrowings, with the reduction in interest expense more than offsetoffsetting the decrease in interest income relating to the outsourcing of our partner notes to a third-party financial institution in August 2004. Interest expense increased in fiscal year 2004 largely due to the addition of the capital lease associated with our new office space. Our ability to generate positive operating cash flow enabled us to expend $85.9 million in capital expenditures, $42.3 million in share repurchases and still reduce our long-term debt by $22.0 million. Going
forward, we expect our continued repurchase of stock, as well as the acquisition of 15 drive-ins effective September 1, 2005 will produce highernet interest expense to increase as a result of the tender offer initiated by the Company in future quartersAugust 2006 and funded in October 2006. The resulting additional long-term borrowings are expected to result in an increase in net interest expense to at least $32 million or more depending on the level of shares repurchased or additional franchise acquisitions.share repurchases and acquisitions of Franchise Drive-Ins.
Income taxes. The provision for income taxes reflectsremained relatively constant for fiscal year 2006 with an effective federal and state tax rate of 36.35% for36.6% compared with 36.9% in fiscal year 2005 compared with 36.82%and 37.8% in fiscal year 2004 and 37.25% in fiscal year 2003.2004. The lower rate for fiscal year 2005 as compared to fiscal year 2004 resulted primarily from a retroactive tax law change that reinstated expired tax credits in the first quarter of fiscal year 2005. The reductionexpiration of the Work Opportunity Tax Credit on January 1, 2006 has negatively impacted and will continue to impact our tax rate going forward. We expect that Congress will reinstate the tax credit retroactively, as they have done in the past. However, we are not allowed to record the benefit of this credit for qualified employees hired after December 31, 2005 until the legislation becomes enacted law. We expect our effective tax rate to be in the range of 36.5% to 37.5% in fiscal year 2004 was primarily a result2007. However, our tax rate may continue to vary significantly from quarter-to-quarter depending upon the timing of the benefit of higher tax credits. We expect the adoption of FAS 123R for stock options in the first quarter of fiscal year 2006 to impact the tax rate, as only the portion of stock option expense expected to result in a future tax deduction is considered deductible for tax accounting purposes. Sonic currently estimates the tax benefit for stock options to be approximately 25%renewal of the amount expensed. Considering these variables, we anticipate that our effective tax rate will increase during fiscal year 2006 to a range of 37.5% to 38.0%Work Opportunity Tax Credit program, option exercises and vary from quarter to quarterdispositions by option-holders and as circumstances on individual tax matters change.
Financial Position
During fiscal year 2005,2006, current assets increased 1.9%20.6% to $35.2$42.5 million compared to $34.6$35.2 million as of the end of fiscal year 2004.2005. Cash balances increased by $3.2 million as a result of positive operating cash flows and current notes receivable from franchisees increased by approximately $2.5 million related to short term financing for certain franchisee capital projects. Net property, equipment and capital leases increased by 12.4%$54.2 million as a result of capital expenditures. Theexpenditures and the Tennessee and Kentucky acquisition. Goodwill increased by $8.5 million and other intangibles increased by $4.3 million as a result of the Tennessee and Kentucky acquisition. These increases combined with the increase in current assets and net property, equipment and capital leases were partially offset by decreasesresulted in notes receivable, resulting from early repayment by franchisees, to produce an 8.6%a 13.3% increase in total assets to $563.3$638.0 million as of the end of fiscal year 2005.2006.
Total current liabilities increased $16.2$12.8 million or 33.0%19.5% during fiscal year 20052006 as a result of increasesa temporary increase in income taxesaccounts payable and trade payables.accrued liabilities, which was partially offset by a reduction in tax liabilities due to the timing of tax payments. The non-currentnoncurrent portion of long-term debt decreased $22.7increased $61.2 million or 28.9%109.5% as a result of repaymentadvances on the Company’s line of debt using cash generated from operating activities.credit to fund portions of the share repurchases, capital expenditures and the Tennessee and Kentucky acquisition. Overall, total liabilities decreased $5.1increased $70.9 million or 2.8%40.4% as a result of the items discussed above.
Stockholders’ equity increased $49.8$3.8 million or 14.9%1.0% during fiscal year 20052006 primarily resulting from earnings during the period of $75.4$78.7 million, along with $18.8 million for stock option-related and other activity, offset by treasury stock repurchases during the period of $42.3$93.7 million. Proceeds and the related tax benefit from the exercise of stock options accounted for the balance of the increase. At the end of fiscal year 2005,2006, our debt-to-total capital ratio stood at 20.4%28.9%, downup from 26.8%20.3% at the end of fiscal year 2004.2005. For the twelve12 months ended August 31, 2005,2006, return on average stockholders'stockholders’ equity was 21.0%20.2% and return on average assets was 13.9%13.1%.
Liquidity and Sources of Capital
Operating Cash Flows. Net cash provided by operating activities increased $25.6decreased $0.2 million or 24.3%0.2% to $132.3$127.5 million in fiscal year 20052006 as compared to $106.7$127.7 million in fiscal year 2004, primarily as a result of an2005. The increase in operating profit before depreciation and amortization and anwas offset by a less significant increase in operating liabilities related to the amount and timing of tax and other liability payments.payments and a decrease in benefit from deferred income taxes. We also anticipate continuing to generate increasing positive free cash flow going forward. We believe free cash flow, which we define as net income plus depreciation, amortization and stock-based compensation expense less capital expenditures, is useful in evaluating the liquidity of the Company by assessing the level of funds available for share repurchases, acquisitions of Franchise Drive-Ins, and repayment of debt.
Investing Cash Flows.We expect free cash flow to approach $50 millionopened 35 newly constructed Partner Drive-Ins and acquired 15 drive-ins from franchisees during fiscal year 2006. We funded total capital additions for fiscal year 2006.
2006 of $113.6 million, which included the cost of newly opened drive-ins, new equipment for existing drive-ins, drive-ins under construction, the acquisition of Franchise Drive-Ins and real estate, and other capital expenditures, from cash generated by operating activities and borrowings under our line of credit. During fiscal year 2006, we purchased the real estate for 24 of the 35 newly constructed and 12 of the 15 acquired drive-ins. Subsequent to year-end, we entered into a sale-leaseback agreement to dispose of the real estate underlying the acquired drive-ins at an amount roughly equal to the purchase price of the real estate. Sales of real estate relating to drive-ins previously sold to franchisees are a component of cash from investing activities and totaled $2.3 million during fiscal year 2006 compared to $1.3 million during fiscal year 2005.
Financing Cash Flows.At August 31, 2006 we had an agreement with a group of banks that providesprovided us with a $150.0 million line of credit expiring in July 2010. As of August 31, 2005,2006, our outstanding borrowings under the line of credit were $30.2$101.2 million at an effective borrowing rate of 5.11%6.1%, as well as $0.7 million in outstanding letters of credit. TheSubsequent to year end, the new senior secured credit facility, described further below, was used to refinance the existing line of credit and the senior unsecured notes balance of $19.9 million. As a result of the subsequent credit facility, the amount availableclassified as a current liability is based upon the $5.1 million due by the end of fiscal year 2007 under the new credit facility rather than upon amounts due under the line of credit as of August 31, 2005, was $119.1 million. We have long-term debt maturing in fiscal year 2006 of $8.9 million. Of this amount, $4.6 million relates to ourand senior unsecured notes that will be maturing in August 2006, and is classified as long-term because we intendthe new facility was utilized to utilize amounts available under our linerepay those obligations. After funding of credit to fund this obligation. We believe that free cash flow will be adequate for repayment of any long-term debt that does not get refinanced or extended. Wethe tender offer described below, we plan to use the line ofnew revolving credit facility to finance the opening of newly constructed drive-ins and other planned capital expenditures, 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.
On April 7, 2005, our2006, the Board of Directors approved an increase in the amount available under ourCompany’s share repurchase program from $60.0$34.6 million to $150.0$110.0 million and extended the program through August 31, 2006.2007. Pursuant to this program, the Company acquired 1.34.8 million shares at an average price of $31.48$19.57 for a total cost of $42.3$93.7 million during fiscal year 2005. As of August 31, 2005, we had $107.72006. Of the amount repurchased during the year, $20.6 million was repurchased after the program’s extension leaving $89.4 million available under the program.program as of August 31, 2006. See Tender Offer below.
We opened 37 newly constructed Partner Drive-InsTender Offer. On August 15, 2006, we commenced a “modified Dutch auction” tender offer, initially offering to purchase 25.5 million shares of our common stock at a price not less than $19.50 and soldnot greater than $22.00 per share, for a netmaximum aggregate purchase price of one drive-in$560 million. On September 25, 2006, we decreased the number of shares sought in the tender offer to franchisees during fiscal year 2005. We funded24.3 million, and increased the purchase price to not less than $19.50 and not greater than $23.00 per share. On October 13, 2006, we repurchased 15.9 million shares of our common stock that were properly tendered and not withdrawn, at a purchase price of $23.00 per share for a total capital additions for fiscal year 2005purchase price of $85.9 million, which included the cost of newly opened drive-ins, new equipment for existing drive-ins, drive-ins under construction, the acquisition of Franchise Drive-Ins, and other capital expenditures, from cash generated by operating activities and borrowings under our line of credit. During fiscal year 2005, we purchased the real estate for 31 of the 41 newly constructed and acquired drive-ins. Sales of real estate relating to drive-ins previously sold to franchisees are a component of cash from investing activities and totaled $1.3 million during fiscal year 2005 compared to $8.8 million during fiscal year 2004.$366.1 million.
Subsequent to August 31, 2005,Senior Secured Credit Facilities.We funded the Company acquired 15 Franchise Drive-Ins for $13.9 million, excluding any post-closing adjustments. The Company also continued to repurchase of the shares of our common stock with the proceeds from new senior secured credit facilities with a syndicate of financial institutions led by Banc of America Securities LLC and Lehman Brothers Inc. The new senior secured credit facilities consist of a $100 million, five-year revolving credit facility and a $486 million, seven-year term loan facility. As of October 13, 2006, we had borrowed $486 million under the share repurchase program, purchasingterm loan facility and no advances were outstanding under the revolving credit facility, to fund the purchase of the shares in the tender offer, as well as refinance certain of our existing indebtedness and pay related fees and expenses.
Interest Rate. Interest on loans under the new senior secured credit facility will be payable at per annum rates equal to (1) in the case of the revolving credit facility, initially, LIBOR plus 175 basis points and adjusting over time based upon Sonic's leverage ratio and (2) in the case of the term loan facility, initially, LIBOR plus 200 basis points and adjusting over time based upon Sonic's credit ratings with Moody's Investors Service Inc. As discussed below, we expect to refinance this facility with an additional 1.4alternative facility that is expected to bear interest at a lower rate.
Commitment Fees. We will pay a commitment fee on the unused portion of the revolving credit facility, starting at 0.375% and adjusting over time based upon our leverage ratio.
Conditions to Funding. Our ability to reserve funds from the revolving credit facility is conditioned upon various customary representations and warranties being true at the time of the borrowing, and upon no event of default existing or resulting from the receipt of such finds.
Security Interests. We and all of our domestic subsidiaries have granted the lenders under the new senior secured credit facility valid and perfected first priority (subject to certain exceptions) liens and security interests in (1) all present and future shares of capital stock (or other ownership profit interests) in each of our present and future subsidiaries (subject to certain limitations), (2) all present and future property and assets, real and personal and (3) all proceeds and products of the property and assets described in clauses (1) and (2).
Covenants and Events of Default. The credit agreement governing the new senior secured credit facilities contains certain affirmative covenants, certain negative covenants, certain financial covenants, certain conditions and events of default that are customarily required for similar financings. Such
negative covenants include limitations on liens, consolidations and mergers, indebtedness, capital expenditures, asset dispositions, sale-leaseback transactions, stock repurchases, transactions with affiliates and other restrictions and limitations. Furthermore, the credit agreement requires us to maintain compliance with certain financial covenants such as a leverage ratio and fixed charge coverage ratio. Although management does not anticipate an event of default, if such an event occurred, the unpaid amounts outstanding could become immediately due and payable.
Securitization.We currently intend to refinance the new senior secured credit facilities in the near future through a securitization of our Franchise and Partner Drive-In royalties and Partner Drive-In rental stream. The securitization is expected to consist of a six-year term asset-backed securitization and a $100 million shares for $40.0variable funding note, and to involve the transfer of certain Franchise and Partner Drive-In assets to a bankruptcy-remote vehicle. We expect the interest rate on the securitization will be between 50 and 125 basis points lower than on the new senior secured credit facilities. The final interest rate will be determined based upon final ratings that are in the process of being determined. Additional fees related to the securitization are estimated at approximately $20 million and will be amortized over the life of the related debt. The securitization and the refinancing of the new senior secured credit facilities are expected to occur by December 31, 2006. If, however, we cannot obtain the securitization on terms satisfactory to us, we expect the new senior secured credit facilities to remain in place until maturity or until an alternative refinancing can be arranged.
Forward Starting Swap Agreement.We have entered into a forward starting swap agreement with J.P. Morgan Chase Bank with a total notional amount of $400 million. The totalforward starting swap agreement was entered into to hedge part of our interest rate exposure associated with the securitized financing. We expect to settle the forward swap agreement upon the initiation of the securitized financing. The settlement of this forward starting swap is expected to provide us with an effective interest rate based upon a five-year swap rate of 5.16% plus 90 to 110 basis points for $400 million of the amount financed. The remaining amount authorizedterm loan balance is expected to bear interest at the five-year swap rate at the time the securitization is funded plus 90 to 110 basis points. If the securitization is not completed for repurchaseany reason, we may redesignate the forward starting swap as a hedge of November 10, 2005 was $67.6 million. These cash outlays also led to additional advancesfuture interest payments under the available line ofnew senior secured credit facilities, with any ineffectiveness recorded as a charge or credit to earnings, or we could terminate the total amount outstanding at November 10, 2005 of $63.0 million,swap resulting in an increase of $32.9 million over the balance at August 31, 2005.immediate charge or credit to earnings.
We plan capital expenditures of approximately $75 to $80 million in fiscal year 2006,2007, excluding potential acquisitions and share repurchases. These capital expenditures primarily relate to the development of additional Partner Drive-Ins, stall additions, relocationsretrofit of older drive-ins, store equipmentexisting Partner Drive-Ins and point-of-sale system upgrades, and enhancements to existing financial and operating information systems.other drive-in level expenditures. We expect to fund these capital expenditures through cash flow from operations and borrowings under our existing line of credit.new senior secured credit facility.
As of August 31, 2005,2006, our total cash balance of $6.4$9.6 million reflected the impact of the cash generated from operating activities, borrowing activity, and capital expenditures mentioned above. We believe that existing cash and funds generated from operations, as well as borrowings under the line ofnew senior secured credit facility, will meet our needs for the foreseeable future.
Known Trends, Events, Demands, Commitments and Uncertainties
Looking forward, the tender offer and related increase in debt and decrease in shares outstanding will impact a number of trends, including interest expense, cash used for financing activities and earnings per share. As a result of the increase in debt, interest expense is expected to increase to at least $32 million or more depending on the level of share repurchases and acquisitions of Franchise Drive-Ins. Sonic is currently pursuing refinancing the senior credit facilities with a securitized financing arrangement. Although we currently expect to successfully complete the securitization, if we are unable to do so or are delayed in completing it, nonrefundable fees associated with the securitization of approximately $1 to $2 million would be expensed immediately rather than amortized over the life of the securitization. Weighted shares outstanding for calculating diluted earnings per share are expected to decrease to approximately 81 million shares for the first fiscal quarter of 2007 and to approximately 75 million for fiscal year 2007, but may vary significantly, depending upon the level of future share repurchases. The decrease in shares outstanding will impact the resulting earnings per share calculations.
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 financings.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, 20052006 are summarized in the following table:
Payments Due by Period | | Payments Due by Period | |
(In Thousands) | (In Thousands) | | (In Thousands) | |
| | | | | | | | | | | | | | | | | | | | | | |
| | Total | | Less than | | 1 - 3 | | 3 - 5 | | More than | | | Total | | Less than | | 1 - 3 | | 3 - 5 | | More than | |
| | | | 1 Year | | Years | | Years | | 5 Years | | | | | 1 Year | | Years | | Years | | 5 Years | |
Contractual Obligations | | | | | | | | | | | | | | | | | | | | | | | | |
Long-term debt | | $ | 60,195 | | $ | 4,261 | | $ | 9,461 | | $ | 42,199 | | $ | 4,274 | | | $ | 122,399 | | $ | 5,227 | | $ | 13,860 | | $ | 13,851 | | $ | 89,461 | |
Capital leases | | | 58,960 | | 4,960 | | 9,522 | | 9,547 | | 34,931 | | | | 54,437 | | 4,891 | | 9,597 | | 9,507 | | 30,442 | |
Operating leases | | | | 168,707 | | | 10,513 | | | 20,792 | | | 20,187 | | | 117,215 | |
Total | | | $ | 345,543 | | $ | 20,631 | | $ | 44,249 | | $ | 43,545 | | $ | 237,118 | |
Operating leases | | | 154,782 | | | 9,722 | | | 19,056 | | | 18,515 | | | 107,489 | |
Total | | $ | 273,937 | | $ | 18,943 | | $ | 38,039 | | $ | 70,261 | | $ | 146,694 | |
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.
Impairment of Long-Lived Assets. We review each Partner Drive-In for impairment when events or circumstances indicate it might be impaired. We test for impairment using historical cash flows and other relevant facts and circumstances as the primary basis for our estimates of future cash flows. This process requires the use of estimates and assumptions, which are subject to a high degree of judgment. In addition, at least annually, we assess the recoverability of goodwill and other intangible assets related to our brand and drive-ins. These impairment tests require us to estimate fair values of our brand and our drive-ins by making assumptions regarding future cash flows and other factors. As of August 31, 2006, we reviewed 21 Partner Drive-ins with combined carrying amounts of $4.9 million in property, equipment and capital leases for possible impairment, and, based on our cash flow assumptions, we determined that no impairments were needed. During the fourth quarter of fiscal year 2006, we performed our annual assessment of recoverability of goodwill and other intangible assets and determined that no impairment was indicated. As of August 31, 2006, goodwill and intangible assets totaled $107.7 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 was previouslyis financed by the Company. We outsourced the financing of partner notes to a third-party in the fourth fiscal quarter of 2004.third parties. Supervisors and managers are neither employees of Sonic nor of the drive-in in which they have an ownership interest.
The investments made byminority 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 each partnership or limited liability company are accounted for as minority interestsearnings of Partner Drive-Ins in the financial statements.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 net book valueCompany 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 acquired by the Company in a Partner Drive-In is recorded as an investment in partnership, which results in a reduction in the minority interest liability on the Consolidated Balance Sheet. If the purchase pricethat 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 results inis recorded as a decreasereduction in purchased goodwill. Any subsequent sale of the minority interest to another minority partner is recorded as a pro-rata reduction of goodwill, and investment, and no gain or loss is recognized on the sale of the minority ownership interest. Goodwill created as a result of the acquisition of minority interests in Partner Drive-Ins is not amortized but is tested annually for impairment under the provisions of FAS 142, “Goodwill and Other Intangible Assets.”
Revenue Recognition Related to Franchise Fees and Royalties. Initial franchise fees are nonrefundable and are recognized in income when we have substantially performed or satisfied all material services or conditions relating to the sale of the franchise. Area development fees are nonrefundable and are recognized in income on a pro-rata basis when the conditions for revenue recognition under the individual development agreements are met. Both initial franchise fees and area development fees are generally recognized upon the opening of a Franchise Drive-In or upon termination of the agreement between Sonic and the franchisee.
Our franchisees are required under the provisions of the license agreements to pay royalties to Sonic each month based on a percentage of actual net sales. However, the royalty payments and supporting financial statements are not due until the 20th of the following month. As a result, we accrue royalty revenue in the month earned based on estimates of Franchise Drive-Ins sales. These estimates are based on actual sales at Partner Drive-Ins and projections of average unit volume growth at Franchise Drive-Ins.
Accounting for Stock-Based Compensation. As discussed further in Note 1 and Note 12 of Notes to the Consolidated Financial Statements in this Form 10-K, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) effective September 1, 2005 using the modified retrospective application method. As a result, financial statement amounts for prior periods presented in this Form 10-K have been adjusted to reflect the fair value method of expensing prescribed by SFAS 123R.
We estimate the fair value of options granted using the Black-Scholes option pricing model along with the assumptions shown in Note 12 to the financial statements. The assumptions used in computing the fair value of share-based payments reflect our best estimates, but involve uncertainties relating to market and other conditions, many of which are outside of our control. We estimate expected volatility based on historical daily price changes of the Company’s stock for a period equal to the current expected term of the options. The expected option term is the number of years the Company estimates that options will be outstanding prior to exercise considering vesting schedules and our historical exercise patterns. If other assumptions or estimates had been used, the stock-based compensation expense that was recorded for the first nine months of 2006 could have been materially different. Furthermore, if different assumptions are used in future periods, stock-based compensation expense could be materially impacted in the future.
Income Taxes. We estimate certain components of our provision for income taxes. These estimates include, among other items, depreciation and amortization expense allowable for tax purposes, allowable tax credits for items such as wages paid to certain employees, effective rates for state and local income taxes and the tax deductibility of certain other items.
Our estimates are based on the best available information at the time that we prepare the provision, including legislative and judicial developments. We generally file our annual income tax returns several months after our fiscal year end. Income tax returns are subject to audit by federal, state and local governments, typically several years after the returns are filed. These returns could be subject to material adjustments or differing interpretations of the tax laws. Adjustments to these estimates or returns can result in significant variability in the tax rate from period to period.
Forward-looking StatementsLeases
This annual report contains various "forward-looking statements" within. 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 meaningexpected 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 Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements represent our expectations or beliefs concerning future events, including the following: any statements regarding future sales or expenses, any statements regarding the continuation of historical trends, and any statements regarding the sufficiencycertain of our working capital and cash generated from operating and financing activities for our future liquidity and capital resource needs. Without limitingleases, there are rent holidays and/or escalations in payments over the foregoing, the words "believes," "anticipates," "plans," "expects," and similar expressions are intended to identify forward-looking statements. We caution that the following important economic and competitive factors, among others, could cause the actual results to differ materially from those in the forward-looking statements made in this report and from time to time in news releases, reports, proxy statements, registration statements, and other written or electronic communication,base lease term, as well as verbal forward-looking statements made from time to time by representativesrenewal periods. The effects of the Company. Factors that may cause actual resultsrent 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 differ materially from forward-looking statements include, without limitation, riskscontrol the use of leased property, which can occur before rent payments are due under the terms of the restaurant industry, including risks oflease. Contingent rent is generally based on sales levels and publicity surrounding food-borne illnesses, a highly competitive industry andis accrued at the impact of changespoint in consumer spending patterns, consumer tastes, local, regional, and national economic conditions, weather, demographic trends, traffic patterns, employee availability, increases in utility costs, and cost increases or shortages in raw food products. In addition, the opening and success of new drive-instime we determine that it is probable that such sales levels will depend on various factors, including weather, strikes, the availability of suitable sites for new drive-ins, the negotiation of acceptable lease or purchase terms for new locations, local permitting and regulatory compliance, our ability to manage the anticipated expansion and hire and train personnel, the financial viability of our franchisees, particularly multi-unit operators, and general economic and business conditions. Accordingly, such forward-looking statements do not purport to be predictions of future events or circumstances and may not be realized. For these reasons, you should not place undue reliance on forward-looking statements. We undertake no obligation to publicly update or revise them.achieved.
We areSonic’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 interest rates on debt and notes receivable, as well as 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. The major risks from interest rate derivatives include changes in the interest rates affecting the fair value of the instruments, potential increases in interest expense due to market increases in floating rates and the creditworthiness of the counterparties in such transactions.
Interest Rate Risk.Our exposure to interest rate risk currently consistsat August 31, 2006 consisted of our senior notes, outstanding line of credit, and notes receivable. The senior notes bear interest at fixed rates which average 6.8%. The aggregate balance outstanding under the senior notes as of August 31, 2005 was $24.4 million. Should interest rates increase or decrease, the estimated fair value of these notes would decrease or increase, respectively. As of August 31, 2005, the estimated fair value of the senior notes exceeded the carrying amount by approximately $0.6 million. Theand line of credit were subsequently repaid with the proceeds under the term loan facility of the new senior secured credit facility. The term loan facility bears interest at a floating rate benchmarked to U.S. and European short-term interest rates. The balancecollective balances outstanding under the line of credit was $30.2 million as of August 31, 2005.2006 that were repaid by the term loan facility totaled $121.0 million. The impact on our results of operations of a one-point interest rate change on the average combined balance that was outstanding balance under the line of credit and senior notes during fiscal year 20052006 would have been approximately $0.8 million. Looking forward, the impact on our results of operations of a one-point interest rate change on the balances subsequently outstanding under the new senior credit facility would be approximately $0.1$4.6 million. We have made certain loans to our franchisees totaling $3.5$5.9 million as of August 31, 2005.2006. The interest rates on these notes are generally between 6.0% and 10.5%. We believe the fair market value of these notes approximates their carrying amount.
The Company entered into an interest rate swap in February 2006, which was designated as a cash flow hedge to modify a portion of the variable rate line of credit to a fixed rate obligation, thereby reducing the exposure to market rate fluctuations. Subsequent to repayment of the line of credit, this interest rate swap was terminated, resulting in an immaterial gain being recognized immediately to income in the first quarter of fiscal year 2007.
In August 2006, the Company entered into a forward starting swap agreement, which was designated as a cash flow hedge of the variability in the cash outflows of interest payments on the securitized financing that is anticipated to be completed by December 31, 2006. The swap has a notional principal amount of $400 million. The gross fair value of the forward starting swap as of August 31, 2006 was a liability of $0.8 million. A 1% increase or decrease in the benchmark rate is estimated to result in approximately a $.2 million increase or decrease, respectively, in the gross fair value of the forward starting swap.
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 and any commodity price aberrations are generally short term in nature.
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, 2005.2006. 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, 2005,2006, the Company’s internal control over financial reporting is effective based on those criteria.
The Company’s independent registered public accounting firm has issued an attestation report on management’s assessment of the Company’s internal control over financial reporting. This report appears on the following page.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
Sonic Corp.
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Sonic Corp. maintained effective internal control over financial reporting as of August 31, 2005,2006, 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. Our responsibility is to express an opinion on management’s assessment and 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, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, 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, management’s assessment that Sonic Corp. maintained effective internal control over financial reporting as of August 31, 2005,2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Sonic Corp. maintained, in all material respects, effective internal control over financial reporting as of August 31, 2005,2006, 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, 20052006 and 2004,2005, and the related consolidated statements of income, retained earnings, and cash flows for each of the three years in the period ended August 31, 20052006 of Sonic Corp. and our report dated November 10, 2005October 27, 2006 expressed an unqualified opinion thereon.
| ERNST & YOUNG LLP |
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Oklahoma City, Oklahoma | |
November 10, 2005 October 27, 2006 | |
No information was required to be disclosed in a Form 8-K during the Company’s fourth quarter of its 20052006 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, 20052006 (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.”
The information required by this item is incorporated by reference from the Proxy Statement under the caption “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”
The information required by this item is incorporated by reference from the Proxy Statement under the caption “Certain Relationships and Related Transactions.”
The information required by this item is incorporated by reference from the Proxy Statement under the caption “Ratification of Independent Registered Public Accounting Firm.”
PART IV
The following consolidated financial statements of the Company appear immediately following this Item 15:
Financial Statement Schedules
The Company has included the following schedule immediately following this Item 15:
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. 33-37158.33-37158 filed on October 3, 1990.
3.02.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.
3.03.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.
3.04.Rights Agreement, which the Company hereby incorporates by reference from Exhibit 99.1 to the Company’s Form 8-K filed on June 17, 1997.
3.05.First Amendment to Rights Agreement dated January 28, 2003, which the Company hereby incorporates by reference from Exhibit 99.1 to the Company’s Form 8-K filed January 29, 2003.
3.06.Second Amendment to Rights Agreement dated January 7, 2005, which the Company hereby incorporates by reference from Exhibit 4 to the Company’s Form 8-K filed January 7, 2005.
3.07. 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.
3.08.3.03. 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 as filed with the Delaware Secretary of State on January 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.Rights Agreement, which the Company hereby incorporates by reference from Exhibit 99.1 to the Company’s Form 8-K filed on June 17, 1997.
4.02.First Amendment to Rights Agreement dated January 28, 2003, which the Company hereby incorporates by reference from Exhibit 99.1 to the Company’s Form 8-K filed January 29, 2003.
4.03.Second Amendment to Rights Agreement dated January 7, 2005, which the Company hereby incorporates by reference from Exhibit 4 to the Company’s Form 8-K filed January 7, 2005.
4.04. 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.
4.02.4.05. Specimen Certificate for Rights, which the Company hereby incorporates by reference from Exhibit 99.1 to the Company’s Form 8-K filed on June 17, 1997.
10.01. Form of 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. 33-37158.33-37158 filed on October 3, 1990.
10.02. Form of 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. 33-37158.33-37158 filed on October 3, 1990.
10.03. Form of 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 Sonic’s Form 10-K for the fiscal year ended August 31, 1994.
10.04. Form of 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 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 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 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 Inc. 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.
10.09. Form of Sonic Industries 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.
10.10. 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.
10.11. 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.*
10.12. 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.*
10.13. 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.*
10.14. 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.*
10.15. 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.*
10.16. 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.*
10.17. 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.*
10.18. 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. *
10.19. Employment Agreement with Ronald L. Matlock dated August 20, 1996, which the Company hereby incorporates by reference from Exhibit 10.20 to the Company’s Form 10-K for the fiscal year ended August 31, 2002. *
10.20. 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. *
10.21. 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. *
10.22. 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. *
10.23. 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. *
10.24. 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. *
10.25. Employment Agreement with Renee G. Shaffer dated April 7, 2005. *
10.26.Employment Agreement with V. Todd Townsend dated August 18, 2005. *
10.27.Consulting Agreement with Pattye L. Moore dated September 10, 2004,2005 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, 2004.2005. *
10.28.10.26. Credit Agreement with Bank of America, N.A., dated April 23, 2003 which the Company hereby incorporates by reference from Exhibit 10.27 to the Company’s Form 10-K for the fiscal year ended August 31, 2004.
10.29.10.27. First Amendment to Credit Agreement with Bank of America, N.A., dated July 28, 2005.September 14, 2006, which the Company hereby incorporates by reference from Exhibit (b)(ii) to the Company’s Amendment No. 3 to Schedule TO filed September 14, 2006.
10.30.10.28. 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.*
10.31.10.29. 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.*
10.32.10.30. Note Purchase Agreement dated August 10, 2001, which the Company hereby incorporates by reference from Exhibit No. 10.34 to the Company’s Form 10-K for the fiscal year ended August 31, 2001.
10.33.10.31. Form of 6.58% Senior Notes, Series A, due August 10, 2008, which the Company hereby incorporates by reference from Exhibit No. 10.35 to the Company’s Form 10-K for the fiscal year ended August 31, 2001.Sonic Corp. 2006 Long Term Incentive Plan.
10.34.Form of 6.87% Senior Notes, Series B, due August 10, 2011, which the Company hereby incorporates by reference from Exhibit No. 10.36 to the Company’s Form 10-K for the fiscal year ended August 31, 2001.*
21.01. Subsidiaries of the Company, which the Company hereby incorporates by reference from Exhibit 21.01 to the Company’s Form 10-K for the fiscal year ended August 31, 2004.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.
The Board of Directors and Stockholders of
Sonic Corp.
We have audited the accompanying consolidated balance sheets of Sonic Corp. as of August 31, 20052006 and 20042005, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended August 31, 2005.2006. 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, 20052006 and 2004,2005, and the consolidated results of itstheir operations and itstheir cash flows for each of the three years in the period ended August 31, 2005,2006, 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.
As discussed in Note 1 and Note 12 to the accompanying consolidated financial statements, in fiscal year 2006, Sonic Corp. adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share Based Payment.”
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, 2005,2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated November 10, 2005,October 27, 2006, expressed an unqualified opinion thereon.
| ERNST & YOUNG LLP |
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Oklahoma City, Oklahoma | |
November 10, 2005 October 27, 2006 | |
| | August 31, | |
| | 2006 | | 2005* | |
| | (In Thousands) | |
| | | | | |
Assets | | | | | |
Current assets: | | | | | | | |
Cash and cash equivalents | | $ | 9,597 | | $ | 6,431 | |
Accounts and notes receivable, net | | | 21,271 | | | 18,801 | |
Net investment in direct financing leases | | | 1,287 | | | 1,174 | |
Inventories | | | 4,200 | | | 3,760 | |
Deferred income taxes | | | 307 | | | 821 | |
Prepaid expenses and other | | | 5,848 | | | 4,262 | |
Total current assets | | | 42,510 | | | 35,249 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Notes receivable, net | | | 5,182 | | | 3,138 | |
| | | | | | | |
Net investment in direct financing leases | | | 3,815 | | | 5,033 | |
| | | | | | | |
Property, equipment and capital leases, net | | | 477,054 | | | 422,825 | |
| | | | | | | |
Goodwill, net | | | 96,949 | | | 88,471 | |
| | | | | | | |
Trademarks, trade names and other intangibles, net | | | 10,746 | | | 6,434 | |
| | | | | | | |
Other assets, net | | | 1,762 | | | 2,166 | |
Total assets | | $ | 638,018 | | $ | 563,316 | |
| | August 31, | |
| | 2005 | | 2004 | |
| | (In Thousands) | |
| | | | | |
Assets | | | | | | | |
Current assets: | | | | | | | |
Cash and cash equivalents | | $ | 6,431 | | $ | 7,993 | |
Accounts and notes receivable, net | | | 18,801 | | | 18,087 | |
Net investment in direct financing leases | | | 1,174 | | | 1,054 | |
Inventories | | | 3,760 | | | 3,551 | |
Deferred income taxes | | | 821 | | | 798 | |
Prepaid expenses and other | | | 4,262 | | | 3,100 | |
Total current assets | | | 35,249 | | | 34,583 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Notes receivable, net | | | 3,138 | | | 5,459 | |
| | | | | | | |
Net investment in direct financing leases | | | 5,033 | | | 6,107 | |
| | | | | | | |
Property, equipment and capital leases, net | | | 422,825 | | | 376,315 | |
| | | | | | | |
Goodwill, net | | | 88,471 | | | 87,420 | |
| | | | | | | |
Trademarks, trade names and other intangibles, net | | | 6,434 | | | 6,450 | |
| | | | | | | |
Other assets, net | | | 2,166 | | | 2,299 | |
Total assets | | $ | 563,316 | | $ | 518,633 | |
Sonic Corp.
Consolidated Balance Sheets (continued)
| | August 31, | |
| | 2006 | | 2005* | |
| | (In Thousands) | |
| | | | | |
Liabilities and stockholders’ equity | | | | | |
Current liabilities: | | | | | | | |
Accounts payable | | $ | 23,438 | | $ | 14,117 | |
Deposits from franchisees | | | 2,553 | | | 3,157 | |
Accrued liabilities | | | 33,874 | | | 26,367 | |
Income taxes payable | | | 10,673 | | | 15,174 | |
Obligations under capital leases and long-term debt due within one year | | | 7,557 | | | 6,527 | |
Total current liabilities | | | 78,095 | | | 65,342 | |
| | | | | | | |
Obligations under capital leases due after one year | | | 34,295 | | | 36,259 | |
Long-term debt due after one year | | | 117,172 | | | 55,934 | |
Other noncurrent liabilities | | | 12,504 | | | 10,078 | |
Deferred income taxes | | | 4,259 | | | 7,786 | |
Commitments and contingencies (Notes 6, 7, 14, and 15) | | | | | | | |
| | | | | | | |
Stockholders’ equity: | | | | | | | |
Preferred stock, par value $.01; 1,000,000 shares authorized; none outstanding | | | ─ | | | ─ | |
Common stock, par value $.01; 245,000,000 shares authorized; shares issued 114,988,369 in 2006 and 113,649,009 in 2005 | | | 1,150 | | | 1,136 | |
Paid-in capital | | | 173,802 | | | 153,776 | |
Retained earnings | | | 476,694 | | | 397,989 | |
Accumulated other comprehensive income | | | (484 | ) | | ─ | |
| | | 651,162 | | | 552,901 | |
Treasury stock, at cost; 29,506,003 shares in 2006 and 24,676,380 shares in 2005 | | | (259,469 | ) | | (164,984 | ) |
Total stockholders’ equity | | | 391,693 | | | 387,917 | |
Total liabilities and stockholders’ equity | | $ | 638,018 | | $ | 563,316 | |
| | August 31, | |
| | 2005 | | 2004 | |
| | (In Thousands) | |
| | | | | |
Liabilities and stockholders’ equity | | | | | | | |
Current liabilities: | | | | | | | |
Accounts payable | | $ | 14,117 | | $ | 9,783 | |
Deposits from franchisees | | | 3,157 | | | 2,867 | |
Accrued liabilities | | | 26,367 | | | 23,733 | |
Income taxes payable | | | 15,174 | | | 6,731 | |
Obligations under capital leases and long-term debt due within one year | | | 6,527 | | | 6,006 | |
Total current liabilities | | | 65,342 | | | 49,120 | |
| | | | | | | |
Obligations under capital leases due after one year | | | 36,259 | | | 38,020 | |
Long-term debt due after one year | | | 55,934 | | | 78,674 | |
Other noncurrent liabilities | | | 10,078 | | | 8,231 | |
Deferred income taxes | | | 11,164 | | | 9,826 | |
Commitments and contingencies (Notes 6, 7, 14, and 15) | | | | | | | |
| | | | | | | |
Stockholders’ equity: | | | | | | | |
Preferred stock, par value $.01; 1,000,000 shares authorized; none outstanding | | | – | | | – | |
Common stock, par value $.01; 100,000,000 shares authorized; shares issued 75,766,006 in 2005 and 74,617,554 in 2004 | | | 758 | | | 746 | |
Paid-in capital | | | 121,982 | | | 105,012 | |
Retained earnings | | | 426,783 | | | 351,402 | |
| | | 549,523 | | | 457,160 | |
Treasury stock, at cost; 16,450,920 shares in 2005 and 15,098,687 shares in 2004 | | | (164,984 | ) | | (122,398 | ) |
Total stockholders’ equity | | | 384,539 | | | 334,762 | |
Total liabilities and stockholders’ equity | | $ | 563,316 | | $ | 518,633 | |
* Adjusted to include the impact of stock-based compensation expense and the three-for-two stock split in April 2006; see Note 1 and Note 12 for additional information.
See accompanying notes.
| | Year ended August 31, | |
| | 2006 | | 2005* | | 2004* | |
| | (In Thousands, Except Per Share Data) | |
Revenues: | | | | | | | | | | |
Partner Drive-In sales | | $ | 585,832 | | $ | 525,988 | | $ | 449,585 | |
Franchise Drive-Ins: | | | | | | | | | | |
Franchise royalties | | | 98,163 | | | 88,027 | | | 77,518 | |
Franchise fees | | | 4,747 | | | 4,311 | | | 4,958 | |
Other | | | 4,520 | | | 4,740 | | | 4,385 | |
| | | 693,262 | | | 623,066 | | | 536,446 | |
Costs and expenses: | | | | | | | | | | |
Partner Drive-Ins: | | | | | | | | | | |
Food and packaging | | | 151,724 | | | 137,845 | | | 118,073 | |
Payroll and other employee benefits | | | 175,610 | | | 159,478 | | | 135,880 | |
Minority interest in earnings of Partner Drive-Ins | | | 25,234 | | | 21,574 | | | 19,947 | |
Other operating expenses, exclusive of depreciation and amortization included below | | | 116,059 | | | 103,009 | | | 84,959 | |
| | | 468,627 | | | 421,906 | | | 358,859 | |
| | | | | | | | | | |
Selling, general and administrative | | | 52,048 | | | 47,503 | | | 44,765 | |
Depreciation and amortization | | | 40,696 | | | 35,821 | | | 32,528 | |
Provision for impairment of long-lived assets | | | 264 | | | 387 | | | 675 | |
| | | 561,635 | | | 505,617 | | | 436,827 | |
Income from operations | | | 131,627 | | | 117,449 | | | 99,619 | |
| | | | | | | | | | |
Interest expense | | | 8,853 | | | 6,418 | | | 7,684 | |
Interest income | | | (1,275 | ) | | (633 | ) | | (1,306 | ) |
Net interest expense | | | 7,578 | | | 5,785 | | | 6,378 | |
Income before income taxes | | | 124,049 | | | 111,664 | | | 93,241 | |
Provision for income taxes | | | 45,344 | | | 41,221 | | | 35,210 | |
Net income | | $ | 78,705 | | $ | 70,443 | | $ | 58,031 | |
| | | | | | | | | | |
Basic income per share | | $ | 0.91 | | $ | 0.78 | | $ | 0.65 | |
| | | | | | | | | | |
Diluted income per share | | $ | 0.88 | | $ | 0.75 | | $ | 0.63 | |
| | | | | | | | | | |
| | Year ended August 31, | |
| | 2005 | | 2004 | | 2003 | |
| | (In Thousands, Except Per Share Data) | |
Revenues: | | | | | | | | | | |
Partner Drive-In sales | | $ | 525,988 | | $ | 449,585 | | $ | 371,518 | |
Franchise Drive-Ins: | | | | | | | | | | |
Franchise royalties | | | 88,027 | | | 77,518 | | | 66,431 | |
Franchise fees | | | 4,311 | | | 4,958 | | | 4,674 | |
Other | | | 4,740 | | | 4,385 | | | 4,017 | |
| | | 623,066 | | | 536,446 | | | 446,640 | |
Costs and expenses: | | | | | | | | | | |
Partner Drive-Ins: | | | | | | | | | | |
Food and packaging | | | 137,845 | | | 118,073 | | | 96,568 | |
Payroll and other employee benefits | | | 159,478 | | | 135,880 | | | 110,009 | |
Minority interest in earnings of Partner Drive-Ins | | | 21,574 | | | 19,947 | | | 14,398 | |
Other operating expenses | | | 103,009 | | | 84,959 | | | 70,789 | |
| | | 421,906 | | | 358,859 | | | 291,764 | |
| | | | | | | | | | |
Selling, general and administrative | | | 40,746 | | | 38,270 | | | 35,426 | |
Depreciation and amortization | | | 35,821 | | | 32,528 | | | 29,223 | |
Provision for impairment of long-lived assets and other | | | 387 | | | 675 | | | 727 | |
| | | 498,860 | | | 430,332 | | | 357,140 | |
Income from operations | | | 124,206 | | | 106,114 | | | 89,500 | |
| | | | | | | | | | |
Interest expense | | | 6,418 | | | 7,684 | | | 7,464 | |
Interest income | | | (633 | ) | | (1,306 | ) | | (1,248 | ) |
Net interest expense | | | 5,785 | | | 6,378 | | | 6,216 | |
Income before income taxes | | | 118,421 | | | 99,736 | | | 83,284 | |
Provision for income taxes | | | 43,040 | | | 36,721 | | | 31,023 | |
Net income | | $ | 75,381 | | $ | 63,015 | | $ | 52,261 | |
| | | | | | | | | | |
Basic income per share | | $ | 1.26 | | $ | 1.06 | | $ | .89 | |
| | | | | | | | | | |
Diluted income per share | | $ | 1.21 | | $ | 1.02 | | $ | .86 | |
| | | | | | | | | | |
* Adjusted to include the impact of stock-based compensation expense and the three-for-two stock split in April 2006; see Note 1 and Note 12 for additional information.
See accompanying notes.
Consolidated Statements of Stockholders’ Equity
| | Common Stock Shares Amount | | Paid-in Capital* | | Retained Earnings* | | Accumulated Other Comprehensive Income | | Treasury Stock Shares Amount | |
| | (In Thousands) | |
| | | | | | | | | | | | | | | | | | | | | | |
Balance at August 31, 2003 | | | 49,181 | | $ | 492 | | $ | 116,753 | | $ | 269,515 | | $ | - | | | 9,964 | | $ | (119,027 | ) |
Exercise of common stock options | | | 592 | | | 6 | | | 5,608 | | | - | | | - | | | - | | | - | |
Stock-based compensation expense | | | - | | | - | | | 6,495 | | | - | | | - | | | - | | | - | |
Tax benefit related to exercise of employee stock options | | | - | | | - | | | 3,398 | | | - | | | - | | | - | | | - | |
Purchase of treasury stock | | | - | | | - | | | - | | | - | | | - | | | 148 | | | (3,371 | ) |
Three-for-two stock split | | | 24,845 | | | 248 | | | (248 | ) | | - | | | - | | | 4,987 | | | - | |
Net income | | | - | | | - | | | - | | | 58,031 | | | - | | | - | | | - | |
Balance at August 31, 2004 | | | 74,618 | | | 746 | | | 132,006 | | | 327,546 | | | - | | | 15,099 | | | (122,398 | ) |
| | | | | | | | | | | | | | | | | | | | | | |
Exercise of common stock options | | | 1,148 | | | 12 | | | 10,796 | | | - | | | - | | | - | | | - | |
Stock-based compensation expense | | | - | | | - | | | 6,757 | | | - | | | - | | | - | | | - | |
Tax benefit related to exercise of employee stock options | | | - | | | - | | | 4,595 | | | - | | | - | | | - | | | - | |
Purchase of treasury stock | | | - | | | - | | | - | | | - | | | - | | | 1,352 | | | (42,586 | ) |
Net income | | | - | | | - | | | - | | | 70,443 | | | - | | | - | | | - | |
Balance at August 31, 2005 | | | 75,766 | | | 758 | | | 154,154 | | | 397,989 | | | - | | | 16,451 | | | (164,984 | ) |
| | | | | | | | | | | | | | | | | | | | | | |
Exercise of common stock options | | | 1,003 | | | 10 | | | 7,981 | | | - | | | - | | | - | | | - | |
Stock-based compensation expense, including capitalized compensation of $216 | | | - | | | - | | | 7,404 | | | - | | | - | | | - | | | - | |
Tax benefit related to exercise of employee stock options | | | - | | | - | | | 4,645 | | | - | | | - | | | - | | | - | |
Purchase of treasury stock | | | - | | | - | | | - | | | - | | | - | | | 3,538 | | | (94,485 | ) |
Three-for-two stock split | | | 38,219 | | | 382 | | | (382 | ) | | - | | | - | | | 9,517 | | | - | |
Deferred hedging losses, net of tax of $300 | | | - | | | - | | | - | | | - | | | (484 | ) | | - | | | - | |
Net income | | | - | | | - | | | - | | | 78,705 | | | - | | | - | | | - | |
Balance at August 31, 2006 | | | 114,988 | | $ | 1,150 | | $ | 173,802 | | $ | 476,694 | | $ | (484 | ) | | 29,506 | | $ | (259,469 | ) |
| | Common Stock | | Paid-in | | Retained | | Treasury Stock | |
| | Shares | | Amount | | Capital | | Earnings | | Shares | | Amount | |
| | (In Thousands) | |
| | | | | | | | | | | | | |
Balance at August 31, 2002 | | | 48,478 | | $ | 485 | | $ | 86,563 | | $ | 236,126 | | | 8,737 | | $ | (92,504 | ) |
| | | | | | | | | | | | | | | | | | | |
Exercise of common stock options | | | 703 | | | 7 | | | 5,671 | | | – | | | – | | | – | |
Tax benefit related to exercise of employee stock options | | | – | | | – | | | 3,312 | | | – | | | – | | | – | |
Purchase of treasury stock | | | – | | | – | | | – | | | – | | | 1,227 | | | (26,523 | ) |
Net income | | | – | | | – | | | – | | | 52,261 | | | – | | | – | |
Balance at August 31, 2003 | | | 49,181 | | | 492 | | | 95,546 | | | 288,387 | | | 9,964 | | | (119,027 | ) |
| | | | | | | | | | | | | | | | | | | |
Exercise of common stock options | | | 592 | | | 6 | | | 5,608 | | | – | | | – | | | – | |
Tax benefit related to exercise of employee stock options | | | – | | | – | | | 4,106 | | | – | | | – | | | – | |
Purchase of treasury stock | | | – | | | – | | | – | | | – | | | 148 | | | (3,371 | ) |
Three-for-two stock split | | | 24,845 | | | 248 | | | (248 | ) | | – | | | 4,987 | | | – | |
Net income | | | – | | | – | | | – | | | 63,015 | | | – | | | – | |
Balance at August 31, 2004 | | | 74,618 | | | 746 | | | 105,012 | | | 351,402 | | | 15,099 | | | (122,398 | ) |
| | | | | | | | | | | | | | | | | | | |
Exercise of common stock options | | | 1,148 | | | 12 | | | 10,796 | | | – | | | – | | | – | |
Tax benefit related to exercise of employee stock options | | | – | | | – | | | 6,174 | | | – | | | – | | | – | |
Purchase of treasury stock | | | – | | | – | | | – | | | – | | | 1,352 | | | (42,586 | ) |
Net income | | | – | | | – | | | – | | | 75,381 | | | – | | | – | |
Balance at August 31, 2005 | | | 75,766 | | $ | 758 | | $ | 121,982 | | $ | 426,783 | | | 16,451 | | $ | (164,984 | ) |
* Prior years adjusted to include the impact of stock-based compensation expense; see Note 1 for additional information.
See accompanying notes.
Consolidated Statements of Cash Flows
| | Year ended August 31, | | | Year ended August 31, | |
| | 2005 | | 2004 | | 2003 | | | 2006 | | 2005* | | 2004* | |
| | (In Thousands) | | | (In Thousands) | |
Cash flows from operating activities | | | | | | | | | | | | | | | | | | | | |
Net income | | $ | 75,381 | | $ | 63,015 | | $ | 52,261 | | | $ | 78,705 | | $ | 70,443 | | $ | 58,031 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | | | | | | | | | | | |
Depreciation | | | 35,435 | | | 32,060 | | | 28,542 | | | | 40,356 | | | 35,435 | | | 32,060 | |
Amortization | | | 386 | | | 468 | | | 681 | | | | 340 | | | 386 | | | 468 | |
(Gains) losses on dispositions of assets | | | (1,115 | ) | | (868 | ) | | (1,149 | ) | |
Amortization of franchise and development fees | | | (4,130 | ) | | (4,839 | ) | | (4,675 | ) | |
Franchise and development fees collected | | | 6,015 | | | 4,974 | | | 4,791 | | |
Provision for deferred income taxes | | | 1,315 | | | 3,509 | | | 1,277 | | |
Gain on dispositions of assets, net | | | | (422 | ) | | (1,115 | ) | | (868 | ) |
Stock-based compensation expense | | | | 7,188 | | | 6,757 | | | 6,495 | |
(Credit) provision for deferred income taxes | | | | (2,713 | ) | | 1,075 | | | 2,706 | |
Provision for impairment of long-lived assets | | | 387 | | | 675 | | | 727 | | | | 264 | | | 387 | | | 675 | |
Tax benefit related to exercise of employee stock options | | | 6,174 | | | 4,106 | | | 3,312 | | |
Excess tax benefit from exercise of employee stock options | | | | (4,645 | ) | | (4,595 | ) | | (3,398 | ) |
Other | | | 500 | | | 145 | | | (141 | ) | | | 625 | | | 500 | | | 145 | |
(Increase) decrease in operating assets: | | | | | | | | | | | |
Increase in operating assets: | | | | | | | | | | | |
Accounts and notes receivable | | | (2,481 | ) | | (737 | ) | | (3,291 | ) | | | (2,275 | ) | | (2,481 | ) | | (737 | ) |
Inventories and prepaid expenses | | | (1,371 | ) | | (1,691 | ) | | 1,666 | | | | (2,267 | ) | | (1,371 | ) | | (1,691 | ) |
Increase (decrease) in operating liabilities: | | | | | | | | | | | |
Increase in operating liabilities: | | | | | | | | | | | |
Accounts payable | | | 3,962 | | | 2,567 | | | 1,098 | | | | 2,821 | | | 5,847 | | | 2,702 | |
Accrued and other liabilities | | | 11,822 | | | 3,274 | | | 5,112 | | | | 9,496 | | | 16,417 | | | 6,672 | |
Total adjustments | | | 56,899 | | | 43,643 | | | 37,950 | | | | 48,768 | | | 57,242 | | | 45,229 | |
Net cash provided by operating activities | | | 132,280 | | | 106,658 | | | 90,211 | | | | 127,473 | | | 127,685 | | | 103,260 | |
| | | | | | | | | | | | | | | | | | | | |
Cash flows from investing activities | | | | | | | | | | | | | | | | | | | | |
Purchases of property and equipment | | | (85,905 | ) | | (57,728 | ) | | (54,417 | ) | | | (86,863 | ) | | (85,905 | ) | | (57,728 | ) |
Acquisition of businesses, net of cash received | | | (820 | ) | | (8,518 | ) | | (35,557 | ) | | | (14,601 | ) | | (820 | ) | | (8,518 | ) |
Acquisition of real estate, net of cash received | | | | (12,125 | ) | | ─ | | | ─ | |
Investments in direct financing leases | | | (320 | ) | | (539 | ) | | (654 | ) | | | (237 | ) | | (320 | ) | | (539 | ) |
Collections on direct financing leases | | | 1,266 | | | 1,124 | | | 1,074 | | | | 1,342 | | | 1,266 | | | 1,124 | |
Proceeds from dispositions of assets | | | 8,882 | | | 18,505 | | | 9,151 | | | | 5,271 | | | 8,882 | | | 18,505 | |
(Increase) decrease in intangibles and other assets | | | (1,053 | ) | | 434 | | | (4,395 | ) | | | (757 | ) | | (1,053 | ) | | 434 | |
Net cash used in investing activities | | | (77,950 | ) | | (46,722 | ) | | (84,798 | ) | | | (107,970 | ) | | (77,950 | ) | | (46,722 | ) |
(Continued on following page)
Sonic Corp.
Consolidated Statements of Cash Flows (continued)
| | Year ended August 31, | |
| | 2006 | | 2005* | | 2004* | |
| | (In Thousands) | |
| | | | | | | |
Cash flows from financing activities | | | | | | | | | | |
Proceeds from borrowings | | $ | 274,763 | | $ | 127,415 | | $ | 76,421 | |
Payments on long-term debt | | | (206,806 | ) | | (149,390 | ) | | (141,978 | ) |
Purchases of treasury stock | | | (93,689 | ) | | (42,324 | ) | | (3,067 | ) |
Payments on capital lease obligations | | | (2,444 | ) | | (2,139 | ) | | (1,839 | ) |
Exercises of stock options | | | 7,194 | | | 10,546 | | | 5,310 | |
Excess tax benefit from exercise of employee stock options | | | 4,645 | | | 4,595 | | | 3,398 | |
Net cash used in financing activities | | | (16,337 | ) | | (51,297 | ) | | (61,755 | ) |
Net increase (decrease) in cash and cash equivalents | | | 3,166 | | | (1,562 | ) | | (5,217 | ) |
| | | | | | | | | | |
Cash and cash equivalents at beginning of the year | | | 6,431 | | | 7,993 | | | 13,210 | |
Cash and cash equivalents at end of the year | | $ | 9,597 | | $ | 6,431 | | $ | 7,993 | |
| | | | | | | | | | |
Supplemental cash flow information | | | | | | | | | | |
Cash paid during the year for: | | | | | | | | | | |
Interest (net of amounts capitalized of $733, $604 and $338, respectively) | | $ | 8,769 | | $ | 7,144 | | $ | 7,739 | |
Income taxes (net of refunds) | | | 48,225 | | | 27,377 | | | 29,869 | |
Additions to capital lease obligations | | | 4,958 | | | 877 | | | 16,098 | |
Accounts and notes receivable and decrease in capital lease | | | | | | | | | | |
obligations from property and equipment sales | | | 6,514 | | | 1,063 | | | 1,656 | |
Stock options exercised by stock swap | | | 787 | | | 250 | | | 298 | |
Store acquisitions financed through long-term notes | | | - | | | - | | | 8,139 | |
| | Year ended August 31, | |
| | 2005 | | 2004 | | 2003 | |
| | (In Thousands) | |
| | | | | | | |
Cash flows from financing activities | | | | | | | | | | |
Proceeds from long-term borrowings | | $ | 127,415 | | $ | 76,421 | | $ | 171,523 | |
Payments on long-term debt | | | (149,390 | ) | | (141,978 | ) | | (141,310 | ) |
Purchases of treasury stock | | | (42,324 | ) | | (3,067 | ) | | (34,348 | ) |
Payments on capital lease obligations | | | (2,139 | ) | | (1,839 | ) | | (1,793 | ) |
Exercises of stock options | | | 10,546 | | | 5,310 | | | 4,774 | |
Net cash used in financing activities | | | (55,892 | ) | | (65,153 | ) | | (1,154 | ) |
Net increase (decrease) in cash and cash equivalents | | | (1,562 | ) | | (5,217 | ) | | 4,259 | |
| | | | | | | | | | |
Cash and cash equivalents at beginning of the year | | | 7,993 | | | 13,210 | | | 8,951 | |
Cash and cash equivalents at end of the year | | $ | 6,431 | | $ | 7,993 | | $ | 13,210 | |
| | | | | | | | | | |
Supplemental cash flow information | | | | | | | | | | |
Cash paid during the year for: | | | | | | | | | | |
Interest (net of amounts capitalized of $604, $338 and $481, respectively) | | $ | 7,144 | | $ | 7,739 | | $ | 7,996 | |
Income taxes (net of refunds) | | | 27,377 | | | 29,869 | | | 24,002 | |
Additions to capital lease obligations | | | 877 | | | 16,098 | | | 16,783 | |
Accounts and notes receivable and decrease in capital lease obligations from property and equipment sales | | | 1,063 | | | 1,656 | | | 1,352 | |
Stock options exercised by stock swap | | | 262 | | | 304 | | | 904 | |
Store acquisitions financed through long-term notes | | | – | | | 8,139 | | | – | |
* Prior years adjusted to include the impact of stock-based compensation expense and the three-for-two stock split in April 2006; see Note 1 and Note 12 for additional information.
See accompanying notes.
Notes to Consolidated Financial Statements
August 31, 2006, 2005 2004 and 20032004
(In Thousands, Except Per Share Data)
1. Summary of Significant Accounting Policies
Operations
Sonic Corp. (the “Company”) operates and franchises a chain of quick-service drive-ins in the United States and Mexico. It derives its revenues primarily from Partner Drive-In sales and royalty fees from franchisees. The Company also leases signs and real estate, and owns a minority interest in several Franchise Drive-Ins.
From time to time, the Company purchases existing Franchise Drive-Ins with proven track records in core markets from franchisees and other minority investors as a means to deploy excess cash generated from operating activities and provide a foundation for future earnings growth. On May 1, 2003, the Company acquired 51 existing drive-ins located in the San Antonio, Texas market from its franchisees for cash consideration of approximately $34.6 million, prior to post closing adjustments. The acquisitions were accounted for under the purchase method of accounting. The Company also entered into long-term lease agreements on each of the acquired drive-ins, which have future minimum rental payments aggregating $3.5 million annually. The following condensed balance sheet reflects the amount assigned to each major asset and liability category as of the acquisition date:
As of May 1, 2003 | |
Current assets | | $ | 322 | |
Property and equipment | | | 7,250 | |
Goodwill | | | 26,995 | |
Total assets acquired | | $ | 34,567 | |
The Company did not assume any liabilities in connection with the acquisition and expects the amount assigned to goodwill to be fully deductible for tax purposes. The results of operations of these drive-ins were included with that of the Company’s commencing May 1, 2003. If the acquisition had been completed as of the beginning of fiscal year 2003, pro forma revenues, net income and basic and diluted earnings per share would have been as follows:
Year ended August 31, 2003 | |
Revenues | | $ | 475,052 | |
| | | | |
Net income | | $ | 53,235 | |
| | | | |
Net income per share: | | | | |
Basic | | $ | .91 | |
Diluted | | $ | .87 | |
The Company completed the sale of 41 Partner Drive-Ins to franchisees during fiscal year 2003, the majority of which were located in developing markets. A total of eight drive-ins were sold in January 2003, eight were sold in April 2003, 15 were sold in May 2003, and the balance were sold at various times during fiscal year 2003. The Company recognized a net gain of $1.6 million in other revenues resulting from the dispositions of these drive-ins.
Principles of Consolidation
The accompanying financial statements include the accounts of the Company, its wholly-owned subsidiaries and its majority-owned, Partner Drive-Ins, organized as general partnerships and limited liability companies. All significant intercompany accounts and transactions have been eliminated.
Certain amounts have been reclassified in the Consolidated Financial Statements to conform to the fiscal year 20052006 presentation.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported and contingent assets and liabilities disclosed in the financial statements and accompanying notes. Actual results may differ from those estimates, and such differences may be material to the financial statements.
Cash Equivalents
Cash equivalents consist of highly liquid investments that mature in three months or less from date of purchase.
Inventories
Inventories consist principally of food and supplies that are carried at the lower of cost (first-in, first-out basis) or market.
Property, Equipment and Capital Leases
Property and equipment are recorded at cost, and leased assets under capital leases are recorded at the present value of future minimum lease payments. Depreciation of property and equipment and capital leases areis computed by the straight-line method over the estimated useful lives or the lease term, including cancelable option periods when appropriate, and are combined for presentation in the financial statements.
Accounting for Long-Lived Assets
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets,"” the Company reviews long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset might not be recoverable. Assets are grouped and evaluated for impairment at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups of assets, which generally represents the individual drive-in. The Company’s primary test for an indicator of potential impairment is operating losses. If an indication of impairment is determined to be present, the Company estimates the future cash flows expected to be generated from the use of the asset and its eventual disposal. If the sum of undiscounted future cash flows is less than the carrying amount of the asset, an impairment loss is recognized. The impairment loss is measured by comparing the fair value of the asset to its carrying amount. Calculating the present value of future cash flows is typically not required. Rather, because drive-in buildings are typically single-purpose assets, the
impairment provided is equal to the carrying amount of the building and any improvements. The equipment associated with a store can be easily relocated to another store, and therefore is not adjusted.
Assets held for disposalSurplus property assets are carried at the lower of depreciated cost or fair value less cost to sell. The majority of the value in surplus property is land. Fair values are estimated based upon appraisals or independent assessments of the assets’ estimated sales values. During the period in which assets are being held for disposal, depreciation and amortization of such assets are not recognized.
Goodwill and Other Intangible Assets
The Company accounts for goodwill and other intangible assets in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”. Intangible assets with lives restricted by contractual, legal, or other means are amortized over their useful lives. Goodwill and other intangible assets not subject to amortization are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. SFAS No. 142 requires a two-step process for testing impairment. First, the fair value of each reporting unit is compared to its carrying value to determine whether an indication of impairment exists. If an impairment is indicated, then the fair value of the reporting unit’s goodwill is determined by allocating the unit’s fair value to its assets and liabilities (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination. The amount of impairment for goodwill and other intangible assets is measured as the excess of its carrying value over its fair value.
The Company’s intangible assets subject to amortization under SFAS No. 142 consist primarily of acquired franchise agreements, franchise fees, and other intangibles. Amortization expense is calculated using the straight-line method over the expected period of benefit, not exceeding 1520 years. The Company’s trademarks and trade names were deemed to have indefinite useful lives and are not subject to amortization. See Note 5 for additional disclosures related to goodwill and other intangibles.
Ownership Program
The Company’s drive-in philosophy stresses an ownership relationship with drive-in supervisors and managers. Most supervisors and managers of Partner Drive-Ins own an equity interest in the drive-in, which was previouslyis financed by the Company. The Company outsourced the financing of partner notes to a third party in the fourth fiscal quarter of 2004.parties. Supervisors and managers are neither employees of the Company nor of the drive-in in which they have an ownership interest.
The investments made byminority 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 each partnership or limited liability company are accounted for as minority interestsearnings of Partner Drive-Ins in the financial statements.Costs and expenses section of the Consolidated Statements of Income. The ownership agreements contain provisions, which give the Company 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 is intended to approximate the fair value of a minority interest in the drive-in.
The net book valueCompany 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 acquired by the Company in a Partner Drive-In is recorded as an investment in partnership, which results in a reduction in the minority interest liability on the Consolidated Balance Sheet. If the purchase pricethat 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 results inis recorded as a decreasereduction in purchased goodwill. Any subsequent sale of the minority interest to another minority partner is recorded as a pro-rata reduction of goodwill, and investment, and no gain or loss is recognized on the sale of the minority ownership interest. Goodwill created as a result of the acquisition of minority interests in Partner Drive-Ins is not amortized but is tested annually for impairment under the provisions of SFAS No. 142.
Revenue Recognition, Franchise Fees and Royalties
Revenue from Partner Drive-In sales is recognized when food and beverage products are sold.
Initial franchise fees are nonrefundable and are recognized in income when all material services or conditions relating to the sale of the franchise have been substantially performed or satisfied by the Company. 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 the Company and the franchisee.
The Company’s franchisees are required under the provisions of the license agreements to pay the Company royalties each month based on a percentage of actual net royalty sales. However, the royalty payments and supporting financial statements are not due until the 20th of the following month. As a result, the Company accrues royalty revenue in the month earned based on estimates of Franchise Drive-In sales. These estimates are based on actual sales at Partner Drive-Ins and projections of average unit volume growth at Franchise Drive-Ins.
Operating Leases
Rent expense 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. 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 holidays and escalations have been reflected in rent expense on a straight-line basis over the expected lease term, which includes cancelable option periods when appropriate. The lease term commences on the date when we have the right to control the use of the leased property, which can occur before rent payments are due under the terms of the lease. Percentage rent expense 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.
Advertising Costs
Costs incurred in connection with the advertising and promotion of the Company’s products are included in other operating expenses and are expensed as incurred. Such costs amounted to $30,948, $28,216, $23,664, and $19,665$23,664 for fiscal years 2006, 2005 and 2004, and 2003, respectively.
Under the Company’s license agreements, both Partner-Drive-Ins and Franchise Drive-Ins must contribute a minimum percentage of revenues to a national media production fund (Sonic Advertising Fund) and spend an additional minimum percentage of gross revenues on local advertising, either directly or through Company-required participation in advertising cooperatives. A portion of the local advertising contributions is redistributed to a System Marketing Fund, which purchases advertising on national cable and broadcast networks and other national media and sponsorship opportunities. As stated in the terms of existing license agreements, these funds do not constitute assets of the Company and the Company acts with limited agency in the administration of these funds. Accordingly, neither the revenues and expenses nor the assets and liabilities of the advertising cooperatives, the Sonic Advertising Fund, or the System Marketing Fund are included in the Company’s consolidated financial statements. However, all advertising contributions by Partner Drive-Ins are recorded as expense on the Company’s financial statements.
Stock-Based Compensation
The Company has elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related interpretations in accounting for its stock options because the alternative fair value accounting provided for under FASB Statement No. 123, “Accounting for Stock-Based Compensation,” requires the use of option valuation models that were not developed for use in valuing such stock options. Under APB 25, because the exercise price of the Company’s stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
Pro forma information regarding net income and net income per share is required by Statement 123, which also requires that the information be determined as ifEffective September 1, 2005, the Company has accounted for its stock options granted subsequent to August 31, 1995 underadopted the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions:
Year of Grant | Risk-Free Interest Rate | Expected Dividend Yield | Expected Volatility | Expected Life (years) |
2005 | 4.0% | 0.0% | 41.1% | 5.1 |
2004 | 3.8 | 0.0 | 45.6 | 5.8 |
2003 | 3.2 | 0.0 | 46.3 | 5.7 |
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee compensation:
| | 2005 | | 2004 | | 2003 | |
Net income, as reported | | $ | 75,381 | | $ | 63,015 | | $ | 52,261 | |
Less stock-based compensation expense using the fair value method, net of related tax effects | | | (4,938 | ) | | (4,984 | ) | | (4,460 | ) |
Pro forma net income | | $ | 70,443 | | $ | 58,031 | | $ | 47,801 | |
| | | | | | | | | | |
Net income per share: | | | | | | | | | | |
Basic: | | | | | | | | | | |
As reported | | $ | 1.26 | | $ | 1.06 | | $ | .89 | |
Pro forma | | $ | 1.17 | | $ | .98 | | $ | .82 | |
Diluted: | | | | | | | | | | |
As reported | | $ | 1.21 | | $ | 1.02 | | $ | .86 | |
Pro forma | | $ | 1.13 | | $ | .94 | | $ | .79 | |
In December 2004, the Financial Accounting Standards Board (“FASB”) issued the final statement on accounting for share-based payments. Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. The Statement establishes fair value as the measurement objective in accounting for share-based payment transactions with employees except for equity instruments held by employee share ownership plans. The Company is required to adopt. Under the provisions of SFAS 123R, asstock-based compensation is measured at the grant date, based on the calculated fair value of the beginningaward, and is recognized as an expense over the requisite employee service period (generally the vesting period of its fiscal year 2006.the grant). The Company is currently evaluatingadopted SFAS 123R using the two adoption alternatives, which aremodified retrospective application method and, as a result, financial statement amounts for the modified-prospectiveprior periods presented in this Form 10-K have been adjusted to reflect the fair value method of expensing prescribed by SFAS 123R. The Company believes that the modified retrospective application of this standard achieves the highest level of clarity and comparability among the presented periods.
The following table shows total stock-based compensation expense and the modified-retrospective application.tax benefit included in the Consolidated Statements of Income and the effect on basic and diluted earnings per share for the years ended August 31:
| | 2006 | | 2005 | | 2004 | |
| | | | | | | |
Selling, general and administrative | | $ | 7,187 | | $ | 6,757 | | $ | 6,495 | |
Income tax benefit | | | (2,266 | ) | | (1,819 | ) | | (1,511 | ) |
Net stock-based compensation expense | | $ | 4,921 | | $ | 4,938 | | $ | 4,984 | |
Impact on net income per share: | | | | | | | | | | |
Basic | | $ | .06 | | $ | .05 | | $ | .06 | |
Diluted | | $ | .06 | | $ | .05 | | $ | .05 | |
Many of the options granted by Sonic are incentive stock options, for which a tax benefit only results if the option holder has a disqualifying disposition. For grants of non-qualified stock options, the Company expects to recognize a tax benefit on exercise of the option, so the full tax benefit is recognized on the related stock-based compensation expense. As a result of the limitation on the tax benefit for incentive stock options, the tax benefit for stock-based compensation will generally be less than the Company’s overall tax rate, and will vary depending on the timing of employees’ exercises and sales of stock.
As a result of adopting SFAS 123R retrospectively, financial statements for the prior periods presented in this Form 10-K have been adjusted to reflect the fair value method of expensing stock options. The Company is also evaluating which valuation model is most appropriate.following table details the impact of retrospective application on previously reported results for the years ended August 31:
| | 2005 | | | | 2004 | |
| | Adjusted | | As Previously Reported | | | | Adjusted | | As Previously Reported | |
Income Statement items: | | | | | | | | | | | | | | | | |
Income from operations | | $ | 117,449 | | $ | 124,206 | | | | | $ | 99,619 | | $ | 106,114 | |
Income before income taxes | | | 111,664 | | | 118,421 | | | | | | 93,241 | | | 99,736 | |
Net income | | | 70,443 | | | 75,381 | | | | | | 58,031 | | | 63,015 | |
| | | | | | | | | | | | | | | | |
Net income per share - basic | | $ | .78 | | $ | .84 | | | | | $ | .65 | | $ | .71 | |
Net income per share - diluted | | | .75 | | | .80 | | | | | | .63 | | | .68 | |
| | | | | | | | | | | | | | | | |
Cash Flow items: | | | | | | | | | | | | | | | | |
Net cash provided by operating activities | | $ | 127,685 | | $ | 132,280 | | | | | $ | 103,260 | | $ | 106,658 | |
Net cash used in financing activities | | | (51,297 | ) | | (55,892 | ) | | | | | (61,755 | ) | | (65,153 | ) |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Balance Sheet items: | | | | | | | |
Deferred income taxes | | $ | 7,786 | | $ | 11,164 | |
Paid-in capital | | | 153,776 | | | 121,982 | |
Retained earnings | | | 397,989 | | | 426,783 | |
Total stockholders’ equity | | | 387,917 | | | 384,539 | |
Total liabilities and stockholders’ equity | | | 563,316 | | | 563,316 | |
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Income tax benefits credited to equity relate to tax benefits associated with amounts that are deductible for income tax purposes but do not affect earnings. These benefits are principally generated from employee exercises of non-qualified stock options and disqualifying dispositions of incentive stock options.
New Accounting Pronouncements
In May 2005, the FASB issued Statement of Financial Accounting StandardsSFAS No. 154, “Accounting Changes and Error Corrections - A Replacementa replacement of APB Opinion No. 20 and FASB StatementSFAS No. 3,3.” whichSFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle and a change required by an accounting pronouncement when the pronouncement does not include specific transition provisions. SFAS No. 154 requires retrospective application to prior periods’ financial statements forof changes inas if the new accounting principle unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. If such
determinations are impracticable, there are other disclosures required under the standard. This standardhad always been used. SFAS No. 154 is effective for fiscal years beginning after December 15, 2005, (the Company’swhich is our fiscal year beginning September 1, 2006), and early adoption is allowed.2006. The adoption of this standardthe pronouncement is not expected to have a material impact on the Company’s consolidatedfinancial position or results of operationsoperations.
In June 2006, the EITF reached consensus on EITF 06-3, “Disclosure Requirements for Taxes Assessed by a Government Authority on Revenue-Producing Transactions.” EITF 06-3 requires disclosure of a company’s accounting policy with respect to presentation of taxes collected on a revenue producing transaction between a seller and a customer. For taxes that are reported on a gross basis (included in revenues and costs), EITF 06-3 also requires disclosure of the amount of taxes included in the financial condition.statements. EITF 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006, which will be our third fiscal quarter beginning March 1, 2007. The Company does not expect the adoption of EITF 06-3 to have a material impact on the Company’s consolidated financial statements.
In June 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement 109,” which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FAS 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006, which will be our fiscal year beginning September 1, 2007. The Company is currently evaluating the impact of adopting FIN 48.
On October 6, 2005,September 13, 2006, the FASBSecurities and Exchange Commission (“SEC”) issued FASB Staff PositionAccounting Bulletin No. FAS 13-1, “Accounting for Rental Costs Incurred during a Construction Period”108 (“FSP 13-1”SAB 108”), which requires rental costs associated with groundprovides interpretive guidance on how the effects of the carryover or building operating leases that are incurred duringreversal of prior year misstatements should be considered in quantifying a construction period be recognized as rental expense. FSP 13-1current year misstatement. SAB 108 is effective for the first reporting period beginning after December 15, 2005 (the Company’s fiscal quarter beginning March 1, 2006), and retrospective application is permitted but not required. The Company has historically capitalized ground operating leases during construction periods, with such capitalization totaling $177 for fiscal year 2005. The Companyending after November 15, 2006, which will expense ground operating leases during construction periodsbe our fiscal year beginning September 1, 2005.2007. The impactadoption of this changestatement is not expected to behave a material toimpact on the Company’s consolidatedfinancial position or results of operationsoperations.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial condition.statements upon adoption.
2. Net Income Per Share
The following table sets forth the computation of basic and diluted earnings per share for the years ended August 31:
| | 2005 | | 2004 | | 2003 | | | 2006 | | 2005* | | 2004* | |
Numerator: | | | | | | | | | | | | | | | | | | | | |
Net income | | $ | 75,381 | | $ | 63,015 | | $ | 52,261 | | | $ | 78,705 | | $ | 70,443 | | $ | 58,031 | |
| | | | | | | | | | | | | | | | | | | | |
Denominator: | | | | | | | | | | | | | | | | | | | | |
Weighted average shares outstanding - basic | | | 59,994,967 | | | 59,313,614 | | | 58,465,029 | | | | 86,260 | | | 89,992 | | | 88,970 | |
Effect of dilutive employee stock options | | | 2,436,475 | | | 2,340,687 | | | 2,444,669 | | | | 2,979 | | | 3,655 | | | 3,511 | |
Weighted average shares - diluted | | | 62,431,442 | | | 61,654,301 | | | 60,909,698 | | | | 89,239 | | | 93,647 | | | 92,481 | |
| | | | | | | | | | | | | | | | | | | | |
Net income per share - basic | | $ | 1.26 | | $ | 1.06 | | $ | .89 | | | $ | 0.91 | | $ | 0.78 | | $ | 0.65 | |
Net income per share - diluted | | $ | 1.21 | | $ | 1.02 | | $ | .86 | | | $ | 0.88 | | $ | 0.75 | | $ | 0.63 | |
| | | | | | | | | | | | | | | | | | | | |
Anti-dilutive employee stock options excluded | | | 166,119 | | | 259,382 | | | 933,774 | | | | 1,378 | | | 249 | | | 389 | |
See Note 12 for information regarding shares available for grant under*Adjusted to include the 2001 Sonic Corp. Stock Option Planimpact of stock-based compensation expense and the 2001 Sonic Corp. Directors’ Stock Option Plan.three-for-two stock split in April 2006
3. Impairment of Long-Lived Assets
During the fiscal years ended August 31, 2006, 2005 and 2004 the Company identified impairments for certain drive-in assets and surplus property held for disposal through regular quarterly reviews of long-lived assets. During fiscal year 2006, these analyses resulted in provisions for impairment totaling $264 to reduce the carrying amount of three surplus properties down to fair value. During fiscal year 2005, these analyses resulted in provisions for impairment totaling $387, including $286 to writedown the carrying amount of building and leasehold improvements on an underperforming drive-in, and $101 to reduce the carrying amount of an asset held for disposala surplus property down to fair value. During fiscal year 2004, the regular quarterly reviews resulted in a provision of $675 to writedown the carrying amount of building and leasehold improvements for anotheran underperforming drive-in.
4. Accounts and Notes Receivable
Accounts and notes receivable consist of the following at August 31, 20052006 and 2004:2005:
| | 2005 | | 2004 | | | 2006 | | 2005 | |
| | | | | | |
Current Accounts and Notes Receivable: | | | | | | | | |
Royalties and other trade receivables | | $ | 10,303 | | $ | 9,042 | | | $ | 12,863 | | $ | 10,303 | |
Notes receivable - current | | | 104 | | | 1,812 | | |
Notes receivable franchisees | | | | 353 | | | 104 | |
Notes receivable from advertising funds | | | | 3,681 | | | 2,171 | |
Other | | | 8,617 | | | 7,489 | | | | 4,682 | | | 6,446 | |
| | | 19,024 | | | 18,343 | | | | 21,579 | | | 19,024 | |
Less allowance for doubtful accounts and notes receivable | | | 223 | | | 256 | | | | 308 | | | 223 | |
| | $ | 18,801 | | $ | 18,087 | | | $ | 21,271 | | $ | 18,801 | |
| | | | | | | | |
Notes receivable - noncurrent | | $ | 3,422 | | $ | 5,729 | | |
Noncurrent Notes Receivable: | | | | | | | | |
Notes receivable franchisees | | | $ | 5,509 | | $ | 3,422 | |
Less allowance for doubtful notes receivable | | | 284 | | | 270 | | | | 327 | | | 284 | |
| | $ | 3,138 | | $ | 5,459 | | | $ | 5,182 | | $ | 3,138 | |
The Company’s receivables are primarily due from franchisees, all of whom are in the restaurant business. Substantially all of the notes receivable from franchisees are collateralized by real estate or equipment. The notes receivable from advertising funds represent transactions in the normal course of business. The Company collects royalties from franchisees and provides for estimated losses for receivables that are not likely to be collected. General allowances for uncollectible receivables are estimated based on historical trends.
5. Goodwill, IntangiblesTrademarks, Trade Names and Other AssetsIntangibles
The gross carrying amount of franchise agreements, franchise fees and other intangibles subject to amortization was $749$5,245 and $2,505$749 at August 31, 20052006 and 2004,2005, respectively. Accumulated amortization related to these intangible assets was $359$543 and $2,099$359 at August 31, 20052006 and 2004,2005, respectively. The carrying amount of trademarks and trade names not subject to amortization was $6,044 at August 31, 20052006 and 2004.2005.
The changes in the carrying amount of goodwill for fiscal years ending August 31, 20052006 and 20042005 were as follows:
| | 2005 | | 2004 | | |
| | | | | | | | | 2006 | | 2005 | |
Balance as of September 1, | | $ | 87,420 | | $ | 77,551 | | | $ | 88,471 | | $ | 87,420 | |
Goodwill acquired during the year | | | 468 | | | 11,374 | | | | 8,504 | | | 468 | |
Goodwill acquired (disposed of) related to the acquisitions and dispositions of minority interests in Partner Drive-Ins, net | | | 733 | | | (929 | ) | |
Goodwill acquired (disposed of) related to the acquisitions and | | | | | | | | |
dispositions of minority interests in Partner Drive-Ins, net | | | | (26 | ) | | 733 | |
Goodwill disposed of related to the sale of Partner Drive-Ins | | | (150 | ) | | (576 | ) | | | ─ | | | (150 | ) |
Balance as of August 31, | | $ | 88,471 | | $ | 87,420 | | | $ | 96,949 | | $ | 88,471 | |
| | | | | | | | | | | | | | |
6. Leases
Description of Leasing Arrangements
The Company’s leasing operations consist principally of leasing certain land, buildings and equipment (including signs) and subleasing certain buildings to franchise operators. The land and building portions of these leases are classified as operating leases and expire over the next 15 years. The equipment portions of these leases are classified principally as direct financing leases and expire principally over the next 10 years. These leases include provisions for contingent rentals that may be received on the basis of a percentage of sales in excess of stipulated amounts. Income is not recognized on contingent rentals until sales exceed the stipulated amounts. Some leases contain escalation clauses over the lives of the leases. Most of the leases contain one to four renewal options at the end of the initial term for periods of five years. The Company classifies income from leasing operations as other revenue in the Consolidated Statements of Income.
Certain Partner Drive-Ins lease land and buildings from third parties. These leases, which expire over the next 1918 years, include provisions for contingent rentals that may be paid on the basis of a percentage of sales in excess of stipulated amounts. TheFor the majority of the leases, the land portions of these leases are classified as operating leases and the building portions are classified as capital leases.
Direct Financing Leases
Components of net investment in direct financing leases are as follows at August 31, 20052006 and 2004:2005:
| | | 2005 | | | 2004 | | | 2006 | | 2005 | |
| | | | | | | | | | | | |
Minimum lease payments receivable | | $ | 8,619 | | $ | 10,313 | | | $ | 6,827 | | $ | 8,619 | |
Less unearned income | | | 2,412 | | | 3,152 | | | | 1,725 | | | 2,412 | |
Net investment in direct financing leases | | | 6,207 | | | 7,161 | | | | 5,102 | | | 6,207 | |
Less amount due within one year | | | 1,174 | | | 1,054 | | | | 1,287 | | | 1,174 | |
Amount due after one year | | $ | 5,033 | | $ | 6,107 | | | $ | 3,815 | | $ | 5,033 | |
Initial direct costs incurred in the negotiations and consummations of direct financing lease transactions have not been material. Accordingly, no portion of unearned income has been recognized to offset those costs.
Future minimum rental payments receivable as of August 31, 20052006 are as follows:
| | Operating | | Direct Financing | | | Operating | | Direct Financing | |
| | | | | | | | | | |
Year ending August 31: | | | | | | | | | | | | | | |
2006 | | $ | 702 | | $ | 1,968 | | |
2007 | | | 738 | | | 1,912 | | | $ | 563 | | $ | 1,920 | |
2008 | | | 755 | | | 1,765 | | | | 575 | | | 1,770 | |
2009 | | | 761 | | | 1,274 | | | | 571 | | | 1,284 | |
2010 | | | 744 | | | 669 | | |
Thereafter | | | 4,346 | | | 1,031 | | |
| | | 8,046 | | | 8,619 | | |
Less unearned income | | | ─ | | | 2,412 | | |
| | $ | 8,046 | | $ | 6,207 | | |
2010 | | | 543 | | | 679 | |
2011 | | | 543 | | | 442 | |
Thereafter | | | 2,960 | | | 732 | |
| | | 5,755 | | | 6,827 | |
Less unearned income | | | - | | | 1,725 | |
| | $ | 5,755 | | $ | 5,102 | |
Capital Leases
Components of obligations under capital leases are as follows at August 31, 20052006 and 2004:2005:
| | 2005 | | 2004 | | | 2006 | | 2005 | |
| | | | | | | | | | |
Total minimum lease payments | | $ | 58,960 | | $ | 63,937 | | | $ | 54,437 | | $ | 58,960 | |
Less amount representing interest averaging 7.3% in 2005 and 7.6% in 2004 | | | 20,435 | | | 23,406 | | |
Less amount representing interest averaging 8.0% in 2006 and 7.3% in 2005 | | | | 17,812 | | | 20,435 | |
Present value of net minimum lease payments | | | 38,525 | | | 40,531 | | | | 36,625 | | | 38,525 | |
Less amount due within one year | | | 2,266 | | | 2,511 | | | | 2,330 | | | 2,266 | |
Amount due after one year | | $ | 36,259 | | $ | 38,020 | | | $ | 34,295 | | $ | 36,259 | |
Maturities of these obligations under capital leases and future minimum rental payments required under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of August 31, 20052006 are as follows:
| | Operating | | Capital | | | Operating | | Capital | |
Year ending August 31: | | | | | | | | | | | | | | |
2006 | | $ | 9,722 | | $ | 4,960 | | |
2007 | | | 9,591 | | | 4,824 | | | $ | 10,513 | | $ | 4,891 | |
2008 | | | 9,465 | | | 4,698 | | | | 10,431 | | | 4,767 | |
2009 | | | 9,321 | | | 4,762 | | | | 10,361 | | | 4,830 | |
2010 | | | 9,194 | | | 4,785 | | | | 10,210 | | | 4,853 | |
2011 | | | | 9,977 | | | 4,654 | |
Thereafter | | | 107,489 | | | 34,931 | | | | 117,215 | | | 30,442 | |
| | | 154,782 | | | 58,960 | | | | 168,707 | | | 54,437 | |
Less amount representing interest | | | – | | | 20,435 | | | | - | | | 17,812 | |
| | $ | 154,782 | | $ | 38,525 | | | $ | 168,707 | | $ | 36,625 | |
Total rent expense for all operating leases and capital leases consists of the following for the years ended August 31:
| | 2006 | | 2005 | | 2004 | |
| | | | | | | |
Operating leases: | | | | | | | | | | |
Minimum rentals | | $ | 12,731 | | $ | 11,355 | | $ | 9,292 | |
Contingent rentals | | | 199 | | | 289 | | | 254 | |
Sublease rentals | | | (542 | ) | | (536 | ) | | (596 | ) |
Capital leases: | | | | | | | | | | |
Contingent rentals | | | 1,123 | | | 1,109 | | | 789 | |
| | $ | 13,511 | | $ | 12,217 | | $ | 9,739 | |
| | 2005 | | 2004 | | 2003 | |
| | | | | | | |
Operating leases: | | | | | | | | | | |
Minimum rentals | | $ | 11,355 | | $ | 9,292 | | $ | 8,118 | |
Contingent rentals | | | 289 | | | 254 | | | 232 | |
Sublease rentals | | | (536 | ) | | (596 | ) | | (321 | ) |
Capital leases: | | | | | | | | | | |
Contingent rentals | | | 1,109 | | | 789 | | | 658 | |
| | $ | 12,217 | | $ | 9,739 | | $ | 8,687 | |
The aggregate future minimum rentals receivable under noncancelable subleases of operating leases as of August 31, 20052006 was $3,121.
$2,767.
7. Property, Equipment and Capital Leases
Property, equipment and capital leases consist of the following at August 31, 20052006 and 2004:2005:
| | Estimated Useful Life | | 2005 | | 2004 | | | Estimated Useful Life | | 2006 | | 2005 | |
Property and equipment: | | | | | | | | | | | | | | | | | | | | |
Home office: | | | | | | | | | | | | | | | | | | | | |
Leasehold improvements | | | Life of lease | | $ | 3,046 | | $ | 3,011 | | | | Life of lease | | $ | 3,066 | | $ | 3,046 | |
Computer and other equipment | | | 2 - 5 yrs | | | 26,338 | | | 29,188 | | | | 2 - 5 yrs | | | 28,842 | | | 26,338 | |
Drive-ins, including those leased to others: | | | | | | | | | | | | | | | | | | | | |
Land | | | | | | 134,695 | | | 113,778 | | | | | | | 154,092 | | | 134,695 | |
Buildings | | | 8 - 25 yrs | | | 231,931 | | | 199,578 | | | | 8 - 25 yrs | | | 275,924 | | | 231,931 | |
Equipment | | | 5 - 7 yrs | | | 146,116 | | | 119,971 | | | | 5 - 7 yrs | | | 168,019 | | | 146,116 | |
Property and equipment, at cost | | | | | | 542,126 | | | 465,526 | | | | | | | 629,943 | | | 542,126 | |
Less accumulated depreciation | | | | | | 154,269 | | | 126,998 | | | | | | | 185,275 | | | 154,269 | |
Property and equipment, net | | | | | | 387,857 | | | 338,528 | | | | | | | 444,668 | | | 387,857 | |
Capital Leases: | | | | | | | | | | | | | | | | | | | | |
Leased home office building | | | Life of lease | | | 9,321 | | | 9,321 | | | | Life of lease | | | 9,321 | | | 9,321 | |
Leased drive-in buildings and equipment under capital leases, including those held for sublease | | | Life of lease | | | 36,111 | | | 36,320 | | |
Leased drive-in buildings, equipment and other assets under | | | | | | | | | | | |
capital leases, including those held for sublease | | | | Life of lease | | | 35,844 | | | 36,111 | |
Less accumulated amortization | | | | | | 10,464 | | | 7,854 | | | | | | | 12,779 | | | 10,464 | |
Capital leases, net | | | | | | 34,968 | | | 37,787 | | | | | | | 32,386 | | | 34,968 | |
Property, equipment and capital leases, net | | | | | $ | 422,825 | | $ | 376,315 | | | | | | $ | 477,054 | | $ | 422,825 | |
Land, buildings and equipment with a carrying amount of $38,476$33,836 at August 31, 20052006 were leased under operating leases to franchisees or other parties. The accumulated depreciation related to these buildings and equipment was $7,526$7,507 at August 31, 2005.2006. As of August 31, 2005,2006, the Company had drive-ins under construction with costs to complete which aggregated $9,120.$3,430.
8. Accrued Liabilities
Accrued liabilities consist of the following at August 31, 20052006 and 2004:2005:
| | 2005 | | 2004 | | | 2006 | | 2005 | |
| | | | | | | | | | |
Wages and other employee benefits | | $ | 6,153 | | $ | 5,751 | | | $ | 9,707 | | $ | 6,153 | |
Taxes, other than income taxes | | | 12,618 | | | 10,904 | | | | 13,476 | | | 12,618 | |
Accrued interest | | | 305 | | | 1,031 | | | | 389 | | | 305 | |
Minority interest in consolidated drive-ins | | | 1,904 | | | 2,012 | | | | 2,610 | | | 1,904 | |
Other | | | 5,387 | | | 4,035 | | | | 7,692 | | | 5,387 | |
| | $ | 26,367 | | $ | 23,733 | | | $ | 33,874 | | $ | 26,367 | |
9. Long-Term Debt
Long-term debt consists of the following at August 31, 20052006 and 2004:2005:
| | 2006 | | 2005 | |
| | | | | |
Borrowings under line of credit (A) | | $ | 101,150 | | $ | 30,150 | |
Senior unsecured notes (B) | | | 19,857 | | | 24,428 | |
Other | | | 1,392 | | | 5,617 | |
| | | 122,399 | | | 60,195 | |
Less long-term debt due within one year(C) | | | 5,227 | | | 4,261 | |
Long-term debt due after one year | | $ | 117,172 | | $ | 55,934 | |
| | 2005 | | 2004 | |
| | | | | |
Senior unsecured notes (A) | | $ | ─ | | $ | 30,000 | |
Borrowings under line of credit (B) | | | 30,150 | | | 14,075 | |
Senior unsecured notes (C) | | | 24,428 | | | 29,000 | |
Other | | | 5,617 | | | 9,094 | |
| | | 60,195 | | | 82,169 | |
Less long-term debt due within one year | | | 4,261 | | | 3,495 | |
Long-term debt due after one year | | $ | 55,934 | | $ | 78,674 | |
(A) | The Company repaid its senior unsecured Series B notes that matured in April 2005 in the amount of $30,000. As ofAt August 31, 2004,2006 the Company intended to refinance the entire $30,000 through availability under its line of credit and had classified that amount as long-term debt on its balance sheet. However, as a result of strong cash flow from operations for the first nine months of fiscal year 2005, the Company repaid $19,525 using cash on hand and refinanced the remaining $10,475 using amounts available under its line of credit. |
(B) | The Company has an agreement with a group of banks that providesprovided for a $150,000 line of credit, including a $2,000 sub-limit for letters of credit, expiring in July 2010. The Company plans to use the line of credit to finance the opening of newly-constructed drive-ins, acquisitions of existing drive-ins, purchases of the Company’s common stock, retirement of senior notes and for general corporate purposes. Borrowings under the line of credit are unsecured and bear interest at a specified bank’s prime rate or, at the Company’s option, LIBOR plus 0.50% to 1.00%. In addition, the Company pays an annual commitment fee ranging from .10% to .20% on the unused portion of the line of credit. As of August 31, 2005, the Company’s effective borrowing rate was 5.11%. In addition to the $30,150$101,150 borrowed under the line of credit as of August 31, 2005,2006, there were $676 in letters of credit outstanding. The Company’s effective borrowing rate under this line of credit as of August 31, 2006 and 2005 was 6.1% and 5.1%, respectively. Subsequent to year-end, Sonic signed a credit agreement requires, among other things,with a group of banks which provides for a $100,000 five-year revolving credit facility and a $476,000 seven-year term loan facility. The new facility was used to refinance the existing line of credit in September 2006. See Note 18 for additional information about the new credit agreement. |
(B) | At August 31, 2006 the Company to maintain equity of a specified amount, maintain ratios of debt to EBITDA and fixed charge coverage and limits additional borrowings and acquisitions and dispositions of businesses. |
(C) | The Company has $24,428had $19,857 of senior unsecured notes with $3,000$2,000 of Series A notes maturing in August 2008 and $21,429$17,857 of Series B notes maturing in August 2011. Interest is2011 with interest payable semi-annually and accrues at 6.58% for the Series A notes and 6.87% for the Series B notes. Required annual prepayments amount to $1,000 from August 2006 to August 2008 on the Series A notes and $3,571 from August 2006 to August 2011 on the Series B notes. The Company has the intent and the ability to refinance the required annual prepayments in 2006 through availability under its line of credit and has classified those amounts as long-term debt as of August 31, 2005 on the consolidated balance sheet. The related agreement requires,agreements required, among other things, the Company to maintain equity of a specified amount, and maintain ratios of debt to equity and fixed charge coverage. Subsequent to year-end, Sonic utilized funds available from the new credit agreement to pay the remaining balance of the senior unsecured notes, incurring early payment penalties of approximately $794. |
(C) | As a result of the subsequent repayment of the line of credit and senior secured notes, the amount of long-term debt due within one year is reflective of the maturities of the new credit agreement, along with maturities of the other notes that were not repaid subsequent to year-end. |
In February 2006, the Company entered into an interest rate swap agreement to modify a portion of the variable rate line of credit to a fixed rate obligation, thereby reducing the exposure to market rate fluctuations. The interest rate swap agreement has been designated as a cash flow hedge, and effectiveness is determined by matching the principal balance and terms with that specific obligation. The effective portions of changes in fair value are recognized in accumulated other comprehensive income in the accompanying Consolidated Balance Sheets. Ineffective portions of changes in fair value are recognized as a charge or credit to earnings. Under the terms of the interest rate swap agreement, the Company makes payments based on a fixed rate of 5.66% and receives interest payments based on 3-month LIBOR on a notional amount of $60,000. The differences to be paid or received under the interest rate swap agreement are recognized as an adjustment to interest expense. By its terms, the agreement would expire in May 2010 and settle quarterly, however, as a result of the repayment of the line of credit that was being hedged by this instrument, this derivative was terminated subsequent to August 31, 2006 resulting in an immaterial gain that will be reflected immediately in income in the first quarter of fiscal year 2007.
In August 2006, the Company entered into a forward starting swap agreement with the same financial institution to hedge part of the exposure associated with the new debt related to the tender offer that is further discussed in Note 18. The forward starting swap has been designated as a cash flow hedge, and is expected to be settled at the time the debt refinancing is completed to provide us with an effective interest rate of 5.16% plus 90 to 110 basis points for $400 million of the amount financed. The effectiveness of the instrument will be assessed quarterly and at the time the financing closes and any ineffectiveness will be recorded as a charge or credit to earnings. As of August 31, 2006, there was no hedge ineffectiveness.
The following table presents the components of comprehensive income for the year ended August 31, 2006:
Net Income | | $ | 78,705 | |
Unrealized gains on interest rate swap agreement, net of tax | | | (484 | ) |
Total comprehensive income | | $ | 78,221 | |
Maturities of long-term debt, reflecting the impact of the debt refinancing further described in Note 18, for each of the five years after August 31, 20052006 are $4,261 in 2006, $4,733$5,227 in 2007, $4,728$6,924 in 2008, $3,738$6,936 in 2009, $38,461$6,937 in 2010, $6,914 in 2011, and $4,274$89,461 thereafter.
10. Other Noncurrent Liabilities
Other noncurrent liabilities consist of the following at August 31, 20052006 and 2004:2005:
| | 2005 | | 2004 | | | 2006 | | 2005 | |
| | | | | | | | | | |
Minority interest in consolidated drive-ins | | $ | 4,182 | | $ | 4,339 | | | $ | 4,566 | | $ | 4,182 | |
Deferred area development fees | | | 2,331 | | | 1,108 | | | | 2,385 | | | 2,331 | |
Other | | | 3,565 | | | 2,784 | | | | 5,553 | | | 3,565 | |
| | $ | 10,078 | | $ | 8,231 | | | $ | 12,504 | | $ | 10,078 | |
11. Income Taxes
The Company’s income before the provision for income taxes is classified by source as domestic income.
The components of the provision for income taxes consist of the following for the years ended August 31:
| | 2005 | | 2004 | | 2003 | | | 2006 | | 2005 | | 2004 | |
Current: | | | | | | | | | | | | | | | | | | | | |
Federal | | $ | 38,384 | | $ | 30,980 | | $ | 27,126 | | | $ | 42,629 | | $ | 37,572 | | $ | 30,388 | |
State | | | 3,341 | | | 2,232 | | | 2,620 | | | | 4,163 | | | 3,269 | | | 2,185 | |
| | | 41,725 | | | 33,212 | | | 29,746 | | | | 46,792 | | | 40,841 | | | 32,573 | |
| | | | | | | | | | | | | | | | | | | | |
Deferred: | | | | | | | | | | | | | | | | | | | | |
Federal | | | 1,143 | | | 3,050 | | | 1,110 | | | | (1,127 | ) | | 284 | | | 2,242 | |
State | | | 172 | | | 459 | | | 167 | | | | (321 | ) | | 96 | | | 395 | |
| | | 1,315 | | | 3,509 | | | 1,277 | | | | (1,448 | ) | | 380 | | | 2,637 | |
Provision for income taxes | | $ | 43,040 | | $ | 36,721 | | $ | 31,023 | | | $ | 45,344 | | $ | 41,221 | | $ | 35,210 | |
The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate due to the following for the years ended August 31:
| | 2005 | | 2004 | | 2003 | | | 2006 | | 2005 | | 2004 | |
| | | | | | | | | | | | | | |
Amount computed by applying a tax rate of 35% | | $ | 41,447 | | $ | 34,908 | | $ | 29,149 | | | $ | 43,417 | | $ | 39,083 | | $ | 32,634 | |
State income taxes (net of federal income tax benefit) | | | 2,578 | | | 1,749 | | | 1,812 | | | | 2,767 | | | 2,481 | | | 1,678 | |
Employment related and other tax credits, net | | | (1,092 | ) | | (337 | ) | | (260 | ) | | | (1,014 | ) | | (1,092 | ) | | (337 | ) |
Other | | | 107 | | | 401 | | | 322 | | | | 174 | | | 749 | | | 1,235 | |
Provision for income taxes | | $ | 43,040 | | $ | 36,721 | | $ | 31,023 | | | $ | 45,344 | | $ | 41,221 | | $ | 35,210 | |
Deferred tax assets and liabilities consist of the following at August 31, 20052006 and 2004:2005:
| | 2005 | | 2004 | | | 2006 | | 2005 | |
Current deferred tax assets (liabilities): | | | | | | | | | | | | | | |
Allowance for doubtful accounts and notes receivable | | $ | 83 | | $ | 77 | | | $ | 83 | | $ | 83 | |
Property, equipment and capital leases | | | 194 | | | 326 | | | | 272 | | | 194 | |
Accrued litigation costs | | | 76 | | | 119 | | | | 76 | | | 76 | |
Accrued liabilities | | | ─ | | | (432 | ) | |
Deferred income from franchisees | | | | (327 | ) | | ─ | |
Deferred income from affiliated technology fund | | | 468 | | | 710 | | | | 203 | | | 468 | |
Other | | | ─ | | | (2 | ) | |
Current deferred tax assets, net | | $ | 821 | | $ | 798 | | | $ | 307 | | $ | 821 | |
| | | | | | | | | | | | | | |
Noncurrent deferred tax assets (liabilities): | | | | | | | | | | | | | | |
Net investment in direct financing leases including differences related to capitalization and amortization | | $ | (2,649 | ) | $ | (2,705 | ) | | $ | (2,390 | ) | $ | (2,649 | ) |
Investment in partnerships, including differences in capitalization and depreciation related to direct financing leases and different year ends for financial and tax reporting purposes | | | (10,587 | ) | | (6,266 | ) | |
Investment in partnerships, including differences in capitalization and depreciation related to direct financing | | | | | | | | |
leases and different year ends for financial and tax reporting purposes | | | | (8,764 | ) | | (10,587 | ) |
Capital loss carryover | | | 1,313 | | | 226 | | | | ─ | | | 1,313 | |
State net operating losses | | | 3,939 | | | 3,460 | | | | 4,247 | | | 3,939 | |
Property, equipment and capital leases | | | (2,104 | ) | | (3,732 | ) | | | (1,150 | ) | | (2,104 | ) |
Allowance for doubtful accounts and notes receivable | | | 111 | | | 201 | | | | 160 | | | 111 | |
Deferred income from affiliated franchise fees | | | 1,559 | | | 1,239 | | | | 1,830 | | | 1,559 | |
Accrued liabilities | | | 1,125 | | | 1,131 | | | | 296 | | | 1,125 | |
Intangibles and other assets | | | 93 | | | 164 | | | | 407 | | | 93 | |
Deferred income from franchisees | | | | 877 | | | ─ | |
Stock compensation | | | | 4,420 | | | 3,378 | |
Other | | | (25 | ) | | (84 | ) | | | 55 | | | (25 | ) |
| | | (7,225 | ) | | (6,366 | ) | | | (12 | ) | | (3,847 | ) |
Valuation allowance | | | (3,939 | ) | | (3,460 | ) | | | (4,247 | ) | | (3,939 | ) |
Noncurrent deferred tax liabilities, net | | $ | (11,164 | ) | $ | (9,826 | ) | | $ | (4,259 | ) | $ | (7,786 | ) |
| | | | | | | | | | | | | | |
Deferred tax assets and (liabilities): | | | | | | | | | | | | | | |
Deferred tax assets (net of valuation allowance) | | $ | 5,022 | | $ | 4,193 | | | $ | 8,679 | | $ | 8,400 | |
Deferred tax liabilities | | | (15,365 | ) | | (13,221 | ) | | | (12,631 | ) | | (15,365 | ) |
Net deferred tax liabilities | | $ | (10,343 | ) | $ | (9,028 | ) | | $ | (3,952 | ) | $ | (6,965 | ) |
State net operating loss carryforwards expire generally beginning in 2010. Management does not believe the Company will be able to realize the state net operating loss carryforwards and therefore has provided a valuation allowance as of August 31, 20052006 and 2004.2005.
The Company has capital loss carryovers of approximately $1.3 million which expire beginning in fiscal year 2008. Management has developed a plan that it believes will result in the realization of the carryovers before they expire.
On April 30, 2004, the Company’s board of directors authorized a three-for-two stock split in the form of a stock dividend. A total of 24,845,13224,845 shares of common stock were issued on May 21, 2004 in connection with the split, and an aggregate amount equal to the par value of the common stock issued of $248 was reclassified from paid-in capital to common stock.
On April 6, 2006, the Company’s board of directors authorized a three-for-two stock split in the form of a stock dividend. A total of 38,219 shares of common stock were issued in connection with the split, and an aggregate amount equal to the par value of the common stock issued of $382 was reclassified from paid-in capital to common stock.
All references in the accompanying consolidated financial statements to weighted average numbers of shares outstanding, per share amounts and Stock Purchase Plan and Stock Options share data have been adjusted to reflect the stock splits on a retroactive basis.
Stock Purchase Plan
The Company has an employee stock purchase plan for all full-time regular employees. Employees are eligible to purchase shares of common stock each year through a payroll deduction not in excess of the lesser of 10% of compensation or $25. The aggregate amount of stock that employees may purchase under this plan is limited to 759,375 shares. The purchase price will be between 85% and 100% of the stock’s fair market value and will be determined by the Company’s board of directors.
Stock OptionsStock-Based Compensation
In January 2001 the stockholders of the Company adopted the 2001 Sonic Corp. Stock Option Plan (the “2001 Employee Plan”) and the 2001 Sonic Corp. Directors’ Stock Option Plan (the “2001 Directors’ Plan”). (The 2001 Employee Plan and the 2001 Directors’ Plan are referred to collectively as the “2001 Plans.”) The 2001 Plans were adopted to replace the 1991 Sonic Corp. Stock Option Plan and the 1991 Sonic Corp. Directors’ Stock Option Plan (collectively, the “1991 Plans”), because the 1991 Plans were expiring after ten years as required by the Internal Revenue Code. Options previously granted under the 1991 Plans continue to be outstanding after the adoption of the 2001 Plans and are exercisable in accordance with the original terms of the applicable 1991 Plan.
Under the 2001 Employee Plan,provisions of SFAS 123R, stock-based compensation is measured at the Company is authorized to grant options to purchase up to 4,050,000 shares ofdate, based on the Company’s common stock to employees of the Company and its subsidiaries. Under the 2001 Directors’ Plan, the Company is authorized to grant options to purchase up to 675,000 shares of the Company’s common stock to the Company’s independent directors. At August 31, 2005, 583,933 shares were available for grant under the 2001 Employee Plan and 334,125 shares were available for grant under the 2001 Director’s Plan. The exercise price of the options to be granted is equal to thecalculated fair market value of the Company’s commonaward, and is recognized as an expense over the requisite employee service period (generally the vesting period of the grant). The Company adopted SFAS 123R effective September 1, 2005, using the modified retrospective application method and, as a result, financial statement amounts for the prior periods presented in this Form 10-K have been adjusted to reflect the fair value method of expensing prescribed by SFAS 123R.
At Sonic’s annual meeting of stockholders on January 31, 2006, the stockholders approved the Sonic Corp. 2006 Long-Term Incentive Plan and the authorization of 6,750 shares for awards to employees and non-employee directors. This omnibus plan provides flexibility to award various forms of equity compensation, such as stock onoptions, stock appreciation rights, performance shares, restricted stock and other stock-based awards. Prior to approval of this plan, the dateCompany had two share-based compensation plans for employees and non-employee directors, which authorized the granting of grant. Unless otherwise provided bystock options. No further awards will be granted under the previous plans now that the 2006 Long-Term Incentive Plan has been approved. The number of shares authorized for issuance under the Company’s Compensation Committee, options under both plans becomeexisting
exercisable ratably over a three-year period or immediately upon change in controlplans as of August 31, 2006 totals 6,051, all of which were available for future issuance. Stock options historically granted under the Company, as defined byCompany’s plans have been granted with an exercise price equal to the plans. All options expire at the earlier of 30 days after termination of employment or ten years after the date of grant.
A summarymarket price of the Company’s stock option activity (adjustedat the date of grant, a contractual term of 10 years, and generally a vesting period of three years. The most recent options granted in April and August 2006 have a contractual term of seven years. The Company’s policy is to recognize compensation cost for these options on a straight-line basis over the requisite service period for the entire award. Additionally, the Company’s policy is to issue new shares of common stock splits),to satisfy stock option exercises.
The Company measures the compensation cost associated with share-based payments by estimating the fair value of stock options as of the grant date using the Black-Scholes option pricing model. The Company believes that the valuation technique and related informationthe approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of the Company’s stock options granted during 2006, 2005 and 2004. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by the employees who receive equity awards.
The per share weighted average fair value of stock options granted during 2006, 2005 and 2004 was as follows for$7.90, $8.94 and $6.89, respectively. In addition to the years ended August 31:exercise and grant date prices of the awards, certain weighted average assumptions that were used to estimate the fair value of stock option grants in the respective periods are listed in the table below:
| | 2005 | | 2004 | | 2003 | |
| | Options | | Weighted Average Exercise Price | | Options | | Weighted Average Exercise Price | | Options | | Weighted Average Exercise Price | |
| | | | | | | | | | | | | |
Outstanding—beginning of year | | | 5,775,322 | | $ | 11.79 | | | 5,949,084 | | $ | 9.93 | | | 6,274,796 | | $ | 8.22 | |
Granted | | | 719,397 | | | 31.80 | | | 743,135 | | | 21.39 | | | 878,552 | | | 17.57 | |
Exercised | | | (1,148,452 | ) | | 9.41 | | | (846,746 | ) | | 6.63 | | | (1,054,362 | ) | | 5.39 | |
Forfeited | | | (129,348 | ) | | 20.33 | | | (70,151 | ) | | 17.82 | | | (149,902 | ) | | 14.99 | |
Outstanding—end of year | | | 5,216,919 | | $ | 14.87 | | | 5,775,322 | | $ | 11.79 | | | 5,949,084 | | $ | 9.93 | |
| | | | | | | | | | | | | | | | | | | |
Exercisable at end of year | | | 3,826,957 | | $ | 10.82 | | | 4,271,690 | | $ | 9.08 | | | 4,292,694 | | $ | 7.36 | |
| | | | | | | | | | | | | | | | | | | |
Weighted average fair value of options granted during the year | | $ | 13.44 | | | | | $ | 10.34 | | | | | $ | 8.30 | | | | |
| 2006 | 2005 | 2004 |
Expected term (years) | 4.5 | 5.1 | 5.8 |
Expected volatility | 34% | 41% | 46% |
Risk-free interest rate | 4.7% | 4.0% | 3.8% |
Expected dividend yield | 0% | 0% | 0% |
A summary
The Company estimates expected volatility based on historical daily price changes of the Company’s common stock for a period equal to the current expected term of the options. The risk-free interest rate is based on the United States treasury yields in effect at the time of grant corresponding with the expected term of the options. The expected option term is the number of years the Company estimates that options will be outstanding prior to exercise considering vesting schedules and our historical exercise patterns. The estimate of expected term for options granted in April 2006 was adjusted to consider the reduced contractual term from 10 years to 7 years, resulting in a lower expected term.
SFAS 123R requires the cash flows resulting from the tax benefits for tax deductions in excess of the compensation expense recorded for those options (excess tax benefits) to be classified as follows as offinancing cash flows. These excess tax benefits were $4,645 for the year ended August 31, 2005:
2006 and are classified as a financing cash inflow in the Company’s Consolidated Statements of Cash Flows.
| | Options Outstanding | | Options Exercisable | |
Range of Exercise Prices | | Number Outstanding as of 8/31/2005 | | Weighted Average Remaining Contractual Life (Yrs.) | | Weighted Average Exercise Price | | Number Exercisable as of 8/31/2005 | | Weighted Average Exercise Price | |
$ 2.99 to $ 5.36 | | | 872,536 | | | 1.28 | | $ | 3.85 | | | 872,536 | | $ | 3.85 | |
$ 5.72 to $ 8.59 | | | 1,066,398 | | | 3.68 | | $ | 7.77 | | | 1,066,398 | | $ | 7.77 | |
$ 9.06 to $16.13 | | | 891,167 | | | 5.67 | | $ | 11.88 | | | 866,189 | | $ | 11.77 | |
$16.45 to $19.54 | | | 1,029,665 | | | 7.30 | | $ | 18.39 | | | 812,746 | | $ | 18.56 | |
$20.39 to $31.61 | | | 877,711 | | | 8.87 | | $ | 23.77 | | | 207,408 | | $ | 21.42 | |
$31.71 to $32.48 | | | 479,442 | | | 9.57 | | $ | 32.37 | | | 1,680 | | $ | 32.48 | |
$ 2.99 to $32.48 | | | 5,216,919 | | | 5.75 | | $ | 14.87 | | | 3,826,957 | | $ | 10.82 | |
A summary of stock option activity under the Company’s share-based compensation plans for the year ended August 31, 2006 is presented in the following table:
| | Options | | Weighted Average Exercise Price | | Weighted Average Remaining Contractual Life (Yrs.) | | Aggregate Intrinsic Value | |
Outstanding-beginning of year | | | 7,826 | | $ | 9.91 | | | | | | | |
Granted | | | 965 | | | 22.08 | | | | | | | |
Exercised | | | (1,339 | ) | | 5.97 | | | | | | | |
Forfeited or expired | | | (221 | ) | | 19.13 | | | | | | | |
Outstanding August 31, 2006 | | | 7,230 | | $ | 11.98 | | | 5.42 | | $ | 72,656 | |
Exercisable August 31, 2006 | | | 5,415 | | $ | 9.10 | | | 4.64 | | $ | 69,445 | |
The total intrinsic value of options exercised during the years ended August 31, 2006, 2005 and 2004 was $19,567, $20,923 and $12,617, respectively. At August 31, 2006, total remaining unrecognized compensation cost related to unvested stock-based arrangements was $12,441 and is expected to be recognized over a weighted average period of 1.6 years.
Stockholder Rights Plan
The Company has a stockholder rights plan which is designed to deter coercive takeover tactics and to prevent a potential acquirer from gaining control of the Company without offering a fair price to all of the Company’s stockholders.
The plan provided for the issuance of one common stock purchase right for each outstanding share of the Company’s common stock. Each right initially entitles stockholders to buy one unit of a share of preferred stock for $85. The rights will be exercisable only if a person or group acquires beneficial ownership of 15% or more of the Company’s common stock or commences a tender or exchange offer upon consummation of which such person or group would beneficially own 15% or more of the Company’s common stock. At August 31, 2005, 50,0002006, 1,000 shares of preferred stock have been reserved for issuance upon exercise of these rights.
If any person becomes the beneficial owner of 15% or more of the Company’s common stock, other than pursuant to a tender or exchange offer for all outstanding shares of the Company approved by a majority of the independent directors not affiliated with a 15%-or-more stockholder, then each right not owned by a 15%-or-more stockholder or related parties will then entitle its holder to purchase, at the right’s then current exercise price, shares of the Company’s common stock having a value of twice the right’s then current exercise price. In addition, if, after any person has become a 15%-or-more stockholder, the Company is involved in a merger or other business combination transaction with another person in which the Company does not survive or in which its common stock is changed or exchanged, or sells 50% or more of its assets or earning power to another person, each right will entitle its holder to purchase, at the right’s then current exercise price, shares of common stock of such other person having a value of twice the right’s then current exercise price. Unless a triggering event occurs, the rights will not trade separately from the common stock.
The Company will generally be entitled to redeem the rights at $0.01 per right at any time until 10 days (subject to extension) following a public announcement that a 15% position has been acquired. The rights expire on June 16, 2007.
Stock Repurchase Program
The Company has a stock repurchase program that is authorized by the Board of Directors. On April 7, 2005,2006, the Board of Directors approved an increase in the Company’s stockshare repurchase program from $60,000$34.6 million to $150,000$110.0 million and extended the program through August 31, 2006.2007. Pursuant to this program, the Company acquired 1,344,2734,787 shares at an average price of $31.48$19.57 for a total cost of $42,324$93,682 during fiscal year 2005.2006. As of August 31, 2005,2006, the remaining amount authorized for repurchases was $107,676.Company had $89,413 available under the program.
13. Net Revenue Incentive Plan
The Company has a Net Revenue Incentive Plan (the “Incentive Plan”), as amended, which applies to certain members of management and is at all times discretionary with the Company’s board of directors. If certain predetermined earnings goals are met, the Incentive Plan provides that a predetermined percentage of the employee’s salary may be paid in the form of a bonus. The Company recognized as expense incentive bonuses of $3,247, $2,997, and $3,070 and $2,038 during fiscal years 2006, 2005 and 2004, and 2003, respectively.
14. Employment Agreements
The Company has employment contracts with its Chairman and Chief Executive Officer and several members of its senior management. These contracts provide for use of Company automobiles or related allowances, medical, life and disability insurance, annual base salaries, as well as an incentive bonus. These contracts also contain provisions for payments in the event of the termination of employment and provide for payments aggregating $8,018$8,608 at August 31, 20052006 due to loss of employment in the event of a change in control (as defined in the contracts).
15. Contingencies
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.
The Company has an agreement with GE Capital Franchise Finance Corporation (“GEC”), pursuant to which GEC made loans to existing Sonic franchisees who met certain underwriting criteria set by GEC. Under the terms of the agreement with GEC, the Company provided a guarantee of 10% of the outstanding balance of loans from GEC to the Sonic franchisees, limited to a maximum amount of $5,000. As of August 31, 2005,2006, the total amount guaranteed under the GEC agreement was $3,793.$2,749. The Company ceased guaranteeing new loans under the program during fiscal year 2002 and has not been required to make any payments under its agreement with GEC. Existing loans under guarantee will expire through 2012. In the event of default by a franchisee, the Company has the option to fulfill the franchisee’s obligations under the note or to become the note holder, which would provide an avenue of recourse with the franchisee under the notes.
The Company has obligations under various lease agreements with third-party lessors related to the real estate for Partner Drive-Ins that were sold to franchisees. Under these agreements, the Company remains secondarily liable for the lease payments for which it was responsible as the original lessee. As of August 31, 2005,2006, the amount remaining under the guaranteed lease obligations totaled $4,900.$3,934.
Effective November 30, 2005, the Company extended a note purchase agreement to a bank that serves to guarantee the repayment of a franchisee loan and also benefits the franchisee with a lower financing rate. In the event of default by the franchisee, the Company would purchase the franchisee loan from the bank, thereby becoming the note holder and providing an avenue of recourse with the franchisee. As of August 31, 2006, the balance of the loan was $2,631.
The Company has not recorded a liability for its obligations under the guarantees, and none of the notes or leasesother than an immaterial amount related to the guarantees were in default asfair value of August 31, 2005.the guarantee associated with the note purchase agreement, and has not been required to make any payments under any of these guarantees.
16. Selected Quarterly Financial Data (Unaudited)
| | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter | | Full Year | | | First Quarter | | Second Quarter | | Third Quarter | | Fourth Quarter | | Full Year | |
| | 2005 | | 2004 | | 2005 | | 2004 | | 2005 | | 2004 | | 2005 | | 2004 | | 2005 | | 2004 | | | 2006 | | 2005* | | 2006 | | 2005* | | 2006 | | 2005* | | 2006 | | 2005* | | 2006 | | 2005* | |
Income statement data: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Partner Drive-In sales | | $ | 120,211 | | $ | 99,745 | | $ | 112,655 | | $ | 94,105 | | $ | 141,797 | | $ | 121,630 | | $ | 151,325 | | $ | 134,105 | | $ | 525,988 | | $ | 449,585 | | | $ | 135,422 | | $ | 120,211 | | $ | 126,376 | | $ | 112,655 | | $ | 156,921 | | $ | 141,797 | | $ | 167,113 | | $ | 151,325 | | $ | 585,832 | | $ | 525,988 | |
Other | | | 22,016 | | | 18,963 | | | 19,958 | | | 17,490 | | | 25,856 | | | 24,312 | | | 29,248 | | | 26,096 | | | 97,078 | | | 86,861 | | | | 24,378 | | | 22,016 | | | 22,572 | | | 19,958 | | | 29,548 | | | 25,856 | | | 30,932 | | | 29,248 | | | 107,430 | | | 97,078 | |
Total revenues | | | 142,227 | | 118,708 | | 132,613 | | 111,595 | | 167,653 | | 145,942 | | 180,573 | | 160,201 | | 623,066 | | 536,446 | | | | 159,800 | | 142,227 | | 148,948 | | 132,613 | | 186,469 | | 167,653 | | 198,045 | | 180,573 | | 693,262 | | 623,066 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Partner Drive-In operating expenses | | | 97,784 | | 79,852 | | 91,682 | | 76,320 | | 111,691 | | 95,723 | | 120,749 | | 106,964 | | 421,906 | | 358,859 | | | | 110,125 | | 97,784 | | 102,615 | | 91,682 | | 123,755 | | 111,691 | | 132,132 | | 120,749 | | 468,627 | | 421,906 | |
Selling, general and administrative | | | 9,493 | | 9,121 | | 10,060 | | 9,083 | | 10,209 | | 9,914 | | 10,984 | | 10,152 | | 40,746 | | 38,270 | | | | 12,196 | | 10,833 | | 13,214 | | 11,785 | | 13,293 | | 12,096 | | 13,345 | | 12,789 | | 52,048 | | 47,503 | |
Other | | | 8,406 | | | 7,823 | | | 9,257 | | | 8,840 | | | 9,051 | | | 8,285 | | | 9,494 | | | 8,255 | | | 36,208 | | | 33,203 | | | | 9,897 | | | 8,406 | | | 9,997 | | | 9,257 | | | 10,361 | | | 9,051 | | | 10,705 | | | 9,494 | | | 40,960 | | | 36,208 | |
Total expenses | | | 115,683 | | | 96,796 | | | 110,999 | | | 94,243 | | | 130,951 | | | 113,922 | | | 141,227 | | | 125,371 | | | 498,860 | | | 430,332 | | | | 132,218 | | | 117,023 | | | 125,826 | | | 112,724 | | | 147,409 | | | 132,838 | | | 156,182 | | | 143,032 | | | 561,635 | | | 505,617 | |
Income from operations | | | 26,544 | | 21,912 | | 21,614 | | 17,352 | | 36,702 | | 32,020 | | 39,346 | | 34,830 | | 124,206 | | 106,114 | | | | 27,582 | | 25,204 | | 23,122 | | 19,889 | | 39,060 | | 34,815 | | 41,863 | | 37,541 | | 131,627 | | 117,449 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest expense, net | | | 1,605 | | | 1,579 | | | 1,532 | | | 1,679 | | | 1,292 | | | 1,586 | | | 1,356 | | | 1,534 | | | 5,785 | | | 6,378 | | | | 1,307 | | | 1,605 | | | 2,096 | | | 1,532 | | | 2,215 | | | 1,292 | | | 1,960 | | | 1,356 | | | 7,578 | | | 5,785 | |
Income before income taxes | | | 24,939 | | 20,333 | | 20,082 | | 15,673 | | 35,410 | | 30,434 | | 37,990 | | 33,296 | | 118,421 | | 99,736 | | | | 26,275 | | 23,599 | | 21,026 | | 18,357 | | 36,845 | | 33,523 | | 39,903 | | 36,185 | | 124,049 | | 111,664 | |
Provision for income taxes | | | 8,939 | | | 7,574 | | | 7,487 | | | 5,838 | | | 12,664 | | | 11,337 | | | 13,950 | | | 11,972 | | | 43,040 | | | 36,721 | | | | 9,845 | | | 8,485 | | | 8,122 | | | 7,084 | | | 13,011 | | | 12,248 | | | 14,366 | | | 13,404 | | | 45,344 | | | 41,221 | |
Net income | | $ | 16,000 | | $ | 12,759 | | $ | 12,595 | | $ | 9,835 | | $ | 22,746 | | $ | 19,097 | | $ | 24,040 | | $ | 21,324 | | $ | 75,381 | | $ | 63,015 | | | $ | 16,430 | | $ | 15,114 | | $ | 12,904 | | $ | 11,273 | | $ | 23,834 | | $ | 21,275 | | $ | 25,537 | | $ | 22,781 | | $ | 78,705 | | $ | 70,443 | |
Net income per share: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Basic | | $ | .27 | | $ | .22 | | $ | .21 | | $ | .17 | | $ | .38 | | $ | .32 | | $ | .40 | | $ | .36 | | $ | 1.26 | | $ | 1.06 | | | $ | 0.19 | | $ | 0.17 | | $ | 0.15 | | $ | 0.12 | | $ | 0.28 | | $ | 0.24 | | $ | 0.30 | | $ | 0.26 | | $ | 0.91 | | $ | 0.78 | |
Diluted | | $ | .26 | | $ | .21 | | $ | .20 | | $ | .16 | | $ | .36 | | $ | .31 | | $ | .39 | | $ | .34 | | $ | 1.21 | | $ | 1.02 | | | $ | 0.18 | | $ | 0.16 | | $ | 0.14 | | $ | 0.12 | | $ | 0.27 | | $ | 0.23 | | $ | 0.29 | | $ | 0.25 | | $ | 0.88 | | $ | 0.75 | |
Weighted average shares outstanding: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Basic | | | 60,010 | | 58,908 | | 60,263 | | 59,237 | | 60,197 | | 59,512 | | 59,509 | | 59,598 | | 59,995 | | 59,314 | | | | 87,415 | | 90,015 | | 86,227 | | 90,394 | | 85,993 | | 90,296 | | 85,405 | | 89,264 | | 86,260 | | 89,992 | |
Diluted | | | 62,386 | | 61,194 | | 62,788 | | 61,689 | | 62,716 | | 61,832 | | 61,836 | | 61,902 | | 62,431 | | 61,654 | | | | 90,521 | | 93,578 | | 89,261 | | 94,182 | | 89,007 | | 94,074 | | 88,168 | | 92,755 | | 89,239 | | 93,647 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
* Prior years adjusted to include the impact of stock-based compensation expense and the three-for-two stock split in April 2006; see Note 1 and Note 12 for additional information.
17. Fair Values of Financial Instruments
The following discussion of fair values is not indicative of the overall fair value of the Company’s consolidated balance sheet since the provisions of SFAS No. 107, “Disclosures About Fair Value of Financial Instruments,” do not apply to all assets, including intangibles.
The following methods and assumptions were used by the Company in estimating its fair values of financial instruments:
Cash and cash equivalents—Carrying value approximates fair value due to the short duration to maturity.
Notes receivable—For variable rate loans with no significant change in credit risk since the loan origination, fair values approximate carrying amounts. Fair values for fixed-rate loans are estimatedesti-mated using discounted cash flow analysis, using interest rates that would currently be offered for loans with similar terms to borrowers of similar credit quality and/or the same remaining maturities.
As of August 31, 20052006 and 2004,2005, carrying values approximate their estimated fair values.
Borrowed funds—Fair values for fixed rate borrowings are estimated using a discounted cash flow analysis that applies interest rates currently being offered on borrowings of similar amounts and terms to those currently outstanding. Carrying values for variable-rate borrowings approximate their fair values.
The carrying amounts, including accrued interest, and estimated fair values of the Company’s fixed-rate borrowings at August 31, 20052006 were $24,526$19,857 and $25,123,$19,925, respectively, and at August 31, 20042005 were $59,955$24,526 and $61,515,$25,123, respectively.
18. Subsequent Events
EffectiveOn August 15, 2006, we commenced a “modified Dutch auction” tender offer, initially offering to purchase 25,455 shares of our common stock at a price not less than $19.50 and not greater than $22.00 per share, for a maximum aggregate purchase price of $560 million. On September 1, 2005,25, 2006, we decreased the Company acquired 15 Franchise Drive-Insnumber of shares sought in the Tennesseetender offer to 24,348, and Kentucky marketsincreased the purchase price to not less than $19.50 and not greater than $23.00 per share. On October 13, 2006, we repurchased 15,918 shares of our common stock that were properly tendered and not withdrawn, at a purchase price of $23.00 per share for approximately $13,895, excluding post-closing adjustments.a total purchase price of $366,117.
Subsequent to August 31, 2005,We funded the Company purchased an additional $40,039repurchase of the shares of our common stock with the proceeds from new senior secured credit facilities with a syndicate of financial institutions led by Banc of America Securities LLC and Lehman Brothers Inc. The new senior secured credit facilities consist of a $100,000, five-year revolving credit facility and a $486,000, seven-year term loan facility. As of October 13, 2006, we had borrowed $486,000 under the share repurchase program that was authorized byterm loan facility and no advances were outstanding under the Boardrevolving credit facility, to fund the purchase of Directorsthe shares in April 2005. The total remaining amount authorized for repurchase after this activitythe tender offer, as well as refinance certain of November 10, 2005 was $67,636.our existing indebtedness and pay related fees and expenses.
As a resultInterest on loans under the new senior secured credit facility will be payable at per annum rates equal to (1) in the case of the franchise acquisitionrevolving credit facility, initially, LIBOR plus 175 basis points and ongoing share repurchases,adjusting over time based upon Sonic's leverage ratio and (2) in the Company took additional advances on its available linecase of credit. The total balance outstanding as of November 10, 2005 was $63,000, an increase of $32,850 from August 31, 2005.the term loan facility, initially, LIBOR plus 200 basis points and adjusting over time based upon Sonic's credit ratings with Moody's Investors Service Inc.
We will pay a commitment fee on the unused portion of the revolving credit facility, starting at 0.375% and adjusting over time based upon our leverage ratio. Our ability to reserve funds from the revolving credit facility is conditioned upon various customary representations and warranties being true at the time of the borrowing, and upon no event of default existing or resulting from the receipt of such finds. We and all of our domestic subsidiaries have granted the lenders under the new senior secured credit facility valid and perfected first priority (subject to certain exceptions) liens and security interests in (1) all present and future shares of capital stock (or other ownership profit interests) in each of our present and future subsidiaries (subject to certain limitations), (2) all present and future property and assets, real and personal and (3) all proceeds and products of the property and assets described in clauses (1) and (2).
The credit agreement governing the new senior secured credit facilities contains certain affirmative covenants, certain negative covenants, certain financial covenants, certain conditions and events of default that are customarily required for similar financings. Such negative covenants include limitations on liens, consolidations and mergers, indebtedness, capital expenditures, asset dispositions, sale-leaseback transactions, stock repurchases, transactions with affiliates and other restrictions and limitations. Furthermore, the credit agreement requires us to maintain compliance with certain financial covenants such as a leverage ratio and fixed charge coverage ratio. Although management does not anticipate an event of default, if such an event occurred, the unpaid amounts outstanding could become immediately due and payable.
Schedule II - Valuation and Qualifying Accounts
Description | | Balance at Beginning of Year | | Additions Charged to Costs and Expenses | | Amounts Written Off Against the Allowance | | (Transfer) Recoveries | | Balance at End of Year | |
| | (In Thousands) | |
| | | | | | | | | | | |
Allowance for doubtful accounts and notes receivable | | | | | | | | | | | | | | | | |
Year ended: | | | | | | | | | | | | | | | | |
August 31, 2005 | | | 526 | | | 414 | | | 542 | | | 109 | | | 507 | |
August 31, 2004 | | | 1,157 | | | 351 | | | 982 | | | – | | | 526 | |
August 31, 2003 | | | 1,993 | | | 177 | | | 1,013 | | | | | | 1,157 | |
| | | | | | | | | | | | | | | | |
Accrued carrying costs for drive-in closings and disposals | | | | | | | | | | | | | | | | |
Year ended: | | | | | | | | | | | | | | | | |
August 31, 2005 | | | 198 | | | – | | | 36 | | | – | | | 162 | |
August 31, 2004 | | | 774 | | | | | | 576 | | | | | | 198 | |
August 31, 2003 | | | 946 | | | 145 | | | 317 | | | | | | 774 | |
Description | | Balance at Beginning of Year | | Additions Charged to Costs and Expenses | | Amounts Written Off Against the Allowance | | (Transfer) Recoveries | | Balance at End of Year | |
| | (In Thousands) | |
| | | | | | | | | | | |
Allowance for doubtful accounts and notes receivable | | | | | | | | | | | |
Year ended: | | | | | | | | | | | | | | | | |
August 31, 2006 | | | 507 | | | (5 | ) | | 86 | | | 219 | | | 635 | |
August 31, 2005 | | | 526 | | | 414 | | | 542 | | | 109 | | | 507 | |
August 31, 2004 | | | 1,157 | | | 351 | | | 982 | | | - | | | 526 | |
| | | | | | | | | | | | | | | | |
Accrued carrying costs for drive-in closings and disposals | | | | | | | | | | | | | | | | |
Year ended: | | | | | | | | | | | | | | | | |
August 31, 2006 | | | 162 | | | - | | | 49 | | | - | | | 113 | |
August 31, 2005 | | | 198 | | | - | | | 36 | | | - | | | 162 | |
August 31, 2004 | | | 774 | | | - | | | 576 | | | - | | | 198 | |
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has caused the undersigned, duly-authorized, to sign this report on its behalf on this 11th30th day of November, 2005.October, 2006.
| Sonic Corp. |
| | |
| By: | /s/ J. Clifford Hudson |
| | J. Clifford Hudson |
| | Chairman, Chief Executive Officer and President |
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the undersigned have signed this report on behalf of the registrant, in the capacities and as of the dates indicated.
| | |
Signature | Title | Date |
| | |
/s/ J. Clifford Hudson | | Chairman of the Board of Directors, Chief Executive Officer | November 11, 2005October 30, 2006 |
J. Clifford Hudson, Principal Executive Officer | Executive Officer and President | |
| | |
/s/ Stephen C. Vaughan | | Vice President, and Chief Financial Officer and Treasurer | November 11, 2005 |
Stephen C. Vaughan, Principal Financial Officer | | |
| | |
/s/ Terry D. Harryman | | Controller | November 11, 2005 |
Terry D. Harryman, Principal Accounting Officer | | |
| | |
/s/ Margaret M. Blair | | Director | November 11, 2005 |
Margaret M. Blair | | |
| | |
/s/ Leonard Lieberman | | Director | November 11, 2005 |
Leonard Lieberman | | |
| | |
/s/ Michael J. Maples | | Director | November 11, 2005 |
Michael J. Maples | | |
| | |
/s/ Pattye L. Moore | | Director | November 11, 2005 |
Pattye L. Moore | | |
| | |
/s/ Federico F. Peña | | Director | November 11, 2005 |
Federico F. Peña | | |
| | |
/s/ H. E. Rainbolt | | Director | November 11, 2005 |
H.E. Rainbolt | | |
| | |
/s/ Frank E. Richardson | | Director | November 11, 2005 |
Frank E. Richardson | | |
| | |
/s/ Robert M. Rosenberg | | Director | November 11, 2005 |
Robert M. Rosenberg | | |
| | |
EXHIBIT INDEX
Exhibit Number and Description Exhibit Number and Description
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