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| SONC > SEC Filings for SONC > Form 10-K on 29-Oct-2009 | All Recent SEC Filings |
29-Oct-2009
Annual Report
Overview
Description of the Business. Sonic operates and franchises the largest chain of drive-in restaurants in the United States. As of August 31, 2009, the Sonic system was comprised of 3,544 drive-ins, of which 13% were Partner Drive-Ins and 87% were Franchise Drive-Ins. Sonic Drive-Ins feature signature menu items such as specialty drinks and frozen desserts, made-to-order sandwiches and a unique breakfast menu. The Company derives revenues primarily from Partner Drive-In sales and royalties from franchisees. The Company also receives revenues from initial franchise fees and, to a lesser extent, from the selling and leasing of signs and real estate.
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. Fiscal year 2009 was a challenging year marked by economic disruptions and constrained consumer discretionary spending. In response to these and other challenges, we made progress against a number of initiatives during the year. In January 2009, we introduced the Sonic Everyday Value Menu featuring 11 items for $1. We also made significant progress against our refranchising initiative evidenced by the sale of 205 Partner Drive-Ins to franchisees during the year. Partner Drive-Ins now comprise 13% of the entire system, down from 20% at the beginning of the fiscal year.
Investments by franchisees in new and existing development remained solid throughout the year, with the opening of 130 new drive-ins, the relocation or rebuilding of 46 existing drive-ins, and the completion of 337 retrofits for the fiscal year. We also opened the first Sonic Drive-Ins in several new markets and new states with very strong opening results.
The growth and success of our business is built around implementation of our multi-layered growth strategy, which features the following components:
· Same-store sales growth fueled by increased media expenditures, new product news, improved sales performance of Partner Drive-Ins and product and service differentiation initiatives;
· Expansion of the Sonic brand through new unit growth, particularly by franchisees;
· Increased franchising income stemming from franchisee new unit growth, same-store sales growth and our unique ascending royalty rate; and
· The use of excess cash for shareholder value-enhancing initiatives.
The following table provides information regarding the number of Partner Drive-Ins and Franchise Drive-Ins in operation as of the end of the years indicated as well as the system-wide growth in sales and average unit volume. System-wide information includes both Partner Drive-In and Franchise Drive-In information, which we believe is useful in analyzing the growth of the brand as well as the Company's revenues since franchisees pay royalties based on a percentage of sales.
System-Wide Performance
($ in thousands)
Year Ended August 31,
2009 2008 2007
Percentage increase in sales 0.7 % 5.6 % 8.6 %
System-wide drive-ins in operation (1):
Total at beginning of period 3,475 3,343 3,188
Opened 141 169 175
Closed (net of re-openings) (72 ) (37 ) (20 )
Total at end of period 3,544 3,475 3,343
Average sales per drive-in: $ 1,093 $ 1,125 $ 1,109
Change in same-store sales (2): (4.3 %) 0.9 % 3.1 %
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(1) Drive-ins that are temporarily closed for various reasons (repairs, remodeling, relocations, etc.) are not considered closed unless the Company determines that they are unlikely to reopen within a reasonable time.
(2) Represents percentage change for drive-ins open for a minimum of 15 months.
System-wide same-store sales decreased 4.3% during fiscal year 2009 primarily as a result of a decrease in the average check amount. The decrease in check is consistent with an industry trend of consumers purchasing fewer items per transaction and purchasing lower-priced items, such as items from our Everyday Value Menu. The Company has initiated strategies to offset this trend including offering a free upgrade to a 44 ounce drink with the purchase of a combo meal during the summer of 2009 and increasing the discount percentage when consumers purchase a combo meal versus the ala carte menu pricing.
During fiscal year 2009, our system-wide media expenditures were approximately $184 million as compared to $190 million in fiscal year 2008. Approximately one-half of our media dollars are spent on system-wide marketing fund efforts, which are largely used for network cable television advertising. Expenditures for national cable advertising increased from approximately $95 million in fiscal year 2008 to approximately $96 million in fiscal year 2009. Increased network cable advertising provides several benefits including the ability to more effectively target and better reach the cable audience, which surpasses broadcast networks in terms of viewers. In addition, national cable advertising allows us to bring additional depth to our media and expand our message beyond our traditional emphasis on a single monthly promotion. The balance of our system-wide media expenditures is focused on local store advertising. Looking forward, we expect system-wide media expenditures to exceed $178 million in fiscal 2010, with the system-wide marketing fund representing approximately one-half of total media expenditures.
The following table provides information regarding drive-in development across the system. Retrofits represent investments to upgrade the exterior look of our drive-ins, typically including an upgraded building exterior, new more energy-efficient lighting, a significantly enhanced patio area, and improved menu housings.
Year ended August 31,
2009 2008 2007
New drive-ins:
Partner 11 29 29
Franchise 130 140 146
System-wide 141 169 175
Rebuilds/relocations:
Partner 4 5 7
Franchise 46 64 35
System-wide 50 69 42
Retrofits, including rebuilds/relocations:
Partner 24 167 175
Franchise 383 800 316
System-wide 407 967 491
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Results of Operations
Revenues. The following table sets forth the components of revenue for the reported periods and the relative change between the comparable periods.
Revenues
($ in thousands)
Percent
Increase/ Increase/
Year Ended August 31, 2009 2008 (Decrease) (Decrease)
Revenues:
Partner Drive-In sales $ 567,436 $ 671,151 $ (103,715 ) (15.5 )%
Franchise revenues:
Franchise royalties 126,706 121,944 4,762 3.9
Franchise fees 5,006 5,167 (161 ) (3.1 )
Gain on sale of Partner Drive-Ins 13,154 3,044 10,110 332.1
Other 6,487 3,407 3,080 90.4
Total revenues $ 718,789 $ 804,713 $ (85,924 ) (10.7 )
Percent
Increase/ Increase/
Year Ended August 31, 2008 2007 (Decrease) (Decrease)
Revenues:
Partner Drive-In sales $ 671,151 $ 646,915 $ 24,236 3.8 %
Franchise revenues:
Franchise royalties 121,944 111,052 10,892 9.8
Franchise fees 5,167 4,574 593 13.0
Gain on sale of Partner Drive-Ins 3,044 732 2,312 315.8
Other 3,407 7,196 (3,789 ) (52.7 )
Total revenues $ 804,713 $ 770,469 $ 34,244 4.4
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The following table reflects the changes in Partner Drive-In sales and comparable drive-in sales. 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)
Year Ended August 31,
2009 2008 2007
Partner Drive-In sales $ 567,436 $ 671,151 $ 646,915
Percentage change (15.5 %) 3.8 % 10.4 %
Partner Drive-Ins in operation (1):
Total at beginning of period 684 654 623
Opened 11 29 29
Acquired from (sold to) franchisees, net (205 ) 6 5
Closed (15 ) (5 ) (3 )
Total at end of period 475 684 654
Average sales per Partner Drive-In $ 954 $ 1,007 $ 1,017
Percentage change (5.3 %) (1.0 %) 3.8 %
Change in same-store sales (2) (6.4 %) (1.6 %) 2.5 %
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(1) Drive-ins that are temporarily closed for various reasons (repairs, remodeling, relocations, etc.) are not considered closed unless the Company determines that they are unlikely to reopen within a reasonable time.
(2) Represents percentage change for drive-ins open for a minimum of 15 months.
For fiscal year 2009, the decrease in Partner Drive-In revenues was largely driven by the decline in same-store sales for existing drive-ins and the refranchising of 205 Partner Drive-Ins. As a result of the refranchising, Partner Drive-Ins now comprise 13% of the entire system compared to 20% in fiscal 2008.
During fiscal year 2009, same-store sales at Partner Drive-Ins declined 6.4%, as compared to the 4.3% decrease for the system. To counteract this decline, the Company implemented initiatives designed to provide a unique and high quality customer service experience with the goal of improving same-store sales. These initiatives include restructuring the Partner Drive-In organization, simplifying incentive compensation plans for store-level management, implementing a customer service satisfaction measurement tool, and implementing a more effective pricing tool at the drive-in level. These efforts are expected to have a positive impact on Partner Drive-In sales going forward.
During fiscal year 2008, Partner Drive-In sales increased 3.8%. The increase was comprised of sales from newly constructed drive-ins and acquired drive-ins, offset by the decrease in sales from lower same-store sales.
The following table reflects the growth in franchise income (franchise royalties and franchise fees) as well as franchise sales, average unit volumes and the number of Franchise Drive-Ins. While we do not record Franchise Drive-In sales as revenues, we believe this information is important in understanding our financial performance since these sales are the basis on which we calculate and record franchise royalties. This information is also indicative of the financial health of our franchisees.
Franchise Information
($ in thousands)
Year Ended August 31,
2009 2008 2007
Franchise fees and royalties (1) $ 131,712 $ 127,111 $ 115,626
Percentage increase 3.6 % 9.9 % 12.4 %
Franchise Drive-Ins in operation (2):
Total at beginning of period 2,791 2,689 2,565
Opened 130 140 146
Acquired from (sold to) Company, net 205 (6 ) (5 )
Closed (57 ) (32 ) (17 )
Total at end of period 3,069 2,791 2,689
Franchise Drive-In sales $ 3,269,930 $ 3,139,996 $ 2,961,168
Percentage increase 4.1 % 6.0 % 8.2 %
Effective royalty rate 3.87 % 3.88 % 3.75 %
Average sales per Franchise Drive-In $ 1,122 $ 1,154 $ 1,132
Change in same-store sales (3) (3.9 %) 1.4 % 3.3 %
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(1) See Revenue Recognition Related to Franchise Fees and Royalties in the Critical Accounting Policies and Estimates section of Management's Discussion and Analysis of Financial Condition and Results of Operations.
(2) Drive-ins that are temporarily closed for various reasons (repairs, remodeling, relocations, etc.) are not considered closed unless the Company determines that they are unlikely to reopen within a reasonable time.
(3) Represents percentage change for drive-ins open for a minimum of 15 months.
Franchise royalties experienced a 4.1% increase related primarily to royalties from new and refranchised drive-ins. This increase was offset by the impact of the decline in same-store sales at Franchise Drive-Ins.
Franchisees opened 130 new drive-ins in fiscal year 2009, down from 140 new drive-ins in fiscal year 2008. However, franchisee investment in existing drive-ins remained strong during fiscal year 2009, including the relocation or rebuild of 46 drive-ins (versus 64 in the prior year) and the retrofit of 337 drive-ins (versus 800 in fiscal year 2008). Franchise fees decreased 3.1% to $5.0 million as a result of fewer Franchise Drive-In openings, in addition to a decline in fees associated with the termination of area development agreements.
The Company recognized a $13.2 million gain from the refranchising of 205 Partner Drive-Ins during fiscal year 2009. We retained a minority ownership interest in the operations of 88 of the refranchised drive-ins.
Other income increased 90.4% to $6.5 million in fiscal year 2009 from $3.4 million in fiscal year 2008. The increase relates primarily from rental revenue on refranchised drive-ins in which the Company retained ownership of real estate.
Operating Expenses. The following table presents the overall costs of drive-in operations as a percentage of Partner Drive-In sales. Minority interest in earnings of Partner 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.
Restaurant-Level Margins
Percentage
points
Year ended August 31, Increase/
2009 2008 (Decrease)
Costs and expenses:
Partner Drive-Ins:
Food and packaging 27.6 % 26.5 % 1.1
Payroll and other employee benefits 32.2 31.1 1.1
Minority interest in earnings of Partner Drive-Ins 2.7 3.3 (0.6 )
Other operating expenses 22.1 20.9 1.2
84.6 % 81.8 % 2.8
Percentage
points
Year ended August 31, Increase/
2008 2007 (Decrease)
Costs and expenses:
Partner Drive-Ins:
Food and packaging 26.5 % 25.7 % 0.8
Payroll and other employee benefits 31.1 30.4 0.7
Minority interest in earnings of Partner Drive-Ins 3.3 4.1 (0.8 )
Other operating expenses 20.9 20.1 0.8
81.8 % 80.3 % 1.5
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Restaurant-level margins declined overall in fiscal year 2009 as a result of higher commodity prices, higher labor costs driven by minimum wage increases and the de-leveraging impact of lower same-store sales. These negative impacts were offset by the decline in minority partners' share of earnings reflecting the margin pressures described above. During the year, the pressure on commodity costs began to subside and turned favorable in the fourth quarter. Looking forward, the Company expects the commodity costs to be favorable in fiscal year 2010. However, the minimum wage increase that was effective in July 2009 will continue to pressure labor costs.
Selling, General and Administrative ("SG&A"). SG&A expenses increased 3.6% to $63.4 million during fiscal year 2009 and 4.2% to $61.2 million during fiscal year 2008 reflecting, in part, ongoing efforts to manage expenses with slowing revenue growth. Salary and health insurance increases were the primary contributor to the increase for fiscal year 2009. Stock-based compensation is included in SG&A, and, as of August 31, 2009, total remaining unrecognized compensation cost related to unvested stock-based arrangements was $12.2 million and is expected to be recognized over a weighted average period of 1.1 years. See Note 1 and Note 13 of the Notes to the Consolidated Financial Statements included in this Form 10-K for additional information regarding our stock-based compensation.
Depreciation and Amortization. Depreciation and amortization expense decreased 5.1% to $48.1 million in fiscal year 2009 primarily as a result of refranchising Partner Drive-Ins. Depreciation and amortization expense increased 12.3% to $50.7 million in fiscal year 2008 primarily as a result of additional capital expenditures for newly-constructed Partner Drive-Ins, the retrofit and relocation of existing Partner Drive-Ins and the acquisition of Franchise Drive-Ins. Capital expenditures during fiscal year 2009 were $36.1 million. For fiscal year 2010, capital expenditures are expected to be approximately $30 to $40 million.
Provision for Impairment of Long-Lived Assets. We assess drive-in assets for
impairment on a quarterly basis under the guidelines of SFAS 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets." Based on the Company's
analysis, we recorded a provision of $11.2 million in fiscal year 2009 to reduce
the carrying cost
of the related operating assets to an estimated fair value. This provision was attributable to the declining trend in Partner Drive-Ins sales and profits that occurred throughout fiscal year 2009. 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 could change in the 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 grow earnings.
Interest Expense and Other Expense, Net. Net interest expense decreased $5.9 million to $42.0 million in fiscal year 2009 and increased $3.5 million to $47.9 million in fiscal year 2008. The primary cause for the decrease in fiscal year 2009 is the $6.4 million gain from the early extinguishment of debt that resulted from purchasing $25.0 million of the Company's fixed rate notes at a discount. Excluding the gain, the decrease in net interest expense relates to the reduction in debt due to scheduled amortization payments on our fixed rate notes and a declining rate on our variable rate notes. The increase in fiscal year 2008 is the result of interest on increased borrowings primarily used to fund share repurchases earlier in the year and drive-in acquisitions from franchisees.
Income Taxes. The provision for income taxes decreased for fiscal year 2009 with an effective federal and state tax rate of 38.4% compared with 37.4% in fiscal year 2008 and 36.4% in fiscal year 2007. The higher rate in fiscal year 2009 related to an increase in the valuation allowance of state net operating losses offset by a reduction in the liability for unrecognized tax benefits. Our tax rate may continue to vary significantly from quarter to quarter depending on the timing of option exercises and dispositions by option-holders, changes to uncertain tax positions and as circumstances on individual tax matters change.
Financial Position
During fiscal year 2009, current assets increased 103.3% to $202.1 million compared to $99.4 million as of the end of fiscal year 2008. Cash balances increased by $93.3 million primarily as a result of refranchising Partner Drive-Ins and advances under the Company's variable funding notes. During fiscal year 2009, noncurrent assets decreased 12.2% to $646.9 million compared to $736.9 million as of the end of fiscal year 2008. The decrease was primarily the result of a $62.3 million reduction of net property and equipment and a decrease of $29.5 million in goodwill, resulting from depreciation and the refranchising of Partner Drive-Ins.
Total liabilities decreased $47.1 million or 5.2% during fiscal year 2009 compared to fiscal year 2008 primarily due to a $59.9 million decrease in long-term debt which resulted from payments on the Company's fixed rate notes.
Stockholders' deficit decreased $59.8 million or 93.3% during fiscal year 2009. Earnings of $49.4 million, along with $10.4 million for the combination of stock compensation and the proceeds and related tax decrement from the exercise of stock options, decreased the stockholders' deficit.
Liquidity and Sources of Capital
Operating Cash Flows. Net cash provided by operating was $88.7 million in fiscal year 2009 as compared to $127.1 million in fiscal year 2008. This decrease generally resulted from a decrease in operating results as reflected by the decrease in net income.
Investing Cash Flows. Net cash provided by investing activities was $51.5 million in fiscal year 2009 as compared to net cash used in investing activities of $107.1 million in fiscal year 2008. The purchase of property and equipment was more than offset by the proceeds from the disposition of Partner Drive-In
assets due to refranchising. During fiscal year 2009, we opened 11 newly constructed Partner Drive-Ins and sold 205 drive-ins to franchisees. The following table sets forth the components of our investments in capital additions for fiscal year 2009 (in millions): New Partner Drive-Ins, including drive-ins under construction $ 18.6 Retrofits, drive-thru additions and LED signs in existing drive-ins 5.5 Rebuilds, relocations and remodels of existing drive-ins 4.5 Replacement equipment for existing drive-ins and other 7.5 Total investing cash flows for capital additions $ 36.1 |
During fiscal year 2009, we purchased the real estate for nine of the 11 newly constructed drive-ins.
Financing Cash Flows. Net cash used in financing activities was $46.9 million in fiscal year 2009 as compared to $1.2 million in fiscal year 2008. The increase in cash used for financing activities in fiscal year 2009 primarily relates to the net repayment of long-term debt compared to net borrowings in fiscal year 2008. The Company has a securitized financing facility of Variable Funding Notes that provides for the issuance of up to $200.0 million in borrowings and certain other credit instruments, including letters of credit. As of August 31, 2009, our outstanding balance under the Variable Funding Notes totaled $187.3 million at an effective borrowing rate of 1.4%, as well as $0.3 million in outstanding letters of credit. During fiscal year 2009, upon request of the Company to draw down the remaining $12.3 million in Variable Funding Notes from one of the lenders, the lender, which had previously filed for Chapter 11 bankruptcy, notified the Company that it could not meet its obligation. The Company no longer considers the $12.3 million to be available.
Despite recent challenges with Partner Drive-In operations, operating cash flows remain healthy, and we believe that cash flows from operations, along with existing cash balances, will be adequate for mandatory repayment of any long-term debt and funding of planned capital expenditures in fiscal year 2010. See Note 10 of the Notes to Consolidated Financial Statements for additional information regarding our long-term debt.
Our variable and fixed rate notes are subject to a series of covenants and restrictions customary for transactions of this type, including (i) required . . .
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