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SONC > SEC Filings for SONC > Form 10-K on 28-Oct-2011All Recent SEC Filings

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Form 10-K for SONIC CORP


28-Oct-2011

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

Description of the Business. Sonic operates and franchises the largest chain of drive-in restaurants in the United States. As of August 31, 2011, the Sonic system was comprised of 3,561 drive-ins, of which 13% were Company Drive-Ins and 87% were Franchise Drive-Ins. Sonic Drive-Ins feature signature menu items such as specialty drinks including cherry limeades and slushes, ice cream desserts, made-to-order sandwiches and hamburgers, six-inch premium beef hot dogs, footlong quarter pound chili cheese coneys, hand-battered onion rings, tater tots, and a unique breakfast menu. We derive our revenues primarily from Company Drive-In sales and royalties from franchisees. We also receive revenues from leasing real estate to franchisees, initial franchise fees, earnings from minority investments in franchise operations and other miscellaneous revenues.

Costs of Company Drive-In sales relate directly to Company Drive-In sales. Other expenses, such as depreciation, amortization, and general and administrative expenses, relate to our franchising operations, as well as Company Drive-In operations. Our revenues and expenses are directly affected by the number and sales volumes of Company 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. Lease revenues are generated by leasing of land and buildings for Company Drive-Ins that have been sold to franchisees.

Overview of Business Performance.Sales momentum for fiscal year 2011 showed improvement, highlighted by positive same-store sales, particularly during the third fiscal quarter. System-wide same-store sales increased 0.5% during fiscal year 2011 as compared to a decline of 7.8% for fiscal year 2010. Same-store sales at Company Drive-Ins increased by 1.8% during fiscal year 2011 as compared to a decline of 8.8% for fiscal year 2010. We believe these results reflect the positive impact of the initiatives implemented in fiscal year 2010, including product quality improvements made over the past two years and a greater emphasis on personalized service with skating carhops. We also believe these results reflect a slightly improving economy. Positive system-wide same-store sales drive other aspects of our multi-layered growth strategy, such as our ascending royalty rate and increased operating cash flows. Net income and diluted earnings per share for fiscal year 2011 were $19.2 million and $0.31, respectively, as compared to net income of $21.2 million or $0.34 per diluted share for fiscal year 2010. Excluding an after-tax net loss of $14.4 million from the early extinguishment of debt during fiscal year 2011 and a $1.1 million tax benefit recognized during the first quarter of fiscal year 2011, net income and diluted earnings per share for fiscal year 2011 were $32.6 million and $0.53, respectively.

Franchisees opened 40 new drive-ins and relocated or rebuilt 11 existing drive-ins during the fiscal year. While the number of new drive-in openings in fiscal year 2011 was down compared to the prior year, investments by franchisees in new and existing locations continued throughout the year. We also continued our expansion in several new markets.

The growth and success of our business is built around implementation of our brand strategy, which features the following components:

Improved performance of Company Drive-Ins, including consistent and improved operations execution, improved speed of service, cleanliness of drive-ins, and focus on the customer experience; and

Same-store sales growth fueled by re-emphasizing our core brand strengths, including high-quality products, new products and service differentiation with skating carhops.

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


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                                                   Fiscal Year Ended              Fiscal Year Ended
                                                    August  31, 2011               August  31, 2010
                                                   Net          Diluted           Net          Diluted
                                                 Income           EPS           Income           EPS
Reported - GAAP                                 $  19,225       $   0.31       $  21,209       $   0.34
After-tax net loss from early extinguishment
of debt                                            14,439           0.24             202             --
Tax benefit from favorable tax settlement          (1,073 )        (0.02 )            --             --
Refranchising loss                                     --             --             492           0.01
Impairment provision                                   --             --           9,776           0.16
Tax benefit of stock option exchange program           --             --          (1,751 )        (0.03 )

Adjusted - Non-GAAP                             $  32,591       $   0.53       $  29,928       $   0.48

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

                            System-Wide Performance

                                ($ in thousands)



                                                                  Year Ended August 31,
                                                    2011              2010              2009

Percentage increase (decrease) in sales                 1.9 %            (5.7 %)            0.7 %

System-wide drive-ins in operation (1):
Total at beginning of period                          3,572             3,544             3,475
Opened                                                   43                85               141
Closed (net of re-openings)                             (54 )             (57 )             (72 )

Total at end of period                                3,561             3,572             3,544


Average sales per drive-in:                       $   1,037         $   1,023         $   1,093

Change in same-store sales (2):                         0.5 %            (7.8 %)           (4.3 %)

(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 continued to improve during fiscal year 2011 which we believe is largely attributable to the ongoing positive impact of our strategic initiatives as well as a slightly improving economy. We implemented a number of initiatives throughout fiscal year 2010 designed to provide a unique and high quality customer service experience with the goal of improving same-store sales by driving both traffic and average check. These initiatives include focusing on customer service and improving the quality of our differentiated food and drink products. System-wide same-store sales increased 0.5% during fiscal year 2011, an improving trend as compared to a decrease of 7.8% for fiscal year 2010.

During fiscal year 2011, our system-wide media expenditures were approximately $170 million as compared to $167 million in fiscal year 2010. We use varying forms of local advertising mediums, such as television, outdoor billboards, radio, online and print to optimize media impressions in drive-in trade areas. We also continue to invest in system-wide marketing fund efforts, which are largely used for national cable television advertising. Expenditures for national media advertising represented 32% of system-wide media expenditures during fiscal year 2011, down from 43% in 2010. For fiscal year 2012, we expect system-wide media expenditures to be approximately $170 million to $175 million with expenditures for national media advertising representing approximately 45% of that amount.


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The following table provides information regarding drive-in development across the system.

                                          000000       000000       000000
                                                    Year ended
                                                    August 31,
                                          2011         2010         2009
                New drive-ins:
                Company                        3            5           11
                Franchise                     40           80          130
                System-wide                   43           85          141
                Rebuilds/relocations:
                Company                        3            -            4
                Franchise                     11           23           46
                System-wide                   14           23           50

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,                 2011              2010              (Decrease)              (Decrease)

Revenues:
Company Drive-In sales             $   410,820       $   414,369       $         (3,549 )                  (0.9 %)
Franchise Drive-Ins:
Franchise royalties                    124,127           122,385                  1,742                     1.4
Franchise fees                           1,744             2,752                 (1,008 )                 (36.6 )
Lease revenue                            6,023             6,879                   (856 )                 (12.4 )
Other                                    3,237             4,541                 (1,304 )                 (28.7 )

Total revenues                     $   545,951       $   550,926       $         (4,975 )                  (0.9 %)


                                                                                                   Percent
                                                                           Increase                Increase
Year Ended August 31,                 2010              2009              (Decrease)              (Decrease)

Revenues:
Company Drive-In sales             $   414,369       $   567,436       $       (153,067 )                 (27.0 %)
Franchise Drive-Ins:
Franchise royalties                    122,385           126,706                 (4,321 )                  (3.4 )
Franchise fees                           2,752             5,006                 (2,254 )                 (45.0 )
Lease revenue                            6,879             3,985                  2,894                    72.6
Other                                    4,541             3,148                  1,393                    44.3

Total revenues                     $   550,926       $   706,281       $       (155,355 )                 (22.0 %)


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

                             Company Drive-In Sales

                                ($ in thousands)



                                                             Year Ended August 31,
                                                2011                  2010                2009

Company Drive-In sales                       $   410,820           $   414,369         $   567,436
Percentage (decrease)                               (0.9 %)              (27.0 %)            (15.5 %)

Company Drive-Ins in operation(1):
Total at beginning of period                         455                   475                 684
Opened                                                 3                     5                  11
Acquired from (sold to) franchisees, net              (5 )                 (16 )              (205 )
Closed (net of re-openings)                           (7 )                  (9 )               (15 )

Total at end of period                               446                   455                 475


Average sales per Company Drive-In           $       920           $       893         $       954
Percentage increase (decrease)                       3.0 %                (6.4 %)             (5.3 %)

Change in same-store sales(2)                        1.8 %                (8.8 %)             (6.4 %)

(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.

Same-store sales for Company Drive-Ins increased 1.8% for fiscal year 2011, as compared to a decline of 8.8% for fiscal year 2010, which represents an improving trend that we attribute to the initiatives we have implemented and a slightly improving economy. In addition to the implementation of system-wide initiatives in fiscal year 2010, we have implemented a number of initiatives at Company Drive-Ins which have contributed to their improved performance. These initiatives included restructuring management of our Company Drive-In operations to reduce excess management layers, revising the compensation program at the drive-in level, and implementing a customer service initiative to improve sales and profits. These efforts were focused on narrowing the average unit volume gap with Franchise Drive-Ins and improving restaurant-level margins. Company Drive-In sales decreased $3.5 million, or 0.9%, during fiscal year 2011 as compared 2010. An improvement in same-store sales and, to a lesser extent, new drive-in openings during fiscal year 2011 resulted in an $8.1 million increase in sales which was more than offset by a $7.2 million decrease in sales caused by the refranchising of 16 Company Drive-Ins in the second quarter of fiscal year 2010 and six drive-ins in fiscal year 2011 as well as a $4.4 million decrease related to drive-ins that were closed during or subsequent to fiscal year 2010.

For fiscal year 2010, Company Drive-In sales decreased $153.1 million, which was largely driven by 245 drive-ins that were refranchised or closed since the beginning of fiscal year 2009 and the decline in same-store sales for existing drive-ins. Of the $153.1 million decrease, $121.3 million related to drive-ins that were refranchised or closed and $36.7 million related to same-store sales decreases for existing drive-ins driven by the impact of severe winter weather as well as a reduction of consumer spending at restaurants. These decreases were partially offset by a $4.9 million increase in sales from drive-ins opened during the period.

The following table reflects the change in franchising revenues (franchise royalties, franchise fees and lease revenues) 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.


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                             Franchise Information

                                ($ in thousands)



                                                               Year Ended August 31,
                                                     2011               2010               2009

Franchising revenues(1)                          $    131,894       $    132,016       $    135,697
Percentage increase (decrease)                           (0.1 %)            (2.7 %)             5.5 %

Franchise Drive-Ins in operation(2):
Total at beginning of period                            3,117              3,069              2,791
Opened                                                     40                 80                130
Acquired from (sold to) Company, net                        5                 16                205
Closed (net of re-openings)                               (47 )              (48 )              (57 )

Total at end of period                                  3,115              3,117              3,069


Franchise Drive-In sales                         $  3,278,208       $  3,205,507       $  3,269,930
Percentage change                                         2.3 %             (2.0 %)             4.1 %

Effective royalty rate                                   3.79 %             3.82 %             3.87 %

Average sales per Franchise Drive-In             $      1,054       $      1,043       $      1,122

Change in same-store sales(3)                             0.4 %             (7.6 %)            (3.9 %)

(1) Consists of revenues derived from franchising activities, including royalties, franchise fees and lease revenues. See Revenue Recognition Related to Franchise Fees and Royalties in the Critical Accounting Policies and Estimates section of 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.

Same-store sales for Franchise Drive-Ins increased 0.4% for fiscal year 2011 as compared to a decline of 7.6% for the same period last year, which represents an improving trend that we attribute to the initiatives we have implemented and a slightly improving economy.

Franchise royalties increased $1.7 million for fiscal year 2011, which was primarily driven by an increase in same-store sales combined with incremental royalties from newly constructed and refranchised drive-ins. The lower effective royalty rate for fiscal year 2011 was attributable to various royalty incentive programs. Franchise royalties declined $4.3 million or 3.4% in fiscal year 2010 as compared to fiscal year 2009. Same-store sales decreases combined with a lower effective royalty rate in 2010 resulted in a decrease in royalties of $11.5 million, which was partially offset by $7.2 million in incremental royalties from newly constructed and refranchised drive-ins.

Franchise fees declined $1.0 million to $1.7 million in fiscal year 2011, which was primarily related to franchisees opening fewer drive-ins during the year as a result of the prior softer sales environment. Franchisees opened 40 new drive-ins during fiscal year 2011, down from 80 in the prior year. Franchisee investment in existing drive-ins continued during fiscal year 2011, and included the relocation or rebuild of 11 drive-ins (versus 23 in the prior year). Franchise fees declined $2.3 million to $2.8 million in fiscal year 2010 as franchisees opened 80 new drive-ins, down from 130 new drive-ins in fiscal year 2009. The decrease is primarily comprised of $1.8 million attributable to fewer new drive-in openings in fiscal 2010, as well as $0.7 million in reduced fees associated with incentives for the development of new Sonic Drive-Ins.

Other income decreased $1.3 million, or 28.7%, to $3.2 million in fiscal year 2011 from $4.5 million in fiscal year 2010 primarily due to a decrease in minority income from investments in franchise operations.


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Operating Expenses. The following table presents the overall costs of drive-in operations as a percentage of Company Drive-In sales. Other operating expenses include direct operating costs such as marketing, telephone and utilities, repair and maintenance, rent, property tax and other controllable expenses. Noncontrolling interests of Company Drive-Ins are no longer included as part of cost of sales in the Consolidated Statements of Income. We have included noncontrolling interests for comparative purposes in the table below because we believe it is helpful in understanding the impact our new compensation program, which was implemented in the third quarter of fiscal year 2010, had on Company Drive-In margins.

                            Company Drive-In Margins




                                               Year ended                         Percentage points
                                               August 31,                             Increase
                                        2011                 2010                    (Decrease)

Costs and expenses(1):
Company Drive-Ins:
Food and packaging                     28.1%                27.6%                        0.5
Payroll and other employee
benefits                               36.1                 35.2                         0.9
Other operating expenses               22.3                 22.8                        (0.5)

Cost of sales, as reported             86.5%                85.6%                        0.9

Noncontrolling interests                0.2%                 1.1%                       (0.9)

Pro forma cost of sales,
including noncontrolling
interests                              86.7%                86.7%                         -



                                               Year ended                         Percentage points
                                               August 31,                             Increase
                                        2010                 2009                    (Decrease)

Costs and expenses(1):
Company Drive-Ins:
Food and packaging                     27.6%                27.6%                        0.0
Payroll and other employee
benefits                               35.2                 32.9                         2.3
Other operating expenses               22.8                 21.4                         1.4

Cost of sales, as reported             85.6%                81.9%                        3.7

Noncontrolling interests                1.1%                 2.7%                       (1.6)

Pro forma cost of sales,
including noncontrolling
interests                              86.7%                84.6%                        2.1

(1) Calculated as a percentage of Company Drive-In Sales.

Operating costs for Company Drive-Ins remained flat in fiscal year 2011 as compared to the same period last year. Food and packaging cost increases during fiscal year 2011 were driven by investments in product quality improvements and higher commodity costs. Payroll and other employee benefit costs increased as a result of increased compensation costs associated with our new compensation program at the Company Drive-In level which was effective April 1, 2010. As a result of our new compensation program introduced as an alternative to our traditional ownership program, compensation costs that were formerly reflected as noncontrolling interests are now included in payroll and other employee benefits. The new compensation program provides managers and supervisors a larger portion of guaranteed base compensation but retains a significant incentive component based on drive-in level performance. Other operating expenses decreased, as a percentage of sales, attributable to leverage from positive same-store sales. The increase in operating costs in fiscal year 2010 as compared to fiscal year 2009 was a result of high labor costs driven by minimum wage increases and the de-leveraging impact of lower same-store sales.

Selling, General and Administrative ("SG&A").SG&A expenses decreased 2.8% to $64.9 million during fiscal year 2011 and increased 5.5% to $66.8 million during fiscal year 2010. The decrease in SG&A expense for


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fiscal year 2011 was largely attributable to a decline in stock compensation expense resulting from a revision in our long-term compensation strategy as well as to declines in bad debt expense, which was primarily related to our provision for bad debt in the prior year and which has moderated in fiscal year 2011 due to an improvement in sales trends. The increase in SG&A expense for fiscal year 2010 was primarily attributable to $2.9 million in provision for bad debt expenses, as well as professional fees associated with financial restructuring services for franchisees.

Depreciation and Amortization. Depreciation and amortization expense decreased 3.3% to $41.2 million in fiscal year 2011 and decreased 11.3% to $42.6 million in fiscal year 2010. The decrease in depreciation and amortization expense for fiscal year 2011 was primarily attributable to the provision for impairment of long-lived assets recorded in the fourth quarter of fiscal 2010 and, to a lesser extent, a result of refranchising 16 Company Drive-Ins in fiscal year 2010. The decrease in depreciation and amortization expense for fiscal year 2010 was largely attributable to the refranchising of 205 Company Drive-Ins in fiscal year 2009. Capital expenditures during fiscal year 2011 were $21.2 million. For fiscal year 2012, capital expenditures are expected to be approximately $25 to $30 million.

Provision for Impairment of Long-Lived Assets. Provision for impairment of long-lived assets decreased $14.3 million for fiscal year 2011. This decrease was primarily the result of the $15.2 million non-cash impairment of long-lived assets we recorded in fiscal year 2010, to reduce the carrying cost of the related operating assets to an estimated fair value. The provision for impairment increase from $11.2 million in fiscal year 2009 to $15.2 million in fiscal year 2010 primarily related to lower sales and profits for Company Drive-Ins resulting from the sustained economic downturn and weak results during the summer months for operating stores. Assets impaired included operating drive-ins, property leased to franchisees, surplus property and other assets.

The decision whether to close or continue to operate a drive-in is made . . .

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