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SONC > SEC Filings for SONC > Form 10-K on 26-Oct-2012All Recent SEC Filings

Show all filings for SONIC CORP

Form 10-K for SONIC CORP


26-Oct-2012

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, 2012, the Sonic system was comprised of 3,556 drive-ins, of which 12% were Company Drive-Ins and 88% 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 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 Company Drive-In expenses are directly affected by the number and sales volumes of Company Drive-Ins. Our revenues and, to a lesser extent, selling, general and administrative 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 the leasing of land and buildings for Company Drive-Ins that have been sold to franchisees.

Overview of Business Performance. Sales momentum for fiscal year 2012 continued to improve from fiscal year 2011. System-wide same-store sales increased 2.2% during fiscal year 2012 as compared to an increase of 0.5% for fiscal year 2011. Same-store sales at Company Drive-Ins increased by 2.8% during fiscal year 2012 as compared to an increase of 1.8% for 2011. We believe the initiatives we have implemented over the last few years, including product quality improvements, a greater emphasis on personalized service and a new creative strategy, have set a solid foundation for growth which is reflected in our operating results. We use a multi-layered growth strategy which incorporates sales growth, operating leverage, deployment of cash, an ascending royalty rate and new drive-in development to achieve earnings growth. Positive system-wide same-store sales is the most important layer and drives operating leverage and increased operating cash flows.

Revenues decreased slightly to $543.7 million for fiscal year 2012 from $546.0 million for the same period last year, which was primarily related to a decline in revenues resulting from the refranchising of 34 Company Drive-Ins during the second fiscal quarter of 2012, mostly offset by an increase in same-store sales. Restaurant margins at Company Drive-Ins improved by 80 basis points during fiscal year 2012, reflecting the leverage of positive same-store sales as well as moderating commodity cost inflation. Net income and diluted earnings per share for fiscal year 2012 were $36.1 million and $0.60, respectively, as compared to net income of $19.2 million or $0.31 per diluted share for fiscal year 2011. 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 relating to the favorable settlement of state tax matters, net income and diluted earnings per share for fiscal year 2012 increased 11% and 13%, respectively.

Franchisees opened 36 new drive-ins and relocated or rebuilt 17 existing drive-ins during the fiscal year. While the number of new drive-in openings in fiscal year 2012 was down compared to the prior year, investments by franchisees in existing locations continued throughout the year, as evidenced by an increase in Franchise Drive-Ins relocated or rebuilt. 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 revenue and margin performance of Company Drive-Ins with consistent and improved operations execution; and

Same-store sales growth fueled by re-emphasizing our core brand strengths, including high-quality products, the introduction of new limited-time products and service differentiation with 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


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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.

                                                    Fiscal Year Ended              Fiscal Year Ended
                                                     August  31, 2012               August  31, 2011
                                                    Net           Diluted          Net          Diluted
                                                  Income            EPS          Income           EPS
Reported - GAAP                                 $    36,085      $    0.60      $  19,225       $   0.31
After-tax net loss from early extinguishment
of debt                                                   -              -         14,439           0.24
Tax benefit from favorable tax settlement                 -              -         (1,073 )        (0.02 )

Adjusted - Non-GAAP                             $    36,085      $    0.60      $  32,591       $   0.53

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,
                                                2012            2011            2010

Percentage increase (decrease) in sales             2.7 %           1.9 %          (5.7 %)

System-wide drive-ins in operation(1):
Total at beginning of year                        3,561           3,572           3,544
Opened                                               37              43              85
Closed (net of re-openings)                         (42 )           (54 )           (57 )

Total at end of year                              3,556           3,561           3,572


Average sales per drive-in:                   $   1,066       $   1,037       $   1,023

Change in same-store sales(2):                      2.2 %           0.5 %          (7.8 %)

(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.


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

                                                   Year ended
                                                   August 31,
                                            2012      2011      2010
                    New drive-ins:
                    Company                     1         3         5
                    Franchise                  36        40        80
                    System-wide                37        43        85
                    Rebuilds/relocations:
                    Company                     1         3         -
                    Franchise                  17        11        23
                    System-wide                18        14        23

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,       2012            2011           (Decrease)           (Decrease)

 Revenues:
 Company Drive-In sales   $   404,443     $   410,820     $        (6,377 )        (1.6%)
 Franchise Drive-Ins:
 Franchise royalties          125,989         124,127               1,862           1.5
 Franchise fees                 2,024           1,744                 280           16.1
 Lease revenue                  6,575           6,023                 552           9.2
 Other                          4,699           3,237               1,462           45.2

 Total revenues           $   543,730     $   545,951     $        (2,221 )        (0.4%)


                                                                                  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%)


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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,
                                          2012              2011              2010

  Company Drive-In sales               $   404,443       $   410,820       $   414,369
  Percentage decrease                         (1.6 %)           (0.9 %)          (27.0 %)

  Company Drive-Ins in operation(1):
  Total at beginning of year                   446               455               475
  Opened                                         1                 3                 5
  Sold to franchisees, net                     (35 )              (5 )             (16 )
  Closed (net of re-openings)                   (3 )              (7 )              (9 )

  Total at end of year                         409               446               455


  Average sales per Company Drive-In   $       958       $       920       $       893
  Percentage increase (decrease)               4.1 %             3.0 %            (6.4 %)

  Change in same-store sales(2)                2.8 %             1.8 %            (8.8 %)

(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 2.8% for fiscal year 2012 and 1.8% for fiscal year 2011, an improving trend that we attribute to the initiatives we have implemented. In addition to the implementation of system-wide initiatives over the last few years, we have implemented a number of initiatives at Company Drive-Ins which have contributed to improved performance. These initiatives included restructuring 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. Company Drive-In sales decreased $6.4 million, or 1.6%, during fiscal year 2012 as compared to 2011. This decrease was primarily attributable to an $18.6 million reduction in sales from the refranchised drive-ins discussed earlier and a $2.3 million decrease related to drive-ins that were closed during or subsequent to fiscal year 2011 partially offset by a $11.0 million improvement in same-store sales and $3.5 million of incremental sales from new drive-in openings during fiscal year 2011.

For fiscal year 2011, Company Drive-In sales decreased $3.5 million, or 0.9%, as compared to 2010. This decrease was primarily attributable to a $7.2 million decrease in sales from 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. These decreases were partially offset by an $8.1 million increase from an improvement in same-store sales and, to a lesser extent, new drive-in openings during fiscal year 2011.

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,
                                                      2012               2011                2010

Franchising revenues(1)                           $    134,588       $    131,894        $    132,016
Percentage increase (decrease)                             2.0 %             (0.1 %)             (2.7 %)

Franchise Drive-Ins in operation(2):
Total at beginning of year                               3,115              3,117               3,069
Opened                                                      36                 40                  80
Acquired from Company, net                                  35                  5                  16
Closed (net of re-openings)                                (39 )              (47 )               (48 )

Total at end of year                                     3,147              3,115               3,117


Franchise Drive-In sales                          $  3,386,218       $  3,278,208        $  3,205,507
Percentage change                                          3.3 %              2.3 %              (2.0 %)

Effective royalty rate                                    3.72 %             3.79 %              3.82 %

Average sales per Franchise Drive-In              $      1,081       $      1,054        $      1,043

Change in same-store sales(3)                              2.2 %              0.4 %              (7.6 %)

(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 Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in this Form 10-K.

(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 2.2% for fiscal year 2012 and 0.4% for fiscal year 2011, an improving trend that we attribute to the initiatives we have implemented. Franchising revenues increased $2.7 million, or 2.0%, for fiscal year 2012 as compared to 2011. The increase in franchising revenues was primarily driven by a $1.9 million increase in franchise royalties. Same-store sales increases combined with incremental royalties from newly constructed and refranchised drive-ins resulted in an increase in royalties of $3.2 million, which was partially offset by a $1.3 million decrease from a lower effective royalty rate. The lower effective royalty rate is due to a temporary reduction in royalty rates from various development incentives and certain franchisee restructuring efforts. Franchisees opened 36 new drive-ins during fiscal year 2012 compared to 40 in the prior year. Franchisee investment in existing drive-ins continued during fiscal year 2012 and included the relocation or rebuilding of 17 drive-ins versus 11 in the prior year.

Franchising revenues were relatively flat in fiscal year 2011 decreasing by $0.1 million, or 0.1%, to $131.9 million as compared to $132.0 million for fiscal year 2010. Franchise royalties increased $1.7 million for fiscal year 2011, which was comprised of a $2.0 million increase from same-store sales and incremental royalties from newly constructed and refranchised drive-ins, partially offset by a $0.3 million decrease from a lower effective royalty rate. 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 weaker overall business environment. Franchisees opened 40 new drive-ins during fiscal year 2011, down from 80 in 2010.

Other revenues increased $1.5 million to $4.7 million in fiscal year 2012 and decreased $1.3 million to $3.2 million in fiscal year 2011 as compared to prior years, primarily due to changes in income from investments in franchise operations.

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.


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                            Company Drive-In Margins



                                                            Year ended
                                                            August 31,                    Percentage points
                                                      2012               2011                (Decrease)

Costs and expenses(1):
Company Drive-Ins:
Food and packaging                                   28.1%              28.1%                     -
Payroll and other employee benefits(2)               35.7               36.4                    (0.7)
Other operating expenses                             22.1               22.2                    (0.1)

Cost of sales                                        85.9%              86.7%                   (0.8)



                                                            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(2)               36.4               35.2                     1.2
Other operating expenses                             22.2               22.8                    (0.6)

Cost of sales                                        86.7%              85.6%                    1.1

Noncontrolling interests(2)                            -                 1.1%                   (1.1)

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

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

(2) Effective April 1, 2010, we revised our compensation program at the Company Drive-In level. As a result of these changes, noncontrolling interests are immaterial for fiscal years 2012 and 2011 and have been included in payroll and other employee benefits. We have included noncontrolling interests for fiscal year 2010 in the table for comparative purposes because we believe it is helpful in understanding the impact our new compensation program had on Company Drive-In margins.

Restaurant-level margins improved by 80 basis points during fiscal year 2012 reflecting leverage from improved same-store sales and, to a lesser extent, the refranchising of 34 lower performing Company Drive-Ins during the second quarter of fiscal year 2012. Food and packaging costs remained flat during fiscal year 2012, which was a combination of moderating commodity cost inflation during the latter half of the year, effective inventory management, and moderate price increases taken over the preceding twelve months. Payroll and other employee benefits as well as other operating expenses improved by a combined 80 basis points primarily as a result of leveraging labor with improved sales.

Restaurant-level margins remained flat in fiscal year 2011 as compared to 2010. 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. Other operating expenses decreased, as a percentage of sales, attributable to leverage from positive same-store sales.

Selling, General and Administrative ("SG&A"). SG&A expenses remained relatively flat for fiscal year 2012 as compared to the prior year, increasing by 0.4% to $65.2 million, and decreased 2.8% to $64.9 million during fiscal year 2011 as compared to fiscal 2010. The decrease in SG&A expense for 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 declines in bad debt expense due to an improvement in sales trends.


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Depreciation and Amortization. Depreciation and amortization expense increased 1.7% to $41.9 million in fiscal year 2012 and decreased 3.3% to $41.2 million in fiscal year 2011. Of the $0.7 million increase in fiscal year 2012, approximately $0.4 million was attributable to the amortization of intellectual property acquired during the second quarter of fiscal year 2012 relating to a point-of-sale system that is used by a majority of the Sonic system. 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, the refranchising of 16 Company Drive-Ins in fiscal year 2010.

Provision for Impairment of Long-Lived Assets. Provision for impairment of long-lived assets remained steady at $0.8 million for fiscal years 2012 and 2011 and decreased $14.3 million in fiscal year 2011 from 2010. This decrease was primarily the result of the $15.2 million non-cash impairment of long-lived assets recorded in fiscal year 2010 to reduce the carrying cost of the related operating assets to an estimated fair value. This provision primarily related to lower sales and profits for Company Drive-Ins resulting from the sustained economic downturn and weak results during fiscal 2010 for operating stores. Assets impaired included operating drive-ins, property leased to franchisees, surplus property and other assets.

Net Interest Expense. Net interest expense decreased in fiscal year 2012 as compared to the same period last year primarily as a result of a $28.2 million loss from the early extinguishment of debt related to the refinancing of our debt in May 2011. In addition, net interest expense for fiscal year 2011 included a $5.2 million gain from the early extinguishment of debt in the second quarter of fiscal year 2011, and net interest expense for fiscal year 2010 included a $0.3 million loss from the early extinguishment of debt during the third quarter of fiscal year 2010. Excluding the early extinguishments of debt, net interest expense decreased $0.9 million in fiscal year 2012 and $3.9 million in fiscal year 2011, primarily related to a decline in debt partially offset by a higher weighted average interest rate. See "Liquidity and Sources of Capital" and "Item 7A. Quantitative and Qualitative Disclosures About Market Risk" below for additional information on factors that could impact interest expense.

Income Taxes. The provision for income taxes reflects an effective tax rate of 37.7% for fiscal year 2012 compared with 32.3% for fiscal year 2011. The higher effective income tax rate for fiscal year 2012 was primarily attributable to a $1.1 million favorable settlement of state tax audits during the first quarter of fiscal year 2011 and the expiration of tax credit programs during the second quarter of fiscal year 2012. The provision for income taxes, excluding income attributable to noncontrolling interests, reflects an effective tax rate of 29.7% for fiscal year 2010. The increase in the tax rate for fiscal year 2011 as compared to 2010 was primarily attributable to a $1.8 million tax benefit associated with the stock option exchange program that was implemented during the third quarter of fiscal year 2010, partially offset by the $1.1 million favorable state tax settlement during 2011 discussed earlier. Our tax rate may continue to vary significantly from quarter to quarter depending on the timing of stock option exercises and dispositions by option-holders, changes in tax credit legislation, changes to uncertain tax positions, and as circumstances on other tax matters change.

Net Income - Noncontrolling Interests. As a result of the change to a new . . .

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