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SONC > SEC Filings for SONC > Form 10-K on 25-Oct-2013All Recent SEC Filings

Show all filings for SONIC CORP

Form 10-K for SONIC CORP


25-Oct-2013

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, 2013, the Sonic system was comprised of 3,522 drive-ins, of which 11% were Company Drive-Ins and 89% were Franchise Drive-Ins. Sonic's signature food items include specialty drinks (such as cherry limeades and slushes), ice cream desserts, made-to-order sandwiches and hamburgers, a variety of hot dogs including six-inch premium beef hot dogs and footlong quarter pound coneys, hand-battered onion rings, tater tots and wraps. Sonic Drive-Ins also offer breakfast items that include a variety of breakfast burritos and serve the full menu all day. We derive our revenues primarily from Company Drive-In sales and royalties from franchisees. We also receive revenues from leasing real estate to franchisees, 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. Franchise royalties and franchise fees are directly affected by the number of operating Franchise Drive-Ins and new 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. System-wide same-store sales increased 2.3% during fiscal year 2013 as compared to an increase of 2.2% for fiscal year 2012. Same-store sales at Company Drive-Ins increased by 2.5% during fiscal year 2013 as compared to an increase of 2.8% for 2012. We believe the successful implementation of initiatives, including product quality improvements, a greater emphasis on personalized service and a tiered pricing strategy, have set a solid foundation for growth which is reflected in our operating results. We continue to focus on our innovative product pipeline, and our recent shift to a higher proportion of national media expenditures is supporting our day-part promotional strategy to drive same-store sales. To achieve earnings per share growth, we utilize a multi-layered growth strategy which incorporates same-store sales growth, operating leverage, new drive-in development, an ascending royalty rate and deployment of cash. Positive same-store sales is the most important layer and drives operating leverage and increased operating cash flows.

Revenues decreased slightly to $542.6 million for fiscal year 2013 from $543.7 million for the same period last year, which was primarily related to a $2.1 million decline in Company Drive-Ins sales resulting from the refranchising of 34 lower-performing Company Drive-Ins during the second fiscal quarter of 2012, offset by an increase in same-store sales. Franchising revenues increased $0.9 million during fiscal year 2013 reflecting an increase in royalties primarily related to positive same-store sales of 2.3% at Franchise Drive-Ins, the refranchising of the 34 drive-ins mentioned above, partially offset by the decline in lease revenues resulting from the transaction during the second quarter of fiscal year 2013, in which a franchisee purchased land and buildings leased or subleased from us relating to previously refranchised drive-ins. Restaurant margins at Company Drive-Ins improved by 60 basis points during fiscal year 2013, reflecting the leverage of positive same-store sales and, to a lesser extent, the refranchising of the 34 Company Drive-Ins mentioned above.

Net income and diluted earnings per share for fiscal year 2013 were $36.7 million and $0.64, respectively, as compared to net income of $36.1 million or $0.60 per diluted share for fiscal year 2012. Excluding various non­GAAP adjustments further described below, net income per diluted share was $0.72 for fiscal year 2013.

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, 2013          August 31, 2012
                                                  Net       Diluted        Net        Diluted
                                                 Income       EPS        Income         EPS
Reported - GAAP                                 $ 36,701    $  0.64     $  36,085     $  0.60
After-tax loss from early extinguishment of
debt(1)                                            2,798       0.05              -           -
Retroactive tax benefit of WOTC and
resolution of tax matters(2)                        (743)     (0.02)             -           -
After-tax loss on closure of Company
Drive-Ins(3)                                       1,510       0.03              -           -
After-tax impairment charge for
point-of-sale assets(4)                            1,013       0.02              -           -
Adjusted - Non-GAAP                             $ 41,279    $  0.72     $  36,085     $  0.60
---------

(1) Loss on early extinguishment of debt including $0.5 million and $3.9 million in the second and fourth quarters of fiscal year 2013, respectively.

(2) Tax benefit which includes the retroactive reinstatement of the Work Opportunity Tax Credit ("WOTC") and resolution of certain income tax matters during the second quarter of fiscal year 2013.

(3) Loss of $2.4 million on the closure of 12 lower-performing Company Drive-Ins as a result of an assessment in advance of capital expenditures for pending technology initiatives.

(4) Impairment charge of $1.6 million related to the write-off of assets associated with a change in the vendor for the Sonic system's new point-of-sale technology.

                                                  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(1)                                               -           -      14,439       0.24
Tax benefit from favorable tax settlement(2)             -           -      (1,073)     (0.02)
Adjusted - Non-GAAP                             $  36,085     $  0.60     $ 32,591    $  0.53
---------

(1) Net loss on early extinguishment of debt including a $5.2 million gain and a $28.2 million loss in the second and third quarters of fiscal year 2011, respectively.

(2) Tax benefit recognized during the first quarter of fiscal year 2011 relating to the favorable settlement of state tax audits.

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.


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                           System-wide Performance
                              ($ in thousands)

                                                Year ended August 31,
                                            2013         2012         2011
Increase in total sales                      2.4  %       2.7  %       1.9  %

System-wide drive-ins in operation(1):
Total at beginning of year                 3,556        3,561        3,572
Opened                                        27           37           43
Closed (net of re-openings)                  (61)         (42)         (54)
Total at end of year                       3,522        3,556        3,561

Average sales per drive-in               $ 1,109      $ 1,066      $ 1,037

Change in same-store sales(2)                2.3  %       2.2  %       0.5  %
---------

(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.

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
                            Year ended August 31,        Increase      Increase
                             2013            2012       (Decrease)    (Decrease)
Revenues:
Company Drive-In sales    $   402,296     $ 404,443     $   (2,147)        (0.5) %
Franchise Drive-Ins:
Franchise royalties           130,009       125,989          4,020          3.2
Franchise fees                    728         2,024         (1,296)       (64.0)
Lease revenue                   4,785         6,575         (1,790)       (27.2)
Other                           4,767         4,699             68          1.4
Total revenues            $   542,585     $ 543,730     $   (1,145)        (0.2) %

                                                                       Percent
                             Year ended August 31,       Increase      Increase
                               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) %


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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,
                                              2013            2012           2011
Company Drive-In sales                     $ 402,296      $ 404,443      $ 410,820
Percentage decrease                             (0.5) %        (1.6) %        (0.9) %

Company Drive-Ins in operation(1):
Total at beginning of year                       409            446            455
Opened                                             2              1              3
Acquired from (sold to) franchisees, net           1            (35)            (5)
Closed (net of re-openings)                      (16)            (3)            (7)
Total at end of year                             396            409            446

Average sales per Company Drive-In         $     990      $     958      $     920

Change in same-store sales(2)                    2.5  %         2.8  %         1.8  %
---------

(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 2.5% for fiscal year 2013 and 2.8% for fiscal year 2012, showing continued momentum from the Company's successful implementation of initiatives to improve product quality, service and value perception. Furthermore, we continued to focus on our innovative product pipeline and increased media effectiveness. Company Drive-In sales decreased $2.1 million, or 0.5%, during fiscal year 2013 as compared to 2012. This decrease was primarily attributable to an $11.3 million reduction in sales from the refranchising of 34 lower-performing drive-ins during the second quarter of fiscal year 2012 and a $2.5 million decrease related to drive-ins that were closed during or subsequent to fiscal year 2012, partially offset by a $10.0 million improvement in same-store sales and $1.7 million of incremental sales from new drive-in openings.

For fiscal year 2012, Company Drive-In sales decreased $6.4 million, or 1.6%, 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 an $11.0 million improvement in same-store sales and $3.5 million of incremental sales from new drive-in openings.


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The following table reflects the change in franchise sales, the number of Franchise Drive-Ins, average unit volumes and franchising revenues. 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,
                                                2013             2012             2011
Franchise Drive-In sales                   $ 3,479,880      $ 3,386,218      $ 3,278,208
Percentage increase                                2.8  %           3.3  %           2.3  %

Franchise Drive-Ins in operation(1):
Total at beginning of year                       3,147            3,115            3,117
Opened                                              25               36               40
Acquired from (sold to) the Company, net            (1)              35                5
Closed (net of re-openings)                        (45)             (39)             (47)
Total at end of year                             3,126            3,147            3,115

Average sales per Franchise Drive-In       $     1,125      $     1,081      $     1,054

Change in same-store sales(2)                      2.3  %           2.2  %           0.4  %

Franchising revenues(3)                    $   135,522      $   134,588      $   131,894
Percentage increase (decrease)                     0.7  %           2.0  %          (0.1) %

Effective royalty rate(4)                         3.74  %          3.72  %          3.79  %
---------

(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.

(3) 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.

(4) Represents franchise royalties as a percentage of Franchise Drive-In sales.

Same-store sales for Franchise Drive-Ins increased 2.3% for fiscal year 2013 and 2.2% for fiscal year 2012, showing continued momentum from the initiatives we have implemented to improve product quality, service and value perception. Furthermore, we continued to focus on our innovative product pipeline and increased media effectiveness. Franchising revenues increased $0.9 million, or 0.7%, for fiscal year 2013 as compared to 2012. The increase in franchising revenues was primarily driven by a $4.0 million increase in franchise royalties partially offset by a $1.8 million decline in lease revenue and a $1.3 million decline in franchise fees. The increase in franchise royalties is primarily attributable to a 2.3% increase in same-store sales, partially offset by various development incentives and certain franchisee restructuring efforts. In addition, approximately $0.4 million of the increase in royalties during fiscal year 2013 was attributable to incremental royalties from the 34 drive-ins refranchised in the second quarter of fiscal year 2012. Lease revenues decreased compared to the prior year resulting from a franchisee's purchase of land and buildings leased or subleased from the Company relating to previous refranchised drive-ins. The effective royalty rate increased slightly compared to fiscal year 2012 primarily as a result of improved same-store sales offset by various development incentives and certain franchisee restructuring efforts.

Franchising revenues increased by $2.7 million, or 2.0%, to $134.6 million for fiscal year 2012 as compared to $131.9 million for fiscal year 2011. The increase in franchise revenues was primarily driven by a $1.9 million increase in royalties resulting from same-store sales increases combined with incremental royalties


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from newly constructed and refranchised drive-ins. These royalty increases and the effective royalty rate were negatively impacted by various development incentives and certain franchisee restructuring efforts.

Other revenues were flat in fiscal year 2013 and increased $1.5 million to $4.7 million in fiscal year 2012 as compared to the prior year. The increase in fiscal year 2012 was primarily due to changes in income from minority 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.

                               Company Drive-In Margins

                                         Year ended August 31,       Percentage Points
                                          2013           2012       Increase (Decrease)
Costs and expenses:
Company Drive-Ins:
Food and packaging                        28.5  %         28.1  %           0.4
Payroll and other employee benefits       35.4            35.7             (0.3)
Other operating expenses                  21.4            22.1             (0.7)
Cost of Company Drive-In sales            85.3  %         85.9  %          (0.6)


                                         Year ended August 31,       Percentage Points
                                          2012           2011           (Decrease)
Costs and expenses:
Company Drive-Ins:
Food and packaging                        28.1  %         28.1  %            -
Payroll and other employee benefits       35.7            36.4             (0.7)
Other operating expenses                  22.1            22.2             (0.1)
Cost of Company Drive-In sales            85.9  %         86.7  %          (0.8)

Drive-in level margins improved by 60 basis points during fiscal year 2013 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 were unfavorable by 40 basis points, which primarily resulted from a product mix shift due to summer promotion activity. Payroll and other employee benefits, as well as other operating expenses, improved 100 basis points primarily as a result of leveraging labor with improved sales and the refranchising of the 34 drive-ins discussed above.

Drive-in level margins improved 80 basis points in fiscal year 2012, as compared to 2011, reflecting leverage from improved same-store sales and the refranchising of lower-performing drive-ins discussed above. 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 12 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.

Selling, General and Administrative ("SG&A"). SG&A expenses increased 1.3% to $66.0 million for fiscal year 2013, and remained relatively flat increasing 0.4% to $65.2 million during fiscal year 2012 as compared to fiscal 2011. The increase in SG&A expense for fiscal year 2013 was largely attributable to an increase in variable compensation offset by a decline in bad debt expense due to improved sales and profitability at Franchise Drive-Ins.

Depreciation and Amortization. Depreciation and amortization expense decreased 3.6% to $40.4 million in fiscal year 2013 and increased 1.7% to $41.9 million in fiscal year 2012. The decline in fiscal year 2013 was


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primarily a result of a franchisee's purchase of land and building leased or subleased from the Company relating to previously refranchised drive-ins during the second quarter of fiscal year 2013. The increase in depreciation and amortization expense for fiscal year 2012 was primarily attributable to the amortization of intellectual property acquired during the second quarter of fiscal year 2012 for the Sonic system's legacy point-of-sale technology that is expected to be replaced over the next several years.

Provision for Impairment of Long-Lived Assets. Provision for impairment of long-lived assets increased $1.0 million to $1.8 million in fiscal year 2013, compared to $0.8 million for fiscal years 2012 and 2011. The increase in fiscal year 2013 was primarily the result of the $1.6 million impairment charge for the write-off of assets associated with a change in the vendor for the Sonic system's new point-of-sale technology.

Other Operating Income and Expense, Net. Fiscal year 2013 reflected $1.9 million in net expenses compared to a net income of $0.5 million and $0.6 million for fiscal years 2012 and 2011, respectively. This $2.4 million increase was primarily a result of the closure of 12 lower-performing Company Drive-Ins on August 31, 2013, in conjunction with an assessment in advance of capital expenditures for pending technology initiatives.

Net Interest Expense. Excluding the items outlined below, net interest expense decreased $2.5 million and $0.9 million in fiscal year 2013 and 2012, respectively, primarily related to a decline in our long-term debt balance. In fiscal year 2013, net interest expense includes a $4.4 million loss on extinguishment of debt related to our $20.0 million debt prepayment during the second quarter and our $155.0 million partial debt refinancing in the fourth quarter. Fiscal year 2011 reflects a $28.2 million loss from the early extinguishment of debt related to the refinancing of our debt in May 2011 and a $5.2 million gain from the early extinguishment of debt related to the repurchase of our variable funding notes in the second quarter of fiscal year 2011. 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 34.8% for fiscal year 2013 compared with 37.7% for fiscal year 2012. The lower effective income tax rate for fiscal year 2013 was primarily attributable to the expiration of a state statute of limitations related to an uncertain tax position and legislation that reinstated and extended the Work Opportunity Tax Credit ("WOTC"). The tax rate for fiscal year 2012 increased from the fiscal year 2011 rate of 32.3%. This increase 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. Our fiscal year 2014 tax rate may vary depending upon the reinstatement of employment tax credit programs that are scheduled to expire on December 31, 2013, and pending resolution of certain tax matters. Further, 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 and as circumstances on other tax matters change.

Financial Position

Total assets decreased $20.0 million, or 2.9%, to $660.8 million during fiscal year 2013 from $680.8 million at the end of fiscal year 2012. The decrease during the year was primarily due to a decline in net property, equipment and capital leases of $43.3 million, reflecting the second quarter of fiscal year 2013 sale of land and buildings to a franchisee for previously refranchised drive-ins, as well as from depreciation during the year, partially offset by capital additions. This decline is, in part, offset by a $25.2 million increase in cash from our operations, partially offset by capital expenditures, purchases under our stock repurchase programs and debt repayments.

Total liabilities decreased $38.2 million, or 6.1%, to $583.3 million during fiscal year 2013 from $621.5 million at the end of fiscal year 2012. This decrease was primarily attributable to scheduled and early debt principal repayments of $34.5 million during fiscal year 2013.

Total stockholders' equity increased $18.2 million, or 30.7%, to $77.5 million during fiscal year 2013 from $59.2 million at the end of fiscal year 2012. This increase was largely attributable to current-year earnings of $36.7 million and . . .

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