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SONC > SEC Filings for SONC > Form 10-Q on 3-Jul-2014All Recent SEC Filings

Show all filings for SONIC CORP

Form 10-Q for SONIC CORP


3-Jul-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

In the Quarterly Report on Form 10-Q, unless the context otherwise requires, the terms "Sonic Corp.," "the Company," "we," "us" and "our" refer to Sonic Corp. and its subsidiaries.

Overview

System-wide same-store sales increased 5.3% during the third quarter and increased 3.1% for the first nine months of fiscal year 2014 as compared to increases of 0.1%, and 0.9%, respectively, for the same periods last year. Same-store sales at Company Drive-Ins increased 5.2% during the third quarter and 3.0% for the first nine months of fiscal year 2014 as compared to a decrease of 1.1% and an increase of 1.5%, respectively, for the same periods last year. Our continued positive same-store sales are a result of the successful implementation of initiatives, including product quality improvements, a greater emphasis on personalized service and a tiered pricing strategy, that have set a solid foundation for growth. We continue to focus on key initiatives such as increased media effectiveness and our innovative product pipeline in supporting our layered day-part promotional strategy to drive same-store sales. To achieve earnings growth, we utilize a multi-layered growth strategy which incorporates same-store sales growth, operating leverage, deployment of cash, an ascending royalty rate and new drive-in development. Positive same-store sales is the most important layer and drives operating leverage and increased operating cash flows.

Revenues increased to $152.2 million for the third quarter of fiscal year 2014 from $146.6 million for the same period last year and increased to $388.6 million for the first nine months of fiscal year 2014 from $383.8 million for the same period last year. The increase in revenues was primarily attributable to an increase in Company Drive-In sales and Franchise Drive-In royalties related to the growth of same-store sales. Restaurant margins at Company Drive-Ins improved 40 basis points during the third quarter and improved 70 basis points during the first nine months of fiscal year 2014 primarily as a result of leverage from improved same-store sales and the closure of 12 lower-performing Company Drive-Ins on August 31, 2013, partially offset by increased commodity costs.

Third quarter results for fiscal year 2014 reflected net income of $16.8 million or $0.30 per diluted share, as compared to net income of $14.8 million or $0.26 per diluted share for the same period last year. Net income and diluted earnings per share for the third quarter of fiscal year 2014 increased 13% and 15%, respectively. Net income and diluted earnings per share for the first nine months of fiscal year 2014 were $29.1 million and $0.51, respectively, as compared to net income of $24.5 million and $0.43 per diluted share for the same period last year. Excluding the non-GAAP adjustments further described below, net income and diluted earnings per share for the first nine months of fiscal year 2014 would have both increased by 19%.

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.

                                          Nine months ended        Nine months ended
                                             May 31, 2014             May 31, 2013
                                           Net        Diluted       Net        Diluted
                                          Income        EPS        Income        EPS
Reported - GAAP                          $ 29,091    $   0.51     $ 24,503    $   0.43
Tax benefit from the IRS' acceptance
of a federal tax method change               (484)      (0.01)            -           -
After-tax loss from early
extinguishment of debt                           -           -         315        0.01
Retroactive tax benefit of Work
Opportunity Tax Credit ("WOTC") and

resolution of tax matters - - (743) (0.02) Adjusted - Non-GAAP $ 28,607 $ 0.50 $ 24,075 $ 0.42


Table of Contents

The following table provides information regarding the number of Company Drive-Ins and Franchise Drive-Ins operating as of the end of the periods 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)

                                            Three months ended         Nine months ended
                                                 May 31,                    May 31,
                                            2014          2013         2014         2013
Increase in total sales                       5.8  %       0.1  %       3.4  %       1.0  %

System-wide drive-ins in operation(1):
Total at beginning of period                3,507        3,526        3,522        3,556
Opened                                         10            6           23           10
Closed (net of re-openings)                    (7)          (6)         (35)         (40)
Total at end of period                      3,510        3,526        3,510        3,526

Average sales per drive-in                $   320      $   301      $   819      $   787

Change in same-store sales(2)                 5.3  %       0.1  %       3.1  %       0.9  %
---------

(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.


Table of Contents

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)

                           Three months ended                       Percent
                                 May 31,             Increase      Increase
                            2014         2013       (Decrease)    (Decrease)
Revenues:
Company Drive-In sales   $ 111,014    $ 108,445      $   2,569         2.4  %
Franchise Drive-Ins:
Franchise royalties         38,519       35,756          2,763         7.7
Franchise fees                 276           77            199       258.4
Lease revenue                1,081        1,089             (8)       (0.7)
Other                        1,297        1,267             30         2.4
Total revenues           $ 152,187    $ 146,634      $   5,553         3.8  %

                            Nine months ended                       Percent
                                 May 31,             Increase      Increase
                             2014         2013      (Decrease)    (Decrease)
Revenues:
Company Drive-In sales   $ 286,361    $ 285,607      $     754         0.3  %
Franchise Drive-Ins:
Franchise royalties         95,807       91,491          4,316         4.7
Franchise fees                 791          258            533       206.6
Lease revenue                2,682        3,524           (842)      (23.9)
Other                        2,939        2,903             36         1.2
Total revenues           $ 388,580    $ 383,783      $   4,797         1.2  %


Table of Contents

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)

                                          Three months ended             Nine months ended
                                                May 31,                       May 31,
                                          2014           2013           2014           2013
Company Drive-In sales                $ 111,014      $ 108,445      $ 286,361      $ 285,607
Percentage increase (decrease)              2.4  %        (1.5) %         0.3  %        (2.9) %

Company Drive-Ins in operation(1):
Total at beginning of period                388            405            396            409
Opened                                        1              1              1              1
Acquired from (sold to) franchisees            -             1             (7)             1
Closed (net of re-openings)                    -              -            (1)            (4)
Total at end of period                      389            407            389            407

Average sales per Company Drive-In    $     286      $     267      $     738      $     704

Change in same-store sales(2)               5.2  %        (1.1) %         3.0  %         1.5  %
---------

(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.

Same-store sales for Company Drive-Ins increased 5.2% for the third quarter and 3.0% for the first nine months of fiscal year 2014, as compared to a decrease of 1.1% and an increase of 1.5%, respectively, for the same periods last year. Company Drive-In sales increased $2.6 million during the third quarter of fiscal year 2014, as compared to the same period last year, mainly due to an increase of $5.6 million in same-store sales and $0.6 million in incremental sales from new drive-in openings. These increases were partially offset by a $2.2 million sales decline primarily related to the closure of 12 lower-performing drive-ins on August 31, 2013 and a $1.4 million decrease related to the refranchising of seven drive-ins during the first quarter of fiscal year 2014. Company Drive-In sales increased $0.8 million during the first nine months of fiscal year 2014, as compared to the same period last year, mainly due to an increase of $9.0 million in same-store sales and $1.4 million in incremental sales from new drive-in openings. These increases were partially offset by a $6.6 million sales decrease primarily related to the closure of 12 lower-performing drive-ins on August 31, 2013 and a $3.0 million decrease related to the refranchising of seven drive-ins during the first quarter of fiscal year 2014.


Table of Contents

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)

                                    Three months ended               Nine months ended
                                          May 31,                         May 31,
                                    2014           2013            2014             2013
Franchise Drive-In sales        $ 995,259      $ 937,092      $ 2,560,933      $ 2,469,033
Percentage increase                   6.2  %         0.3  %           3.7  %           1.5  %

Franchise Drive-Ins in
operation(1):
Total at beginning of period        3,119          3,121            3,126            3,147
Opened                                  9              5               22                9
Acquired from (sold to) the
Company                                  -            (1)               7               (1)
Closed (net of re-openings)            (7)            (6)             (34)             (36)
Total at end of period              3,121          3,119            3,121            3,119

Average sales per Franchise
Drive-In                        $     324      $     306      $       828      $       798

Change in same-store sales(2)         5.3  %         0.2  %           3.2  %           0.9  %

Franchising revenues(3)         $  39,876      $  36,922      $    99,280      $    95,273
Percentage increase
(decrease)                            8.0  %        (2.5) %           4.2  %          (0.2) %

Effective royalty rate(4)            3.87  %        3.82  %          3.74  %          3.71  %
---------

(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" in our Annual Report on Form 10-K for the year ended August 31, 2013.

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

Same-store sales for Franchise Drive-Ins increased 5.3% for the third quarter and increased 3.2% for the first nine months of fiscal year 2014, as compared to an increase of 0.2% and 0.9%, respectively, for the same periods last year. Franchising revenues increased $3.0 million, or 8.0%, for the third quarter and increased $4.0 million, or 4.2%, for the first nine months of fiscal year 2014, compared to the same periods last year. The increase in franchise revenues was primarily attributable to an increase in royalties related to the growth of same-store sales and an increase in franchise fees from the growth in Franchise Drive-Ins openings. The increase for the first nine months of fiscal year 2014 was partially offset by a decline in lease revenue due to a franchisee's purchase during the second quarter of fiscal year 2013 of land and buildings previously leased or subleased from the Company.


Table of Contents

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

                                        Three months ended
                                              May 31,            Percentage Points
                                         2014         2013      Increase (Decrease)
Costs and expenses:
Company Drive-Ins:
Food and packaging                      29.0  %       28.4  %           0.6
Payroll and other employee benefits     34.0          35.0             (1.0)
Other operating expenses                19.6          19.6               -
Cost of Company Drive-In sales          82.6  %       83.0  %          (0.4)

                                         Nine months ended
                                              May 31,            Percentage Points
                                         2014         2013      Increase (Decrease)
Costs and expenses:
Company Drive-Ins:
Food and packaging                      28.4  %       28.3  %           0.1
Payroll and other employee benefits     35.3          36.0             (0.7)
Other operating expenses                21.7          21.8             (0.1)
Cost of Company Drive-In sales          85.4  %       86.1  %          (0.7)

Drive-in level margins improved by 40 basis points during the third quarter and by 70 basis points for the first nine months of fiscal year 2014 as a result of leverage from improved same-store sales and the closure of 12 lower-performing Company Drive-Ins on August 31, 2013. Food and packaging costs were unfavorable by 60 basis points during the third quarter and by 10 basis points during the first nine months of fiscal year 2014. The unfavorable impact during the quarter reflects increased costs in beef, dairy and limes. The slight deterioration for the first nine months of fiscal year 2014 resulted from increased commodity costs described above that were partially offset by menu price increases. Commodity costs are expected to continue to rise in the fourth fiscal quarter, although not to the same extent as in the third fiscal quarter, resulting in expectations of flat to slightly unfavorable food and packaging costs, compared to the prior year. Payroll and other employee benefits, combined with other operating expenses, improved 100 basis points during the quarter and 80 basis points for the first nine months of fiscal year 2014, mainly as a result of leveraging improved sales and the closure of lower-performing drive-ins discussed above.

Selling, General and Administrative ("SG&A"). SG&A expenses increased $0.7 million, or 4.1%, to $17.6 million for the third quarter of fiscal year 2014 and increased $2.0 million, or 4.1%, for the first nine months of fiscal year 2014 as compared to the same periods last year. This increase is primarily related to salary and benefits as a result of additional headcount in support of the company's technology initiatives and higher variable compensation due to improved operating performance.

Depreciation and Amortization. Depreciation and amortization increased $1.2 million, or 12.7%, for the third quarter of fiscal year 2014 to $11.0 million, as compared to the same period last year. This increase is primarily attributable to our increased investments in technology. Depreciation and amortization increased $0.6 million, or 2.1%, to $31.1 million in the first nine months of fiscal year 2014, as compared to the same period last year. This increase is primarily the result of the investments discussed above partially offset by a franchisee's purchase, during the second quarter of fiscal year 2013, of land and buildings previously leased or subleased from the Company.


Table of Contents

Net Interest Expense. Net interest expense decreased $0.8 million, or 11.4%, in the third quarter of fiscal year 2014, as compared to the same period last year. Excluding the $0.5 million loss from the early extinguishment of debt in the second quarter of fiscal year 2013, net interest expense decreased $3.1 million, or 14.2%, for the first nine months of fiscal year 2014, as compared to the same period last year. This decrease was due to a decline in our weighted-average interest rate attributable to our partial debt refinancing completed in the fourth quarter of fiscal year 2013 and a decline in our long-term debt balance. For additional information on long-term debt, see our Annual Report on Form 10-K for the year ended August 31, 2013.

Income Taxes. The provision for income taxes reflects an effective tax rate of 34.1% for the third quarter of fiscal 2014 as compared to 35.6% for the same period in 2013. The lower effective income tax rate during the third quarter of fiscal year 2014 was primarily attributable to a favorable annual return to provision adjustment. Our effective income tax rate declined slightly to 33.4% for the first nine months of fiscal year 2014 from 33.6% for the first nine months of fiscal year 2013. This change is primarily due to the tax benefit resulting from the IRS' acceptance of a federal tax method change during the first quarter of fiscal year 2014 combined with the favorable return to provision adjustment from the third quarter of fiscal year 2014. Our fiscal year 2014 tax rate may vary depending upon the reinstatement of employment tax credit programs that expired on December 31, 2013, and pending resolution of certain tax matters. Further, our tax rate may continue to vary from quarter to quarter depending on the timing of stock option dispositions by option-holders and as circumstances on other tax matters change.

Financial Position

Total assets decreased $19.4 million, or 2.9%, to $641.4 million during the first nine months of fiscal year 2014 from $660.8 million at the end of fiscal year 2013. The decrease in total assets was primarily attributable to a decline in cash of $43.1 million and current-year depreciation of $31.1 million. These declines were partially offset by $54.7 million in property and equipment (largely technology).

Total liabilities increased $0.5 million, or 0.1%, to $583.8 million during the first nine months of fiscal year 2014 from $583.3 million at the end of fiscal year 2013.

Total stockholders' equity decreased $19.9 million, or 25.7%, to $57.5 million during the first nine months of fiscal year 2014 from $77.5 million at the end of fiscal year 2013. This decrease was primarily attributable to $69.4 million in purchases of common stock during the first nine months of the fiscal year partially offset by current-year earnings of $29.1 million and $16.7 million from the issuance of stock related to stock option exercises.

Liquidity and Sources of Capital

Operating Cash Flows. Net cash provided by operating activities increased $15.2 million to $71.1 million for the first nine months of fiscal year 2014, as compared to $55.9 million for the same period in fiscal year 2013. This increase primarily resulted from the receipt of federal income tax refunds of $8.3 million and lower income tax payments for the first nine months of fiscal year 2014, as compared to the same period last year, mainly attributable to the timing of estimated payments along with a $4.6 million increase in net income.

Investing Cash Flows. Cash used in investing activities during the first nine months of fiscal year 2014 increased $57.6 million to $53.5 million compared to cash provided by investing activities of $4.1 million for the same period in fiscal year 2013.


Table of Contents

The table below outlines our use of cash for investments in property and equipment for the first nine months of fiscal year 2014 in millions.

Replacement equipment and technology for existing drive-ins         $ 42.5
Rebuilds, relocations and remodels of existing drive-ins               3.6
Brand technology investments                                           3.3
Newly constructed drive-ins                                            3.1
Acquisition of underlying real estate for drive-ins                    1.3
Retrofits, drive-thru additions and LED signs in existing drive-ins    0.9
Total purchases of property and equipment                           $ 54.7

These purchases increased $26.4 million compared to the same period last year primarily related to our increased investments in technology. Additionally, proceeds from the sale of assets declined $30.7 million primarily related to proceeds from a franchisee's purchase, during the second quarter of fiscal year 2013, of land and buildings previously leased or subleased from the Company.

Financing Cash Flows. Net cash used in financing activities increased $1.6 million to $60.6 million for the first nine months of fiscal year 2014 as compared to $59.0 million for the same period in fiscal year 2013. This variance in financing cash flows was attributable to an increase in treasury stock purchases of $32.3 million, partially offset by a $23.7 million decline in debt payments as a result of the early repayment of $20 million of debt in the second quarter of fiscal year 2013 and a $5.5 million increase in proceeds from stock option exercises.

In August 2013, our Board of Directors extended our share repurchase program, authorizing us to purchase up to $40 million of our outstanding shares of common stock and, in January 2014, our Board of Directors approved an incremental $40 million authorization that allows for up to $80 million of common stock to be repurchased through August 31, 2014. Share repurchases may be made from time to time in the open market or otherwise, including through an accelerated share repurchase program, under terms of a Rule 10b5-1 plan, in privately negotiated transactions or in round lot or block transactions. The share repurchase program may be extended, modified, suspended or discontinued at any time.

In February 2014, we entered into an accelerated share repurchase ("ASR") agreement with a financial institution to purchase $40 million of the Company's common stock, resulting in an average price per share of $19.13.

Including repurchases under the ASR transaction described above, during the first nine months of fiscal year 2014, approximately 3.6 million shares were repurchased for a total cost of $69.4 million, resulting in an average price per share of $19.32.

The total remaining amount authorized under the share repurchase program, as of May 31, 2014, was $10.6 million.

As of May 31, 2014, our total cash balance of $51.3 million ($34.8 million of unrestricted and $16.5 million of restricted cash balances) reflected the impact of the cash generated from operating activities, stock option exercise proceeds, cash used for share repurchases, debt payments and capital expenditures mentioned above. We believe that existing cash, funds generated from operations and the amount available under our Series 2011-1 Senior Secured Variable Funding Notes, Class A-1, will meet our needs for the foreseeable future.

Contractual Obligations and Commitments

During the second quarter of fiscal year 2014, we amended one of our purchase obligation contracts to increase our current volume commitment and extend the term of the contract. The amendment will increase our purchase obligation commitment by approximately $240 million through the life of the contract. For a summary of our commitments to make future payments under contractual obligations, see the Contractual Obligations and Commitments section of Item 7, "Management's Discussion and Analysis of Financial Condition and Results of


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