ITEM 1. BUSINESS - ------- --------
GENERAL
Sonic Corp. (the "Company") operates and franchises the largest chain of drive-in restaurants in the United States. As of August 31, 1997, the Company had 1,680 restaurants in operation, consisting of 256 Company-owned restaurants and 1,424 franchised restaurants, principally in the south central and southeastern United States. Sonic restaurants offer made-to-order hamburgers and other sandwiches and feature Sonic signature items, such as footlong coney cheese dogs, hand-battered onion rings, tater tots, specialty soft drinks, including cherry limeades and slushes, and frozen desserts. At a typical Sonic restaurant, a customer drives into one of 24 to 36 covered drive-in spaces, orders through an intercom, and has the food delivered by a carhop within an average of four minutes.
In September of 1995, the Company reorganized its operating subsidiaries into two, directly-held subsidiaries consisting of Sonic Industries Inc. and Sonic Restaurants, Inc. Sonic Industries Inc. serves as the franchisor of the Sonic restaurant chain, as well as the insurance and administrative services center for the Company. Sonic Restaurants, Inc. develops and operates the Company's Company-owned restaurants. In February of 1996, the Company sold its equipment sales division to N. Wasserstrom & Sons, Inc. of Columbus, Ohio, and discontinued that line of business. The Company continues to rent the Sonic pole signs to its franchisees.
The Company's objective is to maintain its position as, or to become, a leading operator in terms of the number of quick-service restaurants within each of its core and developing markets. The Company has developed and is implementing a strategy designed to build the Sonic brand and to continue to achieve high levels of customer satisfaction and repeat business. The key elements of that strategy are (1) a unique drive-in concept focusing on a menu of quality made-to-order and signature food items; (2) a commitment to customer service featuring the quick delivery of food by carhops; (3) the expansion of Company-owned and franchised restaurants within the Company's core and developing markets; (4) an owner/operator philosophy, in which managers have an equity interest in their restaurant, thereby providing an incentive for managers to operate Company-owned restaurants profitably and efficiently; and (5) a commitment to support the Sonic system.
The Company has its principal executive offices at 101 Park Avenue, Oklahoma City, Oklahoma 73102. Its telephone number is (405) 280-7654. As used in this report, the word "Company" means Sonic Corp. and each of its subsidiaries and predecessors, unless the context indicates otherwise.
RESTAURANT LOCATIONS
As of August 31, 1997, the Company owned or franchised 1,680 drive-in restaurants, principally in the south central and southeastern United States. The Company's core markets, consisting of the nine contiguous states of Texas, Oklahoma, Tennessee, Missouri, Arkansas, Kansas, Louisiana, Mississippi, and New Mexico, contained approximately 84% of all Sonic restaurants as of August 31, 1997. Developing markets primarily are located in Alabama, Arizona, Colorado, Florida, Georgia, Kentucky, North Carolina, and South Carolina. The following table sets forth the number of Company-owned and franchised restaurants by core and developing markets as of August 31, 1997:
COMPANY-OWNED FRANCHISED CORE MARKET RESTAURANTS RESTAURANTS TOTAL ----------- ------------- ----------- ----- Texas 63 433 496 Oklahoma 22 168 190 Tennessee 26 113 139 Missouri 28 99 127 Arkansas 15 103 118 Kansas 7 88 95 Louisiana 15 80 95 Mississippi 0 88 88 New Mexico 0 56 56 --- ----- ----- Total 176 1,228 1,404 --- ----- ----- --- ----- -----
COMPANY-OWNED FRANCHISED DEVELOPING MARKETS RESTAURANTS RESTAURANTS TOTAL ------------------ ------------- ----------- ----- Alabama 35 20 55 Arizona 0 33 33 California 0 4 4 Colorado 0 21 21 Florida 11 2 13 Georgia 2 23 25 Illinois 0 5 5 Indiana 0 3 3 Iowa 0 1 1 Kentucky 9 23 32 Nebraska 0 2 2 Nevada 0 7 7 North Carolina 16 14 30 Ohio 0 3 3 South Carolina 0 31 31 Utah 0 1 1 Virginia 7 2 9 West Virginia 0 1 1 --- ----- ----- Total 80 196 276 --- ----- ----- --- ----- ----- Total System 256 1,424 1,680 --- ----- ----- --- ----- -----
EXPANSION
During fiscal 1997, the Company opened 37 Company-owned restaurants and its franchisees opened 92 restaurants. During fiscal 1998, the Company plans to open at least 50 Company-owned restaurants and anticipates that its franchisees will open at least 90 restaurants. That expansion plan involves the opening of new restaurants by franchisees under existing area development agreements, single-store development by existing franchisees, and development by new franchisees. The Company believes that its existing core and developing markets offer a significant growth opportunity for both Company-owned and franchised restaurant expansion. However, the ability of the Company and its franchisees to open the anticipated number of Sonic drive-in restaurants during fiscal 1998 necessarily will depend on various factors. Those factors include (among others) the availability of suitable sites, the negotiation of acceptable lease or purchase terms for new locations, local permitting and regulatory compliance, the financial resources of the Company's franchisees, and the general economic and business conditions to be faced in fiscal 1998.
The Company's expansion strategy for Company-owned restaurants involves three principal components: (1) the building-out of existing core markets, (2) the further penetration of developing markets, and (3) the acquisition by the Company of existing Sonic franchised restaurants. In addition, the Company may consider the acquisition of other similar concepts for conversion to Sonic restaurants.
RESTAURANT DESIGN AND CONSTRUCTION
GENERAL. The typical Sonic drive-in restaurant consists of a kitchen housed in a one-story building flanked by two canopy-covered rows of 24 to 36 parking spaces, with each space having its own intercom and menu board. In addition, since the first half of fiscal 1995, the Company has incorporated a drive-through window and patio seating area in almost all new Company-owned restaurants. Sonic restaurants generally do not provide an indoor seating area.
RETROFIT PROGRAM. In fiscal 1997, the Company began implementing a program to retrofit all Sonic drive-in restaurants over the next several years. The retrofit includes new signage, new menu and speaker housings, and significant trade dress modifications to the exterior of each restaurant's building. The Company currently estimates the cost to make a standard retrofit at approximately $58,000 to $65,000 per restaurant. The Company is implementing the program on a market-by-market basis, beginning with the Houston, Texas market. In addition, all new restaurants being built in all markets now feature the new retrofit signage and trade dress style. As of November 5, 1997, the Company had retrofitted approximately 28 Company-owned restaurants and had built six new Company-owned restaurants with the new retrofit signage and trade dress.
MARKETING
The Company has designed its marketing program to differentiate Sonic drive-in restaurants from the Company's competitors by emphasizing five key areas of customer satisfaction: (1) the personal manner of service by carhops, (2) made-to-order menu items, (3) speed of service, (4) quality, and (5) value. The marketing plan includes monthly promotions for use throughout the Sonic chain. The Company supports those promotions with television and radio commercials and point-of-sale materials. Those promotions center on a "meal deal" which highlights signature menu items of Sonic drive-in restaurants.
Each year the Company and its advertising agency (with involvement of the Sonic Franchisee Advisory Council) develop a marketing plan. The Company requires the formation of advertising cooperatives among restaurant owners to pool and direct advertising expenditures in local markets. Under each of the Company's license agreements, the franchisee must contribute a minimum percentage of the franchisee's gross revenues to a national media production fund and spend an additional minimum percentage of gross revenues on local advertising, either directly or through the Company-required participation in advertising cooperatives. Depending on the type of license agreement, the
minimum percentages of gross revenues contributed by franchisees for local advertising cooperative funds range from 1.125% to 3.25% and, for the Sonic Advertising Fund (the national fund directed by the Company), the franchisees contribute a range of 0.375% to 0.75% of gross revenues. Franchisees may elect and frequently do elect to contribute more than the minimum percentage of gross revenues to their local advertising cooperative funds.
For fiscal 1997, franchisees participating in cooperatives contributed an average of 2.89% of gross revenues to Sonic advertising cooperatives, exceeding the required 2.375% under most license agreements in effect during that period. As of August 31, 1997, 1,615 Sonic restaurants (approximately 96% of the chain) participated in advertising cooperatives. The Company estimates that the total amount spent on media and media production (principally television) exceeded $33 million for fiscal 1997 and should exceed $42 million for fiscal 1998.
PURCHASING
The Company negotiates with suppliers for its primary food products (hamburger patties, hot dogs, french fries, tater tots, cooking oil, fountain syrup, and other products) and packaging supplies to ensure adequate quantities of food and supplies and to obtain competitive prices. The Company seeks competitive bids from suppliers on many of its food products. The Company approves suppliers of those products and requires them to adhere to product specifications established by the Company. Suppliers manufacture several key products for the Company under private label and sell them to authorized distributors for resale to Company-owned and franchised restaurants. The Company and its franchisees purchase a majority of their food and beverage products from authorized local or national distributors.
The Company requires its Company-owned and franchised restaurants to participate in purchasing cooperatives. Those cooperatives have achieved cost savings, improved food quality and consistency, and helped decrease the volatility of food and supply costs for Sonic restaurants. For fiscal 1997, the average cost of food and paper supplies for a Sonic restaurant, as reported to the Company by its franchisees, equaled approximately 29.9% of revenues. The Company believes that food purchasing cooperatives have allowed Sonic restaurants to avoid menu price increases that otherwise might have occurred. A planned reduction in the number of food and paper product distributors to the Sonic chain has improved the ability of the Company to negotiate more advantageous purchasing terms and to maintain more uniform products.
COMPANY OPERATIONS
RESTAURANT PERSONNEL. A typical Sonic restaurant employs a manager, an assistant manager, and approximately 23 hourly employees, most of whom work part-time. The manager has responsibility for the day-to-day operations of the restaurant.
The Company initially forms a partnership (or limited liability company in some cases) with its supervising partners or members, each of whom on average has the responsibility of overseeing four to six Company-owned restaurants. Those supervising partners or members derive their income out of their share of the net profits of the restaurants they supervise. Supervising partners or members generally may own up to 20% of the restaurants they supervise.
The Company also employs six regional directors who oversee supervising partners or members within their respective regions, and the Company has a Vice President of Operations based in Oklahoma City who oversees the operations of all Company-owned restaurants.
OWNERSHIP PROGRAM. The Sonic restaurant philosophy stresses an ownership relationship between restaurant owners and managers, in which most managers of Company-owned and franchised restaurants own an equity interest in the restaurant. The Company believes that its ownership structure provides a substantial incentive for restaurant managers to operate their restaurants profitably and efficiently.
Under the ownership program, a separate general partnership or limited liability company owns and operates each Company-owned restaurant. The Company, as the general partner or managing member, owns a majority interest and the managers involved in the day-to-day management and operation of the restaurant own a minority interest in the partnership or company. Ownership equity of a typical established Company-owned restaurant generally is distributed 60% to the Company, 20% to the manager, and 20% to the supervising partner or member. The Company records other partners' or members' interests as a minority interest in earnings of restaurant partnerships on its financial statements. Under the standard partnership or operating agreement, the Company has the right to purchase the interest of any other partner or member on short notice. Each supervising and managing partner or member contributes his or her pro rata portion of all start-up costs, which include the required franchise fee, opening inventory, advertising and promotion costs; initial training and insurance costs; and some amounts for working capital. The amount of capital contribution by a supervising and managing partner or member for a restaurant typically equals approximately $10,000 for a 20% interest. Each partnership or company usually purchases equipment with funds borrowed from the Company at competitive rates. In most cases, the Company alone guarantees any third-party lease entered into for the site. The partnerships and companies distribute available cash flow to the partners or members on a monthly basis pursuant to the terms of the partnership and operating agreements.
POINT-OF-SALE SYSTEMS. The Company has developed and is implementing a point-of-sale system in Company-owned restaurants. The Company believes the point-of-sale system will increase speed and accuracy in order-taking and pricing and reduce paper work. In the future, the system will have polling capabilities to allow the Company to obtain current restaurant reporting information, thereby improving the accuracy and efficiency of store-level reporting on a next-day basis. The Company believes the system also should enhance marketing capabilities through the capture of information on customers and their buying habits with respect to the Company's products. As of August 31, 1997, the Company had installed the point-of-sale system in all but two of its Company-owned restaurants.
HOURS OF OPERATION. Sonic restaurants operate seven days a week, typically from 10:30 a.m. to 11:00 p.m.
COMPANY-OWNED RESTAURANT DATA. The following table provides certain financial information relating to Company-owned restaurants and the number of Company-owned restaurants opened and closed during the past five fiscal years.
1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Average Sales per Company-owned Restaurant $649,000 $601,000 $577,000 $558,000 $547,000 Number of Restaurants Total Open at Beginning of Year 231 178 142 120 91 Newly-Opened and Re-Opened 37 30 31 20 10 Purchased from Franchisees -- 28 6 13 20 Sold or Closed (12) (5) (1) (11) (1) --- --- --- --- --- Total Open at Year End 256 231 178 142 120 --- --- --- --- --- --- --- --- --- ---
FRANCHISE PROGRAM
GENERAL. During its more than 40 years in operation, the Sonic system has produced a large number of successful multi-unit franchisee groups. Those franchisees continue to develop new restaurants in their franchise territories either through area development agreements or single site development. The Company considers its franchisees a vital part of the Company's continued growth and believes its relationship with its franchisees is good.
As of August 31, 1997, the Company had 1,424 franchised restaurants operating in 27 states and the Company had development agreements which contemplate the opening of 64 additional restaurants during fiscal 1998. However,
the Company cannot give any assurance that the Company's franchisees will achieve that number of new restaurants for fiscal 1998. During fiscal 1997, the Company's franchisees opened 92 Sonic drive-in restaurants.
FRANCHISE AGREEMENTS. Each Sonic restaurant, including each Company-owned restaurant, operates under a franchise agreement that provides for payments to the Company of an initial franchise fee and a graduated percentage of the gross revenues of the restaurant. In September of 1994, the Company began offering a new Number 6 License Agreement, which provides for a franchise fee of $30,000 and an ascending royalty rate beginning at 1.0% of gross revenues and increasing to 5.0% as the level of gross revenues increases. Pursuant to the terms of existing area development agreements and the outstanding license option agreements described below, approximately 86% of all Sonic restaurants opening in fiscal 1998 will open under either the Number 5 License Agreement (13%) or the Number 5.1 License Agreement (73%). Those agreements each provide for a franchisee fee of $15,000 and an ascending royalty rate beginning at 1.0% of gross revenues and increasing to 4.0% as the level of gross revenues increases. For fiscal 1997, the Company's average royalty rate equaled 2.7%. The Number 5 License Agreement provides for a term of 15 years, with an option to renew pursuant to the terms of the then current license agreement. The Number 5.1 License Agreement and the Number 6 License Agreement provide for a term of 20 years, with one 10-year renewal option. The Company has the right to terminate any franchise agreement for a variety of reasons, including a franchisee's failure to make payments when due or failure to adhere to the Company's policies and standards. Many state franchise laws limit the ability of the Company to terminate or refuse to renew a franchise.
Beginning in fiscal year 1999 and continuing through fiscal year 2010, a total of 886 franchised restaurants currently operating under the Number 4.2 License Agreement will have their royalty rates increase to the same rate as set forth in the Number 5 License Agreement. In addition, beginning in fiscal year 2000 and continuing through fiscal year 2010, the terms of the remaining Number 4 License Agreements will expire and the licensed restaurants either will cease operations or renew their licenses pursuant to the terms of the then current license agreement (currently the Number 6 License Agreement). The Company expects that the automatic conversion of the Number 4.2 License Agreements and the renewals of the expiring Number 4 License Agreements will result in an incremental increase in the Company's royalty revenues attributable to the change in royalty rate. For the 5-year period beginning in fiscal year 2000, the Company expects that process to generate in excess of $10 million in incremental royalty revenue, which will build in a stair-stepped fashion. The actual amount of revenue will depend on a number of factors, including (among others) the average unit volumes of the affected restaurants and the extent to which the expiring Number 4 License Agreements in fact renew and convert to the Number 6 License Agreement.
DEVELOPMENT AGREEMENTS. The Company uses area development agreements to facilitate the planned expansion of the Sonic drive-in restaurant chain through multiple unit development. While existing franchisees continue to expand on a single restaurant basis, approximately 46% of the new franchised restaurants opened during fiscal 1997 occurred as a result of then-existing area development agreements. Each area development agreement gives a developer the exclusive right to construct, own and operate Sonic restaurants within a defined area. In exchange, each developer agrees to open a minimum number of Sonic restaurants in the area within a prescribed time period. If the developer does not meet the minimum opening requirements, the Company has the right to terminate the area development agreement and grant a new area development agreement to other franchisees for the area previously covered by the terminated area development agreement.
During fiscal 1997, the Company entered into 16 new area development agreements calling for the opening of 86 Sonic drive-in restaurants during the next six years. As of August 31, 1997, the Company had a total of 50 area development agreements in effect, calling for the development of 216 additional Sonic drive-in restaurants during the next six years. Of the 55 restaurants scheduled to open during fiscal 1997 under area development agreements in place at the beginning of that fiscal year, 42 (or 76%) opened during the period.
Realization by the Company of the expected benefits under various existing and future area development agreements currently depends and will continue to depend upon the ability of franchisees to open the minimum number of restaurants within the time periods required by the agreements. The financial resources of the developers, as well as
their experience in managing quick-service restaurant franchises, represent critical factors in the success of area development agreements. Although the Company grants area development agreements only to those developers whom the Company believes possess those qualities, the Company cannot give any assurances that the future performance by developers will result in the opening of the minimum number of restaurants contemplated by the development agreements or reach the compliance rate previously experienced by the Company.
OPTION AGREEMENTS. In connection with the Company's introduction of a new Number 6 License Agreement in fiscal 1995, the Company offered its existing franchisees the opportunity to acquire options to purchase the Number 5.1 License Agreement for new Sonic drive-in restaurants developed by the franchisee (the "Number 5.1 Options"). The Number 5.1 License Agreement has a lower initial franchise fee and royalty rate than the Number 6 License Agreement. All outstanding Number 5.1 Options have terms ending on December 31, 1997, with the right to renew for up to three additional years upon the payment of $1,000 on each anniversary date of the option. Unlike the area development agreements described above, the options do not cover any specific location. The Company currently is not offering additional option agreements to its franchisees and, as the options expire or the franchisees exercise them, the number of outstanding options will decrease over time. As of August 31, 1997, the Company had 163 Number 5.1 Options outstanding.
FRANCHISED RESTAURANT DEVELOPMENT. The Company furnishes each franchisee with assistance in selecting sites and developing restaurants. Each franchisee has responsibility for selecting the franchisee's restaurant locations but must obtain Company approval of each restaurant design and each location based on accessibility and visibility of the site and targeted demographic factors, including population, density, income, age and traffic. The Company provides its franchisees with the physical specifications for the typical Sonic drive-in restaurants.
FRANCHISEE FINANCING. The Company has entered into an agreement with Franchise Finance Company of America ("FFCA"), pursuant to which FFCA may make loans to Sonic franchisees who meet certain underwriting criteria set by FFCA. Under the terms of the agreement with FFCA, the Company may provide a guaranty of 10% of the outstanding balance of a loan from FFCA to a Sonic franchisee. The Company retains the absolute right to determine which loans it will guarantee and to impose any conditions the Company may deem appropriate.
The Company also has entered into agreements with NationsBank, N.A. and STI Credit Corporation, pursuant to which each of those lenders may provide financing for the Company's franchisees to implement the retrofit of their existing restaurants. Under the terms of those agreements, the Company has given each lender a limited guaranty of up to $250,000 with regard to all loans made pursuant to the terms of each agreement with the lenders.
FRANCHISEE TRAINING. Each franchisee must have at least one individual working full time at the Sonic drive-in restaurant who has completed the Sonic Management Development Program before opening or operating the Sonic drive-in restaurant. The program consists of six weeks of on-the-job training and one week of classroom development. The program emphasizes food safety, quality food preparation, quick service, cleanliness of restaurants, and consistency of service.
FRANCHISEE SUPPORT. In addition to training, advertising and food purchasing cooperatives, and marketing programs, the Company provides various other services to its franchisees. Those services include (1) assistance with quality control through area field representatives, to ensure that each franchisee consistently delivers high quality food and service; (2) assistance in selecting sites for new restaurants using demographic data and studies of traffic patterns; (3) financing through third party sources to qualified franchisees for purchasing restaurant equipment; and (4) one-stop shopping for all equipment needed to open a new restaurant through N. Wasserstrom & Sons, Inc. in Columbus, Ohio. The Company's field services organization consists of 16 field representatives, five field marketing representatives, and four real estate directors and managers, all with responsibility for defined geographic areas. The field representatives provide operational services and support for the Company's franchisees, while the field marketing representatives assist the franchisees with point-of-sale and local marketing programs. The real estate directors and managers assist the
franchisees with the identification of trade areas for new restaurants, the franchisees' selection of sites for their restaurants, and the approval of those sites by the Company.
FRANCHISE OPERATIONS. All franchisees must operate their Sonic drive-in restaurants in compliance with the Company's policies, standards and specifications, including matters such as menu items, materials, supplies, services, fixtures, furnishings, decor and signs. Each franchisee has full discretion to determine the prices charged to its customers. All restaurants must display a Sonic drive-in restaurant sign manufactured in accordance with Company specifications. In most cases, the Company owns the sign and leases it to the franchisee and, if the franchisee breaches its franchise agreement, the Company may remove the sign.
FRANCHISEE ADVISORY COUNCIL. The Company has established a Franchisee Advisory Council that primarily consists of franchisee representatives. The Franchisee Advisory Council holds periodic meetings to discuss new marketing ideas, operations, growth and other relevant issues.
REPORTING. The Company collects weekly and monthly sales and other operating information from its franchisees. The Company has agreements with many of its franchisees permitting the Company to debit electronically the franchisees' bank accounts for the payment of royalties and advertising fund contributions. That system significantly reduces the resources needed to process receivables, improves cash flow, and reduces past-due accounts receivable.
FRANCHISED RESTAURANT DATA. The following table provides certain financial information relating to franchised restaurants and the number of franchised restaurants opened, purchased from or sold to the Company, and closed during the Company's last five fiscal years.
1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Average Sales Per Franchised Restaurant $720,000 $657,000 $620,000 $592,000 $568,000 Number of Restaurants: Total Open at Beginning of Year 1,336 1,286 1,227 1,154 1,100 New Restaurants 92 81 80 80 82 Sold to the Company -- (28) (6) (13) (20) Purchased from the Company 5 4 1 10 -- Closed and Terminated, Net of Re-openings (9) (7) (16) (4) (8) ----- ----- ----- ----- ----- Total Open at Year End 1,424 1,336 1,286 1,227 1,154 ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
EQUIPMENT SALES
In fiscal 1996, the Company sold its restaurant equipment division and discontinued that operation. As a result, the Company had no revenues from equipment sales during fiscal 1997, compared to approximately $3.7 million during fiscal 1996 (an amount equal to 2.5% of the Company's total consolidated revenues) and approximately $9.1 million (or 7.3% of total consolidated revenues) for fiscal 1995.
COMPETITION
The Company competes in the quick-service restaurant industry, a highly competitive industry in terms of price, service, restaurant location, and food quality, and an industry often affected by changes in consumer trends, economic conditions, demographics, traffic patterns, and concerns about the nutritional content of quick-service foods. The Company competes on the basis of speed and quality of service, method of food preparation (made-to-order), food quality, signature food items, and monthly promotions. The quality of service, featuring the Sonic carhops, constitutes one of the Company's primary marketable points of difference with the competition. Several major chains, many of
which have substantially greater financial resources than the Company, dominate the quick-service restaurant industry. A significant change in pricing or other marketing strategies by one or more of those competitors could have an adverse impact on the Company's sales, earnings and growth. In selling franchises, the Company also competes with many franchisors of fast-food and other restaurants and other business opportunities.
EMPLOYEES
As of August 31, 1997, the Company had 198 full-time employees. No collective bargaining agreement covers any of its employees. Company-owned restaurants (operated as separate partnerships or limited liability companies) employed 692 full-time and 7,134 part-time employees as of August 31, 1997, none of whom constitute employees of the Company. The Company believes that it has good labor relations with its employees.
TRADEMARKS AND SERVICE MARKS
The Company, through a wholly-owned subsidiary, owns numerous trademarks and service marks. The Company has registered many of those marks, including the "Sonic" logo and trademark, with the United States Patent and Trademark Office. The Company believes that its trademarks and service marks have significant value and play an important role in its marketing efforts.
GOVERNMENT REGULATION
The Company must comply with regulations adopted by the Federal Trade Commission (the "FTC") and with several state laws that regulate the offer and sale of franchises. The Company also must comply with a number of state laws that regulate certain substantive aspects of the franchisor-franchisee relationship. The FTC's Trade Regulation Rule on Franchising (the "FTC Rule") requires that the Company furnish prospective franchisees with a franchise offering circular containing information prescribed by the FTC Rule.
State laws that regulate the franchisor-franchisee relationship presently exist in a substantial number of states. Those laws regulate the franchise relationship, for example, by requiring the franchisor to deal with its franchisees in good faith, by prohibiting interference with the right of free association among franchisees, by regulating discrimination among franchisees with regard to charges, royalties or fees, and by restricting the development of other restaurants within certain proscribed distances from existing franchised restaurants. Those laws also restrict a franchisor's rights with regard to the termination of a franchise agreement (for example, by requiring "good cause" to exist as a basis for the termination), by requiring the franchisor to give advance notice and the opportunity to cure the default to the franchisee, and by requiring the franchisor to repurchase the franchisee's inventory or provide other compensation upon termination. To date, those laws have not precluded the Company from seeking franchisees in any given area and have not had a significant effect on the Company's operations.
Each Sonic restaurant must comply with regulations adopted by federal agencies and with licensing and other regulations enforced by state and local health, sanitation, safety, fire and other departments. Difficulties or failures in obtaining the required licenses or approvals can delay and sometimes prevent the opening of a new restaurant.
Sonic restaurants must comply with federal and state environmental regulations, but those regulations have not had a material effect on their operations. More stringent and varied requirements of local governmental bodies with respect to zoning, land use, and environmental factors can delay and sometimes prevent development of new restaurants in particular locations.
The owners of Sonic restaurants must comply with the Fair Labor Standards Act and various state laws governing various matters, such as minimum wages, overtime and other working conditions. Significant numbers of the food service personnel in Sonic restaurants receive compensation at rates related to the federal minimum wage and, accordingly, increases in the minimum wage will increase labor costs at those locations.
The owners of Sonic restaurants also must comply with the provisions of the Americans with Disabilities Act (the "ADA"), which requires the owners to provide reasonable accommodation for employees with disabilities and to make their restaurants accessible to customers with disabilities. The Company has made certain modifications to the design and construction of its restaurants in order to comply with the ADA. However, the ADA has not had a material impact on the Company, primarily because of a drive-in restaurant's inherent accessibility to all customers.
Many owners of Sonic restaurants also must comply with the Family Medical Leave Act (the "Family Leave Act"), which covers employers of 50 or more persons at locations within any 75-mile radius. The Family Leave Act requires covered employers to grant eligible employees up to 12 weeks of unpaid leave for family and medical reasons and to reinstate the employee to the same or an equivalent position at the end of the leave. An employee may take leave for the birth, adoption, or foster care of a child; for any serious health condition of a spouse, sibling, child or parent; or for an employee's own serious health condition.
ITEM 2.
ITEM 2. PROPERTIES - ------- ----------
Of the 256 Company-owned restaurants operating as of August 31, 1997, the Company operated 119 of them on property leased from third parties and 137 of them on property owned by the Company. The leases expire on dates ranging from 1998 to 2017, with the majority of the leases providing for renewal options. All leases provide for specified periodic rental payments, and some leases call for additional rentals based on sales volume. Most leases require the Company to maintain the property and pay the cost of insurance and taxes.
The Company has its principal office located in approximately 50,000 square feet of leased office space in Oklahoma City, Oklahoma, at an effective annual rental rate of $9.15 per square foot. The lease for that property expires in October of 2002. The Company also leases approximately 10,000 square feet of warehouse space in Oklahoma City, Oklahoma, at an annual rental rate of $3.75 per square foot. The Company believes that its leased office and warehouse space provides an adequate amount of space and will meet the Company's needs for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS - ------- -----------------
Except as set forth below, the Company does not have any material legal proceedings pending against the Company, any of its subsidiaries, or any of their properties.
In July of 1996, the Company filed an appeal with the Texas Supreme Court in a case involving L & G Restaurants, Inc., Lucky Ott, and William Owen. The appeal seeks to reverse the ruling of the court of appeals which reinstated a jury verdict against Sonic Land Corporation for tortious interference with contract in that case. The damages, as originally found by the jury and reinstated by the appellate court, consist of actual damages of $52,500 for Mr. Ott and $729,070 for Mr. Owen, as well as punitive damages of $500,000 for Mr. Ott and $500,000 for Mr. Owen. The appellate court affirmed that part of the previous judgment notwithstanding the verdict which threw out the jury's original finding that Sonic Land Corporation had violated the Texas Deceptive Trade Practices Act. In addition, the appellate court itself threw out a $32,000 claim by Carolyn Ott for intentional infliction of emotional distress by Sonic Restaurants, Inc. The Company continues to believe that the findings of the jury had no merit, and will continue to defend its position vigorously during the appellate process. However, the Company cannot guarantee that the Texas Supreme Court will decide to review the case or, if it does, that the Company will receive a favorable outcome from the appeal.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------- ---------------------------------------------------
The Company did not submit any matter during the fourth quarter of the Company's last fiscal year to a vote of the Company's stockholders, through the solicitation of proxies or otherwise.
ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY - -------- ---------------------------------
IDENTIFICATION OF EXECUTIVE OFFICERS
The following table identifies the executive officers of the Company.
NAME AGE POSITION OFFICER SINCE - ---- --- -------- -------------
J. Clifford Hudson 43 President, Chief Executive June of 1985 Officer and Director Kenneth L. Keymer 49 President of Sonic Industries Inc. August of 1996 Michael R. Shumsky 46 President of Sonic Restaurants, October of 1994 Inc. Pattye T. Moore 39 Senior Vice President of Marketing June of 1992 and Brand Development Ronald L. Matlock 46 Vice President, General Counsel April of 1996 and Secretary W. Scott McLain 35 Vice President of Finance, April of 1996 Treasurer and Chief Financial Officer Stephen C. Vaughan 31 Vice President and Controller January of 1996 Diane C. Dolan 35 Vice President of Administration August of 1996 and Corporate Human Resources Donald E. Foringer 45 Vice President of Information August of 1997 Technology Stanley S. Jeska 57 Vice President of Franchise September of 1993 Development of Sonic Industries Inc. Andrew G. Ritger, Jr. 40 Vice President of Purchasing of January of 1996 Sonic Industries Inc. Warner Van Sciver 58 Vice President of Franchise April of 1988 Relations of Sonic Industries Inc. Frank B. Young, Jr. 46 Vice President of Operations of October of 1994 Sonic Restaurants, Inc.
BUSINESS EXPERIENCE
The following material sets forth the business experience of the executive officers of the Company for at least the past five years.
J. Clifford Hudson has served as President and Chief Executive Officer of the Company since April of 1995 and has served as a director of the Company since August of 1993. He served as President and Chief Operating Officer of the Company from August of 1994 until April of 1995, and he served as Executive Vice President and Chief Operating Officer from August of 1993 until August of 1994. From August of 1992 until August of 1993, Mr. Hudson served as Senior Vice President and Chief Financial Officer of the Company. Since October of 1994, Mr. Hudson has served as Chairman of the Board of Securities Investor Protection Corporation, the federally-chartered organization which serves as the insurer of customer accounts with brokerage firms.
Kenneth L. Keymer has served as President and a director of Sonic Industries Inc., the Company's franchise operations subsidiary, since August of 1996. From June of 1994 to August of 1996, Mr. Keymer served as Executive Vice President of Operations for the Memphis, Tennessee region of Perkins Family Restaurants, a subsidiary of Tennessee Restaurant Corporation of Itasca, Illinois. From March of 1993 to June of 1994, Mr. Keymer served as Senior Vice President of Operations for the then Chicago-based Boston Chicken, Inc. From August of 1990 to March of 1993, he served as the Zone Vice President in Chicago, Illinois, for Taco Bell.
Michael R. Shumsky has served as President and a director of Sonic Restaurants, Inc., the Company's restaurant operations subsidiary, since October of 1994. Prior to joining the Company, Mr. Shumsky spent 15 years with Taco Bell, serving most recently as a Zone Vice President in Atlanta, Georgia.
Pattye T. Moore has served as Senior Vice President of Marketing and Brand Development of the Company since April of 1996. From August of 1995 until April of 1996, Mrs. Moore served as Senior Vice President of Marketing and Brand Development for Sonic Industries Inc. and served as Vice President of Marketing of Sonic Industries Inc. from June of 1992 to August of 1995.
Ronald L. Matlock has served as Vice President, General Counsel and Secretary of the Company since April of 1996. Prior to joining the Company, Mr. Matlock practiced law from January of 1995 to April of 1996 with the Matlock Law Firm in Oklahoma City, Oklahoma, concentrating in corporate, securities and franchise law. From November of 1987 to December of 1994, Mr. Matlock was a shareholder and director of the law firm of Hastie & Kirschner in Oklahoma City, Oklahoma.
W. Scott McLain has served as Vice President of Finance, Chief Financial Officer, and Treasurer of the Company since August of 1997. From April of 1996 to August of 1997, he served as Vice President of Finance and Treasurer of the Company. From August of 1993 until joining the Company, Mr. McLain served as Treasurer of Stevens International, Inc. in Fort Worth, Texas. From March of 1991 until August of 1993, he served as a Manager - Corporate Recovery for Price Waterhouse in Dallas, Texas.
Stephen C. Vaughan has served as Vice President and Controller of the Company since August of 1997 and as Controller of the Company since January of 1996. Mr. Vaughan joined the Company in March of 1992 as an internal auditor and became Assistant Controller of the Company in March of 1993.
Diane C. Dolan has served as Vice President of Administration and Corporate Human Resources of the Company since August of 1996. Ms. Dolan served as a human resources consultant for Sonic Restaurants, Inc. from January of 1995 until joining Sonic Restaurants, Inc. as Director of Field Human Resources in July of 1995. From November of 1993 until July of 1995, Ms. Dolan served as a human resources consultant for the American Red Cross in St. Louis, Missouri. From June of 1993 to November of 1993, Ms. Dolan served as a co-instructor of cross-cultural/global management training programs as part of a graduate internship with Training Management Corporation in Princeton, New Jersey. From June of 1991 until June of 1993, Ms. Dolan attended school full time at American Graduate School of International Management in Glendale, Arizona.
Donald E. Foringer has served as Vice President of Information Technology since August of 1997. Prior to joining the Company, Mr. Foringer served as the Director of Information Services for Del Taco, Inc. of Laguna Hills, California. From May of 1992 until joining Del Taco, Inc. in January of 1993, Mr. Foringer served as a general partner of Novare Group of Newport Beach, California, a retail systems consulting firm.
Stanley S. Jeska has served as Vice President of Franchise Development of Sonic Industries Inc. since July of 1996 and also served in that capacity from September of 1993 until August of 1994. Mr. Jeska served as Vice President of Corporate Development for Sonic Restaurants, Inc. from August of 1994 until July of 1996. From April of 1990 until joining the Company, Mr. Jeska founded and served as President of Corporate Real Estate Advisors of Worthington, Ohio, a management consultant firm.
Andrew G. Ritger, Jr. has served as Vice President of Purchasing of Sonic Industries Inc. since January of 1996. From May of 1993 until joining the Company, Mr. Ritger served as Vice President of Purchasing of Fast Food Merchandisers, Inc., a subsidiary of Hardees, Inc. of Rocky Mount, North Carolina. From August of 1987 until May of 1993, he served as General Manager of Logistics of H.J. Heinz, Inc. in Nashville, Tennessee.
Warner L. Van Sciver has served as Vice President of Franchise Relations for Sonic Industries Inc. since April of 1997. From April of 1988 to April of 1997, Mr. Van Sciver served as Vice President of Franchise Services for Sonic Industries Inc.
Frank B. Young, Jr. has served as Vice President of Operations of Sonic Restaurants, Inc. since October of 1994. From April of 1993 until joining the Company, Mr. Young served as the President and sole shareholder of Wendco, Inc. of Madison, Wisconsin, a business consulting firm. From October of 1989 through March of 1993, Mr. Young engaged in business as a franchisee for three Wendy's restaurants in the Madison area.
PART II -------
ITEM 5.
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS - ------ ---------------------------------------------------------------------
MARKET INFORMATION
The Company's common stock trades on the Nasdaq National Market ("Nasdaq") under the symbol "SONC." The following table sets forth the high and low closing bids for the Company's common stock during each fiscal quarter within the two most recent fiscal years as reported on Nasdaq.
QUARTER ENDED HIGH LOW QUARTER ENDED HIGH LOW ------------- ---- --- ------------- ---- --- November 30, 1995 $23.875 $20.125 November 30, 1996 $25.875 $21.000 February 28, 1996 21.500 15.062 February 29, 1997 25.375 17.625 May 31, 1996 24.062 18.750 May 31, 1997 20.250 12.625 August 31, 1996 25.000 20.875 August 31, 1997 25.000 17.375
STOCKHOLDERS
As of November 7, 1997, the Company had 279 record holders of its common stock. As of that date, the Company had approximately 2,600 stockholders, including beneficial owners holding shares in street or nominee names.
DIVIDENDS
The Company did not pay any dividends on its common stock during its two most recent fiscal years and does not intend to pay any dividends in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA - ------- -----------------------
The following table sets forth selected financial data regarding the financial condition and operating results of the Company. One should read the following information in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operation," below, and the Company's Consolidated Financial Statements included elsewhere in this report.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------- ---------------------------------------------------------------
From time to time, the Company may publish forward-looking statements relating to certain matters, including anticipated financial performance, business prospects, the future opening of Company-owned and franchised restaurants, anticipated capital expenditures, and other similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of that safe harbor, the Company notes that a variety of factors could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. In addition, the Company disclaims any intent or obligation to update those forward-looking statements.
RESULTS OF OPERATIONS
The Company derives its revenues primarily from sales by Company-owned restaurants and royalty fees from franchisees. The Company also receives revenues from initial franchise fees, area development fees, and the leasing of signs and real estate. Costs of Company-owned restaurant sales and minority interest in earnings of restaurant partnerships relate directly to Company-owned restaurant sales. Other expenses, such as depreciation, amortization and general and administrative expenses, relate to both Company-owned restaurant operations, as well as the Company's franchising operations. The Company's revenues and expenses are directly affected by the number and sales volumes of Company-owned restaurants. The Company's revenues and, to a lesser extent, expenses are also affected by the number and sales volumes of franchised restaurants. Initial franchise fees are directly affected by the number of franchised restaurant openings.
The following table sets forth the percentage relationship to total revenues, unless otherwise indicated, of certain items included in the Company's statements of income. The table also sets forth certain restaurant data for the periods indicated.
PERCENTAGE RESULTS OF OPERATIONS AND RESTAURANT DATA ($ IN THOUSANDS)
YEAR ENDED AUGUST 31, -------------------------- 1997 1996 1995 ------ ------ ------ INCOME STATEMENT DATA: Revenues: Sales by Company-owned restaurants 83.0% 79.9% 73.9% Franchised restaurants: Franchise fees and royalties 15.5 16.4 17.6 Equipment and sign sales - 2.5 7.3 Other 1.5 1.2 1.2 ------ ------ ------ 100.0% 100.0% 100.0% ------ ------ ------ ------ ------ ------ Costs and expenses: Company-owned restaurants (1) 73.7% 76.8% 79.0% Equipment and sign sales (2) - 82.8 81.0 Selling, general and administrative 10.5 9.6 10.7 Depreciation and amortization 6.7 5.9 4.8 Minority interest in earnings of restaurant partnerships (1) 4.9 4.0 3.6 Provision for impairment of long-lived assets .1 5.7 .1 Income from operations 17.4 12.3 17.5 Net interest expense .8 .3 1.1 Net income 10.4% 7.4% 10.1%
---------------------------------- 1997 1996 1995 ---------- -------- -------- RESTAURANT OPERATING DATA: Company-owned restaurants: Core markets 165 158 128 Developing markets 91 73 50 ---------- -------- -------- All markets (3) 256 231 178 Franchised restaurants (3) 1,424 1,336 1,286 ---------- -------- -------- Total 1,680 1,567 1,464 ---------- -------- -------- ---------- -------- -------- System-wide sales $1,142,636 $984,784 $880,521 Percentage increase (4) 16.0% 11.8% 13.4% Average sales per restaurant: Company owned $649 $601 $577 Franchise 720 657 620 System-wide 707 648 615 Change in comparable restaurant sales (5): Company-owned restaurants: Core markets 8.7% 5.9% 1.9% Developing markets (2.1) (1.0) 1.9 ---------- -------- -------- All markets 6.3% 4.9% 1.9% Franchise 8.5 5.1 3.9 System-wide 8.0 5.0 3.6
- ----------------
(1) As a percentage of sales by Company-owned restaurants. (2) As a percentage of equipment and sign sales. (3) Number of restaurants open at end of year. (The allocation of Company-owned restaurants by core and developing markets differs from the table on page 2 because that table sets forth the numbers by state rather than by television market.) (4) Represents percentage increase from the comparable period in the prior year. (5) Represents percentage increase for restaurants open in both the reported and prior years.
COMPARISON OF FISCAL 1997 TO FISCAL 1996. Total revenues increased 21.8% to $184.0 million in fiscal 1997 from $151.1 million in fiscal 1996. Sales by Company-owned restaurants increased 26.5% to $152.7 million in fiscal 1997 from $120.7 million in fiscal 1996. Of the $32.0 million increase in sales by Company-owned restaurants, $25.8 million was due to the net addition of 78 Company-owned restaurants since the beginning of fiscal 1996. Average sales increases of approximately 6.3% by stores open the full reporting periods of fiscal 1997 and fiscal 1996 accounted for $6.2 million of the increase. Franchise fee revenues increased to $1.7 million during fiscal 1997 as compared to $1.5 million during fiscal 1996, primarily resulting from the opening of 92 new franchise restaurants in fiscal 1997 versus 81 in fiscal 1996. Franchise royalties increased 14.8% to $26.8 million in fiscal 1997 compared to $23.3 million in fiscal 1996. Increased sales by comparable franchised restaurants resulted in an increase in royalties of approximately $2.3 million and resulted from the franchise same store sales growth of 8.5% over fiscal 1996. Additional franchise restaurants in operation resulted in an increase in royalties of $1.1 million. The decrease in equipment sales was due to the sale of the restaurant equipment division in fiscal 1996. The increase in other revenues of approximately $0.9 million resulted primarily from the gain on the sale of the Company's minority interest in 10 restaurants. The sale of these interests is not expected to have a material impact on income in the future.
Restaurant cost of operations, as a percentage of sales by Company-owned restaurants, was 73.7% in fiscal 1997, compared to 76.8% in fiscal 1996. Management believes the improvement in restaurant operating margins resulted from (1) a 3.5% average price increase implemented October 1, 1996, along with a 2.5% average price increase implemented during the second quarter of fiscal 1996, (2) reductions in food and packaging costs due to consolidation of purchasing distribution functions and renegotiation of pricing terms, and (3) improved operational
cost controls through the implementation of a standard ideal food cost program in fiscal 1996. The improvements mentioned above were partially offset by a minimum wage increase which was effective on October 1, 1996, and an increase in marketing expenditures, which reflects the Company's commitment to increased media penetration through its system of advertising cooperatives. Another minimum wage increase became effective September 1, 1997 and is expected to have a negative impact on payroll and employee benefits expense of approximately one percentage point, as a percentage of sales by Company-owned restaurants. Minority interest in earnings of restaurant partnerships increased, as a percentage of sales by Company-owned restaurants, to 4.9% in fiscal 1997 as compared to 4.0% in fiscal 1996. This increase occurred primarily due to the improvements in operating margins discussed above.
Selling, general and administrative expenses, as a percentage of total revenues, increased to 10.5% in fiscal 1997 compared with 9.6% in fiscal 1996. This increase resulted primarily from a provision for expected litigation costs of approximately $1 million recorded in fiscal 1997. Management expects selling, general and administrative expenses to decline in future periods, as a percentage of total revenues, because the Company expects a significant portion of future revenue growth to be attributable to Company-owned restaurants. Company-owned restaurants require a lower level of selling, general and administrative expenses than the Company's franchising operations since most of these expenses are reflected in restaurant cost of operations and minority interest in restaurant operations. Many of the managers and supervisors of Company-owned restaurants own a minority interest in the restaurants, and their compensation flows through the minority interest in earnings of restaurant partnerships. Depreciation and amortization expense increased approximately $3.4 million due to the purchase of buildings and equipment for new and existing restaurants and corporate furniture and information systems upgrades. Management expects this trend to continue due to increased capital expenditures planned for fiscal 1998.
Income from operations increased to $32.0 million from $18.5 million in fiscal 1996. Excluding the provision for adoption of a new accounting standard recorded in fiscal 1996 and discussed below, income from operations increased 18.1%.
Net interest expense increased to $1.6 million in fiscal 1997 from $0.5 million in fiscal 1996. This increase was the result of additional borrowings to partially fund the Company's capital additions of $48.6 million and stock repurchases of $11.4 million. The Company expects interest expense to continue to increase in fiscal 1998.
Provision for income taxes reflects an effective federal and state tax rate of 37.25% for fiscal 1997, compared to 37.75% for the comparable period in fiscal 1996. Net income for the period increased 15.2% to $19.1 million and earnings per share increased 15.4% to $1.42, excluding the after-tax effect of the provision for adoption of a new accounting standard recorded in fiscal 1996.
COMPARISON OF FISCAL 1996 TO FISCAL 1995. Total revenues increased 22.1% to $151.1 million in fiscal 1996 from $123.8 million in fiscal 1995. Sales by Company-owned restaurants increased 32.0% to $120.7 million in fiscal 1996 from $91.4 million in fiscal 1995. Of the $29.3 million increase, $25.3 million was due to the net addition of 89 Company-owned restaurants since the beginning of fiscal 1995. Average sales increases of approximately 4.9% by stores open the full reporting periods of fiscal 1996 and fiscal 1995 accounted for $4.0 million of the increase. Franchise fee revenues increased to $1.5 million during fiscal 1996 as compared to $1.4 million during fiscal 1995. Franchise royalties increased 14.3% to $23.3 million in fiscal 1996, compared to $20.4 million in fiscal 1995. Increased sales by comparable franchised restaurants resulted in an increase in royalties of approximately $1.2 million and resulted from the franchise same store sales growth of 5.1% over fiscal 1995. Approximately $1.0 million of the $2.9 million increase resulted from the progressive nature of the Company's franchise agreements that require a higher royalty percentage as average monthly sales volumes increase. Additional franchise restaurants in operation resulted in an increase in royalties of $0.7 million. Restaurant equipment sales decreased 58.8% to $3.7 million in fiscal 1996 from $9.1 million in fiscal 1995, because of the sale of the restaurant equipment division in the second quarter of fiscal 1996.
Restaurant cost of operations, as a percentage of sales by Company-owned restaurants, was 76.8% in fiscal 1996, compared to 79.0% in fiscal 1995. Management believes the improvement in restaurant operating margins resulted from (1) a 2.5% average price increase implemented during the second quarter of fiscal 1996, (2) reductions in the percentage of promotional discounting from standard menu prices, as a percentage of sales, of approximately 10%, (3) reductions in cost of food and paper items due to declining beef prices and consolidation of purchasing distribution functions, and (4) improved operational cost controls through the implementation of a standard ideal food cost program. The improvements mentioned above were partially offset by an increase in marketing expenditures which reflects the Company's commitment to increased media penetration through its system of advertising cooperatives. Management bonuses also increased, as a percentage of sales, due largely to the improved operating margins. Minority interest in earnings of restaurant partnerships increased, as a percentage of sales by Company-owned restaurants, to 4.0% in fiscal 1996 as compared to 3.6% in fiscal 1995. This increase occurred primarily due to the improvements in operating margins discussed above.
Selling, general and administrative expenses, as a percentage of total revenues, decreased to 9.6% in fiscal 1996 compared with 10.7% in fiscal 1995. That decrease occurred as a result of the increase in the number of Company-owned restaurants. Company-owned restaurants require a lower level of selling, general and administrative expenses than the Company's franchising operations since most of these expenses are reflected in restaurant cost of operations and minority interest in restaurant operations. Many of the managers and supervisors of Company-owned restaurants own a minority interest in the restaurants, and their compensation flows through the minority interest in earnings of restaurant partnerships. Depreciation and amortization expense increased approximately $3.0 million due to the purchase of buildings and equipment for new and existing restaurants and corporate furniture and information systems upgrades.
Effective June 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived Assets and Assets To Be Disposed Of" (SFAS 121). The provision for adoption of SFAS 121 was $8.5 million ($5.3 million after-tax or $.39 per share). For an additional explanation of this provision, see Note 2 in the Notes To Consolidated Financial Statements.
Income from operations decreased to $18.5 million from $21.6 million in fiscal 1995. Excluding the provision for impairment of long-lived assets discussed above, income from operations increased 25.2% to $27.1 million.
Net interest expense decreased to $0.5 million in fiscal 1996 from $1.4 million in fiscal 1995. This decrease was the result of the pay down on the revolving credit facility with the proceeds from a secondary stock offering, as well as increased interest income from the investment of excess offering proceeds during the year.
Provision for income taxes reflects an effective federal and state tax rate of 37.75% for fiscal 1996, compared to 38.25% for the comparable period in fiscal 1995. Net income for the period increased 32.7% to $16.6 million and earnings per share increased 17.1% to $1.23, excluding the after-tax effect of the provision for impairment of long-lived assets discussed above.
LIQUIDITY AND SOURCES OF CAPITAL
During fiscal 1997, the Company opened 37 new restaurants, closed seven restaurants, and sold five restaurants to franchisees. The Company funded total capital additions for fiscal 1997 of $48.6 million (which included the cost of newly-opened restaurants, restaurants under construction, new furniture and equipment for existing restaurants and corporate use) internally from cash generated by operating activities, through borrowings under the Company's line of credit and through the use of capital leases. During fiscal 1997, the Company elected to own the real estate on 34 of the 37 newly-constructed restaurants. The Company expects to own the land and building for approximately 80% of its future newly-constructed restaurants. In addition to the capital expenditures mentioned above, the Company repurchased 799,500 shares of common stock for approximately $11.4 million
during fiscal 1997 with funds from the Company's line of credit. The Company may purchase additional shares of its common stock in the future when appropriate and justified by market conditions at the time.
In June 1997, the Company entered into an agreement with a group of banks to increase its existing $60 million line of credit to $80 million. The Company will use the line of credit to finance the opening of newly-constructed restaurants, acquisitions of existing restaurants and for other general corporate purposes. As of August 31, 1997, the Company's outstanding borrowings under the line of credit were $37 million as well as $0.1 million in outstanding letters of credit. The available line of credit as of August 31, 1997 was $42.9 million. As of August 31, 1997, the Company's total cash balance of $7.3 million reflected the impact of the line of credit activity, the treasury stock purchases, and capital expenditures mentioned above.
The Company expects capital expenditures of approximately $50 million in fiscal 1998, excluding potential acquisitions. These capital expenditures are primarily for the development of additional Company-owned stores, remodeling of Company-owned stores and enhancements to existing financial and operating information systems. The Company expects to fund these capital expenditures through borrowings under its existing unsecured revolving credit facility and cash flow from operations. The Company believes that existing cash and funds generated from internal operations as well as borrowings under the line of credit will be sufficient to meet the Company's needs for the foreseeable future.
IMPACT OF INFLATION
Though increases in labor, food or other operating costs could adversely affect the Company's operations, management does not believe that inflation has had a material effect on income during the past several years. During fiscal 1997, however, Company-owned restaurants increased prices due primarily to higher labor costs resulting from increases in the federal minimum wage.
SEASONALITY
The Company does not expect seasonality to affect its operations in a materially adverse manner. The Company's results during its second quarter, comprising the months of December, January and February, will generally be lower than its other quarters due to the climate of the locations of a number of its restaurants.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- -------------------------------------------
The Company has included the financial statements and supplementary financial information required by this item immediately following Part IV of this report and hereby incorporates by reference the relevant portions of those statements and information into this Item 8.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - ------- -----------------------------------------------------------------
No disagreements between the Company and its accountants have occurred within the 24-month period prior to the date of the Company's most recent financial statements.
PART III
Except for the information on the Company's executive officers set forth under Item 4A of Part I of this report, the Company hereby incorporates by reference the information required by Part III of this report from the definitive proxy statement which the Company must file with the Securities and Exchange Commission in connection with the Company's annual meeting of stockholders following the fiscal year ended August 31, 1997.
PART IV -------
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - -------- ----------------------------------------------------------------
FINANCIAL STATEMENTS
The following consolidated financial statements of the Company appear immediately following this Item 14:
Pages ----- Report of Independent Auditors Consolidated Balance Sheets at August 31, 1997 and 1996 Consolidated Statements of Income for each of the three years in the period ended August 31, 1997 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended August 31, 1997 Consolidated Statements of Cash Flows for each of the three years in the period ended August 31, 1997 Notes to Consolidated Financial Statements
FINANCIAL STATEMENT SCHEDULES
The Company has included the following schedules immediately following this Item 14:
Page ---- Schedule II - Valuation and Qualifying Accounts
The Company has omitted all other schedules because the conditions requiring their filing do not exist or because the required information appears in the Company's Consolidated Financial Statements, including the notes to those statements.
EXHIBITS
The Company has filed the exhibits listed below with this report. The Company has marked all employment contracts and compensatory plans or arrangements with an asterisk (*).
3.01. Certificate of Incorporation of the Company, which the Company hereby incorporates by reference from Exhibit 3.1 to the Company's Form S-1 Registration Statement No. 33-37158.
3.02. Bylaws of the Company, which the Company hereby incorporates by reference from Exhibit 3.2 to the Company's Form S-1 Registration Statement No. 33-37158.
3.03. Certificate of Designations of Series A Junior Preferred Stock, which the Company hereby incorporates by reference from Exhibit 99.1 to the Company's Form 8-K filed on June 17, 1997.
3.04. Rights Agreement, which the Company hereby incorporates by reference from Exhibit 99.1 to the Company's Form 8-K filed on June 17, 1997.
4.01. Specimen Certificate for Common Stock, which the Company hereby incorporates by reference from Exhibit 4.01 to the Company's Form 10-K for the fiscal year ended August 31, 1995.
4.02. Specimen Certificate for Rights, which the Company hereby incorporates by reference from Exhibit 99.1 to the Company's Form 8-K filed on June 17, 1997.
10.01. Form of Sonic Industries Inc. License Agreement (the Number 4 License Agreement), which the Company hereby incorporates by reference from Exhibit 10.1 to the Company's Form S-1 Registration Statement No. 33-37158.
10.02. Form of Sonic Industries Inc. License Agreement (the Number 5 License Agreement), which the Company hereby incorporates by reference from Exhibit 10.2 to the Company's Form S-1 Registration Statement No. 33-37158.
10.03. Form of Sonic Industries Inc. License Agreement (the Number 4.2 License Agreement and Number 5.1 License Agreement), which the Company hereby incorporates by reference from Exhibit 10.03 to the Company's Form 10-K for the fiscal year ended August 31, 1994.
10.04. Form of Sonic Industries Inc. License Agreement (the Number 6 License Agreement), which the Company hereby incorporates by reference from Exhibit 10.04 to the Company's Form 10-K for the fiscal year ended August 31, 1994.
10.05. Form of Sonic Industries Inc. Area Development Agreement, which the Company hereby incorporates by reference from Exhibit 10.05 to the Company's Form 10-K for the fiscal year ended August 31, 1995.
10.06. Form of Sonic Industries Inc. Sign Lease Agreement, which the Company hereby incorporates by reference from Exhibit 10.4 to the Company's Form S-1 Registration Statement No. 33-37158.
10.07. Form of General Partnership Agreement, Limited Liability Company Operating Agreement, Partnership Master Agreement, and Limited Liability Company Master Agreement.
10.08. 1991 Sonic Corp. Stock Option Plan, which the Company hereby incorporates by reference from Exhibit 10.5 to the Company's Form S-1 Registration Statement No. 33-37158.*
10.09. 1991 Sonic Corp. Stock Purchase Plan, which the Company hereby incorporates by reference from Exhibit 10.6 to the Company's Form S-1 Registration Statement No. 33-37158.*
10.10. 1991 Sonic Corp. Directors' Stock Option Plan, which the Company hereby incorporates by reference from Exhibit 10.08 to the Company's Form 10-K for the fiscal year ended August 31, 1991.*
10.11. Sonic Corp. Savings and Profit Sharing Plan, which the Company hereby incorporates by reference from Exhibit 10.8 to the Company's Form S-1 Registration Statement No. 33-37158.*
10.12. Net Revenue Incentive Plan, which the Company hereby incorporates by reference from Exhibit 10.19 to the Company's Form S-1 Registration Statement No. 33-37158.*
10.13. Form of Indemnification Agreement for Directors, which the Company hereby incorporates by reference from Exhibit 10.7 to the Company's Form S-1 Registration Statement No. 33-37158.*
10.14. Form of Indemnification Agreement for Officers, which the Company hereby incorporates by reference from Exhibit 10.14 to the Company's Form 10-K for the fiscal year ended August 31, 1995.*
10.15. Sonic Corp. 1995 Stock Incentive Plan, which the Company hereby incorporates by reference from Exhibit 10.15 to the Company's Form 10-K for the fiscal year ended August 31, 1996.*
10.16. Form of Employment Agreement and Schedule of Material Differences for the Executive Officers of the Company.*
10.17. Loan Agreement with Texas Commerce Bank National Association dated July 31, 1995, which the Company hereby incorporates by reference from Exhibit 10.26 to the Company's Form 10-K for the fiscal year ended August 31, 1995.
10.18. First Amendment to Loan Agreement with Texas Commerce Bank National Association, which the Company hereby incorporates by reference from Exhibit 10.18 to the Company's Form 10-K for the fiscal year ended August 31, 1996.
10.19. Second Amendment to Loan Agreement with Texas Commerce Bank National Association, which the Company hereby incorporates by reference from Exhibit 10.19 to the Company's Form 10-K for the fiscal year ended August 31, 1996.
10.20. Third Amendment to Loan Agreement with Texas Commerce Bank National Association, which the Company hereby incorporates by reference from Exhibit 10.01 to the Company's Form 10-Q for the fiscal quarter ended May 31, 1997.
21.01. Subsidiaries of the Company, which the Company hereby incorporates by reference from Exhibit 21.01 to the Company's Form 10-K for the fiscal year ended August 31, 1996.
23.01. Consent of Independent Auditors.
24.01. Power of Attorney.
27.01. Financial Data Schedule
REPORTS ON FORM 8-K
The Company filed a Form 8-K on June 17, 1997, to report the declaration of a dividend distribution of one right for each outstanding share of common stock of the Company. Upon the occurrence of certain specified events, each right entitles the registered holder to purchase from the Company one one-thousandth of a share of Series A Junior Preferred Stock, par value $.01 per share, at a price of $85 per one-one thousandth share, subject to adjustment. The description and terms of the rights appear in the Rights Agreement listed above as Exhibit 3.04.
Report of Independent Auditors
The Board of Directors and Stockholders Sonic Corp.
We have audited the accompanying consolidated balance sheets of Sonic Corp. as of August 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended August 31, 1997. Our audits also included the financial statement schedule listed in the Index at Item 14. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sonic Corp. at August 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended August 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 2 to the accompanying consolidated financial statements, in fiscal year 1996 Sonic Corp. changed its method of accounting for impairment of long-lived assets by adopting Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."
ERNST & YOUNG LLP
Oklahoma City, Oklahoma October 17, 1997
Sonic Corp.
Consolidated Balance Sheets
AUGUST 31, 1997 1996 --------------------- (IN THOUSANDS) ASSETS Current assets: Cash and cash equivalents $ 7,334 $ 7,706 Accounts and notes receivable, net (NOTE 4) 5,890 5,229 Refundable income taxes 2,489 - Net investment in direct financing and sales-type leases (NOTE 6) 856 783 Inventories 1,239 1,868 Deferred income taxes (NOTE 11) 100 110 Prepaid expenses and other 791 481 --------------------- Total current assets 18,699 16,177
Notes receivable, net (NOTE 4) 3,314 3,063
Net investment in direct financing and sales-type leases (NOTE 6) 3,361 3,421
Deferred income taxes (NOTE 11) - 2,184
Property, equipment and capital leases, net (NOTES 2, 6 AND 7) 136,522 100,505
Intangibles and other assets, net (NOTE 5) 22,945 22,094 --------------------- Total assets $184,841 $147,444 --------------------- ---------------------
Sonic Corp.
Consolidated Balance Sheets (continued)
AUGUST 31, 1997 1996 -------------------- (IN THOUSANDS)
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 4,635 $ 2,904 Deposits from franchisees 780 601 Accrued liabilities (NOTE 8) 8,629 7,841 Obligations under capital leases due within one year (NOTE 6) 1,030 823 Long-term debt due within one year (NOTE 9) 116 517 -------------------- Total current liabilities 15,190 12,686
Obligations under capital leases due after one year (NOTE 6) 8,153 8,985 Long-term debt due after one year (NOTE 9) 37,517 11,884 Other noncurrent liabilities (NOTE 10) 5,051 4,206 Deferred income taxes (NOTE 11) 756 - Commitments and contingencies (NOTES 3, 6, 14 AND 15)
Stockholders' equity (NOTE 12): Preferred stock, par value $.01; 1,000,000 shares authorized; none outstanding - - Common stock, par value $.01; 40,000,000 shares authorized; shares issued--13,531,593 in 1997 and 13,475,078 in 1996 135 135 Paid-in capital 59,891 59,107 Retained earnings 69,666 50,584 -------------------- 129,692 109,826 Treasury stock, at cost; 807,080 shares in 1997 and 7,580 shares in 1996 (11,518) (143) -------------------- Total stockholders' equity 118,174 109,683 -------------------- Total liabilities and stockholders' equity $184,841 $147,444 -------------------- -------------------- SEE ACCOMPANYING NOTES.
Sonic Corp.
Consolidated Statements of Income
YEAR ENDED AUGUST 31, 1997 1996 1995 ------------------------------ (IN THOUSANDS, EXCEPT PER SHARE DATA) Revenues: Sales by Company-owned restaurants $152,739 $120,700 $ 91,438 Franchised restaurants: Franchise fees 1,702 1,453 1,409 Franchise royalties 26,764 23,315 20,392 Equipment and sign sales (NOTE 1) - 3,743 9,076 Other 2,813 1,919 1,445 ------------------------------ 184,018 151,130 123,760
Costs and expenses: Company-owned restaurants: Food and packaging 43,661 37,463 30,073 Payroll and other employee benefits 42,508 34,555 27,265 Other operating expenses 26,419 20,645 14,937 ------------------------------ 112,588 92,663 72,275
Equipment and sign cost of sales (NOTE 1) - 3,101 7,354 Selling, general and administrative 19,318 14,498 13,260 Depreciation and amortization 12,320 8,896 5,910 Minority interest in earnings of restaurant partnerships 7,558 4,806 3,259 Provision for impairment of long-lived assets (NOTE 2) 266 8,627 71 ------------------------------ 152,050 132,591 102,129 ------------------------------ Income from operations 31,968 18,539 21,631
Interest expense 2,154 1,184 1,823 Interest income (596) (708) (409) ------------------------------ Net interest expense 1,558 476 1,414 ------------------------------ Income before income taxes 30,410 18,063 20,217
Provision for income taxes (NOTE 11) 11,328 6,819 7,733 ------------------------------ Net income $ 19,082 $ 11,244 $ 12,484 ------------------------------ ------------------------------ Net income per share (NOTE 12) $ 1.42 $ .84 $ 1.05 ------------------------------ ------------------------------ Weighted average shares outstanding (NOTE 12) 13,434 13,449 11,842 ------------------------------ ------------------------------
SEE ACCOMPANYING NOTES.
Sonic Corp.
Consolidated Statements of Stockholders' Equity
SEE ACCOMPANYING NOTES.
Sonic Corp.
Consolidated Statements of Cash Flows
YEAR ENDED AUGUST 31, 1997 1996 1995 ---------------------------------- (IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 19,082 $ 11,244 $ 12,484 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 10,099 7,166 4,689 Amortization 2,221 1,730 1,221 Gains on dispositions of assets (1,491) (309) (52) Amortization of franchise and development fees (1,702) (1,453) (1,409) Franchise and development fees collected 1,768 1,460 1,376 Provision (credit) for deferred income taxes 2,950 (1,905) 370 Provision for impairment of long-lived assets 266 8,627 71 (Increase) decrease in operating assets: Accounts and notes receivable (5) (380) (448) Refundable income taxes (2,489) - - Inventories and prepaid expenses and other 62 (766) (331) Increase (decrease) in operating liabilities: Accounts payable 1,709 1,213 (741) Accrued and other liabilities 1,649 2,154 2,209 Other 24 74 100 ---------------------------------- Total adjustments 15,061 17,611 7,055 ---------------------------------- Net cash provided by operating activities 34,143 28,855 19,539
CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment (48,048) (41,107) (34,208) Investment in direct financing leases (935) (1,235) (1,016) Collections on direct financing leases 922 987 902 Proceeds from dispositions of assets 3,025 2,450 346 Increase in intangibles and other assets: Goodwill resulting from acquisitions of restaurants - (5,964) (181) Other (3,455) (1,721) (1,592) ---------------------------------- Net cash used in investing activities (48,491) (46,590) (35,749)
(CONTINUED ON FOLLOWING PAGE)
Sonic Corp.
Consolidated Statements of Cash Flows (continued)
YEAR ENDED AUGUST 31, 1997 1996 1995 ---------------------------------- (IN THOUSANDS)
CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from long-term borrowings $ 59,750 $ 11,500 $18,250 Payments on long-term debt (34,542) (24,250) (222) Purchases of treasury stock (11,375) (4) (4,054) Payments on capital lease obligations (641) (669) (549) Exercises of stock options 784 1,900 550 Proceeds from sale of common stock - 33,186 - ---------------------------------- Net cash provided by financing activities 13,976 21,663 13,975 ---------------------------------- Net increase (decrease) in cash and cash equivalents (372) 3,928 (2,235)
Cash and cash equivalents at beginning of the year 7,706 3,778 6,013 ---------------------------------- Cash and cash equivalents at end of the year $ 7,334 $ 7,706 $ 3,778 ---------------------------------- ---------------------------------- SUPPLEMENTAL CASH FLOW INFORMATION Cash paid during the year for: Interest $ 2,254 $ 1,369 $ 1,794 Income taxes (net of refunds) 11,942 8,192 5,581 Additions to capital lease obligations 569 4,203 - Purchases of treasury stock in connection with exercises of stock options - 139 1,695
SEE ACCOMPANYING NOTES.
Sonic Corp.
Notes to Consolidated Financial Statements
August 31, 1997, 1996 and 1995
(In Thousands, Except Share Data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
OPERATIONS
Sonic Corp. (the "Company") operates and franchises a chain of quick-service drive-in restaurants in the United States. In addition, the Company sells and leases restaurant equipment and signs. In February 1997, the Company sold, for cash, its minority investment in 10 restaurants and recognized a pre-tax gain of $1,145. In February 1996, the Company sold its restaurant equipment division, including restaurant equipment inventories of approximately $1,500, for $1,747 in cash and recognized a pre-tax gain of $250. The Company grants credit to its franchisees, all of whom are in the restaurant business. Substantially all of the notes receivable and direct financing leases are collateralized by real estate or equipment.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries and its majority-owned, Company-operated restaurants, organized principally as general partnerships. All significant intercompany accounts and transactions have been eliminated. Investments in minority-owned restaurants, organized principally as general partnerships, and other minority investments are carried at equity and are included in other assets.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported and contingent assets and liabilities disclosed in the financial statements and accompanying notes. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.
INVENTORIES
Inventories consist principally of food and supplies which are carried at the lower of cost (first-in, first-out basis) or market and used restaurant equipment held for sale which is carried at the lower of weighted average cost or market.
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
PROPERTY, EQUIPMENT AND CAPITAL LEASES
Property and equipment are recorded at cost, and leased assets under capital leases are recorded at the present value of future minimum lease payments. Depreciation of property and equipment and amortization of capital leases are computed by the straight-line method over the estimated useful lives or initial terms of the leases, respectively.
ACCOUNTING FOR LONG-LIVED ASSETS
Prior to the fourth quarter of fiscal year 1996, certain restaurants which were nonoperating and were either held for disposition or were under short-term subleases were carried at the lower of depreciated cost or estimated net realizable values. Estimated net realizable values were determined annually based upon appraisals or other independent assessments of the restaurants' estimated sales values. Subsequent to restaurant closings, the related restaurant buildings and equipment were not depreciated and the related leased restaurant buildings under capital leases were not amortized. All estimated costs which were expected to be incurred in the closings and disposals of Company-owned and certain other restaurants were accrued when the decisions were made to close such restaurants. These estimated costs included accruals for future occupancy costs, estimated direct disposal costs and reductions of the carrying values of property, equipment and capital leases to estimated net realizable values. Allowances for impairment and accrued carrying costs for restaurant closings and disposals were adjusted when necessary based on subsequent information and events.
Effective June 1, 1996 (NOTE 2), the Company reviews long-lived assets, identifiable intangibles, and goodwill related to those assets whenever events or changes in circumstances indicate that the carrying amount of an asset might not be recoverable. Assets are grouped and evaluated for impairment at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups of assets. The Company has determined that an individual restaurant is the level at which this review will be applied. The Company's primary test for an indicator of potential impairment is operating losses. If an indication of impairment is determined to be present, the Company estimates the future cash flows expected to be generated from the use of the asset and its eventual disposal. If the sum of undiscounted future cash flows is less than the carrying amount of the asset, an impairment loss is recognized. The impairment loss is measured by comparing the fair value of the asset to its carrying amount. The fair value of the asset is measured by calculating the present value of estimated future cash flows using a discount rate equivalent to the rate of return the Company expects to achieve from its investment in newly-constructed restaurants.
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Long-lived assets and identifiable intangibles held for disposal are carried at the lower of depreciated cost or fair value less cost to sell. Fair values are estimated based upon appraisals or other independent assessments of the assets' estimated sales values. During the period in which assets are being held for disposal, depreciation and amortization of such assets are not recognized.
PRE-OPENING COSTS
The costs of hiring, training and other direct costs associated with opening new restaurants are capitalized and amortized over the first twelve months of restaurant operations.
TRADEMARKS, TRADE NAMES AND OTHER GOODWILL
Trademarks, trade names and other goodwill are amortized on the straight-line method over periods not exceeding 40 years.
OTHER INTANGIBLES
Other intangibles and deferred costs included in other assets are amortized on the straight-line method over the expected period of benefit, not exceeding 15 years.
FRANCHISE FEES AND ROYALTIES
Initial franchise fees are nonrefundable and are recognized in income when all material services or conditions relating to the sale of the franchise have been substantially performed or satisfied by the Company. Area development fees are nonrefundable and are recognized in income on a pro rata basis when the conditions for revenue recognition under the individual development agreements are met. Royalties from franchise operations are recognized in income as earned.
ADVERTISING COSTS
Costs incurred in connection with advertising and promotion of the Company's products are expensed as incurred. Such costs amounted to $6,983, $4,956 and $4,204 for the years ended August 31, 1997, 1996 and 1995, respectively.
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET INCOME PER SHARE
Net income per share is based upon the weighted average number of common shares and dilutive common stock equivalent shares outstanding during each year (NOTE 12).
In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings Per Share," which is required to be adopted by the Company in the reporting period ended February 28, 1998. At that time, the Company will be required to change the method currently used to compute earnings per share and to restate all prior periods. Under the new requirements for calculating basic earnings per share, the dilutive effect of stock options will be excluded. The Company has determined that the impact of SFAS 128 on the calculation of earnings per share for the years ended August 31, 1997, 1996 and 1995 would not be material.
CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments with a maturity of three months or less from date of purchase.
2. IMPAIRMENT OF LONG-LIVED ASSETS
The Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," at the beginning of the fourth quarter of fiscal year 1996. Based on an evaluation of all restaurants which had incurred operating losses through May 31, 1996, the Company determined that certain restaurants and other assets with carrying amounts of $12,553 were impaired and wrote them down to their fair values. The initial charge upon adoption of SFAS 121 was $8,541 ($5,316 after-tax or $.39 per share) and included $5,720
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
2. IMPAIRMENT OF LONG-LIVED ASSETS (CONTINUED)
($3,560 after-tax or $.26 per share) related to restaurants and other assets held for disposal with an estimated sales value, net of related costs to sell of $2,651 and $2,821 ($1,756 after-tax or $.13 per share) related to restaurants to be held and used. The difference in the Company's previous policy and fair value under SFAS 121 for assets held for disposal at the beginning of the fourth quarter of fiscal year 1996 was not material. Certain of these properties with a carrying value of $1,207 were disposed of in fiscal 1997 with net proceeds to the Company of $1,258. The Company plans to dispose of the remaining assets during fiscal year 1998 and has estimated the sales value, net of related costs to sell, at approximately $1,400. The initial charge upon adoption primarily relates to the write-down of certain restaurants to fair value consistent with the earnings expectations of each restaurant using discounted estimated future cash flows. Considerable management judgment is necessary to estimate future discounted cash flows. Accordingly, actual results could vary significantly from management's estimates. The evaluation for impairment is done for each individual restaurant, rather than all restaurants as a group. The initial charge resulted from the Company grouping assets at a lower level than under its previous accounting policy for evaluating and measuring impairment. Prior to adoption of this new standard, a write-down of a restaurant only took place when a decision was made to close or dispose of the restaurant.
3. RESTAURANT TRANSACTIONS WITH RELATED PARTY
In March 1994, the Company entered into an agreement with a director and former officer of the Company in connection with his leaving the Company and returning to his career as a Sonic franchisee. Under that agreement, the director exchanged certain rights under his employment agreement, including the right to purchase six existing Sonic restaurants, for the right to purchase the Company's interest in two existing Sonic restaurants (with financing provided by the Company) and to acquire certain development rights for future Sonic restaurants. As part of the agreement, the Company also agreed to assist the director with obtaining development financing for up to six Sonic restaurants. Since March 1994, the Company has entered into certain agreements with the director and the director's lender which provide that in the event of a default by the director under the terms of the director's restaurant development loans (aggregating $3,556 as of August 31, 1997 and $3,460 as of August 31, 1996), the Company is required to purchase the collateral (shares of the Company's common stock and real estate related to Sonic restaurants) securing the director's loans at fair market value as specified in the repurchase agreements. At August 31, 1997, the Company's repurchase obligations under these agreements expire in 1999 ($1,567), 2000 ($82) and 2001 ($1,907).
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
4. ACCOUNTS AND NOTES RECEIVABLE
Accounts and notes receivable consist of the following at August 31, 1997 and 1996:
1997 1996 -------------------- Trade receivables $ 3,208 $ 2,878 Notes receivable--current 874 846 Other 1,907 1,638 -------------------- 5,989 5,362 Less allowance for doubtful accounts and notes receivable 99 133 -------------------- $ 5,890 $ 5,229 -------------------- --------------------
Notes receivable--noncurrent $ 3,488 $ 3,193 Less allowance for doubtful notes receivable 174 130 -------------------- $ 3,314 $ 3,063 -------------------- --------------------
5. INTANGIBLES AND OTHER ASSETS
Intangibles and other assets consist of the following at August 31, 1997 and 1996:
1997 1996 -------------------- Trademarks, trade names, and other goodwill $21,124 $20,945 Franchise agreements 1,870 1,870 Other intangibles and other assets 6,547 3,775 -------------------- 29,541 26,590 Less accumulated amortization 6,596 4,496 -------------------- $22,945 $22,094 -------------------- --------------------
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
6. LEASES
DESCRIPTION OF LEASING ARRANGEMENTS
The Company's leasing operations consist principally of leasing certain land, buildings and equipment (including signs) and subleasing certain buildings to franchise operators. The land portions of these leases are classified as operating leases and expire over the next six years. The buildings and equipment portions of these leases are classified principally as direct financing or sales-type leases and expire principally over the next six years. These leases include provisions for contingent rentals which may be received on the basis of a percentage of sales in excess of stipulated amounts. Some leases contain escalation clauses over the lives of the leases.
Certain Company-owned restaurants lease land and buildings from third parties. These leases, which expire over the next fourteen years, include provisions for contingent rentals which may be paid on the basis of a percentage of sales in excess of stipulated amounts. The land portions of these leases are classified as operating leases and the buildings portions are classified as capital leases.
DIRECT FINANCING AND SALES-TYPE LEASES
Components of net investment in direct financing and sales-type leases are as follows at August 31, 1997 and 1996:
1997 1996 ------------------ Minimum lease payments receivable $5,441 $5,670 Less unearned income 1,224 1,466 ------------------ Net investment in direct financing and sales-type leases 4,217 4,204 Less amount due within one year 856 783 ------------------ Amount due after one year $3,361 $3,421 ------------------ ------------------
Minimum lease payments receivable for each of the five years after August 31, 1997 are $1,367 in 1998, $1,249 in 1999, $1,013 in 2000, $807 in 2001, $611 in 2002 and $394 thereafter. Initial direct costs incurred in the negotiation and consummation of direct financing and sales-type lease transactions have not been material during fiscal years 1997 and 1996. Accordingly, no portion of unearned income has been recognized to offset those costs.
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
6. LEASES (CONTINUED)
Other revenues include $768, $1,340 and $1,163 for the years ended August 31, 1997, 1996 and 1995, respectively, related to sign lease transactions that have been accounted for as sales-type leases.
CAPITAL LEASES
Components of obligations under capital leases are as follows at August 31, 1997 and 1996:
1997 1996 ------------------ Total minimum lease payments $14,793 $16,701 Less amount representing interest 5,610 6,893 ------------------ Present value of net minimum lease payments 9,183 9,808 Less amount due within one year 1,030 823 ------------------ Amount due after one year $ 8,153 $ 8,985 ------------------ ------------------
Maturities of these obligations under capital leases, including interest, at rates averaging approximately 12% in 1997 and 13% in 1996 and future minimum rental payments required under operating leases that have initial or remaining noncancelable lease terms in excess of one year are as follows:
OPERATING CAPITAL --------- ------- Year ending August 31: 1998 $ 2,579 $ 1,960 1999 2,473 1,790 2000 2,403 1,505 2001 2,358 1,357 2002 2,241 1,283 Thereafter 12,261 6,898 ------------------ 24,315 14,793 Less amount representing interest - 5,610 ------------------ $24,315 $ 9,183 ------------------ ------------------
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
6. LEASES (CONTINUED)
Total minimum lease payments do not include contingent rentals. Contingent rentals on capital leases were $387, $334 and $291 for the years ended August 31, 1997, 1996 and 1995, respectively.
Rent expense on all operating leases was $2,715, $2,443 and $1,918 for the years ended August 31, 1997, 1996 and 1995, respectively.
7. PROPERTY, EQUIPMENT AND CAPITAL LEASES
Property, equipment and capital leases consist of the following at August 31, 1997 and 1996:
1997 1996 ------------------ Home office: Land and leasehold improvements $ 1,262 $ 1,041 Furniture and equipment 17,768 13,165 Restaurants, including those leased to others: Land 33,739 24,184 Buildings, including property held for disposition 53,582 38,013 Equipment 47,884 31,702 ------------------ Property and equipment, at cost 154,235 108,105 Less accumulated depreciation 24,335 15,497 ------------------ Property and equipment, net 129,900 92,608
Leased restaurant buildings and equipment under capital leases, including those held for sublease 10,101 10,809 Less accumulated amortization 3,479 2,912 ------------------ Capital leases, net 6,622 7,897 ------------------ Property, equipment and capital leases, net $136,522 $100,505 ------------------ ------------------
Property and equipment include land, buildings and equipment with a carrying amount of $2,734 at August 31, 1997 which were leased under operating leases to franchisees or other parties. The accumulated depreciation related to these buildings and equipment was $461 at August 31, 1997.
Property, equipment and capital leases also include assets held for disposal or sublease with aggregate net carrying amounts, exclusive of certain carrying costs reflected in liabilities, of $1,464 at August 31, 1997 and $3,571 at August 31, 1996.
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
8. ACCRUED LIABILITIES
Accrued liabilities consist of the following at August 31, 1997 and 1996:
1997 1996 ------------------ Wages and other employee benefits (NOTE 13) $1,383 $1,422 Income taxes payable (NOTE 11) 1,560 2,635 Taxes, other than income taxes 3,487 2,717 Accrued carrying costs for restaurant closings and disposals 370 592 Other 1,829 475 ------------------ $8,629 $7,841 ------------------ ------------------
9. LONG-TERM DEBT
Long-term debt consists of the following at August 31, 1997 and 1996:
1997 1996 ------------------ Borrowings under line of credit (A) $37,000 $11,500 Non-interest bearing obligation, paid in 1997 - 422 8.5% notes payable, due in monthly installments until 2011 384 399 Other 249 80 ------------------ 37,633 12,401 Less long-term debt due within one year 116 517 ------------------ Long-term debt due after one year $37,517 $11,884 ------------------ ------------------
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
9. LONG-TERM DEBT (CONTINUED)
(A) The Company has an agreement (as amended) with a group of banks which provides for a $80,000 line of credit expiring in July 2000. The agreement allows for annual renewal options, subject to approval by the banks, which has not currently been exercised by the Company. The Company uses the line of credit to finance the opening of newly-constructed restaurants, acquisition of existing restaurants and for general corporate purposes. Borrowings under the line of credit are unsecured and bear interest at a specified bank's prime rate or, at the Company's option, LIBOR plus 0.75% to 1.25%. In addition, the Company pays an annual commitment fee ranging from .125% to .25% on the unused portion of the line of credit. As of August 31, 1997, the Company's effective borrowing rate was 7%. Under its line of credit, the Company may borrow up to $80,000 in the form of direct borrowings and letters of credit with a $2,000 sub-limit for letters of credit. As of August 31, 1997 there were $100 in letters of credit outstanding under the line of credit. Borrowings under the line of credit are subject to various restrictive financial covenants.
Maturities of long-term debt for each of the five years after August 31, 1997 are $116 in 1998, $117 in 1999, $37,069 in 2000, $21 in 2001, $23 in 2002 and $287 thereafter.
10. OTHER NONCURRENT LIABILITIES
Other noncurrent liabilities consist of the following at August 31, 1997 and 1996:
1997 1996 ------------------ Deferred area development fees $ 495 $ 608 Minority interest in consolidated restaurant partnerships 2,948 2,589 Accrued carrying costs for restaurant closings and disposals 756 870 Other 852 139 ------------------ $5,051 $4,206 ------------------ ------------------
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
11. INCOME TAXES
The provision for income taxes consists of the following:
YEAR ENDED AUGUST 31, 1997 1996 1995 --------------------------- Current: Federal $ 8,070 $8,371 $6,744 State 308 353 619 --------------------------- 8,378 8,724 7,363
Deferred: Federal 2,847 (1,839) 357 State 103 (66) 13 --------------------------- 2,950 (1,905) 370 --------------------------- Provision for income taxes $11,328 $ 6,819 $7,733 --------------------------- ---------------------------
The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate due to the following:
YEAR ENDED AUGUST 31, 1997 1996 1995 --------------------------- Amount computed by applying a tax rate of 35% $10,643 $ 6,322 $7,076 State income taxes (net of federal income tax benefit) 267 187 411 Permanent differences in expenses for financial and income tax reporting purposes (69) (283) (56) Other 487 593 302 --------------------------- Provision for income taxes $11,328 $ 6,819 $7,733 --------------------------- ---------------------------
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
11. INCOME TAXES (CONTINUED)
Deferred tax assets and liabilities consist of the following at August 31, 1997 and 1996:
1997 1996 ------------------ Deferred tax assets: Property, equipment and capital leases $ 499 $ 2,160 Accrued litigation costs 338 18 Investment in partnerships, including differences in capitalization and depreciation related to direct financing and sales-type leases and different year ends for financial and tax reporting purposes - 1,095 Allowance for doubtful accounts and notes receivable 98 94 Other 337 63 ------------------ 1,272 3,430 Valuation allowance - - ------------------ Deferred tax assets 1,272 3,430
Less deferred tax liabilities:
Accumulated amortization of license agreements, management contracts and other intangibles 736 409
Net investment in direct financing and sales-type leases, including differences related to capitalization and amortization 890 639
Investment in partnerships, including differences in capitalization and depreciation related to direct financing and sales-type leases and different year ends for financial and tax reporting purposes 299 - Other 3 88 ------------------ Deferred tax liabilities 1,928 1,136 ------------------ Net deferred tax assets (liabilities) $ (656) $ 2,294 ------------------ ------------------
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
12. STOCKHOLDERS' EQUITY
In July 1995, the Company's board of directors authorized a three-for-two stock split in the form of a stock dividend. A total of 4,019,321 shares of common stock were issued in connection with the split. The stated par value of each share was not changed from $.01. A total of $41 was reclassified from paid-in capital to common stock. All references in the accompanying consolidated financial statements to average numbers of shares outstanding, per share amounts and Stock Purchase Plan and Stock Options share data have been restated to reflect the split.
In October 1995, the Company completed a public offering of 1,668,826 shares of common stock at $21.25 per share. The offering included 428,026 shares of treasury stock which had a cost of $6,459. The proceeds of the offering, after deducting the underwriting discount and offering expenses, were $33,186. A portion of the proceeds ($23,000) was used to repay the borrowings under the Company's line of credit.
STOCK PURCHASE PLAN
The Company has an employee stock purchase plan for all full-time regular employees of the Company. Employees are eligible to purchase shares of common stock each year through a payroll deduction not in excess of the lesser of 10% of compensation or $25. The aggregate amount of stock that employees may purchase each calendar year under this plan is limited to 150,000 shares. The purchase price will be between 85% and 100% of the stock's fair market value. Such price will be determined by the Company's board of directors.
STOCK OPTIONS
The Company has an Incentive Stock Option Plan (the "Incentive Plan") and a Directors' Stock Option Plan (the "Directors' Plan"). Under the Incentive Plan, the Company is authorized to grant options to purchase up to 1,870,000 shares of the Company's common stock to officers and key employees of the Company and its subsidiaries. Under the Directors' Plan, the Company is authorized to grant options to purchase up to 225,000 shares of the Company's common stock to the Company's outside directors. The exercise price of the options to be granted is equal to the fair market value of the Company's common stock on the date of grant. Unless otherwise provided by the Company's Stock Plan Committee, options under both plans become exercisable ratably over a three-year period or immediately upon change in control of the Company, as defined by the plans. All options expire at the earlier of termination of employment or ten years after the date of grant.
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
12. STOCKHOLDERS' EQUITY (CONTINUED)
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing such stock options. Under APB 25, because the exercise price of the Company's stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
Pro forma information regarding net income and net income per share is required by Statement 123, which also requires that the information be determined as if the Company has accounted for its stock options granted subsequent to August 31, 1995 under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for fiscal years 1997 and 1996, respectively: risk-free interest rates of 6.3% and 6.0%; a dividend yield of 0%; volatility factors of the expected market price of the Company's common stock of 39.9% and 29.5%; and a weighted average expected life of the option of five years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information for the years ended August 31 follows:
1997 1996 ------------------
Pro forma net income $18,435 $11,058 Pro forma net income per share $ 1.37 $ .82
Because Statement 123 is applicable only to options granted subsequent to August 31, 1995, its pro forma effect will not be fully reflected until fiscal year 1998.
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
12. STOCKHOLDERS' EQUITY (CONTINUED)
A summary of the Company's stock option activity, and related information for the years ended August 31 follows:
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
12. STOCKHOLDERS' EQUITY (CONTINUED)
STOCKHOLDER RIGHTS PLAN
On June 16, 1997, the Company announced that its Board of Directors had adopted a stockholder rights plan (the "Rights Plan"). The Rights Plan is designed to deter coercive takeover tactics and to prevent a potential acquirer from gaining control of the Company without offering a fair price to all of the Company's stockholders. The rights were issued to stockholders of record as of June 27, 1997 and expire on June 16, 2007.
The plan provided for the issuance of one common stock purchase right for each outstanding share of the Company's common stock. Each right initially entitles stockholders to buy one unit of a share of preferred stock for $85.00. The rights will be exercisable only if a person or group acquires beneficial ownership of 15% or more of the Company's common stock or commences a tender or exchange offer upon consummation of which such person or group would beneficially own 15% or more of the Company's common stock. At August 31, 1997, 50,000 shares of preferred stock have been reserved for issuance upon exercise of these rights.
If any person becomes the beneficial owner of 15% or more of the Company's common stock, other than pursuant to a tender or exchange offer for all outstanding shares of the Company approved by a majority of the independent directors not affiliated with a 15%-or-more stockholder, then each right not owned by a 15%-or-more stockholder or related parties will then entitle its holder to purchase, at the right's then current exercise price, shares of the Company's common stock having a value of twice the right's then current exercise price. In addition, if, after any person has become a 15%-or-more stockholder, the company is involved in a merger or other business combination transaction with another person in which the company does not survive or in which its common stock is changed or exchanged, or sells 50% or more of its assets or earning power to another person, each right will entitle its holder to purchase, at the right's then current exercise price, shares of common stock of such other person having a value of twice the right's then current exercise price. Unless a triggering event occurs, the rights will not trade separately from the common stock.
The company will generally be entitled to redeem the rights at $0.01 per right at any time until 10 days (subject to extension) following a public announcement that a 15% position has been acquired.
STOCK INCENTIVE PLAN
In November 1995, the Company adopted the Sonic Corp. 1995 Stock Incentive Plan (the "Stock Incentive Plan") whereby the Company may issue up to 120,000 shares of common stock to certain key employees. Participants in the Stock Incentive Plan receive awards of shares of restricted common stock (the "Restricted Stock"), subject to not vesting if the Company does not meet certain annual performance criteria. If the Company meets the performance criteria, the portion of the award tied to the criteria will vest. Until the Restricted Stock vests, an escrow
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
12. STOCKHOLDERS' EQUITY (CONTINUED)
agent holds the Restricted Stock. If the Company does not meet the performance criteria, the portion of the award tied to that criteria will not vest and the related shares are available for future awards. Upon vesting, the participant will have the right to receive certificates representing the shares of vested Restricted Stock.
During fiscal year 1996, the Company awarded 87,000 shares of Restricted Stock which vest over a three-year period if specified performance goals are met (no shares were awarded in fiscal year 1997). The Company did not meet the specified performance criteria in fiscal years 1997 and 1996 which resulted in 24,000 shares and 20,000 shares, respectively, not vesting. In addition, 10,000 shares were forfeited in fiscal year 1997 due to termination of employment. Shares applicable to awards which have not vested are not reflected as shares issued in the accompanying financial statements.
13. EMPLOYEE BENEFIT PLANS
SAVINGS AND PROFIT SHARING PLAN
The Company has a Savings and Profit Sharing Plan (the "Plan"), as amended, for eligible employees. Employees who have completed one year of service with the Company are eligible to participate in the Plan. Under the Plan, participating employees may authorize payroll deductions up to 11% of their earnings. The Company may elect to contribute a percentage of participants' contributions to the Plan. Additional amounts may be contributed at the option of the Company's board of directors. Company contributions are subject to vesting at the rate of 20% each year upon completion of two years of service, with 100% vesting after six years. Matching contributions of $142, $114 and $101 were made by the Company during fiscal years ended 1997, 1996 and 1995, respectively. For fiscal year 1997, a discretionary contribution of $75 was accrued ($35 and $50 for fiscal years 1996 and 1995, respectively).
NET REVENUE INCENTIVE PLAN
The Company has a Net Revenue Incentive Plan (the "Incentive Plan"), as amended, which applies to certain members of management and is at all times discretionary with the Company's board of directors. If certain predetermined earnings goals are met, the Incentive Plan provides that a predetermined percentage of the employee's salary may be paid in the form of a bonus. The Company accrued incentive bonuses of $804, $341 and $367 during fiscal years 1997, 1996 and 1995, respectively.
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
14. EMPLOYMENT AGREEMENTS
The Company has employment contracts with its President and several members of its senior management. These contracts provide for use of Company automobiles or related allowances, medical, life and disability insurance, annual base salaries, as well as an incentive bonus (NOTE 13). These contracts also contain provisions for payments in the event of the termination of employment and provide for payments aggregating $3,308 at August 31, 1997 due to loss of employment in the event of a change in control (as defined in the contracts).
15. CONTINGENCIES
In October 1993, following a jury trial, the District Court of Jefferson County, Texas (the "District Court") entered a judgment against two subsidiaries of the Company in the amount of $935 of actual damages and prejudgment interest, and $1,000 of punitive damages in an action in which the plaintiffs claim the subsidiaries interfered with contractual relations of the plaintiffs and were guilty of deceptive trade practices. In March 1994, the District Court granted a motion for judgment notwithstanding the verdict filed by the two subsidiaries of the Company. The District Court's judgment eliminated the award of actual and punitive damages in favor of certain plaintiffs. The plaintiffs appealed the reversal of the previous judgments. In April 1996, the Texas Court of Appeals reversed the District Court's judgment notwithstanding the verdict and reinstated the jury's verdict in the amount of $782 of actual damages, $1,000 of punitive damages, and pre and post judgment interest. The Company has appealed the Court of Appeals reversal to the Supreme Court of Texas. The Company continues to believe that the findings of the jury and the Court of Appeals had no merit and will defend its position vigorously. The Company presently cannot predict the ultimate outcome of this matter. A final resolution is not expected to have a material adverse effect on the Company's financial position or results of operations.
The Company is a party to several additional legal actions arising in the conduct of its business. Management of the Company believes that the ultimate resolution of these actions will not have a material adverse effect on the Company's financial position or results of operations.
16. QUARTERLY FINANCIAL DATA (UNAUDITED)
(a) Restaurant equipment sales and cost of sales declined due to the sale of the Company's equipment division in February 1996. (b) The Company adopted Statement of Financial Accounting Standards No. 121 during the fourth quarter of 1996 resulting in a $8,541 pre-tax impairment provision.
17. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following discussion of fair values is not indicative of the overall fair value of the Company's consolidated balance sheet since the provisions of SFAS No. 107, "Disclosures About Fair Value of Financial Instruments," do not apply to all assets, including intangibles.
The following methods and assumptions were used by the Company in estimating its fair values of financial instruments:
CASH AND CASH EQUIVALENTS--Carrying value approximates fair value.
NOTES RECEIVABLE--For variable rate loans with no significant change in credit risk since the loan origination, fair values approximate carrying amounts. Fair values for fixed rate loans are estimated using discounted cash flow analysis, using interest rates which would currently be offered for loans with similar terms to borrowers of similar credit quality and/or the same remaining maturities.
As of August 31, 1997 and 1996, carrying values approximate their estimated fair values.
BORROWED FUNDS--Fair values for fixed rate borrowings are estimated using a discounted cash flow analysis that applies interest rates currently being offered on borrowings of similar amounts and terms to those currently outstanding. Carrying values for variable rate borrowings approximate their fair values.
As of August 31, 1997 and 1996, carrying values approximate their estimated fair values.
Sonic Corp.
Schedule II - Valuation and Qualifying Accounts
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Company has caused the undersigned, duly-authorized, to sign this report on its behalf on this 26th day of November, 1997.
Sonic Corp.
By: /s/ J. Clifford Hudson ---------------------------------------- J. Clifford Hudson, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the undersigned have signed this report on behalf of the Company, in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ----
/s/ J. Clifford Hudson President, Chief November 26, 1997 - ------------------------------ Executive Officer and J. Clifford Hudson, Principal Director Executive Officer
/s/ W. Scott McLain Vice President, Chief November 26, 1997 - ------------------------------ Financial Officer W. Scott McLain, Principal and Treasurer Financial Officer
/s/ Stephen C. Vaughan Vice President and November 26, 1997 - ------------------------------ Controller Stephen C. Vaughan, Principal Accounting Officer
/s/ E. Dean Werries Chairman of the Board November 19, 1997 - ------------------------------ and Director E. Dean Werries
/s/ Dennis H. Clark Director November 24, 1997 - ------------------------------ Dennis H. Clark
/s/ Leonard Lieberman Director November 26, 1997 - ------------------------------ Leonard Lieberman
/s/ H. E. Rainbolt Director November 24, 1997 - ------------------------------ H. E. Rainbolt
/s/ Frank E. Richardson Director November 25, 1997 - ------------------------------ Frank E. Richardson
/s/ Robert M. Rosenberg Director November 20, 1997 - ------------------------------ Robert M. Rosenberg
EXHIBIT INDEX
EXHIBIT NUMBER AND DESCRIPTION
10.07. Form of General Partnership Agreement, Limited Liability Company Operating Agreement, Partnership Master Agreement, and Limited Liability Company Master Agreement. 10.16. Form of Employment Agreement and Schedule of Material Differences for the Executive Officers of the Company 23.01. Consent of Independent Auditors 24.01. Power of Attorney 27.01. Financial Data Schedules