Back to GetFilings.com

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Registrant's Telephone Number, Including Area Code: (405) 280-7654

        Securities Registered Pursuant to Section 12(b) of the Exchange Act:

None

Securities Registered Pursuant to Section 12(g) of the Exchange Act:

Common Stock, Par Value $.01
Rights to Purchase Series A Junior Preferred Stock, Par Value $.01

        Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for the shorter period that the Registrant has had to file the reports), and (2) has been subject to the filing requirements for the past 90 days. YES X . No     .

        Indicate by check mark if this Form 10-K does not contain and, to the best of the Registrant’s knowledge, the Registrant’s definitive proxy statement or information statement incorporated by reference in Part III of this Form 10-K will not contain a disclosure of delinquent filers pursuant to Item 405 of Regulation S-K. YES X . No     .

        As of November 1, 2002, the aggregate market value of the 37,467,299 shares of common stock of the Company held by non-affiliates of the Company equaled approximately $892.5 million, based on the closing sales price for the common stock as reported for that date. As of November 1, 2002, the Registrant had 39,125,625 shares of common stock issued and outstanding (excluding 9,364,820 shares of common stock held as treasury stock).

Documents Incorporated by Reference

        Part III of this report incorporates by reference certain portions of the definitive proxy statement which the Registrant will file with the Securities and Exchange Commission in connection with the Company’s annual meeting of stockholders following the fiscal year ended August 31, 2002.

FORM 10-K OF SONIC CORP.

TABLE OF CONTENTS

FORM
10-K

SONIC CORP.

PART I

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, 2002, the Company had 2,533 restaurants in operation, consisting of 452 Company-owned restaurants and 2,081 franchised restaurants, principally in the southern two-thirds of the United States. At a typical Sonic restaurant, a customer drives into one of 24 to 36 covered drive-in spaces, orders through an intercom speaker system, and has the food delivered by a carhop within an average of four minutes.

        The Sonic drive-in restaurant chain began in the early 1950’s. The Company has two operating subsidiaries, Sonic Industries Inc. and Sonic Restaurants, Inc.  Sonic Industries Inc. serves as the franchisor of the Sonic restaurant chain, as well as the administrative services center for the Company. Sonic Restaurants, Inc. develops and operates the Company-owned restaurants. References in this report to the “Company” and “Sonic” are references to Sonic Corp. and its subsidiaries and predecessors, unless the context indicates otherwise.

        The Sonic drive-in restaurant chain began in the early 1950’s. The Company was incorporated in the State of Delaware in 1990, in connection with its 1991 public offering of consumer stock. 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 restaurants profitably and efficiently; and (5) a commitment to support the Sonic system.

        The Sonic drive-in restaurant chain was begun in the early 1950's by the Company's predecessors. The Company was incorporated in the State of Delaware in 1990 in connection with its 1991 public offering of common stock. The Company’s principal executive offices are located at 101 Park Avenue, Oklahoma City, Oklahoma 73102. The Company’s telephone number is (405) 280-7654.

Menu

        Sonic restaurants offer made-to-order hamburgers and other sandwiches and feature Sonic signature items, such as extra-long cheese coneys, hand-battered onion rings, tater tots, specialty soft drinks including cherry limeades and slushes, and frozen desserts. In addition, the Company’s restaurants offer certain other items during limited-time promotions.

        Sonic began offering a breakfast menu in certain test markets in October 1999. The breakfast menu is currently offered in markets comprising approximately 49% of all Sonic restaurants. The Company plans to continue the expansion of the number of restaurants offering the breakfast menu to all Sonic restaurants over the next few years. Those restaurants serving a breakfast menu are open beginning no later than 7 a.m. and serve the full menu all day. Items on the breakfast menu include sausage, ham, or bacon with egg and cheese Toaster_® sandwiches, sausage and egg burritos, and specialty breakfast drinks.

Restaurant Locations

        As of August 31, 2002, the Company owned or franchised 2,533 drive-in restaurants, which are located in 30 states, principally in the southern two-thirds of the United States, and in Mexico. The Company defines its core markets as those television markets where the penetration of Sonic restaurants (as measured by population per restaurant, advertising levels, and share of restaurant spending) has reached a certain level of market maturity established by management. All other television markets where restaurants are located are referred to as developing markets. A market may be located where it extends into more than one state. The Company’s core markets contain approximately 74% of all Sonic restaurants as of August 31, 2002. Developing markets are located in the states indicated below and Mexico. Many states have both core markets and developing markets. Based on the relative composition of core and developing markets within a state, the Company classifies a state as either a core or developing market state. The Company now has two restaurants in Mexico and a development agreement providing for seven additional restaurants to be opened in Mexico in the next three years. The following table sets forth the number of Company-owned and franchised restaurants by core and developing markets as of August 31, 2002:

2

Expansion

        During fiscal year 2002, the Company opened 40 Company-owned restaurants and its franchisees opened 142 restaurants. During fiscal year 2003, the Company plans to open approximately 35 to 40 Company-owned restaurants and anticipates that its franchisees will open approximately 150 to 160 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. The ability of the Company and its franchisees to open the anticipated number of Sonic drive-in restaurants during fiscal year 2003 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 and its franchisees, and the general economic and business conditions to be faced in fiscal year 2003.

        The Company’s expansion strategy for Company-owned restaurants involves two principal components: (1) the building-out of existing core markets and (2) the further penetration of developing markets. 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 speaker system and menu board. In addition, since 1995, the Company has incorporated a drive-through service and patio seating area in most new restaurants. A few Sonic restaurants provide an indoor seating area and a few restaurants are located in non-traditional areas such as shopping mall food courts and convenience stores.

        Retrofit Program. In fiscal year 1997, the Company began implementing a remodeling program to retrofit all Sonic drive-in restaurants. The retrofit included new signage, new menu and speaker housings, and significant trade dress modifications to the exterior of each restaurant’s building. The Company implemented the program on a market-by-market basis and as of August 31, 2002, all markets and 98% of the Sonic chain featured the new retrofit signage and trade dress style.

Marketing

        The Company has designed its marketing program to differentiate Sonic drive-in restaurants from its 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, radio commercials, point-of-sale materials, and other media as appropriate. Those promotions generally center on products which highlight signature menu items of Sonic drive-in restaurants.

        Each year the Company and its advertising agency (with involvement of the Sonic Franchise 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 administered by the Company), the franchisees contribute a range of 0.375% to 0.75% of gross revenues. The members of each local advertising cooperative may elect and frequently do elect to have the cooperative’s member drive-ins contribute more than the minimum percentage of gross revenues to the advertising cooperative’s funds. In 1999, Sonic restaurant owners approved the establishment of a System Marketing Fund which became effective January 1, 2000. The purpose of this fund is to complement local advertising efforts in attracting customers to Sonic restaurants by promoting the message of the Sonic brand to an expanded audience. The primary focus of the fund is to purchase advertising on

3

national cable and broadcast networks and other national media and sponsorship opportunities. The System Marketing Fund is funded by 0.5% of each franchisee’s gross revenues, which amount is redistributed from the franchisee’s local advertising fund contribution.

        For fiscal year 2002, franchisees participating in cooperatives contributed an average of 3.76% of gross revenues to Sonic advertising cooperatives, exceeding the required 1.125% to 3.25% under most license agreements in effect during that period. As of August 31, 2002, 2,444 Sonic restaurants (96% of the chain) participated in advertising cooperatives. The Company estimates that the total amount spent on media (principally television) exceeded $90 million for fiscal year 2002 and expects media expenditures to exceed $100 million for fiscal year 2003.

Purchasing

        The Company negotiates with suppliers for its primary food products (hamburger patties, dairy products, 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. Sonic restaurants 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 purchase from approved distribution centers. By purchasing as a group, the Company has achieved cost savings, improved food quality and consistency, and helped decrease the volatility of food and supply costs for Sonic restaurants. For fiscal year 2002, the average cost of food and packaging for a Sonic restaurant, as reported to the Company by its franchisees, equaled approximately 27.5% of net revenues. The Company believes that negotiating and purchasing food as a system has allowed Sonic restaurants to avoid menu price increases that otherwise might have occurred. The reduction in the number of food and paper product distributors to the Sonic chain over the past few years has improved the ability of the Company to negotiate more advantageous purchasing terms and to maintain more uniform products.

Food Safety and Quality Assurance

        To ensure the consistent delivery of safe, high-quality food, Sonic created a food safety and quality assurance program. Sonic’s food safety program promotes the quality and safety of all products and procedures utilized by all Sonic restaurants, and provides certain requirements that must be adhered to by all suppliers, distributors, and restaurants. The Company also has a comprehensive, restaurant-based food safety program called Sonic Safe. Sonic Safe is a risk-based system that utilizes Hazard Analysis & Critical Control Points (HACCP) principles for managing food safety and quality. The Company’s food safety system includes employee training, supplier product testing, drive-in food safety auditing by independent third parties, and other detailed components that monitor the safety and quality of the products and procedures of the Company at every stage of the food preparation and production cycle. Employee training in food safety is covered under the Company’s franchisee training program, referred to as the STAR Training Program. This program includes specific training information and requirements for every station in the drive-in. The Company also provides training in ServSafe, the most recognized food safety training certification in the restaurant industry.

General Operations

        Management Information Systems. The Company utilizes point-of-sale equipment in each of its Company-owned and franchised restaurants. Certain financial and other information is polled on a daily basis from most Company-owned restaurants. The Company is developing software and hardware enhancements to its management information systems to facilitate communication and the exchange of information among the corporate office and Company-owned and franchised restaurants.

        Reporting. The license agreement requires all Sonic restaurants to submit a profit and loss statement on or before the 20^th of each month. All company-owned stores and approximately 580 or 28.2% of franchise stores submit their data electronically. Sonic expects to add more stores to electronic reporting which will reduce resources needed for manual processing of store level data.

4

        Hours of Operation. Sonic restaurants typically operate seven days a week. The restaurants participating in the breakfast program (approximately 49% of all Sonic restaurants) are generally open no later than 7:00 a.m. and close at 11:00 p.m. All other restaurants are typically open from 10:00 a.m. to 11:00 p.m.

Company Operations

        Restaurant Personnel. A typical Company-owned restaurant is operated by a manager, two to four assistant managers, and approximately 25 hourly employees, many of whom work part-time. The manager has responsibility for the day-to-day operations of the restaurant. Each supervisor has the responsibility of overseeing an average of four to seven Company-owned restaurants. The Company also employs 15 Directors of Operations who oversee an average of five to six supervisors within their respective regions and three regional vice presidents who report to vice presidents. The Directors report to either a regional vice president or a vice president. The Company employs a Senior 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 with supervisors and managers. As part of the ownership program, either a limited liability company or a general partnership is formed to own and operate each individual Company-owned restaurant. The Company owns a majority interest, typically at least 60%, in each of these limited liability companies and partnerships. Generally, the supervisors and managers own a minority interest in the limited liability company or partnership. The Company believes that its ownership structure provides a substantial incentive for restaurant supervisors and managers to operate their restaurants profitably and efficiently.

        The Company records the interests of supervisors and managers as “minority interest in earnings of restaurants” under costs and expenses on its financial statements. The Company estimates that the average percentage interest of a supervisor was 16% and the average percentage interest of a manager in a restaurant was 18% in fiscal year 2002. Each restaurant distributes its available cash flow to its supervisors and managers and to the Company on a monthly basis pursuant to the terms of the operating agreement or partnership agreement for that restaurant. The Company has the right to purchase the minority interest of the supervisor or manager in the restaurant. Typically, the amounts of the buy-in and the buy-out are based on the restaurant’s sales during the preceding 12 months.

        Each restaurant usually purchases equipment with funds borrowed from the Company at competitive rates. In most cases, the Company alone owns or leases the land and building and guarantees any third-party lease entered into for the site.

         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.

        *The relatively large number of stores sold to franchisees in fiscal years 1998 and 1999 and purchased from franchisees in fiscal years 2001 and 2002 represent transactions where a majority of restaurants in a certain market were sold to or purchased

5

from a multi-unit franchisee group. In all such instances where the Company purchased restaurants, the selling multi-unit franchisee groups continued to own and operate multiple franchised Sonic restaurants.

Franchise Program

        General. During its more than 45 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 its continued growth and believes its relationship with its franchisees is good.

        As of August 31, 2002, the Company had 2,081 franchised restaurants operating in 30 states and Mexico, and the Company had entered into area development agreements which contemplate the opening of 152 additional restaurants during fiscal year 2003. However, the Company cannot give any assurance that its franchisees will achieve that number of new restaurants for fiscal year 2003. During fiscal year 2002, the Company’s franchisees opened 85 Sonic drive-in restaurants pursuant to existing area development agreements.

        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 royalty fee based on a graduated percentage of the gross revenues of the restaurant. The Company’s current license agreement provides for a franchise fee of $30,000 and an ascending royalty rate beginning at 1% of gross revenues and increasing to 5% as the level of gross revenues increases. Approximately 99% of all Sonic restaurants opening in fiscal year 2003 are expected to open under the current license agreement. Pursuant to the terms of existing area development agreements, the remaining 1% of all Sonic restaurants opening in fiscal year 2003 will open under a former version of the license agreement, which provides for a franchise fee of $15,000 and an ascending royalty rate beginning at 1% of gross revenues and increasing to 4% as the level of gross revenues increases. All license agreements to be issued to restaurants opening in fiscal year 2003 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 policies and standards of the Company. Many state franchise laws limit the ability of the Company to terminate or refuse to renew a franchise.

        As of August 31, 2002, 30% of all Sonic restaurants were subject to the 1% to 5% graduated royalty rate, 53% were subject to the 1% to 4% graduated royalty rate, and 17% were subject to a former version of the license agreement (which is no longer being issued) providing for a 1% to 3% graduated royalty rate. For fiscal year 2002, the Company’s average royalty rate equaled 3.27%. Beginning in fiscal year 2003 and continuing through fiscal year 2010, a total of 218 franchised restaurants currently operating under the license agreement providing for the 1% to 3% graduated royalty will have their royalty rates increase to the 1% to 4% graduated royalty rate. The license agreements for the remaining 130 restaurants which are subject to the 1% to 3% graduated royalty rate will expire beginning in fiscal year 2003 and continuing through fiscal year 2010. Restaurants currently operating under those expiring license agreements will either cease operations or renew their licenses pursuant to the terms of the then current license agreement. The Company expects that such automatic increase of royalty rates under certain existing license agreements and the renewals of the other expiring license agreements will contribute to an increase in the Company’s royalty revenues.

        Area 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 many existing franchisees continue to expand on a single restaurant basis, approximately 60% of the new franchised restaurants opened during fiscal year 2002 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 year 2002, the Company entered into 34 new area development agreements calling for the opening of 161 Sonic drive-in restaurants during the next six years. As of August 31, 2002, the Company had a total of 130 area development agreements in effect, calling for the development of 575 additional Sonic drive-in restaurants

6

during the next six years. Of the 138 restaurants scheduled to open during fiscal year 2002 under area development agreements in place at the beginning of that fiscal year, 85 or 62% 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 the developers 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 area development agreements or reach the compliance rate the Company has previously experienced.

        Franchised Restaurant Development. The Company assists each franchisee in selecting sites and developing restaurants. Each franchisee has responsibility for selecting the franchisee’s restaurant location, 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. Other than the agreements described below, the Company does not generally provide financing to franchisees or guarantee loans to franchisees made by third parties.

        The Company entered into agreements with various lenders and an agreement with GE Capital Franchise Finance Corporation (“GEC”), pursuant to which GEC made loans to existing Sonic franchisees who met certain underwriting criteria set by GEC. Under the terms of the agreement with GEC, the Company provided a guaranty of 10% of the outstanding balance of a loan from GEC to the Sonic franchisee. The portion of loans made by GEC to Sonic franchisees that are guaranteed by the Company total $5.0 million as of August 31, 2002. The Company ceased guaranteeing loans made under the program during fiscal year 2002 and has not been required to make any payments under its agreement with GEC.

        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 12 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, management techniques and consistency of service. Furthermore, the Company’s management teams receive training in ServSafe, the most recognized food safety training certification in the restaurant industry.

        Franchisee Support. In addition to training, advertising and food purchasing as a system, 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) support of new franchisees with guidance and training in the opening of their first three Sonic restaurants; (3) assistance in selecting sites for new restaurants using demographic data and studies of traffic patterns; (4) and one-stop shopping for all equipment needed to open a new restaurant through N. Wasserstrom & Sons, Inc. in Columbus, Ohio, and Concept Services, Inc. in Austin, Texas. The Company’s field services organization consists of 15 field service consultants, 11 field marketing representatives, and four new franchise consultants, all with responsibility for defined geographic areas. The field service consultants provide operational services and support for the Company’s franchisees, while the field marketing representatives assist the franchisees with the development of co-op and local market promotional activities. New franchise consultants support the successful integration of new franchisees into the Sonic system from training through the first months following the opening of each of the franchisee’s first three Sonic restaurants. The Company also has six real estate directors who 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. Six other field representatives provide a variety of other services to franchisees.

        Franchise Operations. The Company and its franchisees operate all restaurants in accordance with uniform operating standards and specifications. These standards pertain to the quality and preparation of menu items, selection of menu items, maintenance and cleanliness of premises, and employee responsibilities. The Company develops all standards and specifications with input from franchisees, and they are applied on a system-wide basis.

7

Each franchisee has full discretion to determine the prices charged to its customers.

        Franchise Advisory Council. The Company has established a Franchise Advisory Council which provides advice, counsel, and input to the Company on important issues impacting the business, such as marketing and promotions, operations, purchasing, building design, human resources, technology, and new products. The Franchise Advisory Council currently consists of 16 members selected by the Company. Eight executive committee members are selected at large. The remaining eight members are regional members who represent three defined regions of the country and serve two-year terms.

        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.

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 and variety, signature food items, and monthly promotions. The quality of service, featuring Sonic carhops, constitutes one of the Company’s primary marketable points of difference with the competition. There are many well-established competitors with substantially greater financial and other resources. These competitors include a large number of national, regional and local food services, including quick service restaurants and casual dining restaurants. 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.

Seasonality

        The Company’s results during its second fiscal quarter (the months of December, January and February) generally are lower than other quarters because of the climate of the locations of a number of Company-owned and franchised restaurants.

Employees

        As of August 31, 2002, the Company had 282 full-time employees. No collective bargaining agreement covers any of its employees. The Company believes that it has good labor relations with its employees. Company-

8

owned restaurants (operated as separate partnerships or limited liability companies) employed approximately 12,750 full-time and part-time employees as of August 31, 2002, none of whom constitute employees of the Company.

Trademarks and Service Marks

        The Company 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 prescribed 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 laws and regulations governing labor and employment issues, such as minimum wages, overtime, and other working conditions. Many 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.

Item 2. Properties

        Of the 452 Company-owned restaurants operating as of August 31, 2002, the Company operated 171 of them on property leased from third parties and 281 of them on property owned by the Company. The leases expire on dates ranging from 2003 to 2022, with the majority of the leases providing for renewal options. All leases provide for specified monthly rental payments, and some of the leases call for additional rentals based on sales volume. All leases require the Company to maintain the property and pay the cost of insurance and taxes.

        The Company’s corporate headquarters is located in approximately 68,500 square feet of leased office space in Oklahoma City, Oklahoma. The lease for that property expires in November 2003. The Company has entered into a 15 year lease to occupy approximately 78,000 square feet of office space in a new building being constructed in the Bricktown district of downtown Oklahoma City. The new lease is scheduled to commence in November 2003 and has two five-year renewal options. The Company also leases approximately 10,000 square feet of warehouse space in Oklahoma City, Oklahoma. The lease for the warehouse space expires in December 2003.

9

Item 3. Legal Proceedings

        The Company is involved in various legal proceedings and has certain unresolved claims pending. The ultimate liability, if any, for the aggregate amounts claimed cannot be determined at this time. Management believes that all claims currently pending are either adequately covered by insurance or would not have a material adverse effect on the Company’s business or financial condition.

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.

Business Experience

        The following 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 the Company’s Chairman of the Board and Chief Executive Officer since January 2000. He served as President and Chief Executive Officer of the Company from April 1995 until January 2000 and has served as a director of the Company since August 1993. He served as President and Chief Operating Officer of the Company from August 1994 until April 1995, and he served as Executive Vice President and Chief Operating Officer from August 1993 until August 1994. From August 1992 until August 1993, Mr. Hudson served as Senior Vice President and Chief Financial Officer of the Company. From October 1994 until February 2001, Mr. Hudson 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.

        Pattye L. Moore has served as President and Director of the Company since January 2001. Ms. Pattye Moore served as Executive Vice President of the Company from January 2000 until January 2001. Ms. Moore served as Senior Vice President of Marketing and Brand Development of the Company from August 1996 until January 2000. From August 1995 until August 1996, Ms. 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 1992 to August 1995. Ms. Moore serves as a director of ONEOK, Inc., a publicly-held company engaged in several aspects of the energy business.

10

        Ronald L. Matlock has served as Senior Vice President, General Counsel and Secretary of the Company since January 2000. Mr. Matlock served as Vice President, General Counsel and Secretary of the Company from April 1996 until January 2000. Mr. Matlock has also served as a director of Sonic Restaurants, Inc. and as a director of Sonic Industries Inc. since April 1996. Prior to joining the Company, Mr. Matlock practiced law from January 1995 to April 1996 with the Matlock Law Firm in Oklahoma City, Oklahoma, concentrating in corporate, securities and franchise law.

        W. Scott McLain has served as Senior Vice President and Chief Financial Officer of the Company since January 2000. Mr. McLain served as Vice President of Finance and Chief Financial Officer of the Company from August 1997 until January 2000. From August 1997 until August 1999 he also served as Treasurer of the Company. From April 1996 to August 1997, he served as Vice President of Finance and Treasurer of the Company. From August 1993 until joining the Company, Mr. McLain served as Treasurer of Stevens International, Inc. in Fort Worth, Texas. From April 1991 to August 1993, Mr. McLain served as a Manager at Price Waterhouse in Dallas, Texas.

        Frank B. Young, Jr. has served as Senior Vice President of Operations of Sonic Restaurants, Inc. since January 2000, and has also served as a director of Sonic Restaurants, Inc. since January 2000. Mr. Young served as Vice President of Operations of Sonic Restaurants, Inc. from October 1994 to January 2000. From April 1989 until joining the Company, Mr. Young served as the President and sole shareholder of Wendco, Inc. of Madison, Wisconsin, a business consulting firm, and was a franchisee of Wendy’s International, Inc.

        Stephen C. Vaughan has served as Vice President of Planning and Analysis of the Company since January 1999 and has served as Treasurer since November 2001. He also served as a Vice President of the Company from August 1997 until January 1999, and as Controller of the Company from January 1996 until January 1999.

        Terry D. Harryman has served as Controller of the Company since January 1999. From October 1996 until January 1999, Mr. Harryman served as Director of Tax of the Company. From January 1998 until January 1999, Mr. Harryman also served as Assistant Treasurer of the Company. Mr. Harryman served as Assistant Treasurer of Sonic Industries Inc. and Sonic Restaurants, Inc. from October 1996 until January 2002.

PART II

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. Share amounts set forth below and elsewhere in this report have been adjusted to reflect the results of the November 2000 and February 2002 three-for-two stock splits.

Stockholders

        As of November 1, 2002, the Company had 445 record holders of its common stock.

11

Dividends

        The Company did not pay any cash dividends on its common stock during its two most recent fiscal years and does not intend to pay any dividends in the foreseeable future.

Securities

        The following table sets forth information about the Company’s equity compensation plans as of August 31, 2002.

Equity Compensation Plan Information

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 Operations,” below, and the Company’s Consolidated Financial Statements included elsewhere in this report.

12

Selected Financial Data
(In thousands, except per share data)

13

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

        This annual report contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements represent the Company’s expectations or belief concerning future events, including the following: any statements regarding future sales or expenses, any statements regarding the continuation of historical trends, and any statements regarding the sufficiency of the Company’s working capital and cash generated from operating and financing activities for the Company’s future liquidity and capital resources needs. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects,” and similar expressions are intended to identify forward-looking statements. The Company cautions that those statements are further qualified by important economic and competitive factors that could cause actual results to differ materially from those in the forward-looking statements, including, without limitation, risks of the restaurant industry, including a highly competitive industry and the impact of changes in consumer spending patterns, consumer tastes, local, regional and national economic conditions, weather, demographic trends, traffic patterns, employee availability and cost increases. In addition, the opening and success of new restaurants will depend on various factors, including the availability of suitable sites for new restaurants, the negotiation of acceptable lease or purchase terms for new locations, permitting and regulatory compliance, the ability of the Company to manage the anticipated expansion and hire and train personnel, the financial viability of the Company’s franchisees, particularly multi-unit operators, and general economic and business conditions. Accordingly, such forward-looking statements do not purport to be predictions of future events or circumstances and may not be realized.

Results of Operations

        The Company derives its revenues primarily from Company-owned restaurant sales and royalty payments from franchisees. The Company also receives revenues from initial franchise fees, area development fees, and the selling and leasing of signs and real estate. In addition, the Company owns and receives income from a minority interest in a few franchised restaurants. Costs of Company-owned restaurant sales and minority interest in earnings of restaurants 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 and franchise royalties 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.

14

Percentage Results of Operations and Restaurant Data
($ in thousands)

15

        Comparison of Fiscal Year 2002 to Fiscal Year 2001. Total revenues increased 21.0% to $400.2 million during fiscal year 2002 from $330.6 million in fiscal year 2001. Company-owned restaurant sales increased 23.6% to $330.7 million during fiscal year 2002 from $267.5 million in fiscal year 2001. Of the $63.2 million increase, $58.9 million was due to the net addition of 140 Company-owned restaurants since the beginning of fiscal year 2001 ($61.4 million from the addition of 74 newly constructed restaurants and 75 acquired restaurants since the beginning of fiscal year 2001 less $2.5 million from nine stores sold or closed during the same period). Average sales increases of approximately 1.7% by stores open the full reporting periods of fiscal year 2002 and 2001 accounted for $4.3 million of the increase.

        Franchise royalties increased 13.2% to $61.4 million during fiscal year 2002, compared to $54.2 million in fiscal year 2001. Of the $7.2 million increase, approximately $3.9 million was attributable to franchise same-store sales growth of 3.2% combined with an increase in the effective royalty rate from 3.18% in fiscal year 2001 to 3.27% in fiscal year 2002. Each of the Company’s license agreements contains an ascending royalty rate feature whereby the royalty rate increases as sales volumes increase. The balance of the increase resulted from an increase in the number of franchise restaurants operating in fiscal year 2002 compared to fiscal year 2001. Franchise fees decreased 8.8% as 142 franchise drive-ins opened during fiscal year 2002 as compared to 157 in fiscal year 2001. However, the average franchise fee increased as a greater percentage of stores opened under the newest form of license agreement, which has a higher franchise fee and royalty rate.

        The Company expects total revenue growth during fiscal year 2003 of approximately 15% based on targeted same-store sales growth of 1% to 3% as well as the addition of approximately 190 to 200 new drive-ins (35 to 40 Company-owned and 150 to 160 franchise). The Company anticipates that the continued benefit of the ascending royalty rate and new franchise store openings will result in $7.0 million to $8.0 million in incremental franchise royalties and an increase of approximately seven to ten basis points in the average royalty rate.

        Restaurant cost of operations, as a percentage of Company-owned restaurant sales, was 73.2% during fiscal year 2002 compared to 73.0% in fiscal year 2001. Food and packaging costs, as a percentage of Company-owned restaurant sales, remained flat as lower than expected beef costs and a moderation in dairy costs were offset by slightly increased discounting from standard menu prices. Payroll and employee benefits, as a percentage of Company-owned restaurant sales, increased 40 basis points as a result of an increase in average wage rates, increased investment in store-level labor as a part of the Company’s commitment to outstanding customer service, and an increase in training and store-level management for the rollout of the breakfast program. Other operating expenses, as a percentage of Company-owned restaurant sales, decreased 13 basis points primarily as a result of the leverage of higher sales volumes and improvements in utility costs. Minority interest in earnings of restaurants decreased, as a percentage of Company-owned restaurant sales, to 4.5% during fiscal year 2002, compared to 4.7% in fiscal year 2001 as a result of the decline in overall restaurant-level margins. Most of the managers and supervisors of Company-owned restaurants own a minority interest in the restaurants, and a substantial portion of their compensation flows through the minority interest in earnings of restaurants.

        Looking forward, the Company expects restaurant cost of operations to remain flat or increase slightly, as a percentage of Company-owned restaurant sales, during fiscal year 2003 as the leverage of operating at higher volumes and a favorable food cost environment is anticipated to mostly offset the continued investment in store-level labor and rising workers’ compensation insurance rates. The Company continues to look for ways to strengthen its partnership program so that a larger percentage of managers’ and supervisors’ compensation is derived from the partnership program. However, since the Company expects store-level margins to remain flat or deteriorate slightly, minority interest in earnings of restaurants is expected to remain flat or decline slightly as a percentage of Company-owned restaurant sales.

        Selling, general and administrative expenses decreased, as a percentage of total revenues, to 8.4% during fiscal year 2002, compared with 9.3% in fiscal year 2001 as a result of the leverage of operating at higher sales volumes. The Company expects selling, general and administrative expenses to grow by 8% to 10% in fiscal year 2003 while continuing to decline as a percentage of total revenues. A significant portion of the Company’s future revenue growth will be attributable to Company-owned restaurants. Company-owned restaurants require a lower level of selling, general and administrative expenses, as a percentage of revenues, than the Company’s franchising operations since most expenses of Company-owned restaurant operations are reflected in restaurant cost of operations and minority interest in restaurant operations.

16

        Depreciation and amortization expense increased 9.3% to $26.1 million during fiscal year 2002 compared to 17.6% in fiscal year 2001 while declining as a percentage of revenue to 6.5% as compared to 7.2% the prior year. The increase in depreciation resulted primarily from new drive-in development and store acquisitions in the third fiscal quarter of 2002. The Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” effective September 1, 2001 which resulted in a reduction in amortization expense of $2.2 million during fiscal year 2002 as compared to fiscal year 2001, excluding any related tax effects. See Note 1 of Notes to Consolidated Financial Statements for a discussion of the new Accounting Statement. Management expects depreciation and amortization to grow by approximately 12% to 14% during fiscal year 2003 and to continue to decline as a percentage of total revenues.

        During fiscal year 2002, two drive-ins in developing markets became impaired under the guidelines of FAS 121 – “Accounting for the Impairment of Long-Lived Assets,” and estimates were revised on three stores which were previously impaired under FAS 121. As a result, a provision for impairment of long-lived assets of $1.3 million was recorded for the drive-in’s carrying cost in excess of its estimated fair value. During fiscal year 2001, two drive-ins became impaired under FAS 121 resulting in an impairment of $0.8 million. The Company continues to perform quarterly analyses of certain underperforming restaurants. It is reasonably possible that the estimate of future cash flows associated with these restaurants may change in the near future resulting in the need to write-down assets associated with one or more of these restaurants to fair value.

        Income from operations increased 21.8% to $82.3 million during fiscal year 2002 from $67.6 million in fiscal year 2001 due primarily to the growth in revenues and other matters discussed above.

        Net interest expense during fiscal year 2002 increased 14.4% to $6.3 million from $5.5 million in fiscal year 2001. This increase was the result of additional borrowings to fund share repurchases of $26.0 million and capital expenditures of $71.1 million, including $20.5 million for acquisitions. The Company expects interest expense to increase slightly in fiscal year 2003, excluding the impact of potential acquisitions and share repurchases.

        Provision for income taxes reflects an effective federal and state tax rate of 37.25% for fiscal year 2002 and 2001. Net income increased 22.4% to $47.7 million in fiscal year 2002 compared to $39.0 million in fiscal year 2001. Diluted earnings per share increased to $1.13 per share during fiscal year 2002, compared to $0.93 per share in fiscal year 2001, for an increase of 21.5%. The Company expects diluted earnings per share to grow by 18% to 20% during fiscal year 2003.

        Comparison of Fiscal Year 2001 to Fiscal Year 2000. Total revenues increased 18.1% to $330.6 million during fiscal year 2001 from $280.1 million in fiscal year 2000. Company-owned restaurant sales increased 18.9% to $267.5 million in fiscal year 2001 from $224.9 million in fiscal year 2000. Of the $42.6 million increase in Company-owned restaurant sales, $39.3 million was due to the net addition of 97 Company-owned restaurants since the beginning of fiscal 2000 ($42.1 million from the addition of 58 newly constructed restaurants and 52 acquired restaurants since the beginning of fiscal year 2000 less $2.8 million from 13 stores sold or closed during the same period). Average sales increases of approximately 1.8% by stores open throughout the full reporting periods of fiscal year 2001 and 2000 accounted for $3.3 million of the increase.

        Franchise royalties increased 13.9% to $54.2 million in fiscal year 2001, compared to $47.6 million in fiscal year 2000. Of the $6.6 million increase, approximately $3.4 million was attributable to additional franchise restaurants in operation and an increase in royalty rates caused by the conversion of some of the Company’s older license agreements to newer agreements, and the automatic royalty rate step-up feature contained in many of the Company’s older license agreements. The balance of the increase resulted from franchise same-store sales growth of 1.8% in fiscal year 2001. Each of the Company’s license agreements contains an ascending royalty rate feature whereby the royalty rate increases as sales volumes increase. As a result of this feature and the majority of new stores opening under the most current form of license agreement, which contains higher rates, as well as the conversion and automatic step-up features described above, the Company’s average royalty rate grew to 3.18% during fiscal 2001 from 3.06% during fiscal 2000. One hundred fifty-seven franchise drive-ins opened in fiscal year 2001 compared to 150 in fiscal year 2000, resulting in an 18.6% increase in franchise fee revenues.

17

        Restaurant cost of operations, as a percentage of Company-owned restaurant sales, was 73.0% in fiscal year 2001, compared to 72.7% in fiscal year 2000. Food and packaging costs decreased 10 basis points, as a percentage of Company-owned restaurant sales, primarily as a result of a lower rate of discounting from standard menu pricing, which combined with lower unit costs for potatoes and pork to more than offset higher beef, dairy and packaging costs. Payroll and employee benefits, as a percentage of Company-owned restaurant sales, increased 50 basis points from fiscal year 2000 as a result of several factors including an increase in the average wage rate, additional labor related to the Company’s effort to expand its business in under-penetrated day parts, including an expanded breakfast program, as well as incremental training hours associated with an ongoing Quality Assurance initiative. Other operating expenses decreased 10 basis points due to the leveraging of fixed costs over higher volumes and a lower rate of discounting. Minority interest in earnings of restaurants increased 22.3% to $12.4 million in fiscal year 2001, compared to $10.2 million in fiscal year 2000.

        Selling, general and administrative expenses, as a percentage of total revenues, decreased to 9.3% in fiscal year 2001, compared with 10.0% in fiscal year 2000. Depreciation and amortization expense increased 17.6% to $23.9 million in fiscal year 2001 resulting primarily from store acquisitions and new drive-in development as well as store equipment and technology upgrades.

        During fiscal year 2001, two drive-ins became impaired under the guidelines of FAS 121, “Accounting for the Impairment of Long-Lived Assets.” As a result, a provision for impairment of $0.8 million was recorded for the drive-ins’ carrying cost in excess of the present value of estimated future cash flows. Two drive-ins also became impaired under the guidelines of FAS 121 in fiscal year 2000, resulting in an impairment of $1.0 million.

        Income from operations increased 18.2% to $67.6 million in fiscal year 2001 from $57.2 million in fiscal year 2000.

        Net interest expense in fiscal year 2001 increased 6.5% to $5.5 million from $5.2 million in fiscal year 2000. This increase was the result of additional borrowings to fund share repurchases of $2.1 million and capital expenditures of $90.1 million including $29.1 million for acquisitions.

        Provision for income taxes reflects an effective federal and state tax rate of 37.25% for fiscal year 2001 and 2000. Net income increased 19.4% to $39.0 million in fiscal year 2001 compared to $32.6 million in fiscal year 2000. Diluted earnings per share increased to $1.40 per share in fiscal year 2001, compared to $1.17 per share in fiscal year 2000, for an increase of 19.7%.

Liquidity and Sources of Capital

        Net cash provided by operating activities increased $17.8 million or 27.1% in fiscal year 2002 as compared to the same period in fiscal year 2001, primarily as the result of the increase in operating profit before depreciation and amortization and the provision for deferred income taxes.

        The Company opened 40 newly-constructed restaurants and acquired a net of 20 existing restaurants from franchisees in fiscal year 2002. The Company funded total capital additions for fiscal year 2002 of $71.1 million, which included the cost of newly-opened restaurants, new equipment for existing restaurants, retrofits of existing restaurants, restaurants under construction, acquired restaurants, and other capital expenditures, from cash generated by operating activities and through borrowings under the Company’s line of credit. During fiscal year 2002, the Company purchased the real estate for 46 of the 65 newly-constructed and acquired restaurants. The Company expects to own the land and building for most of its future newly-constructed restaurants.

        The Company’s board of directors expanded the stock repurchase program during fiscal year 2002, increasing the funds authorized for the repurchase of the Company’s common stock from $74.6 million to $130.3 million and extended the term of the program to December 31, 2003. The Company repurchased approximately 1.2 million shares of common stock at an aggregate cost of $26.0 million during the year, leaving approximately $49.3 million available under the share repurchase program as of the end of the fiscal year. As of August 31, 2002, the Company’s total cash balance of $9.0 million reflected the impact of the cash generated from operating activities, borrowing activity, and capital expenditures mentioned above.

18

        The Company has an agreement with a group of banks which provides the Company with an $80.0 million line of credit expiring in July of 2004. The Company plans to use the line of credit to finance the opening of newly-constructed restaurants, acquisitions of existing restaurants, purchases of the Company’s common stock, retirement of senior notes and for other general corporate purposes. As of August 31, 2002, the Company’s outstanding borrowings under the line of credit were $29.0 million, at an effective borrowing rate of 3.9%, as well as $0.2 million in outstanding letters of credit. The amount available under the line of credit as of August 31, 2002, was $50.8 million. See Note 9 of the Notes to Consolidated Financial Statements for additional information regarding the Company’s long-term debt.

        The Company plans capital expenditures of $60 to $70 million in fiscal year 2003, excluding potential acquisitions and share repurchases. These capital expenditures primarily relate to the development of additional Company-owned restaurants, stall additions, relocations of older restaurants, store equipment upgrades, and enhancements to existing financial and operating information systems, including refinement of a point-of-sale system. The Company expects to fund these capital expenditures through borrowings under its existing line of credit and cash flow from operations. The Company expects to generate free cash flow, after capital expenditures of $20 million to $25 million during fiscal 2003. The Company has long-term debt maturing in fiscal years 2003, 2004 and 2005 of $20.1 million, $30.1 million and $34.6 million respectively. The Company expects to refinance amounts maturing in 2003 under the senior unsecured notes with its line of credit and plans to extend the line of credit under existing renewal options and to increase the amount available as needed. The Company believes that existing cash and funds generated from operations, as well as borrowings under the line of credit, will 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.

Seasonality

        The Company does not expect seasonality to affect its operations in a materially adverse manner. The Company’s results during its second fiscal quarter (the months of December, January and February) generally are lower than other quarters because of the climate of the locations of a number of Company-owned and franchised restaurants.

Critical Accounting Policies and Estimates 

        The Consolidated Financial Statements and Notes to Consolidated Financial Statements contain information that is pertinent to management’s discussion and analysis. The preparation of financial statements in conformity with generally accepted accounting principles requires management to use its judgment to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities. These assumptions and estimates could have a material affect on the Company’s Financial Statements. The Company evaluates its assumptions and estimates on an ongoing basis based on historical experience and various other factors that are believed to be relevant under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

        The Company annually reviews its financial reporting and disclosure practices and accounting policies to ensure that its financial reporting and disclosures provide accurate and transparent information relative to the current economic and business environment. The Company believes that of its significant accounting policies (see Note 1 of Notes to Consolidated Financial Statements), the following policies involve a higher degree of risk, judgment and/or complexity.

        Impairment of Long-Lived Assets. The Company reviews each restaurant for impairment when events or circumstances indicate it might be impaired. The Company tests for impairment using historical cash flows and other relevant facts and circumstances as the primary basis for its estimates of future cash flows. This process requires the use of estimates and assumptions, which are subject to a high degree of judgment. In addition, at least

19

annually the Company assesses the recoverability of goodwill and other intangible assets related to its brand and its restaurants. These impairment tests require the Company to estimate fair values of its brand and its restaurants by making assumptions regarding future cash flows and other factors. If these assumptions change in the future, the Company may be required to record impairment charges for these assets.

        Ownership Program/Allowance for Uncollectible Notes and Accounts Receivable. The Company’s restaurant philosophy stresses an ownership relationship with supervisors and drive-in managers. Most supervisors and managers of Company-owned restaurants own an equity interest in the restaurant, which is financed by the Company. These notes are typically financed for a term of five years, bear interest at market rates, and are secured by the partner’s equity interest. The Company evaluates whether the partner notes are collectible and makes estimates of bad debts based on the restaurant’s financial performance and collection history with individual partners. If an individual restaurant’s performance declines, the probability of default by the partners is increased.

        The investments made by managers and supervisors in each partnership or limited liability company are accounted for as minority interests in the financial statements. The ownership agreements contain provisions for buying-out partners upon termination. The amount of the investment made by a partner and the amount of the buy-out are based on a number of factors, primarily upon the drive-in’s financial performance for the preceding 12 months. In no case, does the buy-out amount exceed fair market value. Such payments are accounted for under the purchase method of accounting.

        The Company collects royalties from franchisees and provides for estimated losses for receivables that are not likely to be collected. General allowances for uncollectible receivables are estimated based on historical trends. Although the Company has a good relationship with its franchisees and collection rates are currently high, if average sales or the financial health of franchisees were to deteriorate, the Company may have to increase reserves against collection of franchise revenues.

        Contingency Reserves. From time to time, the Company is involved in various legal proceedings and has certain unresolved claims pending involving taxing authorities, franchisees, suppliers, employees and competitors. The Company is required to assess the likelihood of any adverse judgments or outcomes to these matters as well as estimate potential ranges of probable losses. A determination of the amount of reserves required, if any, for these contingencies is made after careful analysis of each issue. In addition, the Company’s estimate of probable losses may change in the future due to new developments or changes in approach such as a change in settlement strategy in dealing with these matters. The Company believes that all claims currently pending are either adequately covered by insurance or would not have a material adverse effect on the Company’s business or financial condition.

        Advertising. Under the Company’s license agreements, each drive-in, either company-owned or franchise, must contribute a minimum percentage of revenues to a national media production fund (Sonic Advertising Fund) and spend an additional minimum percentage of gross revenues on local advertising, either directly or through Company-required participation in advertising cooperatives. A portion of the local advertising contributions is redistributed to a System Marketing Fund, which purchases advertising on national cable and broadcast networks and other national media and sponsorship opportunities. (See further description under Item 1, Marketing.)

        As stated in the terms of existing license agreements, these funds do not constitute assets of the Company and the Company acts with limited agency in the administration of these funds. Accordingly, neither the revenues and expenses nor the assets and liabilities of the advertising cooperatives, the Sonic Advertising Fund, or the System Marketing Fund are included in the Company’s consolidated financial statements. However, all advertising contributions by Company-owned restaurants are recorded as an expense in the Company’s financial statements.

        Revenue Recognition Related to 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. Both initial franchise fees and area development fees are generally recognized upon the opening of a franchise drive-in or upon termination of the agreement between the company and the franchisee.

20

        The Company’s franchisees are required under the provisions of the license agreements to pay the Company royalties each month based on a percentage of actual net royalty sales. However, the royalty payments and supporting financial statements are not due until the 20^th of the following month. As a result, the Company accrues royalty revenue in the month earned based on estimates of franchise store sales. These estimates are based on actual sales at Company-owned stores and projections of average unit volume growth at franchise stores.

        Income Taxes. The Company provides for income taxes based on its estimate of federal and state tax liability. In making this estimate, the Company considers the impact of legislative and judicial developments. As these developments evolve, the Company will update its estimate which could result in an adjustment to the tax rate.

Item 7A.Quantitative and Qualitative Disclosures About Market Risk

        The Company is exposed to market risk from changes in interest rates on debt and notes receivable, as well as changes in commodity prices.

        The Company’s exposure to interest rate risk currently consists of its Senior Notes, outstanding line of credit, and notes receivable. The Senior Notes bear interest at fixed rates which average 6.8%. The aggregate balance outstanding under the Senior Notes as of August 31, 2002 was $80.0 million. Should interest rates increase or decrease, the estimated fair value of these notes would decrease or increase, respectively. As of August 31, 2002, the estimated fair value of the Senior Notes exceeded the carrying amount by approximately $4.2 million. The line of credit bears interest at a rate benchmarked to U.S. and European short-term interest rates. The balance outstanding under the line of credit was $29.0 million as of August 31, 2002. The Company has made certain loans to its store operating partners and franchisees totaling $11.3 million as of August 31, 2002. The interest rates on these notes are generally between 10% and 11%. The Company believes the fair market value of these notes approximates their carrying amount. The impact on the Company’s results of operations of a one-point interest rate change on the outstanding balances under the line of credit as of the end of fiscal year 2002 would be approximately $0.3 million.

        The Company and its franchisees purchase certain commodities such as beef, potatoes, chicken and dairy products. These commodities are generally purchased based upon market prices established with vendors. These purchase arrangements may contain contractual features that limit the price paid by establishing price floors or caps; however, the Company has not made any long-term commitments to purchase any minimum quantities under these arrangements. The Company does not use financial instruments to hedge commodity prices because these purchase agreements help control the ultimate cost and any commodity price aberrations are generally short term in nature.

        This market risk discussion contains forward-looking statements. Actual results may differ materially from this discussion based upon general market conditions and changes in financial markets.

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. 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

Item 10. Directors and Executive Officers of the Registrant

        Information regarding the Company’s executive officers is set forth under Item 4A of Part I of this report. The other information required by this item is incorporated by reference from the definitive proxy statement which the

21

Company must file with the Securities and Exchange Commission in connection with the Company’s annual meeting of stockholders to be held January 28, 2003 (the “Proxy Statement”) under the captions “Election of Directors” and “Section 16 Compliance.”

Item 11. Executive Compensation

        The information required by this item is incorporated by reference from the Proxy Statement under the caption “Executive Compensation.”

Item 12. Security Ownership of Certain Beneficial Owners and Management

        The information required by this item is incorporated by reference from the Proxy Statement under the caption “Security Ownership of Certain Beneficial Owners and Management.”

Item 13. Certain Relationships and Related Transactions

        The information required by this item is incorporated by reference from the Proxy Statement under the caption “Certain Relationships and Related Transactions.”

Item 14. Controls and Procedures

        Within the 90 days prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-14 under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

PART IV

Item 15. 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 15:

Financial Statement Schedules

        The Company has included the following schedule immediately following this Item 15:

22

        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 (*).

23

24

25

Reports on Form 8-K

        The Company filed a report on Form 8-K on June 7, 2002, reporting its change of independent auditors.

26

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, 2002 and 2001, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended August 31, 2002. Our audits also included the financial statement schedule listed in 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 auditing standards generally accepted in the United States. 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, 2002 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended August 31, 2002, in conformity with accounting principles generally accepted in the United States. 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.

F-1

Sonic Corp.

Consolidated Balance Sheets

F-2

Sonic Corp.

Consolidated Balance Sheets (continued)

See accompanying notes.

F-3

Sonic Corp.

Consolidated Statements of Income