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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended Commission File Number
August 31, 1998 0-18859
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SONIC CORP.
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(Exact Name of Registrant as Specified in Its Charter)
Delaware 73-1371046
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(State of Incorporation) (IRS Employer
Identification No.)
101 Park Avenue
Oklahoma City, Oklahoma 73102
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(Address of Principal Executive Offices) (Zip Code)
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 .
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As of November 10, 1998, the aggregate market value of the 17,560,930
shares of common stock of the Company held by non-affiliates of the Company
equaled approximately $326 million, based on the closing sales price for the
common stock as reported for that date. As of November 10, 1998, the
Registrant had 18,888,101 shares of common stock issued and outstanding
(excluding 1,692,370 shares of common stock held as treasury stock).
(Facing Sheet Continued)
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, 1998.
FORM 10-K OF SONIC CORP.
TABLE OF CONTENTS
Page
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PART I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Item 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . 10
Item 4. Submission of Matters to a Vote of Security Holders. . . . . . . . . 11
Item 4A. Executive Officers of the Company. . . . . . . . . . . . . . . . . . 11
PART II
Item 5. Market for the Company's Common Stock and Related Stockholder
Matters. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 6. Selected Financial Data. . . . . . . . . . . . . . . . . . . . . . . 14
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations. . . . . . . . . . . . . . . . . . . . . . . . 16
Item 8. Financial Statements and Supplementary Data. . . . . . . . . . . . . 23
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . 23
PART III
(Incorporated by reference from the Company's definitive
proxy statement for its annual meeting of stockholders
following the fiscal year ended August 31, 1998)
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K . . 23
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, 1998, the
Company had 1,847 restaurants in operation, consisting of 292 Company-owned
restaurants and 1,555 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 extra-long cheese coneys, 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 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, 1998, the Company owned or franchised 1,847 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 81% of all Sonic
restaurants as of August 31, 1998. Developing markets primarily are located
in Alabama, Arizona, Colorado, Florida, Georgia, Kentucky, North Carolina,
South Carolina, and Virginia. The following table sets forth the number of
Company-owned and franchised restaurants by core and developing markets as of
August 31, 1998:
COMPANY-OWNED FRANCHISED
CORE MARKET RESTAURANTS RESTAURANTS TOTAL
----------- ------------- ----------- -----
Texas 77 453 530
Oklahoma 22 175 197
Tennessee 28 122 150
Missouri 31 108 139
Arkansas 15 110 125
Kansas 8 91 99
Louisiana 16 87 103
Mississippi 0 92 92
New Mexico 0 56 56
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Total 197 1,294 1,491
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---- ---- ----
COMPANY-OWNED FRANCHISED
DEVELOPING MARKETS RESTAURANTS RESTAURANTS TOTAL
------------------ ------------- ----------- -----
Alabama 26 37 63
Arizona 0 48 48
California 0 5 5
Colorado 0 27 27
Florida 11 2 13
Georgia 4 29 33
Illinois 0 8 8
Indiana 3 4 7
Iowa 0 3 3
Kentucky 17 25 42
Nebraska 0 2 2
Nevada 0 8 8
North Carolina 22 19 41
Ohio 0 3 3
South Carolina 0 36 36
Utah 0 1 1
Virginia 12 3 15
West Virginia 0 1 1
---- ---- ----
Total 95 261 356
---- ---- ----
---- ---- ----
Total System 292 1,555 1,847
---- ---- ----
---- ---- ----
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EXPANSION
During fiscal 1998, the Company opened 50 Company-owned restaurants and
its franchisees opened 120 restaurants. During fiscal 1999, the Company
plans to open at least 50 Company-owned restaurants and anticipates that its
franchisees will open at least 120 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 1999 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 the Company's franchisees, and the general
economic and business conditions to be faced in fiscal 1999.
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 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 most 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. 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 $70,000 per restaurant. The Company implemented 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 August 31, 1998, the Company
had retrofitted 137 Company-owned restaurants and had built 50 new
Company-owned restaurants with the new retrofit signage and trade dress, and
franchisees had retrofitted 148 restaurants and had built 96 new 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
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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 1998, franchisees participating in cooperatives contributed
an average of 3.26% 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, 1998, 1,767 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 $43 million for fiscal 1998 and is expected
to exceed $52 million for fiscal 1999.
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. 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 1998,
the average cost of food and packaging for a Sonic restaurant, as reported to
the Company by its franchisees, equaled approximately 29% 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 seven regional directors who oversee
supervising partners or members within their respective regions and one
regional vice president who oversees the regional directors. The Company
employs 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
4
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 or operating agreements.
POINT-OF-SALE SYSTEMS. The Company has completed its implementation of
a new point-of-sale system in Company-owned restaurants. With the rollout
complete, the Company is currently implementing a planned enhancement of the
software for these systems to include added store management tools as well as
expanded polling capabilities. The new polling features will allow the
Company to distribute centrally maintained product and promotion information,
thereby improving the integrity of store-level reporting.
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.
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Average Sales per Company-owned
Restaurant (in thousands) $663 $649 $601 $577 $558
Number of Restaurants
Total Open at Beginning of Year 256 231 178 142 120
Newly-opened and Re-opened 50 37 30 31 20
Purchased from Franchisees -- -- 28 6 13
Sold to Franchisees (14) (5) (4) (1) (10)
Closed -- (7) (1) -- (1)
---- ---- ---- ---- ----
Total Open at Year End 292 256 231 178 142
---- ---- ---- ---- ----
---- ---- ---- ---- ----
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, 1998, the Company had 1,555 franchised restaurants
operating in 27 states and the Company had entered into development
agreements which contemplate the opening of 78 additional restaurants during
fiscal 1999. However, the Company cannot give any assurance that the
Company's franchisees will achieve that number of new restaurants for fiscal
1999. During fiscal 1998, the Company's franchisees opened 120 Sonic
drive-in restaurants.
5
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. In September of 1994, the
Company began offering a 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.
Approximately 55% of all Sonic restaurants opening in fiscal year 1999 are
expected to open under the Number 6 License Agreement. Pursuant to the terms
of existing area development agreements and the outstanding license option
agreements described below, approximately 43% of all Sonic restaurants opening
in fiscal 1999 will open under either the Number 5 License Agreement or the
Number 5.1 License Agreement. 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 1998, the Company's average royalty rate equaled 2.81%. 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. In September of 1998, the Company
began offering a Number 6A License Agreement, which provides for the same fees
and other general terms of the Number 6 License Agreement, but also provides
for mutual rights and obligations between the Company and the franchisees in
the event the Company acquires operating restaurants or development sites
within a franchisee's protected territory or desires to develop non-traditional
restaurant locations within a protected territory. The Number 6A License
Agreement requires the Company to offer the franchisee a right of first
refusal to acquire the restaurant or site from the Company at its cost with
the requirement to convert the restaurant or develop the site into a Sonic
restaurant pursuant to the terms of the then current license agreement. 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
the Number 5 License Agreement rate. 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 6A 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 five-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 6A License Agreement.
In July of 1998, the Company gave each franchisee operating under a
Number 1, 4, 4.1 or 5 License Agreement an opportunity to convert the
franchisee's agreement to a Number 5.2 License Agreement. The Number 5.2
License Agreement allows the franchisee with an expiring license agreement
the opportunity to elect to renew prior to the actual expiration date and
accept the terms of the current Number 6 License Agreement. The franchisee
will pay a $1,000 conversion franchisee fee and a higher royalty rate from
the time of conversion through the expiration date of the franchisee's
original license agreement. Upon the expiration of the original term of the
franchisee's license agreement, the Number 5.2 License Agreement will shift
the royalty rate to the Number 6 License Agreement royalty schedule.
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 42% of the new franchised
restaurants opened during fiscal 1998 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 1998, the Company entered into 27 new area development
agreements calling for the opening of 136 Sonic drive-in restaurants during
the next 6 years. As of August 31, 1998, the Company had a total of 65 area
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development agreements in effect, calling for the development of 301
additional Sonic drive-in restaurants during the next 6 years. Of the 68
restaurants scheduled to open during fiscal 1998 under area development
agreements in place at the beginning of that fiscal year, 50 (or 74%) 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, 1998, with the right to renew for up to two 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, 1998, the Company had 123 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 Franchise Mortgage
Acceptance Company, LLC ("FMAC"), NationsBank, N.A. ("NationsBank"), and STI
Credit Corporation ("Sun Trust"), 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 FMAC a limited guaranty of up to $750,000 and NationsBank and Sun
Trust limited guaranties 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;
7
(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.
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, and new products.
The Franchise Advisory Council currently consists of 16 members selected by
the Company. Seven executive committee members are selected at large. The
remaining nine members are regional members who represent three defined
regions of the country and serve two-year terms. The Franchise Advisory
Council serves in an advisory capacity only and does not have decision-making
power. As the franchisor of the Sonic drive-in restaurant chain, the Company
has and reserves the power to change or dissolve the Franchise Advisory
Council as it may deem in its best interest.
REPORTING. The Company collects weekly and monthly sales and other
operating information from its franchisees. The Company has agreements with
72 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.
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Average Sales Per Franchised Restaurant $775 $720 $657 $620 $592
(in thousands)
Number of Restaurants:
Total Open at Beginning of Year 1,424 1,336 1,286 1,227 1,154
New Restaurants 120 92 81 80 80
Sold to the Company -- -- (28) (6) (13)
Purchased from the Company 14 5 4 1 10
Closed and Terminated,
Net of Re-openings (3) (9) (7) (16) (4)
---- ---- ---- ---- ----
Total Open at Year End 1,555 1,424 1,336 1,286 1,227
----- ----- ----- ----- -----
----- ----- ----- ----- -----
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 1998 and fiscal 1997, compared to approximately
$3.7 million during fiscal 1996 (an amount equal to 2.5% of the Company's
total consolidated revenues).
8
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, 1998, the Company had 209 full-time employees. No
collective bargaining agreement covers any of its employees. Company-owned
restaurants (operated as separate partnerships or limited liability
companies) employed 975 full-time and 7,123 part-time employees as of August
31, 1998, 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
9
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 through their motor vehicles.
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. PROPERTIES
Of the 292 Company-owned restaurants operating as of August 31, 1998,
the Company operated 115 of them on property leased from third parties and
177 of them on property owned by the Company. The leases expire on dates
ranging from 1998 to 2018, 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 60,000
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 November 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 lease for the warehouse
space expires in December of 2001. 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. LEGAL PROCEEDINGS
The Company does not have any material legal proceedings pending against
the Company, any of its subsidiaries, or any of their properties.
In May of 1998, the Texas Supreme Court denied the Company's motion for
rehearing of its application for a writ of certiorari in a case involving
L & G Restaurants, Inc., Lucky Ott, and William Owen. That denial lets stand an
earlier court of appeals ruling reinstating a jury verdict against the
Company for actual and punitive damages of approximately $1.8 million, plus
interest and court costs, in an action in which the plaintiffs claimed a
subsidiary of the Company interfered with the contractual relations of the
plaintiffs. In connection with the denial, the Company recorded a charge of
$2.7 million for litigation. The Company paid the judgment in full as of
August 31, 1998.
10
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 44 President, Chief Executive Officer June of 1985
and Director
Kenneth L. Keymer 50 Executive Vice President and August of 1996
Chief Operating Officer of the Company,
President of Sonic Industries Inc.
Pattye L. Moore 40 Senior Vice President of Marketing June of 1992
and Brand Development
Ronald L. Matlock 47 Vice President, General Counsel April of 1996
and Secretary
W. Scott McLain 36 Vice President of Finance, Treasurer April of 1996
and Chief Financial Officer
Stephen C. Vaughan 32 Vice President and Controller January of 1996
Jill M. Hudson 35 Vice President of Administration and November of 1998
Human Resources
Donald E. Foringer 46 Vice President of Information Technology August of 1997
Stanley S. Jeska 58 Vice President of Franchise Development September of 1993
of Sonic Industries Inc.
Andrew G. Ritger, Jr. 41 Vice President of Purchasing of January of 1996
Sonic Industries Inc.
Frank B. Young, Jr. 47 Vice President of Operations of Sonic October of 1994
Restaurants, Inc.
Kris J. Miotke 39 Vice President of Advertising February of 1998
and Sales of Sonic Industries Inc.
G. Michael Gent 50 Vice President of Corporate November of 1997
Development of Sonic Restaurants, Inc.
Michael A. Perry 40 Vice President of Franchise Services March of 1998
of Sonic Industries Inc.
David A. Vernon 40 Vice President of Franchise Sales September of 1998
of Sonic Industries Inc.
Norman R. Kaufman 47 Vice President of Operations Services September of 1998
of Sonic Restaurants, Inc.
11
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. Since May of 1998, Mr. Hudson has served as a director of BancFirst
Corp. of Oklahoma City, Oklahoma.
Kenneth L. Keymer has served as President and a director of Sonic
Industries Inc., the Company's franchise operations subsidiary, since August
of 1996, and as the Executive Vice President and Chief Operating Officer of the
Company since January of 1998. 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.
Pattye L. 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, 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 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. Mr. Matlock has also served as
a director of Sonic Restaurants, Inc. and as a director of Sonic Industries
Inc. 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.
Jill M. Hudson has served as Vice President of Administration and Human
Resources of the Company since November of 1998. From June of 1996 until
joining the Company, Ms. Hudson served as a Regional Human Resources Manager
of McDonald's Corporation. From June of 1993 until June of 1996, she served
as a Regional Human Resources Supervisor of McDonald's.
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.
12
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.
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.
Kris J. Miotke has served as Vice President of Advertising and Sales of
Sonic Industries Inc. since February of 1998. From November of 1996 until
joining the Company, Mr. Miotke served as Vice President, General Manager of
Kragie/Newell, an advertising agency in St. Louis, Missouri. From November
of 1993 until February of 1996, Mr. Miotke served as Director of Advertising
and Promotions for Popeye's Chicken & Biscuits in Atlanta, Georgia.
G. Michael Gent has served as Vice President of Corporate Development of
Sonic Restaurants, Inc. since November of 1997. From May of 1996 until
joining the Company, Mr. Gent served as Vice President of Business
Development of Calido Chile Traders Systems, Inc. in Merriam, Kansas. A
petition under the Federal bankruptcy laws was filed by Calido Chile Traders
Systems, Inc. in October of 1997. A petition under the Federal bankruptcy laws
was filed by Calido Chile Traders Systems, Inc. in October of 1997. From
September of 1995 until May of 1996, Mr. Gent provided consulting services for
multiple unit franchisors and franchisees. From March of 1992 until September
of 1995, he served as Vice President for Franchise Development of Taco John's
International, Inc., in Cheyenne, Wyoming.
Michael A. Perry has served as Vice President of Franchise Services of
Sonic Industries Inc. since September 1, 1998. Mr. Perry served as the Vice
President of Operations Services of Sonic Restaurants, Inc. from March of
1998 until August of 1998. From October of 1994 until joining the Company,
Mr. Perry was a Region Vice President for Au Bon Pain Co., Inc. in Chicago,
Illinois. From February of 1993 until October of 1994, Mr. Perry served as
the Senior Director of Operations for Taco Bell Corp., Division of Pepsico,
in Elmhurst, Illinois.
David A. Vernon has served as Vice President of Franchise Sales for Sonic
Industries Inc. since September of 1998. Mr. Vernon served as the Director
of Franchise Sales for Sonic Industries from December of 1996 until August of
1998. From January of 1996 until December of 1996, Mr. Vernon was the
Franchise Development Manager for Brinker International, Inc., Dallas, Texas.
From February of 1990 until January of 1996, Mr. Vernon was the Director of
Franchise Sales for Pizza Inn, Inc., Dallas, Texas.
Norman R. Kaufman has served as Vice President of Operations Services
for Sonic Restaurants, Inc. since September of 1998. From July of 1997 to
September of 1998, Mr. Kaufman served as a Regional Vice President of Sonic
Industries, Inc. From June of 1993 until joining the Company, he served as
the President, Chief Operating Officer, and Director of Sobik's Subs, Inc. in
Orlando, Florida.
13
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. The
amounts have been adjusted to reflect a three-for-two stock split in the form
of a stock dividend effective May 11, 1998.
QUARTER ENDED HIGH LOW QUARTER ENDED HIGH LOW
------------- ---- --- ------------- ---- ---
November 30, 1996 $17.250 $14.000 November 30, 1997 $19.172 $14.672
February 28, 1997 $16.917 $11.750 February 28, 1998 $19.422 $17.328
May 31, 1997 $13.500 $8.417 May 31, 1998 $22.922 $19.328
August 31, 1997 $16.667 $11.583 August 31, 1998 $22.938 $16.938
STOCKHOLDERS
As of November 10, 1998, the Company had 320 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. 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.
14
SELECTED FINANCIAL DATA
(In thousands, except per share data)
Year ended August 31,
- -------------------------------------------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
INCOME STATEMENT DATA:
Company-owned restaurant sales $ 182,011 $ 152,739 $ 120,700 $ 91,438 $ 72,629
Franchised restaurants:
Franchise fees 2,564 1,702 1,453 1,409 1,144
Franchise royalties 32,391 26,764 23,315 20,392 14,703
Other 2,141 2,813 5,662 10,521 11,228
- -------------------------------------------------------------------------------------------------------------------------------
Total revenues 219,107 184,018 151,130 123,760 99,704
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
Cost of restaurant sales 135,806 112,588 92,663 72,275 56,966
Selling, general and administrative 22,250 19,318 14,498 13,260 10,918
Depreciation and amortization 14,790 12,320 8,896 5,910 4,165
Minority interest in earnings of
restaurant partnerships 7,904 7,558 4,806 3,259 2,723
Provision for impairment of long-lived assets 285 266 8,627 71 4,153
Special provision for litigation settlement 2,700 - - - -
Other operating expenses - - 3,101 7,354 7,775
- -------------------------------------------------------------------------------------------------------------------------------
Total expenses 183,735 152,050 132,591 102,129 86,700
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
Income from operations 35,372 31,968 18,539 21,631 13,004
Net interest expense 2,750 1,558 476 1,414 776
- -------------------------------------------------------------------------------------------------------------------------------
Income before income taxes and cumulative
effect of change in accounting $ 32,622 $ 30,410 $ 18,063 $ 20,217 $ 12,228
- -------------------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of change
in accounting $ 20,470 $ 19,082 $ 11,244 $ 12,484 $ 7,643
Cumulative effect of change in accounting,
net of taxes and minority interest 681 - - - -
- -------------------------------------------------------------------------------------------------------------------------------
Net income $ 19,789 $ 19,082 $ 11,244 $ 12,484 $ 7,643
- -------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------------
Income per share before cumulative effect of
change in accounting (1):
Basic $ 1.07 $ 0.96 $ 0.57 $ 0.71 $ 0.43
Diluted $ 1.03 $ 0.95 $ 0.56 $ 0.70 $ 0.43
BALANCE SHEET DATA:
Working capital (deficit) $ (7,292) $ 3,509 $ 3,491 $ 4,249 $ 7,314
Property, equipment and capital leases, net 188,065 136,522 100,505 70,171 40,979
Total assets 233,180 184,841 147,444 105,331 76,982
Obligations under capital leases (including
current portion) 8,379 9,183 9,808 6,274 6,823
Long-term debt (including current portion) 61,518 37,633 12,401 24,902 6,419
Stockholders' equity 132,011 118,174 109,683 63,357 54,377
(1) Adjusted for a 3-for-2 stock split in 1998 and 1995.
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Form 10-K 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 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 fees from franchisees. The Company also receives revenues
from initial franchise fees, area development fees, the selling and leasing
of signs and real estate, and from minority ownership positions in certain
franchised restaurants. 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.
16
PERCENTAGE RESULTS OF OPERATIONS AND RESTAURANT DATA
($ IN THOUSANDS)
YEAR ENDED AUGUST 31,
-------------------------------------------------
1998 1997 1996
-------------- -------------- -------------
INCOME STATEMENT DATA:
Revenues:
Company-owned restaurant sales 83.0% 83.0% 79.9%
Franchised restaurants:
Franchise fees 1.2 0.9 1.0
Franchise royalties 14.8 14.6 15.4
Other 1.0 1.5 3.7
-------------- -------------- -------------
100.0% 100.0% 100.0%
-------------- -------------- -------------
-------------- -------------- -------------
Costs and expenses:
Company-owned restaurants (1) 74.6% 73.7% 76.8%
Selling, general and administrative 10.2 10.5 9.6
Depreciation and amortization 6.8 6.7 5.9
Minority interest in earnings of restaurant partnerships (1) 4.3 4.9 4.0
Provision for impairment of long-lived assets .1 .1 5.7
Other 1.2 - 2.1
Income from operations 16.1 17.4 12.3
Net interest expense 1.3 .8 .3
Income before cumulative effect of change in accounting 9.3 10.4 7.4
Net income 9.0% 10.4% 7.4%
RESTAURANT OPERATING DATA:
Company-owned restaurants:
Core markets 185 165 158
Developing markets 107 91 73
-------------- -------------- -------------
All markets (2) 292 256 231
Franchised restaurants (2) 1,555 1,424 1,336
-------------- -------------- -------------
Total 1,847 1,680 1,567
-------------- -------------- -------------
-------------- -------------- -------------
System-wide sales $1,333,877 $1,142,636 $984,784
Percentage increase (3) 16.7% 16.0% 11.8%
Average sales per restaurant:
Company-owned $663 $649 $601
Franchise 775 720 657
System-wide 758 707 648
Change in comparable restaurant sales (4):
Company-owned restaurants:
Core markets 5.4% 8.7% 5.9%
Developing markets (2.5) (2.1) (1.0)
-------------- -------------- -------------
All markets 4.0% 6.3% 4.9%
Franchise 6.9 8.5 5.1
System-wide 6.3 8.0 5.0
- ---------------------------
(1) As a percentage of Company-owned restaurant sales.
(2) 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
two because that table sets forth the numbers by state rather than by
television market.)
(3) Represents percentage increase from the comparable period in the prior
year.
(4) Represents percentage increase for restaurants open in both the reported
and prior years.
17
COMPARISON OF FISCAL 1998 TO FISCAL 1997. Total revenues increased
19.1% to $219.1 million in fiscal 1998 from $184.0 million in fiscal 1997.
Company-owned restaurant sales increased 19.2% to $182.0 million in fiscal
1998 from $152.7 million in fiscal 1997. Of the $29.3 million increase in
Company-owned restaurant sales, $24.2 million was due to the net addition of
61 Company-owned restaurants since the beginning of fiscal 1997. Average
sales increases of approximately 4.0% by stores open the full reporting
periods of fiscal 1998 and fiscal 1997 accounted for $5.1 million of the
increase. Franchise fee revenues increased to $2.6 million during fiscal 1998
as compared to $1.7 million during fiscal 1997, primarily resulting from the
opening of 120 new franchise restaurants in fiscal 1998 compared to 92 in
fiscal 1997. Franchise royalties increased 21.0% to $32.4 million in fiscal
1998 compared to $26.8 million in fiscal 1997. Increased sales by comparable
franchised restaurants resulted in an increase in royalties of approximately
$3.1 million and resulted from the franchise same store sales growth of 6.9%
over fiscal 1997. Additional franchise restaurants in operation resulted in
an increase in royalties of $2.5 million. The decrease in other revenues of
approximately $0.7 million resulted primarily from the fiscal year 1997 gain
on the sale of the Company's minority interest in 10 restaurants.
Restaurant cost of operations, as a percentage of Company-owned
restaurant sales, was 74.6% in fiscal 1998, compared to 73.7% in fiscal 1997.
The reported decline in operating margins resulted primarily from the
Company's adoption of a new accounting standard, SOP 98-5, which requires
that pre-opening and other start-up costs be expensed as incurred. The
Company previously capitalized such costs and amortized them over 12 months.
Implementation of the standard resulted in the reclassification of expenses
from depreciation and amortization into restaurant cost of operations. The
following table sets out the pro forma operating margins for fiscal 1998 and
1997 as if the Company had adopted the new standard as of the beginning of
fiscal 1997.
YEAR ENDED
AUGUST 31, August 31,
1998 1997
-----------------------------------
Pro forma margin analysis:
Company-owned restaurants:
Food and packaging 27.6% 28.6%
Payroll and other employee benefits 28.7 28.3
Other operating expenses 18.3 17.6
-----------------------------
74.6% 74.5%
The following discussion is based on the pro forma margin analysis.
Management believes the decrease in food and packaging costs resulted from
the negotiation of more favorable contracts with suppliers, a reduction in
promotional discounting from standard menu prices and a continued shift in
product mix toward higher margin items such as drinks and ice cream. The
increase in payroll and other employee benefit costs resulted primarily from
an increase in the hourly wage rate related to a minimum wage increase which
was effective September 1, 1997 without a corresponding increase in pricing.
The increase in other operating expenses resulted primarily from increased
marketing expenditures, which reflects the Company's commitment to increased
media penetration through its system of advertising cooperatives. Minority
interest in earnings of restaurant partnerships decreased, as a percentage of
Company-owned restaurant sales, to 4.3% in fiscal 1998 versus 4.9% in fiscal
1997. This decrease reflected the minority partners' share of depreciation
expense associated with the roll-out of a point-of-sale system.
Selling, general and administrative expenses, as a percentage of total
revenues, decreased to 10.2% in fiscal 1998 compared with 10.5% in fiscal
1997. Management expects selling, general and administrative expenses to
decline in future periods, as a percentage of total revenues, because the
Company plans to add fewer corporate employees, as a percentage of the
existing corporate employee base, than in previous periods. This strategy is
expected to result in revenues growing at a higher rate than selling, general
and administrative expenses. Depreciation and amortization expense increased
approximately $2.5 million due to the purchase of buildings and equipment for
new restaurants, retrofit expenditures for existing restaurants, and
information systems upgrades. Management expects this trend to continue due
to a similar level of capital expenditures planned for fiscal 1999.
The Company recorded a $2.7 million special provision for litigation
settlement in the third fiscal quarter of 1998 as a result of the denial by
the Supreme Court of the State of Texas of the Company's appeal of a decision
by the
18
Texas Court of Appeals in a real estate related lawsuit that has been ongoing
for several years. See Note 16 of the Notes to Consolidated Financial
Statements.
Income from operations increased to $35.4 million from $32.0 million in
fiscal 1997. Excluding the special provision for litigation settlement
discussed above, income from operations increased 19.1% to $38.1 million.
Net interest expense increased to $2.8 million in fiscal 1998 from $1.6
million in fiscal 1997. This increase was the result of additional
borrowings to partially fund the Company's capital additions of $67.0 million
and stock repurchases of $10.0 million. The Company expects interest expense
to continue to increase in fiscal 1999.
Provision for income taxes reflects an effective federal and state tax
rate of 37.25% for fiscal 1998 and 1997. Net income, excluding the special
provision for litigation settlement and before the cumulative effect of the
change in accounting for pre-opening costs, increased 16.2%. Net income per
diluted share increased 17.9% over fiscal 1997, excluding the cumulative effect
of the accounting change and the special provision for litigation settlement.
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.
Company-owned restaurant sales increased 26.5% to $152.7 million in fiscal
1997 from $120.7 million in fiscal 1996. Of the $32.0 million increase in
Company-owned restaurant sales, $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 vs. 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 other revenues was due
to the sale of the restaurant equipment division in fiscal 1996. This
decrease was offset by 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 Company-owned
restaurant sales, 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 had a negative impact on payroll and employee benefits
expense of approximately one percentage point, as a percentage of Company-owned
restaurant sales. Minority interest in earnings of restaurant partnerships
increased, as a percentage of Company-owned restaurant sales, 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
19
expense increased approximately $3.4 million due to the purchase of buildings
and equipment for new and existing restaurants 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, 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.
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 diluted 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.
LIQUIDITY AND SOURCES OF CAPITAL
During fiscal 1998, the Company opened 50 new restaurants and sold 14
restaurants to franchisees. The Company funded total capital additions for
fiscal 1998 of $67.0 million, which included the cost of newly-opened
restaurants, restaurants under construction, retrofits of existing restaurants,
new equipment for existing restaurants and corporate use, internally from cash
generated by operating activities and through borrowings under the Company's
line of credit. During fiscal 1998, the Company elected to own the real estate
on 47 of the 50 newly-constructed restaurants. The Company expects to own the
land and building for approximately 90% of its future Company-owned newly-
constructed restaurants. In addition to the capital expenditures mentioned
above, the Company repurchased 482,000 shares (as adjusted for the 1998 stock
split) of common stock for approximately $10.0 million during fiscal 1998.
The Company has an agreement with a group of banks which provides the
Company with a $60 million line of credit expiring in July 2001. The Company
will use the line of credit to finance the opening of newly-constructed
restaurants, retrofit of existing restaurants, acquisitions of existing
restaurants, and for other general corporate purposes to the extent such cash
requirements exceed cash provided by operations. As of August 31, 1998, the
Company's outstanding borrowings under the line of credit were $11.0 million,
exclusive of $0.3 million in outstanding letters of credit. The available
line of credit on this facility as of August 31, 1998, was $48.7 million.
Additionally, the Company completed a private placement of $50 million in
Senior Unsecured Notes on April 23, 1998. These notes consist of $20 million
of Series A notes which mature in 2003, and $30 million of Series B notes
which mature in 2005. Interest on the notes will be payable semi-annually in
arrears at an average annual rate of approximately 6.7%. The Company used
the proceeds from the notes to pay down the outstanding borrowings under the
line of credit (discussed above), to repurchase common stock of the Company
and for general corporate purposes.
The Company plans for capital expenditures of approximately $67 million
in fiscal 1999, excluding potential acquisitions. These capital expenditures
are primarily for the development of additional Company-owned stores, retrofit
of Company-owned stores and enhancements to existing financial and operating
information systems. In addition to the planned capital expenditures, the
Company's board of directors has authorized the repurchase of up to $10 million
of additional shares of the Company's common stock. The Company expects to
fund these capital expenditures and share repurchases 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.
YEAR 2000
DESCRIPTION. The Year 2000 issue is the result of computer programs being
written using two digits rather than four to define the applicable year. Any
of the Company's computer programs or hardware that have date-sensitive
20
software or embedded computer chips may recognize a date using "00" as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations which could disrupt the Company's normal business activities.
The Company has established a plan to prepare its systems for the Year
2000 issue as well as to reasonably assure that its critical business partners
are prepared. The phases of the Company's plan to resolve the Year 2000 issue
involve awareness, assessment, remediation, testing, and implementation. To
date, the Company has completed its assessment of all internal systems that
could be significantly affected by the Year 2000 issue. Based upon its
assessment, the Company has determined that it will be required to modify or
replace portions of its software primarily related to customized interfaces
between its financial systems and other applications. The Company believes that
with modifications or replacements of the identified software programs, the Year
2000 issue can be mitigated. However, if all additional phases of the Year 2000
plan are not completed timely, the Year 2000 issue could have a material impact
on the operations of the Company as set forth under RISKS AND CONTINGENCY PLANS.
In addition, the Company is in the process of gathering information about the
Year 2000 compliance status of its key third party business partners.
STATUS. The Company's internal information technology exposures are
primarily related to financial and management information systems. As of
October 31, 1998, the Company is 60% complete on the remediation phase and
expects to complete software reprogramming and replacement no later than
February 28, 1999. Once the software is reprogrammed or replaced with a Year
2000 compliant version, the Company will test and implement the software. As
of October 31, 1998, the Company had completed 25% of its testing and had
implemented 30% of its remediated applications. Completion of the testing
phase for all significant systems is expected by June 30, 1999 with all
remediated systems fully tested and implemented by September 30, 1999.
The Company's non-Information Technology systems consist primarily of
restaurant operating equipment including its point-of-sale systems. The
initial assessment of these systems has indicated that modification or
replacement will not be necessary as a result of the Year 2000 issue. As
such, the Company is not currently remediating this operating equipment.
However, the existence of embedded technology is by nature more difficult to
identify. While the Company believes that all significant non-Information
Technology systems are Year 2000 compliant, the Company plans to continue
testing its operating equipment and expects to complete the testing by March 31,
1999.
SIGNIFICANT THIRD PARTIES. The Company's significant third party
business partners consist of suppliers, banks, and its franchisees. The
Company does not have any significant system interfaces with third parties.
An initial inventory of significant suppliers and distributors has been
completed and letters mailed requesting information regarding each parties'
Year 2000 compliance status. Additionally, the Company has identified
approximately 20 key suppliers and distributors which it intends to meet with
and discuss their Year 2000 readiness. The Company intends to develop
contingency plans by March 31, 1999 for suppliers that appear to have
substantial Year 2000 operational risks which may include the change of
suppliers to minimize such risks.
Letters will be sent to all relationship banks by December 31, 1998
requesting an update on their Year 2000 compliance status. Review and
evaluation of responses will be conducted through June 30, 1999. No later
than September 30, 1999, the Company will discontinue relationships with banks
that indicate compliance with Year 2000 has not been achieved.
A Year 2000 information manual has been sent to all franchisees explaining
the Year 2000 issue and associated business risks. This manual provided
information and tools to assist the franchisees in assessing their Year 2000
risks. The Company will continue its efforts to raise awareness and inform
franchisees of the risks posed by the Year 2000 throughout fiscal year 1999.
COSTS. The Company's Year 2000 plan encompasses the use of both
internal and external resources to identify, remediate, test, and implement
systems for Year 2000 readiness. External resources include contract
resources which will be used to supplement available internal resources. The
total cost of the Year 2000 project, excluding internal personnel costs, is
estimated at $650,000 and is being funded by operating cash flows. As of
August 31, 1998, the Company had incurred approximately $75,000, which has
all been expensed, related to the Year 2000 project. Of the total remaining
project costs, approximately $300,000 is attributable to the purchase and
implementation of new
21
software and will be capitalized. The remaining $275,000 relates to
remediation and testing of software and will be expensed as incurred.
RISKS AND CONTINGENCY PLANS. Management of the Company believes it has
an effective plan in place to resolve the Year 2000 issue in a timely manner.
However, due to the forward-looking nature and lack of historical experience
with Year 2000 issues, it is difficult to predict with certainty what will
happen after December 31, 1999. Despite the Year 2000 remediation efforts
being made, it is likely that there will be disruptions and unexpected
business problems during the early months of 2000. The Company plans to make
diligent efforts to assess the Year 2000 readiness of its significant
business partners and will develop contingency plans for critical areas where
it believes its exposure to Year 2000 risk is the greatest. However, despite
the Company's efforts, it may encounter unanticipated third party failures,
more general public infrastructure failures or a failure to successfully
conclude its remediation efforts as planned. If the remaining Year 2000 plan
is not completed timely, in addition to the implications noted above, the
Company may be required to utilize manual processing of certain otherwise
automated processes primarily related to partner compensation and cash
management. Any one of these unforeseen events could have a material adverse
impact on the Company's results of operations, financial condition, or cash
flows in 1999 and beyond. Additionally, the inability of franchisees to
remit royalty payments on a timely basis could have a material adverse effect
on the Company. The amount of potential loss cannot be reasonably estimated
at this time.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in interest rates on
debt and changes in commodity prices.
The Company's exposure to interest rate risk currently consists of its
Senior notes and outstanding line of credit. The Senior notes bear interest
at fixed rates which average 6.7%. The aggregate balance outstanding under
the Senior notes as of August 31, 1998 was $50.0 million. Should interest
rates increase or decrease, the estimated fair value of these notes would
decrease or increase, respectively. As of August 31, 1998, the estimated fair
value of the Senior notes exceeded the carrying amount by approximately $1.2
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 $11.0 million as of August 31, 1998. The impact on the Company's
results of operations of a one-point interest rate change on the outstanding
balances under the Senior notes and line of credit as of August 31, 1998 would
be immaterial.
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. The Company does not use financial
instruments to hedge commodity prices because these purchase arrangements
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.
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 year 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.
22
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
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, 1998.
PART IV
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 F-1
Consolidated Balance Sheets at August 31, 1998 and 1997 F-2
Consolidated Statements of Income for each of the
three years in the period ended August 31, 1998 F-4
Consolidated Statements of Stockholders' Equity for each of the
the three years in the period ended August 31, 1998 F-5
Consolidated Statements of Cash Flows for each of the
three years in the period ended August 31, 1998 F-6
Notes to Consolidated Financial Statements F-8
FINANCIAL STATEMENT SCHEDULES
The Company has included the following schedule immediately following this
Item 14:
Page
----
Schedule II - Valuation and Qualifying Accounts F-30
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
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. License Agreement (the Number 6A
License Agreement).
10.06. Form of Sonic Industries Inc. License Agreement (the Number 5.2
License Agreement).
10.07. 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.
10.08. 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.
10.09. Form of General Partnership Agreement, Limited Liability Company
Operating Agreement, Partnership Master Agreement, and Limited Liability Company
Master Agreement, which the Company hereby incorporates by reference from
Exhibit 10.07 to the Company's Form 10-K for the fiscal year ended August 31,
1997.
10.10. 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.*
10.11. 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.*
24
10.12. 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.*
10.13. 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.*
10.14. 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.*
10.15. 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.*
10.16. 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.*
10.17. 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.*
10.18. Form of Employment Agreement and Schedule of Material Differences
for the Executive Officers of the Company, which the Company hereby incorporates
by reference form the Company's Form 10-K for the fiscal year ended August 31,
1997.
10.19. 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.
10.20. 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.
10.21. 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.
10.22. 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.
10.23. Fourth Amendment to the Loan Agreement with Chase Bank of Texas,
N.A. (formerly known as Texas Commerce Bank National Association), which the
Company hereby incorporates by reference from Exhibit 10.21 to the Company's
10-Q for the fiscal quarter ended May 31, 1998.
10.24. Fifth Amendment to the Loan Agreement with Chase Bank of Texas,
N.A. (formerly known as Texas Commerce Bank National Association), which the
Company hereby incorporates by reference from Exhibit 10.22 to the Company's
10-Q for the fiscal quarter ended May 31, 1998.
10.25. Note Purchase Agreement dated April 1, 1998, which the Company
hereby incorporates by reference from Exhibit 10.23 to the Company's 10-Q for
the fiscal quarter ended May 31, 1998.
10.26. Form of 6.652% Senior Notes, Series A, due April 1, 2003, which
the Company hereby incorporates by reference from Exhibit 10.24 to the Company's
10-Q for the fiscal quarter ended May 31, 1998.
25
10.27. Form of 6.759% Senior Notes, Series B, due April 1, 2003, which
the Company hereby incorporates by reference from Exhibit 10.24 to the Company's
10-Q for the fiscal quarter ended May 31, 1998.
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 did not file any reports on Form 8-K during its last fiscal
quarter ended August 31, 1998.
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, 1998 and 1997, and the related consolidated statements of
income, stockholders' equity and cash flows for each of the three years in
the period ended August 31, 1998. 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, 1998 and 1997, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended August 31,
1998, 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 1 to the accompanying consolidated financial statements,
in fiscal year 1998 Sonic Corp. changed its method of accounting for
pre-opening and other start-up costs by adopting Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities."
ERNST & YOUNG LLP
Oklahoma City, Oklahoma
October 12, 1998
F-1
Sonic Corp.
Consolidated Balance Sheets
AUGUST 31,
1998 1997
--------------------------------
(IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents $ 2,602 $ 7,334
Accounts and notes receivable, net 7,587 5,890
Refundable income taxes 2,413 2,489
Net investment in direct financing and sales-type leases 1,092 856
Inventories 1,363 1,239
Deferred income taxes 506 100
Prepaid expenses and other 976 791
--------------------------------
Total current assets 16,539 18,699
Notes receivable, net 3,579 3,314
Net investment in direct financing and sales-type leases 3,494 3,361
Property, equipment and capital leases, net 188,065 136,522
Intangibles and other assets, net (NOTE 6) 21,503 22,945
--------------------------------
Total assets $ 233,180 $ 184,841
--------------------------------
--------------------------------
F-2
Sonic Corp.
Consolidated Balance Sheets (continued)
AUGUST 31,
1998 1997
--------------------------------
(IN THOUSANDS)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 10,740 $ 4,635
Deposits from franchisees 883 780
Accrued liabilities 11,140 8,629
Obligations under capital leases due within one year 950 1,030
Long-term debt due within one year 118 116
--------------------------------
Total current liabilities 23,831 15,190
Obligations under capital leases due after one year 7,429 8,153
Long-term debt due after one year 61,400 37,517
Other noncurrent liabilities 4,704 5,051
Deferred income taxes 3,805 756
Commitments and contingencies (NOTES 4, 7, 15, AND 16)
Stockholders' equity:
Preferred stock, par value $.01; 1,000,000 shares authorized;
none outstanding - -
Common stock, par value $.01; 40,000,000 shares authorized;
shares issued 20,554,213 in 1998 and 13,531,593 in 1997 206 135
Paid-in capital 63,866 59,891
Retained earnings 89,455 69,666
--------------------------------
153,527 129,692
Treasury stock, at cost; 1,692,370 shares in 1998 and
807,080 shares in 1997 (21,516) (11,518)
--------------------------------
Total stockholders' equity 132,011 118,174
--------------------------------
Total liabilities and stockholders' equity $ 233,180 $ 184,841
--------------------------------
--------------------------------
SEE ACCOMPANYING NOTES.
F-3
Sonic Corp.
Consolidated Statements of Income
YEAR ENDED AUGUST 31,
1998 1997 1996
-----------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues:
Company-owned restaurant sales $ 182,011 $ 152,739 $ 120,700
Franchised restaurants:
Franchise fees 2,564 1,702 1,453
Franchise royalties 32,391 26,764 23,315
Other 2,141 2,813 5,662
-----------------------------------------------
219,107 184,018 151,130
Costs and expenses:
Company-owned restaurants:
Food and packaging 50,179 43,661 37,463
Payroll and other employee benefits 52,310 42,508 34,555
Other operating expenses 33,317 26,419 20,645
-----------------------------------------------
135,806 112,588 92,663
Selling, general and administrative 22,250 19,318 14,498
Depreciation and amortization 14,790 12,320 8,896
Minority interest in earnings of restaurant partnerships 7,904 7,558 4,806
Provision for impairment of long-lived assets 285 266 8,627
Special provision for litigation settlement 2,700 - -
Other operating expenses - - 3,101
-----------------------------------------------
183,735 152,050 132,591
-----------------------------------------------
Income from operations 35,372 31,968 18,539
Interest expense 3,446 2,154 1,184
Interest income (696) (596) (708)
-----------------------------------------------
Net interest expense 2,750 1,558 476
-----------------------------------------------
Income before income taxes and cumulative effect
of change in accounting 32,622 30,410 18,063
Provision for income taxes 12,152 11,328 6,819
-----------------------------------------------
Income before cumulative effect of change in accounting 20,470 19,082 11,244
Cumulative effect of change in accounting, net of income
taxes of $404 (NOTE 1) 681 - -
-----------------------------------------------
Net income $ 19,789 $ 19,082 $ 11,244
-----------------------------------------------
-----------------------------------------------
Basic income per share:
Income before cumulative effect of change in accounting $ 1.07 $ .96 $ .57
Cumulative effect of change in accounting (.04) - -
-----------------------------------------------
Net income per share - basic $ 1.03 $ .96 $ .57
-----------------------------------------------
-----------------------------------------------
Diluted income per share:
Income before cumulative effect of change in accounting $ 1.03 $ .95 $ .56
Cumulative effect of change in accounting (.03) - -
-----------------------------------------------
Net income per share - diluted $ 1.00 $ .95 $ .56
-----------------------------------------------
-----------------------------------------------
SEE ACCOMPANYING NOTES.
F-4
Sonic Corp.
Consolidated Statements of Stockholders' Equity
COMMON STOCK TREASURY STOCK
------------ PAID IN RETAINED --------------
SHARES AMOUNT CAPITAL EARNINGS SHARES AMOUNT
--------------------------------------------------------------------------------
(IN THOUSANDS)
Balance at August 31, 1995 12,080 $ 121 $ 30,355 $ 39,340 428 $ (6,459)
Exercise of common stock options 154 2 2,037 - - -
Purchase of treasury stock - - - - 8 (143)
Sale of common stock 1,241 12 26,715 - (428) 6,459
Net income - - - 11,244 - -
--------------------------------------------------------------------------------
Balance at August 31, 1996 13,475 135 59,107 50,584 8 (143)
Exercise of common stock options 57 - 784 - - -
Purchase of treasury stock - - - - 799 (11,375)
Net income - - - 19,082 - -
--------------------------------------------------------------------------------
Balance at August 31, 1997 13,532 135 59,891 69,666 807 (11,518)
Exercise of common stock options 187 2 2,690 - - -
Tax benefit related to employee stock
options - - 1,356 - - -
Purchase of treasury stock - - - - 414 (9,998)
Three-for-two stock split, including
$2 paid in cash for fractional shares 6,835 69 (71) - 471 -
Net income - - - 19,789 - -
--------------------------------------------------------------------------------
Balance at August 31, 1998 20,554 $ 206 $ 63,866 $ 89,455 1,692 $(21,516)
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES.
F-5
Sonic Corp.
Consolidated Statements of Cash Flows
YEAR ENDED AUGUST 31,
1998 1997 1996
---------------------------------------------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 19,789 $ 19,082 $ 11,244
Adjustments to reconcile net income to net
cash provided by operating activities:
Cumulative effect of change in accounting 681 - -
Depreciation 13,218 10,099 7,166
Amortization 1,572 2,221 1,730
Gains on dispositions of assets (282) (1,491) (309)
Amortization of franchise and development fees (2,564) (1,702) (1,453)
Franchise and development fees collected 2,771 1,768 1,460
Provision (credit) for deferred income taxes,
net of $404 credit in 1998 2,643 2,950 (1,905)
Provision for impairment of long-lived assets 285 266 8,627
Other 60 24 74
(Increase) decrease in operating assets:
Accounts and notes receivable (632) (5) (380)
Refundable income taxes 76 (2,489) -
Inventories and prepaid expenses and other (309) 62 (766)
Increase in operating liabilities:
Accounts payable 6,105 1,709 1,213
Accrued and other liabilities 3,633 1,649 2,154
---------------------------------------------
Total adjustments 27,257 15,061 17,611
---------------------------------------------
Net cash provided by operating activities 47,046 34,143 28,855
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (66,982) (48,048) (41,107)
Investments in direct financing leases (1,624) (935) (1,235)
Collections on direct financing leases 1,244 922 987
Proceeds from dispositions of assets 1,745 3,025 2,450
Increase in intangibles and other assets:
Goodwill resulting from acquisitions of
restaurants - - (5,964)
Other (1,697) (3,455) (1,721)
---------------------------------------------
Net cash used in investing activities (67,314) (48,491) (46,590)
(CONTINUED ON FOLLOWING PAGE)
F-6
Sonic Corp.
Consolidated Statements of Cash Flows (continued)
YEAR ENDED AUGUST 31,
1998 1997 1996
-----------------------------------------------
(IN THOUSANDS)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term borrowings $ 105,500 $ 59,750 $ 11,500
Payments on long-term debt (81,615) (34,542) (24,250)
Purchases of treasury stock (9,998) (11,375) (4)
Payments on capital lease obligations (1,041) (641) (669)
Exercises of stock options 2,692 784 1,900
Other (2) - -
Proceeds from sale of common stock - - 33,186
-----------------------------------------------
Net cash provided by financing activities 15,536 13,976 21,663
-----------------------------------------------
Net increase (decrease) in cash and cash
equivalents (4,732) (372) 3,928
Cash and cash equivalents at beginning of the year 7,334 7,706 3,778
-----------------------------------------------
Cash and cash equivalents at end of the year $ 2,602 $ 7,334 $ 7,706
-----------------------------------------------
-----------------------------------------------
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ 2,271 $ 2,254 $ 1,369
Income taxes (net of refunds) 8,030 11,942 8,192
Additions to capital lease obligations 249 569 4,203
Purchases of treasury stock in connection with
exercises of stock options - - 139
Accounts and notes receivable from property and
equipment sales 1,330 - -
Tax benefit related to employee stock options 1,356 - -
SEE ACCOMPANYING NOTES.
F-7
Sonic Corp.
Notes to Consolidated Financial Statements
August 31, 1998, 1997 and 1996
(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 leases
restaurant signs. The Company grants credit to its operating partners and 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 accounted for under the
equity method 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.
F-8
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
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.
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.
F-9
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PRE-OPENING COSTS
Prior to fiscal year 1998, the Company capitalized certain direct costs
associated with opening new restaurants and amortized these costs over the first
twelve months of restaurant operations. Effective September 1, 1997, the Company
adopted Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up
Activities." SOP 98-5 requires that pre-opening and other start-up costs be
expensed as incurred. The cumulative effect of adopting SOP 98-5 resulted in a
charge to operations for the unamortized balance of pre-opening and other
start-up costs as of August 31, 1997 of $681 or $.03 per share (diluted), net of
income tax effects of $404 and minority interest of $248.
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 $9,340, $6,983, and
$4,956 for fiscal years 1998, 1997 and 1996, respectively.
F-10
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET INCOME PER SHARE
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, "Earnings per Share." SFAS 128 replaced the calculation of primary and
fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of stock options. Diluted earnings per share is very similar
to the previously reported fully diluted earnings per share calculation. All
earnings per share amounts for all periods have been presented and, where
necessary, restated to conform to SFAS 128 requirements.
CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments with a maturity of
three months or less from date of purchase.
2. NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
YEAR ENDED AUGUST 31,
1998 1997 1996
---------------------------------------------------
Numerator:
Net income $19,789 $19,082 $11,244
Denominator:
Weighted average shares outstanding - basic 19,107,369 19,851,970 19,789,012
Effect of dilutive employee stock options 631,048 304,083 384,480
---------------------------------------------------
Weighted average shares - diluted 19,738,417 20,156,053 20,173,492
---------------------------------------------------
---------------------------------------------------
Net income per share - basic $ 1.03 $ .96 $ .57
---------------------------------------------------
---------------------------------------------------
Net income per share - diluted $ 1.00 $ .95 $ .56
---------------------------------------------------
---------------------------------------------------
Anti-dilutive employee stock options excluded 86,828 310,913 62,455
---------------------------------------------------
---------------------------------------------------
F-11
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
3. 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 then
existing 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 $.26 per share) and included $5,720 ($3,560 after-tax or
$.17 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 $.09 per share) related to restaurants to be held
and used. Certain of these properties with carrying amounts of $857 and
$1,207 were disposed of in fiscal years 1998 and 1997, respectively, with net
proceeds to the Company of $870 and $1,258, respectively. The Company plans
to dispose of the remaining assets during fiscal year 1999 and has estimated
the sales value, net of related costs to sell, at approximately $240. 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. As of August 31,
1998, the Company had identified certain underperforming restaurants whose
operating results indicated that certain assets of these restaurants might be
impaired. The buildings and improvements of these restaurants had combined
carrying amounts of $5,936. Management's estimate of undiscounted future cash
flows indicates that such carrying amounts are expected to be recovered.
However, it is reasonably possible that the estimate of undiscounted cash
flows may change in the near future resulting in the need to write-down one
or more of the identified assets to fair value. 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. 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. 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.
4. 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
F-12
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
4. RESTAURANT TRANSACTIONS WITH RELATED PARTY (CONTINUED)
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 $3,197 as of August 31, 1998 and
$3,556 as of August 31, 1997), 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, 1998, the Company's
repurchase obligations under these agreements expire $1,325 in 1999, $35 in
2000, $736 in 2001, and $1,101 in 2002.
5. ACCOUNTS AND NOTES RECEIVABLE
Accounts and notes receivable consist of the following at August 31, 1998 and
1997:
1998 1997
----------------------------
Trade receivables $2,917 $3,208
Notes receivable--current 2,523 874
Other 2,370 1,907
----------------------------
7,810 5,989
Less allowance for doubtful accounts and notes receivable 223 99
----------------------------
$7,587 $5,890
----------------------------
----------------------------
Notes receivable--noncurrent $3,701 $3,488
Less allowance for doubtful notes receivable 122 174
----------------------------
$3,579 $3,314
----------------------------
----------------------------
F-13
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
6. INTANGIBLES AND OTHER ASSETS
Intangibles and other assets consist of the following at August 31, 1998 and
1997:
1998 1997
-----------------------------
Trademarks, trade names, and other goodwill $21,985 $21,124
Franchise agreements 1,870 1,870
Other intangibles and other assets 5,545 6,547
-----------------------------
29,400 29,541
Less accumulated amortization 7,897 6,596
-----------------------------
$21,503 $22,945
-----------------------------
-----------------------------
7. 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 nineteen 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 ten
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.
Most of the leases contain one to four renewal options at the end of the
initial term for periods of five years. These options enable the Company to
retain use of properties in desirable operating areas.
Certain Company-owned restaurants lease land and buildings from third
parties. These leases, which expire over the next twenty 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.
F-14
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
7. LEASES (CONTINUED)
DIRECT FINANCING AND SALES-TYPE LEASES
Components of net investment in direct financing and sales-type leases are as
follows at August 31, 1998 and 1997:
1998 1997
----------------------------
Minimum lease payments receivable $6,425 $5,441
Less unearned income 1,839 1,224
----------------------------
Net investment in direct financing and sales-type leases 4,586 4,217
Less amount due within one year 1,092 856
----------------------------
Amount due after one year $3,494 $3,361
----------------------------
----------------------------
Minimum lease payments receivable for each of the five years after August 31,
1998 are $1,635 in 1999, $1,166 in 2000, $987 in 2001, $802 in 2002, $634 in
2003 and $1,201 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 1998 and 1997. Accordingly, no portion
of unearned income has been recognized to offset those costs.
Other revenues include $1,570, $768 and $1,340 for fiscal years 1998, 1997
and 1996, 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,
1998 and 1997:
1998 1997
-----------------------------
Total minimum lease payments $13,434 $14,793
Less amount representing interest 5,055 5,610
-----------------------------
Present value of net minimum lease payments 8,379 9,183
Less amount due within one year 950 1,030
-----------------------------
Amount due after one year $ 7,429 $ 8,153
-----------------------------
-----------------------------
Maturities of these obligations under capital leases, including interest
averaging 12% in fiscal years 1998 and 1997, 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:
F-15
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
7. LEASES (CONTINUED)
OPERATING CAPITAL
-------------------------------
Year ending August 31:
1999 $ 2,609 $1,777
2000 2,575 1,561
2001 2,537 1,383
2002 2,426 1,306
2003 1,833 1,233
Thereafter 11,870 6,174
-------------------------------
23,850 13,434
Less amount representing interest - 5,055
-------------------------------
$ 23,850 $8,379
-------------------------------
-------------------------------
Total minimum lease payments do not include contingent rentals on capital leases
which have not been material.
Total rent expense for all operating leases consists of the following:
Year ended August 31,
1998 1997 1996
----------------------------------------------
Minimum rentals $ 3,323 $ 3,035 $ 2,596
Contingent rentals 538 510 432
Less: Sublease rentals (134) (103) (56)
----------------------------------------------
$ 3,727 $ 3,442 $ 2,972
----------------------------------------------
----------------------------------------------
F-16
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
8. PROPERTY, EQUIPMENT AND CAPITAL LEASES
Property, equipment and capital leases consist of the following at August 31,
1998 and 1997:
1998 1997
--------------------------------
Home office:
Land and leasehold improvements $ 1,355 $ 1,262
Computer and other equipment 19,156 17,768
Restaurants, including those leased to others:
Land 49,149 33,739
Buildings, including property held for disposition 85,928 53,582
Equipment 60,812 47,884
--------------------------------
Property and equipment, at cost 216,400 154,235
Less accumulated depreciation 34,496 24,335
--------------------------------
Property and equipment, net 181,904 129,900
Leased restaurant buildings and equipment under capital leases,
including those held for sublease 10,035 10,101
Less accumulated amortization 3,874 3,479
--------------------------------
Capital leases, net 6,161 6,622
--------------------------------
Property, equipment and capital leases, net $188,065 $136,522
--------------------------------
--------------------------------
Property and equipment include land, buildings and equipment with a carrying
amount of $10,181 at August 31, 1998 which were leased under operating leases
to franchisees or other parties. The accumulated depreciation related to
these buildings and equipment was $1,029 at August 31, 1998.
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 $265 at August 31, 1998 and
$1,464 at August 31, 1997.
F-17
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
9. ACCRUED LIABILITIES
Accrued liabilities consist of the following at August 31, 1998 and 1997:
1998 1997
-----------------------------
Wages and other employee benefits $ 2,009 $ 1,383
Income taxes payable 1,201 1,560
Taxes, other than income taxes 4,002 3,487
Accrued carrying costs for restaurant closings and disposals 291 370
Accrued interest 1,243 68
Annual convention deposits 933 882
Other 1,461 879
-----------------------------
$11,140 $ 8,629
-----------------------------
-----------------------------
10. LONG-TERM DEBT
Long-term debt consists of the following at August 31, 1998 and 1997:
1998 1997
--------------------------------
Senior unsecured notes (A) $ 50,000 $ -
Borrowings under line of credit (B) 11,000 37,000
Other 518 633
--------------------------------
61,518 37,633
Less long-term debt due within one year 118 116
--------------------------------
Long-term debt due after one year $ 61,400 $ 37,517
--------------------------------
--------------------------------
(A) In April 1998, the Company completed a private placement of $50,000 of
senior unsecured notes with $20,000 of Series A notes maturing in 2003 and
$30,000 of Series B notes maturing in 2005. Interest is payable
semi-annually and accrues at 6.65% for the Series A notes and 6.76% for the
Series B notes. The proceeds from the issuance were used to pay down the
$43,000 balance then outstanding under the existing line of credit, to fund
repurchases of common stock of the Company and for general corporate
purposes. The related agreement requires, among other things, the Company
to maintain equity of a specified amount, maintain ratios of debt to total
capital and fixed charge coverage and limits additional borrowings.
F-18
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
10. LONG-TERM DEBT (CONTINUED)
(B) The Company has an agreement (as amended) with a group of banks which
provides for a $60,000 line of credit, including a $2,000 sub-limit for
letters of credit, expiring in July 2001. The agreement allows for annual
renewal options, subject to approval by the banks. 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 0.50%
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, 1998, the Company's effective borrowing rate was 6.8%. As of
August 31, 1998 there were $300 in letters of credit outstanding under the
line of credit. The agreement requires, among other things, the Company to
maintain equity of a specified amount, maintain ratios of debt to EBITDA
and fixed charge coverage and limits additional borrowings and
acquisitions of businesses.
Maturities of long-term debt for each of the five years after August 31, 1998
are $118 in 1999, $69 in 2000, $11,021 in 2001, $23 in 2002, $20,025 in 2003
and $30,262 thereafter.
11. OTHER NONCURRENT LIABILITIES
Other noncurrent liabilities consist of the following at August 31, 1998 and
1997:
1998 1997
--------------------------------
Deferred area development fees $ 599 $ 495
Minority interest in consolidated restaurant partnerships 2,841 2,948
Accrued carrying costs for restaurant closings and disposals 971 756
Other 293 852
--------------------------------
$ 4,704 $ 5,051
--------------------------------
--------------------------------
F-19
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
12. INCOME TAXES
The components of the provision (benefit) for income taxes related to income
before cumulative effect of change in accounting principle consists of the
following:
YEAR ENDED AUGUST 31,
1998 1997 1996
-------------------------------------------------
Current:
Federal $ 9,010 $ 8,070 $ 8,371
State 95 308 353
-------------------------------------------------
9,105 8,378 8,724
Deferred:
Federal 2,614 2,847 (1,839)
State 433 103 (66)
-------------------------------------------------
3,047 2,950 (1,905)
-------------------------------------------------
Provision for income taxes $ 12,152 $ 11,328 $6,819
-------------------------------------------------
-------------------------------------------------
The provision for income taxes on income before cumulative effect of change in
accounting principle differs from the amount computed by applying the statutory
federal income tax rate due to the following:
YEAR ENDED AUGUST 31,
1998 1997 1996
-------------------------------------------------
Amount computed by applying a tax rate of 35% $ 11,418 $ 10,643 $ 6,322
State income taxes (net of federal income tax
benefit) 343 267 187
Permanent differences in expenses for financial
and income tax reporting purposes (69) (69) (283)
Other 460 487 593
-------------------------------------------------
Provision for income taxes $ 12,152 $ 11,328 $ 6,819
-------------------------------------------------
-------------------------------------------------
F-20
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
12. INCOME TAXES (CONTINUED)
Deferred tax assets and liabilities consist of the following at August 31, 1998
and 1997:
1998 1997
---------------------------------
Deferred tax assets:
Allowance for doubtful accounts and notes receivable $132 $ 98
Property, equipment and capital leases - 499
Accrued litigation costs 332 343
Other 113 332
---------------------------------
577 1,272
Valuation allowance - -
---------------------------------
Deferred tax assets 577 1,272
Less deferred tax liabilities:
Net investment in direct financing and sales-type leases,
including differences related to capitalization and amortization 1,528 890
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 1,563 299
Property, equipment and capital leases 360 -
Accumulated amortization of license agreements, management
contracts and other intangibles 422 736
Other 3 3
---------------------------------
Deferred tax liabilities 3,876 1,928
---------------------------------
Net deferred tax liabilities $ (3,299) $ (656)
---------------------------------
---------------------------------
F-21
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
13. STOCKHOLDERS' EQUITY
On April 30, 1998, the Company's board of directors authorized a
three-for-two stock split in the form of a stock dividend. A total of
6,835,095 shares of common stock were issued in connection with the split.
The stated par value of each share was not changed from $.01. An aggregate
amount equal to the par value of the common stock issued plus cash paid in
lieu of fractional shares of $71 was reclassified from paid-in capital to
common stock. This transfer has been reflected in the consolidated statement
of stockholders' equity for fiscal year 1998. All references in the
accompanying consolidated financial statements to weighted average numbers of
shares outstanding, per share amounts and Stock Purchase Plan, Stock Options
and Stock Incentive Plan share data have been adjusted to reflect the stock
split on a retroactive basis.
In October 1995, the Company completed a public offering of 1,668,826 shares
of common stock, including 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. 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 225,000 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 2,805,000
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 337,500 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
F-22
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
13. STOCKHOLDERS' EQUITY (CONTINUED)
defined by the plans. All options expire at the earlier of termination of
employment or ten years after the date of grant.
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 1998, 1997, and 1996, respectively: risk-free
interest rates of 5.7%, 6.3%, and 6.0%; a dividend yield of 0%; volatility
factors of the expected market price of the Company's common stock of 40.0%,
39.9%, and 29.5%; and a weighted average expected life of the options 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:
1998 1997 1996
--------------------------------------------------------
Pro forma net income $ 18,394 $ 18,026 $ 10,946
Pro forma net income per share-diluted $ .93 $ .89 $ .54
F-23
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
13. STOCKHOLDERS' EQUITY (CONTINUED)
Because Statement 123 is appplicable only to options granted subsequent to
fiscal year 1995, its pro forma effect was not fully reflected until fiscal
year 1998.
A summary of the Company's stock option activity (adjusted for the stock
split), and related information for the years ended August 31 follows:
1998 1997 1996
--------------------------- --------------------------- -----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
---------------------------------------------------------------------------------------
Outstanding--beginning of year 1,795,287 $ 11.40 1,522,375 $ 11.13 1,477,071 $ 9.91
Granted 388,332 20.26 531,272 11.90 567,681 13.11
Exercised (256,910) 10.48 (84,776) 9.24 (258,015) 8.79
Forfeited (161,982) 12.69 (173,584) 11.64 (264,362) 10.83
------------- ------------- -------------
Outstanding--end of year 1,764,727 $ 13.37 1,795,287 $ 11.40 1,522,375 $ 11.13
------------- ------------- -------------
------------- ------------- -------------
Exercisable at end of year 970,851 $ 11.13 883,877 $ 10.50 610,898 $ 9.92
------------- ------------- -------------
------------- ------------- -------------
Weighted average fair value of
options granted during the year $ 8.87 $ 5.31 $ 4.89
A summary of the Company's options as of August 31, 1998 follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------ ----------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Number of Contractual Exercise Number of Exercise
Range of Exercise Prices Options Life (Yrs.) Price Options Price
- ------------------------------------------------------------------------------ ----------------------------------
$6.67 to $9.78 318,323 4.6 $ 8.72 318,323 $ 8.72
$10.08 to $14.67 931,904 7.4 11.90 593,949 12.02
$15.00 to $21.50 514,500 9.3 18.90 58,579 15.17
--------------- --------------- ------------- --------------- ---------------
$6.67 to $21.50 1,764,727 7.5 $13.37 970,851 $11.13
--------------- --------------- ------------- --------------- ---------------
--------------- --------------- ------------- --------------- ---------------
F-24
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
13. STOCKHOLDERS' EQUITY (CONTINUED)
STOCKHOLDER RIGHTS PLAN
In June 1997, the Company's board of directors 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.
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,
1998, 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 180,000
shares of common stock to
F-25
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
13. STOCKHOLDERS' EQUITY (CONTINUED)
certain key employees. Participants in the Stock Incentive Plan receive
awards of shares of restricted common stock (the "Restricted Stock"), subject
to vesting only if the Company meets 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 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 130,500 shares of Restricted
Stock which vest over a three-year period if specified performance goals are
met (no shares were awarded in fiscal years 1998 and 1997). The Company did
not meet the specified performance criteria in fiscal years 1998, 1997, and
1996 which resulted, or will result, in 28,500 shares, 36,000 shares and
30,000 shares, respectively, not vesting. In addition, 7,500 shares and
15,000 shares were forfeited in fiscal years 1998 and 1997, respectively, due
to termination of employment. Shares applicable to awards which have not
vested are not reflected as shares issued in the accompanying financial
statements.
14. 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 $184,
$142 and $114 were made by the Company during fiscal years 1998, 1997 and
1996, respectively. For fiscal year 1998, a discretionary contribution of
$100 was recognized as expense ($75 and $35 for fiscal years 1997 and 1996,
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
F-26
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
14. EMPLOYEE BENEFIT PLANS (CONTINUED)
that a predetermined percentage of the employee's salary may be paid in the
form of a bonus. The Company recognized as expense incentive bonuses of
$1,137, $804 and $341 during fiscal years 1998, 1997 and 1996, respectively.
15. 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. These contracts also
contain provisions for payments in the event of the termination of employment
and provide for payments aggregating $3,092 at August 31, 1998 due to loss of
employment in the event of a change in control (as defined in the contracts).
16. CONTINGENCIES
During fiscal year 1998, the Texas Supreme Court (the "Court") denied the
Company's motion for rehearing of the application for a writ of error
regarding the Texas Court of Appeals' reversal of the district court's
judgment notwithstanding the verdict which reinstated the jury's verdict of
$782 of actual damages, $1,000 of punitive damages, and interest in an action
in which the plaintiffs claimed a subsidiary of the Company interfered with
the contractual relations of the plaintiffs. The Court refused to exercise
its discretionary jurisdiction to consider the decision of the Texas Court of
Appeals. In connection with the denial, the Company recorded a $2,700
provision for litigation. The judgment was paid in full as of August 31, 1998.
The Company has contingent liabilities for taxes, lawsuits and various other
matters occurring in the ordinary course of business. Management of the
Company believes that the ultimate resolution of these contingencies will not
have a material adverse effect on the Company's financial position or results
of operations.
The Company has entered into agreements with several lenders pursuant to
which such lenders may make loans to qualified franchisees. Under the terms
of these agreements, the Company provides certain guarantees of a portion of
the outstanding balances of the loans to franchisees. At August 31, 1998,
these guarantees totaled $2,397.
F-27
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
17. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
FIRST QUARTER SECOND QUARTER THIRD QUARTER
1998 1997 1998 1997 1998 1997
---------------------------------------------------------------------------------
Income statement data:
Company-owned restaurant sales $ 41,235 $ 33,586 $ 37,198 $ 30,664 $ 49,927 $ 41,411
Franchised restaurants fees and royalties 8,342 6,827 7,005 5,945 8,691 7,080
Other 295 560 623 1,524 600 327
---------------------------------------------------------------------------------
Total revenues 49,872 40,973 44,826 38,133 59,218 48,818
Company-owned restaurants operating
expenses 31,109 25,675 28,269 23,460 36,073 29,609
Selling, general and administrative 5,048 3,886 5,274 5,264 5,977 4,960
Depreciation and amortization 3,463 2,815 3,566 2,955 3,739 3,074
Minority interest in earnings of restaurant
partnerships 1,583 1,357 1,392 1,084 2,730 2,437
Provision for impairment of long-lived assets 15 23 14 15 166 15
Special provision for litigation - - - - 2,700 -
---------------------------------------------------------------------------------
Total expenses 41,218 33,756 38,515 32,778 51,385 40,095
---------------------------------------------------------------------------------
Income from operations 8,654 7,217 6,311 5,355 7,833 8,723
Interest expense, net 619 191 631 322 665 451
---------------------------------------------------------------------------------
Income before income taxes and cumulative
effect 8,035 7,026 5,680 5,033 7,168 8,272
Provision for income taxes 2,992 2,617 2,116 1,875 2,670 3,081
---------------------------------------------------------------------------------
Income before cumulative effect 5,043 4,409 3,564 3,158 4,498 5,191
Cumulative effect of change in accounting 681 - - - - -
---------------------------------------------------------------------------------
Net income $ 4,362 $ 4,409 $ 3,564 $ 3,158 $ 4,498 $ 5,191
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
Income before cumulative effect per share:
Basic $ .26 $ .22 $ .19 $ .16 $ .23 $ .26
Diluted $ .25 $ .21 $ .18 $ .15 $ .23 $ .26
Net income per share:
Basic $ .23 $ .22 $ .19 $ .16 $ .23 $ .26
Diluted $ .22 $ .21 $ .18 $ .15 $ .23 $ .26
Weighted average shares outstanding:
Basic 19,113 20,212 19,179 20,247 19,231 19,859
Diluted 19,701 20,649 19,824 20,582 19,913 19,949
FOURTH QUARTER FULL YEAR
1998 1997 1998 1997
-----------------------------------------------------
Income statement data:
Company-owned restaurant sales $ 53,651 $ 47,078 $182,011 $152,739
Franchised restaurants fees and royalties 10,917 8,614 34,955 28,466
Other 623 402 2,141 2,813
---------------------------------------------------
Total revenues 65,191 56,094 219,107 184,018
Company-owned restaurants operating
expenses 40,355 33,844 135,806 112,588
Selling, general and administrative 5,951 5,208 22,250 19,318
Depreciation and amortization 4,022 3,476 14,790 12,320
Minority interest in earnings of restaurant
partnerships 2,199 2,680 7,904 7,558
Provision for impairment of long-lived assets 90 213 285 266
Special provision for litigation - - 2,700 -
---------------------------------------------------
Total expenses 52,617 45,421 183,735 152,050
---------------------------------------------------
Income from operations 12,574 10,673 35,372 31,968
Interest expense, net 835 594 2,750 1,558
---------------------------------------------------
Income before income taxes and cumulative
effect 11,739 10,079 32,622 30,410
Provision for income taxes 4,374 3,755 12,152 11,328
---------------------------------------------------
Income before cumulative effect 7,365 6,324 20,470 19,082
Cumulative effect of change in accounting - - 681 -
---------------------------------------------------
Net income $ 7,365 $ 6,324 $ 19,789 $ 19,082
---------------------------------------------------
---------------------------------------------------
Income before cumulative effect per share:
Basic $ .39 $ .33 $ 1.07 $ .96
Diluted $ .38 $ .33 $ 1.03 $ .95
Net income per share:
Basic $ .39 $ .33 $ 1.03 $ .96
Diluted $ .38 $ .33 $ 1.00 $ .95
Weighted average shares outstanding:
Basic 18,907 19,086 19,107 19,852
Diluted 19,517 19,441 19,738 20,156
F-28
Sonic Corp.
Notes to Consolidated Financial Statements (continued)
(In Thousands, Except Share Data)
18. 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, 1998 and 1997, 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.
The carrying amounts and estimated fair values of the Company's fixed rate
borrowings at August 31, 1998 were $51,203 and $52,442, respectively, and
at August 31, 1997 the carrying amounts approximate their estimated fair
values.
F-29
Sonic Corp.
Schedule II - Valuation and Qaulifying Accounts
ADDITIONS AMOUNTS WRITTEN
BALANCE AT CHARGED TO WRITTEN OFF BALANCE
BEGINNING COSTS AND AGAINST THE AT END
DESCRIPTION OF YEAR EXPENSES ALLOWANCE RECOVERIES OF YEAR
- --------------------------------------------------------------------------------------------------------------
(IN THOUSANDS)
ALLOWANCE FOR DOUBTFUL
ACCOUNTS AND NOTES
RECEIVABLE
Year ended:
August 31, 1998 $ 273 $ 72 $ - $ - $ 345
August 31, 1997 $ 263 $ 125 $ 115 $ - $ 273
August 31, 1996 $ 177 $ 124 $ 93 $ 55 $ 263
ACCRUED CARRYING COSTS
FOR RESTAURANT CLOSINGS
AND DISPOSALS
Year ended:
August 31, 1998 $1,126 $ 285 $ 149 $ - $1,262
August 31, 1997 $1,462 $ 71 $ 407 $ - $1,126
August 31, 1996 $ 370 $1,354 $ 262 $ - $1,462
F-30
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 24th day of November,
1998.
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 Executive November 24, 1998
- ------------------------------ Officer and Director
J. Clifford Hudson, Principal
Executive Officer
/s/ W. Scott McLain Vice President, Chief Financial November 24, 1998
- ------------------------------ Officer and Treasurer
W. Scott McLain, Principal
Financial Officer
/s/ Stephen C. Vaughan Vice President November 24, 1998
- ------------------------------ and Controller
Stephen C. Vaughan, Principal
Accounting Officer
/s/ E. Dean Werries Chairman of the Board November 24, 1998
- ------------------------------ and Director
E. Dean Werries
/s/ Dennis H. Clark Director November 24, 1998
- ------------------------------
Dennis H. Clark
/s/ Leonard Lieberman Director November 24, 1998
- ------------------------------
Leonard Lieberman
/s/ H. E. Rainbolt Director November 24, 1998
- ------------------------------
H. E. Rainbolt
/s/ Frank E. Richardson Director November 24, 1998
- ------------------------------
Frank E. Richardson
Director November __, 1998
- ------------------------------
Robert M. Rosenberg
EXHIBIT INDEX
EXHIBIT NUMBER AND DESCRIPTION
10.05. Form of Sonic Industries Inc. License Agreement (the Number 6A License
Agreement)
10.06. Form of Sonic Industries Inc. License Agreement (the Number 5.2
License Agreement)
23.01. Consent of Independent Auditors
24.01. Power of Attorney
27.01. Financial Data Schedule