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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

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(Mark One)

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended May 31, 2013

 

OR

 

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _______________ to ________________

 

Commission File Number 0-18859

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SONIC CORP.

(Exact name of registrant as specified in its charter)

_____________________

 

 

 

 

(405) 225-5000

(Registrant’s telephone number, including area code)

_____________________

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x  No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

                        

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

As of June 26, 2013, approximately 55,885,737 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.

 

 

 

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The accompanying notes are an integral part of the consolidated financial statements.

 

 

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The accompanying notes are an integral part of the consolidated financial statements.

 

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The accompanying notes are an integral part of the consolidated financial statements.

 

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1.   Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) and with the rules and regulations of the Securities and Exchange Commission.  Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements of Sonic Corp. (the “Company”).  In the opinion of management, these financial statements reflect all adjustments of a normal recurring nature, including recurring accruals, necessary for the fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods presented in conformity with GAAP.  In certain situations, recurring accruals, including franchise royalties, are based on more limited information at interim reporting dates than at the Company’s fiscal year end due to the abbreviated reporting period.  Actual results may differ from these estimates.  These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the fiscal year ended August 31, 2012 included in the Company’s Annual Report on Form 10-K.  Interim results are not necessarily indicative of the results that may be expected for a full year or any other interim period.

 

Principles of Consolidation

 

The accompanying financial statements include the accounts of the Company, its wholly owned subsidiaries and a number of Company Drive-Ins in which a subsidiary has a controlling ownership interest.  All intercompany accounts and transactions have been eliminated.

 

Reclassifications

 

Certain amounts reported in previous years, which are not material, have been combined and reclassified to conform to the current-year presentation.

 

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2.   Earnings Per Share

 

The following table sets forth the computation of basic and diluted earnings per share:

 

 

(1) Anti-dilutive securities consist of stock options and unvested restricted stock units that were not included in the computation of diluted earnings per share because either the exercise price of the options was greater than the average market price of the common stock or the total assumed proceeds under the treasury stock method resulted in negative incremental shares and thus the inclusion would have been anti-dilutive.

 

3.   Stock Repurchase Program

 

On August 15, 2012, the Company’s Board of Directors approved a stock repurchase program authorizing the Company to purchase up to $40 million of its outstanding shares of common stock.  In January 2013, the Board of Directors increased the stock repurchase program to $55 million in authorized purchases through August 31, 2013.  During the first nine months of fiscal year 2013, approximately 3.3 million shares were acquired pursuant to this program for a total cost of $35.5 million.  Including the $1.1 million purchased in August 2012 and the repurchases in fiscal year 2013, the total remaining amount authorized, as of May 31, 2013, was $18.4 million.  Share repurchases may be made from time to time in the open market or in negotiated transactions, depending on share price, market conditions and other factors.  The stock repurchase program may be extended, modified, suspended or discontinued at any time.

 

4.   Income Taxes

 

The following table presents the Company’s provision for income taxes and effective income tax rate for the periods below:

 

 

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The decrease in the Company’s effective income tax rate during the third quarter of fiscal year 2013 was primarily attributable to tax benefits related to disqualifying dispositions on stock options and a favorable annual return to provision adjustment.  The decline in the effective income tax rate during the first nine months of fiscal year 2013 was attributable to the expiration of a state statute of limitations related to an uncertain tax position and legislation that reinstated and extended the Work Opportunity Tax Credit (“WOTC”) in the second quarter of fiscal year 2013, as well as an adjustment in fiscal year 2012 to deferred tax accounts.

 

As of May 31, 2013, the Company had $2.0 million of unrecognized tax benefits, including $0.4 million of interest and penalties.  During the first nine months of fiscal year 2013, the liability for unrecognized tax benefits decreased by $3.5 million.  The majority of the change was due to the favorable resolution of a federal tax audit, a statute of limitations expiration of a state tax position, a tax method change and a new uncertain position related to a federal credit.  Of this change, only $0.1 million impacted the Company’s tax rate.  The Company recognizes estimated interest and penalties as a component of its income tax expense, net of federal benefit.    If recognized, the entire amount of unrecognized tax benefits would favorably impact the effective tax rate.

 

The Company or one of its subsidiaries is subject to U.S. federal income tax and income tax in multiple U.S. state jurisdictions.  The Company is currently undergoing examinations or appeals by various state and federal authorities.  The Company anticipates that the finalization of these examinations or appeals, combined with the expiration of applicable statutes of limitations and the additional accrual of interest related to unrecognized benefits on various return positions taken in years still open for examination, could result in a change to the liability for unrecognized tax benefits during the next 12 months ranging from a decrease of $1.4 million to an increase of $2.5 million depending on the timing and terms of the examination resolutions.

 

5.   Impairment of Long-Lived Assets and Goodwill

 

Long-Lived Assets

 

The Company assesses long-lived assets used in operations for possible impairment when events and circumstances indicate that such assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than their carrying amount.  No material impairment charges for long-lived assets were recorded in the first nine months of fiscal year 2013 or in the same period last year.  Projecting the cash flows for the impairment analysis involves significant estimates with regard to the performance of each drive-in, and it is reasonably possible that the estimates of cash flows may change in the near term resulting in the need to write down operating assets to fair value.

 

Goodwill

 

The Company is required to test goodwill for impairment on an annual basis and between annual tests as a result of allocating goodwill to Company Drive-Ins that are sold or whenever indications of impairment arise including, but not limited to, a significant decline in cash flows from store operations.  Such tests could result in impairment charges.  As of May 31, 2013, the Company had $77.1 million of goodwill, of which $71.1 million was attributable to the Company Drive-Ins segment and $6.0 million was attributable to the Franchise Operations segment.  For more information regarding the Company’s goodwill and other intangible assets information, see note 1  – Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended August 31, 2012.

 

6.   Accounts and Notes Receivable

 

Accounts and notes receivable consist of the following (in thousands):

 

 

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The Company’s receivables are primarily due from franchisees, all of whom are in the restaurant business.  Substantially all of the notes receivable from franchisees are collateralized by real estate or equipment.  During fiscal year 2013, notes receivable from franchisees increased as a result of the franchisee-exercised option discussed in note 7 – Other Operating Income.    The notes receivable from advertising funds represent transactions in the normal course of business.

 

7.   Other Operating Income

 

During the second quarter of fiscal year 2013, a franchisee exercised an option to acquire land and buildings leased or subleased from the Company relating to previously refranchised drive-ins.  In December 2012, at the time of the sale, these assets had a carrying value of $38.4 million.  The Company received $29.7 million in cash at closing and will receive the remaining $8.7 million (plus interest) over 24 months through the combination of a note receivable and a direct financing lease.  In conjunction with the sale and the assignment of third party leases, the Company removed its escalating lease liability related to the sold properties.  This resulted in a gain of $1.0 million, which is reflected in “Other operating income, net” on the Condensed Consolidated Statements of Income.    For fiscal year 2012, lease revenue, net of sublease payments, related to these assets was approximately $4.8 million.  The Company’s debt covenants require the application of certain asset disposition proceeds as note prepayments, after a $5 million annual exclusion, if the proceeds are not reinvested in eligible assets within a twelve-month period.  During the second quarter of fiscal year 2013, the Company prepaid $20.0 million of debt which was applied toward the prepayment requirements noted above.  See note 9  – Debt for additional information.  In addition, during the second quarter of fiscal year 2013, the Company recorded a charge of $0.8 million in “Other operating income, net” related to a straight-line lease adjustment and franchise rights that should have been expensed in prior years.  Management of the Company evaluated the impact of these adjustments and concluded the effect was immaterial to the current and prior-year financial statements.

 

8.   Contingencies

 

The Company is involved in various legal proceedings and has certain unresolved claims pending.  Based on the information currently available, management believes that all claims currently pending are either covered by insurance or would not have a material adverse effect on the Company’s business, operating results or financial condition.

 

The Company has obligations under various operating lease agreements with third-party lessors related to the real estate for certain Company Drive-In operations that were sold to franchisees.  During the second quarter of fiscal year 2013, the amount remaining under these guaranteed lease obligations increased as a result of the franchisee-exercised option discussed in note 7 – Other Operating Income.  Under these agreements, which expire

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through 2029, the Company remains secondarily liable for the lease payments for which it was responsible as the original lessee.  As of May 31, 2013, the amount remaining under these guaranteed lease obligations totaled $12.2 million.  At this time, the Company does not anticipate any material defaults under the foregoing leases; therefore, no liability has been provided.

 

9.   Debt

 

During the second quarter of fiscal year 2013, the Company made a prepayment of $20.0 million on its Series 2011-1 Senior Secured Fixed Rate Notes, Class A-2 (the “2011 Fixed Rate Notes”).  The prepayment was made at par, as allowed under the terms of the 2011 Fixed Rate Notes.  The Company recognized a $0.5 million loss to record the pro-rata portion of debt origination costs on the early extinguishment of debt.

 

10.   Fair Value of Financial Instruments

 

The fair value of financial instruments is the amount at which the instrument could be exchanged in a current transaction between willing parties.  The Company has no financial liabilities that are required to be measured at fair value on a recurring basis. 

 

The Company categorizes its assets and liabilities recorded at fair value based upon the following fair value hierarchy established by the Financial Accounting Standards Board:

 

•    Level 1 valuations use quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date.  An active market is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

 

•    Level 2 valuations use inputs other than actively quoted market prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.  Level 2 inputs include:  (a) quoted prices for similar assets or liabilities in active markets, (b) quoted prices for identical or similar assets or liabilities in markets that are not active, (c) inputs other than quoted prices that are observable for the asset or liability such as interest rates and yield curves observable at commonly quoted intervals and (d) inputs that are derived principally from or corroborated by observable market data by correlation or other means.

 

•    Level 3 valuations use unobservable inputs for the asset or liability.  Unobservable inputs are used to the extent observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.

 

The table below sets forth our fair value hierarchy for financial assets measured at fair value on a recurring basis (in thousands):

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At May 31, 2013, the fair value of the Company’s 2011 Fixed Rate Notes was estimated at $474.9 million versus a carrying value of $450.9 million, including accrued interest.  At August 31, 2012, the fair value of the 2011 Fixed Rate Notes was estimated at $510.8 million versus a carrying value of $482.0 million, including accrued interest.  The fair value of the 2011 Fixed Rate Notes is estimated using Level 2 inputs from market information available for public debt transactions for companies with ratings that are similar to the Company’s ratings and from information gathered from brokers who trade in the Company’s notes.

 

11.   Segment Information

 

Operating segments are generally defined as components of an enterprise for which separate discrete financial information is available as the basis for management to allocate resources and assess performance. 

 

Based on internal reporting and management structure, the Company has two reportable segments: Company Drive-Ins and Franchise Operations.  The Company Drive-Ins segment consists of the drive-in operations in which the Company owns a controlling ownership interest and derives its revenues from operating drive-in restaurants.  The Franchise Operations segment consists of franchising activities and derives its revenues from royalties, initial franchise fees and lease revenues received from franchisees.  The accounting policies of the segments are the same as those described in the Summary of Significant Accounting Policies in our most recent Annual Report on Form 10-K.  Segment information for total assets and capital expenditures is not presented as such information is not used in measuring segment performance or allocating resources between segments.

 

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The following table presents the revenues and income from operations for each reportable segment, along with reconciliation to reported revenue,  income from operations and income before income taxes:

 

 

12.  Subsequent Event

 

Subsequent to the end of the third fiscal quarter of 2013, the Company announced that certain of its subsidiaries intend to refinance a portion of the 2011 Fixed Rate Notes issued under their securitization debt facility.  The Company’s subsidiaries have entered into a commitment letter, pursuant to which a purchaser has agreed, subject to the conditions contained in the letter, to purchase at par approximately $155 million of Series 2013-1 Senior Secured Fixed Rate Notes, Class A-2 (the “2013 Fixed Rate Notes”) to be issued under the securitization debt facility.  As specified in the commitment letter, the 2013 Fixed Rate Notes are expected to have a fixed interest rate of 3.75%, an anticipated contract monthly weighted average life of seven years and a final legal maturity date in 2043.

 

The net proceeds from the sale of the 2013 Fixed Rate Notes will be used to prepay $155 million of the 2011 Fixed Rate Notes at par.  The 2013 Fixed Rate Notes will be issued pursuant to the securitized financing facility which the Company’s subsidiaries have had in place since May 2011.  The 2011 Fixed Rate Notes have a fixed interest rate of 5.4% with $450.2 million outstanding as of May 31, 2013. 

 

 

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

 

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

 

Overview

 

            System-wide same-store sales increased 0.1% during the third quarter and increased 0.9% for the first nine months of fiscal year 2013 as compared to an increase of 2.8% and 2.2%, respectively, for the same periods last year.  Same-store sales at Company Drive-Ins decreased 1.1% during the third quarter and increased 1.5% for the first nine months of fiscal year 2013 as compared to an increase of 3.7% and 2.3%, respectively, for the same periods last year.  Sales during the third quarter of fiscal year 2013 were impacted by unseasonably cold temperatures in March and April 2013.  We believe the initiatives we have implemented over the last few years, including product quality improvements, a greater emphasis on personalized service and a tiered pricing strategy, have set a solid foundation for growth which is reflected in our year-to-date operating results.  We continue to focus on our innovative product pipeline, and our recent shift from local to national media expenditures is supporting our day-part promotional strategy to drive same-store sales.  To achieve earning growth we utilize a multi-layered growth strategy which incorporates same-store sales growth, operating leverage, new drive-in development, an ascending royalty rate and deployment of cash.  Positive system-wide same-store sales is the most important layer and drives operating leverage and increased operating cash flows.

 

            Revenues decreased to $146.6 million for the third quarter of fiscal year 2013 from $149.4 million for the same period last year and decreased to $383.8 million for the first nine months of fiscal year 2013 from $392.8 million for the same period last year.  The decrease in revenues was primarily related to the decrease in Company Drive-In sales which were impacted by adverse weather during the quarter and the refranchising of 34 Company Drive-Ins during the second fiscal quarter of 2012.  Additionally, lease revenues have also declined as a result of a transaction during the second quarter of fiscal year 2013 in which a franchisee exercised an option to acquire land and buildings leased or subleased from us, relating to previously refranchised drive-ins.  Restaurant margins at Company Drive-Ins were flat during the third quarter of fiscal year 2013.  Margins improved 70 basis points during the first nine months of fiscal year 2013 primarily as a result of leverage from same-store sales increases and the refranchising of 34 lower performing drive-ins in the second fiscal quarter of 2012.

 

            Third quarter results for fiscal year 2013 reflected net income of $14.8 million or $0.26 per diluted share, as compared to net income of $14.4 million or $0.24 per diluted share for the same period last year.  Net income and diluted earnings per share for the first nine months of fiscal year 2013 were $24.5 million and $0.43, respectively, as compared to net income of $21.6 million and $0.36 per diluted share for the same period last year.  Excluding the $0.3 million after-tax loss or $0.01 per diluted share from the early extinguishment of debt and the $0.7 million benefit or $0.02 per diluted share, which includes the retroactive reinstatement of the Work Opportunity Tax Credit (“WOTC”) and resolution of certain income tax matters during the second quarter of fiscal year 2013, net income and diluted earnings per share for the first nine months of fiscal year 2013 increased 12% and 17%, respectively.

 

The following non-GAAP adjustments are intended to supplement the presentation of the Company’s financial results in accordance with GAAP.  We believe the exclusion of these items in evaluating the change in net income and diluted earnings per share for the period below provides useful information to investors and management regarding the underlying business trends and the performance of our ongoing operations and is helpful for period-to-period and company-to-company comparisons, which management believes will assist investors in analyzing the financial results for the Company and predicting future performance.

 

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The following table provides information regarding the number of Company Drive-Ins and Franchise Drive-Ins operating as of the end of the periods indicated as well as the system-wide change in sales and average unit volume.  System-wide information includes both Company Drive-In and Franchise Drive-In information, which we believe is useful in analyzing the growth of the brand as well as the Company’s revenues, since franchisees pay royalties based on a percentage of sales.

 

(1) Drive-ins that are temporarily closed for various reasons (repairs, remodeling, relocations, etc.) are not considered closed unless the Company determines that they are unlikely to reopen within a reasonable time.

(2) Represents percentage change for drive-ins open for a minimum of 15 months.

 

Results of Operations

 

            Revenues.  The following table sets forth the components of revenue for the reported periods and the relative change between the comparable periods.

 

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The following table reflects the changes in sales and same-store sales at Company Drive-Ins.  It also presents information about average unit volumes and the number of Company Drive-Ins, which is useful in analyzing the growth of Company Drive-In sales.

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(1) Drive-ins that are temporarily closed for various reasons (repairs, remodeling, relocations, etc.) are not considered closed unless the Company determines that they are unlikely to reopen within a reasonable time.

(2) Represents percentage change for drive-ins open for a minimum of 15 months.

 

Same-store sales for Company Drive-Ins decreased 1.1% for the third quarter of fiscal year 2013 and increased 1.5% for the first nine months of fiscal year 2013, as compared to an increase of 3.7% and 2.3%, respectively, for the same periods last year.  Company Drive-In sales decreased $1.6 million, or 1.5%, during the third quarter of fiscal year 2013 as compared to the same period last year.  This decrease was primarily due to a $1.1 million reduction in same-store sales attributable to the unseasonably cold temperatures in March and April 2013 and a $0.9 million decrease related to drive-ins that were closed or sold during the preceding twelve months partially offset by $0.4 million of incremental sales from new drive-in openings.  Company Drive-In sales decreased $8.4 million, or 2.9%, for the first nine months of fiscal year 2013 as compared to the same period last year.  This decrease is primarily attributable to an $11.4 million reduction in sales from refranchised drive-ins and $1.8 million related to drive-ins that were closed during the preceding twelve months partially offset by a $4.0 million improvement in same-store sales and $0.8 million of incremental sales from new drive-in openings.

 

The following table reflects the change in franchise sales, the number of Franchise Drive-Ins, average unit volumes and franchising revenues.  While we do not record Franchise Drive-In sales as revenues, we believe this information is important in understanding our financial performance since these sales are the basis on which we calculate and record franchise royalties.  This information is also indicative of the financial health of our franchisees.

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(1) Drive-ins that are temporarily closed for various reasons (repairs, remodeling, relocations, etc.) are not considered closed unless the Company determines that they are unlikely to reopen within a reasonable time.

(2) Represents percentage change for drive-ins open for a minimum of 15 months.

(3) Consists of revenues derived from franchising activities, including royalties, franchise fees and lease revenues.  See Revenue Recognition Related to Franchise Fees and Royalties in the Critical Accounting Policies and Estimates section of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended August 31, 2012.

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

 

Same-store sales for Franchise Drive-Ins increased 0.2% for the third quarter of fiscal year 2013 and 0.9% for the first nine months of fiscal year 2013, as compared to an increase of 2.7% and 2.2%, respectively, for the same periods last year.  Franchising revenues decreased $0.9 million, or 2.5%, for the third quarter of fiscal year 2013 and decreased $0.2 million, or 0.2%, for the first nine months of fiscal year 2013.  The decrease in franchise revenues during the third quarter and first nine months of fiscal year 2013 was primarily attributable to a decrease in lease revenue resulting from the franchisee option, exercised during the second quarter of fiscal year 2013, to acquire land and buildings leased or subleased from the Company relating to previously refranchised drive-ins.  This decrease is partially offset by an increase in franchise royalties during the first nine months of fiscal year 2013 primarily attributable to an increase in same-store sales, partially offset by various development incentives and certain franchisee restructuring efforts.  In addition, approximately $0.8 million of the increase in franchising revenues during the first nine months of fiscal year 2013 was attributable to incremental royalties from the 34 refranchised drive-ins discussed earlier.

 

Operating Expenses.  The following table presents the overall costs of drive-in operations as a percentage of Company Drive-In sales.  Other operating expenses include direct operating costs such as marketing, telephone and utilities, repair and maintenance, rent, property tax and other controllable expenses.

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Drive-in level margins were flat during the third quarter of fiscal year 2013.  Margins improved 70 basis points during the first nine months of fiscal year 2013 primarily as a result of same-store sales increases and the refranchising of 34 lower performing drive-ins in the second fiscal quarter of 2012.  Food and packaging costs were unfavorable by 60 basis points during the quarter and 10 basis points for the first nine months of fiscal year 2013, which primarily resulted from an unfavorable product mix shift due to our current promotions.  Payroll and other employee benefits, as well as other operating expenses, improved by a combined 60 basis points during the third quarter of fiscal year 2013, resulting primarily from a decrease in marketing expenses.  These expense categories were favorable by 80 basis points during the first nine months of fiscal year 2013, primarily due to the refranchising of 34 lower performing drive-ins in the second fiscal quarter of 2012.

 

Selling, General and Administrative (“SG&A”).  SG&A expenses were flat for the third quarter and first nine months of fiscal year 2013 as compared to the same periods last year reflecting $16.9 million and $48.5 million for the third quarter and first nine months of fiscal year 2013, respectively.

 

Depreciation and Amortization.  Depreciation and amortization expense remained relatively flat for the third quarter and first nine months of fiscal year 2013, decreasing by $0.5 million to $9.8 million and $0.8 million to $30.4 million, respectively, as compared to the same periods last year.  This decline is primarily the result of the franchisee option, exercised during the second quarter of fiscal year 2013, to acquire land and buildings leased or subleased from the Company relating to previously refranchised drive-ins.

 

Net Interest Expense.  Net interest expense decreased $0.6 million in the third quarter and $1.0 million for the first nine months of fiscal year 2013 as compared to the same periods last year.  These decreases were primarily due to a decline in our long-term debt balance.  The decrease for the first nine months was partially offset by a $0.5 million loss from the early extinguishment of debt related to our $20.0 million prepayment during the second quarter of fiscal year 2013.  For additional information on long-term debt see our Annual Report on Form 10-K for the year ended August 31, 2012.  

 

Income Taxes.    The provision for income taxes reflects an effective tax rate of 35.6% for the third quarter of fiscal 2013 as compared to 37.6% for the same period in 2012.  This decline was primarily attributable to tax

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benefits related to disqualifying dispositions on stock options and a favorable annual return to provision adjustment.  Our effective income tax rate decreased to 33.6% for the first nine months of fiscal year 2013 from 37.8% for the first nine months of fiscal year 2012.  This decline was attributable to the second quarter of fiscal year 2013 expiration of a state statute of limitations related to an uncertain tax position and legislation that reinstated and extended WOTC, as well as an adjustment in fiscal year 2012 to our deferred tax accounts.  Our tax rate may continue to vary significantly from quarter to quarter depending on the timing of stock option exercises and dispositions by option-holders, changes in tax credit legislation, changes to uncertain tax positions, and as circumstances on other tax matters change.

 

Financial Position

 

Total assets decreased $38.3 million, or 5.6%, to $642.5 million during the first nine months of fiscal year 2013 from $680.8 million at the end of fiscal year 2012.  The decrease in total assets is largely attributable to the decline in net property, equipment and capital leases of $42.0 million, primarily reflecting the second quarter of fiscal year 2013 sale of land and buildings to a franchisee for previously refranchised drive-ins, as well as from depreciation during the first nine months of the year, partially offset by capital additions.

 

Total liabilities decreased $39.4 million, or 6.3%, to $582.1 million during the first nine months of fiscal year 2013 from $621.5 million at the end of fiscal year  2012.  This decrease was primarily attributable to $31.1 million scheduled and early debt principal repayments during the first nine months of fiscal year 2013 and a decrease in income taxes payable of $12.3 million stemming mainly from tax payments during the first nine months of fiscal year 2013.

 

Total stockholders’ equity increased $1.2 million, or 2.0%, to $60.4 million during the first nine months of fiscal year 2013 from $59.2 million at the end of fiscal year 2012.  This increase was attributable to current-year earnings of $24.5 million and $12.8 million related to stock option exercises.  These increases were mostly offset by $35.5 million in purchases of common stock under our stock repurchase program during the first nine months of fiscal year 2013.

 

Liquidity and Sources of Capital

 

Operating Cash Flows.  Net cash provided by operating activities decreased $8.1 million to $55.9 million for the first nine months of fiscal year 2013 as compared to $63.9 million for the same period in fiscal year 2012. This decline primarily resulted from an increase in income tax payments in the first nine months of fiscal year 2013 as compared to the same period last year, partially offset by current-year earnings.

 

Investing Cash Flows.  Cash provided by investing activities during the first nine months of fiscal year 2013 increased $16.3 million to $4.1 million compared to the use of $12.2 million of cash for the same period in fiscal year 2012.  During the first nine months of fiscal year 2013, we used $28.4 million of cash for purchases of property and equipment as outlined in the table below.  These cash outflows were more than offset by $32.3 million in proceeds primarily related to the franchisee-exercised option to acquire land and buildings leased or subleased from us relating to previously refranchised drive-ins, described above.  The balance of the change largely relates to a prior-year use of cash to purchase intellectual property related to a point-of-sale system that is used by a majority of the Sonic system.  The following table sets forth the components of our investments in property and equipment for the first nine months of fiscal year 2013 (in millions):

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Financing Cash Flows.  Net cash used in financing activities increased $19.4 million to $59.0 million for the first nine months of fiscal year 2013 from $39.6 million for the same period in fiscal year 2012.  This increase primarily relates to the use of $20.0 million in cash during the second quarter of fiscal year 2013 to make a prepayment on our Series 2011-1 Senior Secured Fixed Rate Notes, Class A-2 (the “2011 Fixed Rate Notes”).  Also attributable to the increase was the use of $36.5 million of cash during the first nine months of fiscal year 2013 to purchase outstanding common stock under our current stock repurchase program as compared to $25.5 million for the same period in fiscal year 2012 under a prior stock repurchase program.  These uses of cash are being partially offset by $11.2 million in proceeds from stock option exercises during the first nine months of fiscal year 2013.

 

On August 15, 2012, our Board of Directors approved a stock repurchase program authorizing us to purchase up to $40 million of our outstanding shares of common stock.  In January 2013, our Board of Directors increased the stock repurchase program to $55 million in authorized purchases through August 31, 2013.  During the first nine months of fiscal year 2013, approximately 3.3 million shares were acquired pursuant to this program for a total cost of $35.5 million.  Including the $1.1 million purchased in August 2012 and the repurchases in fiscal year 2013, the total remaining amount authorized, as of May 31, 2013, was $18.4 million.  Share repurchases may be made from time to time in the open market or in negotiated transactions, depending on share price, market conditions and other factors.  The stock repurchase program may be extended, modified, suspended or discontinued at any time.

 

As of May 31, 2013, our total cash balance of $70.2 million ($53.6 million of unrestricted and $16.7 million of restricted cash balances) reflected the impact of the cash generated from operating activities, cash used for stock repurchases, debt prepayment, and capital expenditures mentioned above.  We believe that existing cash, funds generated from operations and the $100 million available under our Series 2011-1 Senior Secured Variable Funding Notes, Class A-1, will meet our needs for the foreseeable future.

 

Critical Accounting Policies and Estimates

 

Critical accounting policies are those the Company believes are most important to portraying its financial conditions and results of operations and also require the greatest amount of subjective or complex judgments by management.  Judgments and uncertainties regarding the application of these policies may result in materially different amounts being reported under various conditions or using different assumptions.  There have been no material changes to the critical accounting policies previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2012.  

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

            There has been no material change in the quantitative and qualitative market risks set forth in Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K for the year ended August 31, 2012.

 

Item 4.  Controls and Procedures

 

            As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-14 under the Securities Exchange Act of 1934).  Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives.  Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level.

 

            There were no significant changes in the Company’s internal control over financial reporting during the quarter ended May 31, 2013 that have materially affected, or are reasonably likely to materially affect, the

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Company’s internal controls over financial reporting.

 

PART II – OTHER INFORMATION

 

Item 1.    Legal Proceedings

 

The Company is involved in various legal proceedings and has certain unresolved claims pending.  Based on the information currently available, management believes that all claims currently pending are either covered by insurance or would not have a material adverse effect on the Company’s business, operating results or financial condition.

 

Item 1A.  Risk Factors

 

There has been no material change in the risk factors set forth in Part I, Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended August 31, 2012.

 

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

 

            (c) Issuer Purchases of Equity Securities

Shares repurchased during the third quarter of fiscal 2013 are as follows (in thousands, except per share amounts):

 

 

(1) On August 15, 2012, the Company’s Board of Directors approved a stock repurchase program authorizing the Company to purchase up to $40 million of its outstanding shares of common stock.  In January 2013, the Board of Directors increased the stock repurchase program to $55 million in authorized purchases through August 31, 2013.  Share repurchases may be made from time to time in the open market or in negotiated transactions, depending on share price, market conditions and other factors. The stock repurchase program may be extended, modified, suspended or discontinued at any time.