UNITED STATES

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

 

For the fiscal year ended:  August 31, 2014

 

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 

 

SONIC CORP.

(Exact name of registrant as specified in its charter)

 

 

 

 

Registrant’s telephone number, including area code:   (405) 225-5000

 

Securities registered pursuant to section 12(b) of the Act:

 

None

 

Securities registered pursuant to section 12(g) of the Act:

 

Common Stock, Par Value $.01 (Title of class)

 

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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  ☒  No  ☐

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  ☐  No  ☒

 

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 the reports), and (2) has been subject to the filing requirements for the past 90 days.    Yes  ☒  No  ☐

 

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  ☒  No  ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒

 

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.  (Check one):

 

 

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

 

As of February 28,  2014, the aggregate market value of the 51,522,540 shares of common stock of the Company held by non-affiliates of the Company equaled $1,050,021,213 based on the closing sales price for the common stock as reported for that date.

 

As of October 15,  2014,  the Registrant had 53,018,855 shares of common stock issued and outstanding.

 

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 no later than 120 days after August 31, 2014.

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FORM 10-K OF SONIC CORP.

 

TABLE OF CONTENTS

 

 

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FORM 10-K

 

SONIC CORP.

 

PART I

 

Item 1.  Business

 

Overview

 

Sonic Corp. operates and franchises the largest chain of drive-in restaurants (“Sonic Drive-Ins”) in the United States.  References to “Sonic Corp.,” “Sonic,” “the Company,” “we,” “us” and “our” in this Form 10-K are references to Sonic Corp. and its subsidiaries. 

 

The first Sonic Drive-In restaurant opened in 1953.  As of the end of our fiscal year on August 31, 2014, the Sonic system included 3,518 Sonic Drive-Ins in 44 states of which 391 were owned and operated by Sonic Restaurants, Inc., the Company’s operating subsidiary (“Company Drive-Ins”), and 3,127 were owned and operated by franchisees (“Franchise Drive-Ins”).

 

Sonic Corp. was incorporated in the State of Delaware in 1990 in connection with its 1991 initial public offering of common stock.  Sonic is publicly traded on the NASDAQ National Market Stock Exchange (“NASDAQ”) (Ticker: SONC).

 

Restaurant Design and Construction

 

The typical Sonic Drive-In consists of a kitchen housed in a one-story building, which is approximately 1,500 square feet, flanked by canopy-covered rows of 16 to 24 parking spaces, with each space having its own payment terminal, intercom speaker system and menu board.  At a typical Sonic Drive-In, a customer drives into one of the parking spaces, orders through the intercom speaker system and has the food delivered by a carhop.  Most Sonic Drive‑Ins also include a drive-thru lane and patio seating to provide customers alternative dining options.

 

Menu

 

Sonic maintains a highly diverse menu.  The strategy is to ensure the menu items appeal to a broad range of target customers across different day-parts.  The menu includes a variety of traditional and healthier choices as well as creative and fun items.  Sonic’s signature food items include specialty drinks (such as cherry limeades and slushes), ice cream desserts, made-to-order sandwiches and hamburgers, a variety of hot dogs including six-inch premium beef hot dogs and footlong quarter-pound coneys, hand-battered onion rings, tater tots and wraps.  Sonic Drive-Ins also offer breakfast items that include a variety of breakfast burritos and serve the full menu all day. 

 

Strategy

 

Sonic has developed and implemented a strategy designed to enhance the Sonic brand and to achieve high levels of customer satisfaction and repeat business.  The key elements of our strategy are:

 

 

Sonic’s growth strategies include the following:

 

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Restaurant Locations

 

As of August 31, 2014, 3,518 Sonic Drive-Ins were in operation from coast to coast in 44 states, consisting of 391 Company Drive-Ins and 3,127 Franchise Drive-Ins.  

 

Expansion

 

During fiscal year 2014, we opened 40 Sonic Drive-Ins, which consisted of three Company Drive-Ins and 37 Franchise Drive-Ins.  Expansion plans for fiscal year 2015 involve the opening of multiple Sonic Drive-Ins under development agreements, as well as single-store development by new and long-standing franchisees.  We believe that our existing, as well as newly opened markets, offer significant growth opportunities for both Company Drive-In and Franchise Drive-In expansion over the long term.

   

Marketing

 

We have a fully integrated marketing strategy that includes a national advertising campaign.  We have designed this marketing program to differentiate Sonic Drive-Ins from our competitors by emphasizing high-quality distinctive made-to-order menu items and personalized service featuring friendly carhops.  We support promotions with television, radio, digital media, point-of-sale materials and other communications as appropriate.  Those promotions generally highlight limited-time products and signature menu items.

 

Each year, Sonic develops a marketing plan with the involvement of the Sonic Franchise Advisory Council.  (Information concerning the Sonic Franchise Advisory Council is set forth on page 4 under Franchise Program -Franchise Advisory Council.)  Funding for our marketing plan is provided by the System Marketing Fund, the Sonic Brand Fund and local advertising expenditures.  The System Marketing Fund primarily focuses on purchasing advertising on national cable and broadcast networks and other national media, sponsorship and brand enhancement opportunities.  The Sonic Brand Fund supports national media production as well as other programs designed to promote or enhance the Sonic brand.   Franchisees are also required to spend additional amounts on local advertising, typically through participation in the local advertising cooperative.  Our franchise agreements require advertising contributions by franchisees of up to 5.9% of gross sales to these marketing funds and local advertising cooperatives. 

 

Purchasing

 

We negotiate with suppliers for the Sonic Drive-Ins’ primary food products and packaging supplies to ensure adequate quantities of food and supplies and to obtain competitive prices.  We seek competitive bids from suppliers on many of our food and packaging items.  We approve suppliers of those products and require them to adhere to our established product and food safety specifications.  Suppliers manufacture several key products for Sonic under private label and sell them to authorized distributors for resale to Sonic Drive-Ins.  We require all Sonic Drive-Ins to purchase from approved distributors.

 

Food Safety and Quality Assurance

 

To ensure the consistent delivery of safe, high-quality food, we created a food safety and quality assurance program.  Sonic’s food safety program promotes the quality and safety of all products and procedures utilized by all Sonic Drive-Ins and provides certain requirements that must be adhered to by all suppliers, distributors and Sonic Drive-Ins.  Our comprehensive, restaurant-based food safety program is called Sonic Safe.  Sonic Safe is a risk-based system that utilizes Hazard Analysis & Critical Control Points (“HACCP”) principles for managing food safety and quality.  Our food safety program includes components to monitor and ensure the safety and quality of Sonic’s products and procedures at every stage of the food preparation and production cycle including, but not limited to, employee training, supplier product inspections and testing and unannounced drive-in food safety auditing by independent third parties.  All Sonic Drive-In employees are required to be trained in food safety in their

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first stage of training, utilizing an internal training program.  This program includes specific training on food safety information and requirements for every station in the drive-in.  We also require our drive-in managers and assistant managers to pass and maintain the ServSafe® certification.  ServSafe® is the most recognized food safety training certification in the restaurant industry.

 

Information Systems 

 

Sonic Drive-Ins are equipped with information technology systems that are designed to provide operational tools for sales and inventory.  This technology includes industry-specific, off-the-shelf systems as well as proprietary software that assist in managing food and beverage costs.  These solutions are integrated with our point-of-sale systems to provide daily, weekly and period-to-date information that is important for managers to run efficient and effective operations.  We have centralized financial and accounting systems for Company Drive-Ins.  We also have systems that receive transaction-level data from Franchise Drive-Ins.  We believe these systems are important in analyzing and improving profit margins and accumulating marketing information.  We are also making strategic investments in technology tools such as digital technology point-of-purchase menu boards, mobile payment and mobile gift card capabilities to enhance the customers’ experience and drive sales.  We are further investing in new point-of-sale systems to improve drive-in level operations and profits.    

 

Company Operations

 

Management Structure.  A typical Company Drive-In is operated by a manager, two to four assistant managers, and approximately 25 hourly employees, many of whom work part-time.  The manager has responsibility for the day-to-day operations of the Company Drive-In.  Supervisors oversee several Company Drive-Ins and supervise the managers of those drive-ins.  The employee compensation program at Company Drive-Ins for managers and supervisors is comprised of a guaranteed base compensation with additional significant incentive compensation based on drive-in level performance.    

 

Company Drive-In Data.  The following table provides certain financial information relating to Company Drive-Ins and the number of Company Drive-Ins opened, purchased from or sold to franchisees, and closed during the past five fiscal years and should be read in conjunction with the information in our Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7.

 

 

 

Franchise Program

 

General.  As of August 31, 2014, we had 3,127 Franchise Drive-Ins in operation.  A large number of successful multi-unit franchise groups have developed during the Sonic system’s 61 years of operation.  Those franchisees continue to develop new Franchise Drive-Ins either through development agreements or single-site development.  Our franchisees opened 37 drive-ins during fiscal year 2014.  We consider our franchisees a vital part of our continued growth and believe our relationship with our franchisees is good.

 

Franchise Agreements.  For traditional drive-ins, the current franchise agreement provides for a franchise fee of $45,000 per drive-in, a royalty fee of up to 5% of gross sales on a graduated percentage basis, and a 20-year term.  For fiscal year 2014, Sonic’s average royalty rate was 3.78%.  The franchisee also pays advertising fees of up to 5.9% of gross sales.   

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Development Agreements.  We use development agreements to facilitate the planned expansion of the Sonic Drive-In restaurant chain through single and multiple unit development.  During fiscal year 2014, almost all of our new Franchise Drive-In openings occurred as a result of existing development agreements.    Each development agreement gives a developer the exclusive right to construct, own and operate Sonic Drive-Ins within a defined area.  In exchange, each developer agrees to open a minimum number of Sonic Drive-Ins in the area within a prescribed time period. Franchisees who enter into development agreements are required to pay a fee, a portion of which is credited against franchise fees due when Sonic Drive-Ins are opened in the future.  Franchisees may forfeit such fees and lose their rights to future development if they do not maintain the required schedule of openings. 

 

Franchise Drive-In Development.  We assist each franchisee in selecting sites and developing Sonic Drive‑Ins.  Each franchisee has responsibility for selecting the franchisee’s drive-in location but must obtain our approval of each Sonic Drive-In design and each location based on accessibility and visibility of the site and targeted demographic factors, including population density, income, age and traffic.  We provide our franchisees with the physical specifications for the typical Sonic Drive-In. 

 

Franchise Advisory Council.  Our Franchise Advisory Council provides advice, counsel and input to Sonic on important issues impacting the business, such as marketing and promotions, operations, purchasing, building design, human resources, technology and new products.  The Franchise Advisory Council currently consists of 25 members selected by Sonic.  We have seven executive committee members who are selected at large and 18 regional members representing all regions of the country.  We also have four Franchise Advisory Council task groups comprised of 51 members who generally serve three-year terms and provide support on individual key priorities. 

 

Franchise Drive-In Data.  The following table provides certain financial information relating to Franchise Drive-Ins and the number of Franchise Drive-Ins opened, purchased from or sold to Sonic, and closed during Sonic’s last five fiscal years.  The table should be read in conjunction with the information in our Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7.

 

 

 

Competition

 

We compete in the restaurant industry, specifically in the segment known as the quick-service restaurant (“QSR”) segment, a highly competitive industry in terms of price, service, location, and food quality.  The restaurant industry is often affected by changes in consumer trends, economic conditions, demographics, traffic patterns and concerns about the nutritional content of quick-service foods.  We compete on the basis of distinctive food and service with signature food items, friendly carhops and the method of food preparation (made-to-order).  The quality of service, featuring Sonic carhops, constitutes one of our primary marketable points of difference from the competition.  There are many well-established competitors with substantially greater financial and other resources.  These competitors include a large number of national, regional, and local food service establishments, including QSRs, casual-dining restaurants and convenience stores.  A significant change in market conditions or in pricing or other marketing strategies by one or more of Sonic’s competitors could have an adverse impact on Sonic’s sales, earnings and growth.  Furthermore, the restaurant industry has few barriers to entry, and new competitors may emerge at any time.  In selling franchises, we also compete with many franchisors of QSR and other restaurants, in addition to franchisors of other business opportunities. 

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Seasonality

 

Our results during Sonic’s second fiscal quarter (the months of December, January and February) generally are lower than other quarters because of the lower temperatures in the locations of a number of Sonic Drive-Ins, which tends to reduce customer visits to our drive-ins. 

 

Employees

 

As of August 31, 2014, we had 343 full-time corporate employees and approximately 10,400 full-time and part-time restaurant employees.    None of our employees are subject to a collective bargaining agreement.  We believe that we have good labor relations with our employees. 

 

Intellectual Property

 

Sonic owns or is licensed to use valuable intellectual property including trademarks, service marks, patents, copyrights, trade secrets and other proprietary information, including the “Sonic” logo and trademark, which are of material importance to our business.  Depending on the jurisdiction, trademarks and service marks generally are valid as long as they are used and/or registered.  Patents, copyrights and licenses are of varying durations.

 

Customers

 

Our business is not dependent upon either a single customer or a small group of customers.

 

Government Contracts

 

No portion of our business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the U.S. government.

 

Government Regulation

 

Our restaurants are subject to licensing and regulation by state and local health, safety, fire and other authorities, including licensing requirements and regulations for the sale of food.  The development and construction of new restaurants is subject also to compliance with applicable zoning, land use and environmental regulations.  We are also subject to federal regulation and state laws that regulate the offer and sale of franchises and substantive aspects of the franchisor-franchisee relationship.  Various federal and state labor laws govern our relationship with our employees and affect operating costs.  These laws govern minimum wage requirements, overtime pay, meal and rest breaks, unemployment tax rates, health care and benefits, workers' compensation rates, citizenship or residency requirements, child labor regulations and discriminatory conduct.  Federal, state and local government agencies have established or are in the process of establishing regulations requiring that we disclose to our customers nutritional information regarding our menu items.  We have processes in place to monitor compliance with applicable laws and regulations governing our operations.

 

Environmental Matters

 

We are not aware of any federal, state or local environmental laws or regulations that will materially affect our earnings or competitive position or result in material capital expenditures.  However, we cannot predict the effect on operations of possible future environmental legislation or regulations.  During fiscal year 2014, there were no material capital expenditures for environmental control facilities and no such material expenditures are anticipated.

 

Available Information

 

We maintain a website with the address of www.sonicdrivein.com.  Copies of the Company’s reports filed with, or furnished to, the Securities and Exchange Commission on Forms 10-K, 10-Q and 8-K and any amendments to such reports are available for viewing and copying at such website, free of charge, as soon as reasonably practicable after filing such material with, or furnishing it to, the Securities and Exchange Commission.  In addition,

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copies of Sonic’s corporate governance materials, including the Corporate Governance Guidelines, Audit Committee Charter, Compensation Committee Charter, Nominating and Corporate Governance Committee Charter, Code of Ethics for Financial Officers and Code of Business Conduct and Ethics are available for viewing and copying at the website, free of charge.

 

Forward-Looking Information

 

This Annual Report on Form 10-K includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, principally in the sections captioned “Business,” “Legal Proceedings” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances, and those future events or circumstances may not occur.  In some cases, forward-looking statements can be identified by words such as “anticipate,” “estimate,” “expect,”  “goals,” “guidance,”  “plan,”  “may,” “will,”  “would” and similar expressions.  Investors should not place undue reliance on the forward-looking statements, which speak only as of the date of this report.  These forward-looking statements are all based on currently available operating, financial and competitive information and are subject to various risks and uncertainties.  Our actual future results and trends may differ materially depending on a variety of factors including, but not limited to, the risks and uncertainties discussed below.  We undertake no obligation to publicly update or revise them, except as may be required by law.

 

Item 1A.  Risk Factors

 

We caution you that our business and operations are subject to a number of risks and uncertainties.  The factors listed below are important factors that could cause our actual results to differ materially from our historical results and from projections in forward-looking statements contained in this report, in our other filings with the Securities and Exchange Commission, in our news releases and in oral statements by our representatives.  However, other factors that we do not anticipate or that we do not consider significant based on currently available information may also have an adverse effect on our results.

 

Events reported in the media, including social media, such as incidents involving food-borne illnesses or food tampering, whether or not accurate, can cause damage to our reputation and rapidly affect sales and profitability.

 

Reports, whether true or not, of food-borne illnesses or food tampering have in the past severely injured the reputations of participants in the restaurant industry and could affect us in the future.  The potential for terrorism affecting our nation’s food supply also exists and, if such an event occurs, it could have a negative impact on our brand’s reputation and could severely hurt sales, revenues, and profits.  Our ability to remain a trusted brand and increase sales and profits depends on our ability to manage the potential impact on Sonic of food-borne illnesses or reports of food-borne illnesses.  Our food safety and quality assurance program minimizes the risk of food-borne illness.  Nevertheless, these risks cannot be completely eliminated.  Any outbreak of such illness attributed to our restaurants or within the food service industry, or any widespread negative publicity regarding our brand or the restaurant industry in general, could materially harm our brand, including sales and profitability.

 

The restaurant industry is highly competitive, and that competition could lower our revenues, margins and market share.

 

The restaurant industry is intensely competitive with respect to price, service, location, personnel, dietary trends, including nutritional content of quick-service foods, and quality of food and is often affected by changes in consumer tastes and preferences, economic conditions, population and traffic patterns.  We compete with international, regional and local restaurants, some of which operate more restaurants and have greater financial resources.  We compete primarily through the quality, price, variety and value of food products offered and our distinctive service experience.  Other key competitive factors include the number and location of restaurants, speed of service, attractiveness of facilities, effectiveness of advertising and marketing programs and new product development by us and our competitors.  We cannot ensure that we will compete successfully in the restaurant industry on these factors.  In addition, some of our competitors have substantially larger marketing budgets, which may provide them with a competitive advantage.  Our system also competes within the QSR industry not only for customers but also for management and hourly employees, suitable real estate sites, and qualified franchisees.

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Changing dietary preferences may cause consumers to avoid our products in favor of alternative foods.

 

The restaurant industry is affected by consumer preferences and perceptions.  Although we monitor these changing preferences and strive to adapt to meet changing consumer needs, growth of our brand and, ultimately, system-wide sales depend on the sustained demand for our products.  If dietary preferences and perceptions cause consumers to avoid certain products offered by Sonic Drive-Ins in favor of different foods, demand for our products may be reduced and our business could be harmed.

 

Our earnings and business growth strategy depends in large part on the success of our franchisees, who exercise independent control of their businesses.

 

A significant percentage of restaurants are owned and operated by our franchisees.  A portion of our earnings comes from royalties, rents and other amounts paid by our franchisees.  Franchisees are independent businesses, and their employees are not our employees.  We provide training and support to, and monitor the operations of, our franchisees, but the quality of their drive-in operations may be diminished by any number of factors beyond our control.  Franchisees may not successfully operate drive-ins in a manner consistent with our high standards and requirements, and they may not invest in facilities and initiatives as necessary to compete successfully in the restaurant industry.  Franchisees also may fail to properly implement the requirements of the Patient Protection and Affordable Care Act (the “ACA”) enacted in 2010 or may respond to the ACA in a manner that is viewed negatively by employees or consumers.  In addition, franchisees may not hire and train qualified managers and other restaurant personnel and may not adequately plan for and train their own successors.  Consumers could perceive an operational shortcoming of a Franchise Drive-In as a reflection of the entire Sonic brand, thus damaging our reputation and potentially affecting revenues and profitability.

 

Changes in economic, market and other conditions could adversely affect Sonic and its franchisees, and thereby Sonic’s operating results.

 

The QSR industry is affected by changes in economic conditions, consumer tastes and preferences and spending patterns, demographic trends, consumer perceptions of food safety, weather, traffic patterns, the type, number and location of competing restaurants and the effects of war or terrorist activities and any governmental responses thereto.  We are also affected by these factors, and the concentration of approximately 35% of our Drive-Ins in Texas and Oklahoma further subjects us to risk particularly if these factors impact those states.  Factors such as interest rates, inflation, gasoline prices, energy costs, food and packaging costs, labor and benefit costs, legal claims and the availability of management and hourly employees also affect restaurant operations and administrative expenses for all Drive-Ins.  Economic conditions, including disruptions in the financial markets, interest rates and other government policies impacting land and construction costs and the cost and availability of borrowed funds, affect our ability and our franchisees’ ability to finance new restaurant development, improvements and additions to existing restaurants, and the acquisition of restaurants from, and sale of restaurants to, franchisees.  Inflation can cause increased food, labor and benefits costs and can increase our operating expenses.  As operating expenses increase, we recover increased costs by increasing menu prices, to the extent permitted by competition and the consumer environment, or by implementing alternative products or processes, or by implementing other cost reduction procedures.  We cannot ensure, however, that we will be able to recover increases in operating expenses in this manner.

Our financial results may fluctuate depending on various factors, many of which are beyond our control.

 

Our sales and operating results can vary from quarter to quarter and year to year depending on various factors, many of which are beyond our control.  Certain events and factors may directly and immediately decrease demand for our products, and we cannot ensure that we will be able to respond to or address the events and factors sufficiently.  If customer demand decreases rapidly, our results of operations, including store-level sales and profits, would also decline precipitously.  These events and factors include:

 

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Shortages or interruptions in the supply or delivery of perishable food products or rapid price increases could adversely affect our operating results.

 

We are dependent on frequent deliveries of perishable food products that meet certain specifications.  Shortages or interruptions in the supply of perishable food products may be caused by unanticipated demand, problems in production or distribution, acts of terrorism, financial or other difficulties of suppliers, disease or food-borne illnesses, droughts, inclement weather or other conditions.  We source large quantities of food and supplies, which can be subject to significant price fluctuations due to seasonal shifts, climate conditions, industry demand, energy costs, changes in international commodity markets and other factors.  These shortages or rapid price increases could adversely affect the availability, quality and cost of ingredients, which would likely lower revenues and reduce our profitability.

 

Failure to successfully implement our growth strategy could reduce, or reduce the growth of, our revenue and net income.

 

We plan to continue to increase the number of Sonic Drive-Ins, but may not be able to achieve our growth objectives, and new drive-ins may not be profitable.  The opening and success of drive-ins depends on various factors, including:

 

 

If we are unable to open as many new drive-ins as planned, if the drive-ins are less profitable than anticipated or if we are otherwise unable to successfully implement our growth strategy, revenue and profitability may grow more slowly or even decrease.

 

Our outstanding and future leverage could have an effect on our operations.

 

On May 20, 2011, the Company closed on a securitized financing facility comprised of a $500 million fixed rate term loan and a $100 million variable rate revolving credit facility.  Effective July 22, 2013, we refinanced $155 million of the fixed rate term loan.  As of August 31, 2014, we had outstanding two series of fixed rate notes:  1) 282.6 million in debt including accrued interest at an interest rate of 5.4%, with an anticipated repayment date of May 2018, and 2) $155.2 million in debt including accrued interest at an interest rate of 3.75%, with an anticipated repayment date of July 2020.  We believe our current leverage ratio is moderate.  We have historically generated net

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operating cash flows significantly in excess of our debt service requirements.  In the event that we default on our debt obligations, the following consequences could apply:

 

 

Sonic Drive-Ins are subject to health, employment, environmental and other government regulations, and failure to comply with existing or future government regulations could expose us to litigation, damage to our reputation and lower profits.

 

Sonic and its franchisees are subject to various federal, state and local laws affecting their businesses.  The successful development and operation of restaurants depends to a significant extent on the selection and acquisition of suitable sites, which are subject to zoning, land use (including the placement of drive-thru windows), environmental (including litter), traffic and other regulations.  More stringent requirements of local and state governmental bodies with respect to zoning, land use and environmental factors could delay, prevent or make cost prohibitive the continuing operations of an existing restaurant or the development of new restaurants in particular locations.  Restaurant operations are also subject to licensing and regulation by state and local departments relating to health, food preparation, sanitation and safety standards, federal and state labor and immigration laws (including applicable minimum wage requirements, overtime, working and safety conditions and work authorization requirements), federal and state laws prohibiting discrimination and other laws regulating the design and operation of facilities, such as the Americans with Disabilities Act.  If we fail to comply with any of these laws, we may be subject to governmental action or litigation, and our reputation could be accordingly harmed.  Injury to our reputation would, in turn, likely reduce revenues and profits.

 

In recent years, there has been an increased legislative, regulatory and consumer focus on nutrition and advertising practices in the food industry, particularly among restaurants.  As a result, we have and will become subject to regulatory initiatives in the area of nutritional content, disclosure and advertising, such as requirements to provide information about the nutritional content of our food products, which could increase expenses.  The operation of our franchise system is also subject to franchise laws and regulations enacted by a number of states and rules promulgated by the U.S. Federal Trade Commission.  Any future legislation or legal changes regarding franchise relationships may negatively affect our operations, particularly our relationship with our franchisees and may increase our potential liability for franchisee practices and our costs.  Failure to comply with new or existing franchise laws and regulations in any jurisdiction or to obtain required government approvals could result in a ban or temporary suspension on future franchise sales.  Changes in applicable accounting rules imposed by governmental regulators or private governing bodies could also affect our reported results of operations.

 

We are subject to the Fair Labor Standards Act, which governs such matters as minimum wage, overtime and other working conditions, along with the Americans with Disabilities Act, various family leave mandates and a variety of other laws enacted, or rules and regulations promulgated, by federal, state and local governmental authorities that govern these and other employment matters.  We have experienced and expect further increases in payroll expenses as a result of government-mandated increases in the minimum wage, and although such increases are not expected to be material, there may be material increases in the future.  Enactment and enforcement of various federal, state and local laws, rules and regulations on immigration and labor organizations may adversely impact the availability and costs of labor for our restaurants in a particular area or across the United States.  In addition, our vendors may be affected by higher minimum wage standards or availability of labor, which may increase the price of goods and services they supply to us. 

 

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We are implementing various aspects of the ACA in our business as they take effect.  There are no assurances that a combination of cost management and price increases can accommodate all of the costs associated with compliance.  

 

Litigation from customers, franchisees, employees and others could harm our reputation and impact operating results.

 

Our legal and regulatory environment exposes us to complex compliance and litigation risk.  Claims of illness or injury relating to food content, food quality or food handling are common in the QSR industry, as are intellectual property claims (including often aggressive or opportunistic attempts to enforce patents used in information technology systems).  In addition, class action lawsuits have been filed, and may continue to be filed, against various QSRs alleging, among other things, that QSRs have failed to disclose the health risks associated with foods we serve and that QSR marketing practices have encouraged obesity and other health issues.  There are also litigation and compliance risks and costs associated with privacy, consumer data protection and similar laws, particularly as they apply to children, as well as laws related to the collection or use of consumer, employee or franchisee data.  In addition to decreasing our sales and profitability and diverting management resources, adverse publicity or a substantial judgment against us could negatively impact our reputation, hindering the ability to attract and retain qualified franchisees and grow the business.

 

Further, we may be subject to employee, franchisee and other claims in the future based on, among other things, discrimination, harassment, wrongful termination and wage, rest break and meal break issues, including those relating to overtime compensation.

 

We may not be able to adequately protect our intellectual property, which could decrease the value of our brand and products.

 

The success of our business depends on the continued ability to use existing trademarks, service marks and other components of our brand in order to increase brand awareness and further develop branded products.  All of the steps we have taken to protect our intellectual property may not be adequate. 

 

Our reputation and business could be materially harmed as a result of data breaches. 

 

Unauthorized intrusion into portions of our computer systems and networks or those of our franchisees that transmit, process and store information related to our customers and their transactions may result in the theft of customer data.  We rely on proprietary and commercially available systems, software, tools and monitoring to provide security for processing, transmission and storage of confidential customer information, such as payment card and personal information.  Improper activities by third parties, advances in computer and software capabilities and encryption technology, new tools and discoveries and other events or developments may facilitate or result in a compromise or breach of our or our franchisees’ computer systems and networks.  Any such compromises or breaches could cause interruptions in our operations and damage to our reputation, subject us to costs and liabilities and hurt sales, revenues and profits. 

 

Unreliable or inefficient drive-in technology, lack of support for drive-in technology and failure to successfully implement technology initiatives could adversely impact operating results.

 

We rely on proprietary and commercially available technologies at our drive-ins, including point-of-sale and payment card systems.  We rely on this technology not only to efficiently operate our drive-ins but also to drive sales growth and margin improvement.  Our strategic technology initiatives may not be timely implemented or may not achieve the desired results.  Certain technology systems may also be unreliable or inefficient, and the technology vendors may limit or terminate product support and maintenance, which could impact the reliability of critical systems supporting drive-in operations.  Additionally, replacement parts and support and maintenance skills may become scarce, cost prohibitive or non-existent.  Any such deficiencies could impact sales and profitability by disrupting our operations, damaging our reputation or subjecting us to excessive costs and liabilities.

 

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Ownership and leasing of significant amounts of real estate exposes us to possible liabilities and losses.

 

We own or lease the land and building for all Company Drive-Ins.  Accordingly, we are subject to all of the risks associated with owning and leasing real estate.  In particular, the value of our assets could decrease and our costs could increase because of changes in the investment climate for real estate, demographic trends and supply or demand for the use of our drive-ins, which may result from competition from similar restaurants in the area, as well as liability for environmental conditions.  We generally cannot cancel the leases, so if an existing or future Sonic Drive-In is not profitable, and we decide to close it, we may nonetheless be committed to perform our obligations under the applicable lease including, among other things, paying rent for the balance of the lease term.  In addition, as each of the leases expires, we may fail to negotiate renewals, either on commercially acceptable terms or at all, which could cause us to close drive-ins in desirable locations.

 

Catastrophic events may disrupt our business.

 

Unforeseen events, or the prospect of such events, including war, terrorism and other international conflicts, public health issues, including health epidemics or pandemics, and natural disasters such as hurricanes, earthquakes or other adverse weather and climate conditions, whether occurring in the United States or abroad, could disrupt our operations, disrupt the operations of franchisees, suppliers or customers, or result in political or economic instability.  These events could reduce demand for our products or make it difficult or impossible to receive products from suppliers. 

 

Item 1B.  Unresolved Staff Comments

 

None.

 

Item 2.  Properties

 

Of the 391 Company Drive-Ins operating as of August 31, 2014, we operated 174 of them on property leased from third parties and 217 of them on property we own.  The leases expire on dates ranging from 2014 to 2030, with the majority of the leases providing for renewal options.  All leases provide for specified monthly rental payments and/or rentals based on sales volume.  Most leases require Sonic to maintain the property and pay the cost of insurance and taxes.  We also own and lease 144 properties and sublease 43 properties to franchisees and other parties.  These leases with franchisees expire on dates ranging from 2014 to 2030, with the majority of the leases providing for renewal options.  The majority of the leases for Franchise Drive-Ins provide for percentage rent based on sales volume, with a minimum base rent.  These leases generally require the franchisee to maintain the property and pay the costs of insurance and taxes.  Virtually all of our owned properties are pledged as collateral under the terms of our securitized financing facility, as described under “Liquidity and Sources of Capital” in Part II, Item 7.

 

Our corporate headquarters is located in Oklahoma City.  We have an existing lease to occupy approximately 87,000 square feet.  This lease expires in November 2023 and has two five-year renewal options.  Sonic believes its properties are suitable for the purposes for which they are being used.

 

Item 3.  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 or financial condition.

 

Item 4.  Mine Safety Disclosures

 

Not applicable.

 

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Item 4A.  Executive Officers of the Company

 

Identification of Executive Officers

 

The following table identifies the executive officers of the Company:

 

 

Business Experience

 

The following sets forth the business experience of the executive officers of the Company for at least the past five years:

 

J. Clifford Hudson has served as the Company’s Chairman of the Board since January 2000 and Chief Executive Officer since April 1995.  Mr. Hudson served as President of the Company from April 1995 to January 2000 and reassumed that position from November 2004 until May 2008 and again in April 2013 to the present.  He has served in various other offices with the Company since 1984.  Mr. Hudson has served as a Director of the Company since 1993.  Mr. Hudson has served on the Board of Trustees of the Ford Foundation since January 2006.  

 

Stephen C. Vaughan has served as Executive Vice President of the Company and Chief Financial Officer since August 2008 and was the Company’s Vice President and Chief Financial Officer from November 2004 until August 2008.  Mr. Vaughan also served as Treasurer of the Company from November 2001 until April 2005.  He joined the Company in 1992.

 

Omar R. Janjua has served as President of Sonic Restaurants, Inc. since September 2009 and Chief Restaurant Operations Officer of Sonic Industries Services Inc. since March 2013.  He also served as Executive Vice President of Operations of Sonic Industries Services Inc. from September 2010 until March 2013.  He served as Executive Vice President and Chief Operating Officer for The Steak n Shake Company from June 2007 to September 2009.  Prior to joining Steak n Shake, Mr. Janjua worked for 18 years with YUM! Brands, Inc. in its

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Pizza Hut operations in various positions of increasing responsibility, the most recent of which was Vice President of Company Operations.

 

John H. Budd III has served as Senior Vice President and Chief Development and Strategy Officer since joining the Company in August 2013.  Mr. Budd served in several progressive positions for Boston Consulting Group from 1997 until joining Sonic.  His most recent position with Boston Consulting Group was Partner and Managing Director.  

 

Craig J. Miller has served as Senior Vice President and Chief Information Officer of Sonic Industries Services Inc. since January 2010.  He served as the Executive Vice President and Chief Information Officer for Movie Gallery, Inc., also known as Hollywood Video, from September 2008 until September 2009.  In February 2010, Movie Gallery, Inc. filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code.  Mr. Miller was Senior Vice President of Shared Information Services for Bank of America from February 2005 until July 2008.

 

James P. O’Reilly has served as Senior Vice President and Chief Brand Officer of the Company since April 2014 and served as Senior Vice President and Chief Marketing Officer of the Company from April 2012 until April 2014.  He served as the Chief Concept Officer of Einstein Noah Restaurant Group, Inc. from April 2009 until joining Sonic.  Prior to April 2009, Mr. O'Reilly served for 13 years in progressive roles throughout the YUM! system including Senior Vice President of US Marketing, Chief Marketing Officer of KFC – US and international roles with KFC, Taco Bell, Pizza Hut and Yum! Restaurants International. 

 

Paige S. Bass has served as Senior Vice President and General Counsel of the Company since October 2014 and served as Vice President and General Counsel of the Company from January 2007 until October 2014.  She has also served as Assistant Corporate Secretary since October 2008.  Ms. Bass joined the Company as Associate General Counsel in 2004.  Prior to joining the Company, Ms. Bass was employed as an associate with the law firm of Crowe & Dunlevy in Oklahoma City, Oklahoma.

 

Michelle E. Britten has served as Vice President and Controller of the Company since November 2012.  She served as Senior Director of Corporate Accounting from April 2009 until November 2012 and as Senior Director of SEC Reporting from January 2007 until April 2009.  Ms. Britten joined the Company in 2005 as its Director of SEC Reporting.

 

Carolyn C. Cummins has served as the Company’s Corporate Secretary since January 2007 and as the Company’s Vice President of Compliance since April 2004.  Ms. Cummins joined the Company as Assistant General Counsel in 1999. 

 

Claudia San Pedro has served as Vice President of Investor Relations and Communications of the Company since January 2013 and was its Vice President of Investor Relations from July 2010 until January 2013.  She served as Vice President of Investor Relations and Brand Strategies from October 2009 until July 2010.  Ms. San Pedro has also served as Treasurer of the Company since January 2007 and as Treasurer of Sonic Industries Services Inc. and Sonic Restaurants, Inc. since November 2006.  She served as the Director of the Oklahoma Office of State Finance from June 2005 through November 2006.  From July 2003 to May 2005, Ms. San Pedro served as the Budget Division Director for the Oklahoma Office of State Finance.

 

Todd W. Smith has served as Vice President and Chief Marketing Officer of the Company since April 2014 and was Vice President of Marketing from April 2012 until April 2014.  Mr. Smith was director of marketing and menu innovation for Wendy’s International from December 2009 to April 2012.  He was employed by Yum! Brands (KFC) in various brand marketing roles from January 2006 to November 2009.

 

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PART II

 

Item 5.  Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market Information

 

The Company’s common stock trades on NASDAQ under the symbol “SONC.” The following table sets forth the high and low sales price for the Company’s common stock during each fiscal quarter within the two most recent fiscal years as reported on NASDAQ. 

 

 

 

Stockholders

 

As of October 15, 2014, the Company had 696 record holders of its common stock.  

 

Dividends 

 

The Company did not pay any cash dividends on its common stock during its two most recent fiscal years.  However, in August 2014, the Board of Directors initiated a cash dividend program under which the Company will pay a regular quarterly cash dividend.  The Board declared the first quarterly cash dividend of $0.09 per share of common stock to be paid to stockholders of record as of the close of business on November 12, 2014, with a payment date of November 21, 2014.    The total dividend payable at August 31, 2014 was $4.9 million and is included in accrued liabilities in the consolidated balance sheet.  Future declaration of quarterly dividends and the establishment of future record and payment dates are subject to the final determination of the Company’s Board of Directors.   

 

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Issuer Purchases of Equity Securities

 

Shares repurchased during the fourth quarter of fiscal 2014 are as follows (in thousands, except per share amounts): 

 

 

 (1)  In August 2013, the Company’s Board of Directors extended the Company’s share repurchase program, authorizing the Company to purchase up to $40 million of its outstanding shares of common stock.   In January 2014, the Company’s Board of Directors approved an incremental $40 million authorization for the program that allowed for up to $80 million of common stock to be repurchased through August 31, 2014.  In August 2014, the Company’s Board of Directors further extended the Company’s share repurchase program by authorizing the Company to purchase up to $105 million of its outstanding shares of common stock in fiscal year 2015.  Share repurchases will be made from time to time in the open market or otherwise, including through an accelerated share repurchase program, under terms of a Rule 10b5-1 plan, in privately negotiated transactions or in round lot or block transactions.  The share repurchase program may be extended, modified, suspended or discontinued at any time.

 

 

Item 6.  Selected Financial Data

 

The following table sets forth selected financial data regarding the Company’s financial condition and operating results.  One should read the following information in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below in Part II, Item 7, and the Company’s Consolidated Financial Statements included elsewhere in this report.

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(1)  Includes net loss from early extinguishment of debt of $4.4 million, $23.0 million and $0.3 million for fiscal years 2013,  2011 and 2010,   respectively.

(2)  Effective April 1, 2010, we revised our compensation program at the Company Drive-In level.  As a result of these changes, noncontrolling interests are immaterial for fiscal years 2014, 2013, 2012 and 2011 and have been included in payroll and other employee benefits.

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

 

Overview

 

Description of the Business.  Sonic operates and franchises the largest chain of drive-in restaurants in the United States.  As of August 31, 2014, the Sonic system was comprised of 3,518 drive-ins, of which 11% were Company Drive-Ins and 89% were Franchise Drive-Ins.  Sonic’s signature food items include specialty drinks (such as cherry limeades and slushes), ice cream desserts, made-to-order sandwiches and hamburgers, a variety of hot dogs including six-inch premium beef hot dogs and footlong quarter pound coneys, hand-battered onion rings, tater tots and wraps.  Sonic Drive-Ins also offer breakfast items that include a variety of breakfast burritos and serve the full menu all day.  We derive our revenues primarily from Company Drive-In sales and royalties from franchisees.  We also receive revenues from leasing real estate to franchisees, franchise fees, earnings from minority investments in franchise operations and other miscellaneous revenues. 

 

Costs of Company Drive-In sales relate directly to Company Drive-In sales.  Other expenses, such as depreciation, amortization and general and administrative expenses, relate to our franchising operations, as well as Company Drive-In operations.  Our revenues and Company Drive-In expenses are directly affected by the number and sales volumes of Company Drive-Ins.  Our revenues and, to a lesser extent, selling, general and administrative expenses also are affected by the number and sales volumes of Franchise Drive-Ins.  Franchise royalties and franchise fees are directly affected by the number of operating Franchise Drive-Ins and new drive-in openings.  Lease revenues are generated by the leasing of land and buildings for Company Drive-Ins that have been sold to franchisees.

 

Overview of Business Performance.    System-wide same-store sales increased 3.5% during fiscal year 2014 as compared to an increase of 2.3% for fiscal year 2013.  Same-store sales at Company Drive-Ins increased by 3.5% during fiscal year 2014 as compared to an increase of 2.5% for fiscal year 2013.  Our continued positive same-store sales are a result of the successful implementation of initiatives, including product quality improvements, a greater emphasis on personalized service and a tiered pricing strategy, that have set a solid foundation for growth.  Along with new technology initiatives implemented in Company Drive-Ins during fiscal 2014, we continue to focus on key initiatives such as increased media effectiveness and our innovative product pipeline in supporting our layered day-part promotional strategy to drive same-store sales.  All of these initiatives drive Sonic’s multi-layered growth strategy, which incorporates same-store sales growth, operating leverage, deployment of cash, an ascending royalty rate and new drive-in development.  Positive same-store sales is the most important layer and drives operating leverage and increased operating cash flows.

 

Revenues increased to $552.3 million for fiscal year 2014 from $542.6 million for the same period last year, which was primarily due to an increase in Franchise Drive-In royalties and Company Drive-In sales driven by the growth of same-store sales.  Franchising revenues increased $7.2 million during fiscal year 2014, reflecting an increase in royalties primarily related to positive same-store sales of 3.5% at Franchise Drive-Ins.  Restaurant margins at Company Drive-Ins improved by 90 basis points during fiscal year 2014, reflecting the leverage of positive same-store sales. 

 

Net income and diluted earnings per share for fiscal year 2014 were $47.9 million and $0.85, respectively, as compared to net income of $36.7 million or $0.64 per diluted share for fiscal year 2013.  Excluding the non‑GAAP adjustments further described below, net income per diluted share was $0.84 for fiscal year 2014, compared to $0.72 per diluted share in fiscal year 2013.  

 

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

 

 

 

 

 

(1)  Tax benefit resulting from the IRS’ acceptance of a federal tax method change during the first quarter of fiscal year 2014.

(2)  Loss on early extinguishment of debt including $0.5 million and $3.9 million in the second and fourth quarters of fiscal year 2013, respectively.

(3)  Tax benefit 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.

(4)  Loss of $2.4 million on the closure of 12 lower-performing Company Drive-Ins as a result of an assessment in advance of capital expenditures for planned technology initiatives.

(5)  Impairment charge of $1.6 million related to the write-off of assets associated with a change in the vendor for the Sonic system’s new point-of-sale technology.

 

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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 years 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.

 

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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.

 

 

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

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

 

Same-store sales for Company Drive-Ins increased 3.5% for fiscal year 2014 and 2.5% for fiscal year 2013, showing continued momentum from the Company’s successful implementation of initiatives to improve product quality, service and value perception.  Furthermore, we continued to focus on our innovative product pipeline and increased media effectiveness while implementing new technology initiatives.  Company Drive-In sales increased  $3.1 million, or 0.8%, during fiscal year 2014 as compared to fiscal year 2013.  This improvement was primarily attributable to an increase of $14.4 million in same-store sales and $2.0 million in incremental sales from new drive-in openings.  These increases were partially offset by an  $8.9 million sales decrease primarily related to the closure of 12 lower-performing drive-ins on August 31, 2013 and a $4.4 million decrease related to the refranchising of seven drive-ins during the first quarter of fiscal year 2014.

 

For fiscal year 2013, Company Drive-In sales decreased $2.1 million, or 0.5%, as compared to 2012.  This decrease was primarily attributable to an $11.3 million reduction in sales from the refranchising of 34 lower-performing drive-ins during the second quarter of fiscal year 2012 and a $2.5 million decrease related to drive-ins that were closed during or subsequent to fiscal year 2012, partially offset by a $10.0 million improvement in same-store sales and $1.7 million of incremental sales from new drive-in openings.    

 

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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.

 

 

(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” included in this Form 10-K.

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

 

Same-store sales for Franchise Drive-Ins increased 3.5% for fiscal year 2014 and 2.3% for fiscal year 2013, showing continued momentum from the initiatives we have implemented to improve product quality, service and value perception.  Furthermore, we continued to focus on our innovative product pipeline and increased media effectiveness.  Franchising revenues increased $7.2 million, or 5.3%, for fiscal year 2014 as compared to fiscal year 2013.  The increase in franchising revenues was driven by an increase in franchise royalties primarily attributable to a 3.5% increase in same-store sales and an increase in franchise fees from the increase in Franchise Drive-In openings.  Lease revenues decreased compared to the prior year due to a franchisee’s purchase during the second quarter of fiscal year 2013 of land and buildings leased or subleased from the Company.  The effective royalty rate increased slightly compared to fiscal year 2013 primarily as a result of improved same-store sales.  

 

Franchising revenues increased by $0.9 million, or 0.7%, to $135.5 million for fiscal year 2013 as compared to $134.6 million for fiscal year 2012.  The increase in franchise revenues was primarily driven by a $4.0 million increase in royalties resulting from same-store sales increases partially offset by various development incentives and certain franchisee restructuring efforts.  These royalty increases were also partially offset by a $1.8 million decline in lease revenue due to the franchisee’s purchase during the second quarter of fiscal year 2013 of land and buildings leased or subleased from the Company and a $1.3 million decline in franchise fees.    

 

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Other revenues decreased $0.5 million to $4.3 in fiscal year 2014 and were flat in fiscal year 2013 as compared to the prior year.  The decrease in fiscal year 2014 was partially due to changes in income from minority investments in franchise operations. 

 

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.

 

 

 

Drive-in level margins improved by 90 basis points during fiscal year 2014 reflecting leverage from improved same-store sales and, to a lesser extent, the closure of 12 lower-performing Company Drive-Ins on August 31, 2013.  Food and packaging costs were slightly unfavorable by 20 basis points, which primarily resulted from increased costs in beef and dairy that were partially offset by menu price increases in the second half of the fiscal year.  Payroll and other employee benefits, as well as other operating expenses, improved 110 basis points mainly as a result of leveraging improved sales and the closure of lower-performing Company Drive-Ins discussed above.

 

Drive-in level margins improved by 60 basis points during fiscal year 2013 reflecting leverage from improved same-store sales and, to a lesser extent, the refranchising of 34 lower-performing Company Drive-Ins during the second quarter of fiscal year 2012.  Food and packaging costs were unfavorable by 40 basis points, which primarily resulted from a product mix shift due to summer promotion activity.  Payroll and other employee benefits, as well as other operating expenses, improved 100 basis points primarily as a result of leveraging labor with improved sales and the refranchising of the 34 drive-ins discussed above.

 

Selling, General and Administrative (“SG&A”).  SG&A expenses increased 5.1% to $69.4 million for fiscal year 2014, and increased 1.3% to $66.0 million during fiscal year 2013 as compared to fiscal year 2012.  The increase in SG&A expense for fiscal year 2014 was largely attributable to an increase in salary and benefits as a result of additional headcount in support of the company’s technology initiatives and higher variable compensation due to improved operating performance.    The increase for fiscal year 2013 was largely attributable to an increase in variable compensation offset by a decline in bad debt expense due to improved sales and profitability at Franchise Drive-Ins.    

 

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Depreciation and Amortization.    Depreciation and amortization expense increased 4.5% to $42.2 million in fiscal year 2014.  The increase during fiscal year 2014 was primarily attributable to our increased investment in technology initiatives at Company Drive-Ins partially offset by a franchisee’s purchase, during the second fiscal quarter of 2013, of land and buildings previously leased or subleased from the Company.  Depreciation and amortization decreased 3.6% to $40.4 million in fiscal year 2013.  The decline in fiscal year 2013 was primarily a result of the franchisee’s purchase of land and buildings described above.    

 

Provision for Impairment of Long-Lived Assets.  Provision for impairment of long-lived assets decreased $1.7 million to $0.1 million in fiscal year 2014, compared to $1.8 million for fiscal year 2013 and $0.8 million for 2012.  The decrease in fiscal year 2014 was primarily the result of the $1.6 million impairment charge in fiscal year 2013 for the write-off of assets associated with a change in the vendor for the Sonic system’s new point-of-sale technology.

 

Other Operating Income and Expense, Net.  Fiscal year 2014 reflected $0.2 million in other operating income compared to other operating net expense of $1.9 million for fiscal year 2013 and other operating income of $0.5 million for fiscal year 2012.   This $2.1 million change for fiscal year 2014 and $2.4 million change for fiscal year 2013 are both primarily the result of the loss recorded on the closure of 12 lower-performing Company Drive‑Ins at the end of fiscal year 2013.

 

Net Interest Expense.  Excluding the item outlined below, net interest expense decreased $3.6 million in fiscal year 2014 and $2.5 million in fiscal year 2013.  The decrease in fiscal year 2014 was primarily related to a decline in our weighted-average interest rate attributable to our partial debt refinancing completed in the fourth quarter of fiscal year 2013 and a decline in our long-term debt balance.  The decrease in fiscal year 2013 was primarily the result of a decline in our long-term debt balance.  Fiscal year 2013 reflects a $4.4 million loss on extinguishment of debt related to our $20.0 million debt prepayment during the second quarter and our $155.0 million partial debt refinancing in the fourth quarter.  See “Liquidity and Sources of Capital” and “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” below for additional information on factors that could impact interest expense.

 

Income Taxes.  The provision for income taxes reflects an effective tax rate of 35.0% for fiscal year 2014 compared with 34.8%  for fiscal year 2013.  The slightly higher effective income tax rate for fiscal year 2014 was primarily attributable to legislation that reinstated and extended the Work Opportunity Tax Credit (“WOTC”) in fiscal year 2013 but expired in fiscal year 2014.  The tax rate for fiscal year 2013 decreased from the fiscal year 2012 rate of 37.7%.  This decrease was primarily attributable to the expiration of a state statute of limitations related to an uncertain tax position and legislation that reinstated and extended the WOTC.  Our fiscal year 2015 tax rate may vary depending upon the reinstatement of the WOTC, which expired on December 31, 2013, and pending resolution of certain tax matters.  Further, 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 and as circumstances on other tax matters change.  

 

Financial Position

 

Total assets decreased $9.8 million, or 1.5%, to $651.0 million during fiscal year 2014 from $660.8 million at the end of fiscal year 2013.   The decrease during the year was primarily attributable to a decline in cash of $42.2 million and current-year depreciation of $42.2 million.  These declines were partially offset by $79.0 million in property and equipment additions (largely technology).    

 

Total liabilities increased $5.0 million to $588.3 million during fiscal year 2014 from $583.3 million at the end of fiscal year 2013.  The increase was primarily attributable to the $4.9 million dividend declared in August 2014 and payable in November 2014.

 

Total stockholders’ equity decreased $14.8 million, or 19.1%, to $62.7 million during fiscal year 2014 from $77.5 million at the end of fiscal year 2013. This decrease was primarily attributable to $80.0 million in purchases of common stock under our stock repurchase program and was partially offset by current-year earnings of $47.9 million and $17.4 million from the issuance of stock related to stock option exercises during fiscal year 2014. 

 

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Liquidity and Sources of Capital

 

Operating Cash Flows.  Net cash provided by operating activities increased $15.7 million to $103.5 million for fiscal year 2014 as compared to $87.8 million in fiscal year 2013.  This increase primarily resulted from the receipt of federal income tax refunds of $9.2 million and lower income tax payments for fiscal year 2014 as compared to fiscal year 2013, mainly attributable to the timing of estimated payments along with an  $11.2 million increase in net income.    These increases were partially offset by a $4.4 million decrease due to the fiscal year 2013 loss from the early extinguishment of debt.

 

Investing Cash Flows.    Cash used in investing activities increased $69.3 million to $70.5 million for fiscal year 2014 compared to $1.2 million for fiscal year 2013.  During fiscal year 2014, we used $79.0 million of cash for investments in property and equipment as outlined in the table below. 

 

The following table sets forth the components of our investments in property and equipment for fiscal year 2014 (in millions):

 

 

 

These purchases increased $37.7 million compared to the same period last year, mostly related to our increased investments in technology.  Additionally, proceeds from the sale of assets declined $31.3 million primarily related to proceeds from a franchisee’s purchase, during the second quarter of fiscal year 2013, of land and buildings previously leased or subleased from the Company. 

 

Financing Cash Flows.    Net cash used in financing activities increased $13.8 million to $75.2 million for fiscal year 2014 as compared to $61.4 million in fiscal year 2013.  This increase primarily relates to a $43.2 million increase in purchases of treasury stock, partially offset by a $24.5 million decrease in debt payments and a $5.0 million decrease in debt issuance and extinguishment costs during fiscal year 2014. 

 

In the second quarter of fiscal year 2013, we made a debt prepayment, at par, of $20.0 million on our Series 2011-1 Senior Secured Fixed Rate Notes, Class A-2 (“2011 Fixed Rate Notes”).  In the fourth quarter of fiscal year 2013, in a private transaction we refinanced $155 million of the 2011 Fixed Rate Notes with the issuance of $155 million of Series 2013-1 Senior Secured Fixed Rate Notes, Class A-2 (the “2013 Fixed Rate Notes”), which bear interest at 3.75% per annum.  The 2013 Fixed Rate Notes have an expected life of seven years, interest payable monthly, with no scheduled principal amortization.  As a result, mandatory debt payments have decreased from $15.0 million to $9.8 million per year.  Additionally, in the fourth quarter of fiscal year 2013, we extended the renewal date of our Series 2011-1 Senior Secured Variable Funding Notes, Class A-1 (“2011 Variable Funding Notes”) by two years to May 2018 and decreased the base spread from 3.75% to 3.50%. 

 

At August 31, 2014, the balance outstanding under the 2011 Fixed Rate Notes and the 2013 Fixed Rate Notes, including accrued interest, totaled $282.6 million and $155.2 million, respectively, and there was no outstanding balance under our 2011 Variable Funding Notes.  The weighted-average interest cost of the 2011 Fixed Rate Notes and 2013 Fixed Rate Notes was 5.7% and was 4.1%, respectively.  The weighted-average interest cost includes the effect of the loan origination costs.

 

In fiscal year 2013, the debt prepayment and the partial debt refinancing resulted in a pro-rata write-off of loan origination costs from the 2011 Fixed Rate Notes, representing a majority of the $4.4 million loss which is reflected in “Net loss from early extinguishment of debt” on the Consolidated Statements of Income.  An additional $4.1 million in debt origination costs were capitalized in conjunction with the 2013 Fixed Rate Notes.  Loan costs are being amortized over each note’s expected life.  The amount of loan costs expected to be amortized over the next

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12 months is reflected in “Other current assets” on the Consolidated Balance Sheets.  For additional information on our 2011 Notes and 2013 Fixed Rate Notes, see note 10 – Debt, included in Part II, Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.

 

In October 2011, our Board of Directors approved a $30 million share repurchase program.  Under that program, we were authorized to purchase up to $30 million of our outstanding shares of common stock through August 31, 2012.  During fiscal year 2012, the Company completed this share repurchase program.

 

In August 2012, our Board of Directors approved a $40 million share repurchase program.  Under that program, we were authorized to purchase up to $40 million of our outstanding shares of common stock through August 31, 2013.  In January 2013, the Board of Directors increased the purchase authorization to $55 million.  During fiscal year 2013, we completed this share repurchase program.    

 

In August 2013, the Board of Directors extended the share repurchase program, authorizing us to purchase up to $40 million of our outstanding shares of common stock. In January 2014, our Board of Directors approved an incremental $40 million authorization for this program that allowed for up to $80 million of common stock to be repurchased through August 31, 2014. 

As part of this program, in February 2014, we entered into an accelerated share repurchase (“ASR”) agreement with a financial institution to purchase $40 million of our common stock.  In exchange for a $40 million up-front payment, the financial institution delivered approximately 2.1 million shares.  During March 2014, the ASR purchase period concluded with no additional shares delivered, resulting in an average price per share of $19.13.  We reflected the ASR transaction as a repurchase of common stock for purposes of calculating earnings per share and as a forward contract indexed to its own common stock.  The forward contract met all of the applicable criteria for equity classification.

The Company completed the Board-approved share repurchase program during fiscal year 2014, with approximately 4.1 million shares repurchased, resulting in an average price per share of $19.61. 

 

In August 2014, our Board of Directors further extended our share repurchase program, authorizing us to purchase up to $105 million of our outstanding shares of common stock during fiscal year 2015. 

 

Share repurchases will be made from time to time in the open market or otherwise, including through an accelerated share repurchase program, under the terms of a Rule 10b5-1 plan, in privately negotiated transactions or in round lot or block transactions. The share repurchase program may be extended, modified, suspended or discontinued at any time.  We plan to fund the share repurchase program from existing cash on hand at August 31, 2014, cash flows from operations and borrowings under our 2011 Variable Funding Notes.

 

As of August 31, 2014, our total cash balance of $55.6 million ($35.7 million of unrestricted and $19.9 million of restricted cash balances) reflected the impact of the cash generated from operating activities, cash used for share repurchases,  debt prepayment and capital expenditures mentioned above.  We believe that existing cash, funds generated from operations and the $100 million available under our 2011 Variable Funding Notes will meet our needs for the foreseeable future.    

 

The Company did not pay any cash dividends on its common stock during its two most recent fiscal years.  However, in August 2014, the Board of Directors initiated a cash dividend program under which the Company will pay a regular quarterly cash dividend.  The Board declared the first quarterly cash dividend of $0.09 per share of common stock to be paid to stockholders of record as of the close of business on November 12, 2014, with a payment date of November 21, 2014.  The total dividend payable at August 31, 2014 was $4.9 million and is included in accrued liabilities in the consolidated balance sheet.  Future declaration of quarterly dividends and the establishment of future record and payment dates are subject to the final determination of the Company’s Board of Directors.

 

Off-Balance Sheet Arrangements

 

The Company has obligations for guarantees on certain franchisee loans, which in the aggregate are immaterial, and obligations for guarantees on certain franchisee lease agreements.  Other than such guarantees and

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various operating leases and purchase obligations, which are disclosed below in “Contractual Obligations and Commitments” and in note 7 - Leases and note 15 – Commitments and Contingencies to our Consolidated Financial Statements, the Company has no other material off-balance sheet arrangements.

 

Contractual Obligations and Commitments

 

In the normal course of business, Sonic enters into purchase contracts, lease agreements and borrowing arrangements.  The following table presents our commitments and obligations as of August 31, 2014 (in thousands):

 

 

(1)  Includes scheduled principal and interest payments on our 2011 Fixed Rate Notes and 2013 Fixed Rate Notes and assumes these notes will be outstanding for the expected seven-year life with an anticipated repayment date in May 2018 and July 2020, respectively.

(2)  Purchase obligations primarily relate to the Company’s estimated share of system-wide commitments to purchase food products.  We have excluded agreements that are cancelable without penalty. These amounts require estimates and could vary due to the timing of volumes and changes in market pricing.

(3)  Includes $2.5 million of unrecognized tax benefits related to uncertain tax positions and $15.5 million related to guarantees of franchisee leases and loan agreements.  As we are not able to reasonably estimate the timing or amount of these payments, if any, the related balances have not been reflected in the “Payments Due by Fiscal Year” section of the table.

 

Impact of Inflation

 

We are impacted by inflation which has caused increases in our food, labor and benefits costs and has increased our operating expenses.  To the extent permitted by competition, increased costs are recovered through a combination of menu price increases and alternative products or processes, or by implementing other cost reduction procedures.

 

Critical Accounting Policies and Estimates

 

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

 

We perform a periodic review of our financial reporting and disclosure practices and accounting policies to ensure that our financial reporting and disclosures provide accurate and transparent information relative to the current economic and business environment.  We believe the following significant accounting policies and estimates involve a high degree of risk, judgment and/or complexity.

 

Accounting for Long-Lived Assets.    We review Company Drive-In assets for impairment when events or circumstances indicate they might be impaired.  We test for impairment using historical cash flows and other relevant facts and circumstances as the primary basis for our estimates of future cash flows.  This process requires us

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to estimate fair values of our drive-ins by making assumptions regarding future cash flows and other factors.  It is reasonably possible that our estimates  of future cash flows could change resulting in the need to write down to fair value certain Company Drive-In assets.

 

We assess the recoverability of goodwill at least annually and more frequently if events or changes in circumstances occur indicating that the carrying amount of goodwill may not be recoverable or as a result of allocating goodwill to Company Drive-Ins that are sold.  Since the Company is one reporting unit, we identify potential goodwill impairment by comparing the fair value of the Company to its carrying value.  The fair value of the Company is determined using a market approach.  If the carrying value of the Company exceeds fair value, a comparison of the fair value of goodwill against the carrying value of goodwill is made to determine whether goodwill has been impaired.

 

During the fourth quarter of fiscal year 2014, we performed our annual assessment of recoverability of goodwill and determined that no impairment was indicated.  As of the impairment testing date, the fair value of the Company significantly exceeded the carrying value.  As of August 31, 2014, the Company had $77.1 million of goodwill.

 

Revenue Recognition Related to Franchise Fees and Royalties.  Franchise fees are recognized in income when we have substantially performed or satisfied all material services or conditions relating to the sale of the franchise and the fees are nonrefundable.  Development fees are nonrefundable and are recognized in income on a pro-rata basis when the conditions for revenue recognition under the individual development agreements are met.  Both franchise fees and development fees are generally recognized upon the opening of a Franchise Drive-In or upon termination of the agreement between Sonic and the franchisee.

 

Our franchisees pay royalties based on a percentage of sales.  Royalties are recognized as revenue when they are earned.

 

Accounting for Stock-Based Compensation.  We estimate the fair value of options granted using the Black-Scholes option pricing model along with the assumptions shown in note 13 – Stockholders’ Equity in the Notes to the Consolidated Financial Statements in this Form 10-K.  The assumptions used in computing the fair value of stock-based payments reflect our best estimates, but involve uncertainties relating to market and other conditions, many of which are outside of our control.  We estimate expected volatility based on historical daily price changes of the Company’s stock for a period equal to the current expected term of the options.  The expected option term is the number of years the Company estimates that options will be outstanding prior to exercise considering vesting schedules and our historical exercise patterns.  If other assumptions or estimates had been used, the stock-based compensation expense that was recorded could have been materially different.  Furthermore, if different assumptions are used in future periods, stock-based compensation expense could be materially impacted.

 

Income Taxes.  We estimate certain components of our provision for income taxes.  These estimates include, among other items, depreciation and amortization expense allowable for tax purposes, allowable tax credits for items such as wages paid to certain employees, effective rates for state and local income taxes and the tax deductibility of certain other items.

 

Although we believe we have adequately accounted for our uncertain tax positions, from time to time, audits result in proposed assessments where the ultimate resolution may give rise to us owing additional taxes.  We adjust our uncertain tax positions until they are resolved in light of changing facts and circumstances, such as the completion of a tax audit, expiration of a statute of limitations, the refinement of an estimate, and penalty and interest accruals associated with uncertain tax positions.  We believe that our tax positions comply with applicable tax law and that we have adequately provided for these matters.  However, to the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made.

 

Our estimates are based on the best available information at the time that we prepare the provision, including legislative and judicial developments.  We generally file our annual income tax returns several months after our fiscal year end.  Income tax returns are subject to audit by federal, state and local governments, typically several years after the returns are filed.  These returns could be subject to material adjustments or differing interpretations of the tax laws. 

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Adjustments to these estimates or returns can result in significant variability in the tax rate from period to period.

 

Leases.    We lease the land and buildings for certain Company Drive-Ins from third parties.  Rent expense for operating leases is recognized on a straight-line basis over the expected lease term, including cancelable option periods when it is deemed to be reasonably assured that we would incur an economic penalty for not exercising the options.  Judgment is required to determine options expected to be exercised.  Within the terms of some of our leases, there are rent holidays and/or escalations in payments over the base lease term, as well as renewal periods.  The effects of the rent holidays and escalations are reflected in rent expense on a straight-line basis over the expected lease term, including cancelable option periods when appropriate.  The lease term commences on the date when we have the right to control the use of lease property, which can occur before rent payments are due under the terms of the lease.  Contingent rent is generally based on sales levels and is accrued at the point in time we determine that it is probable that such sales levels will be achieved.

 

Accounts and Notes Receivable.    We charge interest on past due accounts receivable and recognize income as it is collected.  Interest accrues on notes receivable based on the contractual terms of the respective notes.  We monitor all accounts and notes receivable for delinquency and provide for estimated losses for specific receivables that are not likely to be collected.  We assess credit risk for accounts and notes receivable of specific franchisees based on payment history, current payment patterns, the health of the franchisee’s business, and an assessment of the franchisee’s ability to pay outstanding balances.  In addition to allowances for bad debt for specific franchisee receivables, a general provision for bad debt is estimated for accounts receivable based on historical trends.  Account balances generally are charged against the allowance when we believe it is probable that the receivable will not be recovered and legal remedies have been exhausted.  We continually review our allowance for doubtful accounts.

 

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

 

Sonic’s use of debt directly exposes the Company to interest rate risk.  Fixed rate debt, where the interest rate is fixed over the life of the instrument, exposes the Company to changes in market interest rates reflected in the fair value of the debt and to the risk that the Company may need to refinance maturing debt with new debt at a higher rate.  Sonic is also exposed to market risk from changes in commodity prices.  The Company does not utilize financial instruments for trading purposes.  Sonic manages its debt portfolio to achieve an overall desired position of fixed and floating rates. 

 

Interest Rate Risk.  Our exposure to interest rate risk at August 31, 2014, was primarily based on the 2011 Fixed Rate Notes and 2013 Fixed Rate Notes with an effective rate of 5.4% and 3.75%, respectively, before amortization of debt-related costs.  At August 31, 2014, the fair value of the 2011 Fixed Rate Notes and 2013 Fixed Rate Notes approximated their carrying value of $437.8 million, including accrued interest.  To derive the fair value, management used market information available for public debt transactions for companies with ratings that are similar to our ratings and information gathered from brokers who trade in our notes.  Management believes this fair value is a reasonable estimate.  Should interest rates and/or credit spreads increase or decrease by one percentage point, the estimated fair value of the 2011 Fixed Rate Notes and 2013 Fixed Rate Notes would decrease or increase by approximately $15 million, respectively.  The fair value estimate required significant assumptions by management.    

 

Commodity Price Risk.  The Company and its franchisees purchase certain commodities such as beef, potatoes, chicken and dairy products.  These commodities are generally purchased based upon market prices established with vendors.  These purchase arrangements may contain contractual features that limit the price paid by establishing price floors or caps; however, we generally do not make any long-term commitments to purchase any minimum quantities under these arrangements other than as disclosed above in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under “Contractual Obligations and Commitments.”  We also do not use financial instruments to hedge commodity prices because these purchase arrangements help control the ultimate cost. 

 

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. 

 

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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

 

None.

 

Item 9A.  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 controls over financial reporting during the quarter ended August 31, 2014, that have materially affected or are reasonably likely to materially affect the Company’s internal controls over financial reporting.

 

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Management's Report on Internal Control over Financial Reporting

 

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting.  The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements.  All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

 

The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of August 31, 2014.  In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework - 1992.  Based on our assessment, we believe that, as of August 31, 2014, the Company’s internal control over financial reporting is effective based on those criteria.

 

The Company’s independent registered public accounting firm that audited the 2014 financial statements included in this annual report has issued an attestation report on the Company’s internal control over financial reporting.  The report appears on the following page.

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Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Stockholders of Sonic Corp.

 

We have audited Sonic Corp.’s internal control over financial reporting as of August 31, 2014, based on criteria established in Internal Control – Integrated Framework - 1992 issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Sonic Corp.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on Sonic Corp.’s internal control over financial reporting based on our audit.  

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.  

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.  

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.  

 

In our opinion, Sonic Corp. maintained, in all material respects, effective internal control over financial reporting as of August 31, 2014, based on the criteria established in Internal Control – Integrated Framework - 1992 issued by COSO. 

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Sonic Corp. as of August 31, 2014, and the related consolidated statements of income, stockholders’ equity, and cash flows for the year ended August 31, 2014 of Sonic Corp., and our report dated October 24, 2014, expressed an unqualified opinion on those consolidated financial statements.  

 

 

Oklahoma City, Oklahoma
October 24, 2014 

 

 

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Item 9B.  Other Information

 

None.

 

PART III

 

Item 10.  Directors, Executive Officers and Corporate Governance

 

Sonic has adopted a Code of Ethics for Financial Officers and a Code of Business Conduct and Ethics that applies to all directors, officers and employees.  Sonic has posted copies of these codes on the investor section of its website, www.sonicdrivein.com. 

 

Information regarding Sonic’s executive officers is set forth under Item 4A of Part I of this report.  The other information required by this item is incorporated by reference from the definitive proxy statement which Sonic will file with the Securities and Exchange Commission no later than 120 days after August 31, 2014 (the “Proxy Statement”), under the captions “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance.”

 

Item 11.  Executive Compensation

 

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

 

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

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

 

Item 13.  Certain Relationships and Related Transactions, and Director Independence

 

The information required by this item is incorporated by reference from the Proxy Statement under the captions “Certain Relationships and Related Transactions,” “Director Independence,” “Committees of the Board of Directors” and “Compensation Committee Interlocks and Insider Participation.”

 

Item 14.  Principal Accounting Fees and Services

 

The information required by this item is incorporated by reference from the Proxy Statement under the caption “Independent Registered Public Accounting Firm.”

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PART IV

 

Item 15.  Exhibits and Financial Statement Schedules

 

Financial Statements

 

The following consolidated financial statements of the Company appear immediately following this Item 15:

 

 

Financial Statement Schedule

 

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

 

 

The Company has omitted all other schedules because the conditions requiring their filing do not exist or because the required information appears in Sonic’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 management contracts and compensatory plans or arrangements with an asterisk (*).

3.01.         Certificate of Incorporation of the Company, which the Company incorporates by reference from Exhibit 3.1 to the Company’s Form S-1 Registration Statement No. 33-37158 filed on October 3, 1990.

 

3.02.         Certificate of Amendment of Certificate of Incorporation of the Company, March 4, 1996, which the Company incorporates by reference from Exhibit 3.05 to the Company’s Form 10-K for the fiscal year ended August 31, 2000.

 

3.03.         Certificate of Amendment of Certificate of Incorporation of the Company, January 22, 2002, which the Company incorporates by reference from Exhibit 3.06 to the Company’s Form 10-K for the fiscal year ended August 31, 2002.

 

3.04.         Certificate of Amendment of Certificate of Incorporation of the Company, January 31, 2006, which the Company incorporates by reference from Exhibit 3.04 to the Company’s Form 10-K for the fiscal year ended August 31, 2006.

 

4.01.         Bylaws of the Company, as amended and restated January 14, 2010, which the Company incorporates by reference from Exhibit 3.05 to the Company’s Form 10-K for fiscal year ended August 31, 2010.

 

4.02.         Certificate of Designations of Series A Junior Preferred Stock, which the Company incorporates by reference from Exhibit 99.1 to the Company’s Form 8-K filed on June 17, 1997.

 

4.03.         Specimen Certificate for Common Stock, which the Company incorporates by reference from Exhibit 4.01 to the Company’s Form 10-K for the fiscal year ended August 31, 1999.

 

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10.01.       Form of Sonic License Agreement, which the Company incorporates by reference from Exhibit 10.10 to the Company’s Form 10-K for the fiscal year ended August 31, 2007.

 

10.02.       Form of Sonic Development Agreement, which the Company incorporates by reference from Exhibit No. 10.13 to the Company’s Form 10-K for the fiscal year ended August 31, 2007.

 

10.03.       Form of Sonic Sign Lease Agreement, which the Company incorporates by reference from Exhibit 10.4 to the Company’s Form S-1 Registration Statement No. 33-37158.

 

10.04.       Sonic Corp. Stock Purchase Plan, as amended and restated effective April 20, 2011, which the Company incorporates by reference from Exhibit 10.07 to the Company’s Form 10-K for the fiscal year ended August 31, 2012.*

 

10.05.       Sonic Corp. Savings and Profit-Sharing Plan, as amended and restated effective January 1, 2013, which the Company incorporates by reference from Exhibit 10.1 to the Company’s Form 10-Q filed on July 3, 2013.*

 

10.06.       Sonic Corp. Nonqualified Deferred Compensation Plan as amended and restated April 10, 2013, which the Company incorporates by reference from Exhibit 10.06 to the Company’s Form 10-K for the fiscal year ended August 31, 2013.*

 

10.07.       Form of Indemnification Agreement for Directors, which the Company incorporates by reference from Exhibit 10.7 to the Company’s Form S-1 Registration Statement No. 33-37158.*

 

10.08.       Form of Indemnification Agreement for Officers, which the Company incorporates by reference from Exhibit 10.14 to the Company’s Form 10-K for the fiscal year ended August 31, 1995.*

 

10.09.       Form of Chief Executive Officer Amended and Restated Employment Agreement dated November 1, 2012, which the Company incorporates by reference from Exhibit 10.12 to the Company’s Form 10-K for the fiscal year ended August 31, 2012.*

 

10.10.       Form of Executive Officer Amended and Restated Employment Agreement dated November 1, 2012, which the Company incorporates by reference from Exhibit 10.13 to the Company’s Form 10-K for the fiscal year ended August 31, 2012.*

 

10.11.       Amended and Restated Sonic Corp. Executive Severance Plan dated September 1, 2014.*

 

10.12.       2001 Sonic Corp. Stock Option Plan, as amended and restated effective January 14, 2010, which the Company incorporates by reference from Exhibit (d)(3) to the Company’s Schedule TO filed March 31, 2010.*

 

10.13.       2001 Sonic Corp. Directors’ Stock Option Plan, as amended and restated January 14, 2010, which the Company incorporates by reference from Exhibit 10.27 to the Company’s Form 10-K filed on October 29, 2010.*

 

10.14.       Sonic Corp. 2006 Long-Term Incentive Plan, as amended and restated effective January 16, 2014, which the Company incorporates by reference from Exhibit 4.1 to the Company’s Form S-8 filed on April 4, 2014.*

 

10.15.       Form of Award Agreement under Sonic Corp. 2006 Long-Term Incentive Plan, which the Company incorporates by reference from Exhibit (d)(2) to the Company’s Schedule TO filed March 31, 2010.*

 

10.16.       Sonic Corp. Senior Executive Cash Incentive Plan dated January 6, 2011, which the Company incorporates by reference from Exhibit 10.01 to the Company’s Form 10-Q filed on April 8, 2011.*

 

10.17.       Sonic Corp. Employee Cash Incentive Plan dated January 6, 2011, which the Company incorporates by reference from Exhibit 10.02 to the Company’s Form 10-Q filed on April 8, 2011.*

 

10.18.       Base Indenture dated May 20, 2011 among Sonic Capital LLC, Sonic Industries LLC, America’s Drive-In Brand Properties LLC, America’s Drive-In Restaurants LLC, SRI Real Estate Holding LLC and SRI Real Estate Properties LLC, each as Co-Issuer of the Fixed Rate Notes and Citibank, N.A., as Trustee and Securities

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Intermediary, which the Company incorporates by reference from Exhibit 99.1 to the Company’s Form 8-K filed on May 26, 2011.

 

10.19.       Supplemental Indenture dated May 20, 2011 among Sonic Capital LLC, Sonic Industries LLC, America’s Drive-In Brand Properties LLC, America’s Drive-In Restaurants LLC, SRI Real Estate Holding LLC and SRI Real Estate Properties LLC, each as Co-Issuer of the Fixed Rate Notes, and Citibank, N.A. as Trustee and the Series 2011-1 Securities Intermediary, which the Company incorporates by reference from Exhibit 99.2 to the Company’s Form 8-K filed on May 26, 2011.

 

10.20.       Class A-1 Note Purchase Agreement dated May 20, 2011 among Sonic Capital LLC, Sonic Industries LLC, America’s Drive-In Brand Properties LLC, America’s Drive-In Restaurants LLC, SRI Real Estate Holding LLC and SRI Real Estate Properties LLC, each as Co-Issuer and Sonic Industries Services Inc., as Manager, certain private conduit investors, financial institutions and funding agents, Barclays Bank PLC, as provider of letters of credit, and Barclays Bank PLC, as a swing-line lender and as Administrative Agent of the Fixed Rate Notes, which the Company incorporates by reference from Exhibit 99.3 to the Company’s Form 8-K filed on May 26, 2011.

 

10.21.       Guarantee and Collateral Support Agreement dated May 20, 2011 made by Sonic Franchising LLC, as Guarantor in favor of Citibank N.A. as Trustee, which the Company incorporates by reference from Exhibit 99.4 to the Company’s Form 8-K filed on May 26, 2011.

 

10.22.       Parent Company Support Agreement dated May 20, 2011 made by Sonic Corp. in favor of Citibank N.A., as Trustee, which the Company incorporates by reference from Exhibit 99.5 to the Company’s Form 8-K filed on May 26, 2011.

 

10.23.       Supplemental Indenture dated July 18, 2013 among Sonic Capital LLC, Sonic Industries LLC, America's Drive-In Brand Properties LLC, America's Drive-In Restaurants LLC, SRI Real Estate Holding LLC and SRI Real Estate Properties LLC, each as Co-Issuer of the Series 2013-1 Notes, and Citibank, N.A., as Trustee and Series 2013-1 Securities Intermediary, which the Company incorporates by reference to the Company’s Form 8‑K filed on July 24, 2013.

 

21.01.       Subsidiaries of the Company.

 

23.01.       Consent of Independent Registered Public Accounting Firm.

 

23.02.       Consent of Independent Registered Public Accounting Firm.

 

31.01.       Certification of Chief Executive Officer pursuant to S.E.C. Rule 13a-14.

 

31.02.       Certification of Chief Financial Officer pursuant to S.E.C. Rule 13a-14.

 

32.01.       Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.

 

32.02.       Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.

 

101.INS    XBRL Instance Document

 

101.SCH    XBRL Taxonomy Extension Schema Document

 

101.CAL  XBRL Taxonomy Extension Calculation Linkbase Document

 

101.DEF   XBRL Taxonomy Extension Definition Linkbase Document

 

101.LAB  XBRL Taxonomy Extension Label Linkbase Document

 

101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document