PART I
Item 1. Business
Overview
Sonic Corp., through its subsidiaries, 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, 2018
, the Sonic system included
3,606
Sonic Drive-Ins in 45 states of which
3,427
were owned and operated by franchisees (“Franchise Drive-Ins”) and
179
were owned and operated by Sonic Restaurants, Inc., the Company’s operating subsidiary (“Company 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. Many Sonic Drive‑Ins also include a drive-thru lane and patio seating to provide customers with alternative dining options.
Menu
Sonic maintains a highly diverse menu. The menu strategy is to provide a broad range of items that appeal to target customer segments 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 cheeseburgers, chicken entrees ranging from sandwiches to boneless wings, a variety of hot dogs including six-inch premium beef hot dogs and footlong quarter-pound coneys, hand-made onion rings and tater tots. Sonic Drive-Ins also offer breakfast items that include a variety of breakfast
burritos and serve the full menu all day.
Strategy
Sonic’s strategy is to deliver a differentiated and high quality customer service experience. The key elements of our strategy are:
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A distinctive drive-in concept focusing on a unique menu of quality, made-to-order food products including several signature items and innovative technology;
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A commitment to customer service featuring the quick delivery of food by friendly carhops;
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Integrated national marketing programs across media channels, including broadcast, digital and mobile; and
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A commitment to strong franchisee relationships.
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Sonic’s brand growth strategies include the following:
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Same-store sales growth;
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Improved performance of Company Drive-Ins, including consistent operations execution and restaurant-level margins; and
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Expansion of Sonic Drive-Ins.
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Expansion
During fiscal year
2018
, we opened
41
Sonic Drive-Ins, all of which were Franchise Drive-Ins. Expansion plans for fiscal year
2019
involve the opening of multiple Sonic Drive-Ins under development agreements, as well as single-store development by new and existing franchisees. We believe that our existing as well as newly opened markets offer significant growth opportunities 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 3 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, digital media, sponsorship and brand enhancement opportunities. The Sonic Brand Fund supports national creative and content production as well as other programs designed to promote or enhance the Sonic brand. Our license agreements require advertising contributions of up to 5.9% of sales to these marketing funds and local advertising cooperatives.
Purchasing
We negotiate with suppliers for primary food products and packaging supplies for the system and seek competitive bids from suppliers on many of our food and packaging items. Approved suppliers of those products are required 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. All Sonic Drive-Ins are required 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 audits by independent third parties. All Sonic Drive-In employees are required to receive food safety 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 including point-of-sale systems and operational tools for sales, labor 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 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 sales and profit margins and accumulating marketing information. We are also making strategic investments in customer facing digital technologies, including interactive menu boards, a multi-functional mobile application and electronic payment at the stall and off-premises to enhance the customer’s experience and drive sales. We have further invested in new point-of-sale systems. Our license agreements require a
technology contribution of approximately 0.25% of sales to the Brand Technology Fund (“BTF”), which was established in the third quarter of fiscal year 2016 and administers cybersecurity and other technology programs for the Sonic system.
Franchise Program
General
. As of
August 31, 2018
, we had
3,427
Franchise Drive-Ins in operation. A large number of successful multi-unit franchise groups have developed during the Sonic system’s more than 60 years of operation. Those franchisees continue to develop new Franchise Drive-Ins either through development agreements or single-site development. Our franchisees opened
41
drive-ins during fiscal year
2018
. 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 sales on a graduated percentage basis and a 20-year term. For fiscal year
2018
, Sonic’s average royalty rate was
4.08%
. The franchisee also pays advertising fees of up to 5.9% of sales and a technology fee of approximately 0.25% of sales.
Development Agreements
. We use single- and multiple-unit development agreements for opening new drive-ins. During fiscal year
2018
, 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 typically pay a fee, 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, new products, operations, profitability, technology and training. The Franchise Advisory Council currently consists of
26
members selected by Sonic. We have
seven
executive committee members who are selected at large and
19
regional members representing all regions of the country. We also have four Franchise Advisory Council task groups comprised of
55
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.
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2018
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2017
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2016
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2015
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2014
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Average sales per Franchise Drive-In
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$
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1,260
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$
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1,260
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$
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1,301
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$
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1,261
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$
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1,170
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(
In thousands
)
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Number of Franchise Drive-Ins:
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Total open at beginning of year
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3,365
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3,212
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3,139
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3,127
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3,126
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New Franchise Drive-Ins
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41
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63
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52
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38
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37
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Sold to the Company
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—
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—
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—
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(3
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)
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—
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Purchased from the Company
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49
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117
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38
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9
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7
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Closed (net of re-openings)
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(28
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)
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(27
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)
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(17
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(32
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)
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(43
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)
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Total open at end of year
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3,427
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3,365
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3,212
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3,139
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3,127
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Company Operations
Management
Structure.
A typical Company Drive-In is operated by a manager, two to four assistant managers and approximately 25 hourly employees, some 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 incentive compensation based on customer satisfaction, employee staffing and training and drive-in level financial 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.
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2018
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2017
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2016
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2015
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2014
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Average sales per Company Drive-In
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$
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1,155
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$
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1,134
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$
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1,142
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$
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1,116
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$
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1,043
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(
In thousands
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Number of Company Drive-Ins:
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Total open at beginning of year
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228
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345
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387
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391
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396
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New Company Drive-Ins
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—
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3
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1
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3
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3
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Purchased from franchisees
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—
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—
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—
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3
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—
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Sold to franchisees
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(49
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)
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(117
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(38
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)
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(9
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)
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(7
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)
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Closed (net of re-openings)
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—
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(3
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)
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(5
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)
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(1
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(1
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Total open at end of year
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179
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228
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345
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387
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391
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Competition
We compete in the restaurant industry, specifically in the segment known as quick-service restaurants (“QSR”), which is highly competitive in terms of price, service, location and food quality. The restaurant industry is often affected by changes in consumer trends, economic conditions, demographics and traffic patterns. 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 and personalized). Our drive-in format, combined with the quality of service featuring Sonic carhops, constitute a primary marketable point 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 compete with many franchisors of QSR and other restaurants, in addition to franchisors of other business opportunities.
Seasonality
Our sales and earnings results during Sonic’s second fiscal quarter (the months of December, January and February) generally are lower than other quarters because of colder and more volatile weather in the locations of a number of Sonic Drive-Ins.
Employees
As of
August 31, 2018
, we had
391
full-time corporate employees and approximately
4,650
full-time and part-time employees at Company Drive-Ins. 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 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
2018
, 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, 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, food contamination
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, food contamination 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 actual or reports of food safety issues. Our food safety and quality assurance program minimizes food safety risks. Nevertheless, these risks cannot be completely eliminated. Any food safety incident 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.
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, the growth of our brand and, ultimately, system 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 large proportion of Sonic Drive-Ins are owned and operated by our franchisees. A significant 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. To help ensure compliance with brand standards we provide appropriate 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. 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, 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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sales promotions and product offerings by Sonic and its competitors;
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changes in average same-store sales and customer visits;
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the inability to purchase sufficient levels of media;
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variations in the price, availability and shipping costs of supplies such as food products;
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seasonal effects on demand for Sonic’s products;
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slowdowns in new drive-in development or franchise agreement renewals;
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changes in competitive conditions;
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changes in economic conditions generally, including consumer spending;
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consumer sensitivity to price and value;
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changes in consumer tastes and preferences;
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changes in the cost of labor; and
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weather and other acts of God.
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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 or provide a sufficient return on investment. The opening and success of drive-ins depends on various factors, including:
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competition from other restaurants in current and future markets;
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the degree of saturation in existing markets;
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consumer interest in and acceptance of the Sonic brand in existing and new markets;
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the identification and availability of suitable and economically viable locations;
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sales and profit levels at existing drive-ins;
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the negotiation of acceptable lease or purchase terms for new locations;
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permitting and regulatory requirements;
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the cost and availability of construction resources and financing;
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the ability to meet construction schedules;
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the availability of qualified franchisees and their financial and other development capabilities, including their desire and ability to access and commit capital;
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the ability to hire and train qualified management personnel;
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sufficient marketing efforts;
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general economic and business conditions.
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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.
The Company employs securitized financing in the form of fixed rate notes and variable rate notes. As of
August 31, 2018
, we had three outstanding series of fixed rate notes: 1)
$147.6 million
in debt including accrued interest at an interest rate of
3.75%
, with an anticipated repayment date of July 2020, and 2)
$400.4 million
in debt including accrued interest at an interest rate of
4.47%
, with an anticipated repayment date of May 2023, and 3)
$170.2 million
in debt including accrued interest at an interest rate of 4.03%, with an anticipated repayment date of February 2025. In addition, as of
August 31, 2018
, we had
no
outstanding balance under the variable rate notes. Interest on the variable notes is based on the one-month London Interbank Offered Rate or Commercial Paper, depending on the funding source, plus 2.0%, per annum. The variable rate notes have an anticipated repayment date of May 2021, with two one-year options available under certain conditions. We believe our current leverage ratio is moderate. We have historically generated net 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:
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•
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Our flexibility may be reduced in responding to changes in business, industry, regulatory or economic conditions.
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•
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Our ability to obtain additional financing in the future for acquisitions, working capital, capital expenditures and general corporate or other purposes could be impaired or any such financing may not be available on terms favorable to us.
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•
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Any substantial decrease in net operating cash flows or any substantial increase in expenses could make it difficult for us to meet our debt service requirements or force us to modify our operations or sell assets; as a result a substantial portion of our cash flows could be required for debt service and might not be available for our operations or other purposes.
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•
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Unpaid amounts outstanding could become immediately due and payable.
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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 or our franchisees fail to comply with any of these laws, we or they 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 future increases may be material. 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.
We have implemented various aspects of the Affordable Care Act in our business, and the law or other related requirements may change. 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 and use of consumer, employee and franchisee data. We additionally 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. Litigation, as well as regulatory and legal changes, involving our relationship with our franchisees and the legal distinction between our franchisees and us for employment law purposes, if determined adversely, could increase costs, negatively impact the business prospects of our franchisees and subject us to incremental liability for their actions. 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.
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
security breaches.
Security breaches involving our systems or those of our franchisees or third-party providers may occur, such as unauthorized access, denial of service, computer viruses and other disruptive problems caused by hackers and other bad actors. In fact, as further described below, in 2017 the Company discovered that payment card numbers were acquired without authorization as part of a malware attack experienced at certain Sonic Drive-In locations. Our technology systems contain personal, financial and other information that is entrusted to us by our customers and employees as well as financial, proprietary and other confidential information related to our business. While we take precautions to avoid security breaches, an actual or alleged security breach could result in system disruptions, shutdowns, theft or unauthorized disclosure of confidential information. The occurrence of any of these incidents, or the reporting of such incidents whether accurate or not, could result in adverse publicity, loss of consumer confidence, increased costs, reduced sales and profits and criminal penalties or civil liabilities.
We have incurred and in the future may incur costs resulting from breaches of security of confidential consumer information related to our electronic processing of credit and debit card transactions.
A significant portion of our restaurant sales are by credit or debit cards. As previously announced, in 2017 the Company discovered that payment card numbers were acquired without authorization as part of a malware attack experienced at certain Sonic Drive-In locations. The Company was named as a defendant in nine purported class action complaints related to the breach. The cases were consolidated in the Northern District of Ohio (the “Litigation”). The plaintiffs in the Litigation assert various claims related to the Company’s alleged failure to safeguard customer credit card information and seek monetary damages, injunctive and declaratory relief and attorneys’ fees and costs. The Company believes it has meritorious defenses to the Litigation and intends to vigorously oppose the claims asserted by the plaintiffs. On October 10, 2018, the parties to the Litigation filed a joint motion seeking preliminary approval of a class settlement. Based on the terms of class settlement, which is subject to final court approval, we do not believe any payments made in connection with the class settlement or the Litigation more generally would be in excess of our cyber liability insurance coverage. The Company has since been named as a defendant in one additional purported class action complaint filed on October 16, 2018, in the United States District Court for the Eastern District of Arkansas. We cannot provide assurance that we will not become subject to other inquiries or claims relating to the payment card breach. We may be subject to losses associated with claims and anticipated claims by payment card companies for non-ordinary course operating expenses, card issuer losses and card replacement costs, as well as fines and penalties issued by payment card companies in connection with the payment card breach. We may also be subject to fines and penalties imposed by state and/or federal regulators relating to or arising out of the payment card breach. It is possible that losses associated with the payment card breach, including losses associated with the Litigation, could have a material adverse effect on our results of operations in future periods.
We may in the future become subject to additional claims for purportedly fraudulent transactions arising out of the actual or alleged theft of credit or debit card information, and we may also be subject to further lawsuits or other proceedings relating to these types of incidents. Any such claim or proceeding arising from the payment card breach could cause us to incur significant unplanned expenses, which could have an adverse impact on our financial condition and results of operations. Further, adverse publicity resulting from these allegations may have a material adverse effect on us and our restaurants.
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, digital point-of-purchase 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 or effectively implemented or adequately resourced. Certain technology networks and systems may also be unreliable or inefficient, and our technology vendors may limit or terminate product support and maintenance or be unwilling or unable to provide products and services needed to execute our technology initiatives. Additionally, replacement parts and support and maintenance skills may become scarce, cost prohibitive or non-existent. Any such risks could disrupt drive-in operations, render us unable to achieve desired strategic results and impact sales and profitability.
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 domestic or 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
179
Company Drive-Ins operating as of
August 31, 2018
, we operated
83
of them on property leased from third parties and
96
of them on property we own. The leases expire on dates ranging from
2019
to
2037
, with the majority of the third-party leases providing for renewal options. All third-party leases provide for specified monthly rental payments and/or rentals based on sales volume. Most third-party leases require Sonic to maintain the property and pay the cost of insurance and taxes.
We also own and lease
162
properties and sublease
48
properties to franchisees and other parties. These leases with franchisees and other parties expire on dates ranging from
2018
to
2037
, with the majority of the leases providing for renewal options. The majority of the leases and subleases 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
100,433
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 was named as a defendant in nine purported class action complaints related to a 2017 payment card breach at certain Sonic Drive-Ins. The cases were consolidated in the Northern District of Ohio (the “Litigation”). The plaintiffs in the Litigation assert various claims related to the Company’s alleged failure to safeguard customer credit card information and seek monetary damages, injunctive and declaratory relief and attorneys’ fees and costs. The Company believes it has meritorious defenses to the Litigation and intends to vigorously oppose the claims asserted by the plaintiffs. On October 10, 2018, the parties to the Litigation filed a joint motion seeking preliminary approval of a class settlement. Based on the terms of the class settlement, which is subject to final court approval, we do not believe any payments made in connection with the class settlement or the Litigation more generally would be in excess of our cyber liability insurance coverage. The Company has since been named as a defendant in one additional purported class action complaint filed on October 16, 2018, in the United States District Court for the Eastern District of Arkansas. We cannot provide assurance that we will not become subject to other inquiries or claims relating to the payment card breach in the future. Although we maintain cyber liability insurance, it is possible the ultimate amount paid by us relating to the payment card breach may be in excess of our cyber liability insurance coverage applicable to claims of this nature. We are unable to estimate the amount of any such excess.
The Company is involved in various other legal proceedings and has certain unresolved claims pending. Based on the information currently available, management believes that all such other 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.
Item 4A. Executive Officers of the Company
Identification of Executive Officers
The following table identifies the executive officers of the Company:
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Name
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Age
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Position
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Executive
Officer Since
|
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Clifford Hudson
|
|
63
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Chairman of the Board of Directors and Chief Executive Officer
|
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1985
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Claudia S. San Pedro
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49
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President
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2007
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John H. Budd III
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51
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Executive Vice President and Chief Strategy and Business Development Officer
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2013
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Jose A. Dueñas
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46
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Executive Vice President and Chief Brand Officer
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2017
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Christina D. Vaughan
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43
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President of Sonic Restaurants, Inc.
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2017
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Paige S. Bass
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49
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Senior Vice President, General Counsel and Assistant Corporate Secretary
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2007
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E. Edward Saroch
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61
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Senior Vice President of Franchise Relations
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2017
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Corey R. Horsch
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40
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Vice President, Chief Financial Officer and Treasurer
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2015
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Lori Abou Habib
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38
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Vice President and Chief Marketing Officer
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2017
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Michelle E. Britten
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51
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Vice President and Chief Accounting Officer
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2012
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Carolyn C. Cummins
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60
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Vice President of Compliance and Corporate Secretary
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2004
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Business Experience
The following sets forth the business experience of the executive officers of the Company for at least the past five years:
Clifford Hudson has served as the Company’s Chairman of the Board since January 2000 and Chief Executive Officer since April 1995. He also served as President from April 1995 to January 2000, reassumed that position from November 2004 until May 2008, April 2013 to January 2016 and again March 2017 to February 2018. He has served in various other offices with the Company since 1984. Mr. Hudson has served as a Director of the Company since 1993.
Claudia S. San Pedro has served as the Company’s President since February 2018. She served as Executive Vice President and Chief Financial Officer from August 2015 to February 2018 and served as Senior Vice President and Chief Financial Officer from April 2015 until August 2015. Ms. San Pedro served as Vice President of Investor Relations and Communications of the Company from January 2013 until April 2015 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 from January 2007 until October 2015. 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.
John H. Budd III has served as Executive Vice President and Chief Strategy and Business Development Officer of the Company since January 2018. He served as Executive Vice President and Chief Development and Strategy Officer from January 2016 to January 2018, and as Senior Vice President and Chief Development and Strategy Officer from August 2013 until January 2016. Mr. Budd served in several progressive positions for Boston Consulting Group from 1997 until joining Sonic in August 2013. His most recent position with Boston Consulting Group was Partner and Managing Director.
Jose A. Duen͂as has served as Executive Vice President and Chief Brand Officer since August 2017. Mr. Duen͂as served as Executive Vice President and Chief Marketing Officer for Olive Garden, Darden Restaurants, Inc., from November 2014 to August 2017, and was its Senior Vice President of Brand Marketing from June 2012 to October 2014. Mr. Duen͂as served in several progressive positions with Kellogg Company from September 1995 to May 2012, the most recent of which was Vice President and General Manager of the toaster pastries business.
Christina D. Vaughan has served as President of Sonic Restaurants, Inc. since January 2017. She served as Vice President of Market Strategies for the Company from November 2012 until July 2015, and Vice President of Franchise Operations for the Company from August 2015 to December 2016. Ms. Vaughan held various positions of increasing responsibility from the time she first joined the Company as a field marketing representative in September 2002 until November 2012.
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.
E. Edward Saroch has served as Senior Vice President of Franchise Relations since January 2013 and was Senior Vice President of Field Services - West Region from November 2011 until January 2013. Mr. Saroch was the Senior Vice President of East Markets from September 2010 until November 2011. Mr. Saroch joined the Company in October 1995.
Corey R. Horsch has served as Vice President, Chief Financial Officer and Treasurer of the Company since February 2018. He served as Vice President of Investor Relations and Treasurer of the Company from October 2015 to February 2018. Mr. Horsch served as a Portfolio Manager with Surveyor Capital from May 2011 until September 2015. He served as a Senior Research Analyst with Luther King Capital Management from June 2006 until April 2011. Prior to June 2006, Mr. Horsch worked for almost six years with Credit Suisse in various positions of increasing responsibility, the most recent of which was Vice President, Senior U.S. Equity Research Analyst.
Lori I. Abou Habib has served as Vice President and Chief Marketing Officer since August 2017 and served as a Vice President in marketing roles for the Company from January 2016 until August 2017. She held various marketing roles of increasing responsibility from 2007 when she joined Sonic until she became Vice President of Local Relationship Marketing in January 2016.
Michelle E. Britten has served as Vice President and Chief Accounting Officer since January 2016 and as Vice President and Controller of the Company from November 2012 until January 2016. 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.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
1.
Summary of Significant Accounting Policies
Operations
Sonic Corp. (the “Company”), through its subsidiaries, operates and franchises a chain of quick-service restaurants in the United States (“U.S.”). It derives its revenues primarily from Company Drive-In sales and royalty fees from franchisees. The Company also leases real estate and receives equity earnings in noncontrolling ownership in a number of Franchise Drive‑Ins.
Principles of Consolidation
The accompanying financial statements include the accounts of the Company, its wholly owned subsidiaries and a number of Company Drive-Ins in which a subsidiary has a controlling ownership interest. All intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the amounts reported and contingent assets and liabilities disclosed in the financial statements and accompanying notes. Actual results may differ from those estimates, and such differences may be material to the financial statements.
Segment Reporting
In accordance with Accounting Standards Update (“ASU”) No. 280, “Segment Reporting,” the Company uses the management approach for determining its reportable segments. The management approach is based upon the way that management reviews performance and allocates resources. The Company’s chief operating decision maker and his management team review operating results on a consolidated basis for purposes of allocating resources and evaluating the financial performance of the Sonic brand. Accordingly, the Company has determined that it has
one
operating segment and, therefore,
one
reporting segment.
Cash Equivalents
Cash equivalents consist of highly liquid investments, primarily money market accounts that mature in three months or less from the date of purchase, and depository accounts.
Restricted Cash
As of
August 31, 2018
, the Company had restricted cash balances totaling
$27.5 million
for funds required to be held in trust for the benefit of senior noteholders under the Company’s debt arrangements. The current portion of restricted cash of
$19.6 million
represents amounts to be returned to the Company or paid to service current debt obligations, including
$5.0 million
in proceeds from the sale of securitized real estate. The noncurrent portion of
$7.9 million
primarily represents proceeds from the sale of securitized real estate, as well as interest reserves required to be set aside for the duration of the debt. Under the Company's securitized finance structure, the Company has
12 months
to reinvest the real estate proceeds in eligible capital expenses. If the
$12.8 million
in proceeds are not reinvested within a year, all amounts above
$5 million
, which is reflected in current restricted cash, must be used to pay down the fixed-rate debt and may require a make-whole premium. The Company may also pay down debt prior to that 12-month time period which could require a make-whole premium. The make-whole premium calculation is, in general, based on the discounted present value of the amount of interest that would otherwise have been paid had the prepayment not been made.
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
Accounts and Notes Receivable
The Company charges interest on past due accounts receivable and recognizes income as it is collected. Interest accrues on notes receivable based on the contractual terms of the respective note. The Company monitors all accounts and notes receivable for delinquency and provides for estimated losses for specific receivables that are not likely to be collected. The Company assesses 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 the Company’s accounts receivable based on historical trends. Account balances generally are charged against the allowance when the Company believes that the collection is no longer reasonably assured. The Company continually reviews its allowance for doubtful accounts.
Inventories
Inventories consist principally of food and supplies that are carried at the lower of cost (first-in, first-out basis) or market.
Property, Equipment and Capital Leases
Property and equipment are recorded at cost, and leased assets under capital leases are recorded at the present value of future minimum lease payments. Depreciation of property and equipment and amortization of capital leases are computed by the straight-line method over the estimated useful lives or the lease term, including cancelable option periods when appropriate, and are combined for presentation in the financial statements.
Accounting for Long-Lived Assets
The Company reviews long-lived assets quarterly or whenever changes in circumstances indicate that the carrying amount of an asset might not be recoverable. Assets are grouped and evaluated for impairment at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups of assets, which generally represents the individual drive-in. Earnings before interest, taxes and depreciation (“EBITDA”) is the cash flow measure monitored at the drive-in level for indicators of impairment. As the cash flow measure reaches levels to indicate potential impairment, the Company estimates the future cash flows expected to be generated from the use of the asset and its eventual disposal. If the sum of undiscounted future cash flows is less than the carrying amount of the asset, an impairment loss is recognized. The impairment loss is measured by comparing the fair value of the asset to its carrying amount. Fair value is typically determined to be the value of the land since drive-in buildings and improvements are single-purpose assets and have little value to market participants. The equipment associated with a drive-in can be easily relocated to another drive-in and therefore is not adjusted.
Surplus property assets are carried at the lower of depreciated cost or fair value less cost to sell. The majority of the value in surplus property is land. Fair values are estimated based upon management’s assessment as well as independent market value assessments of the assets’ estimated sales values.
Goodwill and Other Intangible Assets
Goodwill is determined based on an acquisition purchase price in excess of the fair value of identified assets. Intangible assets with lives restricted by contractual, legal or other means are amortized over their useful lives. The Company tests goodwill at least annually for impairment using the fair value approach on a reporting unit basis.
Since the Company is
one
reporting unit, potential goodwill impairment is evaluated 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 quarters of fiscal years
2018
and
2017
, the annual assessment of the recoverability of goodwill was performed, and
no
impairment was indicated.
The Company’s intangible assets subject to amortization consist primarily of acquired franchise agreements and other intangibles. Amortization expense is calculated using the straight-line method over the asset’s expected useful life. See note 4 - Goodwill and Other Intangibles for additional related disclosures.
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
Refranchising
and Closure of Company Drive-Ins
Gains and losses from the sale or closure of Company Drive-Ins are recorded as other operating (income) expense, net on the consolidated statements of income.
Revenue Recognition, Franchise Fees and Royalties
Revenue from Company Drive-In sales is recognized when food and beverage products are sold. Company Drive-In sales are presented net of sales tax and other sales-related taxes.
The Company’s gift card program serves all Sonic Drive-Ins and is administered by the Company on behalf of a system advertising fund. The Company records a liability in the period in which a gift card is sold. The gift cards do not have expiration dates. As gift cards are redeemed, the liability is reduced with revenue recognized on redemptions at Company Drive-Ins. Breakage is the amount on a gift card that is not expected to be redeemed and that the Company is not required to remit to a state under unclaimed property laws. The Company estimates breakage based upon the historical trend in redemption patterns from previously sold gift cards. The Company’s policy is to recognize the breakage, using the delayed recognition method, when it is apparent that there is a remote likelihood the gift card balance will be redeemed. The Company reduces the gift card liability for the estimated breakage and uses that amount to defray the costs of operating the gift card program. There is no income recognized on unredeemed gift card balances. Costs to administer the gift card program, net of breakage, are included in the receivables from system funds as set forth in note 3 – Accounts and Notes Receivable. Such costs were not material in fiscal years
2018
,
2017
or
2016
.
Franchise fees are recognized in income when the Company has substantially performed or satisfied all material services or conditions relating to the sale of the franchise, and the fees are generally nonrefundable. Development fees are generally 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 the Company and the franchisee.
The Company’s franchisees pay royalties based on a percentage of sales. Royalties are recognized as revenue when they are earned.
Advertising Costs
Costs incurred in connection with advertising and promoting the Company’s products are included in other operating expenses and are expensed as incurred. Such costs amounted to
$12.6 million
,
$15.8 million
and
$23.4 million
in fiscal years
2018
,
2017
and
2016
, respectively.
Under the Company’s franchise agreements, both Company Drive-Ins and Franchise Drive-Ins must contribute a minimum percentage of revenues to the Sonic Brand Fund, a national media production fund, and spend an additional minimum percentage of revenues on advertising, either directly or through Company-required participation in advertising cooperatives. A significant portion of the advertising cooperative contributions is remitted to the System Marketing Fund, which purchases advertising on national cable and broadcast networks and local broadcast networks and also funds other national media expenses and sponsorship opportunities. As stated in the terms of existing franchise agreements, these funds do not constitute assets of the Company, and the Company acts with limited agency in the administration of these funds. Accordingly, neither the revenues and expenses nor the assets and liabilities of the advertising cooperatives, the Sonic Brand Fund or the System Marketing Fund are included in the Company’s consolidated financial statements. However, all advertising contributions by Company Drive-Ins are recorded as an expense on the Company’s financial statements.
Under the Company’s franchise agreements, the Company is reimbursed by the Sonic Brand Fund for costs incurred to administer the fund at an amount not to exceed
15%
of the Sonic Brand Fund’s gross receipts. Reimbursements from the Sonic Brand Fund are offset against selling, general and administrative expenses and totaled
$5.1 million
,
$5.1 million
and
$5.2 million
in fiscal years
2018
,
2017
and
2016
, respectively.
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
Technology Costs
Under the Company’s franchise agreements, both Company Drive-Ins and Franchise Drive-Ins must pay a set technology fee to the Brand Technology Fund (“BTF”), which was established in the third quarter of fiscal year 2016. The BTF administers cybersecurity and other technology programs for the Sonic system. As stated in the terms of existing franchise agreements, these funds do not constitute assets of the Company, and the Company acts with limited agency in the administration of these funds. Accordingly, neither the revenues
and expenses nor the assets and liabilities of the BTF are included in the Company’s consolidated financial statements. However, technology fees paid by Company Drive-Ins are recorded as an expense on the Company’s financial statements.
Under the Company’s franchise agreements, the Company is reimbursed by the BTF for costs incurred to administer the fund at an amount not to exceed
15%
of the BTF’s gross receipts. Reimbursements from the BTF are offset against selling, general and administrative expenses and totaled
$6.0 million
,
$5.4 million
and
$2.5 million
in fiscal years
2018
,
2017
and
2016
, respectively.
Operating Leases
Rent expense 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 the Company would incur an economic penalty for not exercising the options. Within the terms of some of the leases, there are rent holidays and/or escalations in payments over the base lease term, as well as renewal periods. The effects of the holidays and escalations have been reflected in rent expense on a straight-line basis over the expected lease term, which includes cancelable option periods when appropriate. The lease term commences on the date when the Company has the right to control the use of the leased 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 it is probable that such sales levels will be achieved.
Stock-Based Compensation
The Company
grants
incentive
stock options (“ISOs”),
non-qualified stock options
(“NQs”) and
restricted stock units (“RSUs”). For grants of
NQs
and RSUs, the Company expects to recognize a tax benefit upon exercise of the option or vesting of the RSU. As a result, a
tax benefit is recognized on the related stock-based compensation expense
for these types of awards. For grants of
ISOs, a tax benefit only results if the option holder has a disqualifying disposition. As a result of the limitation on the tax benefit for
ISOs, the tax benefit for stock-based compensation will generally be less than the Company’s overall tax rate and will vary depending on the timing of employees’ exercises and sales of stock.
Stock-based compensation is measured at the grant date based on the calculated fair value of the award and is recognized as an expense on a straight-line basis over the requisite service period of the award,
generally the vesting period of the grant. For additional information on stock-based compensation,
see note 13
- Stockholders’ Equity
(Deficit).
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in income in the period that includes the enactment date.
During the first quarter of fiscal year 2017, the Company early adopted ASU No. 2016-09, “Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting,” which required the Company to recognize excess tax benefits related to share-based payments in the provision for income taxes in the consolidated statements of income. Prior to adoption, the Company recorded these excess tax benefits in additional paid-in capital. These benefits are principally generated from employee exercises of NQs, the vesting of RSUs and disqualifying dispositions of ISOs.
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
The threshold for recognizing the financial statement effects of a tax position is when it is more likely than not, based on the technical merits, that the position will be sustained upon examination by a taxing authority. Recognized tax positions are initially and subsequently measured as the largest amount of tax benefit that is more likely than not to be realized upon ultimate settlement with a taxing authority. Interest and penalties related to unrecognized tax benefits are included in income tax expense.
Additional information regarding the Company’s unrecognized tax benefits is provided in note 12 - Income Taxes.
Fair Value Measurements
The Company’s financial assets and liabilities consist of cash and cash equivalents, accounts and notes receivable, accounts payable and long-term debt. The fair value of cash and cash equivalents, accounts receivable and accounts payable approximates their carrying amounts due to the short-term nature of these assets and liabilities.
The following methods and assumptions were used by the Company in estimating fair values of its financial instruments:
|
|
|
|
•
|
Notes receivable
- As of
August 31, 2018
and
2017
, the carrying amounts of notes receivable (both current and non-current) approximate fair value due to the effect of the related allowance for doubtful accounts.
|
|
|
|
|
•
|
Long-term debt
- The Company prepares a discounted cash flow analysis for its fixed and variable rate borrowings to estimate fair value each quarter. This analysis uses Level 2 inputs from market information available for public debt transactions for companies with ratings that are similar to the Company’s ratings and from information gathered from brokers who trade in the Company’s notes. The fair value estimate required significant assumptions by management. Management believes this fair value is a reasonable estimate. For more information regarding the Company’s long-term debt, see note 10 - Debt and note 11 - Fair Value of Financial Instruments.
|
Certain nonfinancial assets and liabilities are measured at fair value on a nonrecurring basis, which means these assets and liabilities are not measured at fair value on an ongoing basis but are subject to periodic impairment tests. For the Company, these items primarily include long-lived assets, goodwill and other intangible assets. Refer to sections “Accounting for Long-Lived Assets”
and “Goodwill and Other Intangible Assets,” discussed above, for inputs and valuation techniques used to measure the fair value of these nonfinancial assets. The fair value was based upon management’s assessment as well as independent market value assessments which involved Level 2 and Level 3 inputs.
New Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers,” which requires an entity to recognize revenue in an amount that reflects the consideration to which the entity expects to be entitled for the transfer of promised goods or services to customers. The standard also requires additional disclosure regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The FASB has issued clarifying guidance concerning principal versus agent considerations, identifying performance obligations and licensing and corrections or improvements to issues that affect narrow aspects of the guidance. In August 2015, the FASB issued ASU 2015-14 delaying the effective date of adoption. These updates are now effective for annual and interim periods for fiscal years beginning after December 15, 2017, which will require us to adopt these provisions in the first quarter of fiscal 2019. The standards are to be applied retrospectively to each prior period presented or using a modified retrospective transition method.
As a result of our evaluation of the Company’s revenue streams, we do not believe the new revenue recognition standards will impact the Company’s two largest sources of revenue: the recognition of sales from Company Drive-Ins and the recognition of royalty fees from franchisees that are based on a percentage of franchise sales. The standards are also not anticipated to have a material impact to the recognition of gift card breakage. Additionally, the standards will not impact the accounting for Company’s contributions and expenses to its advertising funds. Neither the revenues and expenses nor the assets and liabilities of the advertising funds are included in the Company’s consolidated financial statements and as such, are not included in the scope of the revenue standards.
The new revenue recognition standards will impact the recognition of the initial franchise fee. Under existing guidance, the initial franchise fee is recognized as revenue when the Company has substantially performed or satisfied all material services or
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
conditions relating to the sale of the franchise, which is typically upon the opening of a Franchise Drive-In. Under the new standards, the services provided relating to the sale of the franchise do not constitute a separate and distinct performance obligation from the ongoing franchise right and, as such, the initial franchise fees will be deferred and recognized as revenue over the term of each franchise agreement. The standards require any unamortized portion of the initial franchise fee be presented in the consolidated balance sheets as a deferred revenue liability. The impact of the amortization of these fees is not expected to be material to total revenue or net income.
The standards will impact the Company’s recording of administrative fees received from the Sonic Brand Fund and Brand Technology Fund. The Company currently records the administrative fees from the funds as a reduction to administrative expenses within selling, general, and administrative expenses. Upon adoption of the standards, the Company will recognize the administrative fees from the funds on a gross basis within revenues in the consolidated statements of income, and the related administrative expenses will continue to be reported within selling, general, and administrative expenses.
The Company continues to evaluate the effect the standards will have on related disclosures. Further, the Company is currently implementing internal controls related to the recognition and presentation of revenues under the standards.
The Company will adopt the standards using the modified retrospective transition method effective September 1, 2018, which aligns with the required adoption date. Upon adoption, the Company expects to record a cumulative adjustment before income tax effects of approximately
$17.4 million
to total liabilities in the consolidated balance sheets, with an offsetting adjustment within total stockholder's deficit, primarily related to unearned initial franchise fees for franchise agreements entered into prior to adoption.
In February 2016, the FASB issued ASU No. 2016-02, “Leases.” The new standard, which replaces existing lease guidance, requires lessees to recognize on the balance sheet a liability to make lease payments and a corresponding right-of-use asset. The guidance also requires certain qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. Accounting guidance for lessors is largely unchanged. In January 2018, the FASB issued ASU No. 2018-01 which permits an entity to elect an optional transition practical expedient to forgo the evaluation of land easements that existed or expired before the entity’s adoption of 2016-02 and that were not accounted for as leases under previous lease guidance. Further improvements have been issued in ASUs 2018-10 and 2018-11. The standard is effective for fiscal year 2020, with early application permitted. This standard requires adoption based upon a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with optional practical expedients. Based on a preliminary assessment, the Company expects that most of its operating lease commitments will be subject to the new guidance and recognized as operating lease liabilities and right-of-use assets upon adoption, resulting in a significant increase in the assets and liabilities on the consolidated balance sheets. The Company is continuing its assessment, which may identify additional impacts this standard will have on its consolidated financial statements and related disclosures.
In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses.” The update was issued to provide more decision-useful information about the expected credit losses on financial instruments. The update replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The update is effective for fiscal year 2021, with early adoption permitted for fiscal years beginning after December 15, 2018. The update should be adopted using a modified-retrospective approach. The Company is currently evaluating the effect this update will have on its financial statements and related disclosures.
In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments.” The update is intended to reduce diversity in practice in how certain transactions are classified and will make eight targeted changes to how cash receipts and cash payments are presented in the statement of cash flows. The update is effective for fiscal year 2019. The new standard will require adoption on a retrospective basis unless it is impracticable to apply, in which case the amendments will apply prospectively as of the earliest date practicable. The Company does not expect a material impact on its financial statements and related disclosures.
In October 2016, the FASB issued ASU No. 2016-16, “Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory,” as part of its simplification initiatives. The update requires that an entity recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than deferring the recognition until the asset has
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
been sold to an outside party as is required under current GAAP. The update is effective for fiscal year 2019. The new standard will require adoption on a modified retrospective basis through a cumulative-effect adjustment to retained earnings, and early adoption is permitted. The Company does not expect a material impact on its financial statements and related disclosures.
In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows - Restricted Cash.” The update requires that restricted cash balances be included in the beginning and ending cash balance within the statement of cash flows. The update is effective for fiscal year 2019. The amendments should be adopted on a retrospective basis for each period presented, and early adoption is permitted. The adoption will increase the beginning and ending cash balance within the Company's statement of cash flows by its restricted cash balances and will require a new disclosure to reconcile the cash balances within the statement of cash flows to the balance sheets. The Company does not expect any other material impacts to its financial statements.
In May 2017, the FASB issued ASU No. 2017-09, “Compensation - Stock Compensation: Scope of Modification Accounting,” which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. An entity will account for the effects of a modification unless the fair value of the modified award is the same as the original award, the vesting conditions of the modified award are the same as the original award and the classification of the modified award as an equity instrument or liability instrument is the same as the original award. The update is effective for fiscal year 2019. The update is to be adopted prospectively to an award modified on or after the adoption date. Early adoption is permitted. The Company does not expect a material impact on its financial statements and related disclosures.
In August 2018, the FASB issued ASU No. 2018-15, "Intangibles—Goodwill and Other—Internal-Use Software Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract." The amendments in the update align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The update is effective for fiscal year 2021 and is to be applied either retrospectively or prospectively to all implementation costs incurred after the adoption date. Early adoption is permitted. The Company is currently evaluating the effect of this update but does not believe it will have a material impact on its financial statements and related disclosures.
The Company has reviewed all other recently issued accounting pronouncements and concluded they are not applicable or not expected to be significant to our operations.
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
2. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal year ended August 31,
|
|
|
|
2018
|
|
2017
|
|
2016
|
|
Numerator:
|
|
|
|
|
|
|
|
Net income
|
|
$
|
71,205
|
|
|
$
|
63,663
|
|
|
$
|
64,067
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding– basic
|
|
37,618
|
|
|
43,306
|
|
|
48,703
|
|
|
Effect of dilutive employee stock options and unvested RSUs
|
|
468
|
|
|
737
|
|
|
966
|
|
|
Weighted average common shares outstanding – diluted
|
|
38,086
|
|
|
44,043
|
|
|
49,669
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per common share – basic
|
|
$
|
1.89
|
|
|
$
|
1.47
|
|
|
$
|
1.32
|
|
|
Net income per common share – diluted
|
|
$
|
1.87
|
|
|
$
|
1.45
|
|
|
$
|
1.29
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Anti-dilutive securities excluded
(1)
|
|
1,157
|
|
|
1,154
|
|
|
615
|
|
_______________
|
|
|
|
(1)
|
Anti-dilutive securities consist of stock options and unvested RSUs that were not included in the computation of diluted earnings per share because either the exercise price of the options was greater than the average market price of the common stock or the total assumed proceeds under the treasury stock method resulted in negative incremental shares, and thus the inclusion would have been anti-dilutive.
|
3.
Accounts and Notes Receivable
Accounts and notes receivable consist of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
August 31,
|
|
|
|
2018
|
|
2017
|
|
Current Accounts and Notes Receivable:
|
|
|
|
|
|
Royalties and other trade receivables
|
|
$
|
20,177
|
|
|
$
|
19,571
|
|
|
Notes receivable from franchisees
|
|
2,006
|
|
|
1,441
|
|
|
Receivables from system funds
|
|
2,480
|
|
|
6,360
|
|
|
Other
|
|
11,080
|
|
|
7,475
|
|
|
Accounts and notes receivable, gross
|
|
35,743
|
|
|
34,847
|
|
|
Allowance for doubtful accounts and notes receivable
|
|
(776
|
)
|
|
(1,089
|
)
|
|
Current accounts and notes receivable, net
|
|
$
|
34,967
|
|
|
$
|
33,758
|
|
|
|
|
|
|
|
|
|
|
Noncurrent Notes Receivable:
|
|
|
|
|
|
|
|
Receivables from franchisees
|
|
$
|
7,597
|
|
|
$
|
6,810
|
|
|
Receivables from system funds
|
|
5,143
|
|
|
3,033
|
|
|
Allowance for doubtful notes receivable
|
|
(1,808
|
)
|
|
(42
|
)
|
|
Noncurrent notes receivable, net
|
|
$
|
10,932
|
|
|
$
|
9,801
|
|
The Company’s receivables are primarily due from franchisees, all of whom are in the restaurant business. Substantially all of the notes receivable from franchisees are collateralized by real estate or equipment. The receivables from system funds represent transactions in the normal course of business.
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
4. Goodwill and Other Intangibles
As of
August 31, 2018
, the Company had
$75.3 million
of goodwill.
The changes in the carrying amount of goodwill were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
August 31,
|
|
|
|
2018
|
|
2017
|
|
Balance at beginning of year
|
|
$
|
75,756
|
|
|
$
|
76,734
|
|
|
Goodwill disposed of related to the sale of Company Drive-Ins
|
|
(412
|
)
|
|
(978
|
)
|
|
Balance at end of year
|
|
$
|
75,344
|
|
|
$
|
75,756
|
|
The gross carrying amount of franchise agreements, intellectual property, franchise fees and other intangibles subject to amortization was
$5.9 million
and
$9.3 million
at
August 31, 2018
and
2017
, respectively. Accumulated amortization related to these intangible assets was
$3.4 million
and
$6.6 million
at
August 31, 2018
and
2017
, respectively. Intangible assets amortization expense was
$0.3 million
,
$1.0 million
and
$0.9 million
for fiscal years ended
August 31, 2018
,
2017
and
2016
, respectively. At
August 31, 2018
, the remaining weighted-average life of amortizable intangible assets was approximately
10.7 years
. Estimated intangible assets amortization expense is
$0.3 million
annually for fiscal years
2019
,
2020
,
2021
and
2022
and
$0.2 million
for fiscal year
2023
.
|
|
|
|
5.
|
Other Operating Income
|
During the first quarter of fiscal year 2017, the Company recorded a gain of
$3.8 million
on the sale of minority investments in franchise operations retained as part of a refranchising transaction that occurred in fiscal year 2009. The Company also recorded
$6.8 million
in refranchising initiative gains as described below in note 6 - Refranchising of Company Drive-Ins. During the fourth quarter of fiscal year 2017, the Company recorded a gain of
$4.7 million
on the sale of real estate. In addition, the Company recorded offsetting severance costs of
$1.8 million
related to the elimination of certain corporate positions.
During the third quarter of fiscal year 2018, the Company recorded a gain on refranchised drive-ins of
$3.2 million
, further described below in note 6 - Refranchising of Company Drive-Ins.
6.
Refranchising of Company Drive-Ins
In June 2016, the Company announced plans to refranchise Company Drive-Ins as part of an initiative to move toward an approximately
95%
‑franchised system. During fiscal year 2016, the Company refranchised the operations of
29
Company Drive-Ins and retained a non-controlling minority investment in the franchise operations of
25
of these refranchised drive-ins.
The Company completed the previously announced refranchising initiative during fiscal year 2017. During the first six months of fiscal year 2017,
110
Company Drive-Ins were refranchised and the Company
retained a non-controlling minority investment in
106
of the franchise operations.
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
The following is a summary of the pretax activity recorded as a result of the refranchising initiative (in thousands, except number of refranchised Company Drive-Ins):
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal year ended August 31,
|
|
|
2017
|
|
2016
|
|
Number of refranchised Company Drive-Ins
|
110
|
|
|
29
|
|
|
|
|
|
|
|
Proceeds from sales of Company Drive-Ins
|
$
|
20,036
|
|
|
$
|
3,568
|
|
|
Proceeds from sale of real estate
(1)
|
11,726
|
|
|
—
|
|
|
|
|
|
|
|
Real estate assets sold
(1)
|
(12,095
|
)
|
|
(2,402
|
)
|
|
Assets sold, net of retained minority investment
(2)
|
(7,891
|
)
|
|
—
|
|
|
Initial and subsequent lease payments for real estate option
(1)
|
(3,178
|
)
|
|
—
|
|
|
Goodwill related to sales of Company Drive-Ins
|
(966
|
)
|
|
(194
|
)
|
|
Deferred gain for real estate option
(3)
|
(809
|
)
|
|
—
|
|
|
Loss on assets held for sale
|
(65
|
)
|
|
—
|
|
|
Refranchising initiative gains, net
|
$
|
6,758
|
|
|
$
|
972
|
|
_______________
|
|
|
|
(1)
|
During the first quarter of fiscal year 2017, as part of a
53
drive-in refranchising transaction, a portion of the proceeds was applied as the initial payment for an option to purchase the real estate within the next
24
months. The franchisee exercised the option in the last six months of the fiscal year. Until the option was fully exercised, the franchisee made monthly lease payments which are included in other operating income, net of sub-lease expense.
|
|
|
|
|
(2)
|
Net assets sold consisted primarily of equipment.
|
|
|
|
|
(3)
|
The deferred gain of
$0.8 million
is recorded in other non-current liabilities as a result of a real estate purchase option extended to the franchisee in the second quarter of fiscal year 2017. The deferred gain will continue to be amortized into income through January 2020 when the option becomes exercisable.
|
During fiscal year 2018, the Company recognized a net gain of
$3.2 million
related to the refranchised operations of
41
drive-ins and retained a non-controlling minority investment in the franchise operations. These transactions represent additional markets identified after completion of the refranchising initiative in fiscal year 2017 and bring the Company to a
95%
franchised system.
In addition to the refranchised drive-ins discussed above in which the Company retained a non-controlling minority investment in the operations, the Company also refranchised the operations of
eight
drive-ins during fiscal year 2018,
five
during fiscal year 2017 and
nine
during fiscal year 2016. These refranchising transactions all occurred in the normal course of business and did not result in any retained interests.
Income from minority investments is included in other revenue on the consolidated statements of income. The gains and losses related to refranchised drive-ins are recorded in other operating income, net, on the consolidated statement of income.
7.
Leases
Leasing Arrangements as a Lessor
The Company’s leasing activities consist principally of leasing certain land and buildings as well as subleasing certain buildings to franchise operators. The land and building portions for the majority of these leases are classified as operating leases and have lease terms expiring through
May 2037
. The leases classified as direct financing leases are related to owned and subleased properties that were refranchised in fiscal year 2017 (see note 6 - Refranchising of Company Drive-Ins). The terms of these leases expire through
September 2031
. These leases include provisions for contingent rentals that may be received on the basis of a percentage of sales in excess of stipulated amounts. Income is not recognized on contingent rentals until sales exceed the stipulated amounts. Some leases contain escalation clauses over the lives of the leases. For property owned by third parties, the lease term runs concurrently with the term of the third-party lease arrangement. Most of the leases contain renewal option periods of
five years
at the end of the initial term.
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
Components of net investment in direct financing leases are as follows at August 31:
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|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
Minimum lease payments receivable
|
|
$
|
17,068
|
|
|
$
|
18,156
|
|
|
Less unearned income
|
|
(5,217
|
)
|
|
(5,932
|
)
|
|
Net investment in direct financing leases
|
|
11,851
|
|
|
12,224
|
|
|
Less amount due within one year
|
|
(460
|
)
|
|
(371
|
)
|
|
Amount due after one year
|
|
$
|
11,391
|
|
|
$
|
11,853
|
|
Initial direct costs incurred in the negotiation and consummation of direct financing lease transactions have not been material. Accordingly, no portion of unearned income has been recognized to offset those costs.
Future minimum rental payments receivable as of
August 31, 2018
, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
|
|
Direct Financing
|
|
Years ended August 31:
|
|
|
|
|
|
2019
|
|
$
|
7,124
|
|
|
$
|
1,156
|
|
|
2020
|
|
7,544
|
|
|
1,269
|
|
|
2021
|
|
7,787
|
|
|
1,365
|
|
|
2022
|
|
7,804
|
|
|
1,362
|
|
|
2023
|
|
7,884
|
|
|
1,362
|
|
|
Thereafter
|
|
60,331
|
|
|
10,554
|
|
|
|
|
$
|
98,474
|
|
|
$
|
17,068
|
|
|
Less unearned income
|
|
|
|
$
|
(5,217
|
)
|
|
|
|
|
|
$
|
11,851
|
|
Leasing Arrangements as a Lessee
Certain Company Drive-Ins lease land and buildings from third parties. These leases, with lease terms expiring through
January 2037
, include provisions for contingent rents that may be paid on the basis of a percentage of sales in excess of stipulated amounts. For the majority of leases, the land portions are classified as operating leases, and the building portions are classified as capital leases.
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
Future minimum lease payments on operating and capital leases as of
August 31, 2018
, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
|
|
Capital
|
|
Years ended August 31:
|
|
|
|
|
|
2019
|
|
$
|
8,198
|
|
|
$
|
3,489
|
|
|
2020
|
|
8,173
|
|
|
3,194
|
|
|
2021
|
|
7,536
|
|
|
3,109
|
|
|
2022
|
|
6,393
|
|
|
2,597
|
|
|
2023
|
|
6,437
|
|
|
2,415
|
|
|
Thereafter
|
|
44,017
|
|
|
4,541
|
|
|
Total minimum lease payments
(1)
|
|
$
|
80,754
|
|
|
19,345
|
|
|
Less amount representing interest averaging 5.4%
|
|
|
|
(3,888
|
)
|
|
Present value of net minimum lease payments
|
|
|
|
15,457
|
|
|
Less amount due within one year
|
|
|
|
(2,454
|
)
|
|
Amount due after one year
|
|
|
|
$
|
13,003
|
|
_______________
|
|
|
|
(1)
|
Minimum payments have not been reduced by future minimum rentals receivable under noncancellable operating and capital subleases of
$25.9 million
and
$1.3 million
, respectively. They also do not include contingent rentals which may be due under certain leases. Contingent rentals for capital leases amounted to
$0.2 million
,
$0.3 million
and
$0.9 million
in fiscal years
2018
,
2017
and
2016
, respectively.
|
Total rent expense for all operating leases consists of the following for the years ended August 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
|
Minimum rentals
|
|
$
|
8,039
|
|
|
$
|
11,224
|
|
|
$
|
12,441
|
|
|
Contingent rentals
|
|
140
|
|
|
283
|
|
|
284
|
|
|
Total rent expense
|
|
8,179
|
|
|
11,507
|
|
|
12,725
|
|
|
Less sublease rentals
|
|
(3,464
|
)
|
|
(2,513
|
)
|
|
(2,372
|
)
|
|
Net rent expense
|
|
$
|
4,715
|
|
|
$
|
8,994
|
|
|
$
|
10,353
|
|
8.
Property, Equipment and Capital Leases
Property, equipment and capital leases consist of the following at August 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated
Useful Life
|
|
2018
|
|
2017
|
|
Property, equipment and capital leases:
|
|
|
|
|
|
|
|
Land
|
|
|
|
$
|
120,352
|
|
|
$
|
117,402
|
|
|
Buildings and improvements
|
|
8 – 25 yrs
|
|
243,434
|
|
|
251,695
|
|
|
Drive-In equipment
|
|
5 – 7 yrs
|
|
62,679
|
|
|
75,410
|
|
|
Brand technology development and other equipment
|
|
2 – 5 yrs
|
|
133,020
|
|
|
126,179
|
|
|
Property and equipment, at cost
|
|
|
|
559,485
|
|
|
570,686
|
|
|
Accumulated depreciation
|
|
|
|
(271,940
|
)
|
|
(272,233
|
)
|
|
Property and equipment, net
|
|
|
|
287,545
|
|
|
298,453
|
|
|
|
|
|
|
|
|
|
|
Capital leases
|
|
Life of lease
|
|
39,204
|
|
|
45,315
|
|
|
Accumulated amortization
|
|
|
|
(28,527
|
)
|
|
(31,388
|
)
|
|
Capital leases, net
|
|
|
|
10,677
|
|
|
13,927
|
|
|
Property, equipment and capital leases, net
|
|
|
|
$
|
298,222
|
|
|
$
|
312,380
|
|
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
Depreciation expense for property and equipment was
$35.3 million
,
$35.6 million
and
$40.4 million
for fiscal years
2018
,
2017
and
2016
, respectively. Land, buildings and equipment with a carrying amount of
$155.5 million
and
$110.8 million
at
August 31, 2018
and August 31, 2017, respectively, were leased under operating leases to franchisees and other parties. The accumulated depreciation related to these buildings and equipment was
$63.2 million
and
$45.0 million
at
August 31, 2018
and August 31, 2017, respectively. Amortization expense related to capital leases is included within depreciation and amortization on the consolidated statements of income. As of
August 31, 2018
, the Company had
two
drive-ins under construction with costs to complete.
Interest incurred in connection with the construction of new drive-ins and technology projects is capitalized. Capitalized interest was
$0.4 million
,
$0.6 million
and
$0.6 million
for fiscal years
2018
,
2017
and
2016
, respectively.
9. Accrued Liabilities
Accrued liabilities consist of the following at August 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
Wages and employee benefit costs
|
|
$
|
16,338
|
|
|
$
|
17,705
|
|
|
Property taxes, sales and use taxes and employment taxes
|
|
4,677
|
|
|
5,634
|
|
|
Unredeemed gift cards
|
|
13,184
|
|
|
11,319
|
|
|
Other
|
|
10,115
|
|
|
10,188
|
|
|
|
|
$
|
44,314
|
|
|
$
|
44,846
|
|
10.
Debt
Long-term debt consists of the following at August 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
Class A-2 2018-1 senior secured fixed rate notes
|
|
$
|
170,000
|
|
|
$
|
—
|
|
|
Class A-2 2016-1 senior secured fixed rate notes
|
|
399,911
|
|
|
422,521
|
|
|
Class A-1 2016-1 senior secured variable funding notes
|
|
—
|
|
|
60,000
|
|
|
Class A-2 2013-1 senior secured fixed rate notes
|
|
147,485
|
|
|
155,000
|
|
|
|
|
717,396
|
|
|
637,521
|
|
|
Less unamortized debt issuance costs
|
|
(11,668
|
)
|
|
(9,405
|
)
|
|
Less long-term debt due within one year
|
|
(4,250
|
)
|
|
—
|
|
|
Long-term debt, net
|
|
$
|
701,478
|
|
|
$
|
628,116
|
|
At
August 31, 2018
, future maturities of long-term debt were
$4.3 million
for fiscal year
2019
,
$151.7 million
for fiscal year
2020
,
$4.3 million
for fiscal year
2021
,
$4.3 million
for fiscal year
2022
and
$382.9 million
for fiscal year
2023
. This includes principal payments on the Series 2016-1 Senior Secured Fixed Rate Notes, Class A-2 (the “2016 Fixed Rate Notes”) as a result of an amortization requirement based on a leverage ratio calculation.
During fiscal year 2013, in a private transaction, various subsidiaries of the Company (the “Co-Issuers”) refinanced and paid
$155.0 million
of the Series 2011-1 Senior Secured Fixed Rate Notes, Class A-2 (the “2011 Fixed Rate Notes”) with the issuance of
$155.0 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, no scheduled principal amortization and an anticipated repayment date in
July 2020
.
On May 17, 2016, in a private transaction, the Co-Issuers issued
$425.0 million
of 2016 Fixed Rate Notes, which bear interest at
4.47%
per annum. The 2016 Fixed Rate Notes have an expected life of
seven years
with an anticipated repayment date in
May 2023
.
The Co-Issuers also entered into a securitized financing facility of Series 2016-1 Senior Secured Variable Funding Notes, Class A-1 (the “2016 Variable Funding Notes” and, together with the 2016 Fixed Rate Notes, the “2016 Notes”) to replace the Series
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
2011-1 Senior Secured Variable Funding Notes, Class A-1 (the “2011 Variable Funding Notes”). The 2016 revolving credit facility provided access to a maximum of
$150.0 million
of 2016 Variable Funding Notes and certain other credit instruments, including letters of credit. Interest on the 2016 Variable Funding Notes is based on the one-month London Interbank Offered Rate or Commercial Paper, depending on the funding source, plus
2.0%
, per annum. An annual commitment fee of
0.5%
is payable monthly on the unused portion of the 2016 Variable Funding Notes facility. The 2016 Variable Funding Notes have an expected life of
five years
with an anticipated repayment date in
May 2021
with
two
one
-year extension options available upon certain conditions including meeting a minimum debt service coverage ratio threshold.
Sonic used a portion of the net proceeds from the issuance of the 2016 Fixed Rate Notes to repay its existing 2011 Fixed Rate Notes and 2011 Variable Funding Notes in full and to pay the costs associated with the securitized financing transaction, including prepayment premiums.
Loan origination costs associated with the Company’s 2016 transaction totaled
$12.5 million
and were allocated among the 2016 Notes. In connection with the 2016 transaction described above, the Company recognized an
$8.8 million
loss from the early extinguishment of debt during the third quarter of fiscal year 2016, which primarily consisted of a
$5.9 million
prepayment premium and the
$2.9 million
write-off of unamortized deferred loan fees remaining from the refinanced debt. This is reflected in loss from debt transactions on the consolidated statements of income.
During the second quarter of fiscal year 2018, the Company made a pro rata prepayment of
$28.0 million
on its 2013 Fixed Rate Notes and 2016 Fixed Rate Notes. The prepayment was made at par, as allowed under the note terms.
On February 1, 2018, the Co-Issuers issued
$170.0 million
of Series 2018-1 Senior Secured Fixed Rate Notes, Class A-2 (the "2018 Fixed Rate Notes" and together with the 2016 Fixed Rate Notes and 2013 Fixed Rate Notes, the “Fixed Rate Notes”) in a private transaction which bears interest at
4.03%
per annum. The 2018 Fixed Rate Notes have an expected life of
seven
years with an anticipated repayment date in
February 2025
.
Sonic used a portion of the net proceeds from the issuance of the 2018 Fixed Rate Notes to pay down the outstanding portion of the 2016 Variable Funding Notes and to pay the costs associated with the securitized financing transaction. In conjunction with the issuance of the 2018 Fixed Rate Notes, the commitments under the 2016 Variable Funding Notes were reduced to
$100.0 million
.
Loan origination costs associated with the Company’s 2018 Fixed Rate Notes totaled
$5.0 million
. Loan costs are amortized over each note’s expected life, and the unamortized balance related to the 2016 Variable Funding Notes and the Fixed Rate Notes is included in debt origination costs, net and long-term debt, net, respectively, on the consolidated balance sheets.
In connection with the 2018 transactions described above, the Company recognized a
$1.3 million
loss during the second quarter of fiscal year 2018. The loss consisted of a
$0.7 million
write-off of unamortized deferred debt origination costs related to the reduction of the 2016 Variable Funding Notes commitments, as well as a
$0.4 million
write-off of unamortized deferred debt origination costs related to the prepayment on its 2013 Fixed Rate Notes and 2016 Fixed Rate Notes. Additionally, as required by the terms of the 2016 Fixed Rate Notes, the Company paid a
$0.2 million
prepayment premium.
As of
August 31, 2018
, the weighted-average interest cost of the 2013 Fixed Rate Notes, the 2016 Fixed Rate Notes and the 2018 Fixed Rate Notes was
4.1%
,
4.8%
and
4.4%
, respectively. The weighted-average interest cost includes the effect of the loan origination costs.
While the 2013 Fixed Rate Notes, the 2016 Fixed Rate Notes and the 2018 Fixed Rate Notes are structured to provide for
seven
-year lives from their original issuance dates, they have legal final maturity dates of
July 2043
,
May 2046
and
February 2048
, respectively. The 2016 Variable Funding Notes are structured to provide for a
five
-year life with
two
one
-year options available under certain conditions and with a legal final maturity date of
May 2046
. The Company intends to repay or refinance the 2013 Fixed Rate Notes, the 2018 Fixed Rate Notes and the 2016 Notes on or before the end of their expected lives. If the Company prepays the debt prior to the anticipated repayment date the Company may be required to pay a prepayment penalty under certain circumstances. In the event the 2013 Fixed Rate Notes, the 2018 Fixed Rate Notes and the 2016 Notes are not paid in full by the end of their expected lives, they are subject to an upward adjustment in the annual interest rate of at least
5%
. In addition, principal payments will accelerate by applying all of the royalties, lease revenues and other fees securing the
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
debt, after deducting certain expenses, until the debt is paid in full. Also, any unfunded amount under the 2016 Variable Funding Notes will become unavailable.
The Co-Issuers and Sonic Franchising LLC (the “Guarantor”) are existing special purpose, bankruptcy remote, indirect subsidiaries of Sonic Corp. that hold substantially all of Sonic's franchising assets and real estate. As of
August 31, 2018
, assets for these combined indirect subsidiaries totaled
$242.0 million
, including receivables for royalties, certain Company and Franchise Drive-In real estate, intangible assets and restricted cash balances of
$27.5 million
. The 2013 Fixed Rate Notes, the 2016 Notes and the 2018 Fixed Rate Notes are secured by franchise fees, royalty payments and lease payments, and the repayment of the 2013 Fixed Rate Notes, the 2016 Notes and the 2018 Fixed Rate Notes is expected to be made solely from the income derived from the Co-Issuer's assets. In addition, the Guarantor, a Sonic Corp. subsidiary that acts as a franchisor, has guaranteed the obligations of the Co-Issuers under the 2013 Fixed Rate Notes, 2018 Fixed Rate Notes and the 2016 Notes and pledged substantially all of its assets to secure those obligations.
Neither Sonic Corp., the ultimate parent of the Co-Issuers and the Guarantor, nor any other subsidiary of Sonic Corp., guarantees or is in any way liable for the obligations of the Co-Issuers under the 2013 Fixed Rate Notes, 2018 Fixed Rate Notes and the 2016 Notes. The Company has, however, agreed to cause the performance of certain obligations of its subsidiaries, principally related to managing the assets included as collateral for the 2013 Fixed Rate Notes, 2018 Fixed Rate Notes and the 2016 Notes and certain indemnity obligations relating to the transfer of the collateral assets to the Co-Issuers.
The 2013 Fixed Rate Notes, 2018 Fixed Rate Notes and the 2016 Notes are subject to a series of covenants and restrictions customary for transactions of this type, including (i) required actions to better secure collateral upon the occurrence of certain performance-related events, (ii) application of certain disposition proceeds as note prepayments after a set time is allowed for reinvestment, (iii) maintenance of specified reserve accounts, (iv) maintenance of certain debt service coverage ratios, (v) optional and mandatory prepayments upon change in control, (vi) indemnification payments for defective or ineffective collateral, and (vii) covenants relating to recordkeeping, access to information and similar matters. If certain covenants or restrictions are not met, the 2013 Fixed Rate Notes, 2018 Fixed Rate Notes and the 2016 Notes are subject to customary accelerated repayment events and events of default. Although management does not anticipate an event of default or any other event of noncompliance with the provisions of the debt, if such event occurred, the unpaid amounts outstanding could become immediately due and payable.
11.
Fair Value of Financial Instruments
The fair value of financial instruments is the amount at which the instrument could be exchanged in a current transaction between willing parties. The Company has no financial liabilities that are required to be measured at fair value on a recurring basis.
The Company categorizes its assets and liabilities recorded at fair value based upon the following fair value hierarchy established by the FASB:
|
|
|
|
•
|
Level 1 valuations use quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date. An active market is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
|
|
|
|
|
•
|
Level 2 valuations use inputs other than actively quoted market prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include: (a) quoted prices for similar assets or liabilities in active markets, (b) quoted prices for identical or similar assets or liabilities in markets that are not active, (c) inputs other than quoted prices that are observable for the asset or liability such as interest rates and yield curves observable at commonly quoted intervals and (d) inputs that are derived principally from or corroborated by observable market data by correlation or other means.
|
|
|
|
|
•
|
Level 3 valuations use unobservable inputs for the asset or liability. Unobservable inputs are used to the extent observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.
|
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
The Company’s cash equivalents are carried at cost which approximates fair value and totaled
$58.0 million
and
$73.9 million
at
August 31, 2018
and
2017
, respectively. This fair value is estimated using Level 1 methods.
The fair value of the Company’s 2013 Fixed Rate Notes, 2016 Fixed Rate Notes and 2018 Fixed Rate Notes approximated the carrying value, including accrued interest, of
$718.2 million
at
August 31, 2018
. The fair value of the Company’s 2013 Fixed Rate Notes and 2016 Fixed Rate Notes approximated the carrying value, including accrued interest, of
$578.2 million
at
August 31, 2017
. The 2016 Variable Funding Notes had
no
balance at
August 31, 2018
. The fair value of the Company's 2016 Variable Funding Notes approximated the carrying value, including accrued interest, of
$60.1 million
at
August 31, 2017
. The fair value of the 2013 Fixed Rate Notes, 2016 Notes and 2018 Fixed Rate Notes is estimated using Level 2 inputs from market information available for public debt transactions for companies with ratings that are similar to the Company’s ratings and from information gathered from brokers who trade in the Company’s notes.
12. Income Taxes
The Company’s income before the provision for income taxes is classified by source as domestic income.
The components of the provision for income taxes consist of the following for the years ended August 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
|
Current:
|
|
|
|
|
|
|
|
Federal
|
|
$
|
15,597
|
|
|
$
|
30,352
|
|
|
$
|
20,137
|
|
|
State
|
|
2,949
|
|
|
3,921
|
|
|
3,791
|
|
|
|
|
18,546
|
|
|
34,273
|
|
|
23,928
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
(16,460
|
)
|
|
(2,378
|
)
|
|
4,372
|
|
|
State
|
|
648
|
|
|
(91
|
)
|
|
137
|
|
|
|
|
(15,812
|
)
|
|
(2,469
|
)
|
|
4,509
|
|
|
Provision for income taxes
|
|
$
|
2,734
|
|
|
$
|
31,804
|
|
|
$
|
28,437
|
|
The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate due to the following for the fiscal years ended August 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
|
Amount computed by applying the statutory federal tax rate
|
|
25.7
|
%
|
|
35.0
|
%
|
|
35.0
|
%
|
|
State income taxes (net of federal income tax benefit)
|
|
3.8
|
|
|
2.6
|
|
|
2.8
|
|
|
Employment related and other tax credits, net
|
|
(1.8
|
)
|
|
(1.9
|
)
|
|
(2.5
|
)
|
|
Change in uncertain tax positions
|
|
0.2
|
|
|
—
|
|
|
(3.3
|
)
|
|
Federal tax benefit of statutory tax deduction
|
|
(1.3
|
)
|
|
(1.6
|
)
|
|
(1.4
|
)
|
|
Stock option excess tax benefit
|
|
(2.9
|
)
|
|
(1.0
|
)
|
|
—
|
|
|
Deferred tax revaluation
|
|
(19.1
|
)
|
|
—
|
|
|
—
|
|
|
Other
|
|
(0.9
|
)
|
|
0.2
|
|
|
0.1
|
|
|
Provision for income taxes
|
|
3.7
|
%
|
|
33.3
|
%
|
|
30.7
|
%
|
On December 22, 2017, the Tax Cuts and Job Act ("TCJA") was signed into law, significantly impacting several sections of the Internal Revenue Code. The most significant impacts on the Company for fiscal year 2018 include:
|
|
|
|
•
|
Effective January 1, 2018, the U.S. corporate federal statutory income tax rate was reduced from 35% to 21%. Because of our fiscal year end, the Company’s blended statutory federal tax rate is
25.7%
for fiscal year 2018 and 21% for fiscal year 2019 and thereafter.
|
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
|
|
|
|
•
|
The Company remeasured its existing deferred tax assets and liabilities at the rate the Company expected to be in effect when those deferred taxes would be realized (either 25.7% if in fiscal year 2018 or
21.0%
for fiscal year 2019 and thereafter). The Company recognized a discrete benefit from the deferred tax remeasurement of approximately
$14.1 million
in the second quarter of fiscal year 2018.
|
In December 2017, the Securities and Exchange Commission provided guidance allowing registrants to record provisional amounts, during a specified measurement period, when the necessary information is not available, prepared or analyzed in reasonable detail to account for the impact of the TCJA. Accordingly, during the second and third quarters of fiscal year 2018, we reported the revaluation of our deferred tax assets and liabilities based on provisional amounts. As of August 31, 2018, we have completed our analysis of the revaluation of our deferred tax assets and liabilities and have no material changes to the discrete benefit recognized in the second quarter of fiscal year 2018. We continue to assess the impacts of the TCJA on future fiscal years and monitor the Internal Revenue Service guidance intended to interpret the most complex provisions.
Deferred tax assets and liabilities consist of the following at August 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
Deferred tax assets:
|
|
|
|
|
|
Allowance for doubtful accounts and notes receivable
|
|
$
|
661
|
|
|
$
|
419
|
|
|
Leasing transactions
|
|
1,928
|
|
|
3,083
|
|
|
Deferred income
|
|
1,846
|
|
|
3,011
|
|
|
Accrued liabilities
|
|
2,292
|
|
|
4,339
|
|
|
Stock compensation
|
|
1,553
|
|
|
3,156
|
|
|
Other
|
|
59
|
|
|
929
|
|
|
State net operating losses
|
|
18,659
|
|
|
18,031
|
|
|
Total deferred tax assets
|
|
26,998
|
|
|
32,968
|
|
|
Valuation allowance
|
|
(17,117
|
)
|
|
(16,254
|
)
|
|
Total deferred tax assets after valuation allowance
|
|
$
|
9,881
|
|
|
$
|
16,714
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
Prepaid expenses
|
|
$
|
(798
|
)
|
|
$
|
(956
|
)
|
|
Investment in partnerships, including differences in capitalization,
|
|
|
|
|
|
|
depreciation and direct financing leases
|
|
(3,083
|
)
|
|
(4,026
|
)
|
|
Property, equipment and capital leases
|
|
(12,603
|
)
|
|
(23,756
|
)
|
|
Intangibles and other assets
|
|
(14,837
|
)
|
|
(22,983
|
)
|
|
Debt extinguishment
|
|
—
|
|
|
(838
|
)
|
|
Direct financing leases
|
|
(2,786
|
)
|
|
(4,256
|
)
|
|
Total deferred tax liabilities
|
|
(34,107
|
)
|
|
(56,815
|
)
|
|
Net deferred tax liabilities (noncurrent)
|
|
$
|
(24,226
|
)
|
|
$
|
(40,101
|
)
|
State net operating loss carryforwards expire beginning in
December 2018
through
May 2039
. Management does not believe the Company will be able to realize the state net operating loss carryforwards utilizing future income exclusive of the reversal of existing deferred tax liabilities and therefore has provided a valuation allowance of
$17.1 million
and
$16.3 million
as of
August 31, 2018
and
2017
, respectively.
As of
August 31, 2018
and
2017
, the Company had approximately
$0.8 million
and
$0.6 million
of unrecognized tax benefits, including approximately
$0.4 million
of accrued interest and penalty for each year. If recognized, these benefits would favorably impact the effective tax rate.
The Company recognizes estimated interest and penalties as a component of its income tax expense, net of federal benefit, as a component of provision for income taxes in the consolidated statements of income. During the years ended
August 31, 2018
,
2017
and
2016
, the Company recognized a net expense of
$0.1 million
, a negligible net expense and a net benefit of
$0.1 million
, respectively.
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
A reconciliation of unrecognized tax benefits is as follows for fiscal years ended August 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
Balance at beginning of year
|
|
$
|
643
|
|
|
$
|
625
|
|
|
Additions for tax positions of prior years
|
|
147
|
|
|
18
|
|
|
Balance at end of year
|
|
$
|
790
|
|
|
$
|
643
|
|
The Company or one of its subsidiaries is subject to U.S. federal income tax and income tax in multiple U.S. state jurisdictions. At
August 31, 2018
, the Company was subject to income tax examinations for its U.S. federal income taxes and for state and local income taxes generally after fiscal year 2014. The Company anticipates that the results of any examinations or appeals, combined with the expiration of applicable statutes of limitations and the additional accrual of interest related to unrecognized benefits on various return positions taken in years still open for examination, could result in a change to the liability for unrecognized tax benefits during the next 12 months ranging from a negligible increase to a decrease of
$0.8 million
depending on the timing and terms of the examination resolutions.
13. Stockholders’ Equity
(Deficit)
Employee Stock Purchase Plan
The Company has an employee stock purchase plan (“ESPP”) that permits eligible employees to purchase the Company’s common stock at a
15%
discount from the stock’s fair market value. Participating employees may purchase shares of common stock each year up to the lesser of
10%
of their base compensation or
$25 thousand
in the stock’s fair market value. At
August 31, 2018
,
0.8 million
shares were available for grant under the ESPP.
Stock-Based Compensation
The Sonic Corp. 2006 Long-Term Incentive Plan (the “2006 Plan”) provides flexibility to award various forms of equity compensation, such as stock options, stock appreciation rights, performance shares, RSUs
and other share-based awards. At
August 31, 2018
,
5.8 million
shares were available for grant under the 2006 Plan. The Company grants stock options to employees with a
seven
-year term
and a
three
-year vesting period and
grants
RSUs to employees with a minimum full vesting period of
three
years. The
Company grants stock options to its Board of Directors with a
seven
-year term and
one
-year vesting period and also grants RSUs to its
Board of Directors that vest over
one
year. The Company’s policy is to issue shares from treasury stock to satisfy stock option exercises, the vesting of RSUs and shares issued under the ESPP.
Total stock-based compensation cost recognized for fiscal years
2018
,
2017
and
2016
was
$4.6 million
,
$3.9 million
and
$3.8 million
, respectively, net of related income tax benefits of
$0.3 million
,
$1.3 million
and
$1.2 million
, respectively. At
August 31, 2018
, the total remaining unrecognized compensation cost related to unvested stock-based arrangements was
$7.1 million
and is expected to be recognized over a weighted average period of
1.8 years
.
The Company measures the compensation cost associated with stock option-based payments by estimating the fair value of stock options as of the grant date using the Black-Scholes option pricing model. The Company believes the valuation technique and approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of the Company’s stock options granted during fiscal years
2018
,
2017
and
2016
. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by the employees who receive equity awards. The fair value of RSUs granted is equal to the Company’s closing stock price on the date of the grant.
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
The per share weighted average fair value of stock options granted during
2018
,
2017
and
2016
was
$6.37
,
$6.65
and
$8.23
, respectively. In addition to the exercise and grant date prices of the awards, certain weighted average assumptions that were used to estimate the fair value of stock option grants in the respective periods are listed in the table below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
2016
|
|
Expected term (years)
|
|
5.2
|
|
|
5.3
|
|
|
5.3
|
|
|
Expected volatility
|
|
31
|
%
|
|
34
|
%
|
|
34
|
%
|
|
Risk-free interest rate
|
|
2.5
|
%
|
|
2.0
|
%
|
|
1.4
|
%
|
|
Expected dividend yield
|
|
2.5
|
%
|
|
2.2
|
%
|
|
1.5
|
%
|
The Company estimates expected volatility based on historical daily price changes of the Company’s common stock for a period equal to the current expected term of the options. The risk-free interest rate is based on the
U.S.
treasury yields in effect at the time of grant corresponding with the 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 historical exercise patterns.
Stock Options
A summary of stock option activity under the Company’s stock-based compensation plans for the year ended
August 31, 2018
, is presented in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
|
|
Weighted Average Exercise Price
|
|
Weighted Average Remaining Contractual Life (Yrs.)
|
|
Aggregate Intrinsic Value
|
|
Outstanding September 1, 2017
|
|
2,536
|
|
|
$
|
20.42
|
|
|
|
|
|
|
Granted
|
|
713
|
|
|
25.84
|
|
|
|
|
|
|
Exercised
|
|
(1,055
|
)
|
|
15.59
|
|
|
|
|
|
|
Forfeited or expired
|
|
(101
|
)
|
|
27.93
|
|
|
|
|
|
|
Outstanding at August 31, 2018
|
|
2,093
|
|
|
$
|
24.34
|
|
|
4.68
|
|
$
|
24,117
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at August 31, 2018
|
|
968
|
|
|
$
|
22.42
|
|
|
3.18
|
|
$
|
13,013
|
|
Proceeds from the exercise of stock options for fiscal years
2018
,
2017
and
2016
were
$4.1 million
,
$2.7 million
and
$3.8 million
, respectively. The total intrinsic value of options exercised during the years ended
August 31, 2018
,
2017
and
2016
was
$14.8 million
,
$4.6 million
and
$18.9 million
, respectively.
Restricted Stock Units
A summary of the Company’s RSU activity during the year ended
August 31, 2018
is presented in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted Stock Units
|
|
Weighted Average Grant Date Fair Value
|
|
Outstanding September 1, 2017
|
|
95
|
|
|
$
|
26.64
|
|
|
Granted
|
|
34
|
|
|
25.82
|
|
|
Vested
|
|
(39
|
)
|
|
27.20
|
|
|
Forfeited
|
|
(7
|
)
|
|
29.26
|
|
|
Outstanding at August 31, 2018
|
|
83
|
|
|
$
|
25.75
|
|
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
The aggregate fair value of RSUs that vested during the fiscal years ended
August 31, 2018
,
2017
and
2016
was
$1.2 million
,
$0.5 million
and
$0.4 million
, respectively.
Share Repurchase Programs
In August 2015, the Board of Directors extended the Company’s share repurchase program, authorizing the Company to purchase up to
$145.0 million
of its outstanding shares of common stock through August 31, 2016. The Board of Directors further extended the share repurchase program effective May 2016, authorizing the purchase of up to an additional
$155.0 million
of the Company's outstanding shares of common stock through August 31, 2017. During fiscal year 2016, approximately
5.2 million
shares were repurchased for a total cost of
$148.3 million
, resulting in an average price per share of
$28.48
.
In October 2016, the Board of Directors increased the authorization under the share repurchase program by
$40.0
million. During fiscal year 2017, approximately
6.7 million
shares were repurchased for a total cost of
$172.9 million
, resulting in an average price per share of
$25.71
. In August 2017, the Board of Directors approved an incremental
$160.0
million share repurchase authorization of the Company's outstanding shares of common stock through August 31, 2018.
In June 2018, the Board of Directors authorized a
$500.0
million share repurchase program through August 31, 2021, replacing the Company’s previous fiscal year 2018 authorization. During fiscal year 2018, approximately
5.2
million shares were repurchased for a total cost of
$139.2
million, resulting in an average price per share of
$26.69
. We do not intend to repurchase outstanding shares of our common stock during the pendency of our merger with Inspire Brands, Inc.
Dividends
The Company paid dividends on common stock as follows (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividend per share
|
|
Total amount
|
|
Payment date
|
|
Fiscal year 2018
|
|
|
|
|
|
|
First Quarter
|
$
|
0.16
|
|
|
$
|
6,243
|
|
|
November 17, 2017
|
|
Second Quarter
|
0.16
|
|
|
6,103
|
|
|
February 16, 2018
|
|
Third Quarter
|
0.16
|
|
|
5,879
|
|
|
May 18, 2018
|
|
Fourth Quarter
|
0.16
|
|
|
5,746
|
|
|
August 17, 2018
|
|
|
|
|
|
|
|
|
Fiscal year 2017
|
|
|
|
|
|
|
First Quarter
|
$
|
0.14
|
|
|
$
|
6,359
|
|
|
November 18, 2016
|
|
Second Quarter
|
0.14
|
|
|
6,100
|
|
|
February 17, 2017
|
|
Third Quarter
|
0.14
|
|
|
6,041
|
|
|
May 19, 2017
|
|
Fourth Quarter
|
0.14
|
|
|
5,588
|
|
|
August 18, 2017
|
Subsequent to the end of fiscal year 2018, the Company and Inspire Brands, Inc. ("Inspire") entered into a definitive merger agreement under which Inspire will acquire Sonic. The agreement remains subject to shareholder approval, and the Company is not permitted to pay a dividend prior to the effective time of the merger. For more information regarding the merger agreement, see note 16 - Subsequent events.
14.
Employee Benefit and Cash Incentive Plans
The Company sponsors a qualified defined contribution 401(k) plan for employees meeting certain eligibility requirements. Under the plan, employees are entitled to make pre-tax contributions. The Company matches an amount equal to the employee’s contributions up to a maximum of
6%
of the employee’s salaries depending on years of service and income. The Company’s contributions during fiscal years
2018
,
2017
and
2016
were
$1.8 million
,
$1.9 million
and
$1.8 million
, respectively.
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
The Company has short-term and long-term cash incentive plans (the “Incentive Plans”) that apply to certain employees, and grants of awards under the Incentive Plans are at all times subject to the approval of the Company’s Board of Directors. Under certain awards pursuant to the Incentive Plans, if predetermined earnings goals are met, a predetermined percentage of the employee’s salary may be paid in the form of a bonus. The Company recognized as expense incentive bonuses of
$9.2 million
,
$8.3 million
and
$13.4 million
during fiscal years
2018
,
2017
and
2016
, respectively.
15.
Commitments and Contingencies
Payment Card Breach
On September 18, 2017, the Company was informed by its payment card processor that there appeared to be suspicious activity involving credit and debit cards used at certain Sonic Drive-In locations. Upon learning of the suspicious activity, the Company immediately contacted and began working with law enforcement to investigate the matter. At the same time, the Company immediately launched its own investigation with the help of experienced third-party forensics firms. On October 4, 2017, the Company issued a public statement notifying guests and the public that it had discovered that credit and debit card numbers may have been acquired without authorization as part of a malware attack experienced at certain Sonic Drive-In locations.
Subsequent to September 18, 2017, the Company incurred costs associated with this payment card breach, including legal fees, investigative fees and costs of communications with customers. In addition, payment card companies may issue assessments for card replacement and card issuer losses alleged to be associated with the payment card breach, as well as fines and penalties relating to the payment card breach. The Company expects that certain of such costs and assessments will be covered under the Company’s cyber liability insurance coverage.
Currently, the Company cannot reasonably estimate a loss or range of losses associated with resolution of the payment card networks’ expected claims for non-ordinary course operating expenses or any amounts associated with the networks’ expected claims for alleged card issuer losses and/or card replacement costs. The Company believes that it is possible that the ultimate amount to be paid on payment card network claims, to the extent not covered by, or in excess of the limits of, the Company’s cyber liability insurance, could be material to its results of operations in future periods. The Company will continue to evaluate information as it becomes known and will record an estimate for losses at the time or times when it is both probable that a loss has been incurred and the amount of the loss is reasonably estimable.
In addition, the Company may incur legal and other professional services expenses associated with the payment card breach in future periods. The Company will recognize these expenses as such services are received.
Litigation
The Company was named as a defendant in nine purported class action complaints related to the 2017 payment card breach at certain Sonic Drive-Ins. The cases were consolidated in the Northern District of Ohio (the “Litigation”). The plaintiffs in the Litigation assert various claims related to the Company’s alleged failure to safeguard customer credit card information and seek monetary damages, injunctive and declaratory relief and attorneys’ fees and costs. The Company believes it has meritorious defenses to the Litigation and intends to vigorously oppose the claims asserted by the plaintiffs. On October 10, 2018, the parties to the Litigation filed a joint motion seeking preliminary approval of a class settlement. Based on the terms of class settlement, which is subject to final court approval, we do not believe any payments made in connection with the class settlement or the Litigation more generally would be in excess of our cyber liability insurance coverage. The estimated settlement amount has been recorded in accrued liabilities, with an offsetting amount recorded in accounts and notes receivable, net, related to the cyber liability insurance coverage. The Company has since been named as a defendant in one additional purported class action complaint filed on October 16, 2018, in the United States District Court for the Eastern District of Arkansas. We cannot provide assurance that we will not become subject to other inquiries or claims relating to the payment card breach in the future. Although we maintain cyber liability insurance, it is possible the ultimate amount paid by us relating to the payment card breach may be in excess of our cyber liability insurance coverage applicable to claims of this nature. We are unable to estimate the amount of any such excess.
The Company is involved in various other legal proceedings and has certain unresolved claims pending. Based on the information currently available, management believes that all claims currently pending are either covered by insurance or would not have a material adverse effect on the Company’s business, operating results or financial condition.
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
Note Repurchase Agreement
On December 20, 2013, the Company extended a note purchase agreement to a bank that serves to guarantee the repayment of a franchisee loan, with a term through
2018
, and also benefits the franchisee with a lower financing rate. In the event of default by the franchisee, the Company would purchase the franchisee loan from the bank, thereby becoming the note holder and providing an avenue of recourse with the franchisee. The Company recorded a liability for this guarantee which was based on the Company’s estimate of fair value. As of
August 31, 2018
, the balance of the franchisee’s loan was
$4.4 million
.
Lease Commitments
The Company has obligations under various operating lease agreements with third-party lessors related to the real estate for certain Company Drive-In operations that were sold to franchisees. Under these agreements, which expire through
2029
, the Company remains secondarily liable for the lease payments for which it was responsible as the original lessee. As of
August 31, 2018
, the amount remaining under these guaranteed lease obligations totaled
$15.1 million
. At this time, the Company does not anticipate any material defaults under the foregoing leases; therefore,
no
liability has been provided.
Purchase Obligations
At
August 31, 2018
, the Company had purchase obligations of approximately
$113.2 million
which primarily related to its estimated share of system commitments for food products. The Company has excluded agreements that are cancelable without penalty.
16. Subsequent events
On September 24, 2018, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Inspire Brands, Inc. (“Parent”) and SSK Merger Sub, Inc., a wholly owned subsidiary of Parent (“Merger Sub”). The Merger Agreement provides that, upon the terms and subject to the conditions set forth in the Merger Agreement, Merger Sub will merge with and into the Company (the “Merger” and, together with the other transactions contemplated by the Merger Agreement, the “Transactions”), with the Company continuing as the surviving corporation and as a wholly owned subsidiary of Parent.
At the effective time of the Merger, each share of common stock, par value
$0.01
per share, of the Company (the “Common Stock”), issued and outstanding as of immediately prior to the effective time of the Merger (other than shares of Common Stock (i) held in treasury by the Company or owned by any direct or indirect wholly owned subsidiary of the Company, (ii) owned by Parent or Merger Sub or any direct or indirect wholly owned subsidiary of Parent or (iii) for which appraisal rights have been properly demanded in accordance with the General Corporation Law of the State of Delaware) will be cancelled and automatically converted into the right to receive
$43.50
in cash (the “Merger Consideration”).
In connection with the Merger, each unvested option of the Company that is outstanding and unexercised immediately prior to the effective time of the Merger will vest and each outstanding option that has an exercise price below the Merger Consideration will convert into the right to receive a cash payment equal to the product of (i) the difference between the Merger Consideration and the exercise price and (ii) the number of shares of Common Stock issuable upon exercise of such option. In connection with the Merger, each unvested restricted stock unit of the Company that is outstanding immediately prior to the effective time of the Merger will vest and will convert into the right to receive a cash payment equal to the product of (i) the Merger Consideration and (ii) the number of shares of Common Stock subject to such restricted stock unit.
The Board of Directors of the Company unanimously has (i) determined that the Merger Agreement and the Transactions are in the best interests of the Company and its stockholders, (ii) declared it advisable to enter into the Merger Agreement, (iii) authorized and approved the Merger Agreement and the consummation of the Transactions, (iv) resolved to recommend that the Company’s stockholders vote in favor of adoption of the Merger Agreement and (v) directed that the Merger Agreement be submitted to a vote of the Company’s stockholders. Consummation of the Merger is subject to certain conditions, including (i) the adoption of the Merger Agreement by the Company’s stockholders, (ii) the expiration or termination of any waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act”), and (iii) the absence of any law or order restraining, enjoining or otherwise prohibiting the Merger. Each of Parent’s and the Company’s obligation to c
SONIC CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
August 31, 2018, 2017 and 2016
(In thousands, except per share data)
onsummate the Merger is also subject to certain additional conditions, including (i) subject to specific standards, the accuracy of the representations and warranties of the other party, (ii) performance in all material respects by the other party of its obligations under the Merger Agreement and (iii) with respect to Parent’s obligations to consummate the Merger, the absence of a material adverse effect with respect to the Company. The Merger Agreement provides that consummation of the Merger will occur on the later of (a) two business days after satisfaction or waiver of such closing conditions and (b) December 21, 2018, subject to certain exceptions to extend the consummation of the Merger.
The Company has made customary representations and warranties in the Merger Agreement and has agreed to customary covenants regarding the operation of the business of the Company and its subsidiaries prior to the closing of the Merger. These covenants, among other matters, do not allow the Company to declare or pay dividends during the pendency of the Transactions.
The Company is also subject to customary restrictions on its ability to solicit acquisition proposals from third parties, to provide information to, and enter into discussions or negotiations with, third parties regarding alternative acquisition proposals, and to withdraw its recommendation in favor of the Merger. However, prior to the receipt of the approval of the Merger from the Company’s stockholders, these restrictions are subject to customary “fiduciary out” provisions that allow the Company, under certain circumstances, to (i) provide information to, and enter into discussions or negotiations with, third parties with respect to an acquisition proposal if the Company’s Board of Directors determines that such acquisition proposal either constitutes, or could reasonably be expected to result in, a superior proposal and (ii) withdraw or change its recommendation in favor of the Merger if it determines that its failure to take such action is reasonably likely to be inconsistent with its fiduciary duties under applicable law.
The Merger Agreement contains certain termination rights for the Company and Parent. Upon termination of the Merger Agreement under specified circumstances, the Company will be required to pay Parent a termination fee of
$47,736,000
. Specifically, if the Merger Agreement is terminated by (i) the Company in order to accept a superior proposal, (ii) Parent if the Company’s Board of Directors withdraws or changes its recommendation of the Merger (unless the Company’s stockholders have already approved the Merger) or (iii) Parent or the Company if the Company fails to obtain the necessary approval from the Company’s stockholders, if, prior to the time the Company’s stockholders vote on the Merger (but after the date of the Merger Agreement), an acquisition proposal has been publicly made or becomes publicly known, and not publicly withdrawn, and the Company thereafter consummates, or enters into a definitive agreement providing for, an acquisition transaction within 12 months of the termination of the Merger Agreement. The termination fee will also be payable in certain other circumstances if the Merger Agreement is terminated and prior to such termination (but after the date of the Merger Agreement) an acquisition proposal has been made to the Company’s Board of Directors or becomes publicly known, and is not withdrawn, and the Company later consummates, or enters into a definitive agreement providing for, an acquisition transaction within 12 months of the termination. If the termination fee becomes payable, it is payable upon termination in the case of (i) above, and two business days after termination in the case of (ii) above and all other cases.
Parent has entered into commitment letters with funds managed by Roark Capital Management LLC aggregating approximately
$1.635 billion
pursuant to which the funds have committed to capitalize Parent in connection with the Merger. The equity financing and Merger Agreement contemplate that the existing securitization indebtedness of the Company remains outstanding without default and on current terms in connection with the Merger, provided that the Merger Agreement permits Parent to seek alternative financing to reduce the equity commitment or otherwise finance the Merger.
On October 1, 2018, the Company filed its Premerger Notification and Report Form with respect to the Merger under the HSR Act with the Federal Trade Commission and the Antitrust Division of the U.S. Department of Justice. The HSR waiting period was terminated effective October 15, 2018.
Additional information about the Merger Agreement and the Transactions can be found in the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 27, 2018.
17.
Selected
Quarterly
Financial Data (Unaudited)
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|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
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|
Second Quarter
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|
Third Quarter
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|
Fourth Quarter
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|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
|
Total revenues
|
|
$
|
105,428
|
|
|
$
|
129,551
|
|
|
$
|
88,102
|
|
|
$
|
100,158
|
|
|
$
|
118,306
|
|
|
$
|
123,990
|
|
|
$
|
111,754
|
|
|
$
|
123,568
|
|
|
Income from operations
|
|
22,448
|
|
|
27,052
|
|
|
14,914
|
|
|
22,627
|
|
|
37,261
|
|
|
35,441
|
|
|
31,780
|
|
|
38,155
|
|
|
Net income
(1)
|
|
$
|
11,430
|
|
|
$
|
13,118
|
|
|
$
|
19,607
|
|
|
$
|
10,963
|
|
|
$
|
21,576
|
|
|
$
|
18,751
|
|
|
$
|
18,592
|
|
|
$
|
20,831
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic income per share
(2)
|
|
$
|
0.29
|
|
|
$
|
0.29
|
|
|
$
|
0.51
|
|
|
$
|
0.25
|
|
|
$
|
0.58
|
|
|
$
|
0.44
|
|
|
$
|
0.52
|
|
|
$
|
0.50
|
|
|
Diluted income per share
(2)
|
|
$
|
0.29
|
|
|
$
|
0.28
|
|
|
$
|
0.51
|
|
|
$
|
0.25
|
|
|
$
|
0.58
|
|
|
$
|
0.44
|
|
|
$
|
0.51
|
|
|
$
|
0.50
|
|
__________
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|
|
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(1)
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For fiscal year 2018, includes the after tax expense of
$0.4 million
related to the cybersecurity incident in the first quarter, the after tax expense of
$0.2 million
related to the cybersecurity incident, the
$0.9 million
after tax loss from the debt transactions and
$14.1 million
for the discrete impact of the Tax Cuts and Jobs Act in the second quarter, the after tax expense of
$0.2
related to the cybersecurity incident and the after tax gain of
$2.2 million
on refranchising transactions in the third quarter, and the after tax expense of
$0.3
related to the cybersecurity incident in the fourth quarter. For fiscal year 2017, includes the after tax loss of
$0.6 million
on refranchising transactions and the after tax gain of
$2.4 million
on the sale of investment in refranchised drive-in operations in the first quarter, the after tax gain of
$4.3 million
on refranchising transactions in the second quarter, the after tax gain of
$0.4 million
on refranchising transactions in the third quarter and the after tax gain of
$0.1 million
on refranchising transactions, after tax restructuring charges of
$1.1 million
and the after tax gain on the sale of real estate of
$3.0 million
in the fourth quarter.
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|
|
|
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(2)
|
The sum of per share data may not agree to annual amounts due to rounding.
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