Sonic 2005 Annual Report Download - page 27

During fiscal year 2005, development on the franchise side was negatively impacted by a number of factors. We
had numerous projects affected by various delays caused by zoning and permitting difficulties as well as site specific
location and construction issues. We believe this is a direct by-product of a more challenging development
environment as much of our development is occurring in harder-to-develop markets, including Florida and California.
In addition, since the development cycle tends to be 18 to 24 months long, we are, to some degree, feeling the impact
of a slowdown in store profitability during 2003 that tends to create a more cautious approach to development from
franchisees.
Looking forward, there has been a strong rise in per store profits over the last 24 months that has positively
impacted the pipeline for future franchise development. This is evidenced by 163 area development agreements at
the end of fiscal year 2005 representing approximately 635 planned Franchise Drive-In openings over the next few
years, compared to 157 such agreements at August 31, 2004 which represented approximately 570 planned Franchise
Drive-In openings. Another step that has contributed to growth in the franchise pipeline is the recent planned
expansion into a number of new markets, primarily located along the east and west coasts. In the past, our market
expansion has been limited to a fewer number of markets at one time; we believe the brand awareness provided by
our national cable advertising efforts will support this planned expansion to a greater number of markets.
Twenty Franchise Drive-Ins were closed during fiscal year 2005, which was an increase from the nine Franchise
Drive-Ins closed during fiscal year 2004. Fifteen of the closings occurred during the second quarter and related
primarily to two weaker franchise operators in two different markets. We do not believe that these drive-in closings
are indicative of the Sonic brand’s success. We have taken steps to require stronger financial qualifications of new
franchisees, which we believe will significantly mitigate this type of risk. In addition, we expect that some of these
drive-ins may re-open under new franchisee ownership.
We anticipate 150 to 160 store openings by franchisees during fiscal year 2006. Substantially all of these new
drive-ins will open under our newest form of license agreement, which contains a higher average royalty rate and
initial opening fee. As a result of these new Franchise Drive-In openings and the continued benefit of the ascending
royalty rate, we expect approximately $10 million in incremental franchise fees and royalties in fiscal year 2006.
Operating Expenses.Overall, drive-in cost of operations, as a percentage of Partner Drive-In sales, increased to
80.2% in fiscal year 2005 from 79.8% in fiscal year 2004. Minority interest in earnings of drive-ins is included as a part
of cost of sales, in the table below, since it is directly related to Partner Drive-In operations.
Operating Margins
Year Ended August 31,
2005 2004 2003
Costs and Expenses (1):
Partner Drive-Ins:
Food and packaging 26.2%26.3% 26.0%
Payroll and other employee benefits 30.3 30.2 29.6
Minority interest in earnings of
Partner Drive-Ins 4.1 4.4 3.9
Other operating expenses 19.6 18.9 19.0
Total Partner Drive-In cost of operations 80.2% 79.8% 78.5%
(1) As a percentage of Partner Drive-In sales.
Food and packaging costs decreased by 0.1 percentage points during fiscal year 2005 compared to fiscal year
2004 following an increase of 0.3 percentage points during fiscal year 2004 compared to fiscal year 2003. In the early
part of the year, we experienced significant, year-over-year increases in several commodities including beef, dairy, and
tomatoes. They were offset by menu price increases of approximately 1% in December 2004 and 1.5% in May 2005, as
well as abatement of price pressures for these items, particularly dairy, in the latter part of the year. Looking forward,
we anticipate that slightly lower year-over-year costs for beef, as well as lower costs for other items will result in lower
food and packaging costs, as a percentage of sales, on a year-over-year basis in fiscal year 2006. This favorable outlook
may be negatively impacted if energy prices remain high throughout the year.
Labor costs increased by 0.1 percentage points during fiscal year 2005 compared to fiscal year 2004 after an
increase of 0.6 percentage points during fiscal year 2004 compared to fiscal year 2003. The slight increase for fiscal
year 2005 resulted from staffing increases at the assistant manager level, as well as higher labor costs related to
opening newly constructed stores as higher staffing levels were required for pre-opening training and through the
initial opening period. The 2004 increase was primarily a result of significant payments made under the sales-based
Management’s Discussion and Analysis of Financial Condition and Results of Operations
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