Sonic 2006 Annual Report Download - page 27

provision for impairment of long-lived assets of $0.3 million was recorded for the carrying costs of these assets in
excess of their estimated fair values. One Partner Drive-In and one surplus property became impaired during fiscal
year 2005 which resulted in a provision for impairment of $0.4 million for carrying cost in excess of estimated fair
value for the assets. We continue to perform quarterly analyses of certain underperforming drive-ins. It is reasonably
possible that the estimate of future cash flows associated with these drive-ins may change in the near future resulting
in the need to write-down assets associated with one or more of these drive-ins to fair value.While it is impossible to
predict if future write-downs will occur, we do not believe that future write-downs will impede our ability to continue
growing earnings at a solid rate.
Interest Expense.Net interest expense increased 31.0% in fiscal year 2006 compared to a 9.3% decrease in fiscal
year 2005.The increase in fiscal year 2006 resulted from increased borrowings which have been used largely to fund
approximately $93.7 million in share repurchases during the year and capital expenditures.The reduction in interest
expense for fiscal year 2005 was a result of strong cash flow from operations that limited borrowings, with the
reduction in interest expense more than offsetting the decrease in interest income relating to the outsourcing of our
partner notes to a third-party financial institution in August 2004. Going forward, we expect net interest expense to
increase as a result of the tender offer initiated by the company in August 2006 and funded in October 2006. The
resulting additional long-term borrowings are expected to result in an increase in net interest expense to at least $32
million or more depending on the level of share repurchases and acquisitions of Franchise Drive-Ins.
Income taxes.The provision for income taxes remained relatively constant for fiscal year 2006 with an effective
federal and state tax rate of 36.6% compared with 36.9% in fiscal year 2005 and 37.8% in fiscal year 2004. The lower
rate for fiscal year 2005 as compared to fiscal year 2004 resulted primarily from a retroactive tax law change that
reinstated expired tax credits in the first quarter of fiscal year 2005.The expiration of the Work Opportunity Tax Credit
on January 1, 2006 has negatively impacted and will continue to impact our tax rate going forward.We expect that
Congress will reinstate the tax credit retroactively, as they have done in the past. However, we are not allowed to
record the benefit of this credit for qualified employees hired after December 31, 2005 until the legislation becomes
enacted law. We expect our tax rate to be in the range of 36.5% to 37.5% in fiscal year 2007. However, our tax rate may
continue to vary significantly from quarter-to-quarter depending upon the timing of the renewal of the Work
Opportunity Tax Credit program, option exercises and dispositions by option-holders and as circumstances on
individual tax matters change.
Financial Position
During fiscal year 2006, current assets increased 20.6% to $42.5 million compared to $35.2 million as of the end of
fiscal year 2005. Cash balances increased by $3.2 million as a result of positive operating cash flows and current notes
receivable from franchisees increased by approximately $2.5 million related to short term financing for certain
franchisee capital projects. Net property, equipment and capital leases increased by $54.2 million as a result of capital
expenditures and the Tennessee and Kentucky acquisition. Goodwill increased by $8.5 million and other intangibles
increased by $4.3 million as a result of the Tennessee and Kentucky acquisition. These increases combined with the
increase in current assets resulted in a 13.3% increase in total assets to $638.0 million as of the end of fiscal year 2006.
Total current liabilities increased $12.8 million or 19.5% during fiscal year 2006 as a result of a temporary increase
in accounts payable and accrued liabilities, which was partially offset by a reduction in tax liabilities due to the timing
of tax payments.The noncurrent portion of long-term debt increased $61.2 million or 109.5% as a result of advances
on the company’s line of credit to fund portions of the share repurchases, capital expenditures and the Tennessee and
Kentucky acquisition. Overall, total liabilities increased $70.9 million or 40.4% as a result of the items discussed above.
Stockholders’ equity increased $3.8 million or 1.0% during fiscal year 2006 primarily resulting from earnings
during the period of $78.7 million, along with $18.8 million for stock option-related and other activity, offset by
treasury stock repurchases during the period of $93.7 million. At the end of fiscal year 2006, our debt-to-total capital
ratio stood at 28.9%, up from 20.3% at the end of fiscal year 2005. For the 12 months ended August 31, 2006, return on
average stockholders’ equity was 20.2% and return on average assets was 13.1%.
Sonic Corp. 2006 Annual Report
25
Management’s Discussion and
Analysis of Financial Condition
and Results of Operations